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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

                 For the quarterly period ended September 30, 2004

OR

                 For the transition period from ________________ to ________________

Commission File Number: 1-4797

ILLINOIS TOOL WORKS INC.
(Exact name of registrant as specified in its charter)

(Registrant's telephone number, including area code)   847-724-7500

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  
Yes X . No _____.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  
Yes X . No _____.

The number of shares of registrant’s common stock, $.01 par value, outstanding at October 29, 2004: 295,690,054.

Part I — Financial Information

Item 1

ILLINOIS TOOL WORKS INC. and SUBSIDIARIES

FINANCIAL STATEMENTS

The unaudited financial statements included herein have been prepared by Illinois Tool Works Inc. and Subsidiaries (the “Company”). In the opinion of management, the interim financial statements reflect all adjustments of a normal recurring nature necessary for a fair statement of the results for interim periods. It is suggested that these financial statements be read in conjunction with the financial statements and notes to financial statements included in the Company’s Annual Report on Form 10-K. Certain reclassifications of prior years’ data have been made to conform with current year reporting.

ILLINOIS TOOL WORKS INC. and SUBSIDIARIES
STATEMENT OF INCOME
(UNAUDITED)

ILLINOIS TOOL WORKS INC. and SUBSIDIARIES
STATEMENT OF FINANCIAL POSITION
(UNAUDITED)

ILLINOIS TOOL WORKS INC. and SUBSIDIARIES
STATEMENT OF CASH FLOWS
(UNAUDITED)

ILLINOIS TOOL WORKS INC. and SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)

(1)    STOCK-BASED COMPENSATION:

Stock options have been issued to officers and other management employees under ITW’s 1996 Stock Incentive Plan and Premark’s 1994 Incentive Plan. The stock options generally vest over a four-year period.

The Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, using the intrinsic value method, which does not require that compensation cost be recognized for stock options.

The Company’s net income and earnings per share would have been reduced to the amounts shown below if compensation cost related to stock options had been determined based on fair value at the grant dates in accordance with Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”).

The pro forma net income effect of applying SFAS 123 was as follows:

On January 2, 2003 and 2004, the Company granted 792,158 and 553,981 shares of restricted stock, respectively, to domestic key employees. Compensation expense related to these grants is being recorded over the three-year vesting period as follows:

(2)    INVENTORIES:

Inventories at September 30, 2004 and December 31, 2003 were as follows:

(3)    COMPREHENSIVE INCOME:

The Company’s only component of other comprehensive income in the periods presented is foreign currency translation adjustments.

(In thousands)

(4)    INVESTMENTS:

In 1995, 1996 and 1997, the Company, through its investments in separate mortgage entities, acquired 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 relate to office buildings, apartment buildings and shopping malls located throughout the United States. In conjunction with these transactions, the mortgage entities simultaneously entered into ten-year swap agreements and other related agreements whereby a third party receives the portion of the interest and net operating cash flow from the mortgage-related assets in excess of $26,000,000 per year and a portion of the proceeds from the disposition of the mortgage-related assets and principal repayments, in exchange for the third party making the contractual principal and interest payments on the nonrecourse notes payable. In addition, in the event that the pools of mortgage-related assets do not generate interest and net operating cash flow of $26,000,000 a year, the Company has the right to receive the shortfall from the cash flow generated by three separate pools of mortgage-related assets (owned by third parties in which the Company has minimal interests) which have a total fair value of approximately $1,600,000,000 at December 31, 2003. 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.

As of September 30, 2004 and December 31, 2003, the book value of the assets held by the mortgage entities was as follows:

(In thousands)

Assuming all assets become worthless and the swap counterparty defaults, the Company’s maximum exposure to loss related to the mortgage entities is limited to its investment of $372,358,000 at September 30, 2004.

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

Starting in the third quarter of 2003 and for subsequent periods, the Company accounts for its net investments in the mortgage entities using the equity method of accounting as provided in Statement of Position 78-9, Accounting for Investments in Real Estate Ventures. Under this method, the net mortgage investments are adjusted through income for changes in the Company’s share of the net assets of the mortgage entities. The excess of the estimated liquidation value of the investments in the mortgage entities over their net book value as of July 1, 2003 of $178,333,000 will be recognized as income over the remaining term of each of the investments. The remaining amount of this excess liquidation value over book value at September 30, 2004 and December 31, 2003 was as follows:

(In thousands)

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

The property development partnerships and affordable housing limited partnerships in which the Company has invested are also considered variable interest entities under FIN 46. Because the Company does not bear the majority of the risk of loss nor enjoy the majority of any residual returns relative to these variable interest entities, the Company was not required to consolidate the entities upon its adoption of FIN 46. The Company will continue to account for the property development investments using the equity method and the affordable housing investments using the effective yield method. The Company’s maximum exposure to loss related to these investments is generally limited to their carrying values of $16,355,000 and $95,747,000, respectively, as of September 30, 2004.

(5)     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. The Company performs an annual impairment assessment of goodwill and intangible assets with indefinite lives in the first quarter of each year, based on the fair value of the related reporting unit or intangible asset.

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 fair value of the unit’s goodwill and intangible assets and the carrying value of those assets.

Amortization and impairment of goodwill and other intangible assets for the periods ended September 30, 2004 and 2003 were as follows:

(In thousands)

In the first quarter of 2004, the Company performed its annual impairment testing of its goodwill and intangible assets, which resulted in impairment charges of $21,712,000. The first quarter 2004 goodwill impairment charges of $11,492,000 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 the first quarter of 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 and a U.S. industrial packaging business in the Specialty Systems – North America segment and a U.S. business that manufactures clean room mats in the Engineered Products – North America segment.

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

(6)    RETIREMENT PLANS AND POSTRETIREMENT BENEFITS:

Pension and other postretirement benefit costs for the periods ended September 30, 2004 and 2003 were as follows:

(In thousands)

The impact of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 is not significant to net periodic benefit cost and will be recognized at the next measurement date.

The Company previously disclosed in its financial statements for the year ended December 31, 2003 that it expected to contribute $110,985,000 to its pension plans in 2004. As of September 30, 2004, $112,765,000 of contributions have been made. The Company presently anticipates contributing an additional $22,875,000 to fund its plans in 2004 for a total of $135,640,000.

(7)    SHORT-TERM DEBT:

In 2003, the Company entered into a $400,000,000 Line of Credit Agreement with a termination date of June 18, 2004. This line of credit was replaced on June 18, 2004 by a $400,000,000 Line of Credit Agreement with a termination date of June 17, 2005.

(8)    STOCK REPURCHASE PROGRAM:

On April 19, 2004 the Company’s Board of Directors authorized a stock repurchase program, which provides for the buy back of up to 31,000,000 shares. As of September 30, 2004, the Company has repurchased 13,266,573 shares of its common stock for $1,202,124,000 at an average price of $90.61 per share.

(9)    CONTINGENCIES:

Wilsonart International, Inc. a wholly owned subsidiary of ITW (“Wilsonart”), is a defendant in a consolidated class action lawsuit filed in June 2000 in federal district court in White Plains, New York on behalf of purchasers of high-pressure laminates. The complaint alleges that Wilsonart participated in a conspiracy with competitors to fix, raise, maintain or stabilize prices for high-pressure laminates between January 1, 1994 and June 30, 2000, and seeks injunctive relief as well as treble damages and other costs associated with the litigation. Indirect purchasers of high-pressure laminates filed similar purported class action cases under various state antitrust and consumer protection statutes in Arizona, California, the District of Columbia, Florida, Maine, Michigan, Minnesota, New Mexico, North Carolina, North Dakota, South Dakota, Tennessee, West Virginia and Wisconsin. All of the state cases have been stayed, and certain plaintiffs have opted not to participate in the class litigation. These lawsuits were brought following the commencement of a federal grand jury investigation of price-fixing in the high-pressure laminate industry, which investigation was subsequently closed by the Department of Justice with no further proceedings and with all documents returned to the parties involved. The Company believes that these plaintiffs’ antitrust claims are without merit.

On April 30, 2004, Wilsonart presented and argued its motion for summary judgment in the consolidated class action lawsuit. That motion was denied on September 7, 2004. No trial date has been set and discovery is continuing. On April 29, 2004, International Paper Company, one of the defendants in the consolidated class action case, received preliminary approval of a settlement agreement with the plaintiffs. That settlement agreement, dated as of April 23, 2004 received final court approval on July 14, 2004 and, provides, among other things, for the payment to the class members in the consolidated class actions of $31,000,000. In addition, on July 14, 2004 the plaintiffs sought preliminary approval of a settlement with Panolam International, Inc., another defendant in the case, for $9,500,000, which settlement was approved at a hearing on September 30, 2004. As a result of the International Paper and Panolam settlements and the discharge of Formica Corporation through bankruptcy, Wilsonart is the sole remaining defendant in the consolidated class action lawsuit. While no assurances can be given regarding the ultimate outcome or the timing of the resolution of these claims, the Company intends to continue to defend itself vigorously in this action and all related actions that are now pending or that may be brought in the future. The Company is currently unable to determine a range of its possible exposure for this litigation.

(10)    SEGMENT INFORMATION:

See Management’s Discussion and Analysis for information regarding operating revenues and operating income for the Company’s segments.

Item 2 —Management’s Discussion and Analysis

CONSOLIDATED RESULTS OF OPERATIONS

The Company’s consolidated results of operations for the third quarter and year-to-date periods of 2004 and 2003 were as follows:

In the third quarter and year-to-date periods of 2004, the changes in revenue, operating income and operating margins over the prior year are primarily due to the following factors:

The base business revenue increase in the third quarter and year-to-date periods is primarily related to a 10% revenue increase in North America during both periods. Industrial production levels in North America continued the growth pattern seen in the fourth quarter of 2003 and the first half of 2004. Improvement was evident in both the North American Engineered Products and Specialty Systems segments. Internationally, base business revenues increased 7% in the third quarter and 5% for the year-to-date period as industrial production showed improvement in the major European economies.

Operating income for the third quarter and year-to-date periods improved primarily due to leverage from the growth in base business revenue, favorable currency translation, lower restructuring costs and income from acquired companies. These increases were partially offset by variable margin declines due to raw material cost increases, primarily steel.

As a result of the Company’s annual impairment testing of its goodwill and intangible assets, impairment charges of $21.7 million were incurred in the first quarter of 2004. The impaired assets reflected diminished expectations of future cash flows and primarily related to a European automotive components business, several U.S. welding components businesses, a U.S. electrical components business and a U.S. business that manufactures clean room mats.

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 period of time of less than 30 days.

This segment primarily serves the construction, automotive and general industrial markets.

The results of operations for the Engineered Products – North America segment for the third quarter and year-to-date periods of 2004 and 2003 were as follows:

In the third quarter and year-to-date periods of 2004, the changes in revenue, operating income and operating margins over the prior year are primarily due to the following factors:

Construction base revenues increased 7% for the third quarter and 9% for the year-to-date period primarily as a result of growth in the residential, remodeling/rehab and commercial construction markets. Automotive base revenues increased 1% for both the third quarter and year-to-date periods due to increased product penetration, despite declines of 3%, 2% and 5% in automotive production at the large North American automotive manufacturers in the first, second and third quarters of 2004, respectively. Revenues from the other industrial-based businesses in this segment grew 14% for the third quarter and 11% for the year-to-date periods as they benefited from increased demand in a broad array of end markets.

Operating income increased in the third quarter and year-to-date periods primarily due to leverage from the growth in base business revenues described above, lower restructuring expenses, and increased acquisition income. These increases were partially offset by variable margin declines of 1.7% in the third quarter and 0.9% year-to-date, primarily due to steel raw material cost increases. In addition, year-to-date income was negatively impacted by a second quarter $10 million charge associated with a warranty issue related to a discontinued product at the Wilsonart laminate business. Also partially offsetting the base business income increases in the year-to-date period were first quarter 2004 goodwill and intangible asset impairment charges of $7 million, primarily related to the goodwill of a U.S. electrical components business and the trademarks and brands of a U.S. manufacturer of clean room mats.

ENGINEERED PRODUCTS — INTERNATIONAL

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 period of time of less than 30 days.

This segment primarily serves the construction, automotive and general industrial markets.

The results of operations for the Engineered Products – International segment for the third quarter and year-to-date periods of 2004 and 2003 were as follows:

In the third quarter and year-to-date periods of 2004, the changes in revenue, operating income and operating margins over the prior year are primarily due to the following factors:

Revenues increased in the third quarter and year-to-date periods of 2004 due to higher acquisition revenues, increased base business revenues, and the favorable effect of currency translation, primarily as a result of the Euro strengthening versus the U.S. dollar. The acquisition revenue increase is primarily due to the acquisition of an Australian construction unit and a European polymer unit in the first quarter of 2004 and two European fluid product units in the second quarter of 2004. Base business construction revenues increased 8% in the third quarter and year-to-date periods due to a rise in commercial construction activity in Europe, as well as increased commercial and residential demand in the Australasia region. In addition, automotive base revenues grew 9% and 8% in the third quarter and year-to-date periods, respectively, primarily due to increased product penetration at the European automotive manufacturers. The other businesses in this segment serve a broad array of industrial and commercial markets, and revenues from these businesses increased 11% for the third quarter and 7% for the year-to-date period.

Operating income in the third quarter and year-to-date periods increased primarily due to leverage from the increase in base business revenues described above, the favorable effect of currency translation, increased income from acquisitions and lower restructuring expense. In addition, year-to-date income was adversely affected by a goodwill impairment charge of $8.5 million incurred in the first quarter of 2004 primarily related to diminished cash flow expectations of a European automotive components business.

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’ production process and typically are manufactured and delivered in a period of time of more than 30 days.

This segment primarily serves the food retail and service, general industrial, construction, and food and beverage markets.

The results of operations for the Specialty Systems – North America segment for the third quarter and year-to-date periods of 2004 and 2003 were as follows:

In the third quarter and year-to-date periods of 2004, the changes in revenue, operating income and operating margins over the prior year are primarily due to the following factors:

Base business revenue growth in the third quarter and year-to-date periods of 2004 is primarily due to an increase in demand in most of the end markets that this segment serves. Welding base revenues increased 28% in both the third quarter and year-to-date periods and industrial packaging base revenues grew 11% in both periods. Food equipment base revenues increased 5% in the third quarter and 2% year-to-date as demand modestly increased from restaurant and institutional customers. Base revenues in the other businesses in this segment increased 9% in both the third quarter and year-to-date periods of 2004.

Operating income increased in the third quarter and year-to-date periods of 2004 primarily due to leverage from the base business revenue increases described above. Additionally, acquisitions increased income year-to-date and slightly reduced income in the third quarter of 2004. Variable margins declined 1.4% in the third quarter and 0.5% year-to-date periods of 2004, primarily due to steel raw material cost increases. Additionally, income was adversely impacted in the year-to-date period due to goodwill and intangible asset impairment charges of $6 million incurred in the first quarter of 2004. These charges primarily related to the diminished cash flow expectations at two welding businesses and an industrial packaging unit.

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 period of time of more than 30 days.