Illinois Tool Works Inc. (ITW)

ITW 
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Illinois Tool Works Inc. (ITW)

December 14, 2012 9:00 am ET

Executives

John L. Brooklier - Vice President of Investor Relations

Ronald D. Kropp - Chief Financial officer and Senior Vice President

E. Scott Santi - Chief Executive Officer, President and Director

David C. Parry - Vice Chairman

Analysts

Alexander M. Blanton - Clear Harbor Asset Management, LLC

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Deane M. Dray - Citigroup Inc, Research Division

Brian K. Langenberg - Langenberg & Company, LLC

Presentation

John L. Brooklier

Good morning. Can you hear me? Good morning, everyone. Thank you for coming this morning. We especially say hi to all the people that showed up at 7:30, thinking the meeting started at 8:30. So whoever you are, please self-identify yourself.

We're all glad you're here. Welcome to everybody in the audience. We have a full crowd this morning. We expected pretty good attendance. We also have lots of people joining us on our webcast today. I think we're going to be well in the hundreds. So I think a lot of interest in this meeting. We believe you'll learn a lot about ITW over the next 5 years, and we think what you're going to hear is going to be very, very positive news. And we're going to basically depict a company we believe you're going to want to invest in over the long term.

So before we get into the formal portion of the presentation, I did want to take a couple of minutes and talk about our former CEO, David Speer.

I want to personally thank everybody who was kind enough to send e-mails and make calls, and just send their personal condolences on David's behalf. For those of you in the room who don't know, David passed last month after a long illness, and I would say did it in very, very typical David Speer style.

The illness turned out to be very insurmountable for David and, if you knew David, you knew the word insurmountable was not in his vocabulary. He battled his illness in a way that was very, very typical of David. Let me just tell you a very quick story. We were in New York just a few months ago, and it was August, and David very, very much wanted to travel and do a meeting and meet with the buy side.

So we set up a lunch, had a very spirited lunch with one of our key buy side holders, I won't identify who that person is, let's just say that she held her own during the lunch. And it was very much of a typical David Speer kind of a meeting, point, counterpoint, back and forth, very much trying to impress upon the -- our buy side investor the potential that we had as it relates to these 5-year initiatives that we're going to detail for you later today. So it was very, very much of a David Speer kind of a session. David then traveled over to the New York Stock Exchange and presided over the 100-year anniversary ceremony. ITW's celebrating our 100-year anniversary this year. He had the gavel, he was in great spirits. I think everybody who traveled with him, Ron, David Parry, Scott and a few others, we just absolutely marveled at David's spirit that day. He was funny, he was engaged, he was doing his typical, "David Speer, I love ITW."

I do remember that on the floor, he was actually trying to sell ITW stock to our market makers. I told him that's probably not a good idea but he did it anyway. But I think it's another case of David, and based on his background as a stint salesperson -- that's where he started, he was a salesman -- he very, very much wanted to operate within the environment of, "I got to make the sale."

So that will be my last really, really good memory of David, as he was in New York, and enjoying every minute of the day, from beginning to end.

So what I would ask right now is if you could do a couple things for us. If we could just, one, observe a moment of silence on David's behalf, we'd very much appreciate that.

I'll ask one more thing, please, if everybody could give David a round of applause.

Now I know if David somehow finds out about this, he's going to send me the following e-mail, what's with the round of applause? And why was it so short? So anyway, thank you very much. I know David would love to be here, he's very, very proud of ITW. 34 years with the company, and I don't think there is anything, short of his family, that he loved more. And he even liked a lot of you in the audience, too, so...

So let's move on to the formal part of the presentation. I'll take you through the agenda today. Ron Kropp will be with us in just a few minutes. Ron's going to cover the 2012 financial update and some of our organic growth assumptions around 2013. So we'll give you basically a geographic breakdown of what's happening in 2013 from an organic perspective, and as we've traditionally done, we'll look at it from North America, we'll look at it from Europe and we'll look at it from Asia Pacific.

From there, we'll take a very, very short break to get organized for, I think, the real sort of meat of the presentation today, and that's really the unveiling of our enterprise strategy. Many of us have been on the road over the last 6-plus months talking about this, telling you there are certain things we could tell you and certain things we can't tell you. We're here to give you a lot more detail around what's going to happen relative to our enterprise strategies. We think this is really a qualitative improvement of a company that's already a very good performer, so really blending the core strengths of ITW and taking it to the next level. So we think you're going to like what you're going to see.

So in any event, Scott Santi, our CEO back there; David Parry, our Vice Chair; and Ron Kropp, will be the presenters. And just let me give you a little bit of background on all 3 of them.

As I said, Scott took over as acting CEO, and now has the title of Chief Executive Officer. Scott's been with the company for 34 years. Construction background, started in the construction business and he's probably too shy to tell you but he actually was selling screws on his first job in the construction category many, many years ago. There's a couple of other stories I won't tell but they're pretty humorous. What he probably also won't tell you, is Scott was very, very much a friend and David Speer was very much a mentor to Scott. So I think the transition here is very appropriate and very culturally in line with ITW in terms of how we run the company and this sort of extension of management experience and really understanding the fabric of the company.

David Parry, our Vice Chair. David's been with the company for 18 years, has run a whole succession of businesses for us, came to us from a prior company. David actually is a degreed, highly degreed person with a chemistry background. Now I promised not to do jokes about the periodic table, but David has responsibility for a variety of businesses, including welding -- yes, let's see, I have it right here. But any event, he's -- lots of different businesses and he's really touched all the businesses during his years, essentially since he was Vice Chair starting a few years back. So again, a long-tenured person with ITW.

Ron Kropp, our CFO, comes to us via Arthur Andersen. He was actually working on an ITW project many, many years ago. We stole him from Arthur Andersen a number of years ago and Ron's held a variety of financial positions within the company. Ron is our resident expert on everything financial, and if you have any detailed questions, Ron's your go-to guy.

So we think that the combination of these 3 people's perspective will be a good add to the story you're going to hear about Enterprise Strategy.

Now we do have our Chief Legal Counsel here so I actually am going to go through this in some detail, which I normally don't, but I point you to our forward-looking statement, which I think is even more relevant as we think about the next 5 years. And if you think about this meeting today, it's really the first time that ITW has done a 5-year look at life. So I think our forward-looking statements and all the caveats that are included therein are important.

So with that, I'm going to turn the meeting over to Ron Kropp and Ron will take you through 2012, 2013. Ron?

Ronald D. Kropp

Thank you, John. Good morning, everyone.

So I want to cover 2 things today. One, I'm going to talk about the fourth quarter of 2012 and provide an update on the forecast, which I'll get to in a minute. And then secondly, I'm going to talk about our revenue projections for 2013 by geography.

So 2012 forecast. At the end of the fourth -- at the end of the third quarter when we came out with our guidance, we had not yet closed on our Decorative Surfaces divestiture. So when we put out the guidance, we did exclude 2 months of results because we expected to close at the end of October, but we did not include anything for the large gain on divestiture and any of the ongoing equity accounting. So we've now closed on the transaction. The transaction is -- we sold 51% of the business to a private equity firm via a joint venture, CD&R is the partner. We retained a 49% interest. We received $1 billion in cash proceeds, which is a combination of the sale of our interest plus the debt that went into the new joint venture.

We now have an estimate on the gain so we're increasing our overall guidance as a result, and I'll go through the details of that in a minute.

So from a forecast perspective, I've laid out the October forecast and the current forecast. On the revenue line, revenues are basically in line with what we put out in October, negative 1% to negative 4%. I will point out, included in that revenue guidance is negative 4.5% related to 2 months of Decorative Surfaces not being included in the fourth quarter of this year versus a full quarter in 2011.

Also, a drag on the current quarter's revenue is negative 1% for translation, which is about where it was when we put out guidance 1.5 months ago.

On the EPS side, we're raising our fourth quarter EPS guidance from $0.86 to $0.94 to $1.99 to $2.09, and I'll go through a reconciliation of that in a minute.

Overall, the tax rate is bumping up a bit, 34% for the quarter and 31% for the full year. Overall restructuring guidance has not changed, it's still $100 million to $110 million for the full year.

So let's walk through the pieces of the forecast change. The biggest piece is the Decorative Surfaces gain and some other gains and losses on divestitures, but Decorative Surfaces is a big piece of this, that's $1.30 to $1.36 per share that get added to the fourth quarter and the full year.

On an ongoing basis, we'll pick up 49% equity interest, and I'll talk more about what it looks like going forward in a minute. But for the fourth quarter, because this is the first quarter after the divestiture, the joint venture has to record a lot of transaction expenses as well as initial purchase accounting amortization, so there'll be a $0.04 loss in the fourth quarter related to the 2 months of equity pickup.

There's also some one-off nonoperating corporate items, that's $0.04 a share, and some onetime tax discrete items, that's $0.11 a share, and the biggest piece being an IRS settlement we reached in the fourth quarter.

So if you take our new guidance of $1.99 to $2.09 and back off all those onetime items, you get back to $0.86 to $0.94, which is really the operating forecast we put out at the end of October. So the message here is there's really no change to the operating forecast.

So a little bit about Decorative Surfaces. Because we are retaining a 49% interest, we are not able to reflect Decorative Surfaces as discontinued operations, which means we won't restate prior years and we'll have some comparability things to talk about as we go through the next year.

On a pro forma basis, I've given you the numbers here. These are the revenue in margin numbers that will be in our results for 2011, which is a full 12 months, and 2012 which is 10 months.

One note on the margins, these margins are higher than the reported segment margins because reported segment margins include corporate -- allocations of corporate costs that don't necessarily go away when a business is divested.

So on an ongoing annualized basis, Decorative Surfaces is about $0.24 a share excluding share repurchases from the proceeds. If you factor in the fact that we use the U.S. after tax divestiture proceeds from Decorative Surfaces for share repurchases, the ongoing dilution from this -- from the deal is about $0.15 a share per year.

On an ongoing basis, we will pick up 49% of the operating -- of the net results of the joint venture. The net results is not just operating income, includes interest expense, acquisition accounting amortization, some preferred return from our partners. So if you add all that up, it won't be a whole lot of kind of run rate income that we will pick up on an ongoing basis for our 49%, it will be probably a few million dollars a quarter, after we get past this initial purchase accounting phase.

What we will realize at the end when ultimately, this business is -- either goes public or gets sold on to another party, we will realize 49% of the proceeds at that point.

This ongoing equity income pickup will be reported below operating income, so it won't impact ongoing margins.

So turning to capital allocation for 2012. This pie chart shows how we've allocated our capital this year. 25% of it has gone to dividends. And you may have seen an announcement last week, we announced that we are accelerating our January dividend, previously announced January dividend into December, to take advantage of any potential tax law changes. So that's included in the 25%. So that in total is about $900 million for the year in dividends. Acquisitions is about 21%, that's about $725 million for the year. And then the rest is share repurchases.

What I've done here is I've split share repurchases between share repurchases related to use of divestiture proceeds, that's 29% or about $1 billion this year, and share repurchases related to normal ongoing free operating cash flow, which is about 25%.

Our range for share repurchases for the year is $1.8 billion to $2 billion, so we still have a little bit of December to go through to finalize that.

So overall, if you look at this, almost 80% of our capital this year was somehow returned to shareholders, via -- either via dividends or share repurchases.

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