Illinois Tool Works Inc (ITW) 2002 Q1 法說會逐字稿

Hello and welcome to the ITW 2002, First Quarter Earnings Release Conference Call. All lines will be in the listening mode till we move for question and answer session. At that time instructions will be given to you, if you have a question. At the request of ITW today's call is being recorded, if you have any objections, you may disconnect at this time. I would like to introduce John Brooklier, VP investor relations for ITW.

Mr Brooklier, Sir you may begin.

Thank you,

. Good afternoon. Everyone is welcome to ITW's first quarter 2002 conference call. As noted I am John Brooklier ITW's VP of Investor Relations and on behalf of the company we are pleased that you could join us for today's call. By now many of you should have received our first quarter earnings release information, we are pleased with our performance in the first quarter on 3 separate fronts. First of all we have seen some improvement in North American markets as evidence by our first quarter base business revenue of minus 6, which could be as favorably to minus 9 North American base number for fourth quarter 2001. Secondly we continued to reduce SG&A expense in this case of 5 percent reduction in first quarter and finally our total company operating margins improved 40 basis points for the quarter. In summary we are "Cautiously Optimistic" about our prospects for the remainder of the year.

The agenda for today's call will follow the pattern we have done before in a moment I will introduce Jon C. Kinny our Chief Financial Officer who will give you an overview of the first quarter. I will then come back and give you some additional color on our performance for four manufacturing segments. Jon will then discuss our second quarter and full year forecast. Finally, we will open your call to questions. As I have noted in past quarters since this is an open call please note that today's focus is on our first quarter financial results and our second quarter full year and full year forecast. Any questions not related to these topics will result in me asking the operator to move on to the next question. As usual I am asking each person to ask just one question and one follow up question so we can accommodate everyone who has an inquiry within a reasonable period of time. Another house keeping item, I would like to remind everyone in statements regarding the company's earnings statements contain forward-looking statements within the meaning of Private Security Litigation reform act at 1995 including without limitation of statements regarding the company's 2002 forecast. These statements are subject to certain risk uncertainties and other factors which could ask actual results to differ materially from those anticipated including without limitation for following risks. 1. A further downturn in the construction automotive general industrial food retail and service or real estate markets. 2. Further deterioration in global and domestic business and economic conditions particularly in North America, Europe, and Australia. 3. Interruption and reduction in introduction new products into company's product line. 4. An unfavorable environment for making acquisitions or dispositions domestic and international including adverse accounting of regular tool requirements in market value

. One final piece of business the telephone replay for this conference call will be put through midnight on May 1st. The play back telephone number is 402 220 3456. No pass code is necessary. Now I will turn the call over to Jon Kinny.

Thanks John, Good afternoon everyone. As you may have noted of the space devoted to our per share data and our press release were equal was equal to the size of our entire income statement. So before I start, I would like to get the unusual items out of the way so we can focus on the current credit's operations. The largest unusual item in the quarter was the 72 cents per share cumulative effect of change in accounting principle. Most of you are aware that FAS

has changed the accounting principles for all the account for acquisitions. In connection with this change we were required to test our goodwill and intangibles for impairment based on a much more stringent guidelines. As a result of this testing we recorded an impairment charge a net of tax, of 222 million. The following points should be kept in mind relative to this charge, first the charge represents 4 percent of our invested capital and 10 percent of total goodwill and intangibles. There is another way 90 percent of our acquisitions are adding value using the cost of capital as a benchmark. Second, this charge represents a cumulative adjustment for all previous acquisitions, as a result it has no bearing on the current quarter's performance and lastly on a cumulative basis we have amortized 359 million of goodwill to prior accounting periods. The majority of the amortization would not have been required under the new accounting principle. If we were required to adjust for this prior amortization the 222 million of goodwill adjustment would have been offset by this cumulative amortization. In sort we view the adjustment as a non-event. Before I leave this subject please note that the 222 million charge is an estimate based on a relatively involved process. The process is substantially complete, but as we finalize the process additional fine tuning adjustments may be required. The second unusual item in our quarter's income per share calculation is the one-cent per share for discontinued operations. As most of you know in the fourth quarter of 2001 we announced our plans to divest our consumer businesses. This divestiture was not complete as of the end of the first quarter and as a result we continued to have income from these operations. Finally, the most important per share numbers are the pro forma amounts, which exclude goodwill amortization and discontinued operation effects. The pro forma amounts are 63 cents for 2002 and 65 cents for 2001. The balance of my comments will be focused on the first quarter's results and will exclude discontinued operations and change in the coming principle. The highlights for the quarter were as follows revenues declined 4 percent over last year, this is 1 point better than the fourth quarter. Operating margins improved 40 basis points over last year, this is the first year over year improvement in five quarters. Income per share from continuing operations was down 3 percent compared to last year's decline of 18 percent and free cash flow continued to be strong at 260 million on income from continuing operations of 194 million. Although the improvements are modest after 5 quarters decline it feels real good to say the word improvement. Starting with revenues, the 4 percent revenue decline was 1 point better than the last quarters minus 5 percent. The improvement was a result of three factors first the base revenue decline of minus 6 percent compared favorably to minus 9 percent in fourth quarter. Second, revenues increased in the current quarter by 4 percent due to acquisitions this compares to plus 5 percent in the fourth quarter. Third, translations reduce revenues by 1 percent compared to no effect in fourth quarter. In short, our 1-point lower revenue decline was a result of a 3-point improvement in the base business, but this improvement was soften by slower acquisition impact and negative translation. By geography, the base on business revenue decline of minus 6 percent was made up of minus 6 percent in North American and minus 7 percent Internationally. In North America, the 6 percent decline represents a 4-point improvement over the fourth quarter's 10 percent decline. Internationally, the 7 percent decline was 1-point worse than the fourth quarters 6 percent decline. In short, North America experienced mild improvement and international (indiscernible) John Brooklier provided more details on this one when we discussed our operating segments. Turning to operating margins we gained 40 basis points in the first quarter given that we have experienced five quarters of margin decline this is a clear sign that the 80/20 efforts are paying off. Included in our first quarter operating income is 20 million dollars of restructuring and 5 million dollars of asset write-downs. Excluding these amounts and a 10 basis points dilution from acquisitions our base margins are up 170 basis points. In addition, if base revenues were even with 2001, margins on the base business are estimated to be 16.3 percent compared to last year's 13.7 percent for a 260 basis points improvement. This calculation assumes that we would be able to gain strong operating leverage as revenue levels recover. This quarter demonstrated our ability to increase margins when revenues are down 6 percent so I believe it is clear that we can achieve strong operating leverage on the upside. Before I leave margins let me update you on Premark's progress. Excluding the consumer segment, Premark margins in the first quarter of last year were 9.4 percent. On a sales decline this year of 4 percent this quarter's margins are 11.7 percent or 230 basis points improvement. Have revenues not declined we believe margins in the quarter would be 13.3 percent. Then on Leasing and Investment Segment, income was below last year due to gains on sales of assets in 2001. In the non-operating Area, interest expense was down due to lower debt resulting from our strong cash flow and lower acquisition activity. Other income, was even with last year. Turning to the balance sheet, our invested capital at end of the quarter was 6.4 billion, this was 251 million lower than the end of fourth quarter. The decrease was mainly due to the cumulative effect of change in accounting principle. Excluding acquisitions, invested capital was below last quarter by 286 million. Other measures on the balance sheet, continue to look positive our inventory month on hand were 2.2 months, and the DSO was 59 days. Our Free Cash Flow continues very strong, Free Cash for the quarter was 263 million this was substantially higher than our income from our continuing operations of 109 before (indiscernible) and reflects the continued strong management of our working capital and capital expenditures. For the quarter, acquisitions of 35 million and dividends of 67 million were below our free cash by 161million for the quarter. Our depreciation expense in the quarter was 71m and our capital expenditures were 65 million. On the acquisition front we acquired 4 companies in the first quarter with total revenues of 19 million although activity was slow for the quarter we still have a solid backlog of potential acquisitions. Hey, John back to you.

We continued to forecast our full year earnings per share to be within the range of 295 to 325 per share. This forecast is based on a recovering worldwide economy with positive growth in second half of the year. Overall the base revenue growth is forecasted to be in a range of minus 2 to plus 2 percent. Other assumptions included in this forecast are as follows: Exchange rates holding at today's levels. Acquired revenues in the 200 to 600 million range. Restructuring costs to 55 to 65 million for the full year and a tax rate of 34 percent. Overall, we hit the midpoint of this range, earnings from continuing operations of 2 dollars and 10 cents per share would be 9 percent higher than last year on a consistent reporting basis. We believe this would be solid performance in a zero growth base business environment and reflects last year's successful cost reduction activities. For second quarter we are forecasting earnings per share from continuing operations to be within a range of 77 cents to 0.87 cents per share. A low end of this range assumes a minus 6 percent decline in base revenue, and the high end reflects the minus 2 percent decline. If we hit the midpoint of 82 cents per share we will be even with last year's earnings per share on a consistent reporting basis. Okay John.

Lets open the call to questions.

Thank you, at this time we will be in the question and answer session. If you do have a question simply press star 1 in your telephone touch pad. If you are using speaker equipment you may use your handset prior to pressing start 1. If you want to cancel your question or if your questions have been answered simply press star 2. Star 1 to answer your question and start 2 to cancel your question, 1 moment while the questions register. First question comes from Harriet Baldwin from Deutche Bank.

Good afternoon, for the March quarter particularly Engineered Products, North America obviously March 2001 was compared to January and February 2001, In addition were there any significant sequential improvements from March vs. Jan. and Feb.?

Sequentially, I think things in March actually tailed off a little bit in some other business.

Would that be mostly in Construction relative to weather, or is that true in Auto as well?

No, not for auto, but we had a tail-off in Construction and continued tail-off in Industrial Plastics.

Okay, that is very helpful. In terms of looking at second quarter it seems that you might get a little bit of sequential improvement then as opposed to waiting until the second half. What do you think the possibility of that and with that would you put at the higher end of your range or would you have to actually rethink your range once you saw second quarter?

Our forecast does call for a sequential improvement. We ended the quarter at 6 percent, the low end of our range for the second quarter forecast was minus 6 to minus 2. So you are right, if we continue to see the sequential improvement, in the mid point that would be at in 3 to 4 percent possibly after negative too (indiscernible). We would certainly accept higher.

Our next question comes from Gary McMannis from JP Morgan.

Good afternoon, Can you talk a little bit about how restructuring charges are playing in the quarter last year and also in the first quarter this year, in the past you guys have provided a kind of gross restructuring charge and then you had mild existence savings and then net numbers. I just want to know, how much is that playing into the numbers?

The restructuring for this quarter is clearly going to provide benefits priorly more in the second half then in the first half because of fixed time to get these implemented. This year's effect is probably half of the restructuring costs will be recovered in cost savings on a full-year basis, probably 100 percent recovered in one year.

I am driving out. You did 63 vs. 65 how much was restructuring in both quarters for example initially go through the rest of the year you know what kind of restructuring are you anticipating, both on a gross basis, and what kind of cost savings do you expect as a result? I am just wondering as how do you see the impact of your restructuring, both in the positive and the negative, the charges you have taking plus the positive cost saving? In the past you provided how much earnings were impacted because of restructuring in previous quarters correct?

What we have said this quarter was 25 million, 20 million of restructuring and 5 million of assets (indiscernible). So 5 cents per share if we did not have that restructuring.

And what was it in last year's quarter?

I think it was a little less, about 20 million.

As we go through the year, I assume last year the restructuring was fairly high level throughout 2001, I am assuming the restructuring will become less as we go through this year, and we'll get some cost savings. I just want to know, can you just quantify that?

The cost savings, we originally put a plan together that called for 50 to 60 million dollar range of restructuring when we put our original estimates together for the year. We're not far off the mark on that. We built in probably half of that as cross savings for the year into our plan numbers and then we have a forced carryover benefits from last year's restructuring and at last year I don't hold me to the exact number but it is in the 60 million dollar range also. So we have a carry over effect into this year from last year's cost savings of 50 to 60 million, and those have been factored into our numbers, that is why we are sitting at a point even though we have significant restructuring in the quarter our margins are still up 40 basis points year over year, because of SG&A and manufacturing over head cost structures are significantly lower then last year's levels. Excluding acquisitions I think in the first release we said SG&A is down 5 percent excluding the impacts of acquisition carry over in real terms our base SG&A costs are down close to either 9 percent and our manufacturing overhead is probably down 5 to 6 percent. We are definitely getting strong cost savings from these activities.

Okay, great, Thanks.

Can we get some more information regarding the goodwill write-offs? Can you give us any color as to the deals or how it breaks out by segments. How many acquisitions represents how far back (indiscernible) on those lines?

Sure. There were about 30 operating units that we looked out, it is probably less in terms of acquisitions and maybe 25 acquisitions in total, but we do look at on the operating unit basis. It really cross the (indiscernible) I mean we did have some carryover from Premark acquisitions that were not made under our watch and that was about 60 million of the total. So we had effective Food Equipment, there is also a little bit (indiscernible) and components area some of our packaging businesses all of our Construction business none of them were affected. Little bit in Polymers, small piece in welding. It was pretty much affected lot of different businesses. The ultimate reason for these write-downs is that we paid too much with that 20-20 (indiscernible). The other thing is how far back does this go, this goes back probably you know we have required acquisitions that really started 18 years ago, so it goes back that far we looked at all of the acquisitions. We screened all of our acquisitions and then zeroed in on those we thought there were problems.

That strikes me as a fairly small number of acquisitions, considering that you do anyway between 20 and 40 every year. Is that correct assumption?

Yes, that is correct assumption. I believe that 90 percent of our acquisitions are value-adding acquisitions, in that there are earning above a percent across the capital, I mean that, I think that the (indiscernible) that is used in measuring acquisition validity and then we have got a strong track record compared to what I read on other acquisition being in the

50 percent successful.

Remember, the fine-tuning process be completed?

I would think in the second quarter. We are just working on a little bit more of our intangible efforts, but we believe we have captured 98 percent of what's going on here.

Thank you very much.

Our next question comes from Andrew Casey from Prudential Securities.

Good afternoon, Just on a go forward basis on the outlook, it would appear you're adjusting second quarter, up given your expectation on North American Auto builds on car. Is that a correct assumption, and then are you looking for them to fall off seasonally and then in the fourth quarter given in your budget?

Well, I would say the forecast is reflective of not only automotive being at a higher level then we originally anticipated, but some better income performance of some other business too, but specifically to Auto the expectation is that, as far in April we have seen Auto builds being maintained at a relatively high rate. We are not seeing any dramatic fall off, our expectation is that at least the way we build into our budget and our plan is that build should start to fall off in the third quarter and go down from there. Again we could be wrong , Andy we hope we are but we are still sort of sticking with our minus 4 percent on the builds for 4 years. We certainly take a fresh look at the number after second quarter when we have a half years worth of actual (indiscernible) under our belt and we will take a look at that number, to see if we need to adjust that (indiscernible) down I suspect we wouldn't want to adjust it down anymore but perhaps will bring it up that we will have to see.

Okay, then follow-up on that, are there any markets in your plan you expect to be coming back that have not shown that yet?

I think any thing on the System side will fall on to that category, a short of welding right now. Anything that really has the real CAPEX flavor to it, we are not seeing any material kind of improvement there. Our expectation is that second half of the year we are going to start to see hopefully see some improvement there and if we are going to get the kind of turn we need and other companies need, we are going to need other companies to start spending more on CAPEX and which we would have a direct effect on our system consumable businesses. That is the (indiscernible) sort of look into for better improvement.

Thanks.

Our next question comes from Robert McKarty from Robert W. Baird.

Hello John and Jon, the Industrial Plastics and Metal North America and International as you point out all remains the same, you are talking about year over year comparisons, can you talk a little bit about how it's progressing sequentially business or actually continuing the week in quarter to quarter and if not, if there is a sort of at which point during this year, you know at some point we are going to do anniversary when they fell off the cliff?

Yeah, sequentially, they're getting a bit better, this was really better in the last couple of quarters not dramatically. I think our expectation is that they would get better in second quarter and start to get even better in third and fourth quarter.

So, in second half of the year, we will stop talking about 20 and 40 and we will be talking about 0 and 5 and numbers like that?

Hopefully by the second half of the year, we will be talking about positive numbers.

By other question would have to do with the Strapping business, and I wonder if you could talk about it in terms of North America vs. Internationally. How is strappings doing relative to Equipment, and what you might be able to tell us how that varies by end market, I don't data if you know you get data by whether it is metal or plastic strap or may be you do get some end market data but anything I think would be helpful?

What we know to be true is that the declines for the Industrial Strapping business, both in North American and Internationally I am double checking the number here, they are pretty similar down and sort of that 12 to 15 percent range. It is not a big difference between the two numbers what is here and abroad. What we are hearing is that as relates to specific end markets anything that has sort of general industrial flavor to it, is not doing particularly well right now. Some of the construction related areas are perhaps doing a little bit better.

Any early signs of an improvement demand from the steel business?

No, that also has been pretty weak and continues to be one of the weakest areas.

The whole commodities area, paper, textiles, steel.

Is there a way to talk about how these businesses are performing? Just like we did with Industrial Plastics and Metals, in other words is there also a certain point, like as you said you know minus 20 to 40 on industrial plastic and metal and you think we are going to see positive in a couple of quarters. Is there that kind of progression last year for these businesses?

The expectation again with by the second half of the year we would perhaps re-approaching the 0 level from a comp stand point and then move into positive numbers as we move into the fourth quarter.

Okay, thanks a lot.

Our next question comes from Kevin Silverman from ABN Ambro.

Thank you, Good afternoon, I just have a quick question given the importance of acquisitions historically to your returns can you talk about what is your seeing right now in terms of where are your highest return opportunities are with your capital both internal and external. Whether is any sectors or geography or particularly attractive right now are relative to what you are seeing generally?

In terms of CAPEX, not just acquisitions but CAPEX opportunities as well. To the extent, we do not like doing a lot of CAPEX on expansion at this point. Our CAPEX is really focused on cost improvement coming out of lot of our 80/20 efforts so that is an ongoing process and clearly that is where our biggest opportunity comes from an investment side. On the acquisition front, acquisitions generally don't positively effect earnings significantly historically, 25 percent of our earnings improvement comes from the initial acquisition and we still have a pretty strong backlog, but it's been tougher to close deals, and we still think there is the possibility of having a good year, if we can get these deals closed, better come on our backlog list, and from what I have talked to you some of the (indiscernible) having food items on the list but still activity. In the activities in all areas I mean the stuff going on packaging, welding, plastic and metal (indiscernible) components area, our polymer areas, construction the typical deal for our company is for all of our sectors to participate in the acquisition activity.

So nothing seems different this year in terms of where those opportunities are for you?

No, not really.

How about Geographically?

No, I don't see that either. Although this quarter was small for our acquisitions, two of them acquisitions were North America and two were International.

Okay, thankyou.

Our next question comes from John Inch from Bear Sterans.

Hi, this is actually Elana. How are you? We would have talked to you any way. I won't (indiscernible) on that. What is the year over year delta for pension and healthcare gains this quarter?

For the quarter, I don't know. I don't have that visibility on the quarter, but the year over year change is not much.

Your long-term expected return on plant assets is 10.51 percent. Do you think that this is sustainable, and if you have to move it down, what perspectively would be the impact of the decline?

We review that number annually, and in the last review we kept it in the fourth quarter. We as you saw decided to keep that pretty much were it was. We understand that overall industry is about 9.5 percent and our pension plan has performed in the top (indiscernible) in the last 5 and 10 years, our plan performance has been better then the industry in general by a long shot. So we think we are justified at where we are. In the coming year if we moved anywhere, we would be down a point, and that maybe 2 cents per share, depending where interest rates are. The interest rates get up like the respected to that gets off from that affect, so we are working on about what we are at.

What kind of cash return target that you have for L&I investments?

On L&I investment, we view that on a net basis of (indiscernible), and it's in over 20 percent range.

Can you breakdown the acquired company sales by segment, and total price paid?

I can find my chart here, EP North America: 5.6 million, EPI: 6 million, and Systems International: 6.9 million. Price paid was 35 million.

Thankyou.

Next question comes from Walt Littack from McDonald Investments.

Is the Automotive in EP North America you have some nice margin improvement the 220 basis points and then your comments on automotive slowing? The question is that is 16.9 percent a sustainable rate, given the auto slowing because other things are picking up, you anyway answered that question already, but I just want to ask you specifically. Can you used to say a 17 percent or 16.9 percent of better margin in that segment going forward?

Yes. The 16.9 percent is generally a low point for the year in the Engineer Products area. Some of that are seasonal because of the construction side effects but we see a continued I don't (indiscernible) we had a very nice strong couple of (indiscernible 48:24) margin gain on the base business here, but keep in mind in first quarter of last year automotive sales I know we are down 18 percent so the first quarter of last year was a period of adjustment. We were taking people out, and reducing work weeks, and all of that is disruptive and expensive, but we're getting some of that benefit here in the first quarter, but I think we will continue to see our margin gains in this segment things by the way we think we will.

The tone of your comments, I guess in the press release in today North America sounds like it is bottoming on little bit international could be improving showed order here. If things do recover in second quarter, there is something that changes you go for less of a cost reduction strategy more top line growth or is there something that you change on CAPEX?

Our plan for the year, we have a modified first quarter in spite a little bit better than we had hoped. But at this place with continued improvement over the CAPEX plan of 300 million or so is still what we think it would be. I think top line growth can make penetration gains are always on the minds of the general managers of our businesses, and as we have said before half of our business have been acquired in the last 3 years. In those businesses, there is and continues to be a whole lot of emphasis on the point 80/20 efforts that streamline the business and correspondingly improve profit margins. I think it is a continuation, but the people will have more time to focus on top line because they are not worried about their plant downsize to smaller situations.

Okay, alright, thank you.

Next question comes from Robert McKarty from Robert W. Baird.

John, the welding business really kind of stands out as a sore thumb, business it serves commercial construction and general industrial markets in your sales run up of 7 to 8 percent, it is not led by consumable, it is led by equipment key. Can you talk about there has got to be something going on here in terms of distribution, or product, or penetration. Can you talk about what is driving this?

First of all, we have been in sort of track in December and the last couple of months and we know that the number has like you said it stands out in comparison to the rest of the systems businesses, but I think that what's principally driving equipment is at first there was a little bit of restocking went on, beyond that there is a little bit more of a pull through based on actual demand. I think we noted that there are couple of key markets that have really ramped up for the welding equipment business particularly in the oil pipeline, shipbuilding, and even a little bit on the auto side. So they have gotten some increased penetration or increased sales based on our particular markets.

In less time mistaken, it seems to me that the

consumables business had strong presence in those kinds of nitch application markets and so we are seeing some evidence of the ability to pull through equipment, based on?

I don't know. I could only surmise. I don't that is being like that.

I have got a couple of low clarification number question, Capital spending budget for this year, does the 55 to 60 range on restructuring includes the 5 million asset write down in the first quarter?

No.

And can you tell us what's the effect of foreign currency on operating income was in the quarter?

About a penny. It was minus 1 percent on Income. It is a little bit less than a penny.

And the capital spending budget for the year?

About 300 million. We finished last year at 260 million.

Next question from Andrew Casey from Prudential Securities.

Just a question in terms of if you are seeing any pricing pressure from material that you purchase or energy?

Obviously, the issue of steel and tariffs that has come up over the last few months. We have seen a little bit of pricing pressure on those raw materials for some of our businesses who match up as relate to tariffs. They are trying to work through different kinds of programs to see if they can get some kind of pricing concessions. Lot of our business has been unaffected by steel, I don't think so from an energy standpoint, there hasn't been an issue with oil or anything of that sort. So, I think she was really been more on the steel and the legislation attached to that.

But it's not something that's material that will (indiscernible) your plan?

Some of the businesses that have been affected actually have some forward pricing was been (indiscernible) a bit they really able to smooth it out that over year. Some of them it didn't look in trying to get some price increases, its not a little bit of pass through, but it's not impacting a significant number of our businesses. It is impacting some of them.

Next question comes from Harriet Baldwin from Deutche Bank.

Hello again. I just take myself up so that you can actually hear me easily. I heard you asking question on mute, Oh, I could but that wouldn't do much good. Were there any impacts on either cash flow or timing of tax payment that were catch-up from post September 11disruptions?

No there wasn't. Our pattern is pretty much intact.

In talking about Australia, it sounds like trends were a little stronger then you assumed, but you didn't actually changed you assumptions for full year is that conservatism, or do you think some of the strength you have seen there is slightly to dissipate?

Yes, It's both. We are relatively conservative, and in Australia the numbers tend to bounce around. I am always trying to say that when you think this, everything that was build in Australia was build right before the Olympics. Obviously, there has been a little bit more building on the commercial and residential side, but we would like to see a few more months or performance before we start to change any assumptions.