Illinois Tool Works Inc (ITW) 2013 Q2 法說會逐字稿

Welcome, and thank you for standing by.

At this time, all participants are in a listen-only mode until the question-and-answer session of the call.

(Operator Instructions)

Today's conference is being recorded.

If you have any objections, you may disconnect at this time.

Now I would like to turn over the meeting to John Brooklier, Investor Relations Officer.

Thank you.

Good morning everybody, and welcome to ITW's second-quarter 2013 conference call.

Joining me on today's call is our President and Chief Executive Officer, Scott Santi, and our CFO, Ron Kropp.

Scott, Ron, and I will discuss our Q2 financial results.

And, in addition, we will update you on both our long-term strategic initiatives and the progress related to those, as well as our Q3 and full-year forecast.

Here is the agenda for today's call.

Scott will highlight our Q2 operating results and our strategic initiatives.

Ron will cover our Q2 results in more detail.

I will then talk about our geographic revenue performance and highlight our segment results.

Ron will then come back and update you on our 2013 full-year forecast and introduce our Q3 forecast.

Finally, we will open the call to questions.

As always, we ask for your cooperation on our one question, one follow-up question policy.

As always, we have allotted one hour for today's call.

A couple housekeeping items first.

This presentation contains our financial forecast for full-year 2013, the quarter, and other forward-looking statements identified on this slide.

We refer everybody to the Company's 2012 10-K for more detail about important risks that could cause actual results to differ materially from the Company's expectations.

Now, let's move to the one other housekeeping item.

The telephone replay for this conference call is 800-308-7855, no pass code is necessary.

And the playback will be available until midnight of August 6. Now, let me introduce our CEO, Scott Santi, who will make some comments on the quarter.

Scott?

Thank you, John.

Good morning.

In the second quarter, we were able to offset modestly lower-than-expected revenues with profitability contributions from our Enterprise Initiatives in order to achieve the midpoint of our Q2 EPS forecast of $1.08, excluding the $0.05 pension charge that Ron will discuss in a few minutes.

From a revenue standpoint, softer-than-anticipated demand in our North American Industrial Packaging, Polymers & Fluids, and Welding segments resulted in overall organic growth coming in 100 basis points below our expectations heading into the quarter.

Also, our electronics assembly platform within our Test & Measurement and Electronics segment also faced challenging comps versus last year, as well as continued softness in their end markets.

As a result, overall Company organic revenues in North America were down 1% in the quarter versus last year.

Our Automotive OEM segment continued to perform at a very high level in the quarter, benefiting from focused product development and customer penetration against the backdrop of pretty good worldwide auto builds.

Overall industrial demand remains choppy, with the exception of a few pockets like construction and food equipment in North America.

On the profitability side, we continued to make solid progress in the quarter.

Adjusted Q2 operating margins of 17.4% were up 40 basis points year over year.

The impact of our Enterprise Initiatives contributed 60 basis points of margin improvement in Q2.

And, excluding the $25 million of incremental restructuring expense supporting those initiatives versus Q2 of last year, our adjusted operating margins would have been 18% in the quarter.

Overall, we continue to make excellent progress in the execution of our Enterprise Initiatives across the Company.

We are at or ahead of our internal 2013 plans for all three initiatives and are generating meaningful progress towards our overall enterprise performance goals of 20%-plus pretax margins, and 20%-plus after-tax return on invested capital by 2017.

We are well positioned to fully leverage the benefits of these initiatives as global end markets improve.

Looking at the balance of 2013, we are essentially maintaining the midpoint of our full-year EPS forecast on an operating basis, but reducing it by $0.05 to $4.20 to reflect the Q2 pension settlement charge.

While we expect the demand environment to continue to be uneven, we believe contributions from our Enterprise Initiatives will keep us on a path of continued profitability improvement for the remainder of 2013 and beyond.

Now, let me turn the call over to Ron.

Ron?

Thanks, Scott.

Good morning, everyone.

Before I review our second-quarter operating results, I wanted to walk through some adjustments impacting comparisons in our second-quarter financials.

In the second quarter of 2013, we recognized a $34 million pretax pension settlement charge.

This charge was primarily related to higher lump-sum pension payments related to the exit of our Decorative Services employees from the ITW pension plan.

We've excluded this one-time charge when we are discussing our EPS performance for the quarter.

At this time, we don't expect any significant pension impact related to settlements for the remainder of the year.

Also, as we discussed last quarter, our Q2 2012 comparisons exclude the Decorative Surfaces segment operating results.

Now, here are the highlights for the second quarter.

Total revenues increased 1%, excluding the 2012 Decorative Services revenue.

Worldwide organic revenues were flat, while revenue from acquisitions grew 1%.

Excluding the effect of the pension settlement charge, adjusted operating income was $736 million, which was higher than our 2012 adjusted operating income by $26 million, or 3.7%.

Adjusted operating margins of 17.4% were 40 basis points higher than last year.

Excluding the pension settlement charge, diluted EPS from continuing operations was $1.08, which represents a 6% growth over our adjusted 2012 EPS, and was at our forecasted EPS midpoint.

Our 1% revenue increase in the second quarter was primarily due to the following factors.

Base revenues were flat, with international revenues growing 1.1%.

We saw some stabilization in our European organic revenues, which only declined 1%, while our Asia-Pacific organic revenues increased 2.6%, led by strong growth in China and India.

Our North American-based revenues decreased 1%, as our equipment businesses declined by 4%.

This softness was especially evident in our electronics assembly platform, as we faced challenging comps from last year and continued to see weakness in the general electronics industry.

Excluding the 38% decline in the electronics assembly platform, North America-based revenues would have grown 1%.

As we look at product mix, worldwide organic revenues were up 1% in our consumable business, while as I said, we saw a 4% decline in our worldwide equipment business.

Acquisition added 1% to revenue growth.

Adjusted operating margins for the second quarter of 17.4% were 40 basis points higher than Q2 2012.

Base business margins were up 100 basis points from last year.

A key driver was a 60-basis-point improvement from the results of our Enterprise Initiatives, largely related to our business structure simplification activities, as well as some benefits from sourcing leverage.

Price cost favorability improved margins 50 basis points.

In addition, total operating margins were negatively impacted by $25 million in higher restructuring costs versus last year, reducing our overall margins by 60 basis points.

Despite our flat organic revenue from soft North America end markets and $25 million in dollars in higher restructuring costs, our bottom-line adjusted operating margin improved 40 basis points versus last year.

We continue to see the positive impacts from our Enterprise Initiatives, while continuing to manage overhead costs in an uneven macroeconomic environment.

Our working capital and cash flow continue to be strong, as accounts receivable DSO was 62 days, which was a slight improvement versus last year, and inventory months on hand improved to 1.7.

Adjusted ROIC for the second quarter was 16.1%, which was a 70-basis-point improvement versus the second quarter of last year.

Our ROIC continues to improve toward our target of 20%-plus by 2017.

Net cash provided from operating activities was $643 million for the second quarter, with capital expenditures of $89 million, resulting in free operating cash flow of $554 million, and over $800 million of cash generated in the first half of the year.

We generated 35% more free operating cash flow versus the second quarter of 2012, despite several large businesses being divested in the past year.

For the year, we expect conversion of free operating cash flow to be close to 100% of income from continuing operations.

Turning to capital structure, continue to focus on capital allocation priorities as follows.

Our first priority continues to be organic investments, especially focused on our key growth initiatives.

Examples of our organic investments include R&D spending, additional investments in manufacturing capacity, and restructuring projects which have long-term margin benefits.

Our next capital priority is dividends.

Note that our normal January dividend of $174 million was paid on December 31 last year to allow our shareholders to benefit from the lower 2012 dividend tax rate.

Our current dividend yield continues to be over 2%.

Any excess capital after organic investments and dividends is used for external investments, either share repurchases or acquisitions.

We evaluate the allocation between these investments based on the best risk-adjusted returns, and assess acquisition targets by incorporating our portfolio management criteria of accelerated growth and strong differentiation potential.

In the second quarter, we had $310 million in share repurchases, and have had nearly $700 million in repurchases in the first half of the year.

As we look ahead through the remainder of the year, we have increased our share repurchase forecast from free operating cash flow for the year to be at least $1 billion dollars, versus the $850 million we communicated in April.

In addition, we tend to use -- we intend to use any US after-tax divestiture proceeds for share repurchases as well.

As of the end of the second quarter, we have approximately $1.2 billion of authorized repurchases remaining under our current buyback program.

We utilized $95 million for acquisitions during the first half of the year, with the continued focus on our growth platforms in emerging markets.

In early July, we added to our portfolio with other focused acquisition targets as we closed on two acquisitions -- a Chinese food equipment business and a European consumer packaging equipment supplier.

As we continue to shape our portfolio, our focus remains on two key criteria -- accelerated growth spaces and a strong differentiation potential.

Lastly, our Q2 debt-to-capital ratio is 33%, while our debt-to-adjusted-EBITDA remained constant at 1.5 times.

Our cash balance overseas is nearly $2.8 billion, and we have plenty of debt capacity to make additional investments.

I will now turn it back over to John, who will provide more details on the operating results by geography and individual segments.

Thanks, Ron.

Let me take just a few minutes to review our Q2 '13 geographic trends.

Excluding the impact of the currency on the 2012 revenues from the former Dec Services segment, total Company revenues grew 1% in Q2.

And as Ron noted earlier, total Company organic revenues were flat in the quarter, with North American organic revenues declining 1% and international organic revenues growing 1%.

Most notably, European organic revenues declined only 1%, and Asia-Pacific organic revenues grew 3%.

The positives for us in Q2 were in China and Brazil, where our organic revenues grew 14% and 19%, respectively.

Moving to the next slide, for our Q2 segment results, it's important to note that while our total Company organic revenues were flat, the major negative impact came from our Test & Measurement and Electronics segment.

As Ron mentioned, this segment had very difficult year-over-year comps, and experienced end-market softness in the electronics assembly platform.

Notably, our total Company organic revenues would have been 130 basis points higher if this platform had produced flat organic revenues on a year-over-year basis.

Looking at profitability, six out of our eight segments produced operating margin improvement, ranging from 40 basis points of improvement from our Construction segment to 230 basis points of improvement from -- for our Food Equipment segment.

From my earlier comments, our Test & Measurement and Electronics segment was hit with a 200-basis-points operating margin decline.

If you recall from last quarter, we added an adjusted operating margin metric as part of our portfolio segmentation, which excludes intangible amortization and other non-cash acquisition accounting items from operating income.

We continue to see that our more acquisitive segments, primarily Test & Measurement and Electronics, as well as Polymers & Fluids show a much more consistent performance comparability when we look at adjusted operating margins across our segments.

Now, let's take a peek at our eight reporting segments, beginning with Test & Measurement and Electronics.

This segment had an organic revenue decline of 9%.

T&M's worldwide organic revenues declined 2%, as demand for capital equipment was muted in the quarter, particularly in North America.

And as noted earlier, total electronics organic revenues fell 16%, as the electronics assembly business faced tough comps and soft end markets.

We anticipate that the third quarter will also prove to be a difficult comparison for electronics assembly, due to the fact they had a major customer order in the third quarter of 2012.

Much better news on the Automotive OEM side, which Scott referenced earlier.

It was our fastest growing segment.

In aggregate, Auto OEM's organic revenues grew a very solid 12% versus a worldwide auto build of 3%.

The Auto OEM formula remains the same -- new product innovation and new platform penetration equals enhanced growth versus new car builds.

By geography, while European auto builds grew 1% in the quarter, our organic revenues increased 11% there.

Strong performance in Europe.

Our key OEM relationships with Volkswagen, Ford, and GM in Europe continue to be a successful formula for us.

In North America, our organic revenues of 7% were slightly ahead of our -- of 6% auto builds.

And finally, in China, our organic revenues grew 40% versus auto builds of 11%.

All in all, it was another excellent quarter for our automotive segment -- operating margins of 20.6% improved 70 basis points on a year-over-year basis.

Moving to Polymers & Fluids, organic revenues were again defined by ongoing product line simplification -- what we call PLS activities -- and a loss of key customers.

Organic revenues for worldwide polymers and hygiene, as well as fluids, both declined 4% in the quarter.

Automotive after-market organic revenues decreased 2%, due to ongoing PLS programs and a loss of a key customer.

We believe the sorting-out process of unprofitable customers will diminish as the year progresses.

And, despite some pressure on the top line, we continue to be very pleased with the profitability arc of the segment.

Operating margins of 18.1% were 150 basis points higher than the prior-year period.

In Food Equipment, conditions improved modestly in North America for capital equipment, but remain difficult in Europe.

This resulted in segment organic growth of 1% in the quarter.

Total Food Equipment North America's organic revenues grew 5%, with equipment increasing 4%, due in part to higher cooking revenues for customers serving independent restaurants, lodging area and nursing facilities, and schools.

North America service organic revenues grew a very healthy 5% in the quarter.

Internationally, Food Equipment's organic revenues declined 2%.

Notably, equipment sales fell 7% as cooking and refrigeration slowed in France, Italy, and the UK.

Much like North America, service revenues grew an impressive 7% in the quarter.

Even with muted overall growth, this segment produced operating margins of 18.7%.

That's 230 basis points higher than the year-ago period.

Clearly, lots of good things happening in the food equipment area.

In our Welding segment, worldwide organic revenues were flat, as North American revenues grew and international revenues declined.

In North America, organic revenues were up 1%, in part due to new product launches in the commercial sector that include MRO, small manufacturer, and commercial construction customers.

Internationally, revenues -- organic revenues, declined 2%, largely due to slowing in Asia and the repositioning of the portfolio from shipbuilding to oil and gas and infrastructure activities.

In Asia, the major areas of decline emanated from China and Australia.

Despite all this, operating margins of 26.5% were 60 basis points higher than the year-ago period.

In Construction products, organic revenues were flat, as reasonably good growth in North America was offset by declines, but at moderating rates in Europe.

In North America, total organic revenues grew 2%, with both US residential organic revenues up 2% and renovation organic revenues up 8%.

US commercial construction organic revenues declined 2%, mainly due to softness in the metal business segment, and some related PLS activities.

In Europe, our organic revenues fell 4%, as much improved performance over Q1 when European construction revenues declined 10%.

Asia-Pacific organic revenues grew 3% in the quarter, and this was a turnaround from Q1 when organic revenues declined 1%.

Operating margins of 13.8% continued their movement upward, a 40-basis-point improvement versus the year-ago period.

In Specialty Products, segment organic revenues grew 2% in the quarter.

Segment growth was helped by a 2% organic growth from the consumer packaging businesses.

In particular, global packaging systems led the way, thanks to accelerated growth of warehouse automation system, which includes our Vertique and Hartness businesses.

Our ground support business produced organic revenue growth of 12% in the quarter, while our organic revenues for our worldwide appliance businesses declined 4%.

Operating margins were strong at 22.4%, and that's an increase of 40 basis points versus the year-ago period.

Finally, in our Industrial Packaging segment, which Ron referenced earlier, worldwide organic revenues declined 1%.

Total North American Industrial Packaging organic revenues decreased 3%, due to moderating industrial production trends and softness in the food and beverage category.

Internationally, the news was a bit better as organic revenues increased 1%.

Please note that this was the first positive international revenue number we produced since the fourth quarter of 2011.

Now, let me turn the call over to Ron, who will update you on our forecast.

Ron?

Thanks, John.

As a reminder, our 2012 comparisons exclude the operating results of the former Decorative Services segment, as well as the fourth-quarter 2012 gain on divestiture and equity interests.

For the full-year 2013, our forecasted EPS range for continuing operations is $4.10 to $4.30.

This range assumes a total revenue increase of 0.5% to 2.5% versus an adjusted 2012.

This range is slightly lower than our April forecast, as we now anticipate organic revenue growth of negative 1% to plus 1% for the year.

Additionally, we expect our full-year operating margins to be in a range of 16.9% to 17.3% versus 2012 margins of 16.3%.

Our midpoint of $4.20 would be 14% higher than the 2012 adjusted EPS of $3.70.

The full-year EPS midpoint of $4.20 is down $0.05 from our prior forecast, due to the $0.05 pension forecast from this quarter.

As Scott mentioned, we have kept our second-half operating forecast the same.

Despite the uneven end market environment for some of our segments, we remain confident that our Enterprise Initiatives and strong overhead management will help deliver our bottom line.

For the third quarter of 2013, we are forecasting diluted income per share for continuing operations to be in the range of $1.06 to $1.16, which assumes a total revenue growth of 3% to 5%.

The midpoint of the Q3 diluted EPS range of $1.11 would be a 9% increase versus a 2012 pro forma EPS of $1.02.

I'll now turn it back over to John for the Q&A.

Thanks, Ron.

We'll now open the call to your questions.

And, in the interest of giving more people a chance to ask a question, please honor our one question, one follow-up question request.

We will be finishing the call at the top of the hour.

We're ready for the first question.

(Operator Instructions)

Our first question comes from Ajay Kejriwal.

Thank you.

Good morning.

Hi, Ajay.

So just to maybe clarify on the full-year guide, the $0.05 in pensions, is that being excluded from the guide?

Or is it included?

No, the current guidance, the midpoint is $4.20.

The prior guidance was $4.25.

So the only real change to the EPS guidance was the $0.05 charge that we recognized in the second quarter.

Got it.

So on a non-GAAP basis, if you were to exclude, it's essentially the same?

Correct.

Got it.

That's helpful.

Then on test and measurement, could you maybe talk a little bit about expectations?

I know you, third quarter you have tough comps, but just color on what you're seeing with your customers, please?

What I would say, Ajay, is quote activity remains good in the T&M space.

Electronics is still fairly weak.

The color in the T&M space is the quote activity remains fairly robust, but there is, in the short run, some level of, let's say hesitation in terms of actually customers converting those quotations to actual orders.

But our expectations are things continue to move forward at an okay pace, and hopefully accelerate a little bit as we move through the year.

I think on the electronics side, I think we're expecting the year to be pretty tough all the way around.

Got it.

And maybe one more before I pass it on.

On the auto OEs, you're seeing very, very nice penetration.

Just maybe talk about sustainability and expectations in the second half?

Thank you.

I think we're very well-positioned there.

It's the one part of our business where we have a fairly strong level of forward visibility in that we are selling new content on new models of cars as they are engineered and developed.

So we are set up there for a pretty nice run over the next several years, based on programs that we know we have that will be on new models moving into the market.

I think we're very comfortable through the balance of the year, that we'll have continued strong performance there, and into '14 and '15 as well.

I would just also add that if you look on it from a car build perspective in the second half, we don't expect big movement, or big changes in car build projections, which have been reasonably good around the world.

Got it.

Very helpful.

Thank you.

Next question comes from Jamie Cook.

Hi.

Good morning.

Two questions.

One, I thought your comments on the international industrial packaging businesses were interesting in terms of you're up, and it was the first time that you have seen, I guess that you've been positive since the fourth quarter of 2011.

So if you could just give some color on what actually drove the strength there, and then how sustainable do you think that is?

Then I guess just my second question.

Last quarter when you guys did your earnings call, you said in March you saw an improvement.

I think in US markets, welding, food, as well as test and measurement.

Obviously, things have changed, but can you just give us some color on when things sort of broke down in the quarter, which month?

Thanks.

Okay, on the industrial packaging side, in terms of international revenue, the big contributions on the plus side came out of India and China.

Europe was still down modestly year-on-year in the quarter.

And in terms of the capital spending environment in Q2, what I would say is I think things were relatively sluggish throughout the quarter, as -- and you talked about the segments that were affected.

Food equipment actually stayed pretty strong through the quarter, but certainly in welding, relative to what we saw towards the back half of Q1, things certainly moderated in Q2, and likewise in the test and measurement arena as well.

So there was no sort of fall off the cliff in the second quarter.

We do have an element of seasonality that's baked into our planning between Q1 and Q2.

That's pretty normal.

What I would say is, we just didn't see as much acceleration in Q2 as we normally would seasonally, but all three of those businesses were up sequentially in second quarter versus Q1.

Okay.

So it wasn't a big deceleration.

It was just the lack of, maybe the best way to describe it is things didn't ramp as they -- at the same rate as we would normally expect in Q2.

Okay.

Thanks for the color.

I'll get back in queue.

Next question comes from Rob Wertheimer.

Hi.

Good morning, everybody.

Just wanted to check in.

You gave comments on the construction market, but it continues to be a bit soft.

Can you comment at all on commercial construction, on whether you're gaining or losing penetration/share in the US and globally?

I would say that if you look at the commercial construction numbers, particularly in North America, I think they are roughly in line with what we're seeing with Dodge construction data, which is measured on a square footage basis.

I don't think there's any disconnect there on the commercial side.

Commercial's been much slower to recover.

I think the last set of numbers we saw, commercial was down roughly 1 or 2 points.

So I think our numbers are roughly in line with those.

So I don't think it's a penetration issue at all.

I think it's just the market itself has been slower to recover, as it tries to recover in line with what's going on on the housing side.

Okay, thanks.

And then just as an unrelated follow-up, could you talk about the ramp in strategic initiatives, the savings you've gotten to date?

Is that sort of the run rate for the rest of the year, or is it a continually gradual process?

I just don't know the pace at which you rolling out programs and implementing changes.

So as we said, the Enterprise Initiatives had a 60-basis point benefit in the second quarter, and as we continue to do simplification activities and additional sourcing, we'll continue to see that ramp-up, not just next quarter, but as we move through the next year or two.

So I would expect a bigger impact in the third quarter than the second quarter.

Just to add to that, as you may recall, the impact from initiatives was 40 basis points in Q1.

We got to 60 in Q2.

That's not an infinite slope in that line, but certainly over the next six or eight quarters, we would expect to continue to see further progress on that front.

Great.

Thank you.

Next question comes from Andy Kaplowitz.

Hey, guys.

How are you?

Andy, how are you?

In North American welding, you have some distinct businesses in welding levered toward oil and gas, levered toward heavy equipment, machinery customers.

When you look at Q2, what did you see in those distinct businesses?

Did the major -- did the heavy equipment customers, did they continue to de-stock in the quarter, and that affected the welding business, or was it just more of a slowdown in oil and gas still affecting the business?

And did you see any improvement in that business as oil prices have picked up here recently?

We didn't see any improvement.

I would say dimensionally, the heavy equipment sector was softer in Q2 relative to oil and gas.

I think in both areas, particularly on the capital good, the equipment side, what we saw was certainly more continued tentativeness there around new equipment purchases, but probably the heavy equipments end market's softer than the oil and gas in the quarter.

I would just like to take you back to what I said earlier, Andy.

When we talked about the commercial construction piece being the best piece for us in North America, you think about that.

That tends to be sort of smaller equipment investment around smaller manufacturers, and other related buyers.

So I think that that dichotomy between the two, between the heavy industrial side, or the heavy equipment manufacturers and that is sort of representative of what's going on in welding right now.

I don't think we see -- we're not projecting any further significant declines at this point in time.

No.

Okay.

That's helpful, guys.

And then Scott or John, Europe, it was only down 1% after being down 6% year over year last quarter.

A lot of this does seem like your auto out-performance.

But maybe you could talk about the quarter itself.

Are you getting -- are most markets at least stable to modestly improving sequentially in Europe?

Can we call a bottom here and now an improvement yet, or not really?

I think we have a relatively high degree of confidence that Europe has bottomed.

Certain pockets have gotten a little bit better.

I don't think we've seen anything that's gotten demonstrably worse.

I think it's a bottom.

The question is, how long will the bottom take place?

We're clearly not calling for big recovery in Europe, but I think that it's positive for us and other companies that Europe is showing signs of stability at the bottom.

So we'll continue to ramp up probably good numbers from our auto business, and then we'll keep track of what's going on in our other businesses, and obviously update you on a quarter-to-quarter basis.

John, would you say that construction outperform your expectations in Europe, or is it just kind of trending in line with easier comps?

I would say probably more in line with comps.

One of the things about Europe, obviously, is that you start to comp these numbers, and comps are going to help your comparison numbers, but I would say construction in generally is probably where we would have expected it to be.

Okay.

Thanks, guys.

Andy Casey, your line is open.

Thanks.

Good morning.

Hi, Andy.

Couple things.

Can we walk through the drivers of food equipment, the 230-basis point margin improvement.

Was that all volume price and mix, or was there some benefit from the enterprise strategy in there as well?

It was a little bit of everything.

Price cost had a benefit of about 70 basis points.

Enterprise Initiatives had about 40.

[We just said], we saw overall better variable margins exclusive of price cost of 90, better overhead control of 30.

A part of that would be mix, strong performance out of the service business in both Europe and North America.

Okay, great.

Thank you.

And then second, I'm wondering on your full-year operating margin guidance, you've had pretty good performance in terms of year over year improvement in price cost and enterprise benefits year-to-date.

But it really doesn't look like you're expecting any significant improvement in operating margin performance during the second half.

First, is that a correct assessment?

And then second, why wouldn't you be seeing some flow-through from those benefits into the second half?

So if you look at the margins in the second half, they are about at the run rate as they were in the second quarter, if you back out the pension charge.

Without the pension charge, 17.4%, back half margins are in that range for the rest of the year.

The prior year margins, while we did have a very strong margin third quarter, primarily due to some corporate adjustments, favorable corporate adjustments, it was 17.5% last year.

Fourth quarter was 14.9%.

So we are overall improving it quite a bit in the second half.

A lot of that improvement is coming from Enterprise Initiatives.

Okay.

It's basically flat from here.

Will we expect a step-up through the second half?

(Multiple speakers)

Yes.

I mean, certainly in the fourth quarter.

14.9% versus 17%-plus is a pretty significant margin improvement.

The other element of this is, as we saw in the second quarter, we're expecting a higher restructuring spend year over year.

So even with that higher restructuring spend, we're seeing significant margin improvement.

Okay.

Thank you very much.

Ann Duignan, your line is open.

Hi, good morning, guys.

It's Ann Duignan.

Good morning, Ann.

Good morning.

Two follow-up questions, really.

On the automotive performance, can you just give us a little bit more color on what products and what platforms are winning in Europe and in China?

Is there an opportunity to take those new products in Europe to China in a year or two, or is this kind of a global rollout of a new product and it's simultaneous across the world?

Yes, I, I think a core strategy, without necessarily getting into specific products on specific platforms, is that we have very much the automotive business is globalizing.

So we very much are focused on sort of major global OEMs and our ability to ultimately invest in innovation and new product development in opportunities that have sort of major potential to expand, both from the standpoint of different OEMs and also on a global basis.

The story in China right now is a function of the fact that the quality of cars that they are building in China more and more has reached a point where the kind of solutions that we offer are things that they need.

So as the overall standards of the quality -- standards and the quality and feature sets they are starting to put in the cars in China is certainly creating more and more opportunities for us to bring content that we've already engineered in North America or Europe into the China market.

Okay.

That's helpful, I guess.

And then on the Enterprise Initiatives, are we sort of done with the business unit consolidation, and now we're moving into more of the strategic sourcing i.e., we should look for the improvements going forward to show up in gross margin versus SG&A, or is it going to be a mix of both going forward?

If you could just help from us a modeling perspective, where you would expect the improvements to show up, it would be helpful.

So in two quarters, we're done with the BSFs.

We have -- I'm going to give you a sort of, try to give you a flavor without, -- not having a lot of sort of authoritative facts behind this.

But what I would say is, we're at best 15% of the way through the BSFs in terms of the kind of moves that we have on the board and the things that we're going to do.

We're getting what I would describe as some very consequential but low-hanging fruit benefits at this stage.

This has probably got another two to three years to run on BSFs, and likewise on sourcing.

As we've talked before, we are at the early stages.

I think are very pleased with our progress in '13 on sourcing, but ultimately have some -- the big benefits still ahead of us in terms of '14, '15, '16.

So more of a gross margin impact from the sourcing as we move into '14 and '15, is that the way we should think about it?

On a relative basis, but I wouldn't discount the BSFs in terms of continuing impact for the next -- for '14, '15, and some of '16.

Okay.

Thank you.

I'll get back in line.

Stephen Volkmann, your line is open.

Hi, good morning.

Just a couple of cleanup items, if I could.

What's the organic growth forecast for the third quarter that's in the 3% to 5% total revenue growth?

With organic growth for the third quarter?

Yes.

1%.

1%.

1%, great.

And the quarter end share count?

Quarter end share count, [447 million].

Thank you.

Then restructuring spending in 2014, is it going to be up or down over '13, do we think?

Too early to say.

I would expect it would not be up significantly at the high end.

Okay.

Great.

That's it for me.

Thanks.

[Sean Williams], your line is open.

Hi, good morning.

Good morning, Sean.

Hi.

You guys have been vocal in the past about wanting to expand within quick serve restaurants on the food equipment space.

Obviously you did a purchase here, the Chinese manufacturer.

I'm just wondering, is that it?

Are we kind of done with that, or is there more acquisitions to be done over the next couple of quarters here?

On the quick serve space?

Well, in the quick serve space, or food equipment in general, whichever you feel --

I think the major thrust within food equipment is innovation-based organic growth.

We will certainly continue to look at M&A opportunities as they arise, like we did in China.

I think we're very enthusiastic about how that business fits strategically with our growth plans and opportunities in China.

But I would say the major thrust going forward for us in food equipment is to continue to build a much stronger organic growing business through an accelerated rate of innovation there.

I mean, should we expect that most of the acquisition activity for the portfolio going forward is going to be concentrated within food equipment, or is this kind of, again, it's going to become more one-offs here and there?

I wouldn't say it would be concentrated in food equipment.

I think what we have said as part of our enterprise strategy overall is that this Company, our focus is on really building a much more robust organic front end engine as our primary growth thrust, and that we will certainly supplement that [route] with good strategic acquisitions as those opportunities arise; but ultimately, and those opportunities would -- may arise in any one of the many operating segments that we're in today.

But ultimately that's not the front end in terms of really how we think about it and how we're focused on driving growth going forward.

By example, if you look at what we have acquired thus far this year, I mean, they fall into the areas, such as food equipment, China.

We've also done deals in welding in Europe, and we've also done, I believe, a couple deals on the consumer packaging side.

We're very much targeted to the areas we've talked about that we think have big potential for differentiation and longer term growth.

Highly differentiated technologies in end markets that we know and understand very well.

All right.

Thank you.

John Inch, your line is open.

Thanks.

Good morning, everyone.

Good morning, John.

Good morning.

The weaker North American welding results, do you guys think you lost share, for whatever reason, to either Lincoln or ESAB?

Just thinking, ESAB has got new management.

I think they've launched a new product.

What are your thoughts?

Our thoughts today would be no.

I think we'll obviously -- we're very focused on this.

The welding business is a business that's been a very strong organic grower for us across a very long period.

Our expectations are going forward that that will continue to be at the high end of our overall organic growth performance in terms of our portfolio.

I think given that the market positions that we have in areas like the equipment space, I think our view is what we said before, that Q2 was really more of a demand issue in certain key end markets, like heavy equipment and oil and gas.

Okay.

Scott, the North American results kind of a point of a differential growth that you've called out, was any of this attributable to Canada?

The Canadian economy hasn't been particularly great lately.

I'm just wondering if that's perhaps part of some of the mix of slightly softer revenues.

I don't think it was geographic, John.

I think it was really around, again, the three segments that we talked about.

Industrial packaging was much softer than we expected.

Welding was a little softer, as were polymers and fluids in North America.

Yes, okay.

And then just lastly on restructuring.

Obviously with Enterprise Initiatives, the nature of your restructuring and sort of the approach and so forth is different than what sort of legacy ITW would have pursued in terms of its restructuring.

Can you talk about that a little bit, Scott, in the context of your initiatives?

Are you finding restructuring -- maybe just a little more color.

Are you finding restructuring somewhat more challenging, easier?

Have you picked off a lot of the low-hanging fruit?

Just anything that might give us a sense of sort of the approach and the paybacks, just something that might help us take a look at this.

Well, I think this is -- most of what -- the concentration of spend right now is really around supporting our business structure simplification initiative where we've talked about building scale from the bottom up in our structure, and ultimately a landing spot of 105 or so, much larger, much more globally competitive divisions.

So I think the activities concentrated there, we are -- I talked about this a little bit on the last call.

But I think from the standpoint of the strategic benefits around this and the operating cost benefits, our management team is very motivated, very much behind this initiative.

Lots of opportunity to both position ourselves to be much more competitive on a global basis, to accelerate organic growth, and at the same time drive some pretty consequential overall structural cost savings.

It's not -- I don't know how to characterize it in terms of any difference.

I think it's not dissimilar from restructuring that we would do when we acquired new businesses.

So I don't -- I guess I don't know how to fully answer your question.

It's mostly also I'm assuming been people and overhead.

It's hasn't really -- you haven't been tackling plants or--

No, I would say we absolutely have been tackling facilities, plant consolidations as part of this activity, absolutely.

Okay, all right.

That's fine.

Thank you.

[Ned Over], your line is open.

Good morning, gentlemen.

Good morning, Ned.

How are you?

Doing very well.

Thank you.

I guess I would like to go back to the food equipment segment and to your recent acquisition in China.

Is there any color you can provide us with regards to Vesta's size and relevance in the Chinese market?

Strategically, how are you thinking about this acquisition?

Do you see -- how do their products compare, for instance, from an innovation standpoint with some of the brands that you've got here in the US?

Do you see some potential for technology and manufacturing sharing with the brands they currently have?

Absolutely.

I think the way I would characterize it in terms of how much we probably want to say about it is what we -- I think the combination of that business with our business has great benefits both ways.

It has -- it's a business that operates at a scale well above what we operated at in China up to this point.

We -- what comes with it is a manufacturing footprint and a local R&D capability that is certainly a big step up in terms of scale.

There's some strong differentiation in the product lines that we acquired.

We certainly feel, both through our existing -- technologies that exist in our existing product lines that we're going to be able to supplement their product portfolio, and likewise from the standpoint of service capability.

Big footprint there already.

Something that, in terms of some of the knowledge and know-how we might bring and might learn from them in return.

Some really nice benefits, both from us to them and them to us in this.

Great, and I guess my follow-up here would be, over time, do you see Vesta as a potential player in western markets as well?

It's early.

I don't know that we would want to say much.

I think it's largely a China play.

Great, thanks.

Deane Dray, your line is open.

Thank you.

Good morning, everyone.

Morning, Deane.

You've covered a lot of ground here.

I do have a question for Scott on the electronics business, kind of a broader question.

This is not the first quarter where we've seen some sharp volatility and cyclicality in this business, and the issue is, this business is on a completely different cadence with most of your other, or all of your other industrial businesses.

So maybe just to hear from you, since you've been through this whole portfolio rationalization, is electronics a core business within ITW?

And maybe, what are the key values?

Is it market share, synergies with others, cash flow, just maybe hear your comments on that.

Sure.

I would absolutely tell you that we are thinking a lot about the cyclicality issues in electronics.

I think at its core, what I would say is I think we've been very selective about the pieces of the electronic markets that we choose to play in.

I think in particular we like a couple of spots where we are in terms of, again, some of the sort of value creation attributes of those spaces.

There's some spaces that are relatively under-attended in our view in a market that on a long-term basis, the fundamentals are that they grow and grow quite a bit.

We make good money.

This is a, it's a space where ITW in the aggregate, where it certainly is accretive to our overall margin and return goals, even on the dips.

I think margins in the electronics space, even on a big decline year-on-year, are still in the high teens for us.

So I think we're -- I guess what I would say, Deane, I think there's some things there that remain interesting for us on a long-term basis, but I also think we have to understand how to manage in that space in a way where it's less of an outlier in certain instances.

Got it.

And then on the auto builds, I mean, this is a pattern that we've seen play out over the years, where ITW outpaces builds, US, Europe, but it really looks outsized this quarter.

Is this the expectations on how you can sustain this lead over, is it all market share, it's new product innovations, but that again, this is a high quality problem where you're having to explain the performance versus global builds.

Yes.

What I would say is worth commenting on there is I think the strategy today for us in automotive is very different than some of those prior cycles that you referenced.

The growth engine here is today is all about sort of proprietary solution-based new content.

So we're not at the end of RFQs as a supplier.

We are really focused in on high value, solving sort of big ping point issues for automotive OEMs.

So from the standpoint of, we've talked about this before.

Overall content in North America in the mid-$60 a car range today, Europe at around $50 and Asia at $20, on an overall average material cost in a car is, let's say, $15,000.

Is there another $30 or $40 we can find of really Innovative important solutions for our customers over time?

We have a lot of conviction about that opportunity being out there.

So from a sustainability standpoint, the strategy today is very different.

Much more tightly focused on the kinds of things I talked about.

And so I think both, as I try to dimension the overall size of the opportunity and the uniqueness of our strategy, and by the way, we're pretty uniquely positioned as the only company out there that can deliver these solutions on a global basis.

I think we've got, again, a very different strategy and a lot of conviction about our ability to sustain some pretty strong out-performance here for sometime to come.

Great.

Thank you.

Nigel Coe, your line is open.

Thanks.

Good morning, guys.

Hey, Nigel.

I would agree, the automotive performance is outstanding, and we don't see too many suppliers with 20% margins.

I'm just wondering, do you get any pushback from the OEMs on those levels of margins?

Well, in the end to say we don't -- would probably not be accurate (laughter), but in the end, it's all about the value of the solution.

We're not, again, we're not in big dollar spaces.

I think in general that our OEMs, our customers appreciate the value that we deliver, which is we help them solve, again, sort of big problems that they have in ways that ultimately make them more money and help them be more effective as business.

So in the end, it's really about them -- we're going to get paid if we do our job.

Right, right.

I just did have a couple quick questions.

You've covered a lot of ground here.

But just looking at the 4.4% midpoint revenue growth guidance for 3Q.

I think, John, you mentioned 1% organic growth within that.

So is the 3 point bridge from M&A?

And if so, is that the incremental contribution of investor, or are there some other acquisitions coming through there?

2% of it is acquisitions-related and the rest is currency and other stuff.

Okay.

So 1 point from currency, 2 points from acquisitions, and 1 point of organic, okay.

And then the second thing is, I think, Ron, this is your last quarter.

I'm just wondering where you are in terms of the CFO replacement.

We are making progress.

Okay, great.

Thanks, guys.

Joseph Ritchie, your line is open.

Hey, good morning, everyone.

Morning.

So I had a quick question on the earnings bridge on Slide 13.

It looks like you've taking down revenue guidance.

That should be slightly offset by the increased share repurchases.

But it seems like there is implicitly potentially higher margins or cost-out that should have to have in order for you to maintain your guidance, or the midpoint of your guidance.

Help me rectify that.

Yes.

So here's the way I would look at it.

The revenue forecast is down from where we were before.

The margins are basically the same.

So that means we are taking additional costs out to basically hold the income contribution from base.

So that's the $0.32 in the bridge from base.

From a share repurchase perspective, although we've increased the total for the year, because most of that will come in the back half of the year in the fourth quarter, it will have very little impact.

So it didn't really have a EPS impact in the current year, certainly will going forward.

Okay.

That's really helpful.

Then I guess a follow-up to that, as it relates to that $0.32 base, I think last quarter you mentioned about $0.18 to $0.19 was going to come from the Enterprise Initiatives.

Thus far this year, you've done about $0.06.

Have you increased that target, then?

Yes, it has certainly, as we talked about earlier, it is accelerating.

It's a little bit higher than what we talked about last time, probably in the $0.20 range.

Okay, great.

Thanks a lot.

David Raso, your line is open.

Yes, hi.

Just a further clarification on the guidance.

The 1% you took out of the full-year organic growth rate, did that come out of North America solely, or is it a mix?

A mix.

Mix.

And then for the share count, you mentioned [447 million] at the end of the quarter.

Was that a diluted number or a basic number?

That is a basic.

It is a basic, so it's more around [450 million] diluted?

Yes.

I'm just trying to come up with, it does seem to imply, and maybe the prior answer just now, I didn't fully catch, the margins seem to have to improve, unless am I not recognizing the share repo steps up notably from, say, $300 million a quarter.

How significant is the repo in the back half?

You still kept it as an $0.18 benefit.

Yes.

As I said earlier, we did increase it $150 million, but that's all going to fall in the fourth quarter, and it's going to have very little impact, and really no EPS impact in the current year.

So what's happening on the margins is normally when revenues come down, you would expect there, everything else being equal, there would be a deterioration in margins.

And so we're holding our margins the same.

That's how we're getting basically to the same EPS.

And for the margins in the second half, you said they would be similar to 2Q.

But the amount suggests they have to be in the upper 17%s.

2Q as adjusted, if you back out the pension.

Okay, all right.

So that's your comp.

(multiple speakers) But it's actually 17.4%, even if you pull out the $34 million from SG&A.

That's what I'm saying, is the 17.4%, or in a similar range to the rest of the year.

Okay.

I mean, not to nickel and dime you here, but, I mean, the margins have to be higher than 17.4% the rest of the year on that revenue base, with that kind of share count to hit $4.20 all-in, or $4.25 ex, right?

Yes.

I mean, it's in the range.

I mean, we're not --

Okay.

I just wanted to clarify that.

And the restructuring cadence again, year over year, you said it was $25 million more in 2Q year over year.

What's the cadence again in 3Q, 4Q on the year over year basis?

We're seeing some increase, but not as much.

So probably in the $20 million in the second half above last year.

Okay.

That's helpful.

I appreciate it.

Thank you.

We'll take one more question.

Walt Liptak, your line is open.

Hi, thanks.

Can you hear me?

Yes.

Walt, are you there?

Yes, thanks.

My question's on the guidance, too.

The organic revenue growth being a little bit lighter, is it a result of the second quarter, or is it more of a forward look on the full year?

And then which segments are performing at a lower rate than you thought of back in April?

I think it's really, I think what we tend to do is we tend to hold at second quarter.

It's much harder to forecast on a three- to six-month basis where things are going to be.

So we're basically holding it where we essentially ended the quarter.

I don't think we carved it out per segment, but I don't think they would be radically different than some of the segments we've talked about today per Q2.

Industrial packaging, polymers and fluids would probably be the primary examples there.

Okay, got it.

If I can just get one last welding question in.

You didn't mention anything about pricing, but have you taken up prices yet this year, and with material costs down, is there a price increase for the back half, or maybe a price decrease?

Price increase went into effect, I believe, April 1?

Yes, April of this year.

I wouldn't -- I don't have knowledge of any additional price increases at this point in time.

Okay, and those price increases are sticking, given, even with the commodity prices coming down?

Yes.

All right.

Thank you.

Okay.

We're going to end it there, at the top of the hour.

We thank everybody for joining us on today's call, and we look forward to talking to you later.

Have a good day.

Thank you.

Thank you for your participation in today's conference.

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