Illinois Tool Works Inc (ITW) 2014 Q3 法說會逐字稿

Welcome, and thank you for standing by.

(Operator Instructions)

Today's conference is being recorded.

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

And now I'd like to turn the meeting over to John Brooklier, Vice President, Investor Relations.

Thank you, you may begin.

Thanks, Diane.

Good morning, everyone, and welcome to ITW's third-quarter 2014 conference call.

Joining me this morning is our CEO, Scott Santi, and our CFO, Michael Larsen.

We would also like to welcome Aaron Hoffman, our new VP of Investor Relations.

As you know, Aaron joined us in early September, and we are working on a smooth transition of the Investor Relations role until I retire in March of 2015.

Aaron, good to have you on board.

During today's call, we will discuss our outstanding Q3 financial results, and update you on our earnings forecast.

As usual, we will open the call to your questions.

We ask for you cooperation on our one question, one follow-up question policy, as we have scheduled one hour for today's call.

Before we get to the quarterly data, let me remind you that this presentation contains our financial forecast for the 2014 fourth quarter and full year, as well as other forward looking statements identified on this slide.

We refer you to the Company's 2014 Form 10-Q for the second quarter for more details about the important risks that could cause actual results to differ materially from our expectation.

Also, this presentation uses certain non-GAAP measures.

And a reconciliation of these non-GAAP measures to the most comparable GAAP measures is contained in the press release.

With the business -- taking care of that, I will turn the call over to Scott Santi who will comment on the quarter.

Scott?

Thanks, John, and good morning, everyone.

Overall, we were pleased with our performance in the quarter, and with the progress that we are continuing to make in executing our strategy.

Operating margins in the quarter were a record 20.9%, and were 190 basis points higher than in Q3 of last year, with 120 basis points of that improvement coming directly from enterprise strategy initiatives.

After-tax return on invested capital was 20.1%, marking the first time we've gotten both of these key performance metrics above our stated goals of 20% plus in a quarter since the launch of our enterprise strategy in 2012.

Operating income of $772 million was the highest quarterly total in the Company's history, and free cash flow was very strong at 128% of that income.

EPS of $1.28 was up 42% versus the prior year.

We were also pleased with our organic growth performance in the quarter, as we have had four of our seven business segments deliver organic growth of 5% or better.

While we are still 3 to 4 quarters away from being able to turn the majority of our attention to the growth agenda component of our strategy, it is encouraging to see some early signs of progress on the organic growth front in a number of our businesses.

Product line and customer simplification activities remain an active element of our portfolio management initiative currently, and had a negative impact on the Company's overall organic growth rate of approximately 1 percentage point in the quarter.

I expect that these activities will have a similar 1% negative impact on our organic growth rate throughout most, if not all, of 2015.

However, keep in mind that product line and customer simplification are core components of ITW's 80/20 business management system, and we are in the process of reapplying it to our scaled up operating divisions.

These activities are a key driver of our ability to continue to improve margins and returns, and to accelerate organic growth going forward.

Overall, we are pleased with our progress as we approach the end of year two of our five year enterprise strategy.

At our upcoming Investor Day in December, we will provide investors with an updated view of our performance targets for 2017, as well as lay out a preliminary outline of what we think 2018 and beyond might look like in terms of both strategy and performance.

I'd like to close by thanking all of our people around the world for the great job that they continue to do in serving our customers and in executing our strategy.

Now, I'd like to turn the call over to Michael.

Michael?

Thank you, Scott, and good morning, everyone.

Let's get started with the financial summary on page 2. The third quarter was another quarter with solid execution and a high quality of earnings, with organic growth of 3.5%, record operating income and record operating margins of 20.9%.

EPS of $1.28 was an increase of 42% versus prior year.

Revenues were $3.7 billion, up 3.5%, with growth in all major geographies.

Four segments: automotive, food equipment, test and measurement electronics, and welding stood out, with organic growth of 5% or better.

As Scott mentioned, consistent with the first half of the year, product line simplification was a 1% drag on our overall organic growth rate.

Five of our seven segments expanded margins by more than 200 basis points, with 120 basis points from enterprise initiatives, which included increased contribution from our strategic sourcing efforts.

Incremental margins were 76%, and cash generation was solid, with free operating cash flow at 128%.

We spent $500 million on share repurchases, and you might recall that we raised the dividend 15% in the third quarter.

Good progress on the after tax return on invested capital, with an improvement of 250 basis points.

So overall, we were pleased with the strong results in the quarter, and the continued positive momentum on our enterprise initiatives.

On page 3, a few highlights on organic growth for the quarter with North America up 4%, as a result of continued strength in Automotive, up 8%, and Food Equipment up 6%.

Also in North America, Welding was up 10%, and Test & Measurement and Electronics grew 6%.

Certainly, some encouraging progress on organic growth.

International growth was also positive, up 3% in the quarter, with Europe up 3%.

Four of our segments were positive in Europe, with Automotive up 9% and Food Equipment up 6%.

Asia-Pacific increased 5%, driven by Australia up 5% and China up 3%.

Automotive OEM and Food Equipment in China were both up double digits.

Construction in Australia and Test & Measurement and Electronics in Asia-Pacific were up high-single digits.

So in summary, solid organic growth across all major geographies, and some encouraging signs in our CapEx-driven segments, Welding and Test & Measurement as we continued to apply our 80/20 business system, and position our businesses for future organic growth.

Moving on to slide 4. Operating margins were once again a highlight as solid execution on the enterprise initiatives, which included greater contributions from the strategic sourcing effort led to record operating margins of 20.9%, an increase of 190 basis points from last year.

As Scott mentioned, the third quarter was the highest ever in terms of operating income at $772 million.

Which speaks to the quality of the revenues generated by this portfolio of highly differentiated businesses, after completing the portfolio management component of our enterprise strategy.

The former record was $770 million in the second quarter of 2012, a quarter that had revenues almost $1 billion higher than this quarter.

We were pleased to see that all seven segments improved operating margins, with five of the seven segments expanding margins by more than 200 basis points.

And Polymers & Fluids exceeding 20% the first time.

On the right side of the page, we've listed the drivers of the margin expansion, with the largest contribution being 120 basis points from enterprise initiatives.

We continued to invest in future margin expansion, and spent $28 million on restructuring related to our business structure simplification efforts.

So clearly, more to come in terms of BSS savings, as we spend approximately $100 million this year.

Operating leverage was 80 basis points, and price cost was favorable.

For a total of 190 basis points of margin expansion.

So really great progress, and lots of positive momentum on the enterprise initiatives.

With continued spend on restructuring, and higher contributions from sourcing, which gives us increased confidence in our ability to expand margins in 2015 and beyond.

With that, I'll be back in a few minutes to go over our updated guidance.

But first, let me turn it over to John for some additional commentary on the segments.

John?

Thank you, Michael.

Moving to slide 5, you'll see the breakdown of total revenue and operating income per segment.

Six out of our seven segments produced top line growth in the quarter.

While all seven segments demonstrated operating margin expansion.

Our Auto OEM, Food Equipment, Test & Measurement and Electronics, and Welding segments led the Company's top line growth.

And five out of seven segments produced operating margin over 20%.

This was an outstanding quarter for the Company, as our enterprise initiatives contributed to improved operating margin performance in all of our segments, which I will detail now.

As I cover our segments, I'll remind all of you that our organic revenue growth excludes the impact of currency and acquisition activity.

Moving to Auto OEM, the segment produced another in a long line of solid quarters.

Organic revenue grew 8%, compared to world wide auto builds of 2%, and that was due to ITW customer-backed innovation and ongoing product penetration.

By geography, organic revenue for Europe grew 9%, North America increased 8%, and China was up 12%.

Our European businesses outperformed European auto builds by 10 percentage points, due to penetration gains across all platforms.

In North America, our growth equaled auto builds at 8%; however, Detroit three, where we have significant penetration only grew by 3%.

In China, we outperformed auto builds by 4 percentage points.

Profitability remained high, with operating margins of 23.4%, a 230 basis points improvement from last year.

Moving to slide 6, in our Test & Measurement and Electronic segment, organic revenues increased 5% in Q3, a solid improvement sequentially over last quarter.

Test & Measurement's organic revenues grew 8%, led by strength in our world-wide Instron business, with growth of 22% in Q3.

And both north America and Asia produced good results.

The Electronics business increased organic revenues by 3%, as the electronic assembly business moved into positive territory with 5% growth in Q3.

The remainder of the Electronics business grew 1%.

For the total segment, Q3 operating margins showed notable improvement at 18.7%, and that's 240 basis points higher than the year-ago period.

The Food Equipment segment's organic growth rate of 5% reflected another quarter of very good growth, and showed progress along all major product categories and geographies.

In North America, equipment and service related organic revenues grew 6% and 4% respectively, thanks to growth in refrigeration and cooking businesses and new product innovation.

Internationally, equipment revenues increased 8% due to strong warewash and refrigeration sales, while service organic revenues increased 1%.

The segment's operating margin at 23.1% was a robust 320 basis points higher than the prior-year period.

So again, good progress on the Food Equipment side.

Moving to slide 7, in our Polymers & Fluids segment, organic revenues declined 2%, and that's largely driven by our ongoing product line simplification activity.

As we've noted in prior quarters, we continue to weed out less profitable products and customers in this segment.

Which, as you know, negatively affects organic revenue but substantially improves profitability.

The Polymers & Fluids and Hygiene businesses organic revenues each declined 1%, while Automotive after market declined 4%.

As the product line simplification activity diminishes, we expect the effects of PLS to have less of an impact on organic revenue in 2015 and beyond.

The much better news, shorter term, is that the segment achieved a record Q3 operating margin of 20.2%, a 210 basis point improvement over the year-ago period.

Looking at the Welding segment, worldwide organic revenues grew 5% due to strength in North American equipment sales.

North American organic revenues increased 10%, that's a very good number for them, in the quarter.

And that was driven by robust growth in both industrial and commercial end markets, and growth in the oil and gas business.

International organic revenue declined 7% due to impact of delayed onshore pipeline projects in China and the Middle East.

And also some of the PLS projects in Germany negatively impacted organic revenue growth in the quarter.

All said, the Welding segment continues to lead the way, with Company high operating margins of 26.2%, and that's 80 basis points higher than the year-ago period.

So nice quarter from the Welding segment.

Moving to slide 8, the Construction Products segment produced modest organic revenue growth of 2% in the quarter.

Asia-Pacific led the way with 6% organic growth, and that was largely driven by growth across all Construction sectors in the Australian and New Zealand geographies.

In North America, organic revenue was up 2%, with the residential and renovation categories up, but commercial construction down.

In Europe, organic revenue was down 1%, and that was largely due to product line simplification and declines in France, offset by strength in the United Kingdom.

As noted in the prior quarter, the segment's profitability continues to be our major focus, and operating margins of 18.9% were 270 basis points higher than the year-ago period.

In specialty products, segment's organic revenues were flat, as modest growth across our consumer packaging business was offset by delays in customer projects and our warehouse automation business.

In total, our consumer packaging business and appliance were flat, while ground support was up 2%.

This segment represents a collection of high margin businesses, and the total segment operating margin is at 21.3%, we are 20 basis points higher than the year-ago period.

So, substantially good progress from a lot of our segments.

Now let me turn the call over to Michael, who will cover our fourth-quarter and 2014 full-year guidance.

Michael?

Thanks, John.

So on page 9, let's start with our guidance for the fourth quarter, where we expect 2% to 3% organic revenue growth and 100 basis points of margin expansion from enterprise initiatives.

Currency is a 3% headwind on revenues.

So total revenues are expected to be about flat.

Foreign exchange is a manageable $0.04 head wind to EPS, and EPS is expected to be in the $1.07 to $1.15 range.

With a midpoint of $1.11, that is an increase of 21% over last year.

For the full year, we're raising our EPS guidance for the third time this year to $4.57 to $4.65, which compares to $4.50 to $4.62 previously.

At the new midpoint of $4.61, EPS is expected to be up 27% over 2013.

Our organic revenue growth assumption for the year remains unchanged at 2% to 3%.

And we now expect higher operating margins of approximately 20%; roughly 200 basis points of improvement.

So, in summary, we're pleased with the progress on our enterprise strategy and strong financial results in the quarter and for the year.

In a macro environment similar to the one that we're in today, we have great confidence in our ability to further expand operating margins, and deliver differentiated earnings growth in 2015 and beyond, as the team continues to execute well on our five-year strategy, and position ITW for solid organic growth, with best in class margins and returns.

We look forward to sharing more details with you at our upcoming Investor Day on December 5.

So with that, let me turn is back over to John.

Thanks, Michael.

We'll now open the call to your questions.

But please be brief to allow more people the opportunity to ask a question.

Remember, one question and one follow-up question.

We'll now open the call.

(Operator Instructions)

Rob Wertheimer, your line is now open.

Hello, good morning.

Great results in Welding.

I was curious if there was -- what the discrepancy, if there is one, between Welding and Construction, particularly in north America is?

Does the strength in Welding portend a turnaround in Construction?

Are you trimming product lines somewhere there, or is there just not as much overlap in the customer as I would have guessed?

I'd probably say not as much overlap.

Most of the strength in Welding was in, what I would describe as a more general industrial and oil and gas related end markets.

Less so in commercial construction.

Okay.

Perfect.

Then, just one more on Welding.

Maybe you don't want to get into too much detail on the international side, but are you able to say if the pipeline delays are geopolitically related or whether there's any other more economic reason for the delays?

I'd say hard to say at this point.

We're looking at some things that just got pushed back a little bit relative to our earlier expectations on timing.

I think we'll have to wait and see.

But so far, you don't think it's canceled or gone, it's just pushed out?

No.

Okay, great.

That was my two.

Thank you.

Ann Duignan, your line is now open.

Hello, good morning.

Morning, Ann.

Can you talk a little bit about what you are weeding out on the businesses that you are weeding out, the lagging businesses?

Just talk about just a little bit more color on which business you're actually divesting of or discontinuing?

If you're referring to the product line simplification work, the way I would describe it is the next level down of our portfolio strategy.

And really what we're doing there is weeding out relatively small volume product lines that add complexity, but don't really drive a lot of impact and/or product lines where we don't have the level of differentiation that we're ultimately looking to build the Company around.

So lower profit, certainly lower volume product lines, and that's going on all over the business.

So even Automotive that's got the best growth rate has got a pretty healthy product line simplification agenda underway.

Okay.

So it's more just [AV] trending across the entire business, it's not related to one specific end market

Yes.

Correct.

Well said.

That's helpful to understand.

My follow-up is on Food Equipment.

Can you just give us a little bit more color on what's going on in those businesses?

Those were some pretty solid end results.

I'm just curious to get a bit more color, how much is market, how much is market penetration, innovation, if you can just give us a little bit more quantitative analysis around what's going on there, that would be great.

Thanks.

Yes, I think what I would say overall is, I think we're happy with the Equipment sales increases in the quarter.

The one in Europe certainly stands out from my standpoint, where we're plus 8% international overall.

So part of that is certainly some progress we're making around an acquisition we did last year on China, but also the core European business was actually relatively healthy given a lot of the gloom and doom in terms of the overall economic situation there.

I would say overall, we're not seeing a ton of market lift.

Probably things in North America a little bit better, but largely these numbers are driven by some new product activity.

Any products in particular, or any categories in particular?

Particularly in Europe, I'm just curious --

Warewash, which is our commercial dishwashing business, and also refrigeration in Europe.

Okay.

And you believe those are more market penetration, not end market?

Yes.

Okay.

I'll leave it there.

Thank you.

Take care.

Andrew Kaplowitz, your line is now open.

Hello, guys.

Good morning.

It's Alan Fleming in for Andy this morning.

Alan, how are you?

I'm doing well.

Just on Europe, you saw some acceleration to plus 3% from I think plus 1% last quarter.

And I know some of this seems to be somewhat specific to ITW with strength in Food Equipment and Auto.

But just curious of your guy's view, is it possible that Europe may be a little more stable than some feared, and things have not slowed down as much as it seems?

Maybe if you could just give a little bit more color on that market.

Yes, sure.

And so again, we can comment on what we're seeing in our businesses.

We had obviously a good quarter in Europe, and a good September.

And we haven't seen signs of a slow down in Europe.

We were encouraged to see Automotive up 9%, really continuing to build on strong penetration gains in that business.

Test & Measurement and Electronics has had a good year all around, and we're up in Europe.

We just talked about Food Equipment up 6%.

And then Welding, Polymers & Fluids, and construction you're probably seeing a little bit more product line simplification initiative in those businesses.

But overall, Europe for us, up 3%.

We're pleased, and we have not seen a slow down in Europe.

Okay.

Helpful.

And then just on Construction in North America, I know you're continuing to see some declines on the non-res side.

Is there any reason for hope that you guys are seeing, any positive signs in that market?

The way I would characterize our Construction business North America, is that it's been bouncing around quarter to quarter, it's up a little, down a little.

And I think we're still waiting for some traction overall.

There's a fair amount of good progress we're making inside the business on the margin front.

But from an overall demand standpoint, I think we're still not seeing any consistent trends whether it's housing starts or commercial construction activity.

Okay.

All right.

Thank you, guys.

Jamie Cook, your line is now open.

Hello, good morning.

Two questions, one broader and then one on Test & Measurement.

I guess I'm surprised -- I know you're having the market help -- some of the internal initiatives help your top line.

But I'm surprised when I think about your organic growth of 3.5%, just given a number of pre-announcements that we've seen across industrials and just broader concerns on the macro.

Did any of your businesses see a deterioration as we exited the quarter or as we look into October, and does the headlines you've read from other companies concern you more as you think about 2015?

And then my second question, on the positive, Test & Measurement had a very good quarter.

Your Instron business was up 22%.

I'm just wondering if you could give color there?

And I think last quarter you talked about confidence maybe you could see a pick up in CapEx, just your thoughts there.

Thanks.

So on your first question, Jamie, so we didn't see any of our businesses slow down as we went through the quarter.

We are clearly -- if you look at the comps on a year-over-year basis, that may drive some of what you're referring to.

But generally there was solid strength as we went through the quarter here.

October, it's a little early to comment.

But we haven't seen anything unusual that's inconsistent with what we were expecting, and what's included in our guidance here today.

Now that said, we are obviously -- we are aware of the headlines and what other companies are reporting.

And so, we continue to monitor what's going on inside our businesses and the order rates that we're seeing.

In terms of Test & Measurement, like I said, they've had a good year.

And really, if you go back to the first quarter and the second quarter, order and backlog activity particularly in the Instron business has been excellent.

And we're encouraged by what we're seeing.

Now keep in mind that business was up 8% organically in the fourth quarter last year.

So the comps are going to be a little bit more challenging here in the fourth quarter.

But in terms of seeing a sustained pickup in the CapEx cycle, probably a little too soon to call that.

What we'd say is that we're encouraged by what we saw in the second quarter in Test & Measurement, and obviously in the third quarter.

We're not seeing anything that would suggest that there's a slow down in those businesses.

Thank you.

I'll get back in queue.

Walter Liptak, your line is now open.

Hello, thanks.

I wanted go back to the Welding segment.

And I understand your answer that general industrial is where you're seeing the pickup in North America.

But I wonder if -- we saw a slow down in Welding this year, and now it seems to be picking up.

I wonder if you can attribute that to anything, pent up demand or any different sectors within Welding?

Well, I'd just go back to what I said earlier.

Which is, oil and gas in North America in the quarter was strong, and also the general industrial part of our business and the commercial part was certainly much stronger year-on-year in the third quarter than we have seen over the past prior quarters.

But I'll also reference what Michael just talked about.

The pickups are largely for us in the equipment area.

And from a CapEx standpoint, I think it's been a couple of quarters now of some improving demand rates in the CapEx area.

But I don't think we're ready to yet call any big inflection point.

We'd like to see it sustain itself for another couple of quarters.

Okay.

Does it seem like this is a pickup in the Welding distribution channel, or is it direct to --

The commercial business is --when we talk about general industrial and commercial, we're talking about the more fragmented part of the market.

Most of that is accessed through the distribution channel.

I'd assume that the pick up in the channel, the sales for the channel, are a function of increased demand from their end customers.

Yes, of course.

Okay, thank you.

Ajay Kejriwal, your line is now open.

Thank you, and good morning.

And, Scott, congratulations.

Good to see the organic growth rate come through here.

So maybe talk a little bit about some of the work that's being done.

I'd imagine a lot of it is blocking and tackling business by business.

But then to the extent there are initiatives at the corporate level, be it in terms of what you're doing with incentive structure and maybe other initiatives.

Just give us a sense of what to expect, and the work that you're doing to drive organic growth.

Yes, sure.

So we are -- as I said in my comments, we are still another three or four quarters away from being able to bring the majority of our focus to the organic growth component of the strategy.

We've talked I think to a significant degree in the past about in the end, what makes all of this work is we believe to ultimately move our organic growth rate up.

On historical basis, we're talking about a percentage point or so of improvement relative to history, so we're not talking about a huge step up, but a meaningful one.

Right now, what we're doing is trying to manage these internal initiatives related to our structure, related to sourcing in a thoughtful way to pace the implementation of those.

In such a way that our businesses continue to able to deliver for their customers and deliver for our investors.

We've probably got another three to four quarters of some pretty significant activity in that regard.

So from our organic growth standpoint, I think largely what we've accomplished to date is I think we've got the management team fully aligned around the fact that in this reshaped portfolio we have these highly differentiated businesses.

That all have significant potential to drive organic growth through innovation and penetration.

I think that part is very clear across our management team.

Heading into 2015, we will be doing some work on incentives to get that further flushed out.

So, in 2015 and beyond, we will continue -- we've already made some adjustments.

We will continue to make some more.

But I think this is largely an issue for us of focus and execution.

With a much higher quality portfolio, that ultimately has more inherent potential to grow organically.

Good.

then, enterprise initiatives, obviously very, very impressive margin gains here.

And without taking any of the thunder away from the December meeting, maybe just talk about which innings you are in terms of savings from BSS and then sourcing?

Well, I think the way I would answer that, Ajay, is that we're in the end of year two of a five-year plan that we've said all along has been -- that we're expecting fairly comparable improvements year-by-year as we go through the plan.

I think a couple of years in, we have some better thoughts and visibility on where we think we're going to end up in 2017.

And we're going to build the December meeting around sharing some views on that with our investors.

Okay.

Thank you.

Andy Casey, your line is now open.

Thanks.

Good morning, everybody.

Morning, Andy.

If we could go back to the enterprise initiatives for that last question, you've increased your 2014 operating margin guidance by about 100 basis points through the year.

Now at 20% versus initial 19%, and you're at the bottom range of the longer term 2017 goals.

If you're focusing on returns in the next three to four quarters before you really transition to the organic growth, are we talking about more than 200 basis points left in your view?

Andy, this is Michael.

We're not ready to go down that path just yet for a number of reasons.

One, we'd like to give you the full picture when we get to our Analyst Day on December 5th that you are, of course, invited to.

The other thing I'll tell you is this is annual plan season for us right now.

And so all the businesses are working through their plans for next year, and we'll be able to share a much better view of what this might look like in terms of the landing spot for margins and returns at the end of the five-year enterprise strategy, as well as provide some detail on 2015.

But what I would just echo what Scott just said.

That we expect all our businesses to continue to improve, and get a little bit better every year on operating margins.

And you should expect us to describe that in more detail when we get to the Analyst Day on December 5th.

Okay.

Thanks.

At least the question was good for some laughter in the background.

Thank you for that.

You're welcome.

Thank you.

Going the Q4 organic growth guidance for growth moderation.

Just to clarify that, Michael, is that mainly driven by comparisons, and not trend deterioration?

Yes, that's correct.

And so if you look at the growth rates last year, we were up 3% organically in the fourth quarter.

We were up 1% organically in the third quarter.

We talked about Test & Measurement, in particular, having a more challenging comp.

And then maybe a little bit of a decline in auto builds as well, so that's all factored into our guidance.

But like I said, we haven't seen any deterioration here in terms of our segments.

Thank you very much.

John Inch, your line is now open.

Thanks, good morning, everyone.

So Polymers & Fluids, what was the PLS drag in that segment?

I forget what you said, if you actually called that out.

Do you think, on the top line?

About 2 percentage points in that business.

So, a little bit more than some of the other segments.

Michael, you said, also, I think you or Scott said that you expected the associated drag to lesson in that segment through 2015, if I'm not mistaken.

When do you think overall -- do you think PLS is going to drag the Company's organic at a 1% cadence through 2015, or do you expect the other segments to realize a lessening as well?

I think a conservative expectation would be a 1% drag all of next year, and then largely we've got it behind us.

We may get ahead of it a quarter or two ahead of that, but I think that would be the planning assumption for now.

So is there a -- I assume there's a degree, Scott, of flex in that.

In so far as, maybe naturally it lessens, but then you want to keep it at the 1% to accomplish the enterprise initiatives?

Is that the way to think about it?

In other words, it might naturally lessen, but then you might redouble efforts to bring it back to the 1%?

No, I think most of this is really -- I would describe as in terms of the impact at this magnitude, I would describe it much more as a one time event.

This is really about reshaping the portfolio.

So we did it at the macro level in terms of the divestitures and refocusing the Company.

And what's going on now is really about driving that same principle down into the operating businesses.

So it's exiting product lines that don't carry the level of differentiation that we think are appropriate for our strategy, or exiting small volume small product lines in these scaled up divisions.

So, this is much more of a one time event over a six or eight quarter period of thoughtful repositioning and refocusing of our portfolio.

And we're not trying to pace it.

We're going as fast as we need to go through it.

That makes sense.

So just also the [crullery] is, in theory, you would say well PLS then ebbs beyond 2015 and we get a 1 point boost.

But shouldn't you, in theory, get more than one point, because there's less distractions spread over less robust product lines or whatever the terminology used is?

I won't necessarily apply it on a percentage basis, but a major component of PLS is to get us focused on the stuff that we really have a lot of conviction about.

Being able to grow at the kind of earnings and returns profile we think are appropriate for the Company long term.

So there's an element of this that's certainly margin and return related, but it's equally important from the standpoint of the organic growth accelerations we forward.

In terms of getting us focused on the major product lines where we have major positions in industries that we really think are the right ones for the Company.

And then, Scott, one of the phenoms in the quarter has been just the significant downshift in the price of a barrel of oil.

Presumably, you've looked at this.

It possibly touches a little bit of Welding.

If oil stays around the $80, $85 mark, what do you think the impact is to ITW really if anything?

I actually can't answer that.

We haven't spent a lot of time studying that one at this point.

If it stays down there for another quarter or two, we'll certainly have a more up to date view, a more thoughtful view on it.

But right now, I think it's just something that's moving around but not really driving much change in our business on the ground right now.

So if there was a more significant direct impact, I presume you would have been studying it by now.

Would that be a fair characterization?

Yes.

Thank you.

Joe Ritchie, your line is now open.

Thank you.

Good morning, everyone.

And welcome, Aaron.

My first question is on -- so thinking about the enterprise initiatives and the 100 basis points in benefits that you're expecting to see in the out years, is it fair so say that you're going to see a disproportionate amount from the segments today that are below that 20% threshold.

Because, I guess, as we exit 2014, you're probably going to see at least four of those segments, four of your segments, above the 20% range.

So I'm just curious to hear how you're thinking about it.

I think, like I said, we expect all of our businesses to continue to improve every year.

And just add to that, that some businesses are a little further along than maybe others.

So, if you look at the Welding business, in terms of the enterprise initiatives, maybe a little bit more further along on the enterprise strategy.

And the ability to now focus on organic growth, versus some of the other initiatives.

But overall, I think we've said before, that we expect all of our businesses to reach 20% plus over time.

And, like I said, we expect all of our businesses to continue to improve a little bit every quarter every year.

Okay.

And I guess maybe my one follow on is really, you guys do a nice job of breaking out where you're spending your restructuring spending.

And it looks like in the most recent quarters, you've been spending in Auto and in Food Equipment.

There's been recently some concerns that the auto markets are going to de-accelerate as we head into next year.

And clearly, that's been a big driver for you guys.

And so just any commentary around where you're spending on restructuring, and any view on the auto markets would be helpful.

The restructuring basically follows our BSS initiatives.

There's really no particular bent to it based on end market conditions.

In terms of where we've been deploying that spending over the last couple of years.

From an auto perspective, I think we are certainly in a position to absorb some modest slow down in that market.

We have, in terms of the penetration gains that we have been delivering for the last 8 to 12 quarters now, it's the one part of the business where we have three years of essentially forward visibility in terms of new programs that we've got.

So we've got a pretty good pipeline of new content coming in.

Certainly, tailwind is better than headwind.

But from a can we still operate and generate some really solid organic growth even if the market slows down or flattens out on us, I think we're in good partly position to do that.

Okay.

Thanks, guys.

Eli Lustgarten, your line is now open.

Good morning, everyone.

Can we just follow up your last comment, talk about the Automotive.

You said three years visibility.

The gains in Europe from penetration was absolutely spectacular.

Can you give us an idea of what kind of things we can expect or some color on what we can expect over the next 4 to 6 quarters?

As you said, you had the 8 to 12.

Are they going to stay at the same rate, or can you give us some way of calibrating the penetration gains that we see for the next -- through 2015 and 2016?

I think we've been running at a 4 to 5 percentage point over market growth kind of rate, and I think a good expectation would be for us to be able to continue that.

So it's sustainable at least well through 2015?

Yes.

I'm sorry?

We believe so, yes.

The second point, sourcing and better buying is a big part.

And I guess this year, everybody has been blessed with the fall of [input costs], particularly material prices going online.

Is there any way for you to give us some idea of the benefits of the actual end market -- drop in commodity prices and how that's benefiting your Company versus the initiatives, or get some idea of how you're leveraging that at all?

The way we report it externally is, we give you the price cost metric.

And that has been favorable all year, every quarter, about 10 basis points of price ahead of cost.

And so, that continues to -- I think at this point, we'd describe the material environment as fairly benign.

There's a couple of outliers.

But overall, I think all businesses are doing a good job offsetting material price inflation with price.

On the sourcing side is the bigger contribution to the over 120 basis points of margin expansion.

And while we don't break it out between BSS and sourcing, what I will tell you is that we were very encouraged by the progress that we're seeing on the strategic sourcing side.

And you see it in our variable margins, or our gross margins, with 100 basis points of improvement that we believe is sustainable.

So I think that's how we'd answer your question.

And the bulk of it is coming from the sourcing side at this point, would you guess?

So, we don't break out the [123] at this point.

We don't break it out.

But like I said, we're very encouraged by the positive momentum on the sourcing side, and we expect that to continue.

All right.

Thank you very much.

Joel Tiss, your line is now open.

I didn't think I was going to make it, thanks.

How is it going?

As you guys move through the 80/20 and the simplification and other things that you're working on, are you -- can you just give us a sense of how -- I know you're not looking at acquisitions yet.

But can you talk a little bit about how you're seeing opportunities in that front to fill in different product lines?

And maybe how the philosophy in the future around acquisitions would end up changing instead of buying fixer uppers?

I think we would plan to spend some time on that in December if we can defer answering that question, Joel, until December.

I think as Michael said before, we'd like to be able to talk about that with all of you and our investors in a way that's more comprehensive than a quick answer.

So, it's not too early?

That was the other part of the question.

It's not too early for you guys to start thinking about acquisitions.

There's a lot of stuff on your plate obviously.

Well, I think it's a matter of where do acquisitions fit in our strategy.

I think that's ultimately what we want to talk about, and certainly it's not a matter of wherewithal from a financial standpoint or it's not a matter of capability.

We know how to acquire companies, but ultimately where they fit in our strategy on a go forward basis is a different place than where they fit historically at ITW.

Okay.

And then just lastly, there's no reason to look at the $500 million of share repurchase in the fourth quarter as a sign that things are slowing down a little bit or that there's any concern in the operations?

No, no, I don't think how you would draw that conclusion.

I think we said that we were going to be opportunistic in terms of share repurchases in the second half of the year.

We started out the third quarter with $500 million, and in the fourth quarter we expect to spend at least another $500 million on share repurchases.

So, there's no change in terms of our view of how attractive the share repurchases are, and therefore, we're continuing obviously.

All right.

Thanks very much.

Stanley Elliott, your line is now open.

Thank you guys for fitting me in.

I hate to go back to the Welding business, because there are so many nice things to talk about in the quarter.

But as it relates to the oil piece, could you quantify how big the end market is for Welding in general?

About 20% of our North American business.

It's fair to say though, that when you talk about the general environment, a lot of the growth that you were seeing was more the industrial production, the general fab, which is a significantly larger part of the market, if I'm not mistaken.

Is that correct?

Yes.

Great.

Thank you very much.

Steve Fisher, your line is now open.

Thanks, good morning.

I may have missed this earlier, but can you just discuss the direction of the various components of your business in China?

How they were moving in different directions, or were they all up?

So basically, we saw the Automotive business lead the way, up 12%.

Food Equipment, also up double digits.

Which really says a lot about the acquisition that we did, and how good a job the team has done in terms of integrating that acquisition.

So we're now benefiting from organic growth rates in Food Equipment in China of solid double digits.

Polymers & Fluids had a good quarter, up 5%.

The others are fairly small.

The main drag really was what Scott talked about in terms of oil and gas pipeline projects being deferred in China.

So that business was down.

But other than that --

Which was Welding.

Which was on the Welding side, sorry.

But other than that, we had a good quarter again in China.

Okay, great.

Thank you.

Schon Williams, your line is now open.

Hello, good morning.

Morning, Schon.

I wanted to maybe come back to Food Equipment again.

The incremental margins in that business, significant acceleration there.

Certainly, you've talked about new products.

Can you just help me understand I guess how much of the margin expansion was volume related versus new product introductions?

And then should we start thinking about this business being a 20% to 25% margin business going forward, or was there anything one-timish in the quarter that is unlikely to repeat?

No, there was nothing unusual in the quarter, other than really solid execution and organic growth.

So, to answer your question specifically, if you look at the 270 basis points of margin expansion, in Food Equipment in the quarter, 150 of that came from the initiatives.

So, the work around BSS and sourcing.

And 120 basis points from the operating leverage on the organic growth.

But really just having Scott described it very well in terms of the performance of that business, and we think it's very sustainable on a go forward basis.

All right, thank you.

And then, just a little housekeeping.

The other income came in quite a bit higher than what I would have expected, given the run rate the last couple of quarters.

Can you just talk about what the variance was there?

Yes, it was primarily interest income.

Perfect.

Thank you, guys.

Jim Krapfel, your line is now open.

Hello, good morning.

So just on price cost, I imagine a lot of your raw material costs have come down recently.

And just like to get your comments on the extent of that going forward, and then also your ability to hold and increase pricing from here.

So, I would expect us to continue to be favorable on the price cost side of things.

So, we saw 10 basis points in this quarter, and it's probably going to be in that range for the fourth quarter.

But as these businesses now are working to become more and more differentiated in terms of adding value to customers, you're obviously going to have more leverage from a pricing standpoint.

But I wouldn't expect that just yet.

But nothing has really changed in terms of our ability to continue to get price in all of our businesses to offset costs.

Okay.

Thank you.

(Operator Instructions)

Our next question comes from John Inch, your line is now open.

Hello.

So, just in terms of follow-up, it's more of a big picture question.

Scott, ITW historically has never really been managed on a geographic basis.

Now that you've been CEO, clearly enterprise initiatives have a lot of traction and momentum.

The Company has made a lot of structural changes.

Are you thinking perhaps any more about managing the Company as a bit of a portfolio in so far as your geographic exposures are concerned?

I'll give you an example.

So China, you've done pretty well, but there seemed to be significant -- there's an expectation that China could slow in the coming years.

So I don't know how that could represent your business, as it may be pro or con, but how does it affect corporate in the way you're looking at the world?

That's just one example.

There could be lots of others.

I think where we are, and we've done a lot of thinking about this is, is really the most important decision that we make for the Company and our shareholders is what businesses should we be in.

And geography is, in our view, a secondary condition to our thinking around what businesses should we be in.

So we want to be in great businesses that are highly differentiated.

And if you look across the portfolio that we've assembled, we've got two $1 billion plus businesses, highly differentiated in terms of the things they do for their customers.

Those two $1 billion businesses are in front of $10 billion or $20 billion global markets.

So lots of room to move.

But that ultimately is a much more important decision.

Each of those businesses then has a range of geographic opportunities, but ultimately I wouldn't put the geography ahead of the quality and the overall attributes of the business.

And based on that, I think we're set up the right way.

So would that imply, Scott, that from a geographic standpoint, things are probably going to be as they are in the ITW of the future?

You'll always still have a big slug out of Europe, possibly a little bit less penetration than other multi-industry companies in emerging markets?

Or is there something else based on the way the portfolio almost somewhat naturally plays out based on your commentary that would cause for some sort of a shift over time?

I would overall expect that our that on a percent of revenue basis that it would continue to tilt much more towards a -- not much more, but sequentially more towards emerging markets just based on the underlying growth there.

But ultimately, we make a lot of money in Europe, we make a lot of money in North America.

We have great opportunities to grow in those geographies.

And ultimately, our investments in emerging markets from our standpoint have to stand on equal footing from the standpoint of returns and profitability with our businesses all around the world.

Great, thank you.

We'll take one final question.

Thank you.

David Raso, your line is now open.

Yes, good morning.

Just a quick question thinking about incremental margins for next year.

I know pension has been a help this year, that's been really more of just an absence of some of the curtailments you had last year.

But I'm just trying to think of the puts and takes for next year.

I know you're not going to want to give us too much granularity.

But are there any items that we should be thoughtful about?

Obviously, the enterprise initiatives, but pension, just anything else that we can think through on the modeling?

The last two quarters obviously incrementals have been over 75%.

I'm assume that's not the baseline for next year.

But just trying to get a feel for the puts and takes.

Well I think the way I'd answer your question, David, is that if you look at ITW historically, incremental margins, excluding initiatives, have been in the 30% to 35% range.

And when we're done with the initiatives, we'd expect to be at the high end of that, if not a little better.

But we still have a lot of working on, a lot of margin expansion to come from these initiatives in 2015 and beyond.

So, I can't at this point -- or I should say, I don't want to give you at this point an incremental margin [structure] for 2015.

This will be part of -- when we all get together in December, we'll be happy to give you our best view at that point.

Can I take that to mean that outside of the initiatives, a historical baseline is the way to think about it?

I'm just trying to make sure we're not missing some thoughts maybe you already have around your pension or just any other items maybe we're not thinking through.

So, obviously, without getting into, again, there are small pieces of a bigger puzzle.

But since you're asking specifically, pension has not been a tailwind for us this year in a significant way.

And we don't expect it to be a significant headwind in 2015.

The other item that is maybe worth talking about is currency.

We called out $0.04 of headwind here in the fourth quarter, which we believe is very manageable.

There could be some headwind from currency in 2015, depending on where rates are at the time.

But again, we think that's very manageable at this point.

All right.

I appreciate it.

Thank you very much.

Thanks, everyone, for joining us on today's call.

And we look forward to talking to all of you at some point in time.

Thank you.

This concludes today's conference call.

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