Illinois Tool Works Inc (ITW) 2014 Q4 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'll turn today's meeting over to Aaron Hoffman, Vice President of Investor Relations.

Thank you, sir.

You may begin.

Thank you.

Good morning and welcome to ITW's fourth-quarter 2014 conference call.

Joining me this morning on our call are CEO Scott Santi and Michael Larsen, our CFO.

During today's call we will discuss our Q4 and full-year financial results and update you on our earnings forecast.

Before we get to the results, let me remind you that this presentation contains our financial forecast for the 2015 first quarter and full year, as well as other forward-looking statements identified on the slide.

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

Also this presentation uses certain non-GAAP measures . A reconciliation of the non-GAAP measures to the most comparable GAAP measures is contained in the press release.

With that I will turn the call over to Scott.

Thanks, Aaron, and good morning.

Overall we were pleased with our performance in the fourth quarter and for the full year as we continue to execute well on our enterprise strategy.

In the fourth quarter, earnings per share came in at $1.18, which was an increase of 28% versus Q4 of last year and $0.07 above the midpoint of our forecast.

This above-forecast earnings performance was driven primarily by margin performance that came in at the high end of what we expected heading into the quarter.

Q4 operating margin improved 190 basis points year-on-year with 120 basis points of that improvement coming from enterprise strategy initiatives.

Organic revenues in the quarter were up 2.3%, largely in line with our forecast with ongoing product-line simplification activities reducing organic growth by roughly 1%.

The quarter capped a solid year for ITW.

For the full year, earnings-per-share increased 29%; operating income of $2.9 billion and operating margin of 19.9% were both all-time records for the Company.

After-tax return on invested capital improved 260 basis points to 18.9%.

In 2014 we made significant progress on the execution of our strategy as we simplified the Company through our business structure simplification initiative and generated cost savings from our strategic sourcing initiative that exceeded our plan.

We also completed the heavy lifting with regard to divestitures associated with our portfolio management initiative while our divisions continued to be very active in refining and narrowing the focus of their business portfolios through the implementation of our product line and customer base simplification initiatives.

Free cash flow was strong in 2014 and came in at 110% of adjusted net income.

Through the combination of our strong free cash flow and divestiture proceeds, in 2014 we were able to return a record $5 billion to our shareholders in the form of share repurchases and increased dividends.

In summary, ITW's unique and highly differentiated business model is delivering strong results as we continue to execute our strategy.

As we enter year three of our five-year plan, we are well positioned to deliver another year of solid progress in 2015.

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.

I'll now turn the call over to Michael.

Michael?

Thank you, Scott, and good morning, everyone.

Starting with the financial summary on page 4, fourth-quarter EPS was $1.18, an increase of 28% versus prior year.

The EPS number included $0.04 of currency related headwinds versus prior year.

Enterprise initiatives contributed 120 basis points of margin expansion and led to operating margin of 19.6% and operating income of $686 million.

Also good progress on the after-tax return on invested capital metric with an improvement of 220 basis points to 18.6%.

Revenues were $3.5 billion, up 2.3% organically after the expected 1 percentage point impact from product line simplification.

Foreign currency translation reduced revenues by 3.5% resulting in total revenues declining 1.4%.

Cash generation was as expected with free operating cash flow conversion at 124% and we allocated $800 million to our share repurchase program in the quarter.

The ending diluted share count was 386 million.

Overall we were pleased with the results in the quarter and the positive momentum going into 2015.

Turning to revenue by geography, organic revenue was up 2.3% with positive growth in all major geographies.

North America up 3% as a result of strength in welding up 10%; Food Equipment up 5%; and automotive OEM up 4%.

International growth was stable, up 2%, with Europe up 1%, driven by automotive OEM up 12% and Food Equipment up 5%.

Asia-Pacific and South America were both up 2%, with China up 4% on strength in automotive OEM, Food Equipment and Test & Measurement & Electronics up all 10%.

So 2.3% organic growth after the ongoing product line simplification activities that reduced organic growth by roughly 1% in the quarter.

On page 6, operating margin exceeded our expectations going into the quarter as solid execution on the enterprise initiatives led to an operating margin of 19.6%, an increase of 190 basis points from last year.

Margin expansion was broad-based with six of seven segments expanding margins by more than 100 basis points in the quarter.

On the right side you can see the key drivers of the margin expansion with the largest contribution 120 basis points from enterprise initiatives.

Operating leverage was 60 basis points and price cost was favorable for a total of 190 basis points of margin expansion.

So overall, solid progress on operating margin and we continue to have significant potential to further leverage the enterprise initiatives and expand margin as we move forward.

On page 7, the 2014 financial summary, just a couple of the highlights to recap the year and set the stage for 2015.

Earnings-per-share of $4.67 increased 29% over 2013, with operating margin and operating income at all-time highs.

Operating margin of 19.9% improved 210 basis points with 120 basis points from our enterprise initiatives.

Organic revenue growth was 2.6% and in our expected range of 2% to 3%, and throughout the year PLS reduced revenues by about 1 percentage point.

Cash flow was strong with 110% cash conversion and we returned over $5 billion to shareholders, $4.3 billion in buybacks and $700 million in dividends across the key financial metrics, solid performance and positive momentum, going into 2015.

Turning to the segments, let's start on the left side with full-year segment results for organic revenue growth and operating margin improvement.

As you can see, good progress on margin improvement across the board with more run rate from enterprise initiatives in 2015.

In the automotive OEM segment, another good quarter and a solid year.

Organic revenue in the quarter grew 7% compared to worldwide auto builds of 1%.

By geography, European organic revenue stood out, up 12% with new products and strong penetration gains across all platforms.

In North America, our growth was in line with auto builds at plus 4% as, at the Detroit three where we have above-average content, builds actually declined 4% versus the prior year.

In China we outperformed auto builds by 4 percentage points.

Profitability also improved, with operating margin of 22.3%, 190 basis points improvement from last year.

We expect automotive OEM to continue to outperform auto builds in a meaningful way and the segment is well positioned for another solid year in 2015.

In our Test & Measurement & Electronics segment, organic revenue decreased 1% in the quarter primarily due to challenging comparisons in Test & Measurement where organic revenues declined 4%.

The Electronics business increased organic revenue by 5% as the Electronic assembly business grew 11% in the quarter.

Operating margin declined slightly due to higher restructuring in the quarter.

Continuing its strong performance, Food Equipment's organic growth rate of 5% was broad-based across the major product categories and geographies.

In North America, Equipment organic revenue grew 6% driven by new products and penetration gains in refrigeration and cooking.

Internationally, Equipment revenue increased 6%, driven by strong warewash and refrigeration sales of service organic revenues increased 2%.

The segment's operating margin of 21.7% was 220 basis points higher than the prior year.

So, a solid year for the Food Equipment Group and significant positive momentum going into 2015.

In our Polymers and Fluids segment, organic revenue increased 1% and operating margin expanded by 150 basis points as this segment continues its progression to 20% plus operating margin.

Automotive aftermarket had a good quarter up 2%; Polymers was flat with fluids and hygiene declined 2%.

The welding segment had a solid quarter with organic revenue of 4% driven by continued strength in North America, where organic revenue increased 10% due to demand in both industrial and commercial end markets.

International organic revenue was down as a result of a challenging year-ago comparison and continued product line simplification in Europe.

Welding delivered another 230 basis points of margin expansion this quarter, bringing the margin to 25.4%.

The Construction Products segment produced organic revenue growth of 2% in the quarter.

Enterprise initiatives drove 190 basis points of margin expansion this quarter.

But as you saw in the previous slide, construction is now at 17% for the year, an increase of 310 basis points versus prior year and well on its way to 20 % plus on a sustainable basis.

North America was up 8% with growth in renovation and commercial offset by decline in residential.

Asia-Pacific increased 1% for the quarter and Europe organic revenue was down 4%, largely due to continued product line simplification and weakness in France, offset by strength in the United Kingdom.

In the Specialty Products segment, organic revenue was down 3%, as a 5% decline in consumer packaging was offset by growth in appliance and ground support equipment.

Operating margin of 19% was 110 basis points higher than the year-ago period.

That wraps up our segment discussion.

And turning to our guidance for 2015, and the first quarter, our EPS guidance for 2015 has not changed since our December investor meeting.

We are maintaining our annual EPS guidance of $5.15 to $5.35, an increase of 12% at the midpoint.

Let me walk you through some of the key assumptions included in our guidance, starting with 2.5% to 3.5% organic revenue growth in line with current run rates and what we communicated in December.

As expected, PLS remains a 1 percentage point drag throughout the year.

Total revenue is expected to be down 1% to 2% as a result of the impact of foreign currency translation which creates a 4% headwind at current rates.

As for 2015 operating margin, we expect enterprise initiatives to contribute an additional 100 basis points of improvement which will get us to approximately 21% for the full year.

Our guidance today reflects current exchange rates which creates $0.25 of EPS headwind, up from $0.15 when we met in December.

As we sit here today, we expect a positive momentum that we've generated with our enterprise strategy to offset this increased headwind.

However, exchange rates remain highly volatile and we're keeping a close eye on the situation.

The other topic likely on your mind is the potential impact of lower oil prices.

As discussed at our December meeting, ITW revenues into the oil and gas industry are only in the 2% to 3% range and primarily in the welding segment.

We continue to expect that any potential reduction in revenues from oil and gas related end markets will be offset by lower input costs for raw materials such as chemicals and resins, as well as lower transportation and freight costs.

Overall, we continue to expect that this will be a net neutral for ITW.

A couple of housekeeping items include an expected tax rate of 30% to 31% and restructuring in the range of $70 million to $80 million for the year.

Finally, on capital allocation, free operating cash flow conversion is expected to exceed 100% and we expect to allocate approximately $1.5 billion of our free cash flow to our share repurchase program in 2015.

So for the year, maintaining guidance and well-positioned to deliver another year of solid progress towards our enterprise performance goals.

For the first quarter, we expect EPS to be in the range of $1.13 to $1.21, an increase of 16% at the midpoint of $1.17.

This includes $0.07 of EPS headwinds from currency at current rates.

Organic revenue growth is expected to be 2% to 3% and our enterprise initiatives are expected to generate about 100 basis points of margin expansion in the quarter.

Finally, share repurchase is expected to be at least $500 million in the quarter.

In summary, the positive momentum and strong execution in ITW's enterprise initiatives puts us in a solid position as we enter 2015.

We expect 2015 to be another year of strong progress that keeps us firmly on track to deliver on our 2017 performance goals.

With that, let me turn it back over to Aaron.

Thanks, Michael.

We'll now open up the call to your questions.

Please be brief, so as to allow more people the opportunity to ask a question.

And remember our policy of one question and one follow-up question only.

So with that, let's turn to the questions.

Thank you.

(Operator Instructions)

Joel Tiss of BMO.

It looks like you're reaching or you're moving toward your 2017 goals a little faster than expected.

Is there more benefit you're getting from your initiatives or do you think you're going to finish early?

I'm just trying to -- are you going to have to enhance your plans as we go down the road?

I'm just trying to understand what's going on at the operating level.

The way I would characterize it is I think we are largely on track.

We did update our margin goal in December for 2017 to be in the 23% range.

That 's certainly reflective of the progress generated to date and also what we see ahead in terms of additional opportunity around these initiatives.

But again, I think we are largely where we expect to be executing and making progress quarter by quarter and still remain on track with what we set out to do two years ago.

All right.

Thank you.

Andy Kaplowitz, Barclays.

Nice quarter.

Scott, you talked about welding a bit or you guys talked about oil and gas a bit within welding.

But it was up very strong 10%, and we know oil and gas spend will slow, but you've also talked in the past about it being more downstream and midstream.

So as we look at welding in 2015, can you give us a little more clarity about what you think the non-oil and gas businesses will do?

And then maybe have you gotten more color since the December Analyst Day on what you think oil and gas will do in the business?

I would say relative to the second part of your question, we haven't seen any real noticeable change in terms of buying behavior out of the oil and gas segment to date.

That certainly doesn't mean we don't expect there to be some impact from that as we go forward.

But on the ground in the fourth-quarter we didn't see any significant change relative to the run rates that we had from the oil and gas sector heading into the quarter.

On an overall basis for 2015, I think what we saw that was encouraging was some noticeable improvement in demand in North America through the back half of the year.

Given, certainly, the volatility of the current environment, I don't know that we have anything that we would say is leading us to believe that that won't continue as we go forward.

And so I think we're pleased with the momentum that's been building there and expect it to continue at a moderate level through 2015.

Scott, let me back up to your last response and ask you in general, you mentioned the volatility of the markets.

You can see some of the other guys report in what they're doing.

But you guys have been doing pretty well.

It looks like Europe is holding up for you, but it's pretty heavily weighted toward your auto outperformance and Food Equipment.

So is there a way to characterize what you see in the different geographies, specifically Europe and the US?

Did you see any change in order patterns throughout the end of the year last year and as you started here in January?

Or is it just steady as she goes and we can expect the outperformance that we usually get from ITW?

Well, the answer to that is we really haven't seen any change.

From an overall demand standpoint, in Q4 I think things held up pretty well, right in line with our expectations.

Certainly consistent with Q3 run rates.

So as we've talked before, our planning is built on demand that we're actually seeing on the ground and as it relates to Q4, things held up pretty well.

Certainly on track again with expectations and consistent with Q3 run rates.

Okay.

And throughout Europe as well in major businesses?

Yes.

Thank you, guys.

Jamie Cook, Credit Suisse.

Nice quarter.

A couple questions.

One, within the Construction Products division, the North America up 8% driven by renovation in commercial was encouraging.

You guys have been less optimistic on commercial construction, so can you talk about any change in your outlook?

Does this get you more excited in what you think potentially the effect of energy is on the construction business?

And my last question, I'm sorry if I missed it.

What is your assumption on price cost?

You talked about some of the tailwinds that you could get from resin chemicals, et cetera.

Has that changed relative to your December Outlook meeting?

Thank you.

Let's start on the construction side.

If you look at the total segment, we were up 2% in line with what we've done really throughout 2014.

And so we've been growing in the low single digits in the construction segment and we're not expecting things to improve much as we go into 2015.

Certainly there are some encouraging headlines, but we are not counting on it as we go into 2015.

North America was up 8%.

We saw some strength in renovation.

Some slight growth on the commercial side.

And then a decline in residential.

So I wouldn't get too excited about the number of North America up 8%.

We expect this to continue along with the run rates that we saw in 2014, so low single-digit type growth is how we would characterize the construction in North America, with some optimism given some of the headlines.

On the price cost side, we had 10 points of favorability in 2014.

That is still our base assumption for 2015, but clearly as we talked about the impact of lower crude oil prices and what that may mean to our purchase of chemicals, resins, certainly our transportation and freight costs, we would expect, as those savings come through, to see an improvement in our price cost metric.

For now, we are holding on to the base assumption here of 10 basis points favorable and we'll keep you posted as we go through the quarters.

All right.

Great.

I'll get back in queue.

Andy Casey, Wells Fargo Securities.

Question on -- it's a specific question, but in North America, did you see any benefit in any of your business from the late passage of the Section 179?

No.

I think as we went through the quarter here, this behaved in line with our expectations.

We had a strong finish in December but we always do.

And so there was really nothing unusual about the fourth-quarter as it unfolded.

Okay.

Thank you.

And then as you look at Polymers and Fluids going through 2015, are you expecting a full year pretty consistent impact from PLS initiatives or does that taper off as you go through the year?

I think that's as it relates to that segment specifically, they have been doing some real heavy lifting with respect to PLS and are getting close to getting to the end of that process.

So we would expect that to start to dissipate here as we move through 2015.

Okay.

Thank you very much.

Ajay Kejiwal, FBR Capital Market.

Scott, just maybe on the enterprise initiatives, I know you gave relative detail at the December meeting.

Maybe an update on BSS in terms of what are some of the major items, things that you would be looking to achieve through the course of this year?

And then also on sourcing, does the recent moves in commodity pricing, does that help with how you think about the sourcing gains through the course of this year?

The connection was a little staticy, so I'm going to -- I think the questions related to some commentary around where are we with respect to BSS execution.

And the second is around sourcing impact relative to lower energy prices and the impact those might have on commodities.

Regarding BSS I think we continue to make good progress.

I've been very pleased with both the quality and the pace of execution.

There's been a lot of moving parts inside the Company in support of this initiative and our mantra from day one with our divisions was that we had a lot of important work to do but ultimately we are going to do that in a way we didn't impair our ability to serve our customers or deliver for our shareholders throughout.

And I think we've largely been able to sustain that from day one.

It is a five-year process, and we're certainly heading into year three of that.

I think organizationally, we've got the organizations that we want in place but we are still doing a lot of work down at the individual division level in terms of plant consolidation, facility consolidations, and really getting these businesses in a position to fully operate as single entity global divisions.

That work continues.

I think we're well on track, but we have a fair load of work still to do in 2015 and probably a decent amount in 2016 on that as well.

As it relates to on the sourcing side, any energy savings that accrue this year would be not something we would talk about as it relates to our sourcing initiative.

That would be reflected in our price-cost reporting.

Sourcing initiative is much more around permanent changes in structural costs as a result of a much more focused 80/20 driven effort around improving the efficiency through which we source raw materials.

So as Michael talked about earlier, there is certainly some potential for some benefit on the input cost side related to lower energy prices.

But that is something that we would not report as part of our sourcing initiative.

We would talk about that as a price-cost benefit as we move down the road.

That's very helpful.

Michael, on FX, can you talk about hedging, how you think about your FX exposures, how much is naturally hedged versus through contracts?

Thank you.

So, Ajay, I'd maybe reiterate on the sensitivities around foreign exchange.

And when we were together in December we gave you a rough rule of thumb -- we gave everybody a rough rule of thumb that said $0.01 change in the euro versus dollar rate equates to $0.01 of EPS on an annualized basis.

And obviously since then the euro has weakened versus the dollar to the tune of about $0.10 and so that's the $0.25 of headwind that we talked about now versus the $0.15 in December and obviously all currencies are moving, so this is a rough rule of thumb.

In terms of hedging, we are well-hedged naturally.

So we are a Company that manufactures in the regions that we sell into and so this is really just a translation impact for ITW.

There are no mismatches in terms of revenues and costs.

No structural issues, to speak of, that need to be addressed here.

And so beyond that, we're all looking at the same currency rates.

We've told you what the sensitivities are and we are -- in terms of operationally, our view hasn't really changed.

The way we run the Company hasn't really changed but obviously the way we report our earnings when we consolidate them back into the US are impacted by currency.

But we are not a hedger of translation risk here.

That's correct, yes.

Thanks for the color.

Walter Liptak, Global Hunter.

Good quarter.

Wanted to ask about the welding segment, and if you could break out the North America and give us some indication of price versus volume?

We typically do not go into that level of detail for competitive reasons, Walter, so we're not going to go there today.

I think there's nothing unusual here.

The plus [then] would be largely volume.

Yet.

Very similar to what we've seen in prior quarters.

Nothing unusual.

Okay.

Got it.

And then as another question, not a follow-up, but in the electronics segment you had that plus 11% growth.

I wonder if we can get some color on that?

The products that that was going into, the geographic regions and trying to get an idea if that's sustainable as you go further into 2015?

I think the increase you're talking about was in the electronic assembly piece primarily sold into Asia.

That business can be a little bit lumpy, so I wouldn't read too much into one or two quarters here.

We're certainly encouraged by what we saw in the third and fourth quarter, but the long-term growth rate here is unfortunately probably a little bit lower than what we saw in the fourth-quarter, probably in the low to mid-single digits in that segment.

Okay.

Great.

Thank you.

Rob Wertheimer, Vertical Research Partners.

Not to circle around again, but it sure seems as though the risk is to the benefit on the materials cost side, and we've had a long period of inflation that's flip-flopped in the last year or so.

Have you had more pushback that you're hearing from your sales staff on pricing, on getting any kind of pricing through?

Are they being asked for pass-throughs or is it really the net risk really does lean your way?

There's really been no changes in terms of how we look at price cost inside the Company.

And no increased pushback, to your question.

Okay.

Thanks.

Just real quickly on Food Service, curious about the general feeling in the market propensity to spend, whether you're seeing people do positive capital decisions or whether they're doing more replacement.

I'm curious about what you feel the restaurant market is like.

Thank you.

I think the environment overall is still -- I would certainly not describe it as a market with a lot of tailwind.

A lot of what we're benefiting from right now is a number of meaningful new product launches that are certainly giving us an extra 2% or 3% of organic growth.

I think that's the best color I can give you on it for now, is no big changes in demand over the course of the last year, but we've seen our own growth rate accelerate as we move through the year, largely because of some new product commercializations.

Thank you.

Steven Fisher, UBS.

The Test & Measurement segment was down on tougher comps in the quarter.

What do you expect there for 2015 and do you have any visibility to that showing some growth next year or this year?

If you recall in the fourth quarter, 2013, that business, Test & Measurement was up 8% or 9% organically.

9% organically.

And I think as we look forward into 2015, we expect similar to what we saw in 2014, so in the low to mid-single digits.

As Scott said earlier and we've said many times, in our guidance the way we model this is at current run rates -- so we'd expect Test & Measurement to be in that low to mid-single-digit type growth for 2015.

Okay.

Great.

Not sure if I missed it, but the China 4% growth in the quarter, how you see that playing out in 2015?

China for us is really primarily driven by the strong performance in our automotive business that continues to outperform in a meaningful way.

We also had, in the quarter, Food Equipment, primarily as a result of an acquisition we did a little over a year ago in that space, strong growth in Food Equipment.

And then we talked a little about the Polymers and Fluids business also being positive in China.

So the offset here is primarily similar to what we talked about in the third quarter is the welding business where we continue to see two things going on.

One is product line simplification where we've exited some business lines that didn't meet our thresholds from a margin standpoint.

And then some projects that are still being delayed in China.

So I would expect China -- if you look at China for the year, we've been mid-single-digit type growth rate and based on the continued outperformance in automotive and Food Equipment, we'd expect that to continue.

Great.

Thank you very much.

At this time we're showing no further questions.

Great.

Thank you, everyone, for your time today.

And we'll look forward to speaking to you all again very soon.

Have a great day.

Thank you for your participation.

That does conclude today's conference.

You may disconnect at this time.