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Illinois Tool Works Inc. (NYSE:ITW)

December 14, 2012 9:00 am ET

Executives

John L. Brooklier - Vice President of Investor Relations

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

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

David C. Parry - Vice Chairman

Analysts

Alexander M. Blanton - Clear Harbor Asset Management, LLC

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

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

Deane M. Dray - Citigroup Inc, Research Division

Brian K. Langenberg - Langenberg & Company, LLC

John L. Brooklier

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Ronald D. Kropp

Thank you, John. Good morning, everyone.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

We continue to have a strong balance sheet, a strong free cash flow. We expect to convert close to 100% of free operating cash flow this year. Our debt metrics are strong, debt to EBITDA of 1.4x, so we -- we're in a good position on the balance sheet even after returning a lot to shareholders this year.

So turning to revenue for a minute. So as you know at this meeting each year, we provide a forecast of revenue and we always look back and say, "Here's what we said, and here's what happened."

And so overall, what we said last year was we expected organic revenues to be 3% to 5%, we came in at -- we're going to come in at about 2% for the year. Why is that? North America was certainly on the high end of the range and performed a bit better than we expected. We said 4% to 5%, it's about 5%, and that's really been driven by growth in industrial production, growth in autobuild. A couple of businesses really contributed for us this year, the welding business, the Automotive business, the test and measurement business in North America.

On the Europe side, at this time last year, there was certainly a lot of uncertainty around Europe. We estimated that Europe revenues would be flat for the year. It's coming in for us at about negative 3% as the whole environment's been weaker, and that's really been across all of our businesses.

Asia Pacific was a big surprise for us and a lot of companies this year. We had estimated 5% to 6% last year. It's going to come in at about 1% this year, and a lot of that's tied to the weaker performance in China. This year, we expect our China revenue to be down about 1% organically.

So what do we see for next year? These are our regional growth assumptions for next year at the current time. Overall, we're expecting slowing growth, 1% to 3% overall. Again, a similar story, where North America, we expect to be stronger, positive 2% to 4%. Again, we expect Europe to be flat, and not that it's going to get that much better but we'll have easier comparables. And then Asia Pacific, we expect to be up 2% to 4%, with China performing better than they did in 2012.

In the appendix, we've included a lot of detailed financial information. And one of the slides back in the appendix is a breakdown by segment of the organic growth expectations for 2013, so I won't get into that here but that is there available.

So with that, I will take any questions.

Question-and-Answer Session

Ronald D. Kropp

Yes. Hold on, when we have questions, since we're on a webcast, we'll need to have a mic.

Unknown Attendee

As you look out to 2013 and your sort of flattish year opinion, we -- a lot of European companies are now going to short work weeks. Of course, that's -- and looking at particularly a very weak automotive market, and that's resulting in the government taking part of the salary. Are you -- one, assuming that you'll have any short work weeks going on in Europe, and flat -- I hope it's the right forecast, I have no idea, but is there -- that -- do you think there's more downside or upside to that, looking at and going out to Europe?

Ronald D. Kropp

So I think there's probably more downside risk. There are easier comparables certainly. We had more downside risk, I think, at this point last year. So do I think it will be potentially negative 3%? No. But certainly, there's -- there could be some downside risk depending on how they work through the various issues. From an economic situation, certainly, there's areas that are slowing, for instance, Germany. The way we're organized, we have a lot of decentralized businesses that are focused on particular end markets or customers, so they are able to react very quickly when they see things happen like short work weeks at customers and things. So certainly, I'm sure some of our businesses have reacted accordingly, whether it's through taking out shifts or shorter work weeks or even restructuring programs.

Unknown Attendee

And if I have -- a quick follow-up. Has your profitability been protected for '13 versus '12, given the conditions at this point? I mean are you comfortable that you'll be able to maintain, if not drive, profitability margins?

Ronald D. Kropp

Yes. And I mean, and we'll talk more about that later, but there's a lot of other things going on from an initiative perspective that we think can drive margin improvement even in a variety of different economic scenarios.

Alexander M. Blanton - Clear Harbor Asset Management, LLC

It's Alex Blanton from Clear Harbor Asset Management. The most uncertain thing going on now is what's happening in Washington with the negotiations on the fiscal situation. And yet, most companies are not even mentioning this in their outlook statements or analysis. They're giving us a forecast for next year when the economy is extremely uncertain for next year depending on what happens in Washington. So could you please give us a little insight into the company's thinking on this? What happens if there is no agreement, what happens to your revenues next year? And what happens if there is?

Ronald D. Kropp

Well, I think you're correct that, that is one of the biggest uncertainties for 2013 for most companies. And I think that the -- what we've modeled here in our forecast is really assuming that we get something done here somehow. And what exactly that looks like, it's hard to know. And what impact it has on the economy, it's hard to know. And the doomsday scenario of us not getting something done in Washington and in having -- certainly would have a significant impact on the economy. And I think, us, like most companies would have to determine what that is and figure out how to react. One of the advantages of our decentralized organization is we're able to react quickly when circumstances change. So we don't have any predictions on what would happen to the economy in the event of a major fiscal cliff issue. It's really impossible to predict. And so if it happens, we'll have to deal with it. But right now, we're assuming that there's really no significant impact on the economy, and the economy continues to perform in the U.S. like it has over the last year.

Alexander M. Blanton - Clear Harbor Asset Management, LLC

When you mentioned flexibility, could you just quickly describe what you mean? Manufacturing flexibility and the plans to react quickly, reduce inventory and so on?

Ronald D. Kropp

Well, in our decentralized environment, even as we scale up our businesses, which we'll talk more about later, we're still -- it's still relatively small businesses that are run day-to-day by the people on the ground, by the General Manager. So when they see something happen to the economy, to their end market, to a major customer, they can react quickly, because they don't need to go through a lot of bureaucracy to figure out what they need to do to take out costs and a bunch of levels of approval, et cetera. They understand their business. They can look at their plans, say, "Okay, if this slows down, we can take off a second shift, or we can combine some functions here, or we can do different things." And that's something that we saw a big benefit of, that kind of reaction time, a big benefit in 2009. We've got a lot of questions in 2009 at the beginning around how you're going to react to the downturn, and can -- in a decentralized environment, can you react quickly enough? And the answer was us at corporate aren't the ones that need to react. It's really the people on the ground in the businesses. And we demonstrated back in 2009 that we have to react very quickly, take cost out as necessary, and sometimes that's restructuring, sometimes, that's just reducing overhead or slowing down manufacturing. So I think we have a good track record for that, and we feel comfortable that whatever happens, we're pretty nimble and can react. Andy?

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

Ron, Andy Casey. Just a clarification if you could. On the 1% to 3% organic, on the base that, that is built off of, could you clarify whether that includes Dec Surfaces as reported, or if it excludes it out of pro forma?

Ronald D. Kropp

That excludes Dec Surfaces. And I alluded to it earlier, because Dec Surfaces is not part of discontinuing operations, we will have to, over this next year, continue to talk about pro forma without Dec Surfaces. So when we come out with our guidance for 2013 in detail or EPS guidance in January, we will present guidance on a pro forma basis, so it's clear to everybody.

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

This is Ajay, FBR. So just on your North America guidance for '13, the organic growth, could you maybe give a little bit color around businesses that you expect to improve versus areas that could decelerate because that 2% to 4% looks like it's a little bit decelerating versus what you did this year, 5%?

Ronald D. Kropp

Yes. As we look at it, North America in 2013 looks very similar to North America in the back half of 2012. So some of the same businesses that have performed well in 2012, even though they've been slowing a bit, have been welding, Automotive, test and measurement. So certainly, welding and Automotive especially, we expect to be big contributors in North America in 2013.

Deane M. Dray - Citigroup Inc, Research Division

Deane Dray from Citi Research. A couple of questions on the base business, core revenue growth assumptions, what's baked in for price cost? And are we going to hear more about the simplification and sourcing? And is there initiatives -- is there any benefit of that being baked in, in the price costs for this year?

Ronald D. Kropp

From a -- the way we're looking at price costs is really absent any sourcing benefits, and certainly, we'll talk more about sourcing later. So just a normal market price cost. We've seen a lot of pickups during this year, for instance, the 80 basis points in the third quarter. It won't be quite as big in the fourth, but it'll be -- it will be a pickup in price cost. There will be some overlap into the early part of 2013. We can't quantify that at this point, but it will certainly be less of an impact than it has been in 2012. Overall, raw material costs have either stabilized, or in some cases, gone down on a market basis, so certainly, we'll start to see that in our businesses. And the key thing for us will be to make sure that to the extent we've had price increases, we're able to hold those as the costs go down.

Deane M. Dray - Citigroup Inc, Research Division

And the extent to which it's meaningful, any comment on the unfavorable tax settlement in the quarter?

Ronald D. Kropp

Yes, we have -- we're under continuous audit by the IRS. We have a complex structure and organization from a tax side, and it's just normal part of working through the process and -- to have a tax settlement. Sometimes, they're favorable; sometimes, they're unfavorable.

Unknown Attendee

The U.S. economy has been weakening since the third quarter. Your reiteration of your bottom line earnings target for the fourth quarter in advance of prospectively some very significant extended shutdowns in September -- in December, is that because you've been able to make this up on the cost side? Or is there some other aspect of the portfolio where things actually you think have been more resilient perhaps in your longer cycle businesses, first question. Second question is first quarter of '13 could look very bad for lots of different reasons, I'm not talking ITW, it's just in general. Is your expectation at this point that your '13 organic is going to be very back-end-loaded or at least second half weighted?

Ronald D. Kropp

I think you're correct. Based on where we're at today in the fourth quarter, I think the first quarter will probably be one of the weaker quarters and even the first half. But certainly, we expect -- and part of it's just lapping the comps for Europe. But so as we move through the year, we expect things to get better as we go through the year. Your first question was, sorry?

Unknown Attendee

Basically, the U.S. economy macro has been deteriorating. It's in the start-stall phase. You guys have a lot of short-cycle businesses. I realize you're in different verticals versus every other company so every company has their story, but are you experiencing that as well? And how are you basically reiterating your fourth quarter in advance of extended December shutdowns? Are you making this up on the cost side or what -- or is there some other aspect of the business that's just done better?

Ronald D. Kropp

Well, I think after 2 months, and we ran into the fourth quarter with, I think, that same view, right? That things were slowing a bit, maybe not as much as some other companies had seen from the third quarter versus the second quarter. So we built that into our guidance, and that's why our organic guidance -- organic number in the guidance is like in the 50-basis point range, right? So that's played out in the -- as we expected. And we've held our EPS guidance, which means that the margins on the cost side has played out as well, so we're holding in.

Unknown Attendee

I think of your welding business and also the welder can be used as a power generator and some of your construction businesses which are very coincident with activity. Are you seeing any of your businesses doing a little bit better on the back of Sandy?

Ronald D. Kropp

We've heard anecdotally, for instance, more generators and stuff, but nothing of any significance that would make an overall impact.

Unknown Attendee

Maybe a somewhat related question. Welding in 2013, you show it to be quite resilient versus '12. Production is coming down from some of your customers, so maybe you can give us your confidence level around that growth rate? And then just the other question is around construction. You've got a nice bounceback sort of modeled in for 2013. Is that mostly Asia? Is that U.S. housing starts continuing to get better or sort of...

Ronald D. Kropp

Yes. On the construction side, certainly, we do expect housing starts to get better from where they've been, so that's really the contributor to the construction numbers. Offsetting that is -- more than 50% of our construction business is outside the U.S., and Europe and Australia, which is a big piece of it, is still slowing or negative. So there are some upside on the U.S. side from residential but offset by international. On the welding side, it's really a function of where we've made some innovation investments, and we'll talk more about this again in the enterprise strategy, we have some examples. But in places like oil and gas where we've invested in particular products that serve that end market, that's done very well. We've increased our penetration above and beyond what the market growth has been, so that's really what's driving the welding growth.

Unknown Attendee

So it sounds a lot like transportation where you're -- a lot of it is beating the market versus -- potentially.

Ronald D. Kropp

Yes, yes, and really focused innovation on solving customer issues.

Unknown Attendee

You've talked about a significant percentage of your sales as potential divestitures kind of going along the core business lines going forward. I think you mentioned 25% or somewhere around that range. Can you talk about 2013 and your expectations for additional divestitures? And you mentioned on -- the proceeds would be used for -- potentially for repurchases. Would you expect all of that to go to repurchases? Or do you think that you have a fairly aggressive program for acquisitions, and that could actually be used for acquisitions instead of share repurchase

Ronald D. Kropp

So if I can, the discussion on the portfolio, the 25% and the capital allocation, I'll defer that question. I will answer that question as we go through the enterprise strategy presentation in the next part of this.

Unknown Attendee

Ron, is there any reason that we should think about puts and takes on your normal incremental margin on the core organic growth in 2013?

Ronald D. Kropp

Well, I think -- our normal incrementals are typically 30% to 35%. So I think -- and just the normal organic growth, we'll continue to see that. What's really adding onto that is -- will be the impact of the initiatives that we'll talk about next.

All right, anymore?

All right, thank you very much. We will take a short break and -- we have one more?

Unknown Attendee

Along the same lines of the question about incremental margin, is there anything that would affect the business model in 2013, including tax rate and pension costs?

Ronald D. Kropp

Nothing significant. I mean, certainly, we're not putting out earnings guidance at this meeting. As we work through the guidance we put out in January, we'll button down things like tax rate and pension, et cetera. But where we sit today, there's nothing significant that I'm aware of that would impact 2013 EPS.

All right, with that, we will take a short break.

John L. Brooklier

Yes, could I just add one thing? For earnings guidance, it's -- traditionally, over the last number of years, we have never provided earnings guidance at this particular meeting, so this is not different, this is not something that's new. So as our traditional, historical way of doing things, we'll report it out in January when we think we have a much better view of what 2013 is going to look like, so we've never been big believers on trying to figure out next year 2 months ago. So just want to clarify that.

So we'll take a break, a very short break, come back, and we'll spend the rest of the morning on enterprise strategy. Thank you.

[Break]

John L. Brooklier

Okay, we're going to get started on the centerpiece of our presentation today, enterprise strategy over the next 5 years, the new improved, the better ITW. So one thing I would ask is we would like to go through the presentation. Please hold your questions 'til the end. It's going to take us a while to sort of set up a framework for the presentation, go through it. It will be presented in 3 different parts by 3 different presenters. And then we will take -- we -- I guarantee you, we will take plenty of time to answer all of your questions. We'll continue to entertain questions through the lunch break too. So with that, I'll introduce Scott Santi. Scott?

E. Scott Santi

Thank you, John. Good morning, everyone. Let me get to the right slide here. Thank you.

So what we are going to take you through today is really the culmination of a solid couple of years of work inside the company. Really starting with some really deep thinking that's been going on around the way the environment in which we're operating in is evolving and the way it's likely to continue to evolve as we see it going forward. And really, what do we need to do to leverage what we feel are still some pretty compelling core capabilities in the company to maximize their leverage and impact in the context of the kind of changes in the external environment that we are seeing and expect to see going forward.

So this slide is really the sort of strategy framework that we're going to spend the bulk of our time this morning walking you through. We're going to highlight ITW's unique core capabilities, our 80/20 business model, sustainable differentiation and our entrepreneurial culture. We're going to detail out the key enterprise initiatives, along with a very disciplined capital allocation strategy that we think are the core to driving the kind of differentiated performance that we could deliver across a variety of economic scenarios. And we'll walk you through that. And lastly, we'll detail out our -- the performance goals for the enterprise that we have attached to this enterprise strategy. And that's actually where we'll begin this morning.

So looking at sort of the various scenarios for the company. This is a simplified version of the internal modeling that's going on around the strategy, really starting with what the external environment is going to offer in terms of growth. We're dealing out -- detailing out here sort of the low, mid and high scenario.

So starting on your left, from the standpoint of global industrial production, and this is all over the 5-year period, so these are growth CAGRs across the 2013 to 2017 period. So we're looking at a low of 2% CAGR, mid of 3% and a high of 4%. So within those various scenarios, our assumptions around the overall organic growth for the enterprise on a global basis, we'll talk in a minute about one of our core goals related to our strategy around organic growth. This is sort of a midpoint between this 1.5 points above the market growth is the midpoint between where we've been historically, which is about 100 basis point above global IP grower to the overall target which is to get to 200 basis points above global IP, so we're sort of calibrated the improvement throughout this period.

From the standpoint of the portfolio strategy and the net of acquisitions and divestitures, you'll see a negative 2.5% compounded. That's certainly not necessarily going to play out that way year-by-year, but in the aggregate, we've talked before and we'll talk some more in a minute about the fact that around our portfolio strategy, we expect to divest roughly 25% of the company's revenues as of the beginning of 2012.

Net against that is -- so that represents about a 6% negative CAGR on top line, if you smooth that out. Netted against that is about 3.5% assumption on acquisitions going forward, which is well below the company's historical average of 5% to 7% of revenue. And we'll talk about -- a lot about sort of where acquisitions fit in the context of our enterprise strategy.

So you can see the net we get to in terms of overall enterprise growth as a result of all those elements. And the key thing that we want to emphasize here is that regardless of those scenarios, given the things that we're doing that we could deliver some fairly strong EPS growth under a variety of scenarios as we're dealing with exiting roughly 25% of our revenues. So under the low scenario, EPS CAGR over this period of 7% to 9%, in the mid, 9% to 11% and on the high side, 11% to 13%.

So in terms of the enterprise performance goals, around this strategy, over the next 5-year period you see them listed there on the slide. Organic growth, as I said, 200 basis points above global industrial production by 2017. That represents a 100-basis point improvement from our past history. And the reality is that there's an element -- we've got a lot of parts of the company already performing at or above this level, so this isn't about a big change, it's about -- it's really more related to focusing the portfolio on the elements that we have that really can deliver this kind of growth on a go-forward basis.

Operating margins, 20%-plus by 2017, and we have a lot of people that like to sort of talk about us in terms of peak margin. This is sustained margin over time. So this isn't a onetime peak. This is getting to 20% and staying there long term. Return on invested capital of 20% plus, which is essentially the byproduct of all the initiatives that we're talking about, and free operating cash flow conversion of over 100%-plus over this 5-year period. And long-term EPS growth target of 12%-plus once we're through this 5-year period.

So just a moment on sort of how we're thinking about the external environment. And I -- hopefully, at least in terms of the short-term, I'm not going to have a hard time selling the fact that it's pretty tough out there and only going to get tougher as we go forward, sort of beyond a lot of the near-term stuff related to the fiscal cliff and a lot of the fiscal and policy issues in front of us. There's no question that the -- the environment that we operate in continues to globalize, continues to become more and more competitive. The competitive intensity around the world is going to do nothing in our view but elevate further as we go forward. Certainly, a slower growth environment, maybe not for the entire 5-year plan period, but certainly, as we look at the next 2 or 3 years for sure.

And ultimately, in our view, some fundamental changes in the competitive landscape, that our competitive side is increasingly becoming populated by firms that have very different views around things like profitability and return on capital than what our company and our shareholders have typically experienced. So we're increasingly competing with firms from emerging markets all over the world that have very different profitability expectations, very different return hurdles in terms of capital. And that's a reality of the competitive environment that is certainly going to continue as we see it going forward.

So the sort of core work going on as we've thought about -- built this strategy inside is really a function of, a, having the right view, sort of the realistic view of what the environment is going to be like. And ultimately, looking at the core competitive advantages, the core capabilities of ITW and really thinking deeply about, a, how do we project their relevance in this new world, this new environment or this emerging or evolving environment. And our view is 80-20 sustainable differentiation in our entrepreneurial culture are even more relevant in terms of potential impact in that environment in all that uncertainty, in all that challenge than maybe they've been historically, but the reality is that applying them in the same old ways we've always applied them is certainly not the route to get there. So this whole strategy is really about how do we take these core elements of what makes ITW, ITW’s really robust core capabilities, and ultimately apply them in ways that maximizes their relevance in the kind of world we're going to operate in going forward.

So let's take a few minutes and we'll just go through a little bit of an overview of what we view to be our very robust and very differentiated core capabilities. First one is 80/20. This is not a new topic for a lot of you in this room, but 80/20 is alive and well inside the company, continues to be a big driver of a lot of advantages both from the standpoint of operating performance, financial metrics and competitiveness in terms of customer value add.

Essentially, 80/20 is a proprietary business model inside ITW. It is applied in every business in the company. It's been around since the mid '80s and in the state of continuous evolvement -- evolution over that time. Essentially what we do, in a very simplified way, with 80/20 is we identify the key customers and key products that really drive all the profit and then some in the business and, ultimately, structure the entire business around fully leveraging a relative handful of customers and product lines.

So from the standpoint of a couple of examples, 80/20 in action. Got a couple of acquisition examples we'll talk about first. This happens to be an acquisition from 2005. You can see the before-and-after delta on both from the operating margin side, 12% to 27% now. From an ROIC standpoint, 6% at the point of entry, with the acquisition up to 22%-plus, those are after-tax returns. And you can see the delta in terms of the core product and customer set businesses that have evolved as a result of the application of 80/20.

Another example, a little different starting point, so this is an example of a higher-margin starting point so this business came in to the company at 17% EBIT margins. You can see that 80/20 still works and works very well. Ending margins are up 900 basis points. ROIC, from 11% to 24%, and again, similar metrics in terms of before and after around core products, core customer set. So 2 different examples from an acquisition standpoint, some different starting point characteristics, but ultimately, big impact from 80/20.

So 80/20 is also something that's alive in the company from the standpoint of existing businesses, these are a couple of examples of how we use 80/20 inside businesses that have been around the company for a while to sort of reinvigorate their performance, reposition themselves in terms of particular core product lines. This first example is from our Food Equipment business where they went through a fairly extensive 80/20 review of their food machine product line, and you can see the before-and-after metrics in terms of how does the 80/20 impact existing businesses that have been around the company. Operating margins through this effort went up 800 basis points on this product category, and the number of products was reduced 64%.

Another example, from our Instron business, of a similar effort. This is a particular product inside Instron that basically gets samples to temperature before they're tested. Here is a before-and-after and these -- the cycle times on these are typically 12 to 18 months. So acquisitions, we talk about cycle times in terms of full implementation of 80/20 where we're really working the entire business is typically a 3- to 5-year period. These product line types of efforts are typically a 12- to 18-month, before and after. Operating margin share up 540 basis points, and again, a 88% reduction in the overall number of SKUs in the product line.

So again, 80/20 drives operating margins, profitability, cash flow, ROIC and a number of sort of very important competitive attributes in the marketplace around things like delivery cost, quality, et cetera. Very much alive and well in the company, and very much a core part of who ITW is and what ITW is on a go forward basis.

So the second of the 3 that we want to talk about is the element of sustainable differentiation inside the company. And essentially, this is how we live and breathe every day, is our business model is squarely centered on consistently seeking ways to deliver unique value add for our customers, often in ways that others can't or won't. And I highlight a couple of dimensions of this from our perspective, one is it's very much 80/20 enabled in terms of how we practice it. So our core focus on really narrowing in at the business level on the relative handful of customers that drive the bulk of the revenue and earnings in the business, really gives us the opportunity to get very deep and intimate with that relatively small number of customers in terms of really understanding what their key pain points are, what they're trying to accomplish as businesses, and ultimately, delivering the end solutions that help them accomplish their objectives, improve their performance, et cetera. So this is -- 80/20 is a big part of how we get this done. So that focus again on a relatively handful of -- sort of deep with a relative handful of customers as opposed to broad is a big part of the enabling dynamic in terms of how this plays out inside the company.

Small-scale differentiation is what I described a minute ago. It's our general managers operating every day, trying to find ways, trying to find problems they can solve, trying to find performance improvements that they can execute. They really are all around, how do we add value for our customers, how do we do it in ways that's special and unique.

And the last element is certainly game changing innovation. This has been a hallmark of ITW for a long time. We have an active patent portfolio of over 19,000 patents. Last 2 years, we've issued just under 3,000 so this whole issue of kind of small-scale every day, but sort of meaningful, significant innovation periodically, and how those all come together is essentially core to the way we run our businesses.

We've talked in previous sessions about a corporate capability to support innovation inside our tech center that we have launched that basically is helping us drive and execute on the top 10 to 15 innovation opportunities in the company, that has been alive for about 3 years now. It continues to mature and continues to create some real wins.

I'm going to give you just a couple of examples of some of how this plays out in the company. First example is from our welding segment, within the oil and gas platform. And as I talk again about sort of how 80/20 plays, one of their core end markets are people that fabricate oil and gas infrastructure, people that build offshore refineries, offshore platforms. And some of the key pain points there are really around it's an extremely demanding welding environment, a very tough, challenging specifications around the quality of the weld. So you're welding a pipeline that's snaking through a refinery. There's very stringent requirements around the quality. And yet you're doing -- you're having to apply that weld in an environment, outdoors, construction, difficult to reach places. So major downtime and quality issues for our core customers. The other element around the welding space is that more and more of the skill set in the industry has declined, as older skilled welders are retiring, not being replaced by new welders as much or at rates like they've been historically. So the solution set here is really around how do we develop a much simpler user interface that allows less well-trained, less skilled welders to effectively execute high-quality welds in this environment. The product is the Pipeworks [ph] and essentially generated 14 patents behind this solution. The product's been out about 1.5 years.

Another example inside the company is in our Consumer Packaging area where we deal with all of the large consumer beverage producers so Coke, Pepsi, Ambev, et cetera. Some of their pain points, as I'm sure you're all aware of, the aggressive consolidation taking place in those industries as those customers consolidate. They're dealing with a lighter and lighter array of SKUs in their distribution centers. And they also have increasing demands from their customers to deliver mixed pallets of products, which creates a number of different productivity and accuracy issues for those customers. We're going to show you a video in a second of a solution that was developed by one of our businesses around a way to automate in this arena. Again, close sort of proximity to those customers results in what is a pretty compelling solution to this problem.

So no sound with this so I will narrate. So this is inside of distributions -- beverage distribution center, you can see with some of the different colors, of the variety of different elements. And essentially, this is automated from the stocking point, all the way to the pallet building. And you can see different types of beverages coming together and these -- those will be assembled onto a mixed pallet based on customer order. So that solution is how do you get -- how do you fill an order for your retailer, your -- whether it's a convenience store or a grocery store where the customers can order mixed quantities of various types of beverages and we see them all completely accurate, stacked in skids that are sturdy and strong, get to the customer in sellable condition.

All right, the third example comes from our Auto OEM space. This was really an outgrowth of some work we did around pain points in our auto OEM customers related to increasing fuel efficiency standards and vehicle emissions standards. This is an innovative ball valve that essentially replaces conventional thermostats, improves vehicle efficiency and CO2 emissions and allows for faster temperature start-up for more efficient combustion. Five new and leveraged patents, this is a product that is already in production, with 2 European Auto OEMs and we expect this to become a major product category for our auto OEM business going forward.

So the third element of our -- of the sort of core capabilities of the company that we're going to highlight is really around our entrepreneurial culture. We've historically been a very decentralized company. For us, that means fast, that means responsive, that means not bureaucratic, and, absolutely, that represents a core pillar of capability that we need to take going forward in terms of to be able to operate where we think we can operate in the environment we're going to be in. Flexibility within that framework, there's been some circles and interpretation that decentralized means anarchy. And I can assure you that that's never been the case in the company. So there's always been a very strong core framework in the company, but we absolutely believe in a lot of latitude within that framework for our managers and our leaders to apply that framework in a way that they think is most relevant and delivers the best results for the business and their customer base.

This is a results-driven culture. 80/20, again, helps that. In our DNA, everyday is trying to figure out the 2 or 3 things that really matter in terms of decisions we need to make, actions we need to take, and making sure that we make something happen around those core issues or core opportunities. And what goes hand in hand with that, in terms of the kind of autonomy we allow and we want to have in our culture, is a very high degree of accountability. So the scorecards are apparent, so a lot of flexibility within that framework but a very clear scorecard. The P&L drives, that's where we keep score. And that's where we keep score in all of our divisions. So ultimately, a lot of latitude but a lot of accountability around doing what you say, delivering the results that are expected in terms of the overall enterprise's performance objectives and expectations.

We've got another couple of videos, these with sound, that I'll show you in a minute. But essentially, the core elements of our culture from our point of view is again what I said before which is the ability to respond quickly to customer needs, react quickly to market conditions, and it's a performance driver for us.

[Presentation]

E. Scott Santi

So the net on the culture is about sort of big-company resources but small-company responsiveness, small-company nimbleness, and absolutely, as you think -- as we think about an environment that's going to be nothing but more challenging and more complex, a critical part of what we take forward and a critical advantage for us.

So we're going to turn the page now and focus in on the core enterprise initiatives that are ultimately the bridge between these core capabilities and the kind of differentiated enterprise performance that we're capable of delivering in the context of this changing world we're going to operate in. Those 3 core capabilities are portfolio management, business structure simplification and strategic sourcing. I'll walk you through the portfolio management piece and then we'll have David Parry come up and take you through the next 2.

So from the standpoint of the portfolio and how do we think about that going forward, essentially, what we're talking about is focusing the entire company on the businesses best positioned to fully leverage those -- the core capabilities we just talked about in the context of this increasingly challenging external operating environment.

There's really 2 pieces of this as we execute the strategy, one is really around what should be in the portfolio, how do we construct the portfolio. And the second is around, once we've determined the go forward portfolio, how do we allocate resources in terms of both capital, energy and investment from the company's standpoint in the areas that are best aligned with the profitable growth potential and profitable growth objectives that we have.

So what we'll walk you through is really a sort of a segmented portfolio structure that is really driving the thinking and the action inside the company.

Three pieces. We've got an accelerated growth component and we'll talk about the details around each of those. That represents 40% of the existing revenue and this is as of the start of 2012. We've got a market rate growth component that represents 35% of the portfolio. And then we've got a commoditizing piece that represents 25%, and that's -- when we've talked about divestitures, that's really what we're linking into in terms of divesting 25% of the revenue over the plan period.

So let's sort of talk about the -- sort of the commoditization section first, and this is really about shaping and changing the thinking inside the company. We've long viewed sustainable differentiation as a very, very desirable attribute as we construct the portfolio. The reality is that this market continues to evolve as the competitive intensity goes up, as the competitive set is increasingly populated by the kinds of firms that I've described earlier. The reality for us is that we've got to move sustainable differentiation from a desirable attribute to a must have as we construct the portfolio.

Operational excellence alone is no longer enough. So as we think about those 3 core capabilities of the company. 80/20 is alive everywhere. ITW's culture is alive everywhere. But the element of sustainable differentiation is ultimately a function as much about the external conditions in the marketplace as it is the attributes we can control. So as certain markets commoditize, we lose that third lever, we lose that sustainable differentiation level -- lever. And the reality is, in terms of the way businesses perform inside ITW, we've seen a real evolution there over the last 5 years. So businesses that were largely 80/20 plays, so culture plus 80/20 have the 2 out of the 3. Those businesses 4 and 5 years ago were still high teens margin businesses. The reality today is those are now businesses that are 13%, 14% margin businesses; certainly, leaders in their industry. They're typically doing very well against a number of 4% and 5% margin competitors in their industries. So you can have bad businesses, but ultimately, these are businesses that are capable of fully leveraging all 3 elements of ITW's core capabilities and that's the delta in terms of how we think about the portfolio going forward.

So we've got to narrow in our focus really on those businesses that are what's coming to be called 3 out of 3 businesses inside the company. Those businesses that can leverage 80/20, the culture, but absolutely generate sustainable differentiation as we go forward.

So in terms of actions around this for 2012, we have been very active on the divestiture front, have divested about $1.7 billion. So in terms of the overall sort of flag point around this of roughly 25% of revenues, we've got about 10% of that done in 2012. You're familiar with a number of the -- a couple of the larger ones here, and there's been a number of activities in the last bucket as well with some midsized to smaller businesses. But absolutely, we are committed to a portfolio that fully leverages all of our core capabilities. And the reality is that the performance metrics we've talked about, some elements, there's a meaningful contribution to those overall performance goals that are really around addition by subtraction from an organic growth rate standpoint. These commoditizing businesses inside our portfolio have been a negative drag on our growth rate. These are businesses under much more pricing pressure than a big part -- the other parts of the portfolio, because they're tougher to grow as things go forward and certainly from a margin standpoint. These are, as I said, low to midteens margin businesses and a business that has large parts -- in a company that has large parts of our portfolio operating in that 20%-plus range today.

So from the standpoint then of the go forward portfolio, really 2 pieces here in terms of how we align our strategy and thinking and resources. The first is the accelerated growth bucket. And the core attributes here are robust core competitive advantages, strong sustainable differentiation attributes, and market fundamentals that really suggests some really strong growth and market tailwind on a go forward basis. The overlay strategy here is this is where we want to be even more aggressive perhaps than we've been from a growth standpoint in the past in terms of both organic investments. And this is the part of the company where we expect to concentrate the M&A on a go forward basis, to really support and round out and develop these areas of opportunity.

So as we think about an example of an accelerated growth platform inside the company, we'll go back to welding, the oil and gas platform. We've got just a terrific market position. We've got deep customer knowledge, deep end market knowledge. We've been very effective around customer and end market segment innovation, I gave you an example of that before. We're developing some really compelling core technology around -- and capability around how we simplify user interfaces. Welding equipment is a very sophisticated piece of equipment, lots of capability required to do it well. But the simpler you can make all that technology in terms of the actual welder being able to deploy effectively, the more compelling the product offering is.

And the other element here, in terms of the competitive advantage supporting this positioning in the portfolio, is that we've developed a number of capabilities, pre and post weld. So we've got a position now that allows us to deliver solutions -- broader solutions in this industry.

And from a market attribute standpoint, I'm sure you're all very familiar with these, but the amount of oil and gas investment that's going to be made over -- on a global basis over the next 5 to 10 years is very compelling, huge infrastructure play -- oil and gas infrastructure play in emerging markets and a whole bunch of things going on offshore requiring deeper and deeper drilling, lots of new technologies and capabilities, lots of room to get in there and operate and help customers in this space solve problems.

So from the standpoint then of the next category, which is what we're calling market growth, as I said before, core competitive advantage and sustainable differentiation still absolutely is critical. The only difference here between this category and the one I just talked about is a function of the market characteristics. So these would be spaces where we have terrific competitive advantage to generate great earnings, great returns, but the market attributes themselves don't suggest outlier kind of growth on a go-forward basis.

So an example of that inside ITW would be our residential construction products business. Outside of the inevitable housing recovery in North America that's likely to play out on a long-term basis, this is a part of our portfolio where we've got some very -- some -- excuse me, terrific brands. We lead in cordless technology, which is a really big deal in this space and a number of other innovative fastening solutions around the residential housing market. But from a market attribute standpoint, and these are all things that I'm sure you know very well as well, on a cycle-to-cycle basis, it's a net average grower at best, certainly above average cyclicality as we've all known forever but certainly have lived through in the last 5 years even then so. And you've got, sort of, general rate of change in this industry that's, on the whole, very slow.

So lots of established traditions, lots of very slow-to-adopt technology so the raw material for accelerated growth and penetration is not anywhere near what it is in the oil and gas space for the welding business. The other element of this is it's a very regional business, so it's -- construction practices vary greatly around the world, so it's a hard business to leverage on a global basis. Is this a bad business? No, this is a terrific business for the company, great margins, great returns, but ultimately doesn't have the kind of juice in terms of the external market characteristics that put it in an accelerated bucket, but it's certainly a business that contributes to the overall company performance objectives from a margin standpoint, from a return standpoint and one that's worthy of our investment and focus. But from a growth standpoint, the investments are more muted with the objectives here to grow at market rates. To maintain profitability, we want to grow with excellent incrementals. And certainly, from an overall percentage of capital deployed here, these positions from an M&A standpoint on the whole less, we will certainly do things in this space but we're going to do things from an acquisition standpoint only if they're really strong core fits. These are like -- so right now, wheelhouse kinds of deals but not at the -- we're not going to be there from the standpoint of overall M&A activity anywhere the degree as we would be in the accelerated growth positions.

So lining up around this new portfolio strategy, we are going to be implementing a new segment structure beginning in 2013. The major moving pieces here are, first of all, we've divested Decorative Surfaces that you know about. We are going to be transitioning the Automotive -- what was formerly the Transportation segment will be a pure Automotive OEM segment, and this is all about sort of lining up the segment structure inside the company to fit the kind of portfolio structure that I just described a minute ago.

We will have a test and measurement and electronics segment. That business has now grown to the point where it is a substantial part of the company and a core part of the overall growth profile of the company going forward. The welding business will now be a stand-alone reportable segment that we manage through internally and report externally as well. And just for fun, we've changed All Other to Specialty Products because you guys love the All Other category. So anyway, there's some details in the appendix right now.

Just to give you some dimension on relative size, this represents -- these are all $2 billion to $3 billion parts of the company. And as we go forward into 2013, we'll obviously start to round out some of the information for you all around these new operating segments in our reporting behind them.

So summary on portfolio is very disciplined approach to our portfolio. We need to be much more disciplined in the kind of environment we're going to be in. We've got to pick our spots. We've got some great positions in the company, many of which are already operating at or above the overall enterprise performance metrics that we're laying out as our goal. But given the environment, it's going to be nothing but tougher and tougher as we go forward. The ability to really sort of pick our spots, focus in, invest in big positions in sort of big global markets, $2 billion positions in front of $20 billion or $30 billion global markets with the kind of sustainable differentiation attributes and capabilities around them is really the sort of headline in the story here. And over the next 2 or 3 years, we're going to be divesting ourselves out of parts of the portfolio that are ultimately subject to or vulnerable to commoditization.

So with that, let me turn it over to my colleague, David Parry.

David C. Parry

Okay. Thank you, Scott. Good morning, ladies and gentlemen. I'm going to cover the next 2 themes of our enterprise strategy. So I'm going to cover business simplification and scale-up, and I'm going to talk about strategic sourcing for the whole enterprise.

So moving to report the -- I'm sorry. That's interesting, it's going backwards. I was going to say, words didn't make sense. So I'm going to talk about business structure simplification, and I think the highlighted words you've got on this slide are really important. So it's very much about simplification. It's very much about scale-up, and it's very much around focusing our activities, all right, on the things that really matter, all right. And the last thing is really about being globally competitive in an increasingly competitive environment. So it's simplify, scale up the operating approach or structure to improve on and focus and enhance our global competitiveness.

Many of you who have been with the company and following the company for a long time will have heard the magic 800 business unit number, all right? Well, I can officially tell you that number's dead. It won't be with us any longer. And so basically, what we're doing here is we're moving and scaling up our businesses, right, or divisions from 800 and scaling them up, so there will be 150 units approximately, it's give or take, it's not an exact number, but it's the number, and the average size of those businesses and divisions is going to change. Instead of being $25 million, they're going to be more in the $100 million category. So 800 divisions going to 150, size going from $25 million to $100 million.

Let's try and put some meat around that as to what exactly that means, and I look at this slide in a sort of a what-why sort of a process. So what is this all about? This is all about getting profitable growth. And how do we get profitable growth? We get profitable growth by focusing in on some of the core areas that offer more advantageous growth and sustained differentiation possibilities. So we want to make sure we have the capabilities and the resources to be able to put that effort in place.

If you've got a $100 million business, you start to have the size and capability to make that happen. This gives you sustained innovation, right, and allows you to put energies into where the growth now is coming, whether it be in emerging markets, whether it be in some of the more mature markets. If we go to the why, which is all around improved margins, and really there are 2 elements to this as far as I'm concerned.

The first one is about reduced management structure. And as I'll show on a subsequent slide, clearly, the structure is going to change and there's going to be some benefits from that, all right. But the second element, which I think is also equally important, is that we can reapply our 80/20 design holistic model, right, on this now scaled-up business unit, which will give us, again, opportunities.

You can do all of this, but I really want to stress around the ITW culture. From a very personal position, I have been with a prior company, which was very much more centralized, very much more structured, so I'm very much dedicated to the concept of ITW being decentralized, entrepreneurial in approach, all right? That is not going away, all right? I've lived the other side of the margin. I know what it's like. I don't want to go there, all right? This is -- ITW's culture is too precious, so there's lots of changes going on, but this 80/20 design entrepreneurial spirit is absolutely core to how we handle our businesses.

So this improves our capacity to have sustained differentiation, right, through added scale. Those are the sort of take-away words that you need to take from this particular slide.

Let me try and put some sort of metrics around this to give you an idea. This is a sort of schematic -- it's not one particular business in particular, but if you look at this, so if you have basically 4 businesses, which you're now going to combine, effectively, those businesses would have one general manager; one controller; a sales force, which may be regional in nature; and maybe a few plants. If you now scale those up, so you now create $100 million, clearly, you're going to go from 4 general managers to one, you're going to go from one -- 4 controllers to one controller, you're going to have regional sales offices that are probably going to go to global sale office -- or sales organizations. The number of plants may be 6, maybe 8, it's going to reduce down to 4, 5.

So what does this also allow you to do? This allows you to take those resources and really focus those resources on potential growth opportunities you've got. If you have a $25 million business and you've got one research capability, then that person is going to get pulled all sorts of different directions, trying to meet whether it be customer needs, short-term or long-term, trying to deal with problems on the plant.

In a $100 million business, you have the size and the scale to be able to allocate the resources to the growth areas for your business. So it really is starting to give you potential to do growth. And lastly, obviously, you'll go through the whole 80/20 design process all over again on the global business. So scale-up, yes, but also added focus in what are the growth opportunities for that business. This process is not a short-term process. This process will take time. This process will probably take maybe as much as 3 years, all right, as we slowly work it through. So it's not a one-shot wonder, it's a slow and steady process.

So let me try and give you some examples to illustrate the point. So clearly, this process has started -- with any organization, it was started as being thought about for certainly, the last 2 or 3 years, we certainly started to get in the implementation stage in 2012. So this is going to roll through 2013, 2014, right, and that's where you're going to start seeing the benefits, all right. So here is an example for the Automotive OEM business. You see 78 business divisions here, which are going down to 13, all right? In general management positions, you're seeing a reduction from 67 to 23.

To give you another example, for the Polymers and Fluids business, here, you see the business divisions going down from 56 going down to 17, and the general management positions going down from 56 to 23.

So in summary, for business simplification and scale-up, this is all around a simplified and scaled-up process to improve focus on what are the really true, core opportunities for our business, improving our margins while at the same time not forgetting about the ITW entrepreneurial culture, 80/20 design, right, and close-to-customer approach.

The second part I want to cover now is the strategic sourcing part. This is all about leveraging our purchasing scale. Obviously, we're an $18 billion organization, and it's a matter of leveraging that scale to enhance our profitability, all right, and create global competitiveness. There's lots of suppliers out there. We want to make use of their capabilities to help grow our business. So this is a key focus for us going forwards.

So this is really a slide to try and illustrate, in the very simplistic terms, how we're going from what we are today, right, to where we want to be. So today, we are basically a highly fragmented, maybe under-leveraged business, managed locally, right. And we're going to move our organization to more a highly coordinated, heavily leveraged segment-led business, right. The total addressable spend for ITW is roughly around $11 billion.

So what's the game plan going forwards? The first thing is we're going to transform our sourcing into a core strategic function. We're going to build that by building a sourcing organization and putting capabilities in place. And I stress this at both the enterprise level and at the segment level, and I'll show you a slide later, which illustrates the point. So this is not an enterprise total issue. And then obviously, it's a matter of executing, implementing those sourcing waves, right. And again, I would stress, this is a drawn-out process. To actually get the benefits from this, these -- you're going to see these savings much more in the future. You're not going to see these in 2013. These are going to roll out in future years. You're going to see a little bit of benefit in 2013, but you're going to see the -- it roll out and increasing as we go through the 5-year period.

To give you a split of our $11 billion addressable spend, you see this breakdown here in this histogram. Basically 53% of it is enterprise-led. That is global direct materials and indirect, and then materials and services that are used pretty much across the various segments that we highlighted earlier. The other 47% is very much segment-led. These are, again, direct and indirect materials that are very specific to that particular segment.

So to give you an example, enterprise-led spend may be something like steel that goes across a whole range of different segments, whereas a segment-led spend may be some sort of motor, right, or harness that is specific to a welding segment or a construction or electronics platform.

Clearly, to exercise or produce this benefit, we need to build a sourcing capability. And here, I'm just trying to step you through about the various capabilities that we're going to add. Now this is not a massive amount of people that we're going to add here. Basically, what we think here is this is about 10 to 15, maybe 20 people that we're adding in total. And as I work your way through it, our enterprise leadership will be led by basically a chief procurement officer, which we're in the process of searching for and should be with us pretty soon. The next level is around our enterprise level, right, and those are around major commodity lead sourcing professionals. So to use my steel example again, steel would be a classic example, so this will be a specialist in the steel market, and similar products would be resins, plastics. There'd be 3 or 4 of these would lead these, again, across the enterprise.

And then, moving back to the actual segments, each segment will have its own segment sourcing professional, who will concentrate on the sort of key raw materials that are within that particular segment. And as many of you already know, we have been using PwC to help us through this transition phase. They will continue to help us through 2013 as we roll this whole process out. So a chief procurement officer heading up the organization from an enterprise perspective, lead buyers again at the enterprise level and then segment initiatives being led by segment sourcing professionals.

This is a slightly complicated slide. Hopefully, I can do it justice and explain it in simple terms to you, right, but I thought it'd be important to try and explain how the sort of sourcing process works. And basically, it's a 5-step process. Obviously, the first stage is you got to analyze the data, who you're buying from, what you're buying, what are the terms, what are the conditions, fairly obvious. And then, you go out into a bid process. You get the prices, you get the quotes, you get the various offers back and, obviously, you make comparisons on those. So then you get into the implementation stage, and the implementation stage is the first element in sourcing terms, is what they call back leverage. It's very simple. You're just comparing prices. Prices come down, all right? You continue with the same supplier possibly, right? And that flow starts to flow through. And if you measure the total savings potential here of being about 100%, this first element is probably only about 20% of the savings you're going to get. The second stage is where you start switching suppliers. You decide to combine certain requirements that come together, increase the volume, all right? Obviously, leverage the price, look at the capabilities, and that sort of switching of suppliers tends to be about 40% of the benefit you're going to see.

And the last element, which is obviously a little bit more difficult because you're going to now start switching suppliers, right, with regard to changing of specifications. That takes more time as it has ramifications for your own end use customers. That's another 40% that comes through in the benefit. This is very much a 5-year process. So as we look at our various themes, and we'll touch on this, the benefits that come through, you're going to see the benefits for the enterprise on sourcing appearing more towards the end of our 5-year period than you are at the beginning. And then of course, you'll obviously go through a continuous improvement stage and get into a virtuous circle.

So we are approaching this in what we call waves. And the first wave has started. We started with our -- some of our steel purchases. That started in 2012. That will roll through 2013 and, obviously, onwards, all right? We will then move into wave 2 and wave 3 and wave 4 and wave 5, right? Roughly, wave 1 is roughly about 20% to 30% of our total addressable spend, right? And you can see here that wave 3, 4 and 5 is roughly about 40% of our spend, right? Each wave will have different commodities within it. And I'm going to show you an example of the commodities that we're basically attacking in wave 1 for 2013. And you look at those commodities and basically you 80/20 them with regard to complexity, ease, volume, price capabilities, where they are, and they vary across a whole spectrum. So if you're buying -- to stick with the steel -- you're going to have a lot of suppliers. If you are basically acquiring, let's say, telecommunications, as you all know, there's 4 suppliers, very sort of broad spread of complexity and issues.

So here's wave 1, right, as with regard to 2013, 2012, right, and it's basically breaks down into 3 areas. So we have the indirect, which is very much around the enterprise. And you can see the segments here being logistics, distribution, energy, packaging, temp labor, all right, travel and IT, right.

The direct -- the area where we've chosen the direct is on our steel and coil. That's one of our big segments within the steel area. We will then move to other steel needs that we have. We'll address those probably towards the back end of 2013.

And the last element is around direct segments, which -- or direct purchases that relate particularly to the EVP segments. And each EVP segment will basically address 2 or 3 commodities that are particular to their particular segment. I haven't put those down here. Obviously, it'd be a list that would be quite long. So this is a long process. It's a 5-year game plan, right, and it's back-end loaded.

So the whole strategic sourcing initiative is about leveraging our scale to enhance our profitability, right, ensuring to become globally competitive, right, and we're trying to transform our sourcing in truly a core strategic function within the company.

So I've covered there business structure simplification and strategic sourcing. I'll now pass to Ron to go through our capital allocation strategy.

Ronald D. Kropp

So certainly, these initiatives are going to generate a lot of profit and a lot of cash. So an important part of the strategy is what are we going to do with that cash? That's what I'm going to go through here.

I'm going to start with our capital allocation priorities. We've been talking a lot about this especially over the last year. We've been more and more deliberate around what our priorities are and some guidelines. The first priority is organic investment, and I'll talk more about that. But these are the best return investments we can make if we make the right choices around the 80/20-focused investments, with the right R&D spend, we talked about 80/20 enabled, the right CapEx, et cetera.

Dividends. We've been a strong dividend payer. That's the second priority. I'll talk more about that. And then, lastly, external investments, which we allocate between share repurchases and acquisitions based on the best risk-adjusted returns. So what does that mean? When we look at share repurchase versus acquisitions, from a share repurchase perspective, we have our view on what the intrinsic value of the stock is. And to the extent that the intrinsic value is global by more, the intrinsic value is closer to the market, then we'll buy less, and we're comparing that to the risk-adjusted return of potential acquisitions.

Now if we have the right acquisition, and I'll talk more about acquisitions in a minute, but if it's in the right growth area with sustainable differentiation and good potential for 80/20 operational improvement, that mitigates our risk significantly. So as we look at our returns and our return potential, a lot of times, if we could find the right acquisitions, that will be a priority over share repurchase because on a risk-adjusted basis, the returns are better, but it has to be the right acquisitions.

So on the organic side, given there's a lot of different organic investments you can make, these are some examples of the key -- the key ones. R&D and innovation, we talked about already. This is an area where, especially in our accelerated growth businesses, we've invested a lot, and we're going to continue to invest a lot in R&D and innovation and really trying to drive -- continue to drive sustainable differentiation.

On the CapEx side, again, this has been focused in our higher growth platforms and segments, and that will continue. This is about adding a new plant for a new particular product in the oil and gas segment for instance. So there's a lot of different areas where we can invest in CapEx. A lot of times, it's not necessarily brick-and-mortar, it's really adding product line, equipment, et cetera within existing plants.

Also as we continue to grow our global business, there'll be opportunities on both -- from a both geographic and an end market penetration perspective. So we've built a lot of plants in China over the last 5 years for instance because that's where a lot of the growth has been over the last couple of years.

Then lastly, from a restructuring perspective, we also look at that as an organic investment. We're paying money upfront to drive long-term margin improvement. So organic investment's really about focus, picking the right investments. Our 80/20 process helps in it a lot, and those investments are either going to drive organic growth, margin improvement or both.

Turning to dividends. This is our 5-year chart on dividends. We've always been a strong dividend payer. We've had 50 consecutive years of dividend rate increases. I talked earlier about our accelerated dividend. So this year, looks like a bigger growth year than it really is because we just moved up a payment but it's $1.84 a share this year, and we expect that to continue. It's a good way for us to return capital to shareholders, especially given our strong, consistent cash flow. We have a dividend payout guideline of 30% to 45% of the trailing 2 years net income, and our current dividend yield is about 2.5%.

Another key way to return capital to shareholders is share repurchases, and that remains a consistent part of our capital allocation strategy. We've done a lot of share repurchases over the last 7 or 8 years. We are now being more explicit about how we're going to allocate the share repurchases. First of all, we've talked a lot about divestitures today. And what we've done and what we're going to do in the future is to the extent we have after-tax divestiture proceeds in the U.S., we will use those for share repurchases to partially offset some of the dilution. So I talked earlier, we spent $1 billion on share repurchases from divestiture proceeds this year. That's Decorative Surfaces, Finishing and some of the other divestitures we've done. The U.S. portions of those, obviously, the international portions is cash that is overseas.

The second part of it is as we've looked at our free cash flow over this 5-year period and going forward, we're going to generate a lot of cash. All the income from these initiatives we're talking about is going to fall to the bottom line and fall and be turned into cash. So we're going to have a lot of free cash flow to allocate. And as we look at the normal ongoing run rate for share repurchases, we think at a minimum, we can do $300 million to $500 million in share repurchases on an annual basis.

The other external investments is acquisitions. We've talked a little bit about this already. Historically, we've made acquisitions that have had a big focus on meaningful 80/20 performance, potential improvement. Scott talked about moving from desiring to have strong differentiation potential to differentiation of potential being a must have. And that's a key part of our go-forward acquisition strategy and the other part of it is, again, back to the portfolio discussion, we're going to do -- most of our acquisitions are going to be in the accelerated growth space and it's going to be much more focused, strategically.

From a valuation perspective, our valuation methodology is the same. We've always been highly disciplined. We expect to generate on a particular deal, ROIC, well above the cost of capital in a 3- to 5-year period.

So what does all that mean? That means we will likely do fewer acquisitions in the future, and the acquisitions will be more lumpy than they have been historically.

So as a result of the key initiatives we've talked about, the disciplined capital allocation strategy, we think we can drive significant differentiated performance over the next 5 years and after that as well. So what does that mean? Start with solid revenue growth. We defined solid revenue growth, as Scott talked about earlier, as 200 basis points above global industrial production by 2017. How are we going to do that? Changing the portfolio mix, more focus on higher growth businesses, larger scaled-up business units that can compete better globally and have more resources to make investments to compete and also, focused acquisitions on higher growth space.

Strong returns. Our current ROIC is around 16%, which is significantly above our cost of capital. We think as a result of these initiatives and our capital allocation strategy, that we will be above 20% by 2017. Lastly, our 80/20 business model, we believe, makes us a best-in-class operator and can drive best-in-class margins. And that means 20-plus percent margins by 2017 and staying above 20% for the long term.

Certainly, we've got a lot to work through over the next 5-year period through 2017 but as Scott talked about earlier, once we get past the divestiture and some of the other things, we expect our long-term EPS CAGR to be above 12%. So solid growth, strong returns, best-in-class operator.

So let me talk a little bit about the initiatives. Certainly, a lot of questions around these. And what this chart shows is the relative impact from a timing perspective of the 3 key initiatives. So the darker red means more impact.

So starting with portfolio management. When you think about margin impact, as we start divesting businesses and that's going to happen over the next couple of years, that'll have a margin impact as we start doing that, putting things in discontinued operations, et cetera, so that would have a more immediate impact than the other 2 initiatives. Business structure simplification that David talked about, it will take a couple of years to work through and achieve all the benefits. We certainly have started implementing the new management structure. We'll start to see the benefits of that in 2013, but we will also be incurring higher than normal restructuring costs over the next couple of years that offsets some of those benefits.

Also, a key element of the BSS initiative is the fact that the business, as it becomes scaled up, has to go through a reapplication of 80/20 which will also take some time.

And then lastly, as David talked about, strategic sourcing. The timing of that benefit is more towards the back end, years 3 to 5 of this period, and that's really a function of it takes time to build an organization, it takes time to attack the $11 billion addressable spend in the various waves, each of the waves takes time to achieve the full benefit. So it's a long-term process but the idea is to build a strategic sourcing capability that will benefit us for the long-term.

So we've talked about margins going from today's 16% to 2017 and beyond, above 20%. This is a trajectory. It's not an exact trajectory based on our model but it's a representation of how we think the margin benefit will play out. These are all end margins. This is not just margins from initiatives or a portfolio or whatever, all end margins, that includes organic growth and the leverage from organic growth, it includes acquisitions, which potentially can dilute margins, at least, in the early years, and it includes the impact of the 3 initiatives, portfolio management, BSS and sourcing.

The cost savings element of this, that's really the cost savings from BSS, the cost savings of sourcing over this period by the end of 2017, will be $600 million to $800 million. So certainly, that's a large piece of the build-up in this margin from 16% to 20%, but there's also a lot of other pieces that are in here.

Another comment on timing. You can see that the early part of the graph, it's a little bit flatter. We would expect that the margin benefit year-on-year, after we get past 2013, will be relatively consistent but that 2013 will be a little bit less, primarily because it's still taking a while for the sourcing to kick in, as well as higher restructuring cost related to BSS.

So with that, I will turn it back over to Scott to summarize.

E. Scott Santi

Thank you, Ron. So tying this all together, this is not about reinventing the company. This is about repositioning the company. This is a strategy very much built on some very well-known, very well-practiced core capability with inside -- inside the company, and we've been here before. This is a company that's been around 100 years. So it's a company that obviously, to be around that long, has to adapt, has to evolve. This is not a revolution but this is a pretty significant pivot or evolution around a core set of capabilities that we absolutely believe are the right moves to position the company to continue to be successful in the kind of environment we're going to be operating in.

These strategies also, that we've spent a lot of time talking about, these are things that have been going on inside the company in various places for some time. So within the portfolio piece, we have been able to -- we certainly can see clearly the difference between the kind of performance attributes and growth capabilities, businesses that are well positioned from a sustainable differentiation standpoint versus those that are less well positioned. We have large parts of the company that are already generating consistent year-on-year organic growth at 200 basis points or even higher above overall market growth rates. So these are things already going on inside the company.

Some of the headlines as we've started to talk about the portfolio move here around the 25% of the revenue that we're going to divest under this strategy, I'd like to point to the other 75%. So we love 75% of the revenue base in the company, a great fit on a go-forward basis in terms of the kind of return in margin profile we're already generating and the kind of growth capabilities. So this isn't about us having to exit some pieces and go find some new areas of opportunity, these are some really strong, compelling core positions, couple of billion dollar existing positions in front of $20 billion or $30 billion global markets, generating great margins, great returns today. So we've got a lot this already going on inside the company. The portfolio move is really about how do we narrow the focus to really leverage our effort and energy around those pieces.

From a business structure simplification standpoint, we've had a couple of segments, in particular, operating in this larger division format for some time. Those would be the Welding and Food Equipment segments where we've operated with division sizes at or above $100 million for some time and the ability to observe the kind of competitive characteristics and the kind of investment in growth capabilities that those larger divisions have, competing in global markets has been very informative to us in thinking about whether this is the right move to take across the company. So these are also things, again, that we're not making up from scratch but ultimately, using observations, using data points, using experiences inside the company to ultimately develop the kind of conviction around these. Certainly, the sourcing one is a little bit different in terms of leveraging less internal experiences inside the company but as David mentioned, we think we've got some real experience, outside resources helping us through that and it's complex in terms of the execution but it's not that complicated in what we're trying to do. $11 billion of spend, if we focus on it like ITW does, apply a lot of 80/20, can we get incrementally better at that in a way that drives meaningful impact on the bottom line? We have no doubt.

So essentially, this isn't about reinventing ITW. We're the same ITW, only more focused, more efficient and more streamlined in order to continue to deliver the kind of profitable growth and return performance that ITW has been known for, for a long, long time in the context of a much more challenging external environment.

With that, we thank you for being here and your attention and we'd be delighted to take your questions.

Unknown Attendee

Scott, just on the operating margin goals. So the 20%-plus, how should we think about that 20%? Is that the minimum number that you achieve if the environment remains tough? And then, the -- what's the upside when we think about the plus? Is that more associated with the high end of the range and is that another couple of hundred basis points? I mean, any color around that would be helpful.

E. Scott Santi

Sure. So the overall objectives that we laid out were objectives that we feel very strongly we can accomplish under any of the 3 economic scenarios we laid out. So certainly, from the standpoint of the structure of the objectives is under that lowest growth scenario, all of those objectives still apply. So certainly, if we get more tailwind from the market, that's going to help us in 1 or 2 ways. One is either the timing, so we get there sooner if we get more tailwind or ultimately, what the ultimate margin potential is. But under any of those scenarios, we have a lot of conviction about being able to operate this company at a margin of 20%-plus and again, to do so on a sustained basis not just as a peak margin but ultimately, that's the kind of company performance that we should be delivering consistently.

Unknown Attendee

Two questions. First, you talked about in general, the $600 million to $800 million in cost savings. I was wondering if you could just break out, put into different buckets where that's coming from, how much is strategic sourcing, as more simplified management structure, et cetera? And then my second question is more strategic, how -- when you think about ITW relative to the other multis or diversifieds, your earnings have always been more cyclical. How big of a focus will it be for you to reduce the cyclicality of your earnings? Do you think you can get there through the operational initiatives you have in place or do you think you need M&A to achieve that, for example, acquiring businesses with a greater recurring revenue stream?

E. Scott Santi

As to the first question, we're not going to detail out these -- the sort the breakdown of those savings by particular initiative for a couple of reasons. One is, they're interconnected. So there are elements of one that apply that help the other and vice versa and the other is that ultimately, in the aggregate, this is something we know we can do. We've got a lot of conviction about it but to throw sort of piecemeal pieces of that out today when, in fact, we're going to go year by year in implementing these things is -- there's no way to tell you today exactly what is going to come from where. But believe me, we've got enough sort of data and modeling and excellent implementation around these that we're very comfortable with that aggregate number. On the cyclicality piece, I think there is an element of our historic cyclicality that's been a function of just the percent of M&A overall that contributes to the top line. We don't have any goals on this to sort of eliminate cyclicality, per se but it's certainly a factor as we think about -- and I talked about it before in terms of the portfolio split. So there's an element in the construction business around cyclicality that probably mean that we don't want to -- we're not in an aggressive posture there. But net-net, the way we deal with cyclicality is much more around the margin line in our view, which is we've got a company that's capable of delivering margins at 20%-plus on a consistent basis. And so rather than at the peak we get through once every 3 or 4 years, probably because the amount of acquisition dilution going in, it's much more about sort of achieving that rate on a consistent basis and there's absolute capability in this company to do so.

Unknown Attendee

Yes, just a question on acquisitions and divestitures. It sounds like from your strategy to divest some of the, I don't know if you'd want to call them lower quality or lower margin businesses, generally speaking, those are somewhat lower multiple businesses and then you take into account taxes and what the after-tax proceeds would be to the company. You're also talking about acquisitions in higher growth areas which are generally higher multiple businesses as well. So I mean, part of your strategy seems like dilutive multiples on divestitures and dilutive multiples on acquisitions and I'm just wondering how you create a lot of shareholder value when you're basically doing dilutive deals on both ends.

E. Scott Santi

Well, I think from a dilutive standpoint, you're talking about we're going to divest EPS. There's no question about it. But it's, again, about -- fundamentally about how do we create the kind of enterprise performance in the aggregate that we're capable of delivering. We've taken you through modeling here around managing that dilution. It's about positioning the company to focus on the kind of businesses and the positions we have that can generate that kind of performance. These initiatives help us through that process certainly, from a standpoint of offset to that dilution. So what we said is regardless of the fact that we're going to sell 25% of -- or divest 25% of the revenue, we're still going to deliver EPS growth of between 7% and 11% or 12% over this period while we're going through that. So we absolutely have to get position there. The other reality, in terms of, sort of, not moving out of those businesses is the conditions in those markets are only going to make the performance of those businesses more and more challenging over time. So from the standpoint of that end of it, we deal with it now, we deal with it later, but we're going to have to deal with it if, in fact, we want to sort of generate the kind of performance that we're capable of. On the acquisition side, I think the multiple part, we've always managed more from the standpoint of what we can do to the business after we buy it. So as Ron talked about, we've got a lot of financial discipline. We don't have to buy or acquire anything. But ultimately, the fact that we've got 80/20 in our pocket, so whether we're buying a -- paying market multiple for a 7% margin business or a 15% margin business, the fact that we can generate 2x, 3x kinds of improvements in those operating margins, is really what matters. And what we're saying is in addition to that, what really matters is our ability to really grow that and whatever we buy an accelerated rate once we're done improving and fixing the business. And so whether we pay 7x, 8x EBITDA at the front end, it doesn't matter anywhere near as much as the fact that we can deliver the kind of improvement in the front-line profitability of that business and generate returns well above our cost of capital in the end. So we're finding it in the kind of spaces that we want to play in but as Ron said, these acquisitions we're looking have to fit a certain profile, right? We have to be able to -- we have to have a lot of conviction about their fit and growth in these accelerated growth spaces and we have to have a lot of conviction about the fact that we can move margins in a real meaningful way.

Unknown Attendee

Just a quick follow-on. The divestiture you did was with a financial buyer. Would you expect that -- would it be -- what would be the percentage or some sort of color around the strategic nature of the remaining businesses that you consider in the 25%?

Ronald D. Kropp

I think as we look at each individual divestiture, it's all, in fact, in such circumstances. So in the case of Decorative Surfaces, it wasn't a business that was necessarily for sale right at that point. But we were approached, it was a good transaction for us to pull a lot of the value out and still retain some of the upside long-term. Those kinds of decisions are going to have to happen as each divestiture comes up for discussion and the idea is to figure out how to maximize the after-tax proceeds, how to best achieve shareholder value. For a particular divestiture there's a lot of different options that come up related to that.

E. Scott Santi

Let me just add one more thing to that. Keep in mind that these are not bad businesses, these are not broken businesses. These are businesses that are leaders in their industries. These are businesses that generate pretty darn good returns, pretty good margins in their field. They just don't have the characteristics to deliver the kind of performance that in our view, ITW is capable of. So these aren't fire sales, these are assets that have value outside of ITW. So we still -- will we get ITW multiple for them? Likely not but we're going to get good value and I think we've proven that already in the divestitures done over the last year.

Unknown Attendee

Can I go back to this 20% margin, 16%, in a little different way because we like to see, right, how do we get there. Divesting 25% in more commoditized businesses, divesting lower margin business and it would seem that from the 16% to 20%, at least 1% would come mathematically from losing -- divesting the lower margins. And secondly, ITW was always -- had better margins than we see because of the dilution from the acquisitions. And I think your strategy was a little bit lower percentage coming from acquisitions over -- in this time period as you structure the company. So I guess going from 16% to 20%, is it fair to say -- how much are we going to get from getting rid of low margins, that 1% or more, how to get from lower acquisition impact on margins that's -- so it looks like at least 1% or more. So we're sort of halfway there by just the structural changes that are taking place, and the rest coming over the next 5 years from that. Is that a fair way to look at how we're going to get 20% or can you put some color in that kind of number?

Ronald D. Kropp

Well, we're not going to parse out the individual pieces of it. I mean, certainly, all those things have a contribution to the margin benefit. We will have some addition by subtraction from divestitures. How much that is and when it happens, we'll have to play out. Certainly, growth -- organic growth leverage will play a part and improve margins, especially just on a normal basis, if we're at incremental to 35%. But then there's the big chunk from business structure simplification and sourcing, which is bottom line savings. So all 3 -- all of those play a part in the overall margin goal. So we're not going to necessarily parse out the individual pieces.

Unknown Attendee

And one quick follow-on, we hear -- talk about changing portfolio structure, but we didn't talk on anything about changing the geographic distribution of ITW, which still is somewhat underrepresented in emerging market countries versus a lot of peers, competitors. Can you talk about that impact and what you're trying to do over the next couple of years because that's probably a missing element...

E. Scott Santi

Well, I think the way we think about it in terms of geographic is really a function. You got to start with the existing positions. These are global positions. So emerging markets in these accelerated growth categories certainly have -- are a core part of the overall growth opportunity. But in our view, we've always managed emerging markets much less around revenue position and much more around ability to sustain earnings on the investments we make there. So we are a point or 2 in terms overall revenue composition, probably lighter than some of our peers. But I would put our margins and our earnings in those markets up against anybody's, and I think that's the way we continue to look at it. We're not trying to underemphasize emerging markets but ultimately, really describe the emerging market opportunity as a function of the core competitive advantages and the sustainable differentiation potential around these global positions. So within welding, within Food Equipment, the emerging markets are a subset of those pieces rather than as ITW, we've just got to be big in China.

Unknown Attendee

I wanted to ask about the comment about 2013, 2014 higher restructuring cost. I wonder if you can give us some color on how much more relative to 2012 and maybe some specifics on what you've got planned for next year both -- either related to these initiatives versus what's regular and ongoing?

Ronald D. Kropp

So as we've talked about earlier in this year, part of our guidance, our restructuring spend this year is $100 million to $110 million. Our normal restructuring spend is probably $60 million to $80 million on just on a normal run-rate basis. So we've already bumped up the restructuring this year and we've talked about it being really related to business structure simplification. As we look into 2013, certainly, we have some visibility on that. We are looking at similar levels, maybe even a little bit higher levels of restructuring in 2013 related to BSS.

E. Scott Santi

But not anything dramatic.

Ronald D. Kropp

But not anything dramatic. So as we move through this next 3 to 5 years, we won't see any significant ramp-up in restructuring but probably at a higher level than the normal run rate.

Unknown Attendee

Okay. And when you say related to BSS, you mean as you're divesting, you're getting dilution or is it because of special charges as you eliminate positions or facilities?

Ronald D. Kropp

Well, it's really the headcount reductions. BSS is the business structure simplification piece. We're on a 3-letter acronym mode now, sorry about that. So it's not portfolio, it's related to the scale-up of the structure.

Unknown Attendee

Going back to the past, to 20% and you made it pretty clear that there is restructuring charges coming in 2013, and that's why the chart starts off flattish, but then it goes linear and I don't know if you're suggesting that it really is a linear progression or whether this slide has been oversimplified. But you would think that there would be almost like an S curve where the earlier years would yield some of the low-lying fruit and divestitures you can get out of the way. Is -- maybe you can just address that question whether it's linear or might there be earlier margin gains rather than in the out years?

E. Scott Santi

So as I talked about on that one heat chart, the different issues come in at different times. Portfolio at the beginning, business structure simplification more in the middle and sourcing at the end. And so as we've rolled that up and there's certainly ranges for each, right? But as we roll it up, it's pretty consistent once you get past year one.

Unknown Attendee

Okay. And then, I know this should be a rhetorical question for ITW but I still wanted you to hear it, hear you say it, is that all these restructurings are being done on a pay-as-you-go basis.

E. Scott Santi

That's correct.

Unknown Attendee

Okay. So there's no big bath restructuring. [indiscernible]

E. Scott Santi

These margin goals are not net of restructuring. These are after restructuring.

Unknown Attendee

Okay, good. Just want to make sure that was clear. And then my last question is related to acquisitions. And historically, ITW's -- some of their best deals have been harvested on a bottom-up method where the small operating units are coming closest to the -- their competition, closest to the opportunities. If you go fewer and lumpier, does that imply that some of these deals will be directed from a headquarters or will it still be a bottom-up harvesting and sourcing of deals?

E. Scott Santi

No. The reality inside the company is that the strategic center in terms of how we operate has moved from the division level to the platform level, fundamentally. So the platform for us is a $0.5 billion-ish position, multiple divisions. And ultimately, that's how we want to be looking at opportunities. So the welding, oil and gas is an example of a platform that we took you through. So from an M&A standpoint, it all starts, a, in these higher accelerated growth areas with what are our growth strategies? What are the opportunities? If there's an organic piece to it, and then how do acquisitions ultimately help us get there faster or more effectively or have a broader view of what our opportunities are? So I don't think it's a matter of bottoms-up top-down as much as it's much more -- starts with a core strategy, less about financial return alone, can we buy something that we kind of know that we can improve the margins on to get a financial return? But it's 80/20. These are, for us now, it's as much about sort of the energy that we deploy as the capital. I don't mean to minimize the capital part but this -- the decisions for us from the standpoint -- and it's as important to us to buy the right things because we're going to devote a lot of time and effort on those things. And ultimately, to buy into spaces where we've got a lot of conviction about -- we know a lot about them, we've got a lot of conviction about the growth potential in those spaces and we've got operating metrics to support the fact that we can do really well here. So that's the top-down part. But ultimately, is it some corporate strategy staff doing this stuff? Absolutely not. These are people that are running these segments, collaborating with their general managers. So it's still got -- it's very much -- the ownership level and the accountability around it is still very much with the businesses, but are David and I and Ron, having more guidance in terms of what we're buying and why we're buying it, than used to go on in the company? Absolutely.

Ronald D. Kropp

But I will -- and I will add, though, that we're not talking about -- when we talk about potentially bigger deals driven from the top, we're not talking about $1 billion deals here. Bigger deals for us has always been $100 million to $400 million, $500 million, and that will continue to be the case.

E. Scott Santi

And we gave you a couple of examples for a reason, right, that we talked about, right, these are $250 million deals. This is kind of -- this is the sweet spot for us, right? We talked about the 80/20 impact. I mean, these are not new things for the company. We've done these before, we've done really well with them, but that's what we're talking about around largers. The old days of 50 deals of $1 billion of acquired revenue, that's probably not going to happen again. But I think from the standpoint of 2 or 3 really good ones like this year, absolutely.

Unknown Attendee

[indiscernible] Scott, you presented a resegmentation of the company that still has 8 segments. Once we get through the next couple of years and complete the diversification element of this new strategy, is it your expectation that we'll still be looking at 8 segments?

E. Scott Santi

Maybe. You sort of have 2 choices. One is from the -- the sort of issues are one of both how do we see the company actually operating? How many spaces can we play? And then the other is how we report externally. And we absolutely understand how much easier your modeling gets with less segments. So we get that part. But ultimately, we could have done a lot of this stuff together and come up with -- you remember the old ITW days of engineered components and -- I forget what the other thing was, right -- that had no meaning anywhere inside the company. The reality for us is as we think -- as I think about -- we think about sort of the long haul, we have sort of great experience and demonstrated success in building substantial new pieces of the company. So test and measurement, that was a single acquisition in 2005, is now part of a major segment for the company. So I understand the added complexity from the standpoint of the analytics and the investment side, but from a business strategy standpoint, I have a hard time walking away from that as a future objective for the company, the next test and measurement, the next welding, I think we're going to spray to far fewer fields in trying to develop that. But ultimately, part of our long-term growth is a function of our ability to continue to add attractive new pieces to the company. And our view now those have to be -- they have the potential to get to a couple of billion dollars or bigger. So there's an element of scale around the analytics on the entree point. But it's hard -- I think it's too -- it's been too important a part of our growth history and it's too important a part of our growth potential going forward, just to say, well, the whole objective is to dumb the company down to 3 or 4 things.

Unknown Attendee

Right. I think investors appreciate the transparency too, Scott. A separate question. As you talk about the business simplification process and the example that Craig (sic) [David Parry] presented was U.S., Europe, Brazil, China, part of the ITW strategy has always been to be localized, to produce in the market where your customer is. Is any of that -- should we look for any of that to change?

David C. Parry

No. The -- obviously, as we scale up our businesses, as you saw there, being more regional going towards more global, that those -- they will combine and we will look at our businesses in a very much a global approach. So if we need to make investments in China or Brazil, whatever, then that business or division as we call it, or platform, will decide where it wants to put its money and put its energy, which has the best opportunities, so there'll be no change with regard to picking which is the best areas for us to get sustainable differentiated growth.

E. Scott Santi

Yes. We have fundamentally been always a company that believes in producing close to our customers rather than chasing low labor rates around the world. It takes -- sourcing raw material in the same currency we want to sell it takes a lot of currency risk out. Supply chains are a lot shorter, ability to service our customers, all of that stuff -- no change at all in our conviction, particularly as we look forward. The example that David talked about though was probably under this old structure, the old sort of ITW, the whole system and the before-stage might have had 4 or 5 plants and now we need 3 or 4. There's some, certainly some incremental rationalization that can take place, and we've seen it in some respects but it's not about sort of eliminating the underlying strategy of regional presence. But in the aggregate, given the sort of volumes we're dealing with, we probably only need to make the 80 products locally made. We don't need to make all the smaller volume stuff that's part of, again, the reapplication of 80/20, but it's not mass centralization of the manufacturing footprint into one location in the world.

Brian K. Langenberg - Langenberg & Company, LLC

Brian Langenberg with Langenberg & Company. A couple of questions for you, Scott, 2, and I'll give them both up.

E. Scott Santi

Thank you.

Brian K. Langenberg - Langenberg & Company, LLC

First of all, in terms of direction, it makes sense you're going to go in a certain place to get better. But you play in a tough league, obviously. There are some other good companies who operate well.

E. Scott Santi

Sure. Great companies, yes.

Brian K. Langenberg - Langenberg & Company, LLC

Talk about your secret sauce for getting better faster, which is the trick. And the second part, the second question's a little bit different. It's about strategic vision, managers, who gets promoted and that running a $25 million to $50 million business is one thing. Thinking globally, think in a more sophisticated linked way, is different. Does this start to evolve how you think about who you select for leadership roles and also from time to time going out. So those are my 2 questions.

E. Scott Santi

Yes. The second one I'll handle first, because it's the easiest one and the answer is absolutely, it does. We've been, I think, very clear in our thinking from the outset around the kind of leadership attributes and experiences necessary to run a $100 million to $150 million global division has been far different than running a $30 million or $40 million regional one. I think we've been very conscious about selecting the sort of leaders for these larger divisions on that basis. The first question around how do we get better faster? All I can point to is that we've got a lot of energy, a lot of conviction. This enterprise strategy is now probably 250 leaders deep in the organization. I don't mean from the standpoint of who knows about it, but ultimately, where we've spent as a leadership team -- significant quality time working with the leadership teams around what we need to do, why we need to do it, what the outcomes are that we think we can get from it. So we've got an engaged group of leaders that are pretty fired up about this and what it can do and where we can go as a company. Ultimately, from the standpoint of my tenure at ITW, this goes right back to our culture that when we sort of put our minds to something we need to get done, we generally get it done. All that being said, we've been trying to be very clear about, there's no shortcuts here. These are some pretty substantial undertakings that -- we're going to have to do the work. We can't just say it, we have to do it. And doing the work is going to take some time and some effort, and we're going to stub our toe a few times along the way, but we'll get it done. But it's not like we can cycle-time this process shorter because it's going to create -- this isn't a high risk move but if we start to drive new stuff like that, that's unnecessarily elevating the risk profile. This is not a broken company. This is not a company that needs to get fixed, but this is a company that we think can do a lot better. And ultimately, we've got it -- we've got to sort of manage the implementation process around this in such a way that we don't drop any big balls in the process. We've got a company to run. We've got things to do every day, and we're going to do those things. So I think the timing of this is right, I think the initiatives are right, and we all do.

David C. Parry

I think the other thing, just to add in your comment, is we've been very open with our management teams about the skills and competencies required to be a VP GM or a group president. So it's not as though this has been not communicated pretty clearly and openly. So there's been very good communication and clarity in those sort of roles.

Alexander M. Blanton - Clear Harbor Asset Management, LLC

Alex Blanton, Clear Harbor Asset Management. Could you give us an idea on the share repurchase program, how much of your long-term EPS growth goals are from that alone, for just from share repurchase? How many cent -- or how many percentage points?

Ronald D. Kropp

So I'm not going to give that level of detail around the modeling going forward, but certainly, as we shrink the company by 25% from divestitures, we're getting some of that back -- certainly not all of it -- but some of that back from share repurchases. So you can probably estimate that. If you estimate proceeds and after tax and all that, and come up with a number, it'd probably be reasonably accurate.

Alexander M. Blanton - Clear Harbor Asset Management, LLC

I probably could, I thought you might have done it. Second question is about Lean. I haven't heard that term mentioned today yet. However, I did see in one of the slides, you related to continuous improvement. Could you give us an idea of what the role of Lean is in all of this? I'm sure it's very significant, but you haven't really talked about it today yet, and it's important from a margin standpoint.

E. Scott Santi

Well, I will be happy to weigh in and then I'll ask my colleagues to help me here. What I would say about fundamentally that Lean -- 80/20 is different than Lean. There are elements of Lean inside 80/20 but the fundamental difference is 80/20 applies to the whole business, not just the factory floor. So...

Alexander M. Blanton - Clear Harbor Asset Management, LLC

Lean also applies to the whole business, if you take the broader view.

E. Scott Santi

Well, I absolutely appreciate that. I think we'd be happy to sort of put our application of 80/20 up against anybody else's application of Lean, and you can make your own call as to whether 80/20 is effective.

Alexander M. Blanton - Clear Harbor Asset Management, LLC

But could you give us an idea of how you implement Lean in your organization?

E. Scott Santi

Well, we implement 80/20 in our organization. That's what we talked about. And as I said before there are elements of Lean inside 80/20 but it's applied in a much more comprehensive and holistic way, as I would view it.

David C. Parry

Can I just add? I think the big difference, I mean, sometimes between Lean and 80/20 is we're spending our resources on the things that really will grow our top line and focus our energies on the priorities, whereas Lean is more about working really efficiently.

Alexander M. Blanton - Clear Harbor Asset Management, LLC

Well that's right, I mean, it has to do with inventory reduction, cycle time, all of that, but you haven't really talked about that. The emphasis has been mainly on 80/20.

Unknown Attendee

I would like to hear your perspectives on what do you think ITW needs to do differently than it has done in the past to spur the organic growth rate up 100 basis points? I understand you're going to focus more, but where are you going to invest? Are you going to do more R&D? Could you give us a few examples of what you are doing differently in the company versus what you might have done in the past to get to a higher growth point?

E. Scott Santi

Sure. The way I would describe it is we've been doing some things differently for the last 3 or 4 years. The absolute biggest factor in terms of achieving the growth goal that I described is really back to the portfolio, that we have large parts of the company today that are already at or above the enterprise growth goal from an organic standpoint that we've put out there. The reality is that that's been offset by a negative drag from the 25% of the portfolio that's been under commoditization pressure where we get basically 0 growth. So this is not about a whole bunch of new initiatives around organic growth as much as it's really focusing the company on those positions we have today that are well positioned to grow and are already delivering growth. That's not to say that we're not going to get further sort of -- when we talk about aggressive growth posture, that's not to say that we're not going to step it up further in those spaces. But the reality is the R&D investment in those spaces is already higher than the company average. So there's a lot of things that are already there and in place. And the ultimate issue from our standpoint is we're diluting some of our resources in areas, no matter how well we manage them, that the market characteristics are such that we just can't generate the kind of growth. And so it's much more about -- and all of that only gets worse as you head forward. So it's really about how do we use -- how do we sort of focus on areas that are -- that we're already in, that have the potential to grow at these rates. So it's less about turning a switch and more about sort of addition by subtraction here.

Alexander M. Blanton - Clear Harbor Asset Management, LLC

A lot of your company -- a lot of your peer companies talk about the savings from Lean or sourcing being channeled into growth investments. Do you see -- is that part of what's happening in ITW as you see it?

E. Scott Santi

That's a capital allocation question. Why don't you take it?

Ronald D. Kropp

Well, so…

Alexander M. Blanton - Clear Harbor Asset Management, LLC

No, it's not necessarily capital allocation. It could be spent on more salesmen in emerging markets, or R&D.

E. Scott Santi

Well, we -- there's never been -- I'll give you the simple answer to this, never been something we haven't done because we say we just don't have the money. 80/20 is all about sort of investing in areas that are -- that have the sort of most impact in our -- and that we qualify well. So we generate plenty of cash. So it's not about redeploying cash in this case. It's about -- going back to what I said before, we don't need to take proceeds from divestitures and so we -- because we want to invest more in growth, we don't -- it's not a trade-off for us. We could invest as much growth -- and we got a lot of capability to invest. It's more the quality of the investments than the quantity. And it's -- again, we've had big parts of the company already doing the kinds of things that we're talking about doing and we need to do on a go-forward basis.

Alexander M. Blanton - Clear Harbor Asset Management, LLC

Okay. My last question is in looking at businesses that are in the 25% that you plan to take out over time, we've seen a few large deals done already, are the -- is the remaining set scattered throughout the company? Or are there 2 or 3 larger pieces that need to be moved?

E. Scott Santi

Yes. We're not going to give you any more detail on that. We're not completely through the planning process yet. But certainly, as I'm sure you would appreciate, we're not going to want to preannounce anything here at this meeting. And as those decisions get made inside the company and a number of cases get approved by our board, then we'll certainly announce those in a timely way.

Unknown Attendee

[indiscernible] Alex, I'll be happy to do a 80/20 101 for you.

Alexander M. Blanton - Clear Harbor Asset Management, LLC

Thank you.

Unknown Attendee

[indiscernible] Can you talk a little bit about -- if you look out a year or 2, can you give us some comfort that we're not going to be sitting back here -- and now you're talking about, "Gee, we need ERP implementation in order to generate the savings on sourcing and we need more corporate -- we're from corporate, we're here to help resources." Same question in M&A, as you go through the divestitures and the acquisitions, they're going to be bigger, they're going to be more complex, there's going to be of them if you include divestitures. Give us some comfort that we're not going to see corporate scope [indiscernible], if you like?

David C. Parry

Okay, yes. Well, I'll touch on the sourcing element and maybe just quickly touch on the acquisition side as well, but maybe Scott will add on the acquisitions. As far as sourcing, I mentioned right at the beginning about the sort of resources that we're adding, I mentioned the number, about 10 to 15 people, right, so this is not a case of we're trying to add a big corporate infrastructure here. Are we trying to build up some sort of capability within the company with sourcing professionals and are we going outside to find that capability? Yes, that is true. But the people we are looking for is literally one CPO, right? We're looking for one sourcing director for each of the EDP segments, so there's 8 segments -- or 9 segments, sorry, right? So there's 9 sourcing directors. So no, this is not an attempt to sort of coordinate everything. The other thing that I would also say is that you go to the split between sort of enterprise and segment, and you saw it's 50-50. So I'm -- or put 53-47 -- so you're seeing that things, a lot of the effort here has been done within the segments, right? And that detail has been done within the actual platforms, the divisions, right? So no, this is not a -- this is a matter of using our scale. This is not a matter of bringing everything into one big central computer and we're going to do everything. No, that's not the case, so be assure on that.

Ronald D. Kropp

And from a BSS perspective, right, as we talked about, we're -- even though we're operating at larger scale businesses, $100 million-plus, we're not operating as one business. So we're not talking about one system for all the businesses. Certainly, each of the businesses will have to evaluate their own system but they're still managing it in a decentralized fashion, they're still keeping their own [ph] culture.

David C. Parry

Right. If I then go to the acquisition, I think. I think, actually, Scott mentioned it before is the acquisition activity is still going to be driven at the platform division level. All that we have done is simply, perhaps, move the emphasis more from what we used to call the 800 business units and moved it up, perhaps, a little level so that it fits. So we could actually get the growth of that platform and division. So again, we're not going to have one big merger and acquisitions department. So...

E. Scott Santi

And my only add on is 80/20 applies to all of it. So from a sourcing standpoint, it's not about an SAP system that can grab every check we cut for every nickel that we spend all over the world, it's -- the 20% of stuff that we buy that represents 80% of the volume, and so we don't -- our view is we don't need -- I think we've had enough outside eyeballs on this from PWC and others that we agree that we don't need massive centralization of command and control to be able to get the sourcing thing done. What we need is a few people and some focus.

David C. Parry

Yes.

E. Scott Santi

And some very meaningful objectives and people's objectives. So...

Unknown Attendee

Back here. A lot of stuff going on with a lot of long-term promise, and I'm just wondering for 2013, should we expect any margin improvement?

Ronald D. Kropp

Yes.

E. Scott Santi

Yes.

Unknown Attendee

Could you give us a ballpark?

Ronald D. Kropp

Yes. Certainly, we'll have more guidance at the end of January. But as we've looked at it, where we're at currently, we're looking at margins between 16.5% and 16.75% in 2013.

Unknown Attendee

I just wanted to make sure I understand the -- this is the slide that described the initiative impact of 10%, basically CAGR and EPS, at the midpoint. Does that assume that the extra 15 percentage points of revenue divestitures have happened already as we start the clock January 1 of '13? Is that what that means? That those revenues are not in those numbers, in the associated profits in '12, like at the start of the year or whatever?

Ronald D. Kropp

Yes. The starting point for the calculations in there is really the current business at the end of 2012, which excludes tech services and any of the other divestitures we had during the year.

E. Scott Santi

So the EPS CAGRs are 13% through 17%.

Ronald D. Kropp

Right.

Unknown Attendee

Off of effectively a pro forma 75% of the revenue base?

Ronald D. Kropp

Yes.

E. Scott Santi

No, no, no.

Ronald D. Kropp

Starting with 2012, so...

E. Scott Santi

And including the divestitures as we go through.

Unknown Attendee

Yes. 75% of what you would have had if you hadn't done the divestitures?

E. Scott Santi

No. Only divestitures…

Ronald D. Kropp

Those have already happened, not the remaining...

E. Scott Santi

Yes. And those CAGRs include dilution from divestitures.

Unknown Attendee

Okay. So the CAGR assumes [ph] that there's going to be future divestitures, not that they've already happened.

E. Scott Santi

Yes.

Ronald D. Kropp

Yes. We've talked about 25%. We're just about at 10% now. So...

E. Scott Santi

Well, we can deliver those EPS CAGRs while we're doing those divestitures.

Unknown Attendee

Okay. So I mean if you go back historically, you -- there's lots of ways to cut this, right? Old ITW, you've obviously got to manage around your sections. But you've done a lot better than 10% EPS CAGR without massively disrupting the company and going through this whole initiative. So I kind of agree with Eli's point, if you simply didn't do acquisitions, and 80/20-ed what you already had, you're going to get margin uplift. You just described a '13 environment, a very slow growth where you've got 50 to 70 basis points of margin uplift. You've got the impact of getting rid of these lower margin businesses, that's giving you margin uplift. The 20% sounds good, but it strikes me that you're almost lowballing these expectations. What could go better to drive an EPS contribution impact in the future that should be actually higher? Or otherwise, why go through this whole exercise?

E. Scott Santi

Well, we appreciate your perspective that we are lowballing. I assure you we are not. We actually though we were stepping up with some pretty transformative performance skills for the company. This company has never operated at the kind of margins and returns that we're talking about getting the company to. A big part of what you have to factor in, again, is changes in the external environment. So this is about -- it's not a math exercise, simply, this is about the way the world is going to change, the environment we're going to be in. You can't take a static view that says nothing is going to change. So if we just keep doing the same things we've always done, we're going to be the same ITW from a performance standpoint because the world is getting nothing but more and more competitive. We're seeing signs inside the company, is what we described, as you start to see some divergence of performance around this issue of commoditization that we have to deal with. Ultimately, we've got the potential to perform at a much higher level. So it's not a slice and dice and make -- sort of move some parts around and generated some better results for a while. There's some fundamental strategic elements of this that are really around what the competitive environment is going to be like and we've got to take businesses into the future that ultimately have the kind of attributes necessary -- they can generate ITW-caliber performance, but other parts of the company can't, because of -- not because of the things we control, but because of the things we can't. So it's -- there's math in how we get there, ultimately, around these initiatives. But in the end, you also can't look at here's where we are today and if we just keep doing what we're doing, everything's going to be just as rosy 5 years out, because it's not. I mean, that's -- if you want to disagree with me on that issue, that's -- you're right and that's fine. But there's going to be more and more margin pressures, more and more competitive pressures building on those businesses that aren't in a position to ultimately succumb or do well in that.

Unknown Attendee

That's the answer. If you weren't doing this, things are going to get an awful lot worse...

E. Scott Santi

That's our view. Yes, yes, yes. Okay. All right.

Unknown Attendee

You talked about Food Equipment as an example of having larger business units, and you've shown strong improvement in that business over the last 1 to 2 years. So can you maybe give us some color on what you did on that business between business simplification and 80/20 that will be helpful for what we [indiscernible]. And just one other thing around strategic sourcing. ITW has always had voluntary strategic sourcing, if you may. So I just wonder why will it take a while to ramp up because it's -- you've had it before. I know you have to hire a bunch of people, but still it's not like this is the first time you're doing centralized procurement or trying to.

E. Scott Santi

Well, I'll let Mr. Parry answer that, but the simple answer is there's a difference between voluntary and mandatory.

David C. Parry

That's very fine. I think the work we've done before on sourcing and it's a very small department we have today is what I will call an opt in and opt out program. It was more an advisory, all right, and there were certain programs, yes. But the businesses could very much depend upon how they want to go forwards and proceed. Now it's much more of an opt in and you will proceed down this path. I can give some very simple examples.

E. Scott Santi

And what I would add to that is David's bringing -- and Ron [indiscernible] charge on this, will bring much more of an enterprise perspective. It's voluntary, is sort of in the individual business' interest. The enterprise perspective is where we, as a company, spend the big bucks and let's go get after it, and I think that's a big part of the change here.

David C. Parry

That's right. So just simple things whether it be travel or things like that, when you use the American Express system or do you use, whatever the -- what we call, Concur, in the past, that was very much voluntary. Now you have to use the enterprise-wide process.

E. Scott Santi

That we'd only -- we don't reimburse you for your expenses unless you do.

David C. Parry

Basically. And what does that mean? That means you leverage your scale much more. You can actually flow through the profitability. So that's a big change. And so yes, it will take time. And the other thing that I would say is if you go through the process, the chart that I showed you before about how you actually get the leverage on -- whether it be steel or whether it be resins or whether it be chemicals, that does take time. It does. And you don't want to rush that process because if you rush it too quickly, what will happen if you get to the end and you change the specifications, you're going to end up with quality problems and you're going to waste all the money you saved in simply trying to repair all the damage you've done to your customers. So this needs to be done in an 80/20, very much focused way. And this is a case of you measure 2 or 3 times and cut once.

Ronald D. Kropp

The other thing I'll add to that is historically our sourcing efforts have been focused on the indirect spend. And a key part of this sourcing strategy is really attacking the correct spend inside the segment. And that's where we're putting some sourcing professionals and other resources.

David C. Parry

Right. And the whole -- I mean, Scott mentioned as well before, all these things are all overlapping. Clearly, if you've now got 150 divisions, coordinating that activity to get leveraged spend, it's obviously a lot easier than trying to do across 800.

E. Scott Santi

So Food Equipment, quickly, was -- the relatively short answer there is that's a business that as of about 3 years ago, they had a view that it was going to be pretty soft, pretty tough going for a while given some of the economic forces and they've been hitting 80/20 really hard, so sort of a big reinvigoration program around 80/20, and I think through it, margin -- operating margins are up 200-plus basis points this year, year-on-year, on a really relatively flat top line. So just back to 80/20 there and that business now, with some growth behind it, it's going to do phenomenally well.

John L. Brooklier

Who wants the last question? Who wants to ask the last question?

Unknown Attendee

My question is for Ron. With the expectation that interest rates will likely remain low for much longer than we all thought a couple of years ago, can you talk a little bit about how you think about your capital structure within the context of driving shareholder returns? Today, you're rated high single A by both rating agencies. Do you really have to be rated that high in order to retain your competitive position? In other words, what's kind of your ideal rating within that context again of driving shareholder returns?

Ronald D. Kropp

So certainly, as we look at the capital structure, we evaluate where we think rates are going, where they are, et cetera. And in fact, one of the things we've done over the last couple of years, twice, is we've issued some long-term bonds at really low attractive rates over -- for a 30-year period. So we're trying to reduce the overall borrowing cost for long-term as we do that. From a ratings standpoint, we don't manage the company for a particular rating or around a particular rating. In fact, over the last few years, we moved down into the A ratings we're in now, and it's really a function of giving us enough flexibility to do acquisitions and other things as we see necessary and make the right external investments. So we're at 1.4x EBITDA. That's a pretty reasonable range for us. Could we go up a little bit? Sure. Would we do that for the right external investment? Absolutely. So we're not managing to the ratings, and we're not tied into where we are. But we like where we are from a flexibility perspective.

John L. Brooklier

Okay. I think we'll end it there. Management will be available through lunch to answer any additional questions. So thank everybody for coming. We greatly appreciate it.

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