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Illinois Tool Works Inc. (NYSE:ITW)

February 21, 2013 2:10 pm ET

Executives

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

Analysts

Andy Kaplowitz - Barclays Capital, Research Division

Andy Kaplowitz - Barclays Capital, Research Division

Okay. I think we're going to get started again. This is our last presentation of the day but certainly not least, to have ITW with us, as ITW has been with us probably for the past 15 years plus at the Lehman/Barclays conference, one of the preeminent diversified industrial manufacturers in the world. We have with us Scott Santi, who is the President and CEO.

Question-and-Answer Session

Andy Kaplowitz - Barclays Capital, Research Division

So maybe I think what will best is if I just ask you, Scott, just to start off. We've heard a lot about in this conference sort of mixed messages about the economy. You guys cover a lot of different spaces, do a lot of different things. Sort of maybe if you could just sum up how you see the environment right now. Have we've seen any changes over the last couple of months, as maybe we've started to solve some of the government problems that we've had? But we still have many others out there, too.

E. Scott Santi

Well, thanks, Andy. And thanks for having us. And it's nice to be here with you all. In terms of our sort of view around economic conditions around the world, what I would say is essentially, not a lot has changed over the last 2 or 3 months. We have continued to see sort of reasonably positive demand in North America. Europe remains flattish, after obviously some pretty challenging conditions over the last year. Asia in the fourth quarter seemed to pick up a little bit, I think, particularly China, starting out this year, given the difference in timing on the Chinese New Year. The comps looked great in January. We'll see whether they hold up, given the timing of the new year, but we'll see whether things continue on. But I think things are starting to look better there.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. That's great. So maybe I'll ask you a couple questions about enterprise strategy, it's a big part of ITW right now. Maybe the obvious question that comes out is you announced that you were looking at strategic alternatives for Industrial Packaging right before our conference. So maybe you could talk about that, sort of why you announced that. I think people who know your company probably know that Industrial Packaging has modestly lower margins than you would like and maybe can be a little more competitive than some of the other divisions. So maybe I'm answering your question. But at the same time, maybe you could talk about it.

E. Scott Santi

Sure, great. Maybe as a bit of context, we have been working very hard on the go-forward enterprise strategy for the company really over the last couple of years. And essentially, what we -- where we are on that and spent some time at our Investor Day in New York detailing this is we have a lot of conviction about the strength and robustness of our core business model and have a lot of enthusiasm for an opportunity that we think we have to take the company's performance up another significant notch by being a little bit more disciplined and focused around only engaging where we can get the full bang for the buck from the elements of the business model. And the 3 core pieces of our business model: our 80/20 operating system; our ability to differentiate, solve problems for customers in innovative ways; and then our decentralized entrepreneurial culture that essentially is a very fast and nimble sort of delivery vehicle for those 2 things. So from the standpoint of portfolio, essentially what we are doing is looking at -- looking hard at all our businesses and ultimately making some calls around where we think our ability to drive that differentiation element of our core business model is going to be challenging going forward. Our Industrial Packaging business is an example of that. So we've got a big part of the company that generates margins north of 20%, returns on capital after-tax north of 20%. And really as we analyze those, it's when we get both world-class operating economics from 80/20 and have a lot of sustainable differentiation in terms of how we serve our customers. That, that's the sweet spot in terms of fully leveraging the business model. And our sort of embedded in our strategy is that we've got an opportunity to be a lot more disciplined about how we deploy capital and resources only into those spaces that can fully leverage the unique business model that we have. And in the case of Industrial Packaging, a leading business in its industry, margins in the mid-teens. But from the standpoint of the market characteristics, is there enough differentiation there to ultimately get full value from our business model? And obviously, in our view, that's not the case.

Andy Kaplowitz - Barclays Capital, Research Division

So Scott, for now, I mean, you're going to reach -- if you do divest this business, you're going reach your sort of 25% goal or close to it in revenue and divested...

E. Scott Santi

Yes. We will be about 20% -- what we said for those of you that haven't heard us is that about 25% of our overall portfolio, we're going to want to look at hard in terms of exiting and refocusing the company. And with Industrial Packaging, we're roughly 20% to 25% there. So...

Andy Kaplowitz - Barclays Capital, Research Division

So I guess, my question is this -- in terms of the big things like as we look at the rest of the portfolio, are there any of the other businesses that are not as competitive as you would like and-- or beyond that point of no return? Because there's some businesses that might not be as competitive as you would like, but you can improve them.

E. Scott Santi

Yes. Well, and ultimately, the portfolio strategy in and of itself is really not about have we undermanaged a position. It's not about the ability to improve, it's about the fundamental raw material of our ability to get sort of maximum returns on capital, maximum operating margin. So there's certainly other parts of the company that we've got some ability to improve. But anything we're divesting is not a function of we fell asleep and we'd rather get rid of it. This is really about where's the best place for us to invest our capital and our resources on a long-term basis. But the answer to your question is this is the last big piece, the 20% -- 20% of the 25% we've detailed, that's where we are. The other 5% are some relatively small pieces that will play their way out over the course of 2013. But yes, the last big chunk, for sure.

Andy Kaplowitz - Barclays Capital, Research Division

So everybody is going to -- I'm sure, has been asking sort of where do you redirect your cash spend. You sell this business, we're a year from now, what's the highest priority? We know that you're going to do some share repurchases. But how do you balance the share repurchases versus putting more into welding, for instance?

E. Scott Santi

Well, we have never been capital-constrained. So fundamentally, it's really not about redeploying capital in the sense of if we sort of pull cash out of areas that are low return, we can put it to work in areas of higher growth. It's more about ultimately focusing the company on areas where we can grow. And about 75% of the company is already extremely well positioned from a standpoint of strong competitive differentiation, high margins, solid organic growth. And certainly, if we think by better focusing the company in those areas, we can certainly incrementally improve. But these aren't low-growth business that also we need to jumpstart. These are businesses that have been already growing at a high clip. So from the capital priority standpoint, we certainly prioritize investments in organic growth, first and foremost, in those businesses. We are also -- a piece of that is restructuring investment related to a piece of our strategy, around how we're scaling up our structure. But ultimately then, our overall capital deployment focus is we're going to deploy capital where we can get full bang for the buck for our business model and to the extent we generate surplus cash beyond that, and we certainly believe that we will, then we're happy to return that to shareholders in the form of both buybacks and dividends.

Andy Kaplowitz - Barclays Capital, Research Division

So you -- I mean, you unofficially announced the strategy in the summer last year, correct? Sort of when you first came out with a slide that you were going to do some stuff. And so it's been kind of a year of in process where you officially announced it. And so I guess, my point is how has the company taken it so far? I mean, this is a very entrepreneurial spirit of this company. But you're telling your business units to sort of consolidate to some extent, which some people say to me, "Well, that's sort of opposite of the entrepreneurial thing." But I'm sure you're not going to say that, so maybe you could talk to that.

E. Scott Santi

Yes. I think that's a great question. I think fundamentally, this enterprise strategy has resonated extremely well inside the company, primarily because the thing that we were doing, first and foremost, is sort of recommitting to a very compelling core business model, sort of doubling down on 80/20, recommitting to driving sustainable differentiation through innovation, recommitting to decentralization. And our entrepreneurial culture is a core part of how we deliver value to our customers, and ultimately, our shareholders. So this isn't about transforming the company. This is about refocusing the company on how do we get the maximum bang for the buck, if you will, from these differentiated capabilities that we have. So, while there's some differences on how we apply those things, fundamentally, it's built on a bedrock of things that all of our people get up doing every day, day in and day out. And so the big cultural issues, we just have to be really clear about why we're doing what we're doing. And it's a pivot, it's not a reinvention of the company. And we haven't gotten to be 100 years old by not making changes when necessary. But we also haven't gotten to be 100 years old by forgetting what got us here in terms of the core strengths and capabilities of the company.

Andy Kaplowitz - Barclays Capital, Research Division

So your restructuring expenses have sort of drifted up over the last 2 years. Is this sort of what you expected as you're starting to get into the meat of the enterprise strategy? Or is it more...

E. Scott Santi

Yes. It's the sort of normal restructuring run rate that I would put into the category of just normal churn from the application of 80/20 and our businesses day in and day out historically is running the $50 million to $60 million a year range in 2012. So, one of the initiatives that we have -- maybe I'll just sort of give a little bit of a high-level description of this. That one of the core pieces of our enterprise strategy really relates to adding some scale to our structure in the sense that we are going from an average division size of roughly $25 million a year to an average division size of over $100 million a year, still very decentralized. We end up with about 150, 120 businesses, so it's not consolidation. But what it is, is adding sort of more of a global focus rather than a regional focus to our operating structure. And in that, there are certainly some meaningful cost savings and margin improvement associated with management infrastructure efficiency and plant capacity efficiency, et cetera, and that's what's driving a lot of the uptick over the last -- so in '12, we went from $60 million to about $100 million. We expect this year to be about $130 million all related to this initiative. And I think this is -- I think there's no question that this is clearly the peak year that we should start to see it, head back down in newer direction in 2014 and beyond.

Andy Kaplowitz - Barclays Capital, Research Division

So as you've gone through this strategy, or at least for this year, M&A, you've said, is going to take a backseat, I mean. So as you go over the next, let's say, 3 to 5 years, though, I assume you'll do some mix of M&A. The question is where do you think you'd -- are there any particular divisions that you think really needs help still, the ones that are going to be left?

E. Scott Santi

Help in what sense?

Andy Kaplowitz - Barclays Capital, Research Division

They could be improved from M&A. In other words, in the past, you focused M&A, for instance, on welding and test and measurement. Those have been your sort of stated goals. Would that still be the same going forward for...

E. Scott Santi

Yes. I think in terms of where do we want to deploy capital, yes, we've got -- we want to be investing in businesses that are again generating returns on capital and generating cash flow as reflected in very high margins that are at a rate that our business model is capable of. And we've put an overall enterprise, a set of goals out there for 2017 that basically lay out our commitment to get operating margins from 15% to 20% pretax over the next 5 years, returns on capital from 15% to 20%, generate organic growth at 200 basis points above market from 100 basis points as a starting point and generate free cash flow at a minimum of 100% of net income. So from the standpoint of how we deploy capital generally, we were going to want to do it into those businesses that ultimately can contribute to the company's overall performance in that regard. I think at the end of it all, from the standpoint of how we think about growth, in my view, on a go-forward basis, we're much more organic as the lead. And then we're going to be very happy to do some M&A to help us accelerate the growth rate of businesses that have a proven capability to grow at the kind of margins and returns that I'm talking about. But ultimately, the days of 50 deals a year and buy companies, improve margins, buy some more is-- at our size and with the kind of return and margin and cash flow generation potential we have, it's much more the organic that leads.

Andy Kaplowitz - Barclays Capital, Research Division

So kind of the targets that you stated though, which target do you think will be the easiest to achieve and the most difficult to achieve?

E. Scott Santi

Well, I think the easiest in a sense is the ROIC because ultimately, if you get the margin, you manage your working capital well, the ROIC is going to go. So I think that's the sort of the outcome rather than the thing you focus on driving. But we've got to be very disciplined about investing in the right spaces, or we can mess that up in a hurry. But I think -- I also think from a standpoint of the margin, we've got a game plan in place today from the standpoint of the impact of 2 key initiatives. One is the business structure simplification initiative that I talked about a minute ago. The other is a big push on strategic sourcing that we are very clear that we've got between $600 million and $800 million of annualized hard cost takeout impact by year 5, so by 2017. That certainly gets us a long way towards the 20% margin goal. So I think for us, we know what we've got to do, and it's all about execution from here forward.

Andy Kaplowitz - Barclays Capital, Research Division

I think I asked you in December at your Analyst Day about strategic sourcing and how it was going. It's only 2 months later. So have you hired sort of a Chief Procurement Officer?

E. Scott Santi

Yes, we have. As a matter of fact, last week, we had -- we've got a plan in place to put some resources in. For us, the strategic sourcing focus is a significant incremental opportunity in terms of overall margin and cost productivity. We've got an overall sort of base spend of about $11 billion. So if we can get focused on not so much how do we be perfect in terms of how we source everything but really use 80/20 well and focus on the 20% of things that we're spending 80% of our dollars on. If we get 1% or 2% better a year on a $11 billion spend, that's some real money, and it's certainly there to be had.

Andy Kaplowitz - Barclays Capital, Research Division

So I want to ask you one more question on sort of the enterprise strategy stuff for now, and then we'll do a couple of automated questions. But I know these guys all want you to do share repurchases. You know that's what they're going to say. But at the same time, you've been pretty good at M&A over time. And so one of the questions I have is that like as you consolidate the businesses, these guys are going to see more. They're going to be in charge of $100 million, $200 million businesses instead $25 million businesses. So technically, they should be able to do sort of medium-sized acquisitions better than sort of the old ITW. I mean, am I thinking about that correctly? Is that part of the strategy? Or is that just kind of like, well, we'll see what happens?

E. Scott Santi

Well, I think, again as we look at sort of the go-forward portfolio, we've got those businesses, like our welding businesses, it's a $2 billion business, great margins, great returns sitting in front of a $15 billion-plus global market. Our auto OEM business, same boat, test and measurement, these are big billion-dollar positions with a great track record of proven returns and proven cash flow generation today. And so from the standpoint of an M&A strategy, ultimately, it's about -- I think we're a much better company if we're focused down on really sort of maximizing our potential in those spaces. And there's plenty of room there to grow organically and generate really solid growth for the overall enterprise. And to the extent there's an opportunity to acquire that helps us sort of accelerate that, I think that absolutely is a fit. But I think to just say, "We generate a lot of cash and let's go buy a lot of things because we generated cash," I don't think that's the right play for our company because ultimately, we're not sort of focused on how do we best maximize the sort of returns and growth potential from our core business model. And I think we're much smarter to let -- return that excess cash to shareholders and let you all invest it as you see fit.

Andy Kaplowitz - Barclays Capital, Research Division

Okay, great. Let's do question 1 and 2 on the automated system. Do you currently own the stock? One, yes, overweight; two, yes, equal weight; three, underweight -- you're allowed to vote. Four, no.

[Voting]

Andy Kaplowitz - Barclays Capital, Research Division

Okay. So still not a lot of ownership. But we've had that same issue with most of the companies that I've hosted in this room, is that I kind of feel like some machinery and some of these industrial investments are on their own. But let's move to question 2. What is your general bias towards the stock right now: one, positive; two, negative; three, neutral?

[Voting]

Andy Kaplowitz - Barclays Capital, Research Division

So pretty balanced when it comes down to it, not a lot of negative. So I think they kind of like what you're doing.

E. Scott Santi

Look, it's 80-20, 80% positive and neutral.

Andy Kaplowitz - Barclays Capital, Research Division

That's pretty good actually. But I think that goes to show you sort of your strategy has been sort of well accepted by the street. I mean, where do you get the most pushback though, I should ask you on it?

E. Scott Santi

Well, I think probably the biggest feedback I've had -- and it's not necessarily pushback, but I think the whole issue of this sort of short-term dilution around divestitures. And ultimately, what we've said all the way along is we are going to -- to the extent we can take divestiture proceeds and buy back shares. But there's no question that we're not going to get ITW multiples for what we sell on the outside. We're also going to have some tax leakage on these transactions. It's certainly something we want to minimize to the best -- to the greatest extent possible. And we're also going to have -- some of these entities are going to be located outside of the U.S., and so our ability to have full access to the proceeds is impaired. But in the end, it's a route to a much higher return, much higher cash flow, much faster-growing organic business. And $0.10 or $0.20 of dilution in the short run, given where we're going and also given the fact that again, we've got $600 million to $800 million of structural cost savings coming out, that will more than offset it. And I think to get too worried about the timing of the ins and the outs of the first couple of years is just something that we're not going to be able to manage to the last decimal point.

Andy Kaplowitz - Barclays Capital, Research Division

So before I shift from enterprise strategy, I should open up to the audience. Do you guys have any questions that you want to ask on this topic? Anybody have a question? All right. Well, then it's back to me. So let me ask you then about your welding business. It's been a good performer over the last couple of quarters, maybe it slowed down a little bit as some of the bigger sort of manufacturers have slowed down their business. It's outperforming in oil and gas. Maybe construction and mining has been a little bit more of a hindrance. So what have you seen today? And you have a pretty optimistic growth forecast for 2013 in welding. Now how confident are you in that forecast?

E. Scott Santi

I think the sort of conditions on the ground, we saw things certainly slow up in terms of a year-on-year growth standpoint in the fourth quarter. I think we were a plus 1% organic. And it's a business that was plus over 20% in Q1 of last year. So certainly, some significant deceleration. But a fair amount of the product portfolio is capital goods. I think our people there feel like they're -- in the business feel like there's some impact from some of the fiscal uncertainty and people just becoming very cautious. We love the business on a long-term basis. And we love it because it's a very hard thing to do and a hard thing to do well. And we are really good at it. And there are certainly other people that are good at it. But ultimately, from a standpoint of the other thing I talked about before, which is being able to operate in spaces with great potential to sustain differentiation, this is one of the great examples in the company.

Andy Kaplowitz - Barclays Capital, Research Division

So let me ask you about your Construction business. It's maybe a little differently than we talked about last night. The U.S. business, everybody says ITW is leveraged to residential construction, nonres improvements. I think you tell me that you've been modestly underperforming the U.S. market in some of your businesses and that you're still pretty European-focused in your overall Construction business. So maybe talk about what you see over the next couple of years in terms of how you're going to improve the U.S. business, what's going to happen in Europe, you've got a sizable Southeast Asian business.

E. Scott Santi

Well, Construction for us is a couple of billion dollar part of the company. And it has -- we have a lot of conviction about the sustainable differentiation potential in that business. We have some great technology in front of some sort of market niches in the construction arena that we spend a lot of time thinking our way through and come out the other side with a lot of conviction about the fact that our Construction business can be a real contributor to the company. I think the short-term fundamentals are, given where housing's been and all that stuff, things seem to be modestly improving. I think the reality for us is this is a business that's got to perform a lot better at current demand levels. We've probably sat around a little too long waiting for the recovery to occur and sort of under the guise of trying to preserve our ability to recover quickly, haven't managed the cost side as well as we need to. And so I think regardless of the recovery, we've got some significant room to improve the underlying margins and profitability in the business over the next 2 years. And our management team there is highly focused on that, I assure you. And then some sort of tailwind behind that. And in addition to that, this is going to be a segment of the company that's going to more than pull its own weight in terms of the performance goals I laid out earlier. I have no doubt.

Andy Kaplowitz - Barclays Capital, Research Division

The Construction business is a little black box, seeing demand in the sense that you've got this sizable Southeast Asian business as dependent on Australia, but it's also got a New Zealand piece. So maybe you can talk about that out of the business. You've seen some improvement in that this business. Will that continue, you think?

E. Scott Santi

We have, I think it's -- the rough exposure we have on a global basis is about 1/3 residential, 1/3 commercial and 1/3 remodel. So we've got pretty good balance in terms of end markets. And from that standpoint and from a geographic standpoint, it's about 40% North America; 40% Europe; 20% Asia. The Asian business in particular has been a reasonably good performer in terms of underlying market demand. Nowhere in the Construction business are we at the call sort of a raging recovery anywhere. And that would be inclusive of our business in Australia. But I think we certainly do look forward to the next 5 years and say fundamentally, there is a lot more upside in terms of underlying demand and upside potential than downside risk. And again, our big priorities are really around driving some real improvement in profitability that is independent of market recovery.

Andy Kaplowitz - Barclays Capital, Research Division

Maybe while I remember to ask you, like if I think about the segments that have the most margin upside, it seems like it's Construction.

E. Scott Santi

There's no question. Yes.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. Easy question. All right. Let's talk about auto for a second. You've done very well in auto, sort of outperforming the business. The European numbers continue to look crappy. U.S. looks pretty good. So maybe talk about -- I think a lot of this is you're on the right platforms, but you also innovate very well. So I think it's seems good to talk about this business.

E. Scott Santi

Yes, I'd love to. We're very proud of that business and we're on the right platforms. But we're also focused on sort of engaging with our customers on the right things, as you alluded to. And so our auto OEM business is all about talking to our key customers and finding out where they've got some big pain points and how we can be helpful in inventing a solution to address them. It's not a bid at the end of an RFQ kind of business at all. So we want to engage where we can do things that are again about solving pain points for auto OEMs. Ideally, we can -- those solutions can be proprietary, and we've got a great team in that business, have had a nice -- this sort of strategic path they've been going on for about the last 5 years. And what we're seeing now is sort of the outcome of that effort. So even as we shifted strategy, it takes 2 to 3 years to get these solutions, actually not only spec-ed in but then have them go into production with new model years. And we're just starting to see some real confirmation coming out the other side that we're on the right track. So it's a couple billion dollars part of the business, margins well north of the company average, great returns, largely an organic grower. It's again part of what I think has underappreciated about the company overall is we've had this view that we're a relatively slow-growth organic business at about 3% or roughly GDP growth or a little bit better. And the reality is inside the company, about 70% of it has been growing a lot faster than market. And at the same time, there's been a drag from some of these businesses that are not as differentiated, that are more vulnerable to the commoditization. So the auto OEM business is again a big organic story, just like the welding business. We built that business 80%-plus with organic rather than M&A. And we see all kinds of potential to continue on that path. Just to dimension that a little bit, our content per car in North America is in the $60 range. And again, this is just the sort of full collection of different relatively small products that we supply. We're at about $45 in Europe and about $15 in China. And I can't give you a dollars per car as the ultimate market potential other than the average cost in an automobile. It obviously varies a lot as, let's say, $15,000-plus of material in there, so there's, you know we're at $60. There's a lot it we don't want to be in, but there's certainly room to grow. And so I think it's a real sort of engine in terms of our go-forward around high-quality, high-return, high-margin organic growth.

Andy Kaplowitz - Barclays Capital, Research Division

So your auto OEM business is arguably the best premium business that you have or one of them. Is there any risk to competition being able to penetrate the business for you guys?

E. Scott Santi

Well, there's risk of competition everywhere. And it obviously keeps us sharp. I think the reality for us in terms of strategy is we're focused not again on going after big dollar opportunities in the sense of it's a percentage of the overall cost of content of the car. What we want to do is solve problems. And there's some pretty unique core capability that really drives all of this around, some production capability that we have. So it's not only about can we engineer the solution, but we have the ability to actually produce those solutions with some capability that is not easy to come by.

Andy Kaplowitz - Barclays Capital, Research Division

So I would joke with you on about the Food Equipment business and say that it's not that great of a business. It's institutional-focused. But you've done a great job of really improving the margins in that business over time. And now you're talking more about sort of getting into that chain business, the higher-growth platforms. So maybe what's the potential of that business over the next 3 years or so as you go forward?

E. Scott Santi

Yes. We love that business. It is -- again it's another example of a couple of billion dollar position in an area where the quality of the solution really matters for the customer. We make great money, great returns, and we're sitting in front of -- depending on which product categories you throw in, a $20-plus billion dollar global markets. So at $2 billion, is there room to add another $1 billion to it from organic? Absolutely, and then some. So it certainly got the potential to grow at an accelerated rate, like the other businesses that we've talked about. The reality is it hasn't been growing that fast and we need to get it going.

Andy Kaplowitz - Barclays Capital, Research Division

Does it need to acquire versus some of the other businesses, given its exposure to maybe slower-growing customers?

E. Scott Santi

We don't need to acquire anywhere. We've got the ability to generate strong income growth. Food Equipment is -- we've been very focused on margin improvement there. So despite the fact that it's grown sort of at the market over the last couple of years. We've added 200 basis points of margin, now we're pushing close to 20%. So there's plenty of room to grow earnings. And obviously, when you get a business that makes that kind of money, then the faster you can grow it particularly organically, that's obviously very shareholder-accretive, right? So it's a very high-return, high pull-through growth. So it's not growth-challenged. It's an asset with a lot of very strong core competitive advantages that, given the market conditions right now, hasn't been growing as fast as we think it can on a medium- to long-term basis.

Andy Kaplowitz - Barclays Capital, Research Division

And do you think most of the growth in the Food Equipment -- well, let me ask it to you this way. In Food Equipment, would more of the growth come out of the emerging markets or out of the U.S. sort of penetrating the more chain restaurants and that kind of...

E. Scott Santi

Yes, I think both. I think we've got -- one of the parts of it that I certainly think is much more of a global strategy than a geographic one is our service business. So we've got a $2 billion business, about 1/3 of that revenue is generated from service, which is a mid-20s margin business, and we probably have at best 20% share of our installed base through that service business. And that's on a worldwide basis. So there is a ton of potential to continue to grow that business all around the world. And it's again one of the advantages of -- a pretty unique core competitive advantage that we have, that we have to figure out how lever it to a far greater degree, how can we integrate service better with the customers' decision about what equipment they buy, for example, which we do at some level, but certainly lots of potential to do that better. The other side of that is, I think, China in particular represents a terrific opportunity. We have some very differentiated technology in our wear wash business, which is what they call dishwashing in the-- for a commercial space, where we have some leading technology on energy reduction, on water consumption that are sort of big purchasing decision drivers in the Chinese market and others around the world. So another business that I'm obviously very excited about going forward.

Andy Kaplowitz - Barclays Capital, Research Division

So Scott, maybe you can talk about your ability to price in the current environment. Price cost is still positive on for 2013. But material costs are still pretty benign. You had -- what was it, 80 basis points last year? I forgot the exact number.

E. Scott Santi

On a full year, I think it was something like that, yes.

Andy Kaplowitz - Barclays Capital, Research Division

Yes. So I mean, can this year be somewhat like that? Or is it more neutral?

E. Scott Santi

Yes. I think our overall view is it's going to be neutral. And I think there's not a lot -- sitting here today, there's certainly not a lot of sort of macro demand stimulation, things that would stimulate some increase in raw material cost nor there's a lot of logic around why from a raising price standpoint either. So I think it's a pretty benign environment right now. And that's our expectation going forward. But I think fundamentally, going back to our core business model, this whole issue of sustainable differentiation and why it's such an important element of how we think about where we're going to invest capital going forward is we don't want to be in a place where we ultimately are subject to a lot of forces outside our control. So when we're in areas that not only will generate world-class operating economics, but we also have -- we're in areas where our solutions matter to the customers. It's not about the price of the materials that drives the price, it's about the value of the solution to the customer. And that's ultimately again where we're going to build some even tighter discipline around where we deploy capital and invest time, effort, and energy in the company going forward.

Andy Kaplowitz - Barclays Capital, Research Division

Sometimes investors ask me in a very benign material cost environment or even declining, whether you'd have to give backup price? But I think what you're saying to me is based on your sustainable differentiation, no. But...

E. Scott Santi

The solution is worth -- or the product that we're selling is worth the value of the solution to the customer, not a multiple of the raw material cost going in. And that fundamentally is something we have a huge track record in terms of our ability to do. We've got a patent portfolio of over 19,000 patents today. I think all we're saying is that we've got to get even more disciplined about only focusing investment on areas that have the potential to really lever that in addition to 80/20.

Andy Kaplowitz - Barclays Capital, Research Division

Any questions from the audience? Right over here.

Unknown Analyst

I apologize if you've said this and I missed it somehow. But when you're done with the 25% divestitures, so you're left with those core businesses, what sort of organic growth do you think they can do annually? And do you think 2013 will be on target with that? Or given the slower growth in the economy, could 2013 be below the average for the next few years?

E. Scott Santi

Yes. The goal that we have out there is ultimately to get to for the overall company organic growth at 200 basis points above market. And for us, our market proxy is global industrial production. And most of our customers are manufacturing things in one form or another. And the delta on that in terms of the before and after is moving from a -- we've been historically about a 50 to 100 basis point grower above market. So this is another 100 basis points of incremental improvement. As I said before, we've got lots of parts of the company that are already there or ahead of that level. So some of our ability to get there is just a function of the addition by subtraction of the elimination of relatively low growth to no growth parts of the portfolio. But it's also about getting more focused on those areas and those areas alone. So a couple hundred basis points. I don't think we're there in '13. I think we've still got too many things, moving parts in terms of the other elements of our strategy, so we're going through a big move in terms of structure. But I think we're certainly going to make some progress in that direction.

Andy Kaplowitz - Barclays Capital, Research Division

Any other question from the audience? All right. Let's ask a couple of the electronic questions, as we go to 3 and 4. In your opinion, do you expect EPS growth for ITW will be: one, above peers; two, in line with peers; or three, below peers?

[Voting]

Andy Kaplowitz - Barclays Capital, Research Division

So it's interesting because historically, you've generated growth above peers, yet the audience still thinks you'll generate in line with peers. Maybe let's talk about that. Is that just because we need to see this enterprise strategy play out over time? Is that probably more than...

E. Scott Santi

Well, I think the question relates to EPS growth. And what I've said all along is we're not about EPS for EPS's sake. We're about high-return, high-quality growth and very disciplined and focused deployment of capital. So in my view, it's not about -- generating EPS growth without talking about the return metrics and the profitability metrics, it's a pretty low bar. And so I don't necessarily disagree with this. I think the way we've structured the company in terms of our enterprise strategy is we're going to deliver good growth with best-in-class margin returns and be able to position the company to do that on a sustained basis. And I think that for the investors that sort of value that in their portfolio, then that's playing to our strengths. And I think that's ultimately the best way to run the company is we've got to focus even tighter on playing to the strengths of our business model. And that doesn't mean we're going to be great everywhere. So it's about sort of disciplined focus and there's a lot of great financial performance and quality growth in doing so. And we're pretty excited about that, as you can tell.

Andy Kaplowitz - Barclays Capital, Research Division

Just do question 4, if we could. In your opinion, what should ITW do with excess cash: one, bolt-on M&As; two, larger M&As; three, share repurchases; four, dividends; five, debt paydown; or six, internal investments?

[Voting]

Andy Kaplowitz - Barclays Capital, Research Division

Okay. So this is not a surprise there. I don't even know if there's anything that really we need to talk about. That's really your strategy in a nutshell, more or less. So let's just keep going on, question 5. In your opinion, what multiple of 2013 earnings should ITW trade: one, less than 10x; two, 10 and 12x; three, 13 to 15x; four, 16 to 18x; five, 19 to 21x; six, higher than 21x?

[Voting]

Andy Kaplowitz - Barclays Capital, Research Division

13 to 15x. It's kind of like right where you are right now. That's what seems to happen as it just sort of gets moved to right where you are right now.

E. Scott Santi

Nobody wants to give away..

Andy Kaplowitz - Barclays Capital, Research Division

That's right. Let's see the final question while we're at it. What do you see as the most significant issue for ITW: one, core growth; two, margin performance; three, capital deployment; or four, execution to our strategy?

[Voting]

Andy Kaplowitz - Barclays Capital, Research Division

So it's interesting. For you guys, it is a little more balanced. I've seen a lot of core growth answers over the last couple of days. But for you guys, it's very important to execute this strategy as you know.

E. Scott Santi

Yes. I am 100% there with the audience on that one. We have a game plan that we have a lot of conviction about in terms of the right direction for the company, the right direction for our shareholders and all of our stakeholders. It's not a reinvention of the company, as I said before, but it is a significant rethink on how we best maximize the value of a pretty differentiated and compelling business model. And it's all about execution from here forward, no question about it.

Andy Kaplowitz - Barclays Capital, Research Division

Yes. That seems like a good place to end it. I've got a couple of other questions, but it's the last one of the day. So let's take it easy on you. But thank you very much, for your participation. Oh, we do have a question? Go ahead, sorry.

Unknown Analyst

You talked a lot about growth and some of the interesting potential opportunities such as cross selling within the Food Equipment business. What other opportunities for growth -- as far as like, how are you going to drive growth across all these different kind of segments? Are some of them kind of -- is there an opportunity to invest internally? And if so, kind of what returns are you talking about?

E. Scott Santi

Yes. I don't want to -- the impression that we haven't been investing internally is not the one I want you to have, okay? So from a standpoint of -- I think the important part of the strategy to remember is that we've got a lot of parts of the company already performing in terms of really solid organic growth already. So it's not about we're going to sell some businesses, generate some cash and now we're going to start investing and growing in the right areas. That investment is already there, and just throwing more money at it is not going to make them grow faster. But I think, ultimately, there are some really strong growth opportunities. Frankly, better focus in the overall company on sort of not fighting some battles in areas that are commoditizing and really getting the portfolio focused. Certainly, over time, we're going to have some positive benefit in terms of further acceleration. But we've had a welding business that's compounded top line over 11% organic for the last 3 years; test and measurement, 7%; auto OEM, 6% or 7%. So there's plenty of good growth already there. And it's all about paying attention, operating in markets where customers have some really challenging problems that they like some help solving and us executing well on those. Simple as that.

Andy Kaplowitz - Barclays Capital, Research Division

Any other questions in the audience?

Andy Kaplowitz - Barclays Capital, Research Division

Thank you very much for joining us, Scott. Appreciate it.

E. Scott Santi

Thank you.

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Source: Illinois Tool Works Inc. Presents at Barclays Industrial Select Conference, Feb-21-2013 02:10 PM
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