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Illinois Tool Works Inc. (NYSE:ITW)

Annual Investor and Analyst Day Conference

December 06, 2013 9:00 am ET

Executives

John L. Brooklier - Vice President of Investor Relations

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

David C. Parry - Vice Chairman

Michael M. Larsen - Chief Financial Officer and Senior Vice President

John L. Brooklier

Okay, we'll get started. Good morning to everybody here. Welcome to our annual investor and analyst day. We're pleased you could join us for the meeting, both in the room and on our webcast. We're estimating approximately 100-plus people in the room and another couple of hundred people on our webcast and probably another 200 to 300, you're going to look at this webcast over the next month, so we appreciate everybody's attention to the ITW story. And we look forward to getting you in on what kind of progress we made over the last 12 months.

Let me move to today's agenda and let me make a couple of comments about the meeting. You'll be hearing from Scott Santi; David Parry; and our new CFO, Michael Larsen, throughout the course of the morning and both presentation and Q&A formats. They'll cover topics such as strategy, execution and financial performance, and I think a handful of themes will emerge during the day.

One, per our enterprise strategy, we've made -- we believe we have made very, very strong progress and is -- in what is year 1 of a 5-year plan. As we end the -- as we near the end of 2013, we've made substantial progress around our portfolio management and our business structure simplification initiatives, BSS, business structure simplification. Let me make a couple of comments on portfolio management. Once we completed the sale of our Industrial Packaging asset, which will we think will be probably by middle of next year, we will have achieved our goal of divesting 25% of the portfolio. That's compared to the 2011 ITW portfolio, so roughly about $4 billion worth of revenues. Per BSS, as you'll hear later on, we put all of our divisional VPs and GMs in place and are basically executing both short term and long term in terms of how they construct their businesses. So we're moving ahead on BSS, making good progress in that particular area. Finally, as you'll hear from David Parry a little bit later in the presentation, we've made solid progress in year 1 of our strategic sourcing effort, building the right infrastructure, building the right team for longer-term strategic sourcing gains.

Our progress in year 1 is probably best expressed by our financial performance. We've put up solid operating margin growth in each of the first 3 quarters of '13, and we're forecasting full year operating margins of high 17s for the full year. Michael will cover this in more detail as we get through the presentation. One thing I would remind you, that's going to be about roughly 90 basis points higher than what we did the year before on a comparative basis. For those of you who are here last year, recall we told you about 80 basis points of margin improvement, so we think we've delivered or more than delivered on that particular goal based on what we told to you last year. We've also had good success in driving ROIC up to higher numbers. ROIC at the end of the year is going to be roughly about 16% and that's almost 170 basis points higher than what we did the prior year. So all in all, we're very pleased with what we've accomplished.

One thing I would note is while we're optimistic about what we've done and what we have achieved, we fully realized there's still much more to be done. You'll be hearing Scott address this. You'll be hearing David and Michael address in this. But more to be done. It's a 5-year plan. We are in year 1 of a 5-year plan. So we'll move on and cover a couple of housekeeping things.

Our forward-looking statements, not going to read all of this but what we present today clearly is going to be projections related to earnings, operating metrics for 2014, so we are covered by our forward-looking statements, so I would ask everybody to just sort of peruse this at your leisure.

Finally, our presenters for today, just let me give you just a couple of background notes on our 3 presenters. Scott Santi, as you probably know, our CEO has spent his entire career at ITW. And I learned yesterday coming in on the plane that Scott started as a summer intern at our Buildex operation way back when. So for those of you who ever wonder about if internships pay off, I think Scott's probably the upside example. Scott also spent a number of years in our Welding business. And I would say that the activity in Welding, the growth and profitability, one of our strongest businesses, has certainly proved to be a template for what we've done relative to enterprise strategy company-wide.

Second presenter will be David Parry. David, 19 years with the company, a big chunk of that time running our Polymers and Fluids business. David is currently responsible for overseeing a number of the operating segments within the company and has direct oversight of the strategic sourcing initiatives. So any additional questions around strategic sourcing, make sure that you see David.

And finally, I want to welcome our new CFO, Michael Larsen, to his first ITW Investor Analyst Day. As you may know, Michael came to us from Gardner Denver where he served as both CEO and CFO. He brings extensive operational expertise from his 15 years at GE. And for those of us who have gotten to know Michael over the last 3 months, we're very, very welcome to add him to the ITW team.

So without further ado, I'll bring Scott up and we'll start on the presentation.

E. Scott Santi

Well, thank you, John. Good morning, everyone. Happy holidays, and thank you all for being here. See if I can get this right here. So up here, we've got the same slide we showed you last year. This is the game plan for the company that we presented last year. And it's really all about refocusing the company on leveraging our very differentiated business model to deliver consistent solid growth with strong returns on capital and best-in-class operating margins.

As we've interacted and traveled around within -- and visited investors over the course of the last year, we've often been asked the question around what was the impetus for this enterprise strategy. And the reality is it started back in 2009, 2010, early 2011 as we were observing how the company was performing coming out of the recession. And what we're observing was that the company from the standpoint of our margin and return metrics was not snapping back at quite the same rate that we had seen in previous cycles. And performance in the company wasn't terrible by any stretch. There was nothing that was obvious in terms of being broken and yet we weren't seeing the kind of performance that was irrelative to our standards that we had seen in prior cycles.

We could look at the time inside the company and see a number of major businesses that were generating margins and return performance that were world-class, that were as good or better than they had done from the standpoint of prior cycles. And yet when we added it all up, we weren't seeing the overall enterprise performance at a level that was consistent with what we believe the potential of the company to be. And that was really the issue that the management team spent a good period of time wrestling with in the 2010, early 2011 timeframe.

And from that work, we really landed on sort of 2 issues that we thought were really the sort of driving issues around this relative delta in terms of our overall performance. The first issue related to really how the world was evolving in the context in which the company was operating was evolving. And by that, I mean, clearly, globalization was starting to have a real impact in terms of the characteristics of the markets in which we operated.

And what that really showed up inside the company is that we started to see real divergences. We dug down in terms of the company's performance between the underlying performance of businesses that operated in markets where there is a high degree of innovation potential, a high degree of sustainable differentiation compared to those businesses that operated in markets that were sort of less differentiated.

80/20, we had certainly as part of our arsenal in either case, but ultimately, based on historic differences in performance and inside the company between businesses that were in highly differentiated spaces and those that were in less differentiated spaces, we have, for a long period of time, see that a relative performance differential of maybe 100 or 200 basis points in terms of margin. Now 2010, 2011, that differential is more like 500 or 600 basis points inside the company in terms of difference. And our conclusion was that, ultimately, that was about the impact of global competition. That we were competing more and more with firms around the world that had very different expectations in terms of returns on capital, fundamental profitability and operating in those spaces where we couldn't make the product itself special or differentiated enough. And ultimately, the vulnerability we had, even though we are getting world-class operating economics from 80/20, that ultimately the relative differential in terms of performance inside the company at a 500 or 600 basis point gap, all of a sudden the opportunity cost at that level from the standpoint of deploying capital and resources into areas went in, on the one hand, under certain set of characteristics, we could generate margins and returns in the high teens and 20s. And then the other situation, given the state of play in the global competitive environment, we're in the low to mid-teens, all of a sudden became a differential that was too big to ignore. And that's essentially where the portfolio management initiative came from. That we had to make a choice about really how we were going to focus the company to best leverage this business model and ultimately had to make a decision where we're going to focus only on spaces and areas of opportunity where we could get multiple world-class operating economics from 80/20 and get a high degree of innovation in terms of differentiation on a go-forward basis.

The strategic sourcing element also came right there. That given the state of evolution and the global competitive environment that we had to sort of up our game with respect to the sourcing and cost side of the business, and clearly, mobilize a big effort behind that. But both of those elements of the enterprise strategy really relate to our reaction, if you will, to the changes in the external environment.

And then from the standpoint of the other big issue that we settled on as we were going through this evaluation process that's really related to a couple of internal factors, one was that the company's structure had evolved over a period of time. From the mid-80s to the mid-2000, the company had grown from right about $1 billion to over $18 billion in sales by the mid- to late 2000s. And from the standpoint of the underlying structure of the company, we've gotten ourselves into a position where we're highly fragmented. Over 800 different operating business is around the company. Certainly, again, no obvious broken elements with respect to that, but ultimately, much too complex, much to one really and that we had to bring some level of -- sort of rethink around how we structure the company. We remain avid believers, and we'll talk about that some more in a minute, in decentralization. But ultimately, the ability for us to be the best ITW we could be with a structure that was as fragmented as it was, was ultimately, in our view, not something we were going to be able to do. So the business structure simplification initiative is really all about getting at that.

And the last element was really related to sort of the relative growth mix in the company and how we were thinking and driving action behind that. And for the period of -- that I just talked about, from the mid-80s to the mid-2000s, over 2/3 of the overall revenue growth in the company had come from acquired sources. We stood here and built the company with that model from $1 billion, as I said, to $18 billion in sales. We were -- we stood there to in 2010 with returns on capital after tax in the mid-teens after doing over 400 -- 40-plus acquisitions. So certainly from the standpoint of overall success, that was the right strategy for the company for that period of time. However, as we look forward, that the sort of sustainability of continuing to generate over 2/3 of our overall growth given now the current size and scale of the company at $15 billion, $16 billion plus, we saw as much more problematic, primarily because the law of large numbers starts to really become problematic. We were -- when I talk about over 2/3 of our overall growth coming from acquired sources, what that translated to on an annual basis was what we're acquiring in roughly 5% to 7% of our revenue every year. And that number, as we're a $1 billion company or a $5 billion company or even a $10 billion company, is a reasonably comfortable number. But as we're getting bigger and bigger as a company, obviously, that number becomes much more challenging, particularly as -- if your goal is to operate the company in a way where we're generating best-in-class margins and returns. So the issue of the law of large numbers from the standpoint of the overall growth model of the company was that we're -- if we're going to continue to acquire at the same rate we had historically, then ultimately we're going to have to sacrifice margins and returns. And ultimately, what that said to us, in our view, was that we needed to swing the wheel around in terms of the overall growth focus. And instead of 2/3 acquisition, 1/3 organic on a go-forward basis as a core part of our enterprise strategy, we want to see that mix reverse. So 2/3 organic, still do M&A but use M&A in a very tight strategical way to help supplement and accelerate the organic growth potential in the core portfolio of the company. So that's a little of the history behind the enterprise strategy.

As I said before, sort of at its core, what this is all about is a significant recommitment to the core ITW business model. And I want to spend just a couple of minutes reviewing with you the 3 elements of that. So it wouldn't be an ITW Investor Day without talking about 80/20. What I want you to know is that embedded in this enterprise strategy is a major doubling down of our commitment to 80/20 in a sort of recommitment to getting everything out of 80/20 that we should be getting across the business each and every day.

Fundamentally, 80/20 is a differentiated operating model that identifies the key profit drivers in the business and structures the entire business to fully leverage them. And the real delta on 80/20, if I had to describe it at a high level, is the fact that rather than try to manage complexity, what is fundamental to 80/20 is we use 80/20 data to eliminate complexity before we really work on improving business performance. And there's a lot of companies out there that are investing in systems to manage complexity. And again, the real delta here is we eliminate that complexity before we make investments in improving the business.

Focuses on high-value -- highest value items. It's applied to every part of the business so this isn't a factory for tool. This is a comprehensive business model redesign tool for us and it is a unique process to ITW. Basic principles, many of you have seen these, I know, numerous times. But essentially, 20% of a business is customer based. Our product lines typically generate over 80% of the profit. It's just that the core accounting systems and business management systems ultimately don't create that kind of insight. So it's hard to see it unless you know how to go find it and ultimately structure the business around it.

And the other core element is the complexity associated with the 80% of things that only drive 20% of the results is really, in many cases, what drives significant and unnecessary overhead costs. And 80/20, for us, is all about sort of getting at generating inside around those concepts in restructuring businesses to take advantage of them.

A lot of people that know the company pretty well, I think, appreciate that 80/20 is -- has a big impact in terms of the underlying operating cost economics for ITW businesses. But I think maybe what's a little bit underappreciated is the impact that 80/20 has on the strategy side of our businesses. And essentially, 80/20 for us gets us very focused on the relative handful of major large customers in each of our businesses. We spend a lot of time focusing on the growth potential within those customers. Easiest place to grow is to major customers that know you and hopefully appreciate you and the value that you drive in their business, and that's essentially the simple concept that we use. Time and time again, as we apply 80/20 and analyze our positions with our largest customers in our businesses, we are typically in the 25% to 35% of share of spend kind of range, so plenty of room to grow. There's certainly some elements of the stuff that we don't have that we may not be interested in given the differentiation characteristics that we're looking for. But ultimately, significant potential to grow within the core customer base of our divisions. And we find that over and over again, we redesign -- essentially redesign the businesses to serve our largest customers with excellence. So from a competitive position, we talk about delivery metrics, quality metrics, et cetera. We really build our businesses to create big competitive moats around our biggest customers and we use that tight, we'll come back to the innovation approach in the company in a second, that tight focus on our core set of customers to get really deep in terms of our knowledge and relationships with those major customers that drives the bulk of the innovation inside the company.

So this is just a little pictorial of how the 80/20 process typically plays out. So first couple of years, we are working hard on product line re-rationalization, customer base re-rationalization. It tends to be relatively revenue neutral, but you can see here the impact and I'm talking about the first phase, the first 1 to 2 years of the process, impact in overhead costs productivity, and ultimately, operating profit. And then as we move through that process, we have real clarity around who our core customers are, what the core product lines are that we're going to support. And ultimately then that sort of tight focus on growth opportunities inside our major customers becomes the focus. And so over a 3-year -- plus year period, positive to revenue, certainly significantly positive to operating profit, cash generation and returns on capital.

Cycle inside the company typically runs in 4- to 5-year increments, so businesses that have been with the company for a while will go back to the beginning, start a fresh process every 4 to 5 years. So we're in a constant state of application and reapplication of 80/20 inside the company.

So 80/20 for us is a unique methodology. It is something that's been in continuous evolution inside the company since the mid-80s. Built on 30 years of practice, it continues to evolve today, and it's something that's extremely difficult to replicate. Most people, I think, get the whole concept of 80/20 so it's been around for much longer than ITW's been practicing or utilizing. I'm talking about the general concept of 80/20, the Pareto Principle, if you will. But ultimately, what we do with that is a real proprietary methodology inside the company, and it's one that requires there's -- that there's no immediate gratification. There is no -- requires a significant investment at the front end. I showed you that report or that chart a few minutes ago. We fire customers, we eliminate products. There are things that we do where we're investing today in terms of -- that are only going to pay benefits down the road, and ultimately, that's what creates a pretty big moat around this for us in terms of the challenges for -- we often get asked the question, "If this is so good, why don't other companies do it?" And ultimately, it comes down to that. It's not an easy process to implement. Big leaps of faith at the front end, no immediate gratification. But given our 30 years of experience, we're in a position to -- we move well beyond the leap-of-faith stage and in a position to really sort of live this and breathe this every day.

So we've talked about financial performance benefits associated with this. But the efficiency that we get in terms of the tight focus around our biggest and best customers, the elimination of the complexity and the associated over cost -- overhead costs that goes with that, ultimately, leaves the best-in-class operating margins, high levels of capital efficiency and strong returns on invested capital.

So from the standpoint of innovation as the second leg in the story of the ITW business model, let me sort of characterize it for you this way. I think we are in a pretty unique bucket in terms of our approach to innovation. We are not what I would describe as a big I innovation house. We are not centered on laboratory investment, on R&D investment in the back office. What we are is a customer-back innovator. So we are working from the customer back so we are not working to create new-to-the-world molecules or technologies or capability and ultimately develop markets for those new inventions, if you will. What we are doing each and every day is focus on solving problems for our key 80 customers in ways that are innovative and unique and that add real value to their businesses. So the -- maybe the best way to bring that out is to tell you a little story about one of our innovations. Get my assistant to give me a prop here.

So we have -- some of you may be familiar with the capitalist fuel system and I'll pass them around in a minute for those of you that have not. But this is an innovation in our Automotive business that is -- was invented a few years ago. And the story around how this came out, I think this is very illustrative of the overall innovation approach inside the company. So this started with a conversation with one of our major auto OEM customers, around one of our 80 customers, around what their big warranty problems were at that particular time. And the conversation gravitated towards their #1 problem, which was the check engine light coming on. Anybody ever had that problem? A real nuisance, I know. So the check engine light comes on. Would you be surprised if I told you that the #1 reason that check engine light comes on is that the customer doesn't screw the gas cap on? There's 3 clicks or whatever you're supposed to do. So you got thousands of vehicles going back to the dealership with the check engine light on and the mechanic having to unscrew the gas caps, screw it in, restart the engine. That was a $50 million a year problem for that particular auto OEM customer. And this was the fix, which was to eliminate the cap on top. This is a self-sealing mechanism. Again, I'll pass them around. But ultimately, you can start having a cap, the problem goes away because this is a self-sealing mechanism from the inside. So when I talk about customer-back innovation, there's no revolutionary technology in this innovation but this is some pretty clever mechanical engineering patented product, but this is the sum total of the innovation approach of the company. So no revolutionary technology but some really clever innovative solution development for our key customers. Can you catch?

We've got a patent portfolio today of over 12,000 patents and it's all stuff like that. So that's what we do from the standpoint of innovation. For us, the way we describe it is we're a high-velocity singles and doubles hitter. As we look at innovation, we're not trying to hit home runs. We are very efficient in terms of how we approach and invest in innovation in that we are not working on anything that's not attached to a customer problem that we know about. So very little wasted motion, and overall, very strong performance.

The last element of the business model really relates to the culture of the company, and embedded in ITW's history is a real conviction about the fact that the way we structure and operate the company. We want the vast majority of decisions made is close to the point of attack with the customer as we can get it. This has been a hallmark of the company for a long time. And we've had a number of questions as it relates to BSS and our efforts to simplify the structure and add some scale to it and whether that's going to have a negative impact on the culture. And we are absolutely committed to decentralization. We are a low bureaucracy, fast decision-making, no BS kind of company and we absolutely intend to stay that way as far into the future as this management team is around for sure.

Fosters entrepreneurialism, innovation. What we really operate their company is flexibility within the framework. And the framework is very tightly defined. That's the core business model and strategy of the company. Decentralization doesn't mean anarchy for us. It doesn't mean everybody can do what they want as long as they deliver they deliver their numbers. But it does mean within the framework of our core business model and the enterprise strategy that we want a lot of latitude in terms of allowing our leaders of our individual businesses to be able to customize those capabilities in ways that maximize their relevance and impact for their particular customers.

So with that, I'm going to turn over to David Parry, who's going to give you an overview of our progress on our key enterprise initiatives. David?

David C. Parry

Thank you, Scott, and welcome, everybody. I have the pleasure of being able to go through the 3 core elements of our enterprise strategy. You probably all know them by now. We've introduced these back in 2012. Then as an introduction phase, this is basically a report card of how we're doing after year 1.

One of the things I would stress about all these things is that there's pace that's required as we go through these. The pace for each of them is different. Some of them, we have obviously progressed that fairly quickly and we're starting to make some real inroads and maybe getting to more towards the end. Others, we're very much at the beginning. So we'll go through all 3 elements of the portfolio, business structure simplification, strategic resourcing to give you a flavor as to how those come together.

So portfolio management, first element. The first thing to remember about portfolio management, it's all around having a business that has sustainable differentiation. And that is the lens that we look at our businesses as we go forward. So are they demonstrating that individuality, that difference as it ties into some of the innovation that Scott was giving you about our history after 2008, 2009. So these are businesses that recovered, showed demonstrable growth. They're in accelerated growth markets. It's an area where we want to be, and this is where we want our overall total portfolio to be active.

Our focus is on achieving 200 basis points above the market. In the past, the historical growth rate is probably more in the 100 basis points, so this is not as though it's a great leap of faith. Obviously, it's on improvement, and there are several factors that I'll touch on that we feel very comfortable that we can achieve this.

In 2013, we've made substantial progress on this and I'll illustrate that in a minute, all right? Although this is a slight -- perhaps a slight change, the one thing that I do want to make sure, all right, is that something stay the same, all right? And the ITW's business model, 80/20 design, is not going away, very much part of the same store -- core of our philosophy.

In the second slide, I'll touch on the progress, run -- go through it on the slide here. Many of these companies you may recognize that were or still, in 1 or 2 cases, are in our portfolio. So during 2012, the Wilsonart business, which sells in to construction solid surface, laminates business that was sold to CD&R. The finishing business, which is DeVilbiss, Binks, those businesses, they were sold to Graco again in 2012. And as probably you've all read, the Industrial Packaging business was put up for the bid auction, if you like, earlier this year. And we expect this business to be divested probably sometime mid-2014, as John touched on.

These are all good businesses, these are not bad businesses. In many ways, these will be star businesses in other people's portfolios. But in our portfolio, when you compare them with the other business they have, they are lower growth, all right, and they have operating margins that are in the low-double digits, are sustained from high-double digits or even in the 20s. So removing these businesses from our portfolio will inevitably is addition by subtraction, if you like. It does mean that our revenue growth will accelerate, all right, our operating margins will increase. It's an inevitable conclusion, it's mathematical.

The flip side is obviously acquisitions, and there are several things we need to take out of this particular slide. The first element is the switch. And again, Scott mentioned it, 2/3 organic growth is our focus going forward, 1/3 acquisitions whereas the reverse was very much 2/3 acquisitions, 1/3 organic growth. As we look at our acquisitions, we're very much focused, again, on building our global platforms. So in all these 3 examples that you see here, they're all a matter of extending that platform. And do they offer us sustainable differentiation long term? Do they have products that are unique, differentiated, have the capability of really meeting customer needs? So the 3 companies that you see here, Vesta, Chinese Western cooking, very much supplies the 4, 5 star Western cooking hotels, chains, restaurants, has a very good supply chain within China itself. We have our technology, very much a good match for our 2 businesses.

meurer isn't the automotive packaging solutions business. So if you go into a big bottling manufacturer, Pepsi, Coke, Equal, you will find these products. We have a company called Hartness that operates in the United States with very good technology. meurer is a German organization, all right? Again, good technology. Both can win and both can use their products in the opposing markets. So again, a good win-win situation. And Stein is building on our Welding business, which has long been a growth platform for us and a great business. Again, building our Welding business in Europe where we are perhaps a little less well known than we are in the United States or in Asia. And very much focused on the oil and gas platforms, which is a very strong core focus for that particular business.

If you look at our overall portfolio after the IPG divestiture, this is what you see. So you see the 7 business segments, all right, 7 segments here. This is how we run the business. The EVPs, Executive Vice Presidents, one runs each of these businesses. And to give you just some clarity with regard to how the organizational structure works, so the segments, so what you see here on each of the segments, we have platforms. The platforms are run by our group presidents, roughly $500 million in revenue. Beneath the group presidents, there are divisions. Again, roughly, as I'll touch on in subsequent slides, around about $150 million revenue run by VP/GM. That's the overall running structure.

So here, you see 7 segments. It's a very balanced portfolio. There's no one business that dominates the overall total enterprise. And if you look at the overall operating margins, and these are operating margins before amortization and various sort of accounting wizardry, I made to say that to Michael, all right, are obviously very strong numbers. And if you see the improvement that we have made in this last year, it's quite significant. Some are SARs. Obviously, the highest one up there is the Construction business. You may think 240 is sort of way out there. In the third quarter, it was actually 360 basis points.

And even the one that's minus 50. If you exclude the electronic assembly business, then even that business had 100 basis points improvement. So we've seen -- these got a balanced revenue, highly differentiated businesses now with very strong core margins, and these are businesses that can truly outperform the market.

If you look at the bottom green line, you'll see there that the global industrial production from 2009, 2013 was roughly around 3.1%. If you take these businesses that we've done, let me show you here, then the CAGR is 4.6%. So trying to get to that 200 basis points is clearly very achievable.

This is really just reemphasizing the point that I made earlier, is the focus on organic growth, sustained growth, innovative growth, 1/3 acquisition, 2/3 organic. Very much done with global divisions that can truly allocate resources to the growth areas of their business. So they can drive innovation and sustain that organic growth that we so want.

Clearly, we are going to make selective acquisitions, looking again through the same lens to bolster these. And the 3 acquisitions that I showed you in 2013 are very good illustrative examples of that philosophy and approach.

If I move now to business structure simplification. This is clearly moving to a simpler organizational model and I'll show you some figures later. Very much focusing on larger scale, but at the same time, still staying close to customer. Our innovation, as we said, is singles and doubles. It's being close to the customer, understanding their needs, understanding their pain points. And to do that, you cannot have an organization that is monolithic. It has to be capable of reacting. Under the new global environment, the scale of those businesses needs to be bigger than that $25 million that we had before. I'm going to show you where we've got to in that. This is very much, I think, an illustration of ITW at its best with the 80/20 design as well because this is focused on what is really important. So where we got to on this? I think, take the baseball analogy, we'll probably cover the fourth, bottom of the third. It varies dependent upon which one of this you speak to, but we're somewhere on that. So we're probably 1 year done, still 2 years to go. So you're going to see benefits on these in 2014 and in 2015.

We've got leadership in place with the VP/GMs and I'll show you those, in fact, on the next slide.

So as Scott mentioned, 800 business units in the past, now reduced down to 90. The message that I'm really going to take away from this was that 90 is a number that sort of we, on the third floor in Glenview, you didn't suddenly come up with one wonderful Sunday morning and say this is a new number. In fact, if you look back in the slides of a year ago, the number there was about 150, which was the original number that the group presidents, the VP/GMs were thinking where we were heading. And as we went through the process, that number actually started to go down, not from pushing from us but from bottoms up, classic ITW philosophy. Coming from weather businesses, the divisions where the action was. And in fact, that number kept on coming down and came down to around about 110. The difference from 110 to 90 is the Industrial Packaging removal because they have about 18 divisions. So this was very much a bottom of implementation going from 800 to 90.

If you look at the revenue size, our businesses, roughly $25 million in revenue size. And again, it wasn't any specified number that we came up with. In fact, the original number we came up with was probably around about $100 million. Now it's climbed, it's now about $150 million on average. Is it true to say that the divisions actually do range probably from size from probably the smallest being around $80 million, $90 million to the biggest probably being around about $200 million.

However, what has not changed is the decentralized approach, the focus on the customers, all right. Are the businesses bigger? Yes, but they're still very sort of nimble and capable of adapting to meeting our market needs. So they're small enough to react quickly and staying close to our customers. So I will contend, 90 units, 90 divisions is still a very decentralized organization.

Scott touched on this when he went through some of the history on why we went down this. We had some templates, if that's the right phrase, to actually show how to go. So our Welding and Food Equipment businesses, maybe historically, had some much larger scale of businesses. There are businesses that operate in a larger format. They still maintain their decentralized entrepreneurial nature but they were meeting customer needs from a much bigger scale and base. And we saw that innovation capability and growth capability and try to match it. So here, you see Welding, it's a $1.5 billion business, very much focused on 3 platforms, each basically run by a group president. So you have oil and gas, the industrial, the commercial and then the 11 divisions run underneath those by the VP/GMs. Food Equipment, very similar story, $2.1 billion in this particular case. Again, 4 platforms that you can read on the slide and 16 divisions. So this is the template with took company-wide.

I'd like to give you 2 examples, if I can, and I'm going to touch on Construction Products, North America, and Polymers and Fluids Sealants business. So these are now divisions. So let's give you some sort of scale. So Construction Products, commercial construction today is roughly around about $115 million business. It is made up of 3 $35 million businesses. It's products are things like concrete fasteners, pins, some powder-actuated tools, trade under 3 brand names, Ramset, Red Head and Buildex, very much known in the marketplace. So it's 3 divisions that went down to 1; 3 GMs down to 1; 6 facilities down to 3; and obviously, a notable reduction in overheads.

This business can now truly focus on its core markets. We're not focused on those that were not so differentiated or had growth potential. This business has significantly improved in its operating margins and you -- if you take the operating margin improvement, we think it's going to be roughly around about 750 basis points. And as I mentioned before, construction in total in Q3 was actually plus 360, so there's a lot of runway to go in these businesses.

If I take the North American Polymers and Fluids Sealants business, this is about $120 million business. And it supplies sealants into environmentally friendly roofing applications, coating applications and also the aerospace sealant industry. What it no longer is in is the HVAC markets or the solvent-based construction adhesives business. So we've withdrawn from those and focus on where it can offer true differentiation and growth.

Recently had 5 operating divisions, or units, now it's down to 1; 4 GMs down to 1 VP/GM; 4 or 5 R&D facilities, down to 1 R&D facility based in Irving, Texas; 1 R&D director; 1 customer service; 16 accounting people down to 7; an R&D team focused on global growth for environmental coatings that are water-based or aerospace, which is more rapidly growing.

Before this is a business that had operating margins that were in the low 20s. So it still applies. The businesses, they still make a lot of money. By most company standards, this will be a business that you would say this is a superstar. But we think this isn't going to be a business that's in the high 20s.

The last theme that I have to cover is strategic sourcing. And I hastened to add, all right, this is not about centralization. This is not about bringing everything into Chicago and going to run everything from there. That's not what this is about. This is about leveraging our scale, not centralization. We will apply and are applying 80/20 sourcing just as vigorously as we do to every other part of our business. So are we going to chase every $100 to sourcing benefits? No, we're going to chase the $80. Our sourcing teams are in place. They're now completed. We've made great progress in putting the capabilities in place. In total, we've added about 50 people probably in total. Partly commodity experts, whether it be steel, resin, plastics, whatever, and we've also put in segment sourcing directors, so each EVP has their own segment sourcing director.

Our targets for 2013 was set obviously at the beginning of the year, and we exceeded those. This, again, is a ramp-up. Unlike portfolio management where we're going to the end of the portfolio activities and BSS where I said we were sort of 1/3 the way through, this, we're in the maybe first, second innings so we keep the baseball analogy going. So 1 year target met. We have a target for, obviously, 2014. We feel very comfortable that we can achieve the targets that we've set, which will be higher than the 2013 target.

So this is the case of using our purchasing, buying capability. I wouldn't want you to go with the impression that we did purchasing badly, that would be very unfair to the people who have been doing purchasing and sourcing within ITW in the past. However, it's much more of a strategic function and it's now much more of a global function looking for suppliers globally as distinct from just in a local region. So we have moved from a sort of operational purchasing methodology or buying, if you like, which was fragmented, very underleveraged to moving to much more strategic sourcing capability, coordinated and leveraged.

This is a breakdown of our sort of pie to look at, if you like. And those of you who got great memories will remember the number here, that was $11 billion. What we've removed from here is our own internal sourcing as we supplied ourselves, and obviously, removed Industrial Packaging from this as well. So the true spend is around about $8 billion. And our goal is basically to get about 1% improvement in spend per year for 5 years. As I said, it ramps up and then -- not in the first year but as it goes through years 2, 3, they start to ramp up. So it's a matter of managing the pace and bigger benefits will come later in the plan.

And then we also try and just give you, before I conclude, just a couple of examples, just to illustrate the point. So here you see the split between indirect and direct. Indirect, an indirect example would be, say, MRO. So maintenance and repair goes into every single plant, whether it be motors, cleaning materials, nuts, bolts, screws, whatever you want to talk about that go into any plant around. As purchase of that or our spend of that is roughly about $80 million. We had 2,000 suppliers, very much local, maybe somewhat regional. After this exercise we've done in 2013, we have -- 2,000 is now 14. The simplification that comes out of that is very obvious. The savings out of that were roughly around $6.5 million, $5 million. It gives you an idea for a direct. If you take -- sorry, indirect. If you take direct, flat steel would be a classic example. Flat steel, we spend roughly around $450 million. We had 64 suppliers that just supply those materials. Today, we have 36 suppliers and those 36 suppliers are actually now dual sourcing our facilities whereas before we had single sourcing to some of the facilities. So now we can leverage one against the other, we have fewer. But again, one of the big measures I want you to take away, it's very easy to change your raw material sources but you got to bear in mind quality and service to your end customers. And therefore, this has to be done with intelligence, with pace, with consideration. And so what's the next step in flat steel? It's a matter of harmonizing the tolerances, that means changing the specs. That is not something that you do quickly, it's something you take time. So there are more savings to come in this area. So if you like, we're in the first innings.

Hopefully, that gives you a sort of sense of scale, the various things that are going on within the sourcing area. So those are the 3 strategic enterprise initiatives. I hope you've got a flavor. We have made great progress in year 1, very comfortable about our progress we're going to make in year 2 and 3. And I look forward to reporting equal success next year.

With that, I'll pass over to Michael.

Michael M. Larsen

All right. Thanks, David, and good morning, everyone. It's great to be here and see so many familiar faces here today. So I'm going to walk you through how this all -- this strategy, these initiatives that we've been describing, when they're applied to the ITW business model, translates into financials. We clearly believe, and I'll show you why that is, that as we execute -- continue to execute well on these initiatives, we'll deliver differentiated performance from a financial perspective. So in terms of solid growth ahead of the market, strong returns, best-in-class operating margins as we continue our track record of strong operational execution. I'll also walk you through an update on our 2013 performance, as well as our outlook for 2014, really in the context of the enterprise strategy.

So let me start by saying as we look at the goals here for 2017 that -- versus what we made out last year, there's no changes to our goals. First, around solid growth, as we really aim to achieve growth above market rates, we're building a portfolio that David described that's more competitive, more differentiated, very well positioned at some attractive end markets with some long-term growth rates that we'll benefit from. With this portfolio, as well as the increased focus on organic growth versus acquisition that Scott talked about, we believe that we can achieve organic growth 200 basis points above the market by the time we get to 2017.

In terms of operations, ITW has a very long track record here as the best-in-class operator. To some extent, you already see that in our margins today. But really, as we continue to apply 80/20 across the simpler business, as we get really good at strategic sourcing, as David described, we believe that we'll achieve margins that are in excess of 20% operating margins by the time we get to 2017. Company has a strong track record in terms of cash flows and returns. We continue to be very disciplined and returns focused in terms of capital allocation. And again, here, the goal is to achieve returns on invested capital that exceed 20% by the time we get to 2017. And we're pleased over the progress we've made in 2013. We feel good about the momentum going into 2014. And that really gives us increased confidence that we'll achieve these goals for 2017.

So let me walk you through in a little more detail on the progress in 2013 and then go through our outlook for 2014. This morning, I'm sure many of you saw, that we confirmed our fourth quarter total year EPS guidance for the year. In other words, the fourth quarter is tracking according to plan and kind of in line with the expectations that we laid out on the last earnings call.

Enterprise initiatives delivered margin expansion, 90 basis points, slightly ahead of what we told you this meeting last year. We're pleased with the progress in terms of the IPG sale process. We're nearing the end of our portfolio management initiative. And as you can see also on BSS and sourcing, we're delivering restructuring savings, and the sourcing efforts and the associated cost reductions are ramping up very nicely. Company had a very good year in terms of cash generation. We, like I said, remain very committed to our disciplined capital allocation approach. No change to the priorities as we move into 2014. We returned about $2.5 billion to our shareholders, 2013, in the form of an attractive dividend yield and an active share repurchase program.

This page summarizes our 2013 financial performance. You can see earnings per share at $3.60, up 12%, that's on a fairly modest revenue growth of 1.5%. Operating margins were at 17.8%, an increase of 90 basis points driven primarily by BSS, as David described, and then we have the sourcing initiatives ramping up very nicely. Good progress also on returns in cash flows. I should mention here that we expect to repurchase approximately a little bit more than 10 million shares here in the fourth quarter of 2013, and I'll walk you through kind of our assumptions in terms of how we think the program will play out in 2014.

Just real quick on the cash flow. We anticipate that our free cash flows this year will exceed 100% of net income, so very pleased with the conversion rate here. Like I said, no change to our capital allocation priorities that we described last year. Our internal initiatives are on growth, CapEx, R&D, restructuring are fully funded. We remain committed to an attractive dividend, 50 years of consecutive increases. And then we continue to look at external investments really from a return standpoint. So we're obviously, as you can see from the graph on the left side, leaning towards share repurchases, and we continue to execute well on our buyback program.

Our balance sheet is strong, gives us plenty of flexibility as we move forward. We've discussed on the last earnings call the plan to take on some additional leverage here in the first half of '14 to execute the buyback program and we think that will translate into a leverage ratio in terms of debt-to-EBITDA, kind of in the low 2s, something we're very comfortable with in terms of the interest expense that goes with that, which is going to be manageable for us, as well as we foresee very limited impact, if any, to our credit ratings as we execute that program.

So just kind of our scorecard here in year 1. We're pleased with our progress. Portfolio moves nearing completion. We've increased focus on organic growth. We're ramping up to our growth target by 2017. I'll walk you through what we think '14 is going to look like. Margins, returns are improving, continue to execute well an 80/20 initiatives. Very pleased with the progress on the industrial packaging divestiture. We're on track to do what we said we were going to do, which is get the transaction closed by the middle of next year, 2014. By then, we will have divested approximately 25% of our 2011 revenues. So really good progress and momentum as we enter into 2014, but clearly lots more to do from an execution standpoint.

But with that, let me walk you through how we think about 2014. And so I think as you saw this morning, we're giving EPS guidance of $4.30 to $4.50 in terms of dollars per share for 2014. That would be an increase in the range of 19% to 25% over 2013, and here is the framework on how we think about it. I'd say we're cautiously optimistic on the macroenvironment, we're seeing a sort of gradual, slow improvement in global demand. We saw some of that in the third quarter, some encouraging trends including in Europe to some extent, and the fourth quarter is tracking according to plan.

For 2013, we expect overall organic growth in the 2% to 3% range. You can see here, North America, up 2% to 3%; Europe slightly lower than that, 1% to 2% range; Asia Pacific & Other, up 4% to 6%. So I'd say a fairly conservative growth assumption as we go into 2014.

And we expect the operating margins to be about 19%. That would be an increase of 120 basis points from the call we did, at 90 basis points in 2013. And so, really one of the key drivers there is the sourcing efforts that David described ramping up. I mean, the operating teams in our segments are executing very well on the initiatives how you laid out, pleased with the momentum, and we have good line of sight to the cost reductions that we need for '14.

Kind of on the right side, the key assumptions. We talked about IPG getting closed by mid-'14. And so in terms of the program we announced to repurchase 50 million shares to offset the EPS dilution from the sale -- from a planned perspective in these numbers, we are -- we've laid it out at 10 million shares a quarter, right? So by year-end '14, we'll essentially be complete in terms of the 50 million shares. Like I said, in the fourth quarter, we're going to do 10 million. The proceeds will really be a combination of continued strong cash flows, the additional debt leverage that I described in the first half, and obviously, the proceeds from the sale. So I'll also tell you, if everything lines up perfectly, there is a path of doing slightly better than what I just described, which is the 10 million shares a quarter. And obviously, we'll keep you updated as we execute the program and go through the quarterly earnings calls.

Restructuring will be slightly less in 2014 at about $100 million. That's not a forced number, that's really what the business, the segments are asking for so. And so we feel good about funding what we need to get done, want to get done in '14 And there is no acquisitions in the 2014 numbers other than the carry over from the transactions that were completed here in 2013 that David showed you, but that's really a fairly minimal impact for 2014.

So this is what the financial summary looks like for 2014. I'd say in a fairly modest -- moderate-growth scenario, 2% to 3% range. It's really the execution of our initiatives. So things that are largely within our own control, our controllable operating improvements, as I'd like to call them, that are driving the earnings growth in 2014 earnings per share, you can see here up 19% to 25%. And again, in the context of what we're trying to accomplish by 2017, 2014 puts us firmly on track to achieve those targets.

So just tying everything back to the enterprise strategy and the associated financial performance goals for '17, obviously, what we reaffirm in our commitments to these targets. By 2017, we expect that this is a company that will grow on a consistent sustainable basis in 5% to 6% range, and the way we get there is really on assumption for market growth, 200 basis points on top of that and then selective acquisitions to supplement that. And we really -- from a planning perspective, we see this as a fairly gradual ramp up starting with 2% to 3% here organic growth rate in '14.

1-year in, we have a good line of sight to the $600 million to $800 million on savings from the initiatives. That number hasn't changed. We expect those cost reductions to be fairly evenly split as we go through the 5-year plan here. And really as David described, BSS takes us through 2015, and we're starting to see really the sourcing efforts continue to ramp up.

So in summary, we feel good about where we're at in 2013. The company executed well, good momentum and well positioned for 2014. EPS guidance for '14 at $4.30 to $4.50, which is an expected increase of 19% to 25%. The strategic initiatives that we went through are on track. And while there's still a lot of execution ahead of us here, we're confident in our ability to deliver on the goals that we've laid out for 2017.

So with that, we'll take a 15-minute break, I believe, John. And then we'll come back for Q&A at approximately 10:25, okay? Thank you.

[Break]

David C. Parry

Hello. Can we get everybody back in their seats? We're going to -- we'll do the official Q&A now, not that we've done the unofficial.

Coming up, before we start, I need to offer an apology. Somebody pointed out that as we use this baseball analogy, top of the first, bottom and third, nobody from Chicago should ever use a baseball analogy. So for all the Boston New York fans here, we apologize. You're a Red Sox fan, that's right. Okay.

Unknown Executive

Okay. No questions.

Unknown Executive

I think we're ready. We've got a couple of mics.

Unknown Executive

Can we get the mic and question?

Unknown Attendee

So I've got the mic. I'll ask Mike the first question. What happens to the return on invested capital if you add that 49% back in from Decorative Surfaces?

Michael M. Larsen

That's a very good -- that's a good question. I don't have a numeric answer for you. If we're going to try to get out is whether this was a transaction that made sense for us in terms of returns on capital and the portfolio in what we describe that they're more trying to accomplish to answer that absolutely, but I have to get back to you on the exact number on that. Okay?

Unknown Attendee

One of the few wrinkles for the format today was, we didn't get a bottom-up analysis of the segments that roll up to that 2% to 3% organic revenue growth. So it's a kind of a 2-part question as to maybe some flavor on how you get there. And then since so much of the change, as you pivot away from M&A to organic, you've going -- there's much more reliance on how you get that 200 basis points above market and maybe a little more granularity as to what are you thinking about price, how must each mix giving you that how your growth rate, how are you the price/cost relationship, maybe that's for Michael. So a little flavor on the bottom-up analysis to get us to 2% to 3% ...

Unknown Executive

Sure.

Unknown Analyst

And then some color on that 200 basis points and talk about price and so forth.

Michael M. Larsen

Okay. So let me start and if I forget a piece of that along the way, you'll remind me. So that -- from a standpoint of the overall '14 forecast and how we're thinking about revenue, essentially the planning is largely built on current trends we're seeing in the business. So clearly we're expecting our Auto OEM business to continue to be strong and outperform next year. We're very happy with the acceleration of growth that we're seeing in the Food Equipment business over the last couple of quarters. The other side of that is that in our view the capital spending environment remains relatively weak, so that's had negative pressure on businesses like welding and Test & Measurement for us. So there's not a lot of new news in terms of the forecast. We're looking at the trends over the last 2, 3 quarters. Essentially, we're not expecting a lot of change in 2014. What I would say, in addition, Deane [ph], there's not a lot of incentive for us to try to outthink the market, that we've got enough going on inside the company that ultimately would better serve than our view from a planning scenario, by not sticking our necks out and expecting a whole lot of change. And when that happens, we'll be very pleased to see more tailwind. But ultimately, sort of taking the current on the ground scenario projecting into '14 as the planning scenario, that I think in our case was the right one for us. So on the longer-term growth prospects, I'll go back as a starting point to the slide that David put up in the meeting -- that sort of building blocks are one, is that portfolio is really about portfolio construction. So he showed you some metrics that's essentially the changes in the portfolio, at least if you look at the recent history, '09 to '13, that gets us half of the way to the goal, right? We grew at 150 basis points above market with a go-forward portfolio over this '09 to '13 period. So we're in position's that are certainly much more conducive to growth and outgrowth. When we talk about this whole dynamic around sustainable differentiation, another way to think about that is we're operating in markets where innovation matters, where there's a sophisticated customer need at the end of the business. And so our ability to drive have -- more of it on an overall percentage basis have more of our overall growth than our control through these customer back-innovation opportunities that I talked about is going to help. The third piece that I'll tell you is that, the shift in focus inside the company between organic and acquisition. I think we all expect that just, just that shift in focus alone to have some material incremental impact. Let's face it, we've had a significant component of our management time and talking about people on the ground running businesses out of focus and where is the next business to buy. Doesn't necessarily mean they weren't focused on organic, but we're getting everything of that we could. And we are going to align incentives inside the company now behind this organic focus. And I think that's where we start, whether that's ultimately enough or not. But we're talking about 50 bps of movement. We're not talking about a moon shot here.

E. Scott Santi

Yes, if I could just add, if I could. You want the 2 things I would add to that is, one is, maybe you may see in 2014 some construction improvement within that area. Because we all stand to see some signs of movement with regard to commercial construction, so that's in generic. The other thing that I would say with regard to the organic growth aspect, I'd go back to the 2 slides that we put up on both commercial construction in North America and Panamas in fleury seasons. Both those businesses after they're done their BSS activities in 2013 were basically flat, all right? In 2014, both of them expect to grow somewhere around about 4% or 5%. And why they're doing that, let's take the Polymers & Fluids example, they're focusing on aerospace sealants and they're focusing on the environmental coatings, which are more rapidly growing and going out of -- have gone out of solvent-based adhesives, which were flat or declining. That's 80/20 focus occurring up the division level, so they're doing their portfolio analysis of that granularity, not just at the enterprise level.

Michael M. Larsen

So I'll just add on the price/cost planning assumption that you asked about. So this year, we'll be about 20, 30 basis points positive, and we've made the same assumption for 2014.

Unknown Attendee

So we saw a couple of good examples today of BSS at play at the division level. So that's all very good -- good to see the impressive margin improvement that you are forecasting. Just maybe talk a little bit about -- so the 750 basis points in construction materials -- Construction Products and you have 350 bps in Polymer Fluid. How much of that is just BSS versus any growth that you are making in, in terms of end markets or top line?

Michael M. Larsen

Yes, the Construction North America business, effectively that was a business, if you go back to 2009, was 7% to 8% of return on sales business. And in 2014, 2013 is basically going to be about a 15% business. I do -- we believe that business can grow to certainly in excess of 20% over the next basically 3 to 4 years absolutely. And in the past, on a work that's being done is probably at the moment it's 80/20 is in the BSS activities and 20% is some margin improvement. I think as we start moving through that process, you're going to see that ratio move more and more towards product innovation side than you are to the BSS activity.

David C. Parry

I think the question was around the margin improvement that you show in the slide. How much of that is related to volume growth expectation versus core changes in cost structure?

Michael M. Larsen

Okay, sorry, I misunderstood the question.

Unknown Attendee

Yes, that's exactly those questions.

Michael M. Larsen

Yes, I mean, basically, that somewhere in 50 basis points is internal. It's not related to the actual market.

Unknown Attendee

Got it. That's very helpful. So if the market growth in construction picks up, you would see some additional...

Michael M. Larsen

Yes.

Unknown Attendee

Good. And then the second question on the savings, the $600 million to $800 million that you are forecasting is the same number as last year. But obviously, your revenues are lower because of the divestiture. So is the underlying savings kind of higher as a percent of revenue?

Michael M. Larsen

Yes, I think that's the right way to look at it. I mean, we spent some time trying -- I think if you -- I think David may have mentioned this, if you look at on the sourcing side, for example, the total spend last year we have defined it as about $11 billion. This year, taking out IPG worth $8 billion, but we kept the same savings numbers. And so you could say that with a smaller kind of opportunity to go after and the savings are the same number, okay?

Unknown Attendee

A year later where we have more detail and more...

Michael M. Larsen

Yes, no, I think that's right. I mean, I think part of it is -- one of the reasons we were able to maintain that is the progress we saw in '13, the momentum going into '14 and then the line of sight, just the projects that are being executed inside the company to achieve those savings. And so, it wasn't just a numeric exercise, we really -- based on what we're seeing, we feel good about the savings number, even with a smaller pie, so to speak.

Unknown Attendee

I want to go back to your growth assumptions for a second. And just to clarify, so the 2% to 3%, North America 2% to 3%, EMEA, Asia Pac, these are ITW numbers? This is not ...

Michael M. Larsen

These are ITW organic growth numbers. So the total -- if you take the total, 2% to 3% is the organic growth number. There is some carryover from acquisitions done in '13, which adds about 50 basis points. But those are the ITW organic growth numbers on that side.

Unknown Executive

Yes, the assumptions and our EPS for. Yes.

Unknown Attendee

Do you guys make -- like some companies have some sort of a macro starting point and I'll combine macro with bottoms up. I mean, we probably blend, these numbers look like they could be GDP numbers. And we all know industrial production sort of supersedes in the upside and is worse on the downside. I mean, you're sort of -- I mean, I get your point, you want to be super cautious. But is there something else about the complexion of how we should be thinking about your expected growth rates next year? Doesn't sound like it. But you haven't incorporate some sort of austere macros [indiscernible] exercise.

Michael M. Larsen

No. I think -- here's how I'd describe it. I'd say, if you look at the guidance that we've given here for the second half of '13, right, and you look at the growth in the second half of '13, you're getting numbers somewhere in the 2% to 3% range, 2.5%. Okay? And so really what we're doing is run rate for second half of '13 into '14, okay? acknowledging that here today are some positive data points in our businesses. We'd like to see a couple more quarters to really cause it to trend. But I think as I mentioned early on, I mean, these are, I'd say fairly conservative, kind of moderate growth assumptions. And again, we don't -- we're not in a position where we have to rely on the macroenvironment to deliver on the numbers that we gave today. We don't have to rely on a number of acquisitions to come through -- I mean, these -- what -- when you describe this plan really, what -- what I like about it as a CFO is that it's really the controllable operating improvements as we continue to execute well in these initiatives are going to get us to an earnings per share number, an associated earnings per share growth rate that I think compares quite favorably and I think you could describe in fairness as differentiated performance.

Unknown Attendee

Mike, can you talk about tax? I think we've all ...

Unknown Executive

Yes.

Unknown Analyst

about 29% in the first month.

Unknown Executive

Yes, yes.

Unknown Attendee

I know there's is R&D tax credit question marks. What did you guys baked in, and sort of how should we be thinking about maybe tax progression, sequentially?

Michael M. Larsen

Yes, yes. So historically, we have guided to kind of a 29% tax rate number if you go back and look in time. If you look at the rate for the last 2 years, we've been slightly north of 30%, 30.5%. And so what we've included in the guidance today is a tax rate of 30%, okay? So that is a slight increase on our -- let's say, a more conservative assumption versus what we've had historically.

Unknown Attendee

Okay. There's no's R&D tax credit assumption baked into that?

Michael M. Larsen

No, no.

Unknown Attendee

Okay. One more final question. So the $600 million to $800 million, you've articulated this as being a linear process, right? But I guess what's not entirely clear is, I mean, businesses -- business generally doesn't work in a linear fashion, little on linear over 5 years. Conceptually, you could be targeting easier to achieve savings and sourcing initiatives earlier or projects. I mean, I don't understand necessarily why it's linear. I understand that would be good planning assumption at the start of the process. But after a year into it with sort of some acceleration you've seen with the BSS, why wouldn't there be some sort of a gradian change over the coming 4 years for whatever reason?

Michael M. Larsen

Well I -- you're -- I think the way that we think about this, this year is quarter-to-quarter, year-to-year. So I think we're giving you our view today based -- and largely the focus should be on '14 and the progress increment that we think we can achieve. What I would tell you is that there is a really critical element of this in our view inside the company, which is managing the pace. Absolutely, we could step on the gas pedal and try to accelerate on all these fronts, but ultimately, we'll -- what we also have to do is preserve our business' ability to serve their customers and to perform financially as we do this. So there's a lot of things going on with the company. So some of the linear pacing is intentional. We're generating solid incremental progress every year. Should go faster on all of our -- try to go faster on all, but absolutely, we could. Within my view and our view, we would be elevating the risk profile around, making sure that our ability to serve our customers well and serve our investors well as we go through, absolutely. So there's a big element of this. We spent more time mitigating pace than anything because ultimately, it's about being a little bit better every quarter, not how fast can we get this done. This isn't a broken company that needs to be fixed. But this is a pretty good company with what we think a pretty good plan to be an even better company and that's really the sort of mindset that we've got inside the company. So we're not trying to match it up in even increments, but we are managing the pace in what we think are sort of logical step change increments.

Unknown Attendee

[indiscernible]

Michael M. Larsen

No.

Unknown Attendee

[indiscernible]

Michael M. Larsen

No.

Unknown Attendee

[indiscernible]

David C. Parry

I think one of the things you'd probably, that would be worth explaining is that the 3 initiatives are actually all interrelated. Because clearly you do portfolio management at the division level, than not decides upon what markets, what products you're going to go into. If you combine your businesses into a division, now you've got one business that's looking after its raw materials. So the whole thing is all completely linked. And so you've -- the pace is absolutely critical and also there's a lot of work going on with regard to restructuring everything else. And so, you need to make sure that your people are focused than trying to get the priority. Otherwise, you're just going to overwhelm them and say get everything done by yesterday. Well that's not the way the world works.

Unknown Attendee

A couple of questions. The first one is kind of long-term philosophical capital deployment. Post the 2014 initiatives and the share repo, is it fair to assume that the available cash that you generate after investment in the business and all that, would be continue to be redistributed to shareholders?

Michael M. Larsen

Yes. I mean the way I would think about it is, if you just try to keep it simple yourself. We generate about $2 billion of free cash flow right now, and that number will continue to go up, right? We -- we're -- and we -- and that's after we've fully funded everything we want to do internally, okay? And so that leaves with 3 things from a capital deployment standpoint. One is, the dividends and we're committed to a dividend that is -- has been gone up 50 years in a row here, an attractive dividend's yield relative to our peers on go-forward basis. We'll continue, I think, to see the share repurchase program beyond the IPG-specific program to continue to be an important part of what we do from a capital allocation standpoint, Okay? And so that leaves acquisitions, acquisitions that we're going to look at to a different lengths like Scott described. Really a company are more differentiated, more competitive, that can grow above market and kind of we can bring to the targets that we're communicating today. So we want to -- it's hard for us to get our arms around an acquisition that can't get to operating margins north of 20, returns north of 20, and one that can grow faster than the market. And so we're going to look at all those 3 variables and redeploy it in our returns, focused, discipline, balanced matter. But I think it's fair to say that share repurchases will continue to be a significant part of what we do. And actually, if I may just add, if you look at the last 10 years of history here, the company has retired approximately 220 million shares. Our share count at end of third quarter was approximately 430, 434 million shares, okay? We've spent -- we will spend by, the end of this year approximately $12 billion over the last 10 years, so a little over $1 billion a year. And the average purchase price is around $51 per share. So it's been, I'd say, a very good program for the company and one that we intend to have -- be a significant part of how we allocate our capital.

Unknown Attendee

Okay. And then a question on the margin. Clearly in the guidance for 2014, we're talking about 19%, which is just south of the 20% threshold. At what point does -- we're all looking at how good is good? Is there a ceiling on the margin realizing its a business-by-business discussion where the margin gets too high and you start to impede the growth prospects? And what would that number be?

E. Scott Santi

I don't know there's a ceiling. I think we were very intentional in terms of describing the goal as 20-plus. And I think it's ultimately something we look at much less as a target number that we apply to all the businesses. Within each business, you can see the spread even more than the 7 businesses that we talked about and the numbers that David showed you, you see a reasonable spread. So the answer to that question, I'd -- will vary a little bit business-by-business inside the company. But I think the goal right now is to get to 19% for the full year next year. And then we'll come back and tell you what we think we can do in '15 and what we can ultimately get to. I don't think we'd spent a lot of time worrying about right now because we don't know. Markets change, the competition continues to evolve. But I think centering how we think about our businesses, and making the operating margin a critical dynamic of how we evaluate businesses really puts that whole issue of sustainable differentiation front and center. You can't get here unless you're doing something pretty special for the customer in the end, where your end markets where you can price based on the quality and value of the solution, not based on the input cost of a material. And that's the advantage that you get in terms of the way we're focusing the portfolio. But what the ultimate upside is, I don't think any of this could tell you in order that we spent a lot of time trying to figure it out.

Unknown Attendee

You know in terms of your organic growth target getting to grow 200 basis points above the market. can you just -- I mean, that's a big change culturally. Could you talk about how each of the segments plan to get there? Is it more -- we have a series of new product launches coming in? Is it increasing your wallet share with each of the customers? And then which segments do you feel like will be most challenged in terms of achieving the 200 basis points of market growth.

Michael M. Larsen

Sure. I'll start and you can pile on. I think the first point of clarification is the goal is not that every segment in the company growth. That rate is really about the mix across the company. So the portfolio construction call that we're really making at its core is first and foremost, about back to this issue of sustainable differentiation. When we're in businesses that have big moats around and we can generate this most around them we can generate these kinds of outside margins kinds of outside markets returns and ultimately that's the sort of funnel that the portfolio call decisions are processed through. Once we're through that funnel, ultimately then what we expect is a mix of businesses, we're to going have some businesses in the company, they're going -- their growth potential was going to be framed by the economy maybe a hair more but given the kinds of returns and cash flow they generate, given their characteristics, were going to have those businesses as part of the company and the other end of the spectrum, we've historically had businesses like welding and Test & Measurement and our Auto -- sort of Auto OEM in Q3, which would be an example of sort of the higher end of the spectrum. That's a business that outgrew their market by 750 basis points in Q3. So first point of clarification is it's not a universal goal for every segment but it is absolutely a goal we're committed for the overall company. And then I think the path is, just what I said a little while also, which is I don't think it's a huge cultural change. I think that the biggest cultural changes really the split from the acquisition first to organic first. I think in significant impact just in terms of focus and execution. I think we know how to grow. I think we then do talk about some things within 80/20. So it's not an issue of we need to invest more in growth from the standpoint of monetary investment, we need to invest more effort in organic growth, and I think our businesses and our leadership gets that. We're fundamentally, in terms of the portfolio and businesses that have a lot more potential to do that. And ultimately we're going to line up, as I said before, the incentives behind what we want, the behaviors that we want to see happen. And those are the first steps. And -- all of that is not good enough, then obviously we'll kick it harder. But I think we're feeling pretty good about what I just said is going to get us pretty close, if not above that goal.

Michael M. Larsen

Yes, I mean, I've got no way, not much more to add to that. Also we gave you the figures of 2009, 2013. 3.1 versus 4.6, so there's already only 150 basis points there. Clearly, in that period, we've been doing a fair bit of BSS and part-of-line certifications, so that's also have been a little bit drag on the growth and that's also been back on the growth. The other element I'd say is again, the same message starts repeating earlier with regard to the focus within each of the divisions on the accelerated growth markets, that's going to give them the growth so I think we feel fairly comfortable this is very much doable.

Unknown Attendee

Actually, I had a similar question on growth. Just wanted to see, I mean, I get the impression from some of what you've said that the focus on growth and you mentioned term structure shifting a little bit towards it is more on the calm than it has been over the last year. Is it fair to say that the organization has been more focused on cost and simplification of growth and that's why the growth can accelerate throughout the rest of what you do? And is there anything inherent in the new structure that you think will unleash growth? Or is it more just be a more centralized? Or is it more you need to continue to focus on it?

Michael M. Larsen

Okay. obviously, as you go back into the divisions, our innovation work is done very much with the customer. So if you focus in on some of the markets that you really feel are the growth potentials then your energy is focused on growing in that sector so inevitably with that focus is going to become more intensity and that'll get a faster growth rate. If you're also getting out of the businesses that don't give you the growth. You actually got the same addition by subscription routine at the same time. So has there been an favorable effort in the last year a year, 1.5 years on restructuring? Yes, there has, but I'll go back to my comment that I sort of slightly alluded to, with regard to 4 engineers in 4 different businesses. If you have 4 engineers and they were operating separately within those businesses, that 1 engineer was spending a time on plan prepare, product development, innovation on the customer service complaint. Can now combine them together into 1 division, you say, "fine, I still got 4 guys, so girls, I can have one focus on one topic, one focus on another. So the innovation work doesn't get left to the last sort of half hour of today. You get more focused classic 80/20, focus your energies on growth areas, yes.

David C. Parry

[indiscernible] that big impetus behind BSS is really about better leveraging our capabilities with respect to growth. When David talked in the presentation about the fact that we used our Welding and our Food Equipment business is as kind of the informative templates that really drove us to launch BSS company-wide, it was really about looking at the innovation productivity in the organic growth record in those businesses so there is a structural element that the BSS that we expect to be contributory to the overall growth rate of the company. And the other part of your question is I think what we want to be clear about is that we are very focused on this but right now what we're focused on -- we've got a lot of BSS work to do, we're going to have a lot more to do in '14. So this is, those that are looking for more immediate impact around organic, we're not be stepping fully on gas pedal there. And again, it comes back to one of those issues about, we can't do all this stuff all at the same time so we got some more work to do. We expect organic growth better in '14 than '13 and better again in '15. And that's the way that we are thinking about and managing and incentivizing inside the company.

Unknown Attendee

If I look at your '14 guidance, the 2% to 3%, how would you compare that to the underlying growth of the markets that you're in?

Michael M. Larsen

I mean, I think, we're not really expecting much more than market growth. I think the best point making these look like GDP numbers, right? So we're not really expecting any outsized growth above and beyond market next year.

Unknown Attendee

And so from your guidance from what I gather that you expect to exit or be in 2017 at this 200 basis points better-than-market growth. Or in a few years, you'll be growing 200 basis points faster than the market, but you're not doing that right now. Is that what you're saying?

Michael M. Larsen

That's right.

Unknown Attendee

Okay. So my follow-on question to that is, if I look into BSS and the strategic sourcing, those still seem to be in relatively early stages and you're going to get continued benefits over that, over the next couple of years. Do you view those as investments in growing the core business? So in other words, we're looking at the numbers saying, "Okay, if you cut $600 million, $800 million off, you're going to get to x margins if I just take your cost base right now. But to get to 200 basis points of growth exiting, do you view these investments that you're making as creating a leaner cost structure so you can invest more in salespeople and things to get your top line growing? Or do you view this as permanent cuts to your cost base?

Michael M. Larsen

And the other part of your question is, I think what we want to be clear about is that we are very focused on this. But right now, what we're focused -- and we got a lot of BSS work to do, we're going to have a lot of more to do in '14. So this is -- those that are looking for more immediate impact around organic, we're not yet stepping fully on the gas pedal there. And again, it comes back to one of those issues about, we can't do all this stuff all at the same time. So we got some more work to do. We expect organic growth to be better in '14 than '13. And better again in '15, and that's the way that we are thinking about it and managing and incentivizing it inside the company.

Unknown Attendee

Yes. If I look at your '14 guidance, the 2% to 3%, how would you compare that to the underlying growth of the markets that you're in?

E. Scott Santi

Market...

Michael M. Larsen

Yes, I mean, I think we're not really expecting much more than market growth. I think at this point, the new is making these -- these look a lot like GDP numbers, right? So we're not really expecting any outsized growth above and beyond market next year.

Unknown Attendee

And so, from your guidance, from what I gather, that you expect to exit or be in 2017 at this 200 basis points better than market growth. Or in a few years, you'll be growing 200 basis points faster than the market, but you're not doing that right now, is that what you're saying?

E. Scott Santi

Correct.

Michael M. Larsen

That is correct. Yes.

Unknown Attendee

Okay. And then so my follow-on question to that is if I look at BSS and the strategic sourcing, those still seem to be in relatively early stages, and you're going to get continued benefits over that over the next couple of years. Do you view those as investments in growing the core business? So in other words, we're looking at the numbers saying, "Okay, if you cut $600 million, $800 million off, you're going to x margins, if I just take your cost base right now." But to get to 200 basis points of growth exiting, do you view these investments that you're making as creating a leaner cost structure so you can invest more in salespeople and things to get your top line growing? Or do you view these as permanent cuts to your cost base?

E. Scott Santi

Well, I think on the BSS side for sure, it's summable. I think it's moving the structure, again, from a highly fragmented structure where it was really difficult to get organic leverage from a resource deployment standpoint. So it's not really about more money, but it's about more effective leveraging of what we have invested. We certainly have the capability to invest, but we've never constrained organic investment inside the company, given the cash flow. But, certainly, from a standpoint of chopping those investments into 800 little pieces versus now, we're much more concentrated around 90 bigger global positions, that's going to have some significant impact. So I think BSS, that sometimes gets characterized as a margin move, is first and foremost, about better positioning the company to grow, with some margin savings that are certainly significant, but ancillary benefits to that overall strategy. And we certainly reserve the right to use some of those proceeds to reinvest where we are. I mean, that's -- this is not about squeezing every nickel out of cost. So, absolutely, that's -- these are investments in our position in the company to ultimately operate consistently with the margin and return metrics that we laid out in January, really sell the growth consistently. I think on the sourcing side, that's much more about how we're going to view to sustain those margins and returns at those levels as the markets in which we operate continue to become more and more competitive as we go. We're not a price -- cost of price kind of seller, given the value-weighted content, but, certainly, really important that we continue and accelerate our ability to drive costs down as a buffer against a market that's going to get nothing but more and more competitive as we go forward.

David C. Parry

And the other thing I would add on the sourcing side, if I may as well, is that obviously as you start reducing the number of suppliers you have here, then you can work more closely with those suppliers, right, and, therefore, bring in their capabilities to design products going forward. So what new resin, new steel could you bring to the party? Now I'm not saying that doesn't go on today, but, clearly, if you have fewer people that you need to talk to and you have a bigger mind share, they're going to be more instant than having that sort of discussion with you.

Unknown Attendee

So if I get this right, you essentially view a good deal of this as investments and you think we're better off as shareholders by cutting the cost structure and making it more efficient and investing a good portion of that to and whatever it is, be in a competitive environment to grow the top line and maybe not take the last nickel on the margins, but be able to grow the top line at a faster rate than market with those investments?

E. Scott Santi

Yes, I think the position of the company is really around how do we be the best ITW we can be, and, ultimately, if we can deliver, it's not about how do we get -- how do we maximize margins, but we've clearly got an operating model that we think can deliver consistent best-in-class margins and a reasonable growth rate. We are making trade-offs between quality of growth and quantity of growth that -- those are inherent in our strategy. We should -- given the cash flow that we generate, we certainly have the capability to deploy that cash and to buy EPS. But ultimately, we're not going to then be a company that's known and respected and appreciated for the quality of the underlying business model. It's not a right or wrong issue. There are good companies that do all kinds of things around that spectrum. In terms of playing to our strengths though, in our view, a big part of our review was ultimately that we are the best company we can be when we're leveraging the core business model of the company and, ultimately, focusing on quality of growth rather than quantity of growth. And that quality shows up in returns on capital and the margin. And that's just from my perspective, and our perspective playing to our strengths. It doesn't mean we're right and everybody else is wrong. There are good models all the way around. Our job is to be very clear about that with investors and let the investors that are interested in investing in a company that's going to do what we're going to do. That's up to you. That's up to the investor base.

Unknown Attendee

I'd like to go back to capital. I think you mentioned, Michael, in the presentation, that you're taking the debt-to-EBITDA ratio up to the low 2s. If EBITDA grows over time, would you imagine holding that stable? And would that create a source for additional share repurchases?

Michael M. Larsen

Yes. I mean, I think, what I would -- so what you said is correct. That in the first half of '14, we expect that our leverage ratio will go to kind of the low 2s, so 2.2x, 2.3x EBITDA. And I think it's a leverage that we're very comfortable with in terms of our ratings and our ability to generate cash to support the debt. So -- and also manage the interest expense that goes with that additional leverage. I think in terms of if you're asking kind of your long-term targets, in terms of your leverage ratios, I think my view is that given the strength of the balance sheet, given the strength of our cash flows, we'd be quite comfortable with slightly more leverage than what we have seen historically. And so, how we redeploy that will be consistent with what we've said in terms of our priorities, but in terms of additional leverage, I think we'd be comfortable with that.

Unknown Attendee

So I obviously love the questions on growth. So here's one more. So Mike, you mentioned that the plan for '14 is almost independent of macro, it's -- a lot is in your hands. So it almost feels like the 2% to 3% is almost like a balance in number. And I know it isn't, but obviously...

Michael M. Larsen

What number?

Unknown Attendee

It feels like a balance in number in some ways.

Michael M. Larsen

Balancing?

Unknown Attendee

No, no. I don't mean it to be just like balancing number.

Michael M. Larsen

No, I'm just trying to understand the word.

E. Scott Santi

Yes.

Michael M. Larsen

Yes. It's just hard to hear up here. This -- you said balancing number?

Unknown Attendee

Well, I said a balance in number. Yes, I don't mean it was a balance in number, but it seems like a very conservative view of the world. And here's where I come back to, okay? PMI, 57 and new order, 53. Your short cycle business, I'd expect it to be some form of improvements in your order rates, et cetera. I mean, are you seeing any of this coming through? And do you think that the 2%, 3% -- and what I'm trying to say is the 2% to 3% feels like the lower end of your kind of range for '14. Is that a fair assessment?

Michael M. Larsen

I'll start and then -- I mean, I think if you go back and look at what we said a year ago, you could have made the same argument that those were pretty conservative numbers. They turned out to be pretty accurate. And so...

Unknown Attendee

Yes, but the PMI wasn't 57?

Michael M. Larsen

No -- and so, kind of to answer your question, I think when you look at the data that we're seeing in terms of PMI and ISM, and what I'll tell you is there's a little bit of disconnect between what we're seeing, and I think we're not alone, right?

E. Scott Santi

You may have seen that?

Michael M. Larsen

So, I mean...

E. Scott Santi

That's what you're hearing from other companies?

Michael M. Larsen

I think if you look at our peers, there is a little bit of a -- well, it's a lag or the way it's calculated, not quite sure, okay? But -- and at the same time, though, we are starting to see a gradual improvement in our underlying business. And so, we're starting to see in some of the segments we talk about, food, equipment, automotive, construction, I mean, there's some real momentum in those businesses. And so, again, the way we approach the plan was we didn't want to bet on macro. We rolled up a set of assumptions from our segments and we went through those, and we want to make sure that we captured all the operating improvements accurately because that's where that we really want to bet on. We don't want to bet on -- now look, here's what I'll tell you, if macro is better, it will show up, right? So that's how to answer your question.

Unknown Attendee

Yes, that actually was the question. The 2%, 3% versus the PMI at very high levels, that was the question. It wasn't the balance in number question. It was the -- and then secondly, obviously, the divisional size is much larger than it was a 2 years ago. And you expect to decide to do larger deals, maybe fewer deals going forward than it has been in the past. Is that a fair comment?

E. Scott Santi

I don't think we've said larger deals. I think, ultimately, what we've said is we're going to deploy M&A under this enterprise strategy in ways that are very tightly focused around supporting the organic growth strategies of the 7 really strong positions that we have. Sizes ain't the issue necessarily.

Unknown Attendee

Great. On M&A multiples, I mean, you clearly want to own differentiated businesses, which I assume would then mean higher multiples paid for them. So I guess the question is, how hard is it going to be to find those deals that will then be able to meet your ultimate return requirements?

E. Scott Santi

Well, I'll have a take a stab. What I would say is that we found 3 really good ones this year. I think the advantage, we have always been very return-focused. So multiples, as a percent of EBITDA, are not really all that relevant, relative to what you're going to do with the earnings generation capability of the business once you own it. So 80/20 remains a huge advantage for us, and that our ability to go in and significantly improve the underlying margins of whatever we might acquire is a significant advantage in terms of multiple. If we're acquiring more differentiated business, the starting point for the margin may be higher than historic. So instead of buying a 7% margin business, we're buying a 12% or 13%. But I think David gave you a couple of good examples inside the company of 80/20, and its impact even on business is they already have pretty high margins. We're talking about bumping up margins 300 or 400 basis points there, starting in the 20. So, ultimately, we're not going to buy anything where 80/20 doesn't give us a significant amount of leverage, right? So it's about the strategic fit and it also is about -- and 80/20 gives us a real competitive advantage in the acquisition space. So -- and we're also not trying to buy 5, 50 or 60 companies a year either anymore, right? This is how it's going to look. 3 or 4 or 5 really good acquisitions and things that we know really well, that really fit the business. So I don't think we're in the realm of not being able to execute on this. But it's a very different approach than what we've done historically.

David C. Parry

And I think the only thing I would add on that is, well, obviously, we have modeling with regard to doing our acquisitions. That's a very disciplined process. That discipline is going to remain, and like Scott mentioned, we're going to get the returns that we want to achieve for our business. And that's where our modeling goes. I mentioned a little bit about on acquisitions, and I think that sweet spot probably still remains between $50 million and, say, $500 million of -- so that's still probably our sweet spot. But I think we've proven in 2013, there's candidates out there and I'm fairly comfortable we will find those candidates in 2014 and 2015.

Unknown Attendee

Okay. And just to follow up on the Electronics and Measurement business, it's been a weaker business this year, did you say kind of what your expectations are for 2014 on that one? And what will it take to get that business going better?

E. Scott Santi

Yes, well, I think those are -- there's 2 pieces to that. The one subject of conversation that was out there throughout much of this year was really the revenue comp issue in the Electronics space, and that related to some fairly significant onetime orders in '12 that are not likely to repeat. So we're through that comp issue now as we head into 2014. The Electronics business that we're in is about $1 billion, about half of that overall segment. Core margins this year are going to be north of 17%. And most of that business for us is what I would describe as MRO into the Electronics space. We're not highly volatile. We're not selling components that go into Electronics. They're really supporting the manufacturing of Electronics. So I think we're okay from the standpoint of both the kind of returns we generate in that business, the volatility issues should be out as we go forward, and we'll see how it goes. But I think, ultimately, we're out of the place where that -- this Electronics piece is a significant year-on-year drag on the company's overall growth. On the Test & Measurement space, fundamentally a very strong business. It's in the bucket right now with our Welding business, where I think the capital spending environment overall is relatively sluggish. And so, from the standpoint of underlying growth rate, it's certainly not -- neither one of those businesses is at the high single-digit numbers that we've seen historically through the cycle. We're kind of at a low point right now. But now you said, I think 150 basis points of margin improvement. You mentioned, David, in terms of Test & Measurement, great fundamentals for the long haul and we expect that, hopefully, we see some improvement in both Welding and Test & Measurement next year. But, again, as Michael said, it's -- the planning scenario right now is we're going to expect more of the same until we see something different.

Unknown Attendee

I'm just going to identify myself as Cliff Rams [ph] and because this is probably the only company presentation than I've seen in -- for a company that I followed for probably close to 20 years where I have no questions. Thank you for your clarity and transparency that you're giving us. On the other hand, you have been a super achiever in my universe, since I started this company 10 years ago. And what you're -- I know what a wrenching transition this is. You're making it sound like we're living on a history of 80/20. But the fact of the matter is what you're doing is, I think, damn near incomparable to anything else I've seen for a company your size. And I frankly just wanted to thank you.

E. Scott Santi

Thank you.

Michael M. Larsen

Thank you.

Unknown Attendee

You talked earlier about your acquisitions this year, and I know that you bought a medical products manufacturer. Could you just remind us of your historical and current exposure to just health care? And is this maybe a kind of a dry well for a platform we might see later on?

E. Scott Santi

Well, we -- so the business you're talking about, we actually bought in '12, which is why it wasn't on the list. And I think it's a good example of some of the things that we have working on inside the company. We will do sort of relatively small entrée-point acquisitions into some areas of potential opportunity. This business we bought, for those of you who aren't -- that aren't familiar, is a manufacturer of components in the medical field. So it was an opportunity to go in and basically learn something about a market that might have some -- that -- where we thought the raw material that was there for some -- in terms of relevance to our business model for the long haul, that's been our ammo throughout. We've never been sort of a big bet, push all our chips in on the latest hot sector of the economy. But if we go back to things, even like Welding and Test & Measurement, those all started with relatively low-scale entrée-point acquisitions. And our practice is to use the actual experience in those industries we get to help us make the go-or-no-go decisions in terms of scaleups. So that would be an example of relatively early-stage entrée-point acquisition. Some of them work, some of them don't. But, again, with 80/20, it's -- at a minimum, what we do is make a significant improvement in the underlying profitability of the business, and whether we decide it's long-term something that's worth our effort and attention to build out or whether it's not. We're not taking a lot of risk, but I think our history is that we've generally been much better served by actually participating in industries before we make the big scaleup decisions, and that's another example. As to the history there, we don't have any. That was -- that's why we're doing that, yes.

Unknown Attendee

I think I have the mic here. I'm not going to ask you a question about growth, but maybe the impact of growth. How about, if things were to turn out 150, 200 basis points better than you're modeling, how should we think about that 19% margin target? Would there be additional costs that would come online? Or would we have normal incrementals on whatever upside we want to factor in?

Michael M. Larsen

I mean, I -- if I understood your question correctly, so in terms of the incremental margins, we are expecting kind of the -- what we've been historically -- when you take out the impact of BSS and sourcing, we're kind of in the 30% and 35% range. If you're asking in a higher growth scenario would that change, we wouldn't expect it to change significantly, no.

Unknown Attendee

Great. And then I wonder if you could just update, you must do scenario planning. If we were to have a recession, what is the new ITW's kind of trough margin look like in whatever the next recession is?

Michael M. Larsen

Yes, yes. I mean, and so obviously, that's kind of a buildup of a moving target right now. I could be flip and say it's higher than the last time. And I'd rather do that than give you a firm number, how about that? So -- but, currently, we are looking at different scenarios here and what are -- if things, if we enter into kind of an '09 scenario, again, what are the levers that we're going to pull. And so we have plans that we think about on a regular basis. Hopefully, we will not need them, but, certainly, we think about that.

Unknown Attendee

So just turning to the end markets for a minute. On the construction side, in particular, you sound maybe a little more optimistic than some of the other companies we've heard from lately. Can you talk about where you're seeing improvements in that business and maybe regionally around the globe, where you're most optimistic about the potential for upside in Construction?

David C. Parry

Okay. All right. As many of you may know, basically our Construction business is effectively split, 1/3, 1/3, 1/3, regionally. So it's approximately 1/3, United States, 1/3 in Europe, 1/3 in Australasia and New Zealand. So I'll sort of respond to the question by sort of covering those 3 regions, has been the simplest way of doing it. North American market, certainly residential housing has certainly picked up in 2013. We expect that to continue in 2014. I think it's probably going to continue to accelerate through 2014. It's not a major proportion of our business in the United States, but it's certainly significant. As far as commercial construction, commercial construction in the U.S. is varied from -- you've seen a whole set of different people giving different parameters. We tend to feel that the commercial construction tends to follow residential by about 2 to 3 years. We are starting to see, in the United States, the commercial construction business start to pick up. That happened at the back end of Q3, and it started to come through in Q4. So it's about pretty much on line with where we'd expect it to be. That's basically United States. As far as Europe is concerned, I really don't see Europe really going very far in 2014. It has been going down, obviously 2012, 2013. I think it's pretty much hit bottom. Our activities on the Construction side are all around self-help. That's where we've chosen -- that's where we've talked about the 750 basis points, and that focus in construction is very much about self-help. So a lot of our businesses are in Europe. The restructurings and the sort of capabilities that we've been doing in the U.S., but I mentioned, clearly, those activities take a certain sort of length of time longer in Europe because of social practices that are a little more convoluted. I'll leave it like that. And so, clearly, it's harder to make that change, but we will make those changes. As far as Australasia is concerned, that was fairly flat and it's now starting to sort of turn back the other way and starting to grow 2%, 3%. So those things make us feel pretty optimistic about Construction. But I would stress to point out to you that our activities in 2013 and 2014 are very much around self-help and not from what the market is doing for us. We get market lift, which we think is coming, but that's not where our margin improvement is going to come from. And it really is going to come from a lot of the hard work that we've been to. We started in 2012, we implement in 2013, there's more to come through in 2014, and feel very comfortable with what we've got there. And as we slide through 2014 and 2015, will the emphasis change and move more towards innovation and growth, and focusing on the markets where, really, we want to be core and active.

John L. Brooklier

Any more questions? So one last question.

E. Scott Santi

Out of gas.

John L. Brooklier

They ran out of gas. Anybody? What's that?

Unknown Attendee

No more growth questions?

John L. Brooklier

There are no more growth questions. Okay. Thank you, gentlemen. I appreciate it. We'll be here through lunch, so if anybody wants to stay, we'll be entertaining additional questions. Thank you. Thanks for coming.

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