Illinois Tool Works Inc (ITW) 2016 Q1 法說會逐字稿

Welcome and thank you all for standing by.

(Operator Instructions)

This call is being recorded.

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

Now I'll turn the meeting over to your host, Aaron Hoffman.

Sir, you may begin.

Thank you, Yvonne.

Good morning and welcome to ITW's first-quarter 2016 conference call.

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

During today's call, we will discuss our first-quarter 2016 financial results and update you on our 2016 earnings forecast.

Before we get to the results, let me remind you that this presentation contains our financial forecast for the 2016 second quarter and full year, as well as other forward-looking statements identified on this slide.

We refer you to the Company's 2015 form 10-K for more detail about important risks that could cause actual results to differ materially from our expectations.

Also, this presentation uses certain non-GAAP measures.

While we use very few non-GAAP measures, a reconciliation of those non-GAAP measures to the most comparable GAAP measure is contained in the press release.

And with that, I'll turn the call over to Scott.

Thanks, Aaron, and good morning.

Overall a pretty solid start to the year for ITW as we delivered solid near-term results and continued to make good progress in executing our strategy to position the Company to deliver solid growth with best-in-class margins and returns.

In the quarter we continued to deliver meaningful improvement on all of our key performance metrics.

We grew EPS 7%, 10% excluding the impact of foreign currency translation.

Organic growth came in at the midpoint of our forecast and was up 1%, 2% excluding the impact of our PLS initiatives.

We improved operating margin by 120 basis points to 22.1%, and increased after-tax return on invested capital by 180 basis points to 21.2%.

Both our operating margin and our ROIC metrics were new all-time first quarter highs for the Company.

Free cash flow was also strong in the quarter at 90% of net income.

Based on current demand trends and our strong operational and margin performance in the quarter, we are raising our GAAP EPS guidance for 2016 by $0.05 at the midpoint.

Before turning the call over to Michael for more detail on our Q1 results, I'd like to thank all of our ITW colleagues around the world for the great job that they continue to do in serving our customers and in executing our strategy.

Michael, over to you.

Thank you, Scott, and good morning, everybody.

As you saw this morning, ITW is off to a strong start in 2016 as the Company delivered another solid quarter with excellent quality of earnings.

GAAP EPS of $1.29 increased 7% versus prior year and exceeded the midpoint of our guidance range by $0.04, driven by better operating margin as a result of strong operational execution on our enterprise initiatives.

Organic revenue was up 1% and in line with our guidance, as North America grew 2% and international declined 1%.

As Scott mentioned, we established a number of new all-time highs for our first quarter.

Operating margin of 22.1% improved 120 basis points, with strategic sourcing, 80/20 practice excellence, and business structure simplification all contributing in a very meaningful way.

Given the strong margin performance in the quarter, we now expect that operating margin will exceed 22.5% for the full year.

Operating income of $722 million was also a first-quarter record.

The prior record of $705 million was pre-enterprise strategy in 2012, and was achieved with revenues that were $1.3 billion higher than this quarter.

After-tax ROIC was solid, free cash flow was strong, and we repurchased shares for $500 million.

Just to comment on our external financial reporting.

As you know, at ITW we work hard to keep our external reporting simple, consistent, and transparent.

We only report one EPS number and that is GAAP EPS.

There are no adjusted EPS numbers.

That said, let me just point out two items that are included in our first quarter GAAP EPS number of $1.29.

First, foreign currency translation, which was right in line with our guidance assumption, an unfavorable $0.04 year over year.

Second, last year's first quarter included a non-recurring gain on the sale of a business.

As a result in the first quarter last year, other income was $21 million compared to $4 million this quarter.

Excluding these two items, EPS would have increased 13%.

We strongly believe that in the current economic environment and over the long term, our highly profitable and diversified portfolio is a core strength of the Company.

We are very well balanced in terms of our end market and geographic exposures, and well positioned to perform at a high level across a wide range of economic scenarios.

Our consumer facing businesses make up 60% of our revenues, and include the automotive OEM and food equipment segments as well as portions of specialty product and construction.

These businesses continued to deliver stable, high quality growth.

In the first quarter our consumer facing businesses were up 3% versus prior year and up 1% sequentially.

Our industrial facing businesses, such as welding and test and measurement and electronics, account for 40% of our revenues, and as expected they declined year over year.

As you can see, these businesses were down 3% but showed some improvement versus Q4 when they were down 6%.

As you know, the year-over-year comparisons continue to ease as we go through the year.

1% organic revenue growth in the quarter, 2% excluding our product line simplification initiatives, or PLS.

By region North America was up 2% with our consumer facing businesses up 5%.

Solid growth continues in food equipment up 5%, automotive up 4%, and construction products with renovation remodeling up 22%.

Industrial facing businesses were down 3%, with welding down 7% and test and measurement and electronics down 1%.

On the international side, overall down 1% with Europe up 1% and Asia-Pac down 2%.

Our international consumer businesses grew 1%, and industrial is down 4% primarily due to welding.

At ITW we believe that operating margin is a key indicator of our business's competitive advantage and the efficiency with which they leverage it.

It is in our view a compelling indicator of the strength and competitiveness of ITW, and it is a key performance metric for every ITW business.

In the first quarter, operating margin improved 120 basis points to 22.1% as six of our seven segments improved.

Construction products increased 440 basis points, specialty products 350 basis points, food equipment 190 basis points, and automotive was up 140 basis points to mention a few.

Approximately half of the decline in welding this quarter is related to restructuring and other non-operating items, and the team continues to do a good job in a challenging environment as evidenced by their ability to sustain operating margins in the mid-20%s despite a significant decline in revenue.

You can also see the positive impact of volume leverage in the faster growing segments which gives you a sense for what margins and overall profitability will look like as organic growth picks up.

On the right side of the page we listed the drivers of our operating margin improvement this quarter, starting with 130 basis points from our self-help enterprise initiatives.

Given this strong performance and positive momentum, we are now expecting more than 100 basis points from enterprise initiatives this year.

Price/cost came in as expected, stable and favorable at 20 basis points.

The unfavorable 50 basis points in the other line is primarily related to investments in growth and overhead inflation.

Overall, continued strong execution on enterprise initiatives and progress on delivering best-in-class margins consistently and sustainably.

Before we get into the segment results, we listed the quarterly progression on operating margin expansion since the first quarter of 2013.

520 basis points at the enterprise level; as you can see construction improved 930 basis points; 780 basis points in food equipment; and more than 600 basis points in automotive and in specialty products.

Overall good progress with more to come.

Turning to the segments.

Automotive OEM had another strong quarter, with organic revenue up 3% and 26.4% operating margin.

While 3% organic growth is a little below what we've seen out of our automotive OEM segment in the last several quarters, this segment had a very tough comp and Q1 revenue came in right where we planned it to be.

In the first quarter of last year, the launch of several new programs in Europe resulted in revenue growth of 13% versus builds of 2%, which is what created the tough comp for the business this year.

Our long-term growth target for our automotive OEM business remains 2 to 4 percentage points of above-market growth annually, and based on already sold programs and our new program pipeline, we expect to meet or exceed that target both in 2016 and for at least the next several years beyond.

In North America 4% organic growth compares to auto builds of up 5% and the Detroit 3 up 4%.

China was up 6% in the quarter despite the fact that builds at western OEMs were down slightly.

As expected, operating margin improved 140 basis points to 26.4%, the highest in the Company.

A quick update on the acquisition of EF&C from ZF TRW that we announced last quarter.

The acquisition remains on track and we expect the deal to close mid-year.

As a reminder, EF&C should be modestly accretive to EPS in the first 12 months, with accelerating benefits in 2017 and beyond.

Another strong quarter in food equipment, up 3% organically with strength in North America up 5% despite a challenging comparison.

North America equipment was up 5% with strength in refrigeration and cooking, and service was up 4%.

International was up 1% with equipment up 3% and service flat.

Continued strong margin performance as operating margin improved by 190 basis points to 24.5%.

Test and measurement and electronics organic revenue down 2%.

Test and measurement down 3% and electronics slightly better at down 1%.

Sequentially, this segment was stable, down 7% compared to typical seasonality of down 6%.

Still a challenging external environment for our welding business as organic revenue declined 9%.

The 9% year-over-year decline breaks down as 5 points from oil and gas, 3 points from industrial, and 1 point from commercial.

North America was down 7% with equipment down 10% and consumables down 1%.

International was down 15% primarily due to oil and gas.

We saw some slowing sequentially, with demand trends down 3% compared to the typical 3% increase, and the team continues to take appropriate action on the cost side.

As I mentioned earlier, approximately half of the operating margin decline in welding this quarter is related to restructuring and other non-operating items.

Polymers and fluids achieved positive organic revenue growth of 1%, North America and international were both up 1%, and automotive aftermarket improved 2%.

Strong quarter in construction products as organic revenue increased 5% with North America up 11%.

Renovation/remodeling was up 22%, commercial was up 8%, and residential was up 2%.

Asia Pacific was up 2% and Europe flat.

Very strong progress on operating margin, up 440 basis points to 21%.

Solid quarter in specialty products, with organic revenue up 3% with strength in our consumer packaging businesses.

North America was up 5% and international was flat.

And very strong progress on operating margin, with an increase of 350 basis points to 26.1%.

So for the year, based on our margin performance in the first quarter, we are raising our full-year EPS guidance by $0.05 to a new range of $5.40 to $5.60.

The $5.50 midpoint is 7% earnings growth.

Our organic revenue growth expectation of 1% to 3% is unchanged and in line with current run rates.

We're forecasting that enterprise initiatives will deliver more than 100 basis points of margin improvement and that full-year operating margin will exceed 22.5%.

We still expect free cash flow conversion to exceed 100%, and we're targeting $2 billion in share repurchases.

For the second quarter, our GAAP EPS guidance is $1.34 to $1.44, up 7% at the $1.39 midpoint.

That puts 49% of our full-year EPS forecast in the first half of the year, which is consistent with prior years.

And with that, let me turn the call back to Aaron.

Great, thanks, Michael.

We will now open the call to your questions.

Please be brief so as to allow more people the opportunity to ask a question, and please remember one question and one follow-up question.

Thank you.

(Operator Instructions)

Our first question comes from the line of John Inch from Deutsche Bank.

Thank you.

Where am I from?

First I wanted to thank you by the way for the GAAP presentation of earnings and frankly for doing a call and not a selective disclosure podcast.

So much appreciated.

Can we -- and don't answer that.

Can we just talk about currency, Michael?

I know you said it was in line with expectations.

It was a little bit more of a drag just based on where we were marking currencies that we thought would happen in the quarter, so was there -- I realize you got a lot of exposure to Australian dollar and I don't know, just with the pound and so forth maybe could you talk about, just give us a little more color in terms of the currency fluctuation and where you've marked this for the rest of the year and how you expect that to progress in terms of dragger contribution?

Right, John.

So you're headed down the right path here.

So you have to look beyond just the euro, and if you look at the changes in pound, Canadian and Australian dollar, that's when you get to the 3% translation impact here in the first quarter on the top line and $0.04 of EPS headwind, which was right in line with the assumption we had in our guidance.

For the rest of the year, that translation impact will at current rates as we sit here today, will be lower.

And maybe if you're headed down the path of EPS impact for the balance of the year, it is correct that based on current rates as we sit here today, not just looking at the euro but at the other currencies we mentioned, if currency stays exactly where it is, things could turn out a little bit better.

But as you know, there's a lot of volatility in currency.

So we have not included that in the numbers we gave you today.

Okay, but did you did beat the midpoint of your guide by almost $0.05.

And that is entirely driven by operating margin.

Right.

I see that, but at current rates how much of a tailwind do we have in currency today versus what we had when you first marked rates giving the first quarter in your head guidance?

Isn't it like $0.05 or something?

I'll just say this, John.

It's a little bit better than what we had assumed, and as we sit here today let's see where rates go from here.

But like I said, it could be a little better based on rates as they are today.

Okay.

So my follow up, I want to ask you and Scott what do you think of the -- or what do you make of the ISM?

It's all that everyone seems to look at, and if you look at the new orders component, it's telling you that a big quote-unquote recovery is on the come.

Now last year it was flashing green and manufacturing was going the other way, so I think I'm just trying to get your sense.

You're a realtime Company, short cycle, you're in the economy.

Do you think that the ISM is reflecting perhaps some seasonal improvement, some sentiment improvement, only perhaps a little bit of systematic inventory restock?

Or are you just seeing a complete disconnect?

I just want, again, focus on North America please and how do you, based on your years of experience, how do you interpret the ISM and why frankly wouldn't you be even more positive on your outlook?

Yes, we've never from our particular lens, we've never viewed the ISM number as having a terrific correlation to conditions we're seeing on the ground.

Certainly not way out, but from the standpoint of either leading or lagging, it's not been particularly reflective of the conditions that we're seeing.

What I will tell you is my take on the quarter is that we saw pretty solid demand throughout.

So I think things are relatively firm for right now, the one exception to that is obviously welding where hopefully we're getting close to a bottom, but I can't say that we're seeing anything that tells us that.

But beyond that, the overall demand profile inside the Company was pretty solid as we moved through the quarter.

So no big movement and certainly not any weakening as we move through the quarter.

Well Scott, every month has its own seasonal characteristics; then we had these weather compares, especially in the midwest and northeast.

I realize it's complicated, but if you try and adjust for all that do you think that underlying demand is picking up for your businesses, or is it still not clear?

Like if you at -- think of how the quarter progressed and then into April.

Yes, I'd say it's been pretty firm.

I think it's a little early in a quarter to call with one quarters worth of data, but I think again in the aggregate things were pretty solid through the quarter.

Look at our consumer facing businesses where the overall demand rates have been pretty solid going back four or five quarters now.

I think we're feeling good about where we sit in the overall demand picture that we saw in the first quarter.

That being said, it's still a pretty choppy environment out there.

But there is no new worry beads based on our first-quarter performance that we saw across the Company.

Okay.

So basically signs of -- very stable, but no obvious inflections of sequential improvement on the come, right?

No.

Again, adjusting for seasonality?

Correct.

Good enough.

Thanks, appreciate it.

Thank you.

Our next question comes from the line of Joseph Ritchie from Goldman Sachs.

Thanks, good morning.

Good morning.

So I guess my first question is on auto.

Again, and first a solid quarter, but clearly, you had a really, really tough comp, especially if you look on a two-year stack.

Is the expectation that growth starts to improve beyond the first quarter on your auto business, just based on what you know on production schedules and the platforms that you're on?

Yes, so I think we talked about a tough comp in the first quarter due to the new programs launched in Europe.

And if you'll recall, Europe last year was up 11% on builds of 1%.

So that comp will be with us for the year.

But in terms of the year-over-year organic growth rate, as we sit here today looking at the typical seasonality, Q1 is the low point for the year and the organic growth rate on a year-over-year basis will improve as we go through the year.

Okay, great.

Thanks, Michael.

And maybe my follow-on question, moving on to welding, so clearly part of the portfolio there's been a little bit more challenge.

You mentioned half of the margin performance this quarter was related to restructuring actions.

Does that start to tail off as we progress through the year?

Or how are you thinking about that business?

Because clearly on the face of it when you take a look at the decremental margins, the decremental margins in the first quarter are pretty high.

I'm just trying to get a sense for how that business will traject for the rest of the year.

Yes, so we had as you said about half of the impact in the first quarter here, the margin decline down 9%, which is pretty significant organic, about half of that was restructuring related.

We expect a similar impact here in Q2 and then improvement in the second half of the year on the margin side.

And obviously the comparisons get significant to easier in the back half of the year.

So last year in the first quarter welding was down 3%, which sounds like an easy comp but actually it's not when you look at how the rest of 2015 unfolded.

So the comps will get better as we go through this year.

Based on current sequential trends that we look at, we'll see flat to positive in the back half and margins will improve also in the back half.

We have another slug of restructuring to get through in the second quarter, and then for now hopefully the worst is behind us.

Okay great, thanks.

Thank you.

Our next question comes from the line of Nigel Coe from Morgan Stanley.

Thanks, good morning.

I just wanted to follow up on John's question.

Hello, can you hear me?

Yes, we got you.

Oh, good.

So there's some chatter out there that March was a bit weaker than January and February for industrial markets.

Did you see that?

Doesn't sound like you did given your comments, Scott.

We did not.

Okay, good.

Moving on to construction, and construction was the standout this quarter with 5% and 11% in North America.

I'm wondering is there any way to try and understand how much of this is weather driven?

I'm assuming that construction activity did benefit from weather, and how much has been pulled forward from maybe Q2 into Q1.

And maybe just characterize that by talking about how you exit the quarter on construction products with it pretty steady as well.

The answer to your first question is there is really no way to factor weather in in terms of how it might have impacted our results relative to whatever you might call a normalized year, which is a big reason why we usually don't bite on any single quarter trends in construction as predictive or indicative of overall demand.

I think what I would say is we certainly exited the quarter in pretty good shape there.

So I think we're not seeing anything slow down or ease up, and we will hope it continues through the balance of the year for sure.

Just a quick follow-on on construction, Europe was flat and we're seeing some signs of maybe green shoots in construction activity in Europe.

But I know that UK is an important end market, so I'm wondering can you maybe just talk about what you've seen in Europe?

Is the UK starting to slow down for Europe, and are you seeing some green shoots in continental Europe?

No, we're not seeing anything slow down.

We are a bit of a lagger in terms of when our products are actually going onto the job.

It's well after the start phase.

So I think in terms of color, our overall macro view over there from the standpoint of construction is things are heading in the right direction.

Great, thanks a lot.

Our next question comes from the line of Andrew Kaplowitz from Citigroup.

Good morning, nice quarter.

Thank you.

You're four years into enterprise strategy and Q1 2016 appears to be your best quarter really in the last four years in terms of margin contribution from the revised strategy.

So what's surprising is that we would think that given tougher comparisons and given your now obviously more than halfway done with your initiative you're hitting this kind of performance.

Can you give us a little more color as to what's going on?

Is it just that your team is now better at implementing your initiatives than earlier in the program, or is it that you're tackling more complicated areas of your business such as European construction or specialty products, that you actually find it's easier to improve efficiency?

Well, what I would probably say is that we are -- these were not a series of initiatives that were all implemented simultaneously.

So we are basically sequencing through.

If you look at the progression that we laid out, and we've talked about this, as early on that we were heavily focused on the portfolio, business structure simplification, sourcing we said all along had a ramp.

If you remember that it was now famously known as the heat map from our first presentation, and then we had an initiative that was related to what we call business model excellence.

It's reapplying the ITW business model to the scaled up much more focused businesses.

So what we are seeing today is much more now of an impact from sourcing the later stage stuff.

So it wasn't necessarily an all at once level of execution across all of those initiatives.

They were very intentionally laid out in a sequence because we had to get certain things done that would allow us to get to the next phase things.

So some of the improvement that we are seeing is just now sourcing in business model excellence starting to take over from BSS and the portfolio work that we did.

And the other thing that I would say is you're starting to see some impact from incremental contribution from organic growth as we are starting to make the pivot to growth.

And Michael showed you a chart earlier, but if you look at where we had the best margin performance in the quarter, it was in the parts of the Company that were generating the most organic growth.

So the elevated level of profitability and the incremental profit we generate and every dollar of organic is now starting to contribute as we move into this next phase of our strategy.

Got it, Scott.

So let me ask you about the pivot to growth.

You've talked before about 85% of your businesses being ready to go by the end of 2016 from 60% at the end of last year.

So how many more businesses -- or even should we be thinking like this, did you convert in Q1 as ready to grow?

And when you do convert these, are you seeing the growth progression in those businesses that you expect?

And you still have a percentage for headwind on growth from PLS in the quarter, I think you've talked about 90 bps for the year, how does that progression work out?

Does the headwind start falling significantly just at the very end of the year?

Does it start falling now?

Well to start with the last part first, the portfolio work that we're doing at the product line level at some point is going to dissipate.

I think we are -- frankly there's still a fair amount of that to do heading into 2016.

We won't know what that looks like for 2017 fully until we get into the planning cycle, but I would say we're certainly moving in the direction of getting to the tail end of that, and it will not be -- it will be some ongoing maintenance that we do, but it will not be something we'll talk about anymore.

It won't have a significant impact at some point.

It is a process that takes some time to work through.

We have to move customers from product A to product B. It's not something that we can just stop selling something, so it does take some work and there's a process attached to it.

But I would expect that that number in 2017 will be lower than it was in 2016.

And certainly by the end of 2017 it should be a non-factor.

On the first part of your question, we are executing the plan that we laid out.

I can't give you a number for how many across the transition line from preparing to grow to ready to grow in the first quarter, but we've got a lot of planning around hitting that 85% level by year end.

And at that point those businesses start to change their focus to growth, I would certainly note that it's not necessarily something where we look for an immediate ramp, but ultimately what it means is that a significant part of their organizational energy and effort, 75% plus start to go into focusing on fully leveraging their organic growth potential.

And from that we certainly expect a change in growth rate velocity inside those businesses.

And I think we've already shown that in places like food equipment and automotive that have been the furthest ones down the path.

Thanks, Scott.

Thank you.

Our next question comes from the line of David Raso from Evercore ISI.

Thank you.

I know you maintained your organic sales growth guidance in total as well as total Company sales, but maybe I missed it, but did you change your outlook at all within the business segments?

Any particular end markets be it global auto builds, construction starts; any color you can give us on changes within that keeping the total?

No, David we didn't change anything by segment.

So when we look at our internal planning, like we said automotive as well as the other segments were right on track in Q1.

So we haven't changed anything in terms of our outlook for the year by segments.

And then given the auto acquisition still hopefully going to be closed here relatively soon, but the M&A front obviously wasn't that big a deal.

I assume you're still out looking at other things.

Can you give us an update on how we should think about M&A as we move further into the year into next year?

We are still focused on working the plan, which M&A is not a big priority.

We have what we think is a terrific opportunity that we brought in in this auto business, and we're focused on getting that one closed.

We've talked about where acquisitions fit in our strategy.

We will look at things that we think can further support or reinforce the organic growth strategies of our seven segments, and there's probably two or three little bolt-ons floating around at any given time, but not a big priority.

Our big priority is continuing to move down the path of executing these initiatives internally, getting ourselves very focused on fully leveraging the organic growth potential for all the reasons I talked about earlier.

That the incremental profitability from every dollar of organic revenue growth is by far the most accretive thing we can do.

Lastly, I apologize if I missed it, but the share repo for the quarter?

What was it?

$500 million in line with the planning that we laid out.

So think of the $2 billion as $500 million per quarter is the way we've planned it out.

That's helpful.

Okay, thank you very much.

Thank you.

Our next question comes from the line of Deane Dray from RBC.

I was hoping you'd give us an update on price/cost in the quarter, and then the outlook given some of the changes for some of the raws like steel for the balance of the year?

Yes, Deane so price/cost like I said was 20 basis points for the quarter, right in line with our planning assumption, right in line with what we saw last year.

And that remains our assumption for the rest of the year.

Nothing unusual again this quarter by segment, everything is on track.

So that's the color I can give you.

Got it.

And then just to go back on the comment at the beginning regarding the emphasis on GAAP earnings; and I think I certainly applaud that.

I know from a quality of earnings standpoint that that gets recognized.

And so I was interested hearing that you're doing some of what we call quiet restructuring in welding, and you've sized that for us.

What's the payback that you're expecting on that?

And is there any other quiet restructuring going on elsewhere in the segment?

The payback is on these projects is typically less than a year.

This one is actually quite a bit better than that.

It's primarily focused on North America.

And we do disclose, the last page in the press release lays out restructuring by segment.

And you can see the most significant one was welding this quarter.

Like I said, there will be another series of restructuring here in welding in Q2, and then we will update you as we go through the year.

And how much of that is cash?

This is actually all cash.

But not significant.

I mean you look at how much cash we generate this does not -- don't think of it as having an impact on our capital allocation strategy.

Understood, thank you.

Thank you.

Our next question comes from the line of Mig Dobre from Baird.

Great, thank you, good morning.

Maybe clarification for me if you would, looking at slide 5 where you're talking about your consumer and industrial businesses on a sequential basis.

So my understanding is that the sequential numbers that you're providing are adjusted for seasonality per the footnote on the page.

I'm looking at industrial businesses being down 5%, I think last quarter they were up 4% sequentially.

So I'm trying to understand exactly what's going on in these industrial businesses.

And in welding specifically, because that appears to be the driver here.

Are things getting incrementally worse in welding, or was it simply that we had some sort of a pull forward of demand last quarter?

No, I wouldn't say there was any pull forward in demand.

I mean the reason for the sequential decline is essentially all welding.

Typically in Q1 versus Q4 like we said, we would expect our welding business to be up 3%, and it was actually down 3%.

Test and measurement, which is the other segment in here, was essentially stable from Q4 to Q1.

So it's all welding driven, Mig.

Right.

And I guess the spirit of my question was there's a sense out there that maybe things are stabilizing in some of these end markets that have been really challenged in 2015.

And in welding you've got exposure in a lot of them.

What's your read through based on the way your business is progressing?

Well I think, as Scott said earlier, other than welding everything is favorable and feels pretty firm as we start the year here.

In welding we continue to see the impact from energy, oil and gas, which accounts for the decline on the international side.

General fabrication is still challenged, especially going into mining, agriculture, heavy equipment.

So the demand environment in terms of capital equipment going into the industrial economy, we would describe as still sluggish.

And as Scott said, we have not seen any sign yet that -- of improvement at this point.

The last thing is when you're talking about volumes maybe being stable to slightly up in welding in the back half, I'm trying to understand how you think about this business sequentially, seasonally adjusted.

That's purely a comparison.

Current run rate.

So current run rates, if you run those out and you look at on a year-over-year basis, that's when you get 9% decline organic in Q1, you'll get another decline in Q2, and then stable to up in the second half, a bit flat to up in the back half of the year.

At current run rates; that can obviously change, but at current run rates given the comparisons year over year that's what we would expect to see.

Okay, thank you.

Thank you.

Our next question comes from the line of Joel Tiss from BMO.

Alright, thank you very much.

I just wondered if we can dig a little bit more into the food business.

Can you give us any color on the different end markets and what some of the drivers in the improvement were and what the outlook is going for the next couple of quarters?

Yes, Joel, we feel very good about the first quarter, particularly if you look at North America, up 5% on the equipment side, up 4% service.

From a product line standpoint, refrigeration and cooking are the big drivers this quarter.

And then by end market it's really healthcare and lodging continued to be solid for us.

But really across the board we feel very good about the outlook for the year.

We have a number of new products coming in here in Q2, and so we would expect that business to be up similar to last year in that 3% to 4% range as we talked about on the last call.

Okay, can we do the same thing for polymers and fluids?

There's so many different end markets and different pieces, can you just give us a little deeper color there too?

Thank you.

Yes, what I would offer on polymers and fluids is it's basically an MRO business, two-thirds of it, the other one-third is the automotive aftermarket piece.

The automotive aftermarket side of it had a pretty solid quarter, up 2%.

I think largely how I would characterize the overall growth performance during the quarter is they've gotten to the end of a pretty extensive PLS process and are starting to now -- the pipeline is much more stable than its been over the last eight quarters, and they are starting to now turn their attention more to growth.

And so very pleased to see positive overall organic out of that segment in the quarter.

Thank you very much.

Thank you.

Our next question comes from the line of Andy Casey from Wells Fargo.

Thanks a lot; good morning.

Kind of a detail question to start.

On the 50-basis point drag in components of margin that you call out on slide 7, you mentioned overhead inflation.

Could you provide a little bit more detail on what's driving that inflation?

Salary increases.

Good for you guys.

Then on the follow up, if we look at some of the macro data the inventory-to-sales ratios are relatively high in the US in some areas.

Have you seen any change in customer inventory actions, meaning destock/restock, or is it just pretty consistent based on your commentary about overall trends outside of welding?

I'd say very consistent.

Andy, you're seeing a little bit of seasonality in Q1, but if you look at the first quarter relative to the first quarter last year, really solid working capital performance and nothing unusual.

And just look at the free cash flow number, 90% the average is about -- the last few years has been 65%.

So really strong cash flow performance again in the first quarter.

And keep in mind that we typically ramp up from here.

So from a conversion standpoint, this is typically our lowest quarter and then we will go up sequentially as we go through the year; just typical seasonality.

So nothing unusual in terms of working capital; continued strong performance.

Okay, thank you very much.

Thank you.

Our next question comes from the line of Stephen Volkmann from Jefferies.

Hi, good morning.

Scott, I think you mentioned that the best return that you could come up with, I'm paraphrasing here, was basically incremental margin on organic growth.

And I'm wondering if you've changed the way that you're thinking about that.

And it seems like in 2017 maybe we'll get a little less PLS headwind and maybe we get a little organic growth.

If we were to have a couple of points of organic growth in 2017, my numbers not yours, but how do you think about incrementals against that backdrop?

Well, what I said was that incremental profit from every dollar of incremental -- dollar of organic revenue was the highest value opportunity that we had and really what we were focused on leveraging to its full potential, not the percentage.

We've talked about incremental margin, so our target is roughly 35% going forward in terms of conversion to the bottom line from every incremental dollar of organic growth.

That will vary up or down a little bit depending on the segment.

And if anything I would expect we would comfortably do that or be even a little bit better given the elevated levels of profitability that we're now operating at.

Okay, great, that's exactly what I was looking for.

And then just on test measurement on electronics, the absolute level of margin there is still not quite in line with some of your others.

And I know there's a fair amount of acquisition-related intangibles, et cetera.

But is that an okay level in your mind for that business?

Is that just what that business can do, or is there some sort of bigger picture thing that you can do to get that more into the mid-20%s?

What I'd say is 15.5% operating margin includes, as you point out, the 420 basis points of non-cash amortization expense.

So you add that back, it's about 20%, it's still on the lower end inside of ITW.

We expect all of our businesses to continue to improve margins.

Some will do so more than others, and I would probably put test and measurement in that category of more margin potential than some of the other segments.

So we expect that segment to continue to improve on the margin side including in 2016.

As these amortization charges also bleed off over time.

Amortization charges as well as the enterprise initiatives.

Underlining operating performance improvement.

Exactly.

Great, thank you very much.

Thank you.

Our next question comes from the line of Schon Williams from BB&T Capital Markets.

Hi, good morning.

Good morning.

Wonder if we could just maybe go back to food equipment.

Certainly the margin improvement within that segment has been tremendous over the last several years.

I just wonder if you could talk a little bit about where do we go from here?

Obviously I'd expect maybe further improvement in the back half of the year seasonally speaking, but I don't know, can you just talk about what are the big picture opportunities so far for food equipment, given that you're already approaching best-in-class margins there?

Like I said, I think we expect all of our segments to improve including food equipment.

Certainly good progress, but also more to come.

And I think we'll give you -- if you look at the schedule on the back of the press release, you can see the various components.

And so the margin expansion now is half is operating leverage and the other half approximately is the enterprise initiatives.

You're talking about within food equipment.

Within food equipment specifically, yes.

We expect that to -- we would expect that business to continue to improve.

Alright, that's helpful.

And then could we just maybe come back and maybe your thoughts on some of the overseas markets?

Could you just maybe talk generally industrial versus consumer facing for Asia-Pacific?

I know that looked like sequentially it was down.

I didn't know if that was a tough comp, but just what you're seeing in Asia-Pacific, and then any green shoots in Europe as well?

We're not going to parse it much more than what we did in the prepared remarks and what you can see on page 6. And the outlook for the rest of the year in Asia-Pacific is growth rates very similar to what we saw here in Q1.

Certainly encouraged by China automotive of 6% as well as continued progress in construction products, which as you may know is primarily Australia based.

So that's how we'd described that.

And then any thoughts on Europe?

Europe for the year we expect very similar again to Q1, so up in the very low single digits based on current run rates.

Alright, thanks.

Thank you.

Our next question comes from the line of Jamie Cook from Credit Suisse.

Hi, good morning.

Two quick clarifications.

One, I think within auto you talked about in your prepared remarks being able to grow I think 2 to 4 points better than whatever the market is doing.

Just in terms of a clarification, does that include the auto acquisition or is that exclusive of the auto acquisition?

And then last, just another question on the guide.

I'm sort of struggling with how you don't get to the mid or high end given the first quarter, given FX, given commentary, industrial is very stable outside of welding.

I mean, I'm just trying to figure out what in your repo, would price costs be the biggest risk?

I'm just trying to get a sense of what you're most concerned about.

Thanks.

Well on the first question, that growth target we talked about does not include the acquisition.

That's core organic and that's our expectation both for 2016 and our longer-term growth target for the auto OEM segment.

With respect to the balance of the year, Michael talked about it before.

The currency is there is no win in trying to forecast where currency goes.

So we've always used current run rates on currency.

We use obviously at the quarterly level they move around, so we're not going to forward forecast where currency is going to be.

Michael's comment was that if everything stayed exactly where it was -- two comments that I'll repeat.

One is that we're impacted by more than just the euro; Aussie dollar, Canadian dollar also reasonably material factors as is the pound.

And then the other part of that is if everything stayed exactly where it is, I don't know if you're marking the market today, Michael, but around right now that there's probably a few pennies of upside on a full-year basis.

That's exactly right.

Who knows if that will happen.

And it may go the other -- may be a headwind.

I just wanted to get a sense more on the end market side, because again consumer is pretty good.

Outside of welding, industrial is pretty stable; do you know what I mean?

I'm just more on an end market or geography where you're most concerned.

Well, I think generally speaking we're feeling like the first quarter was pretty solid, pretty firm.

We've talked about this before.

We are basically taking current run rates and projecting those through the year, and that's how we derive our growth and earnings forecast for the year.

So if things stay where they are today, we are in pretty solid shape.

Okay.

Thank you.

Thank you.

Our next question comes from the line of Ann Duignan from JPMorgan.

Hi, good morning.

Good morning.

Most of my questions have been answered, but maybe taking Jamie's question and asking it a slightly different way.

What would have to happen for you to come in at the low end of your Q2 guidance and then the high end of your Q2 guidance?

What are you contemplating in those ranges?

Well the drivers would be a variance from current run rates, either better or worse than what we see today.

So that would be the primary driver.

I think on the things that are within our own control in terms of the so-called self-help enterprise initiatives, we feel very good about continuing to execute the way we have for the last -- since we embarked on the enterprise strategy.

So I think those are on the margin side very solid.

The delta is the demand side.

Right.

Yes, but within which segments?

When you're putting your plan together where do you think the downside risk is, where do you think the upside risk is?

I think -- here is what I'd say.

I'd say one of the real strengths of the Company, and we talked about this, is this really well balanced, diversified, high quality portfolio of businesses.

And so if certain things are better than run rates in one part of the Company, it will offset in other [pre-existing].

So I wouldn't -- I can't go down the path of by segment how we think about this.

Okay.

And maybe as a follow up then, within welding it does seem to be the one segment where maybe you're not as upbeat about where things are.

Can you just talk about a little bit about the difference you're seeing in oil and gas at this point versus -- you did talk about fabrication for mining, ag, heavy equipment.

Have any of those end markets gotten incrementally worse, or is it just they're bad and they're not getting any better?

Well, I think like we said earlier, welding did decelerate in Q1 versus Q4.

And when you look at the year-over-year decline, more than half of that organic decline is oil and gas.

So that is the main driver.

And like we said earlier, we haven't seen any signs that things are getting better there yet.

And on the industrial side?

Those are fairly stable.

The decline is primarily on the oil and gas side.

Okay, thank you.

I'll leave it there.

Thank you.

Our next question comes from the line of Steven Fisher from UBS.

Great, thanks.

Good morning.

I just want to come back to the price/cost that Deane was asking about before, because the costs have risen as the quarter has gone along.

So maybe how are the pricing discussions going at the start of Q2?

Are those adjusting in real time to more than offset the higher input costs?

How do you keep that price/cost stable?

Well, I'm not sure how I'd answer it other than what I said earlier in my prepared remarks and in response to Deane's question.

Price/cost was favorable 20 points, no change, and we expect it to remain at 20 basis points as we go through the year.

And if that changes we'll let you know on the next earnings call.

But we don't expect it to.

Basically it sounds like you're able to raise prices to offset the cost as it's increased?

If you look at our historical performance and what I just said, that would be the conclusion, yes.

And then just to summarize this, I know it's been discussed before, but does your base case assume that the industrial facing businesses exit the year neutral or positive?

Or will it still be declining?

Well the base cases take the order rates we are getting today on a daily basis and project them through the end of the year.

The comps get easier, as Michael said, but we are projecting no acceleration or further deceleration from here.

And we've talked about that before, we are a fast reactor.

We're not a predictor of the future.

So embedded in both our organic numbers and our EPS forecast is an assumption that demand stays exactly where it is today across all seven segments projected out through the rest of the year.

So will the comps get you to neutral in industrial facing by exiting the year then?

Maybe.

Close.

Okay, thank you.

Great.

And that takes us to the top of the hour.

We appreciate everybody's time this morning, and have an outstanding day.

Thank you, speakers.

And that concludes today's call.

Thank you all for joining.

You may now disconnect.