Illinois Tool Works Inc (ITW) 2017 Q4 法說會逐字稿

Welcome, and thank you for standing by.

(Operator Instructions) This call is also being recorded.

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

May I introduce your speaker for today, Michael Larsen, Senior Vice President and Chief Financial Officer.

Please go ahead, sir.

Thank you, Dale.

Good morning, and welcome to ITW's Fourth Quarter and Full Year 2017 Conference Call.

I am Michael Larsen, ITW's Senior Vice President and CFO, and joining me this morning is our Chairman and CEO, Scott Santi.

I'm also joined by Karen Fletcher, our new Head of Investor Relations.

Many of you may know Karen from her 5 years as Head of Investor Relations at DuPont.

So welcome, Karen.

Thank you.

During today's call, we will discuss our fourth quarter and full year 2017 financial results and update you on our 2018 earnings forecast.

Before we get to the results, let me remind you that this presentation contains our financial forecasts for the first quarter and full year 2018 as well as other forward-looking statements identified on this slide.

We refer you to the company's 2016 Form 10-K for more detail about important risks that could cause actual results to differ materially from our own expectations.

Also, this presentation uses certain non-GAAP measures.

A reconciliation of those measures to the most comparable GAAP measures is contained in the press release.

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

Thanks, Michael, and good morning, everyone.

The fourth quarter closed out another year of record performance and strong execution by the ITW team.

Excluding onetime tax and legal items, 2017 earnings per share of $6.59 was up 16% versus 2016 and we achieved record performance on all of our key operating metrics.

Operating income of $3.4 billion was up 11%, operating margin of 23.7% was up 120 basis points and after-tax return on invested capital of 24.4% was up 230 basis points.

In addition, we returned more than $1.9 billion of capital to our shareholders through dividends and share repurchases.

We also continued to make meaningful progress on our focused efforts to accelerate organic growth.

Our 2017 organic growth rate of 3% was up almost 2 full percentage points versus 2016 and, in addition, our Q4 organic growth rate of 4% gives us good momentum heading into 2018.

Overall, these results demonstrate that we are continuing to make progress in our efforts to position ITW to generate consistent differentiated performance on a sustained basis.

Through the combination of ITW's high-quality business portfolio and our continued focus on leveraging ITW's powerful business model to full potential, we are well-positioned to continue to deliver strong results in 2018 and beyond.

In closing, let me say we owe a huge debt of gratitude to our ITW colleagues around the world for their commitment to executing our strategy and serving our customers with excellence each and every day.

They are responsible for ITW's strong performance and give us great confidence in our ability to continue to deliver sustained top-tier performance as we go forward.

With that, I'll turn the call back over to Michael, who will provide you with more detail regarding our Q4 and full year 2017 performance and on our updated 2018 forecasts.

Back to you, Michael.

All right.

Thank you, Scott.

So starting on Slide 3. Before I get to the details regarding our 2017 performance and 2018 forecast, I wanted to spend a few minutes clarifying the impact of the new tax legislation on our reported Q4 and full year 2017 results.

This schedule walks you through the impact of the onetime Q4 tax charge associated with the Tax Cuts and Jobs Act.

And then, I'll talk about the tax rate and capital flexibility benefits that we'll accrue in 2018 and beyond.

As you can see, we recorded a onetime tax charge of $658 million or the equivalent of $1.92 of EPS in the fourth quarter, reducing EPS from $1.70 to a GAAP EPS loss of $0.22.

I should point out that this charge is our best estimate based on all the information available to us today.

The charge has 2 primary elements: One, a $729 million charge for the estimated repatriation taxes; and 2, a net benefit of $71 million resulting from the revaluation of ITW's deferred taxes.

We are in the process of analyzing the implications of the new tax law from a capital structure and capital allocation standpoint.

Given both the magnitude of the changes involved and that we expect further clarification with regard to the application of certain provisions of the legislation, we're not far enough along our analysis to make any strategic decisions with regard to how we will deploy our existing overseas cash or to make a determination as to whether it will cause us to alter our capital structure or capital allocation framework.

That said, we have begun implementing plans to repatriate approximately $2 billion of surplus capital to the U.S. by year-end 2018 and we have decided to accelerate our previously announced plan to increase ITW's dividend payout ratio.

Subject to formal board approval, we now expect to increase our dividend payout ratio from 43% to approximately 50% of free cash flow on a run rate basis in August of this year versus by 2020 as previously communicated.

With regard to the impact of the new tax legislation on our tax rate, we estimate that our tax rate for 2018 will be in the range of 25% to 26%.

As you may recall, we used a tax rate of 29% when we issued guidance in December.

Our updated guidance today incorporates the benefit of the lower rate, which has a favorable EPS impact of $0.35 or 5%.

We'll provide additional detail and analysis of the onetime charge in our 10-K.

Moving on to Slide 4. We've also included a schedule for the full year 2017 that separates out the onetime impact of the tax legislation that I just talked about and a previously disclosed legal item from the underlying operating performance of ITW.

You can see our full year results with 5% revenue growth, 11% operating income growth, 120 basis points of margin expansion and 16% EPS growth.

I'll cover those results in more detail in a few slides.

So with the impact of these nonrecurring items clearly identified upfront, when I discuss our financial results for Q4 and full year 2017 on the following slides, the results presented and my commentary will exclude the impact of these 2 onetime items and focus on the operating performance of the company.

So on Slide 5, our Q4 performance ex the tax charge, we grew EPS by 17% year-over-year to $1.70, exceeding the $1.60 midpoint of our prior guidance, with $0.04 contribution from operations and $0.06 from a lower tax rate.

You may recall that in Q4 last year, we recorded a net EPS benefit of $0.06 from a dividend payment offset by several small divestitures.

If you adjust for these items, our Q4 EPS growth on an apples-to-apples basis was 22%.

Total revenue was $3.6 billion, an increase of 7% with organic growth of 4%, led by Test & Measurement and Electronics up 9%, Welding up 6% and Specialty Products up 5%.

All major geographies are positive: 4% growth in North America, 3% growth in Europe and 5% growth in Asia Pacific, including 7% in China.

We improved operating margin by 160 basis points to 23.4% with Enterprise Initiatives contributing 140 basis points.

Free cash flow of $617 million was 106% of adjusted net income.

So overall, another strong high-quality quarter to wrap up 2017 as the ITW team continues to execute.

On Slide 6, you can see the drivers of our operating margin performance this quarter, which was once again driven by strong execution on Enterprise Initiatives.

They continue to be the main driver of our operating margin expansion and contributed 140 basis points in the quarter, which is the highest level since we launched our enterprise strategy 5 years ago.

Good momentum and a solid backlog of opportunities in both our Strategic Sourcing and 80/20 reapplication initiatives have us well set up for another 100 basis points of margin expansion in 2018 independent of volume.

Volume leverage was 90 basis points and, as expected, price/cost was slightly unfavorable this quarter at 50 basis points.

As you may recall in our guidance for 2018, we are assuming 30 to 40 basis points of headwind from price/cost.

Overall, operating margin of 23.4% was an increase of 160 basis points and a new Q4 record for the company.

On Slide 7, you can see the meaningful progress on our focused efforts to accelerate organic growth across the segments.

Our Q4 '17 organic growth rate of 4% was up 2 percentage points year-over-year.

And when you look at the detail by segment, you can see the strength of ITW's diversified high-quality business portfolio.

Some of our faster growers last year, like Automotive OEM and Food Equipment, may have slowed in the near term due to market conditions, but others, like Test & Measurement, Electronics and Welding, have accelerated and net, we're growing at 2x last year's rate.

In addition, when you look at the operating margins, you notice 2 things: One, everyone improved year-over-year; and 2, there are no weak links across our diversified portfolio.

Let's go a little deeper by segment, starting with Automotive OEM where we had another strong quarter with overall organic growth of 3% in a flat market with above-market growth in all geographies as we continue to increase our content per vehicle.

In North America, organic growth was down 2%, better than auto builds, which were down 4% overall and down 7% with the Detroit 3. Growth in the international side was very strong with Europe up 7% and China was up 14%.

As you know, the growth on a quarterly basis can bounce around a bit so we added the full year organic growth and build numbers to the page.

In North America, we managed to hold revenue to down 1% for the year, but overall builds were down 4%.

In Europe and China, our growth of 8% and 17% significantly outpaced builds of 3% and 2%, respectively.

Operating margin improved despite the previously discussed price/cost headwinds.

In terms of 2018, the most recent IHS forecast has auto builds up 1% to 2%.

And we have essentially locked in content growth for 2018 that gets the Automotive OEM segment to organic growth of 4% to 5% for the year at these build levels.

Food Equipment organic revenue this quarter was flat overall with North America down 1% in a soft market and against the comparison of up 4% last year as institutional sales were down 8% against the tough 2016 comparison of plus 23%.

Retail was also down 5%.

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

And operating margin improved 110 basis points to 25.8%.

Very strong quarter for Test & Measurement and Electronics.

Organic revenue grew 9% as Test & Measurement grew by 13%.

In Instron, where demand is tied closely to the business investment cycle, organic growth was up 8% and Electronics was up 4%.

Progress in operating margin performance was also very strong at 23.4%, an improvement of 330 basis points, driven by Enterprise Initiatives and volume leverage.

As a reminder, the 23.4% includes 280 basis points of noncash expense associated with amortizing acquisition-related intangible assets.

Also on Slide 9, strong momentum in Welding continues with organic growth of 6% in Q4.

By geography, North America was up 10%.

Our industrial equipment business, which sells primarily into manufacturing, including automotive and heavy equipment, was up 15% in the quarter; while our commercial equipment business, which sells through distribution to construction, light fabrication and farm and ranch customers, was up a solid 5% year-on-year.

Overall, equipment was up 13% and consumables were down 2%.

International was down 10% due primarily to oil and gas.

And please keep in mind that international only represents approximately 20% of our Welding segment.

On the margin front, operating margin improved this quarter by 200 basis points to 26.4%.

Polymers & Fluids with positive organic revenue growth of 3% as Fluids grew by 5% and Automotive Aftermarket and Polymers both grew 2%.

As a reminder here, the 19.9% operating margin includes 400 basis points of noncash expense associated with amortizing acquisition-related intangible assets.

Construction Products grew 4% organically.

North America was up 2% with residential remodel up 2% and commercial down 1%.

International was strong with Europe up 5% and Asia Pacific was up 4%.

Operating margin performance was solid at 23.4%, which represents 200 basis points improvement year-over-year, primarily due to Enterprise Initiatives.

Finally, in Specialty Products, organic revenue was up 5% with notable strength on the equipment side.

And by geography, North America was up 4% and international was up 6%.

As Scott mentioned, as you can see on Slide 11, 2017 was a record year for ITW.

We achieved 16% EPS growth, increased revenue 5% to $14.3 billion and continued to make meaningful progress with 3% organic growth and positive organic growth in all 7 segments and all major geographies.

The key performance metrics are all new all-time records, including 23.7% operating margin and after-tax ROIC of 24.4%.

Free cash flow was $2.2 billion, an increase of 9%.

In terms of capital allocation in 2017, we invested almost $600 million in our businesses for growth and productivity, increased ITW's dividend 20% and returned more than $1.9 billion to shareholders through dividends and share repurchases.

Turning to Slide 12, you can see our record operating margin performance with 120 basis points of improvement year-on-year and record operating margin of 23.7%, excluding the legal item.

We listed the key drivers here, including Enterprise Initiatives, up 120 basis points; volume, 70 basis points; price/cost, down 40 basis points as expected but positive on a dollar basis.

EF&C was slightly dilutive and the legal item added 70 basis points for a total reported margin expansion of 190 basis points.

Turning to Slide 13, as many of you know, we've done a lot of work over the past 5 years to position ITW to consistently deliver solid high-quality growth.

We've made some good progress in this regard as 2017 marked the third year in a row of meaningful improvement in our organic growth rate.

As you can see, slightly negative organic growth in 2015 with a lot of PLS activity.

Turning positive 1% in 2016, 3% in 2017, and based on this positive momentum and our current run rates, we expect to make meaningful progress again in 2018 with a growth rate in the 3% to 4% range.

Let's turn to our updated guidance on Slide 14.

Relative to our December meeting, we raised our full year GAAP EPS guidance at the midpoint by $0.40 or 6% to a new range of $7.45 to $7.65, which represents 15% year-on-year earnings growth at the $7.55 midpoint.

The $0.40 increase is essentially $0.35 benefit from our estimated lower tax rate of 25% to 26% and $0.05 from current foreign exchange rates.

For 2018, we expect organic growth of 3% to 4% based on current run rates and operating margin of 25% to 25.5% with another 100 basis points of structural margin improvement from our Enterprise Initiatives.

Free cash flow conversion is expected to exceed 100% of net income and we've allocated $1 billion of surplus capital to share repurchases.

As we mentioned earlier, we plan to increase the dividend payout ratio to a run rate of 50% of free cash flow, subject to formal board approval in August.

For the first quarter, our GAAP EPS guidance is $1.80 to $1.90, which represents 20% earnings growth year-over-year at the midpoint, with organic growth of 3% to 4%, in line with current levels of demand.

As per usual, our guidance is based on current foreign exchange rates and we are estimating a 24.5% to 25.5% tax rate for Q1.

So with that, we'll now open the call to your questions.

And Dale, if you could please open the line for the Q&A session of the call.

(Operator Instructions) Speakers, we do have our first question in queue.

This one comes from Andrew Kaplowitz of Citi.

So Scott or Mike, you didn't change your organic growth guidance for '18, 3% to 4%, and we know it's early in the year.

We know your forecast to current run rates, but you didn't beat your own organic growth forecast in 4Q with 3.7% and it does seem like many of your businesses are accelerating, Welding, Test & Measurement.

So why wouldn't you deliver at least toward the higher end of your organic growth if current economic conditions hold?

Essentially, I think you've pegged it pretty well, Andy.

The guidance we gave in December was based on activity we're already seeing in the fourth quarter.

As you run rate it out, we're still -- we think 3% to 4% is the right number.

Certainly, would acknowledge the fact that there is some momentum building.

It is only January so to the extent things continued on the path they're on from the standpoint of the macro environment, I think the possibility is good that we would certainly be in the high end of that range.

But from where we sit today, while things are incrementally better, the forecast that we gave you in December was based on what we already knew was hit going on in the fourth quarter.

Got it.

And then, I have to ask you guys about price versus cost obviously in the sense that margin improvement of 40 was still very strong, but maybe slightly light of your forecast given the 50 basis points of price versus cost.

You mentioned that you still expect 30 to 40 for '18.

What are the chances that the headwind from price versus cost gets a little worse before it gets better?

And, again, you mentioned you're still covering it dollar-wise.

So how concerned are you about sort of the range you gave out on margins given relatively high raw material costs?

So Andy, I mean, we're closely watching this and there certainly is some inflation that is being addressed in our business units, but I think we have it well covered in our current guidance.

So as you point out, our strategy in '17, and it will be the same in '18, is to offset any material cost inflation dollar for dollar with price.

And we've been able to do that successfully at the enterprise level.

We have assumed for 2018 that we will see a similar impact from a margin standpoint of 30 to 40 basis points.

As we talked about in December in New York, to be hopefully somewhat conservative, we baked in some EPS headwind as well on the price/cost side.

So certainly not complacent, taking action, getting price in all of our businesses with Automotive being the one that's a little more challenging just given how the -- that industry is structured, but overall, feel good about price/cost going into '18.

What I would just add to that real quick is I think the reality is, as you know, that this affects percentages, but I think we're very comfortable with our ability to recover dollar for dollar.

So from the standpoint of actual EPS risk in 2018, we're very comfortable that this is not going to be a significant factor as we sit here today.

Our next question in queue comes from John Inch of Deutsche Bank.

So cash flow in '17 on the conversion side, a little lighter.

Your guide has it above 100%.

What were the dynamics?

And then, did that have anything to do, Michael or Scott, with kind of the $600 million of investment spending?

And I forgot what you said the investment spending is going to be for '18, but maybe you could add a little more color there.

Yes, that's actually not the main driver, John.

I mean, our investment was up slightly and that's really -- if you look at our CapEx and our R&D spend, it's typically in that 2% of sales range for CapEx and 1.6%, 1.7% for R&D.

And so our sales grow, those investments will grow.

Operationally, we delivered 100%.

There are 2 things going on in the full year number: One is the decision that we made last year to fully fund our pension plans.

We talked about that contribution.

I think it was in the second quarter last year.

On top of our regular contribution, the total is about $150 million.

And our pension plans are now fully funded to the point where we've stress tested them in another '08, '09 type scenario.

We are not going to be in a position where we are underfunded on the pension side.

And the other piece that gets you to the 100% free cash flow is just the timing of some cash tax payment in '17 versus '16.

So operationally, we did 100%.

Now, if you're really picky, if you look at Q4, we did see a slight increase in working capital and that's just to support the higher demand and the increase in backlog that we're seeing in some of our businesses.

Which frankly you would have expected.

So I think that's -- I think that makes sense.

If there's any of the businesses that potentially seem like they maybe could do a bit better, it's Food Equipment.

And there's really no evidence of that in the fourth quarter print.

And your guide, kind of around 1%, doesn't anticipate much.

Maybe you could just explain to us what could be the variables that could actually drive that business higher?

Because obviously, the U.S. economy seems to be accelerating.

And is -- Food Equipment, does it typically historically roll higher or could it all of a sudden start to surprise higher?

I mean, what are the dynamics in that segment that we should be watching for in 2018?

I think our current view is that in the first half of the year, we don't expect much improvement in market conditions in North America.

There's some optimism as it relates to the second half.

We are modeling at current run rates.

We should end up at 2% to 3% for the year, but it continues to be a fairly challenging environment as we've talked about for several quarters now in North America.

That's fine.

Just last, Michael, on tax.

One, is the 2018 effective rate, the 25%, 26%, is that sustainable?

Is that kind of a number that sustains, barring any other changes that are unforeseen, meaning you fast forward a few years, it should still be 25% to 26% unless something is changed?

And then, just on that point, I think at the December 1 meeting, you had -- again, informally, it wasn't guidance.

You said mainly the rate drives into the lower 20s.

And I think if there's anything that seems to be a pattern, it's that effective tax rate on the part of the companies are coming in higher than people had otherwise perhaps anticipated informally.

So I'm just curious if you could comment on sort of both fronts.

Is the rate higher and why is it higher?

And then, is it sustainable or does it tick higher or lower do you think over time?

Yes.

It's a good question, John.

So to answer your first question, we do expect that this is a year 1 rate of 25% to 26%.

And as we get ourselves organized here, we could potentially see that go lower from here.

The rate is slightly higher not just for us, but I think you've seen that for others as well than maybe we had expected.

One, the rate -- the federal rate went to 21%, not to 20%.

And the other piece is that there are some, we believe, somewhat unintended consequences in this Act associated with a foreign -- a tax -- a U.S. tax on foreign earnings and the so-called GILTI tax.

And the way the math works on that, that's about 2 points of headwind to the overall rate.

Now, that could get further clarified and maybe there is a workaround, but as the math works today, we're sitting at 25% to 26% and maybe a little bit better on a go-forward basis.

Meaning if you hadn't had U.S. tax reform, you were working various angles legitimately to bring your tax rate down.

Does U.S. tax reform kind of bump it lower and then you're still on that trajectory?

Or does it actually -- with GILTI, essentially, does it kind of plug that?

I guess, that's kind of also what I was trying to understand.

No, I think the current rate reflects our current planning, but obviously, as these new rules -- and they are new.

We're talking 30 days here.

As we analyze and interpret those and tie it back to the comments we made around our capital structure, I mean, there's some far-reaching implications here.

As we work through that and get our planning organized, I think that's what we believe will give us room to lower the rate on a go-forward basis.

Our next question comes from Joe Ritchie of Goldman Sachs.

Welcome, Karen.

So my first question, I guess, Michael, maybe talking about capital deployment for a second.

So clearly, nice to see the dividend payout ratio go up and the share repurchases, you can easily fund out of your free cash flow.

So given that you guys are repatriating $2 billion, I'd be curious to hear if you have any initial thoughts on how you're going to allocate that capital.

I think, Joe, I'll go back to what I said earlier is that we're still analyzing all the implications of the new tax law from a capital structure and capital allocation standpoint.

As you know, these are pretty significant changes.

Some of the rules are not entirely clear yet in terms of their application and we expect to receive further guidance.

And we simply haven't had enough time to really work through this in a deliberate and thoughtful way as a management team and with our board.

So we're not at a point today where we can really make any strategic decisions on how we'll deploy that overseas cash this year and also in future years as it now is available to us here.

And what that exactly means from a -- either from a capital structure or capital allocation framework.

So what we can tell you is that we're working to get the $2 billion back by year-end.

We don't have the money as we sit here today.

And we have made the decision to accelerate the dividend payout ratio as we talked about earlier.

And that's really as far as we can go as we sit here today.

And we'll keep you posted as we work through this.

And so if we have more information here when we report Q1, we'll give you an update.

Okay.

That's helpful, Michael.

And maybe my follow-on question and just kind of thinking about the end-market trends.

Clearly, you guys ended 2017 with a lot of momentum, particularly within the -- within your industrial businesses.

So I'd be curious to hear your thoughts around, given this effect of the tax change, some thoughts around CapEx potentially reaccelerating here in the U.S. How are you thinking about the industrial businesses particularly and what the growth trajectory for those businesses should look like?

And I know you've given guidance on a segment basis, but I'm wondering if you're expecting to see an uptick from further CapEx investing across the U.S.

Well, I think we're certainly hopeful and the early indications are that we were seeing some acceleration in business investment already.

I mean, prior to passage, our Q4 rates, one of the big deltas was clearly some really meaningful acceleration in demand trends in Welding, Test & Measurement and the capital bits -- components of our Specialty segment.

And certainly, Joe, to your point, I think this new tax legislation has great potential to add some further momentum and stimulation to the economy overall and, in particular, to business investment.

So I think the raw material, in terms of some sustained recovery, if you will, and business investment, particularly in the U.S. is certainly there, but as is our habit, we'll wait to see it before we plan on it.

Got it.

And if I could maybe just add one more, Scott.

I noticed that your Welding business on the international side was down double digits.

Maybe just a little bit more color on what's happening within that market?

Yes.

I suppose it's -- they are -- mostly, it's a relatively small part of the overall business, as Michael said, and our position there is heavily weighted towards oil and gas.

So it's nothing more than that.

It certainly should, to the extent it is turning any direction, I'd say we're certainly bottoming out there, but I don't think we're a particularly good proxy for the overall welding market internationally given the narrowness of our position there.

Speakers, our next question comes from David Raso from Evercore ISI.

I was curious, the organic sales guide for the year.

What's the cadence?

That 1Q is 3% to 4%, full year's 3% to 4%.

What would be the cadence?

Yes.

It's actually, if you look at it at current run rates, the 3% to 4%, and I'm not giving guidance for Q2 or Q3, but it's in that range.

And then, probably a little bit lower than that in the fourth quarter just on -- from a comp standpoint.

So even though the comps get a little easier 2Q and 3Q, just think of it as sort of 3% to 4%?

Yes, maybe at the higher end of the range, but in that 3% to 4% range based on run rates as we sit here today.

And the inventory being flat sequentially, it's usually down 6% or so 3Q to 4Q.

Where was the inventory in particular held a little higher, anticipating superior growth historically?

It was pretty broad-based.

So I think, as you'd expect, the ones with the highest acceleration in Q4 that we just talked about had a little bit more, but overall, there's some pretty good momentum across the portfolio here.

And these are -- just to add on to that, the way that gets managed internally with 80/20 is that's sort of an automatic reaction, that's not a forward forecast.

So just as Michael said, it's -- it happens because demand dictates, not because we're making our own bet down where things are headed.

So there's nothing really anticipatory about it.

It's simply the way it works?

No.

No, I mean, we don't -- as you know, most of our businesses are we get the order today, we ship tomorrow, we replenish the inventory the following day.

And as demand picks up, we build more inventory again.

So that's really what you're seeing.

So I think it's nothing to be alarmed about.

Our next question comes from Ann Duignan of JP Morgan.

I'd like to ask a tax question in kind of a different way.

I mean, there are a lot of changes, as you know, the accelerated depreciation on new and used equipment, the elimination of Section 1031.

As you sit there running a broad base of businesses, do you expect any changes in purchasing behavior by any of your customers?

I mean, I'm thinking Food Equipment, Automotive, Welding.

Any changes that you're contemplating in the way people buy your products because of tax changes?

I think I'd tie it back to what Scott said earlier.

It's really on the business investment side where these new accelerated depreciation rules have probably created some positive stimulus and so that would be primarily Test & Measurement, Welding as well as portions of Specialty.

So I think it's hard to tie it back to what specific was tax-related, but I think it's part of an overall improving momentum in those businesses.

Okay.

I appreciate the color.

And then, on the flip side, a lot of talk about NAFTA and it does seem to be all about automotive and content and where it's built.

If NAFTA were to be eliminated even for a short term, can you talk about what impact it might have or could have on your Automotive business?

Ann, overall, what I can tell you is we produce close to where our customers produce in that space.

So to the extent this impacts where they choose to produce vehicles on which we have content, then we are -- over time, we would certainly follow those moves.

We are well-positioned.

In fact, one of the strengths of our position is our ability to provide copies of that product all over the world.

So it's certainly something that is well in our capacity to react to.

I can't really speak as much in terms of overall demand impact for our customers in the short run, but I think in terms of does it create any long-term structural issues for us, I can't really think of any sitting here today.

Our next question comes from Andy Casey of Wells Fargo Securities.

I was wondering if we could go back to Test & Measurement and Electronics.

Could you give a little bit more color on what happened in the fourth quarter?

The organic growth rate moved up pretty substantially and part of it seems to be comps, but is there anything else going on there?

Well, I think it was pretty broad-based really on the Test & Measurement side.

And part of what we're seeing is some strength in the businesses that are tied to the semiconductor end market.

But also, like I said -- we pointed out, Instron up 8%, which we believe, again, is driven by CapEx, increased demand for CapEx.

So those are the 2 dynamics in Test & Measurement.

We could say it looks pretty for the year.

In December, we said 4% to 5% so kind of mid-single-digit type growth for Test & Measurement and Electronics.

And as we sit here today, that's supported by the current run rate and the backlog in that business.

Okay, Michael.

And then, if I look at the components of the 2018 guide and then look at the bottom line, I'm just trying to reconcile, are you expecting any significant change in below the line items, interest expense or other income?

So I think that kind of from a modeling standpoint on the interest expense, it will probably be a little bit higher not because of an assumption around increased debt, but it's really some of the euro-denominated debt at current currency rates.

So I think that's a $10 million, $15 million increase, if I remember correctly, on the interest expense side.

Most everything -- depreciation might be up a little bit as a result of the increased investment that we talked about to support the growth this year.

The intangibles would typically go down $10 million to $15 million so probably a similar trajectory for '18.

And then, the other thing that's a little unusual is the unallocated line this year because of the legal item is actually showing a positive number.

If you take the Q4 number, which is the $20 million or so and run rate that out, so about $80 million for the year, I think that gives you kind of the key pieces that you need to put this together for '18.

Our next question comes from Jamie Cook of Crédit Suisse.

Since Jamie is not responding, shall we go to the next question?

Yes.

Let me go back to Jamie if she is still there.

Next question comes from Joel Tiss of BMO.

I just wondered if you repatriate some capital and it comes back kind of chunkier, do you think the share repurchases would flow with that?

Or are they going to be more systematic as we go through the year?

Yes.

What I can tell you, Joel, is we have $1 billion in the plan, which is consistent with what we said in December.

And from a planning standpoint, that's $250 million a quarter.

And as I said earlier, we can't really comment on the plans for the additional surplus capital, the $2 billion or so in terms of the timing.

It will come back by year-end, but we're still working through the exact timing.

And then, what that means from a capital allocation or capital structure standpoint, it's a little too early to comment on that.

And then, the same sort of question on acquisitions.

Would this kind of accelerate your thinking on making bigger acquisitions or the same thing, that's more of an opportunistic exercise and the capital flows wouldn't have any impact?

Yes.

This doesn't have any impact on our thinking around acquisitions.

Our next question in queue is from Mig Dobre of Baird.

I want to ask that acquisition question maybe a little bit differently.

Based on what you know thus far from tax reform, are you changing your thinking on M&A at all, meaning the way you're thinking about tax shields, the way you're thinking about the cost of capital, whether or not U.S. acquisitions versus international ones are more or less attractive, really anything different in the wake of this legislation?

The simple answer is, at this point, no.

Okay.

Then, maybe I'll ask a pricing question.

You talked about Automotive may be struggling a little bit, but I'm wondering do you have any segments in which pricing is perhaps stronger than you anticipated at -- when you issued your original guidance at the Analyst Day?

No.

I think we're -- the general framework is -- really goes back to how we structured the portfolio from a price/cost standpoint.

So we are operating in spaces and our products are not commodities.

They -- their performance matters to the customer so we expect, given that any changes in input costs over some reasonable period of time, that those changes in input costs will get reflected in the prices we charge our customers.

That's just being fair, but we are certainly much more into towards how do we grow this high-quality portfolio.

And so from the standpoint of overall how we manage this, we're just trying to cover the costs and really remain focused on leveraging the portfolio to continue to accelerate organic growth.

I appreciate that.

I guess, I was just wondering on some of your businesses that are clearly showing real volume inflection if it's fair to think that those are the ones that are getting the best price at this point.

I'm sorry.

You broke up on the last part, Mig.

What I'm trying to get at is some of your businesses were clearly seeing a volume inflection.

I'm wondering if it's fair to assume that these are also the ones that are currently getting the best price out there.

I don't know how to...

Yes.

I think, Mig, for us, it's really -- for us, price/cost is a function of just wanting to recover the inflation that we're seeing over time.

And there's typically a little bit of lag as you saw last year, but we're not trying to get greedy here and charge more in a business than we normally would.

So it doesn't really impact our thinking.

Next question in queue is from Steven Fisher of UBS.

Just coming back to tax reform and CapEx.

I know you said you're still determining your overall capital allocation plans.

I'm not sure if that includes CapEx.

And you did say that CapEx is a function of sales.

But, I guess, to what extent do you have more motivation to increase your own CapEx as a result of tax changes?

And if you did, what would be the types of things that you would invest in?

Would it be automation, more capacity in general, relocating capacities?

Any thoughts there?

Yes.

So I think, Steve, the answer is if you just look at our strong cash flow that we're already generating and have been for many years, we're already fully invested in our businesses and in our strategy before the passage of this tax legislation.

So there's nothing that we would do or could do now that we didn't do before that would be accretive or add to our performance or ability to execute on our strategy.

So at this point, we're modeling and we've penciled in 2% of sales on CapEx.

So we talked a lot about that in December and how we think about these internal investments.

And this -- any changes on the tax side have not -- don't have any impact here.

Okay.

And I know you were looking for flat commercial construction in 2018 back at the Investor Day.

What have you seen over the last 1.5 months that may shift that in one direction or another, if anything?

I think at this point, broadly for Construction Products, we're still in that 3% to 4% organic growth range for the year.

And commercial, we don't -- there's really no change in terms of our view on the commercial side.

Okay.

So still flat?

Yes, flattish.

Yes.

Next question in queue is from Nathan Jones of Stifel.

Michael, the $729 million repatriation charge, is that your expectation of what the cash charge will be over 8 years, so like $90 million a year?

And does that include free cash flow?

Yes.

So as you look at the overall charge, the $658 million is very close to a cash number for all intents and purposes.

So if you look at our balance sheet, you'll see a payable there, a noncurrent tax payable, that's $614 million, and then there's another $50 million or so in current payables all related to tax reform.

I should point out maybe as a point of clarification that the repatriation tax number, the $729 million, also includes any foreign withholding tax on those cash distributions.

So any taxes that are payable overseas related to the $2 billion are already accounted for in that number.

Okay.

So the $660-odd million is roughly the cash payment over 8 years that you're -- you'll get?

Yes.

Okay.

Got it.

And then, just a question, I guess it's around T&M and around the CapEx cycle here.

I mean, we've seen pretty good recovery really in short-cycle general industrial, but, I guess, one thing that's been missing in this recovery has been really any CapEx cycle.

You've got a few of your businesses here related to CapEx.

I think Instron is one that's particularly levered to that, that are showing good growth that seems to have inflected higher in the fourth quarter.

Is this something that you're expecting to continue?

Are you seeing signs, ex the impact of the tax bill here, that kind of a CapEx cycle was budding here anyway?

I think we've seen a pickup in those businesses that goes back to before the passage of the Tax Act.

So these businesses, so Test & Measurement, Welding in particular, have been pretty sluggish for a number of years.

And I think the recovery that we saw in those businesses goes back to November -- October, November of 2016.

And so if anything, maybe there's some additional stimulus here in those businesses and that would certainly be beneficial to ITW if that's the case.

Next in line is Walter Liptak of Seaport Global.

Wanted to ask about the 2017 organic growth, the 2.9% and have you guys been able to parse out how much is internal initiatives versus market growth?

It's -- I'll tell you, we do collect some data on that.

I'm not comfortable really sharing that externally.

I think it's a combination of the 2 as we said in the past.

I mean, I think clearly, what we'd point to, Walter, is just look at the progression of our overall organic growth rate with more than 1 percentage point improvement in '15 -- over '15, '16 and '17 and another meaningful improvement in the growth rate for '18.

And it's really a combination of things.

And I think only recently, last year, we've seen a little pickup from a market standpoint, but if you look at the last 3 years, we've delivered meaningful improvement really in a pretty sluggish overall, a pretty challenging macro.

So that's the best answer I can give you on that, Walter.

It's a little bit of both.

Okay.

It looks good.

In -- is the PLS in 2017, have you been able to quantify how much improvement was there?

Yes.

It was for the year -- 50 basis points for the year and 70 basis points in Q4.

Okay.

Is there any PLS headwind in 2018?

It will probably be about the same in '18.

So we're expecting another 50 basis points here really as a result of the reapplication of the -- our 80/20 reapplication initiatives across the businesses.

And you see the benefits we're accruing not just in terms of the -- from a margin standpoint, but also creating a portfolio that has significantly higher organic growth potential.

So...

Okay.

And then, in 2018, the 3% to 4%, I guess, it's probably the same as in 2017 where there's some internal, but it's hard to parse it out.

Is that right?

Yes.

It will be a combination again in -- obviously, the further along we are in the process, it would be reasonable to expect a higher contribution from the organic growth initiatives that we are executing across our businesses.

Our next question will be coming from Ross Gilardi of Bank of America Merrill Lynch.

I'm just wondering if you could talk a little bit more about that strength in the industrial welding part of your business in North America.

And are you seeing your customers continuing to ramp production?

Is there any reason to expect that, that won't accelerate further in 2018 as the year unfolds?

I think industrial up 15% is -- that's a pretty solid number.

I don't know if I would count on further acceleration from there on a sequential basis.

The comps year-over-year are going to change as we go through the year, but we feel really good about the improved demand on the industrial side.

Okay.

And then, just any color on China as it pertains to Auto?

I realize China auto in the grand scheme of your portfolio is small, but it is an important part of Auto.

And your ability to continue to generate 1,000-plus basis points of outgrowth in China auto and anything you can say about like what types of products that's coming from?

Well, it's actually not that small anymore.

I mean, these -- that team has been putting up some really strong growth rates for a long period of time.

And as I said, for the full year, the China automotive business is up 17% and up 14% here in Q4.

And when we look at the backlog in terms of further content per vehicle growth, that is a sustainable above-market growth rate.

We show no further questions in queue.

(Operator Instructions)

If not, Dale, why don't we just wrap it up here?

And I'd like to thank everybody for dialing in today.

And Karen and I are around if you want to give us a call.

Thank you.

That concludes today's conference.

Thank you for your participation.

You may now disconnect.