Illinois Tool Works Inc. (ITW) Q1 2016 Earnings Report, Transcript and Summary

Welcome and thank you all for standing by. At this time, all participants are in a listen-only mode until the question-and-answer session of today’s conference. [Operator Instructions] This call is being recorded. If you have any objections, you may disconnect at this point. Now I will turn the meeting over to your host Aaron Hoffman. Sir, you may begin.

Thanks, Evan. 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 continue 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 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 executing our strategy. Michael, over to you.

Thank you, Scoot 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 about $1.3 billion higher in this quarter. After tax ROIC was solid, fee cash flow was strong and we repurchased shares for $500 million. Just a 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 our business. As a result, in the first quarter of 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 the 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 makeup 60% of our revenues and include the automotive OEM and food equipment segments as well as portions of specialty products and construction. These businesses continue 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 now 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 was down 4% primarily due to welding. At ITW we believe that operating margin is a key indicator of our business as 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 is a key performance metric for every ITW business. In the first quarter, operating margin improved 120 basis points to 22.1% and 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-20s 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 the strong performance, and positive momentum, we are now expecting more than 100 basis points in the 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 the 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 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 over the last several quarters, this segment had a very tough comp and Q1 revenue came in right what 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 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 programs 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 the builds at Western OEMs were down slightly. As expected operating margin improved 140 basis points to 26.4% the highest in the company. The 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 benefit from 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 the 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 & Measurement and Electronics organic revenue down 2%, Test & Measurement down 3% and electronics slightly better at down 1%. Sequentially the segment was stable down 7% compared to typical seasonality of down 6%. Still a challenging external environment for our welding business and organic growth 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 declined in welding this quarter is related to restructuring and other non-operating items. Polymers & 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 of 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 are 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 into 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 question. Please be brief so to allow more people the opportunity to ask a question and please remember one question and one follow-up question.

Thank you, speakers. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of John Inch from Deutsche Bank. Your line is now open.

Thank you. Where am I from, alright? First I want 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 realized 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 driver your contribution?

Right, John. So you are 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 lined 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 headed down the path of EPS impact for the balance of the year, it is correct, but based on current rates as we sit here today not just looking at the euro, but at the other currency that we mentioned. If currency stays exactly where it is, things could turn out a little bit better. But as you know there is a lot of volatility in currency. So we have not included that in the numbers we gave you today.

Okay. But you did beat the midpoint of your guide by almost $0.05 and...

Yes and that is entirely driven by operating margins.

Right. No I see....

So the....

No, it's right. I see that. But at current rates how much of a tailwind 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 just say this, it’s a little bit better than what we had assumed and that’s as we sit here today. Let’s see where rates go from here. Like I said it could be a little bit 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 saw that everyone seems to look at and if you look at the new orders component. I mean it sort of telling you that a big recovery is on the comp. Now last year was flashing green and manufacturing was going the other way. So I think I’m just trying to get your sense, you are a real time company short cycle you are 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 in your years of experience, how do you interpret the ISM and why frankly wouldn’t you be even more positive on your outlook?

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 off, but I think 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 is, my take on the quarter is that we saw a pretty solid demands throughout. So I think things are relatively firm for right now, the one exception to that is obviously welding, we’re hopefully, we’re getting to close 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 move 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 and we had this weather compares, especially in the Midwest, it's [indiscernible] because 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 look at things of how the quarter progressed and then into April.

Yeah. 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, you know, four or five quarters now, I think we’re feeling good about where we sit in the kind of 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 was no new worry beats based on our first quarter performance that we saw across the company.

Okay. So basically signs are very stable, but no sort of obvious inflections of sequential improvement on the comp right again adjusting for seasonality.

No.

Okay, good enough. Thank you, guys. Appreciate it.

Thank you. Our next question comes from the line of Joseph Ritchie from Goldman Sachs. Your line is now open.

Thanks. Good morning, guys.

Good morning.

So I guess, my first question is on Auto, again first, solid quarter, but clearly you guys had a really, really tough comp, especially if you look on a two year stack. Is the expectations that growth starts to improve beyond the first quarter on your auto business just based on what you know on production schedules and where in the platforms that you are on?

Yeah. So I think, you know, we talked about a tough comp in the first quarter due to the new programs launched in Europe and if you 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 following question moving onto Welding so clearly the part of your portfolio there has been a little bit more challenge, you guys mentioned half of the margin performance this quarter was related to restructuring action, does that start to tail-off as we progress through the year or how were you thinking about that business? I guess clearly on the face of it when you take a look at the detrimental, detrimental margins in the first quarter are pretty high, just trying to get a sense for how that business will project for the rest of the year?

Yeah. So we had as you said about half of the impact in the first quarter here the margin decline down 9%, which is a 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 significantly 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 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 the 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, guys.

Thank you. Our next question comes from the line of Nigel Coe from Morgan Stanley. Your line is now open.

Thanks. Good morning. Just wanted to follow-up on John’s question. Hello can you hear me?

Yeah we can hear you.

So there is some chatter that the March was a bit weaker than Jan and February for industrial markets. Did you see that, doesn’t sound like you did given your comments?

We did not.

Okay, good. Moving on to construction and construction was the stand out this quarter with 5% and 11% North America. And I’m wondering is there any way to trying to understand how of this is weather driven, I’m assuming the construction activity did benefit from weather and how much has been pulled forward from maybe 2Q into Q1? And maybe just characterize that by talking about how you exit the quarter on Construction Products was it pretty steady as well?

Yeah, to answer to your 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 it normalized year. So 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. And so I think we are not seeing anything slow down or ease up and we’ll hope it continues through the balance of the year for sure.

Okay, great. And just a quick follow-on on the construction, Europe is flat and we’ve seen 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 leasing in Europe as the UK starting to slow down for Europe and I see in some green shoots in Continental Europe?

No, we are not seeing anything slowdown. We are a bit of lager in terms of when our products are actually going on to the job it’s well after the start phase. So I think in terms of color the overall sort of macro view over there from the standpoint construction is things are heading in the right direction.

Great, thanks a lot guys.

Thank you. Our next question comes from the line of Andrew Kaplowitz from Citigroup. Your line is now open.

Good morning, guys. Nice quarter.

Thank you.

Good morning.

You’re more than - you are four years into Enterprise Strategy and Q1 ‘16 appears to be your best quarter really in the last four years in terms of margin contribution from the Enterprise Strategy. So what surprising is that we would think that given tougher comparisons and given you are now obviously more than half way done with your initiatives, you are 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 are they nearly in the program or is that you are tackling more complicated areas of your business such as European Construction or Specific Products that you actually find it easier to improve efficiency?

Well, what I would probably say is that we are these were not a series of initiatives that we are all implemented simultaneously. So we are basically sequencing through. If you look at the progression that we laid out and we talked about this as early on that we were heavily focused on the portfolio, business structure simplification, sourcing we said all long 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, which we’re applying the ITW business model to be scaled up much more focused businesses and so what we are seeing today is much more now of an impact from sourcing the layer stage stuff. So it wasn’t necessarily in all at once sort of level of execution across all those initiatives they were very intentionally laid out in the sequence because we had to get certain things done that will allow us to get to the next phase things. So some of the improvement that we are seeing and is just now sourcing and 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 are starting to see some impact from incremental contribution from organic growth as we starting to make the pivot to growth. And Michael showed you a chart earlier, but if you look at that where we had the best margin performance in the quarter was in this the parts of the company that were generating 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 that you’ve talked before about 85% of your businesses is being ready to grow by the end of ‘16 from 60% I guess in the last year. So how many more businesses or even should we be thinking like this that you convert in 1Q as ready to grow. And when you do convert these are you seeing the growth progression of businesses that you expect. And you still have percentage point headwind on growth from PLS in the quarter I think you’ve thought about 90 bps for the year. How does that progression work out, does it start falling does the headwind start falling significantly just at the very end of the year or 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 we’re there is still a fair amount of that to do heading into ‘16. We won’t know what that looks like for ‘17 fully until we get into the planning cycle, but I would say we’re certainly moving in the direction of getting to the tailwind of that. And it will not be some ongoing maintenance that we do, but it will not be something we’ll talk about anymore. Won’t have a significant impact at some point. But 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 - we just start selling something. So it does take some work and there is a process attached to it. But I would expect that number in ‘17 will be lower than it was in ‘16. And certainly by the end of the ‘17 it should be a non-factor. On the first part of your question we are sort of executing the plan that we laid out. We are - I can’t give you a number for how many crossed 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 grow as I would certainly note that it’s not necessarily something where we look for an immediate ramp. But ultimately what it means is there is 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 we’ve already shown that in places like Food Equipment and Automotive that have been that furthest ones down the path.

Thanks, Scott.

Thank you. Our next question comes from the line of David Raso from Evercore ISI. Your line is now open.

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 I mean 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 and as well as the other segments we’re right on track in Q1. And so we haven’t changed anything in terms of our outlook for the year by segments.

And then given the auto acquisition is still hopefully you are going to be closed to relatively soon. But the M&A front, obviously was not bigger 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?

Yeah we are still focused on working the plan which is not - 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. There is and we’ve talked about where these - where acquisitions fitting our strategy. This is we’re going to - we'll look at things that we think can further support to reinforce the organic growth strategies of our seven segments. And there is probably two or three little bolt-on 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 then on fully leveraging the organic growth potential for other reasons I talked about earlier. With the incremental profitability from every dollar of organic revenue growth is by far the most accretive thing we can do.

Okay. And lastly I apologize if I missed it, but the share repo for the quarter what was...

$500 million in line with the planning that we lead out. So think of the $2 billion as $500 million for a 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. Your line is now open.

I was hoping you’d give us 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?

Yeah Deane so price cost like I said was 20 basis points for the quarter right in line with our planning assumptions, 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 gets recognized. And so I was interested in hearing that you’re doing somewhat we would call quite 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 quite restructuring going on elsewhere in the segments?

The payback is on this project is typically less than the 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 is Welding this quarter like I said there’ll be another series of restructuring here in Welding in Q2 and that we’ll kind of update you as we go through the year.

And how much of that is cash?

So it’s actually all cash, but not significant I mean you look at how much cash we generate this does not don’t think if it is 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. Your line is now open.

Great, thank you. Good morning. Maybe a clarification for me if you would, looking at slide number five where you’re talking about your consumer and industrial businesses on a sequential basis so my understanding is that the sequential number that you’re providing are adjusted for seasonality for 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 sort of 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 this 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%, I mean it was actually down 3%. Test & Measurement which is the other segment in here was essentially stable from Q4 to Q1. So it’s all Welding driven mix.

Right. And I guess the spirit of my question was there is a sense out there 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?

I think as Scott said earlier I think other than welding everything is stable and feels pretty firm as we start the year. In Welding we continue to see the impact on 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’ve not seen any sign yet of improvement at this point.

Okay. And then maybe…

Go ahead.

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?

Yeah Mig that’s purely a comparison current run rate. So at 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 us another decline in Q2 and then stable to up in the second half, flat to up in the back half of the year at current run-rate. 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. Your line is now open.

Alright, thank you very much. I just wondered if we can dig a little bit more into the food business. And 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 to the next couple of quarters?

Yeah so Joe we feel very good about the first quarter, particularly if you look at North America up 5% and 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 continue 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’d expect that business to be up similar to last year in the 3% to 4% range as we talked about in the last call.

Okay. Can we do the same thing for polymers and fluids? There are so many different end markets and different pieces. Can you just give us a little deeper color there too? Thank you.

Yeah what I would offer on polymers and fluids is it’s a basically an MRO business. Two thirds of it the third is the automotive aftermarket piece, the automotive aftermarket side of it they had a pretty solid quarter up 2%. I think largely how I would characterize the overall growth performance on the quarter is they’ve gotten to the end of a pretty extensive PLS process and are starting to now - the product line is much more stable than it’s been over the last eight quarters and they’re 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.

Alright, thank you very much.

Thank you. Our next question comes from the line of Andy Casey from Wells Fargo. Your line is now open.

Thanks, good morning. Kind of a detail question to start the 50 basis point drag in components on margin that you call out on slide seven. Your mentioned the 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 U.S. in some areas, have you guys 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. And you’re seeing 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 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 Steve Volkmann from Jefferies. Your line is now open.

Hi, good morning. Scott I think you mentioned that the best return that you could come up with I am 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 ‘17, my number is not yours, but what - how do you think about incrementals against that backdrop?

Well. What I said was that the 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 towards full potential not the percentage. And 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 and Electronics, the absolute levels margin there is still not quite in line with some of your others and I know there is a fair amount of acquisition related intangibles et cetera, but is that kind of an okay level in your mind for that business, is that just kind of what that business can do or is there some sort of bigger picture thing that you can do to get that sort of more into the mid-20s?

So what I would 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 continue to improve margins some will as you saw more than others and I would probably put Test & 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, exactly.

Great, thank you very much.

Thank you. Our next question comes from the line of Sean Williams from BB&T Capital Markets. Your line is now open.

Hi, good morning.

Good morning.

Wonder, if we just maybe go back to Food Equipment, certainly the margin improvements within that segment has been tremendous over last several years; I just wonder if you could talk a little bit about kind of where we’d go from here? I mean, obviously the - I’d expect maybe further improvement in the back half of the year just kind of seasonal speaking, but I don’t know can just talk about what are the kind of the big opportunities for Food Equipment given that, you’re already kind of approaching best-in-class margins there?

Like I said, I mean, 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 and 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 and within Food Equipments specifically, yes. So we’d expect that business to continue to improve.

Alright, that’s helpful. And then, could we just maybe come back and maybe your thoughts on kind of some of the overseas markets. Could you just maybe talk generally kind of industrial versus consumer facing for Asia Pacific I know that that look like sequentially it was down I know that was a tough comp, but just where you’re seeing in Asia Pacific and then any green sheets in Europe as well?

So I wouldn’t - we’re not going parse it much more than what we did in the prepared remarks and what you can see on page six. And the outlook for the rest of the year in the Asia Pacific is growth rates very similar to what we saw here in the Q1 certainly encouraged by China Automotive of 6%, as well as continued progress on the - in Construction Products, which as may know is primarily Australia based. So that’s how we would describe that.

And then any thoughts on Europe?

Europe, I think 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 guys.

Thank you. Our next question comes from the line of Jamie Cook from Credit Suisse. Your line is now open.

Hi, good morning. Just 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 the 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 industrialist very stable outside of Welding I mean what... I’m just trying to figure out what you did in your repo is what price cost be the biggest risk? I’m just trying to get a sense of what you’re most concerned about? Thanks.

On the first question that growth target we talked about is it does not include the acquisition, that’s core organic and that’s our expectation both for ‘16 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 sort of use current run rates on currency. We use obviously at the quarterly levels they move around. So there is - we are 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 are 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 stay exactly where it is and I don’t know if you marking the market today Michael but around right now that there is probably a few pennies of upside is on the full year basis. Who knows if that will happen and may go the other…

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. And I’m just more on an end market or geography where you are most concerned.

I think generally speaking we are feeling like the first quarter was pretty solid, pretty firm. We have 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’re in pretty solid shape.

Okay, thanks a lot.

Yeah.

Thank you.

Thank you. Our next question comes from the line of Ann Duignan from JPMorgan. Your line is now open.

Hi, good morning. One of my questions has been answered. But maybe taking Jaime’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?

The drivers would be of 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.

But within which segments, when you are putting your plan together where do you think the down side risk is, where do you think the up side risk is?

I think here is what I’d say, I would say one of the real strengths of the company and we talked about this is 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. And so I wouldn’t - I can’t go down the path by segment how we think about this.

Okay. And maybe as a follow-up and within welding it does seem to be the one segment where maybe you are not as upbeat about where things are, can you just talk about - a little bit about the difference we are seeing in oil and gas at this point versus you did talk about fabrication for mining and heavy equipment, have any of those end-markets gotten incrementally worse or is it just they’re bad and they aren’t getting any better?

I think like we said earlier I mean Welding did decelerate in Q1 versus Q4. And when you look at the year-over-year decline, the more than half of that organic decline is oil and gas. So that is the main driver and it 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. So…

Okay, thank you. I leave it there.

Thank you. Our next question comes from the line of Steven Fisher from UBS. Your line is now open.

Great, thanks. Good morning. I just want to come back to the price cost that Deane was asking about before, because the cost have risen as the core has gone along. So maybe how are the pricing discussions going at the start of Q2? Are those adjusting kind of in real time to more than offset the higher input cost, how do you keep that price cost stable?

Well I mean I am not sure how to answer that, other than what I said earlier in my prepared remarks and the 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 over the next earnings call. But we don’t expect it to.

And so basically it sounds like you’re able to raise prices to offset the costs as it increased.

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

Okay. And then just summarize this, I know it’s been discussed before, but does your base case assume that the industrial facing businesses exist the year neutral or positive or there will it still be declining?

Well the base case is take the order rates where you’re 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 on 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?

It may be 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.