Illinois Tool Works Inc. (ITW) Q4 2016 Earnings Report, Transcript and Summary

Welcome and thank you all for standing by. At this time, all participants will be in listen-only mode until the question-and-answer of today’s conference. [Operator Instructions] Today's conference call is being recorded. If you have any objections, you may disconnect at this time. Now I would like to introduce Mr. Michael Larsen, Senior Vice President and Chief Financial Officer. Sir you may begin.

Hi, thank you, Leon, good morning and welcome to ITW's fourth quarter and full year 2016 conference call. I am Michael Larsen, ITW’s Senior Vice President and CFO. Joining me this morning is our Chairman and CEO, Scott Santi. During today's call, we will discuss our fourth quarter and full-year 2016 financial results, update you on our 2017 earnings forecast. Before we get to the results, let me remind you that this presentation contains our financial forecast for the first quarter and full-year 2017, as well as other forward-looking statements identified on this slide. We refer you to the company's 2015 Form 10-K and third quarter 2016 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 and while we use very few non-GAAP measures, a reconciliation of the non-GAAP 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. The fourth quarter closed out a year of record financial performance and strong execution for ITW. In fact 2016 was the most profitable year in the company’s 104 year history. Earnings per share of $5.70 was up 11% versus 2015 and we achieved all time record performance in the following key operating metrics. Operating income of $3.1 billion was up 7%, operating margin of 22.5% was up 110 basis points and after-tax return on invested capital of 22.1% was up 170 basis points. We continue to generate strong free cash flow in 2016, which we utilized to reinvest in the growth and productivity of our core businesses and to acquire EF&C, a highly complementary bolt-on acquisition for our Automotive OEM segment. We also returned more than $2.8 billion of surplus capital to our shareholders through dividends and share repurchases. The end of 2016 also marked a completion of the fourth year of our enterprise strategy. We launched our current strategy in late 2012 with a goal of positioning ITW to deliver solid growth with best in class margins and returns. In conjunction with our strategy we have implemented major steps to focus the entire company and leveraging ITWs highly differentiated and proprietary business model to drive profitable growth and enhance productivity throughout ITW. We have come a long way since we started over four years ago and ITWs performance is now approaching best in class levels. That being said, it is clear to us that we have significant capacity to further improve our performance. Within the framework of our current strategy before ITW is operating to its full potential. Moving forward we will remain focused on pushing our performance to our full potential by capitalizing on the significant opportunities that we have in front of us. For meaningful additional structural margin improvement and sustained above market organic growth. To our continuing focus on a commitment to executing our strategy, we are well positioned to deliver differentiated performance in 2017 and beyond. I'd like to close by acknowledging the huge debt of gratitude that we owe to our more than 50,000 ITW colleagues around the world for the great job that they continue to do in executing our strategy and serving our customers with excellence each and every day. They are responsible for ITWs strong performance over the last four years and give us great confidence in our ability to continue to improve and make further progress in the past ITWs full potential. With that, I'll turn the call back over to Michael, who will provide you with more detail regarding our Q4 performance and 2017 forecast. Michael?

Thank you, Scott. Taking a look at slide 3, ITW finished 2016 with another strong quarter of differentiated operational and financial performance as evidenced by record quarterly operating income, operating margin and after-tax return on invested capital. GAAP EPS of $1.45 increased 18% and exceed a midpoint of our guidance with $0.03 from better than expected organic growth and operating margin and $0.06 net benefit from non-recurring items. In the quarter, we received $167 million cash dividend distribution related to our investment in Wilsonart, the former decorative services segment. The resulting EPS benefit of $0.10 was partially offset by $0.04 of one-time non-cash charges related to two small divestitures of non-core assets. The net benefit of these items is the sixth sense and without them, EPS grew 13%. Total revenue was $3.4 billion, an increase of 4% and organic growth was 2%, slightly ahead of the midpoint of our guidance. Operating margin was 21.8%. 22.2% excluding EF&C and all seven segments improved margins. Operating income grew 9% to $742 million and free cash flow of $593 million was 170% of net income. So, overall we’re very pleased with our strong finish to 2016. On slide 4, you’ll see that our enterprise initiatives continue to be the key driver of our operating margin performance as they contributed 130 basis points. This was the 13th quarter that enterprise initiatives exceeded 100 basis points. Our performance was minimally offset by price cost, which was slightly unfavorable this quarter due to higher metal and resin prices. Volume leverage was 40 basis points and EF&C diluted margin 40 basis points resulting in operating margin of 12.8%, an increase of 110 basis points and a new Q4 record for the company. Turning to page 5, let’s go into detail around segment results. Starting with Automotive OEM, we had a really strong quarter with organic revenue of 7% and solid penetration gains. In North America 2% organic growth compares to auto bills of 1%. But keep in mind that number includes the builds down 3% with the Detroit 3 where we have relatively higher content. Europe was up 8% with 500 basis points of penetration gains and China was up 33% also with very significant penetration gains. Excluding EF&C operating margin improved 320 basis points in Q4. Food Equipment had a solid quarter up 3% organically, North America equipment was up 9% due to strong demand for warewash, refrigeration and cooking. As expected service was down as we continue to work through the final phase of some fairly significant PLS activity. International equipment was flat and service was up 1%. Turning to slide 6, we also had another good quarter for Test & Measurement/Electronics and as underlying demand trends remain pretty stable. Organic revenue was flat, but margins improved 200 basis points to 20.1%. The underlying demand levels in welding have remained pretty stable for three quarters now. Year-over-year it’s still pretty challenging, as evidenced by the 8% decline in organic revenues, but as you know comparisons start to ease now and that current is welding organic growth rates should be down low-to-mid single digits in Q1. The 8% decline in year-over-year revenues breaks down as 2 points from oil and gas, 5 points from industrial, which is mostly heavy equipment related to agriculture, infrastructure and mining and 1 point from commercial. On the margin front, margin improved again in welding this time by 190 basis points to 24.4%. Turning to slide 7, Polymers & Fluids delivered positive organic revenue growth of 2%. On a regional basis, international was up 3% and North America was up 1%. Automotive aftermarket and Polymers both grew 3% and Fluids declined 1%. Construction Products grew 3% organically, North America was up a solid 4%, with residential remodel up 6% and commercial down 3%. As you know quarterly growth rates can be a little lump in this segment. For the full year, North America commercial construction was up 4%, which is a better indicator of the underlying demand trends heading into 2017. Keep in mind also that the year-over-year comparison in the first quarter is pretty challenging. In Q1 2016, construction was up 5% with North America up 11%. Asia Pacific was up 1% and Europe was up 3%. Turning to slide 8, in Specialty Products organic revenue was up 1% solid growth in our consumer packaging, consumable businesses was offset by weaker demand for capital equipment. On the right side of the page, you can see the broad-based improvement in operating margin by segment. On a year-over-year basis and since we launched the enterprise strategy in 2012. It's worth noting that at the enterprise level, the non-cash expense associated with amortizing the acquisition related intangible assets has an impact of 170 basis points of operating margin and roughly $0.50 of EPS. On slide 9, you can see that we’re continuing to make good progress in executing our pivot to growth. In 2016 our organic growth rate improved 160 basis points. Six of our seven segments delivered positive year-on-year organic growth. 85% of our divisions have achieved ready to grow status. In addition ITW generated organic growth above the average of our peer group and while we have more work to do to sustain organic growth and our goal is 2 percentage points or more above market, at a minimum these data points are good indicators of meaningful progress and they give us confidence that we're on the right track for 2017 and beyond. As Scott mentioned and as you can see on slide 10, 2016 was a record year, we achieved double digit EPS growth and increased revenue of $13.6 billion. Our enterprise strategy initiatives contributed 130 basis points of margin expansion as five of seven segments increased their operating margins. We increased the dividend 18%, allocated $2 billion of surplus capital to share repurchases and converted 100% of net income to free cash flow for the year. If you adjust for the timing of $145 million in cash tax payments year-over-year. Free cash flow conversion would have been 107% and more in line with 106% in 2015. Total shareholder returns for 2016 was 35% well ahead of the market in our peer group. By any financial measure ITW delivered another great year. Turning to slide 11, before discussing our outlook for 2017, I want to take this opportunity to briefly reflect on the progress of our enterprise strategy. Over the past four years we've had essentially achieved all the goals that we laid out in 2012, including increasing ITWs core operating margins from 15.9% to 22.5% and after-tax return on invested capital from 14.5% to 22.1%. As Scott, said even though our performance is nearing best in class levels we continue to see meaningful potential for further performance improvement as we work hard to deliver on ITWs full performance potential. As demonstrated on slide 12, that potential is reflected in our long term financial performance targets that will increase at our investor day in December. We maintain a clear line of sight to another 200 basis points of margin expansion from our enterprise initiatives and 25% plus operating margin by the end of 2018. We're also committed to achieving organic growth of 200 basis points or more above market. 20% plus after-tax return on invested capital, free cash flow of 100% plus of net income and 12% to 14% average total shareholder returns. Looking at the year ahead on slide 13. We're very well positioned for strong financial performance again in 2017. Today we reaffirm guidance including full year GAAP EPS in the $6 to $6.20 range with organic growth of 1.5% to 3.5%. We expect strong incremental profitability on that organic growth with core incremental margins in the 30% to 35% range. For the year, we also expect operating margin to exceed 23.5% with another 100 basis points of structural margin improvement from sourcing and 80/20. Free cash flow conversion is expected to exceed 100% of net income and we have allocated $1 billion of surplus capital to share repurchases. EF&C is off to a really good start. We expect revenues of about $500 million, operating margins of approximately 10%. After purchase accounting EF&C should contribute $0.02 to $0.04 of EPS. Finally for the first quarter our EPS guidance is $1.39 to $1.49, which is 12% year-over-year earnings growth at the midpoint with organic growth of 1% to 2%. In line with current levels of demand and as usual our guidance is based on current foreign exchange rate. Okay, with that we will now open the call to your questions.

[Operator Instructions] Our first question is coming from Andrew Kaplowitz from Citi.

Good morning guys. I think that’s me. How are you doing? So Scott or Michael, since you guided 2017 as your investor day, you might agree that global economic sentiment seems to have continued to improve and certainly not good indicators of generally getting better. Your organic growth guidance includes essentially no improvement in macro conditions, for your segments with auto, as you said at the analyst day getting worse or at least conservatively you have a build down. So, do you think at this point we should look at least at the low end of your 1.5% to 3.5% organic growth range is a bit conservative given we could see some improvements from your investor related businesses. How do you plan on that now?

Well, my response would be that we are applying you know the same approaches to our forecast and that we always have and that’s that we deal with current run rates. So our forecast is absolutely 100% based on current rates projected through the year. I would certainly agree that the sediment if you will, has gotten a bit better. But I think it's really your job is to apply whatever sort of macro forecast that you see ahead to our results what we are giving you is based on actual real demand. In our businesses today how does that project through the year? I would as we said many times, we've gone through four years of work here without a lot of headwind in terms of any help from the marketplace, so we would love to see it. Pick up absolutely, but until it actually is in the businesses our approach is to deal with reality as it exists today.

Understood. And did you see any improvement in December through January, so far in any of the businesses or it's kind of just steady as she goes there?

I think fourth quarter was right on track. First quarter, early January also looks solidly on track.

Okay, Scott, so can I ask you about welding. If I remember correctly about 10% of the business or so are delivered in gas. You talked about the split, basically it looks oil and gas got a little bit better. But it doesn’t seem like it's responded that much yet to the upstream oil and gas environment getting better. Certainly your heavy equipment seems, same as last quarter maybe a little worse. So I’m a little surprised that welding hasn't shown any signs of improvement. Have you seen anything there? And do you expect maybe oil and gas to start to improve from here?

I think, I'll go back to what Michael said in his remarks, which is we've seen pretty solid floor [ph] for the last three quarters and I think that in and of itself as – I would consider that to be modestly encouraging. I think we're a ways away from, I mean, I don’t know about ways away, but I think we haven't seen anything in terms of and what I would describe is a noticeable uptick from there. But it sits now three quarters of pretty firm stable bottom, which is always the first part of any turnaround. So again hopeful that things start to improve there, but nothing we’re seeing yet.

All right. Thanks for that Scott.

The next question we have coming from the line of John Inch from Deutsche Bank. Your line is open.

How did Europe do overall, Scott and Michael, 3M called out a better Europe, they talked about. I know you’re a big company in Germany, they talked about three quarters of kind of improving results in Germany. What are you guys seeing there?

Well, John, this is Michael here. I mean, the big driver of the 3% growth in Europe is the automotive business as you might expect. So I'm not sure we are really good proxy for what's going on in terms of the broader macro environment, but our automotive business as you saw what's up 8% in Europe and that's where the main driver of the 3% growth this quarter.

Well, you’re also a big construction company in Europe, has that shown any sort of trend one way or another?

Construction has been pretty stable, but positive in Europe and was up by 3% in the fourth quarter.

All right. And then I wanted to ask you going back to welding, so the government is looking to prospectively approve more pipeline activity. What is the nature of Miller's exposure to pipelines? And is that obviously not a short-term, but is it a longer term opportunity because you obviously are big player in North America, right, but what about the pipeline aspect of this?

Yeah, I would say we've got a pretty reasonable position there. Overall oil and gas for welding is roughly 15% of revenue and that includes pipeline, upstream, downstream, refining, construction, offshore et cetera and I think our exposures are pretty balanced though, certainly any uptick in activity in terms of pipeline construction would surely be incrementally favorable to us.

Your European welding businesses is also heavily oil and gas. The stabilization/MRO sort of slow that you've seen improving in the upstream improvement. If you were to look at your oil and gas welding, vertical kind of regionally, right, and I'm just thinking of Europe because it may be a good proxy. Has Europe – have there been any signs of life in that business going back to the premise of you know when do you start to see welding turn. Because I think Scott you have made comments before that you thought there was a fairly robust pent up demand kind of more broadly in welding, given what’s happened the last couple of years. Is there anything [indiscernible] from that?

Sure. I’d still agree with that statement and that’s just based on our historical participation in this market going back to the early 90s. You know usually come out of these down cycles there is a lot of demand and recoveries are pretty robust. This one has been particularly, noteworthy decline. At this point, what I would say about Europe and our welding business is the first thing is it's a pretty small piece of the overall welding business, so I'm not sure how indicative it is in terms of overall oil and gas activity. Our big oil and gas positions are North American and China. Welding Europe was down about the same percentage on a full year basis. As the overall business down about 9%, so I think, A; given our relatively small position in Europe, not a great indicator of overall macro oil and gas and B; we haven't really seen any change over there.

Just lastly is there any price change in welding given the sort of the collapse in the oil and gas market. So now we're probably at the trough, and we’ve had three quarters of sequential stability. What's going on with price in that business? So in other words when it comes back, 3/9.11 of the world price more aggressively kind of taken your variable contribution away or what do you feel guys telling on price? Thank you.

Well, like it's been very stable over the course of the last four quarters. We talked before about our overall mix tilting very heavily towards the more value-added components of the welding product portfolio, if you will. So from the standpoint of our overall exposure to pricing pressure, I think we're in pretty good shape there. As I said it's not been – we haven’t seen any evidence of any downward trends of any, at any meaningful level over the last four quarters.

Thank you very much.

The next question we have is coming from the line of Scott Davis from Barclays. Your line is open.

I'm not familiar with EF&C so I apologize to those on the phone who are. But can you tell us kind of what's the plan on how you get that 10% margin up or is this the turnaround story with some low hanging fruit that is a manufacturing cost, is it something else that give you some confidence, you can get this thing up to, kind of your type of margins over time?

Yeah, well it is simply an 80/20 application sort. You know we have an existing business operating at mid-20s EBIT margins applying 80/20 you know very effectively and so I wouldn't call it a turnaround, it's a very good business, very well positioned. It has absolutely all the same characteristics in terms of value-add content, niche in their approach as our legacy business. It's just a function of going through the process of adding the 80/20 management process to all the sort of great raw material and great operating capability that already exists in that business. That is not a quick fix, that's typically 3 year to 5 year process, so the plan is, I think the entry margins were 7 and so we’ve talked about before is going from 7% to 20% over a five year period.

Is the gross margin comparable to kind of what your business’ gross margin was before you fixed your own internal business?

Yeah I would offer that we have some very well developed diagnostics around applicability in fit for 80/20 and all of the raw materials there and then some.

Okay, that's all I had. I’ll pass it on. Thank you.

Thank you. The next question we have is coming from the line of Joe Ritchie from Goldman Sachs. Your line is open.

Thanks, good morning everyone. So maybe sorry Michael can you parse out the price cost this quarter, I know it was negative in total, but how much pricing did you guys get and what was the cost impact this quarter?

Yeah, so what you're seeing Joe, is price was a fundamentally unchanged, nothing has changed in terms of our ability to get price. The difference, the 10 basis points is really as a result of increase in raw material prices specifically metal and resins in a few of our segments. But just to put it in context, the difference between flat price cost, which is our assumption for the year in 2017 which is unchanged and down 10 basis points is $3 million. So on total, relative to total operating income this quarter of $742 million. So I just wanted to put in context for you and again, I mean, price cost has not been a big favorable margin driver for us and we don't expect it to be a big headwind for 2017.

And just to add a clarifying point, sourcing benefit is communicated in the enterprise initiatives and this is the normal.

Yeah, the key driver obviously, remains as I said in the prepared remarks of our margin expansion is the enterprise initiatives, so that's 80/20 and the sourcing efforts that contributed 130 basis points this quarter and for the year.

That makes sense. Maybe shifting gears a little bit, Auto OEM and the margin expansion this quarter, it was much better than we anticipated over 300 basis points EF&C. Can you guys just give us a little bit more color? Clearly the enterprise initiatives are working there, but what else kind of drove the stronger margin performance in auto OEM?

If you go to, Joe, the, there’s slide in the appendix of the press release that lays out the drivers of the operating margin by segment and in total. And really as you point out the operating leverage was 100 basis points enterprise initiatives about 160 basis points. Then EF&C diluted by 220 basis points, restructuring and other was slightly lower, 60 basis points so overall 100 basis points of total operating margin change on the core business. I just wanted you know so the better proxy for where this business is operating I think is the, if you look at the full year for 2016 on slide 8, 24.1% that includes 160 basis points of EF&C so 25.7% EBIT margins in the core business in automotive in 2016 with room to improve from here.

Got it. And maybe if I can sneak one more in here, I saw that commercial in North America was down 3, are you starting to see any pressure in that business, just from an end market standpoint or anything notable that occurred this quarter?

No, no that's just – it can be a little lumpy in construction and that's really it, I mean, like I said the better way to look at is the 4% growth for the year. As a good proxy for what 2017 might look like.

Okay. Fair enough. Thanks guys.

All right. The next question we have is coming from Nigel Coe from Morgan Stanley. Your line is open

Yeah, thanks good morning. Just obviously, you talk about, Scott, you mentioned in your opening remarks, about how there still, a lot of runway from end price initiatives, you got 25% are in target. I’m just wondering obviously the early stages was dominated by the business transformation structural organizational changes. I think then the sourcing was meant to kind of like pick up like towards the back end of the plan. I’m just wondering how you view the major drivers of further margin expansion between organizational PLS and sourcing?

Well, what we talked about back in December was from the sourcing standpoint. We think we've got at least another couple of years of work in opportunity in front of us in terms of additional structural changes for the benefit of the company. At some point it becomes a much more of maintenance activity, but we've got a solid pipeline of targets in activity going on. So there's at least a couple of years worth of work, an opportunity there. Likewise from an 80/20 perspective our efforts to reapply this sort of the current version of 80/20 inside ITW that we talked about again back in December where we’ve completely reengineered the process and are very focused on executing it to its full potential. There's at least a couple of years worth of work there. I think the best way I can characterize and then on top of it, is as we expect further organic acceleration at you know solid 35% incremental all that gives us room to run this out for you at least the next couple of years, if not longer. We’ve also talked about the fact that this is, we’re operating at levels today that we didn't see as even within our scope of potential four years ago, so this has been a process of the deeper we go, the more opportunity we find. I think we've got the ability to sort of plan and execute on sort of sequential to your parents or your time horizons given what we have visibility of. But I you know I would rule out the fact that, now that we’re in, we’re going to find some more opportunity and that’s really been the way this has been playing out.

Okay. Again, going back to December, it doesn’t feel like there's a huge change in the way you’re viewing capital allocations between share buybacks and M&A. But I thought the comment you gave to Scott is comment about EF&C, what’s driving that margin is that applying A22 [ph] to that structure. So I’m just wondering why wouldn’t that principle apply to other opportunities, given that you're running well ahead of where some of your competitors are? Why wouldn’t kind of the pendulum swings towards more M&A. Do you have confidence that you can run businesses better than your competitors?

Well, I think running them better is one thing, growing them is another. I think that's really been you know, that's the big delta in terms of M&A fits. We didn’t buy EF&C because we can improve the margins. We bought EF&C because it extends, in our view in a very meaningful way our organic growth potential in the Automotive segment. The margin improvement - the ability improve margins it's certainly through 80/20 is an important part of the equation. But I would view that as more risk mitigation on return on investment. It's not the core reason we buy. You know we can buy a lot of things and work really hard for five years improving the operating margins, but ultimately if we can't grow them when we're done doing that at a rate that's consistent with what we're trying to do get done here it becomes counterproductive and creates a lot of complexity.

Yeah, that's good answer. Thanks a lot.

The next question is coming from the line of Andy Casey from Wells Fargo Securities. Your line is open.

I know you talked about stable demand, but if market demand supports faster organic growth through the year you know let's say above that 3.5% upper end of organic guidance. All else equal, would you expect short-term core incrementals to exceed the upper end of guidance, you know that 30% to 35%. Or could you pivot and reinvest in the core business at a faster rate?

I think, Andy, as we talked about in December that that incremental margin of 30% to 35% already includes all the investment that we want to make in our businesses, so that's a sustainable rate on a go forward basis and it’s a by-product of the way we run the business, it's not a target that we drive to with intention.

Sure. I'm just wondering if given that outlook, if you kind of have a reinvestment budget in mind. If the actual end market growth exceeds the outlook, does the upper end of that core incremental start to exceed 35% in the short-term?

They might. Yeah and it's not because we’re holding back investment, I think the point that we want to make sure is clear, is that we are fully invested and continue to improve the productivity and accelerate the organic growth of these businesses. When Michael talks about our capital allocation, he talk about that as our first priority. So it's not like we're saying, we’re only going to do so much because we can afford to do more, it's that we are – its only so much you can do, particularly through the lens of quality investment and things that drive results at ITW. All that gets prioritized as the first priority with regard to our capital allocation. There’s not, just because things are better than our forecasting scenario, there’s not a bunch of things we wish we could do that we're not doing that we’ll all of a sudden turn on, that’s not, it's just not how it works here. So I think in the short run faster growth is certainly going to have the potential to have higher incrementals.

Okay, thanks a lot, Scott. And then one additional thing, I know you talked about stability in the quarter and so far in January. In addition to some of these sentiment indices, other companies have talked about kind of, you know some catch-up demand during the quarter where the post-election environment in the U.S. might have been a little bit better than the pre-election. Did you see any of that sort of inflection? I know it could just be a temporary phenomenon. I just wondered if you guys saw any of that?

No, I think the simple sort of way to look at the quarter from a demand standpoint is all the segments we’re on trend, we thought of being a little bit better.

Yeah and I’d just add, Andy, if you look at the monthly very similar in 2016 to 2015 and prior years, so nothing unusual.

Okay. Thank you very much.

Next question is from Mig Dobre from Robert W. Baird. Your line is open.

Maybe trying to ask the prior question a little bit differently. If I'm looking at North America, I know you talked about it throughout 2016. In the first three quarters, North America has grown for you anywhere between 0.5% to 2% and you were flat in the fourth quarter. So wondering if there are some comps issue here or anything like that? How do you think about North America in 2017 within the context of your 1.5 to 3.5 organic guidance?

This is Mike. I mean, the delta in Q4 relative to Q3 and year-to-date growth rates was really have Test & Measurement had a big Q3 as you recall, up 7% and was down slightly in North America, so that's really what tipped the scale here in Q4. I think in terms of 2017, if you took at current run rates, we still expect low single digit type growth in North America.

But if I may tease this out a little bit, do you think that North America is going to be towards kind of the low end of that organic guidance or towards the higher end of that organic guidance?

Well, so we don't give guidance by geography and we give guidance on current run rate sentiment. It’s certainly more positive, we acknowledge and we’ve talked automotive as a little bit of a wildcard in terms of the outlook for the year, but overall we feel very good going into 2017.

Okay, great. Then my follow-up, maybe you can comment a little bit on your geographic balance from a manufacturing standpoint. Are you net exporter or importer out of the U.S.? Are you making any sort of changes to your manufacturing strategy, given all the talk that's out there on policy changes?

Yeah, the overall answer to that is that we have been a produce where we sell company for a long, long time and none of what's out there in the conversation right now would have any impact in terms of our, any changes in that. We are roughly a modest net exporter from North America to the tune of 4% to 5% of revenue. So pretty balanced in terms of, I think that supports what I’ve just said, we are largely producing where our customers are. We do that not because it's low cost, but because it's the most efficient way to serve our customers around the world and it is something that has served us very well and I don't see that changing regardless of any changes in some of the rules in trade policies, et cetera.

Great. Thank you guys.

The next question is coming from the line of Ann Duignan from JPMorgan. Your line is now.

Can you talk a little bit about as you enter 2017, which of your businesses are achieving the 200 basis points above market growth? Obviously, Automotive is one of those. And which are you most concerned about are working hard just went to accomplish that 200 bps above market?

Well, I think there are a number of businesses that, first let me just answer the enterprise level. I think, if you look at our performance in 2016 relative to peers or relative to market at the enterprise level we would certainly argue that we grew above market in 2016. If you just look at the performance by business, certainly automotive as you mentioned grew above market. Food Equipment overall, grew above market, we’ve talked about the service fees there, but certainly on the equipment side. I would put Test & Measurement, probably in line with market into 2016. Polymers & Fluids; Polymers, show some PLS activity. In 2016 construction specialty right in line with market.

Okay, that’s very helpful. And on the construction side what specifically do you think you need to do to get benefits outperforming because it is a very [indiscernible].

Yeah, I think the big part of the agenda there's, we still got a decent percentage of not ready to do businesses primarily in Europe, we're still working on restructuring our European businesses over there. We made a lot of progress in that regard in 2016. And would expect to get through the bulk of that probably by the end of 2017. But North America, the business is performing pretty well and certainly is – the bulk of the agenda now in our North American construction business is centered around consulting organic growth and I think we're really well positioned to do that. But we got Europe straightened away.

Okay, and that’s been pretty consistent, I think. Just a quick follow-up on the metals and resin price increases. I'm assuming Polymer includes the segment most impacted by resin, which of the businesses, has been impacted by our metal prices. I know you said that’s them, not very material, but still it is a rising risk?

Yeah, you're right, I mean, we think this is very manageable, I mean Automotive, Food would be the primary ones, steel prices. Then also on the welding side, a little bit, but again it's not, our business units are all over this. We have a pretty good track record of managing the price cost equation. As a reminder we’re not trying to generate, price significantly above inflation. We’re just trying to cover our costs and I think we've done a pretty good job with that historically.

Probably just one, the first quarter since we could find where it was a negative. So I think it just caused some of [indiscernible]?

We talked a little bit about it in December, right, that we wouldn't be surprised if we saw some headwind on the price cost equation for a quarter or two until we get a chance to kind of respond. Then I would just point out, like I said, earlier we're talking about the difference between neutral and 10 basis points is $3 million out of $742 million of operating income in the quarter. So, I wouldn't get too alarmed.

Fair point, okay I’ll get back in line. Thanks.

The next question is coming from the line of Steven Fisher from UBS. Your line is open.

Thanks. Just to follow-up on North American growth in 2017. Would you expect the growth to start-off the year slower given the tough comp you mentioned in construction in Q1, I assume that construction comp it was driven by North America? And then would you see acceleration expected starting already in Q2?

As you know Steven, the forecasting business, I mean, we said 1% to 2% for overall enterprise growth in the first quarter that's a little bit below where we are for the year. So the improvement in the growth rate in the second half of 2017 is really based on comps. Comps getting a little bit easier, so that's how I would position it and that's all this is at current run rates.

Okay. I was just trying to have the expectation that if we see a soft North America in Q1, that’s kind of within your expectations. It sounds like it would be, but just on expectation.

Yeah, well, that's right. Yeah, that's right and then primarily, I mean, the comp in construction –

It’s all relative to comp.

Yeah, I mean, the comp in construction, that up 11%, that’s a tough one, so you're right.

Okay. Then how sensitive is your buyback programs, to level of the stock price or will it be entirely independent there. I mean, you doubled your plan buyback at the beginning of last year, which I assume is partly because the stock was down was up. But actually we think about the judgment that we apply, that, we don’t have $2 billion of cash flow expected here, only 1 billion of buyback.

Yeah, I mean, the stock wasn’t really down last year. I mean, the average for the year is 107, so $2 million at an average of 107. And we’ve talked about this before, I mean, we really are in the market on a continuous basis and so this year we have planned it as $250 a quarter, similar to what we did last year. If we were able to the extent that there is a market correction, we certainly have the ability to step in and do a little bit more. But fundamentally the way we think about it is we have a business model here that over the long-term can generate 12% to 14% TSR. Over the long-term that will be reflected we believe in the value of the company and so on and that's how we approach the share buyback program. And it’s really our way to return incremental surplus capital to shareholder business, if there is not an alternative, got to learn some use of that cash other than we could sit on it.

That's right, $1 billion that we have allocated in 2017 is our best estimate of the surplus capital available in North America and so that's. Once we're done with that everything, we talked about the internal investments, dividends, acquisitions that need a set of criteria, with the remainder of the surplus capital then allocated to the share buyback program. Just going to add one other clarification which was the incremental 1 million that we had last year was to some repatriation that we were able to do, it wasn’t related to share price, which was up 35% once. Just to point that out.

That's perfect. Thank you very much.

The next question comes from Jamie Cook from Credit Suisse. Your line is open.

guess two quick questions. One, I mean everyone's tried the question of whether we've seen improvement in demand post-election and you’ve said no. You have referenced better sort of sentiment out there? When you're talking sentiment is that because you're specifically talking to your customers and they're telling you they feel better or are you just watching the stock market and the broader new. I'm just wondering if it's stuff you're reading or stuff you’re hearing from your customers? Then my second question assuming North America does get better at some point. Is there a difference, should we think about North America, is the profitability, I guess, across the different geographies similar now? Or is North America generally have more profitable businesses you know based on what you've done with the enterprise initiatives I don't know if that's - you know the profit by geographies changed at all? Thank you.

Yeah, I’ll take the first one and let Michael talk about the second. In terms of the sentiment, I would say it's all of the above. In other words, it's what we read is what our customers talk about, but I'm not sure our customers are doing anything other than reacting to what they're reading, who they're talking to so. As we've talked before, it's I don't think there's any secret that the overall mood seems to be modestly better. Whether that translates into anything meaningful in terms of demand that remains to be seen in terms of our planning. It’s as we said many times we're going to set ourselves up to execute well in the environment as it exists today and certainly be in a position to continue to do so, whichever way the market moves.

Then, Jamie, your question on margins in North America, they are very consistent across all three geographies at ITW, so we could choose different than it was five years.

Yeah, absolutely and I think there's - if you look at, so the average of the company is about 23% now that's fairly consistent in North America and Europe as well as, Asia Pacific. Obviously, we have on a relative basis more exposure in North America, about 50% of our sales are in North America, but the margins are the same.

Okay. That's very helpful. Thanks, I’ll get back in queue.

Thank you. The next question is coming from Walter Liptak from Seaport Global. Your line is open.

I wanted to ask one about the Food Equipment business and there has been some volatility around some of the restaurants and questions about CapEx. I know you guys have a lot of institutional or are you seeing the same kind of volatility to or same concern on either side.

This is Michael, so institution was really strong in the fourth quarter, you saw Equipment up 9 in North America. Restaurants maybe a little slow early in the quarter, but then picked up in November, December and really stable demand. Then the third piece, I’d just add our retail business, also a solid growth on that side. We haven’t seen any - just look at the number, it’s up 9%, anything to suggest that things are slowing down.

Well, that's great thank you.

Thank you. The next question is coming from Eli Lustgarten from Longbow Securities. Your line is open.

A couple of follow-on questions since we’ve covered a lot of ground; one, the 100 basis points improvement in profitability. I mean, can you give us an idea where to expect more to come from and I assume welding is going to have difficulty holding its margins collections for – showing much improvement in 2017 versus 2016. Give us some idea where the probability change we expect across the segments?

Well, I mean, the best answer, Eli, I can give you that we would expect to see improvement in all of our segments as we continue to execute on the enterprise strategy, so.

Anyone else besides welding that would be more challenged in 2017, I think welding will be challenged this year?

I don't think we would share that view. I think welding has done a nice job, sustaining margins with a lot of downward pressure on revenue. Certainly, has more room to run in terms of enterprise initiatives.

Welding will be part of the –

Yeah, I mean, look at welding margins this year, right, and big improvement again in Q4, up 190 basis points and 210 basis points of that was from enterprise initiatives. So –

Are you talking about a business that’s down peak to trough, more than 20 percent.

Yeah.

15 days, you announced the formation of the integrated electronic assembly equipment division and you made some changes. I assume maybe handicap, what can we expect out of that consolidation, I assume there’s no improvement for changes in the past 2017 forecast, but even some handicap of what we might be able to do for the segments and improving that?

I think from your perspective Eli, it’s not going to do anything, so this is more of a natural outcome of continuing to simplify these businesses and structures and the final phases of business structure simplification, so doesn't do anything in terms of the overall results that we're looking at here.

Just one on automotive, with the slowdown of production is, are there any changes in the automotive spending habits or spending that you’re hearing across the board, particularly in North America, where they just – this is what adjustments and factored and your penetration will offset it.

I think it's been pretty stable I think there are some forecasts out for some slowing in North America in the back half of the year. But in terms of what we're seeing right now and you could see the numbers. Q4 was strong, we’re telling Q1 is in solid shape. Certainly, we’re aware of some of the expectations, but nothing coming through for our customers at this point.

Great. Thank you very much.

All right. The last question we had on the line is – coming from the line of Joe O'Dea from Vertical Research Partners. Your line is now open.

First, just a clarification on some of the welding in oil and gas comments that the stabilization that you’ve seen over the past few quarters, are you seeing it similarly in the North America onshore markets as you are in the offshore markets. I think you know some encouraging signs recently in the onshore markets, but just want to get a sense of whether or not you think both onshore and offshore have bottomed at this point.

We participate in all those markets, I don't have the data right in front of me to answer your question with a great level of detail. So I'll just go back to what we said earlier, overall demand is stable in that business including on the oil and gas side so.

Then just one on some potential policy and you commented on this past year taking advantage of some repatriation to take up the buyback. If you do find that there is policy that enables you to access. A lot of cash that is overseas, is share repurchase the most likely avenue for that? Or are there other capital deployment sides of it that we should be thinking about.

Yeah, I think it's a little too early to tell. I think that policy in that area is still evolving and trying to guess where it might end up, I don't think would be prudent. We have about, a little more than $2 billion of capital overseas. If we bring some of that back, it would go into the surplus capital category and we would kind of look into the options at that point, but again it's hard to say anything really insightful given the uncertainty in this area.

Very fair. Thanks very much.

At this time speakers, not showing further questions on queue.

Okay. Great. Thank you for joining us and have a good day.

Thank you.

That concludes today’s conference. Thank you all for joining. You may disconnect at this time.