Illinois Tool Works Inc. (ITW) Q4 2017 Earnings Report, Transcript and Summary

Welcome and thank you for standing by. At this time, all participants will be in a listen-only mode until the question-and-answer session of today's conference. [Operator Instructions] This call is also being recorded. If you have any objections, you may disconnect at this time. May I introduce your speaker for today, Michael Larsen, Senior Vice President and Chief Financial Officer. Please go ahead, sir.

All right, thank you Dale. Good morning, and welcome to ITW’s fourth quarter and full year 2017 conference call. I am Michael Larsen, ITW’s Senior Vice President and CFO. And joining me this morning is our Chairman and CEO, Scott Santi. I am also joined by Karen Fletcher, our new head of Investor Relations. Many of you may know Karen from her five years as head of investor relations at DuPont, so welcome Karen. During today’s call, we will discuss our fourth quarter and full year 2017 financial results and update you on our 2018 earnings forecast. Before we get to the results, let me remind you that this presentation contains our financial forecast for the first quarter and full year 2018 as well as other forward-looking statements identified on this slide. We refer you to the company’s 2016 Form 10-K for more detailed about important risks that could cause actual results to differ materially from our expectations. Also, this presentation uses certain non-GAAP measures, and a reconciliation of those measures to the most comparable GAAP measures is contained in the press release. With that, I’ll turn the call over to Scott.

Thanks, Michael, and good morning everyone. The fourth quarter closed out another year of record performance and strong execution by the ITW team, excluding one-time tax and legal items 2017 earnings per share of $6.59 was up 16% versus 2016 and we achieved record performance and all of our key operating metrics. Operating income of $3.4 billion was up 11%, operating margin of 23.7% was up 120 basis points and after-tax return on invested capital of 24.4% was up 230 basis points. In addition, we returned more than $1.9 billion of capital to our shareholders through dividends and share repurchases. We also continued to make meaningful progress on our focused efforts to accelerate organic growth. Our 2017 organic growth rate of 3% was up almost 2 full percentage points versus 2016, and in additional our Q4 organic growth rate of 4% gives us good momentum heading into 2018. Overall these results demonstrate that we are continuing to make progress in our efforts to position ITW to generate consistent differentiated performance on a sustained basis. Through the combination of ITW’s high-quality business portfolio and our continued focus on leveraging ITW’s powerful business model to full potential, we are well-positioned to continue to deliver strong results in 2018 and beyond. In closing, let me say we owe a huge debt of gratitude to our ITW colleagues around the world for their commitment to executing our strategy and serving our customers with excellence each and every day. They are responsible for ITW’s strong performance and give us great confidence in our ability to continue to deliver sustained top-tier performance as we go forward. With that, I’ll turn the call back over to Michael who will provide you with more detail regarding our Q4 and full year 2017 performance, and on our updated 2018 forecast. Back to you, Michael.

All right, thank you Scott. So starting on slide three, before I get to the details regarding our 2017 performance and 2018 forecast, I wanted to spend a few minutes clarifying the impact of the new tax legislation on our reported Q4 and full year 2017 results. This schedule walks us through the impact of the one-time Q4 tax charge associated with the tax cuts and jobs act and then I’ll talk about the tax rate and capital flexibility benefits that would accrue to 2018 and beyond. As you can see, we recorded a one-time tax charge of $658 million or the equivalent of $1.92 of EPS in the fourth quarter, reducing EPS from $1.70 to a GAAP EPS loss of $0.22. I should point out that this charge is our best estimate based on all the information available to us today. The charge has two primary elements, one a $729 million charge for the estimated repatriation taxes, and two, a net benefit of $71 million resulting from the revaluation or ITW’s deferred taxes. We are in the process of analyzing the implications of the new tax law from a capital structure and capital allocation standpoint. Given both the magnitude of the changes involved, and that we expect further clarification with regard to the application of certain provisions of the legislation, we are not far enough along in our analysis to make any strategic decisions with regard to how we will deploy our existing overseas cash or to make a determination as to whether it will cause us to alter our capital structure or capital allocation framework. That said, we have begun implementing plans to repatriate approximately $2 billion of surplus capital to the U.S. by year-end 2018 and we have decided to accelerate our previously announced plan to increase ITW’s dividend payout ratio. Subject to formal board approval, we now expect to increase our dividend payout ratio from 43% to approximately 50% of free cash flow on a run rate basis in August of this year versus by 2020 as previously communicated. With regard to the impact of the new tax legislation on our tax rate, we estimate that our tax rate for 2018 will be in the range of 25% to 26%. As you may recall, we use the tax rate of 29% when we should issued guidance in December. Our updated guidance today incorporates the benefit of the lower rate, which has a favorable EPS impact of $0.35 or 5%. We will provide additional detail and analysis of the one-time charge in our 10K. Moving onto slide four, we have also included a schedule for the full year 2017 that separates out the one-time impact of the tax legislation that I just talked about, and a previously disclosed legal item from the underlying operating performance of ITW. You can see our full year results with 5% revenue growth and 11% operating income growth, 120 basis points of margin expansion and 16% EPS growth. I’ll cover those results in more detail in a few slides. So with the impact of these non-recurring items clearly identified upfront, when I discuss our financial results for Q4, and full year 2017 on the following slides, the results presented and my commentary will exclude the impact of these two one-time items and focus on the operating performance of the company. We’ll exclude the impact of these two one-time items and focus on the operating performance of the company. So on slide five, our Q4 performance ex the tax charge we grew EPS by 17% year-over-year to $1.70 exceeding the $1.60 midpoint of our prior guidance with $0.04 contribution from operations and $0.06 from a lower tax rate. You may recall that in Q4 last year, we recorded a net EPS benefit of $0.06 from a dividend payment offset by several small divestitures. If you adjust for these items, our Q4 EPS on an apples-to-apples basis was 22%. Total revenue was $3.6 billion, an increase of 7% with organic growth of 4% led by Test and Measurement/Electronics up 9%, welding up 6% and specialty product up 5%. All major geographies are positive, 4% growth in North America, 3% growth in Europe, 5% growth in Asia-Pacific including 7% in China. We improved operating margin by 160 basis points to 23.4% with Enterprise initiatives contributing 140 basis points. Free cash flow of $617 million was 106% of adjusted net income. So overall, another strong high-quality quarter to wrap up 2017 as the ITW team continues to execute. On slide six, you can see the drivers of our operating margin performance this quarter, which was once again driven by strong executional enterprise initiatives. They continue to be the main driver of our operating margin expansion and contributed 140 basis points in the quarter, which is the highest level since we launched our enterprise strategy five years ago. Good momentum and a solid backlog of opportunities in both our strategic sourcing and 8020 [ph] reapplication initiatives have us well set up for another 100 basis points of margin expansion in 2018 independent of volume. Volume leverage was 90 basis points and as expected price cost was slightly unfavorable this quarter at 50 basis points. As you may recall in our guidance for 2018, we are assuming 30 to 40 basis points of headwind from price cost. Overall, operating margin of 23.4% was an increase of 160 basis points and a new Q4 record for the company. On slide seven, you can see the meaningful progress on our focused efforts to accelerate organic growth across the segments. Our Q4, 2017 organic growth rate of 4% was up 2 percentage points year-over-year. And when you look at the detail by segment, you can see the strength of ITW’s diversified high-quality business portfolio. Some of our faster growers last year like automotive OEM and food equipment may have slowed in the near-term due to market conditions, but others like Test and Measurement, Electronics and Welding have accelerated and net were growing at 2X last year’s rate. In addition when you look at the operating margins, you notice two things, one, everyone improved year-over-year, and two, there are no weak links across our diversified portfolio. Let’s go a little deeper by segment starting with automotive OEM, where we had another strong quarter with overall organic growth of 3% in a flat market with above market growth in all geographies, as we continue to increase our content per vehicle. In North America, organic growth was down 2% better than auto bills, which were down 4% overall and down 7% with the Detroit 3. Growth on the international side was very strong with Europe up 7%, and China was up 14%. As you know the growth on a quarterly basis can bounce around a bit, so we added the full year organic growth and build’s numbers to the page. In North America, we managed to hold revenue to down 1% for the year, while overall builds were down four. In Europe and China our growth of 8% and 17% significantly outpaced bills of 3% and 2% respectively. Operating margin improved despite the previously discussed price cost headwinds. In terms of 2018, the most recent HIS forecast has auto build up 1% to 2% and we have essentially locked in content growth for 2018 against the automotive OEM segment organic growth of 4% to 5% for the year at these build levels. Food equipment organic revenue this quarter was flat overall, with North America down 1% in a soft market and against the comparison of up 4% last year as institutional sales was down 8% against the tough 2016 comparison of plus 23%. Retail was also down 5%. International was flat with equipment down 1% and service up 3% and operating margin improved 110 basis points to 25.8%. Very strong quarter for Test and Measurement and Electronics, organic revenue grew 9% as Test & Measurement grew by 13%. In Instron, where demand is tied closely to the business investment cycle, organic growth was up 8% and electronics was up 4%. Progress on operating margin performance was also very strong at 23.4% an improvement of 330 basis points driven by enterprise initiatives and volume leverage. As a reminder, the 23.4% includes 280 basis points of non-cash expense associated with amortizing acquisition related intangible assets. Also on slide nine, strong momentum in welding continues with organic growth of 6% in Q4. By geography, North America was up 10%, our industrial equipment business which serves primary into manufacturing including automotive and heavy equipment was up 15% in the quarter, while our commercial equipment business which sells through distribution to construction, light fabrication and farm and ranch customers, was up a solid 5% year-on-year. Overall, equipment was up 13% while consumables were down 2%. International was down 10% due primary to oil and gas and please keep in mind that international only represents approximately 20% of our welding segment. On the margin front, operating margin improved this quarter by 200 basis points to 26.4%. Polymers & Fluids with positive organic revenue growth of 3% as fluids grew by 5% and automotive aftermarket and polymers both grew 2%. As a reminder here, the 19.9% operating margin includes 400 basis points of non-cash expense associated with amortizing acquisition related intangible assets. Construction products grew 4% organically. North America was up 2 with residential remodel of 2% and commercial down 1%. International was strong with Europe up 5% and Asia-Pacific was up 4%. Operating margin performance was solid at 23.4% which represents 200 basis point improvement year-over-years primarily due to enterprise initiatives. Finally, in specialty product organic revenue was up 5% with notable strength on the equipment side and by geography North America was up 4% and international was up 6%. As Scott mentioned as you can see on slide 11, 2017 was a record year for ITW. We achieved 16% EPS growth, increase revenue of 5% to $14.3 billion and continued to make meaningful progress with 3% organic growth, and positive organic growth in all seven segments and all major geographies. The key performance metrics are all new all-time records including 23.7% operating margin and after-tax ROIC of 24.4%. Free cash flow was $2.2 billion, an increase of 9%. In terms of capital allocation in 2017, we invested almost $600 million in our businesses for growth, and productivity increased ITW’s dividend 20% and returned more than $1.9 billion to shareholders through dividends and share repurchase. Turning to slide 12, you can see our record operating margin performance with 120 basis points of improvement year-on-year and record operating margin of 23.7% excluding the legal item. We listed the key drivers here including enterprise initiatives of 120 basis points, volume 70 basis points, price cost down 40 basis points, as expected but positive on a dollar basis. EF&C was slightly dilutive and the legal item added 70 basis points for a total reported margin expansion of 190 basis points. Turning to slide 13, as many of you know we’ve done a lot of work over the past five years to position ITW to consistently deliver solid high-quality growth. We have made some good progress in this regard, as 2017 marked their third year in a row of a meaningful improvement in our organic growth rate. As you can see slightly negative organic growth in 2015 with a lot of PLS activity turning positive 1% in 2016, 3% in 2017 and based on this positive momentum, in our current run rates, we expect to make meaningful progress again in 2018 with a growth rate in the 3% to 4% range. Let’s turn to our updated guidance on slide 14. Relative to your December meeting, we raised our full year GAAP EPS guidance at the midpoint by $0.40 or 6% to new range of 745 to 765 which represents 15% year-on-year earnings growth at the 755 midpoint. The $0.40 increase is essentially $0.35 benefit from our estimated lower tax rate of 25% to 26% and $0.05 from current foreign exchange rates. For 2018, we expect organic growth of 3% to 4% based on current run rates and operating margin of 25% to 25.5% with another 100 basis points of structural margin improvement from our enterprise initiatives. Free cash flow conversion is expected to exceed 100% of net income and we’ve allocated $1 billion of surplus capital to share repurchases. As we mentioned earlier, we are planning to increase the dividend payout ratio to a run rate of 50% of free cash flow subject to formal board approval in August. For the first quarter our GAAP EPS guidance is a $1.80 to $1.90 which represents 20% earnings growth year-over-year at the midpoint with organic growth of 3% to 4% in line with current levels of demand. As per usual our guidance is based on current foreign exchange rates and we are estimating a 24.5% to 25.5% tax rate for Q1. So with that, we’ll now open the call to your questions. And Dale, if you could please open the line for the Q&A session of the call.

Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions] Speakers, we do have our first question in queue. This one comes from Andrew Kaplowitz of Citi. Andrew, your line is now open.

So Scott or Mike, you didn’t change your organic growth guidance for 2018, 3% to 4% and we know it’s early in the year. We know your forecast current run rates but you did beat your own organic growth forecast in 4Q was 3.7% and it does seem like many of your businesses are accelerating, you know welding, test and measurement. So why wouldn’t you deliver at least towards the higher end of your organic growth, if current economic conditions hold.

Sorry about that, by the way the phone ringing in at the background. So essentially I think you’ve pegged it pretty well and the guidance we gave in December was based on activity we were already seeing in the fourth quarter. As you run rate it out, we are still; we think 3 to 4 is the right number. Certainly would acknowledge the fact that there is some momentum building. It is only January, so to the extent things continued on the path of run from the standpoint of the macro environment, I think the possibility is good that we would certainly be in the high end of that range, but from where we sit today, while things are incrementally better, you know the forecast that we gave you in December was based on what we already knew was had going on in the fourth quarter.

Got it. And then I have to ask you guys about price versus cost obviously in the sense that you know margin improvement of 4Q was still very strong but maybe slightly light of your forecast given the 50 basis points of price versus cost. You mentioned that you still expect 30 to 40 for 2018, what are the chances that the headwinds from price versus cost gets a little worse before it gets better and you know again you mentioned you are still covering it dollar wise. So, you know how concerned are you about sort of the range to get that on margins given relatively high raw material cost?

So Andy, I mean we are closely watching this and there certainly is some inflation that is being addressed in our business units. But, I think we have it well covered in our current guidance. So, as you point out, our strategy in 2017 and it will be the same in 2018 is to offset any material cost inflation dollar for dollar with price, and we have been able to do that successfully at the enterprise level. We have assumed for 2018 that we will see a similar impact from a margin standpoint of 30 to 40 basis points. As we talked about in December in New York to be hopefully somewhat conservative we have baked in some EPS headwind as well on the price cost side. So sudden not complacent and taking action getting price in all of our businesses with automotive being the one that’s a little more challenging just given how that industry is structured, but overall feel good about price cost going into 2018.

What I would just – would just add to that real quick. I think the reality is as you know this affects percentages, but our – I think we are very comfortable with our ability to recover dollar for dollar. So from the standpoint of actual EPS risk in 2018 we are very comfortable this is not going to be a significant factor as we sit here today.

Appreciate it guys, nice quarter.

Thank you.

Thank you. Our next question in queue comes from John Inch of Deutsche Bank. John, your line is now open.

Thank you. Good morning, everyone.

Good morning, John.

Morning guys. So cash flow in 2017 on the conversion side, a little wider, your guide has it above 100%. What were the dynamics and then does that have anything to do, Mike or Scott with kind of $600 million of investment spending and I forget what you said the investment spending is going to be for 2018, but maybe you could add a little more color there?

Yes, that’s actually not the main driver, John. I mean, our investment was up slightly and that’s really if you look at our CapEx and our R&D spend, it’s typically in that 2% of sales range for CapEx and 1.6%, 1.7% for R&D. And so our sales grow, those investments will grow. Operationally we delivered 100%. There are two things going on in the full year number. One is the decision that we made last year to fully fund our pension plans. We talked about that contribution, I think it was in the second quarter last year, on top of our regular contribution the total was about 150 million. And our pension plans are now fully funded to the point where we stress tested them in another '08 '09 type scenario. We are not going to be in a position where we are underfunded on the pension side. And the other piece that gets you to the 100% free cash flow is just the timing of some cash tax payment in 2017 versus 2016. So operationally we did 100%. Now, if you’re really picky, if you look at Q4, we did see a slight increase in working capital and that’s just to assume, support the higher demand and the increase in backlog that we are seeing in some of our businesses.

Which frankly you would have expected, so I think that makes sense. If there is any of the businesses that potentially seem like they maybe could do a bit better, its food equipment and there’s really no evidence of that in the fourth quarter print and your guide kind of around 1% doesn’t anticipate much. Maybe you could just explain to us what could be the variables that could actually drive that business higher? It would obviously be the U.S. economies, it seems to be accelerating. And is Food Equipment, does it typically historically roll higher or could it all of a sudden start to surprise higher. I mean what are the dynamics in that segment that we should be watching for in 2018?

I think our current view and it is that in the first half of the year we don’t expect much improvement in market conditions in North America. There is some optimism as it relates to the second half. We are modelling at current run rates. We should end up at 2% to 3% for the year, but it continues to be a fairly challenging environment as we’ve talked about for several quarters now in North America.

That’s fine. And just last, Michael on tax, one is the 2018 effective rate, the 25, 26 is that kind of a number that sustains, barring any other changes that are unforeseen, meaning you know if you fast forward a few years it should still be 25 to 26 unless something has changed. And then just on that point, I think at the December 1st meeting, you had again informally was it guidance, you said maybe the rate rise in the lower 20s. And I think if there is anything that seems to be a pattern, it’s that you know effective tax rate from the part of the company they are coming in higher than people had otherwise perhaps anticipated, uniformly so I’m just curious if you comment on sort of both fronts. Is the rate higher and why is it higher and then is it sustainable or does it tick higher or lower do you think overtime?

Yes, it’s a good question, John. So, to answer your first question, we do expect that this is a year one [ph] run rate of 25 to 26, and as we get ourselves organized here we could potentially see that go lower from here. The rate is slightly higher, not just for us but I think you’ve seen that for others as well then maybe we had expected one, you know the rate, the federal rate went to 21 not to 20. And the other piece is that there are some we believe somewhat unintended consequences in this act associated with a foreign tax, U.S. tax on foreign earnings of the so-called guilty tax And the way the math works on that, that’s about two points a headwind to the overall rate. Now that could get, that could get further clarified and maybe there is a workaround, but as the math works today, we are sitting at 25 to 26, and maybe a little bit better on a go-forward basis.

Meaning if you hadn’t had U.S. tax reform, you were working various angles legitimately to bring your tax rate down. Does U.S. tax reform kind of bump it lower and then you are still on that trajectory or does it actually with guilty etcetera does it kind of plug that? I guess that’s kind of also what I was trying to…

No, I think the current rate reflects our current planning, but obviously as these new rules and they are new, we are talking 30 days here, as we analyze and interpret those and those tied back to the comments we made around our capital structure, I mean there’s some far-reaching implications here as we work through that and get our planning organized. I think that that’s what we believe will give us room to lower the rate on a go-forward basis.

Got it. Thank you very much.

Sure.

Thank you. Our next question comes from Joe Ritchie of Goldman Sachs. Joe, your line is now open.

Thank you. Good morning guys, and welcome Karen. So my first question, I guess Michael maybe talking about capital deployment for a second, so clearly nice to see the dividend payout ratio go up and you know the share repurchases, you can easily find out of your free cash flow. So given that you guys are repatriating $2 billion, I’d be curious to hear if you have any initial thoughts on how you are going to allocate that capital?

I think Joe, I’ll go back to what I said earlier, is that we are still analyzing all the implications of the new tax law from a capital structure and capital allocation standpoint. As you know, these are pretty significant changes. Some of the rules are not entirely clear yet in terms of their application and we expect to receive a further guidance and we simply haven’t had enough time to really work through this in a deliberate and thoughtful way as the management team and with our board. So we are not at a point today where we can really make any strategic decisions on how we’ll deploy that overseas cash this year and also in the future years as it now is available to us here. And what that exactly it means from a either from a capital structure or a capital allocation framework. So what we can’t tell you is that we are working to get the 2 billion back by year-end. We don’t have the money as we sit here today and we have made the decision to accelerate the dividend payout ratio as we talked about it earlier. And that’s really as far as we can go, as we sit here today and we’ll keep you posted as we work through this. And so if we have more information here, when we report Q1, we’ll give you an update.

Okay, that’s helpful Michael. And maybe my follow on question and just kind of thinking about the end market trends, clearly you guys ended 2017 with a lot of momentum, particularly within your industrial businesses. So I’d be curious to hear your thoughts around you know given this effect of the tax change, some thoughts around you know CapEx potentially reaccelerating here in the U.S. How are you thinking about the industrial businesses particularly and what the growth trajectory for those businesses should look like? And I know you’ve given guidance on a segment basis, but I’m wondering if you are expecting to see an uptake from further CapEx investing across the U.S.?

Well, I think we are certainly hopeful and the early indications are that we were seeing some acceleration in business investment already, I mean prior to passage, our Q4 rates, you know one of the big deltas was clearly some really meaningful acceleration and demand trends and involving test and measurement and the capital goods components of our specialty segment. And certainly Joe to your point, I think this new tax legislation has great potential to add some further momentum and stimulation to the economy overall and in particular to business investment. So, I think the raw material in terms of some sustained recovery if you will in business investment particularly the U.S. is certainly there, but as is our habit we’ll wait to see it before we plan on it.

Got it. And then if I could maybe just add one more Scott, I noticed that your welding business on the international side was down, you know double-digits, can you maybe just a little bit more color on what’s happening within that market?

Yes. I suppose that's -- they are mostly it's a relatively small part of the overall business as Michael said and our position there is heavily weighted towards oil and gas. So it’s nothing more than that. Certainly it should to the extent it is a turning in – any direction I’d say we are certainly bottoming out there. But I don’t think we are particularly good proxy for the overall welding market internationally, given the narrowness of our position there.

Got it, okay thanks guys.

Thank you. Speakers, our next question comes from David Raso of Evercore ISI. David, your line is now open.

Good morning. I was curious the organic sales guide for the year, what’s the cadence? The 1Q is three to four – years three to four, what will be the cadence?

It’s actually if you look at it at current run rates, the 3 to 4 and I’m not giving guidance for Q2 or Q3 but it’s in that range, and then probably a little bit lower than that in the fourth quarter just on from a comp standpoint.

So even as the comps get a little easier 2Q and 3Q, just thinks if it is sort of 3 to 4?

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

And the inventory being flat sequentially it’s usually down 6% or so 3Q to 4Q. Where was the inventory in particular held a little higher anticipating superior growth historically?

It was pretty broad based, so I think as you would expect the ones with the highest acceleration in Q4 that we just talked about had a little bit more, but overall there is some pretty good momentum across the portfolio here.

And these are – just to add onto that, the way that gets managed internally whether it’s one year is that’s sort of an automatic reaction, that’s not a full forecast. So just as Michael said it happens because demand dictates, not because we're making our own bet on where things are heading.

Yes, nothing really but nothing really anticipatory about it. It's simply the way it works

No, no this – we don’t as you know most of our businesses are we get the order – today, we shift tomorrow, we’ve replenished inventory the following day and as demand picks up, we build more inventory. And so that’s really what you are seeing. So I think it’s nothing to be alarmed about.

All right, appreciate it. Thank you.

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

Yes, good morning.

Hi, Ann.

Hi, I’d like to ask a tax question in kind of a different way. I mean there are lot of changes as you noted that accelerated depreciation on new unused equipment, the elimination of section 1031. You know as you sit there running out a broad base of businesses, do you expect any changes in purchasing behaviour by any of your customers, I mean I’m thinking through the equipment, automotive, welding you know of any changes that you are contemplating in the way people buy your products because of tax changes.

Yes, I think I’d tie back to what Scott said earlier. It’s really you know on the business investment side were these new accelerated as depreciation rose, I have probably created some positive stimulus and so that it would be primarily test and measurement, welding as well as portions of specialty. So, I think it’s hard to tie back to you know what specific was tax related but I think its part of an overall improving momentum in those businesses.

Okay. I appreciate the color. And then on the flip side, a lot of talk about NAFTA and it does seem to be all about automotive and content on where it’s built. If NAFTA were to be eliminated even for a short term and can you talk about what impact it might have or could have on your automotive business?

You know and overall what I can tell you is we produce close to where our customers produced in that space. So to the extent this impacts where they choose to produce vehicles and which we have content then we are overtime we would certainly follow those moves. We are well positioned; in fact one of the strengths of our position is our belief to provide copies of that product all over the world, so it's certainly something that is well within our capacity to react to. I can’t really speak as much in terms of overall demand impact for customers in the short run, but I think in terms of does it create any long-term structural issues for us, I can’t really think of any sitting here today.

Okay. I’ll leave there. And I appreciate that.

Thank you. Our next question comes from Andy Casey of Wells Fargo Securities. Andy, your line is now open.

Thanks a lot. Good morning everybody. I was wondering if we could go back to test measurement and electronics. Could you give a little bit more color on what happened in the fourth quarter that organic growth rate moved up pretty substantially and part of it seems to be comps, but is there anything else going on there?

Well, I think it was pretty broad based really on the test and measurement side and part of what we’re seeing is some strength in the businesses that are tied to the semiconductor end market. But also like I said -- we pointed out, Instron up 8, which we believe again is driven by CapEx, increased demand for CapEx. So those are the two dynamics in test and measurement. We say it looks pretty for the year. In December, we said 4% to 5%, so it’s kind of mid single-digit type growth for test and measurement and electronics, and as we said here today and that supported by the current run rates and the backlog in that business.

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

So, I think kind of from a modeling standpoint on the interest expense, it will probably be a little bit higher, not because of an assumption around increased debt, but its really some of the euro denominated debt at current currency rate, so I think that’s a $10 million, $15 million increase, if I remember correctly on the interest expense side. Most everything, depreciation might be up a little bit as a result of the increased investment that we talk about to support the growth this year. The intangibles, we typically go down $10 million to $15 million, so probably a similar trajectory for 2018. And then the other thing that’s little unusual is the unallocated line this year of the legal item is actually showing a positive number. If you take the Q4 number which is the $20 million or so and run rate that out, so about $18 million for the year. I think that gives you kind of the key pieces that you need to put this together for 2018.

Okay. Thank you very much.

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

Hello, Jamie.

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

We can go back to the Jamie, if she – he is still there.

Next question comes from Joel Tiss of BMO.

How you are doing guys?

Hi, Joel.

I just wondered if you repatriate some capital and it comes back kind of chunkier, do you think the share repurchases would flow with that? Or they’re going to be more systematic as we go through the year?

What I can’t tell you Joel is we have a $1 billion in the plan which is consistent with what we said in December. And from a planning standpoint that’s $250 million a quarter. And as I said early we can really comment on the plans for the additional surplus capital, the $2 billion or so in terms of the timing. It will comeback by year-end, but we’re still working through the exact timing. And then what that means from a capital allocation or capital structure standpoint, it's a little too early to comment on that.

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

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

Okay. All right. Thank you.

Thank you. Our next question in queue is from Mig Dobre of Baird. Mig, your line is now open.

Thank you. Good morning everyone. I want to ask that acquisition question maybe a little differently. Based on what you know thus far from tax reform, are you changing your thinking on M&A at all, meaning, the way you're thinking about tax shields, the way you’re think about the cost of capital, whether or not U.S. acquisitions versus international ones are more or less attractive, really anything different in the wake of this legislation?

The simple answer is at this point, no.

Okay. Then maybe I'll ask a pricing question. You talked about automotive maybe struggling a little bit, but I’m wondering do you have any segments in which pricing is perhaps stronger than you anticipated when you should original guidance at the Analyst Day?

I think the general framework is really goes back to how we structure the portfolio from a price cost standpoint. So we are operating in spaces and our products are not commodities, their performance matters to the customer, so we expect given that that any changes in input costs over some reasonable period of time that will -- that those changes in input cost will get reflected in the prices we charge our customers, that just been fair, but we are certainly much more oriented towards how do we grow the high-quality portfolio. And so from the standpoint of overall how to manage this we’re just trying to cover the cost and really remain focused on leveraging the portfolio to continue to accelerate organic growth.

I appreciate that. I guess I was just wondering on some your businesses that are clearly showing real volume inflection if it's fair to think that those are the ones that are -- getting [Indiscernible] to this point?

I’m sorry; you broke up on the last part Mig.

What I’m trying to get at is, some of your businesses were clearly seeing a volume inflection. I'm wondering if it's fair to assume that these are also the ones that are currently getting the best price out there.

I don’t know how to.

I think, Mig, for us its really – for us price cost is a function of just wanting to recover the inflation that we’re seeing over time. And there is typically a little bit about lag as you saw last year, but we’re not trying to get greedy here and charge more in their business than we normally would, so it doesn’t really impact our thinking.

Okay. Thank you.

Thank you. Next question in queue is from Steven Fisher of UBS. Steven, your line is now open.

Thanks. Good morning.

Good morning.

Good morning. Just coming back to tax reform and CapEx, I know you said you're still determining your overall capital allocation plans after that include CapEx, and you say that CapEx is a function of sales, but I guess to what extend do you have more motivation to increase your own CapEx as a result of tax changes? And if you did what will be the types of things that you invest in? Would it be automation, more capacity in general, relocating capacities, any thought there?

I think, Steve, the answer is, if you look at our strong cash flow that we’re already generating and have been for many years. We are already full invested in businesses and in our strategy before the passage of this tax legislation. So there's nothing that we would do or could do now that we didn't do before that would be accretive or at the performance or ability to execute a strategy, so at this point we’re modeling and we penciled in two percent of sales on CapEx. We talked a lot about that in December how we think about these internal investments. And this any changes on the tax side have not – don’t have any impact there.

Okay. And I know you're looking for flat commercial construction in 2018 back at the Investor Day. What have you seen over the last month and a half that may shift that in one direction or another if anything?

I think at this point broadly for construction products we’re still in that 3% to 4% organic growth range for the year and commercial we don't – there’s really no change in terms of our view on the commercial side.

Okay. So it’s still flat.

Yes, flattish. Yes.

Okay. All right. Thanks very much.

Thank you.

Thank you. Next question in queue is from Nathan Jones of Stifel. Nathan, your line is now open.

Good morning, everyone.

Good morning.

Michael, the $729 million repatriation charges that your expectation of what the cash charge will be over eight year, so like 90 million a year? And does that include free cash flow?

Yes. So, if you look at the overall charge, the $658 million is very close to a cash number fin two free cash flow yet the liability will charge 608 million is very close to a cast number for all intents and purposes. So if you look at our balance sheet, you’ll see a payable there, non-current tax payable that 614 and then there’s another 50 million or so in current payables, all related to tax reform. I should point of clarification that the repatriation tax number, the 729 also includes any foreign withholding tax on those cash distribution. So any taxes that are payable overseas related to the 2 billion are already accounted for in that number.

Okay. So the 660 odd [ph] is roughly that payment over eight years that you'll get?

Yes.

Okay. Got it. And then just a question I guess it's around T&M and around the CapEx cycle here, I mean, we've seen pretty good recovery in short cycle general industrial, but I guess one thing that's been missing in his recovery is being really any CapEx cycle. You’ve got a few businesses here related CapEx, I think Intron is one that’s particularly levered to that, that is showing good growth that seems to have inflected higher in the fourth quarter. Is it something that you're expecting to continue? Are you seeing signs ex the impact of the tax bill here? Did kind of CapEx cycle was budding here anyway?

I think we’ve seen a pickup in those businesses that goes back to before the passage of the tax act. So these businesses and so test and measurement, welding in particular have been pretty sluggish for a number for years. And I think it the recovery that we saw in those businesses goes back to November – October, November of 2016 and so if anything maybe there some additional stimulus here in those businesses and that would certainly be beneficial to ITW if that’s the case.

Okay. That’s helpful. Thanks very much.

Thank you.

Thank you. Next in line is Walter Liptak of Seaport Global. Walter, your line is now open.

Hi. Thanks. Good morning. Thanks for taking my question. I want to ask about 2017 organic growth of 2.9% and have you guys been able to parse out how much his internal initiative versus market growth?

I’ll tell you we do collect some data on that. I’m not comfortable really sharing that externally. I think it's a combination of the two as we said in the past. I mean, I think clearly what we had point to Walters just look at the progression of overall organic growth rate with more than one percentage point improvement of 15 over 2015, 2016, 2017 and another meaningful improvement in the growth rate for 2018, and its really a combination of things. And I think only recently last year we’ve seen a little bit pickup from a market standpoint, but if you look the last three years we've delivered meaningful improvement really in a pretty sluggish overall pretty challenging macro. So that’s the best thing, so I can give that Walter. It’s a little bit of both.

Okay. It looks good. Is the PLS in 2017, have you been able to quantify how much of that one was there?

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

Okay. Is there any PLS headwind in 2018?

It will be probably about the same in 2018, so we’re expecting another 50 basis points here maybe as a result of the reapplication of the -- our 8020 [ph] reapplication initiatives across the businesses and you see the benefits were accruing not just in terms of – from a margin standpoint but also creating a portfolio that has significantly higher organic growth potential.

Okay. And then in 2018 the 3% to 4%, I guess it’s probably the same as in 2017 where there is some internal, but it’s hard to pass it out as a ring.

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

Okay. Great, okay thank you.

Thank you.

Thank you. Our next question will be coming from Ross Gilardi of Bank of America Merrill Lynch. Ross, your line is now open.

Thanks, good morning gentlemen.

Good morning.

I’m just wondering if you talk a little bit more about that strength in the industrial welding part of your business in North America. And are you seeing your customers continuing to ramp production, is the only reason to expect that that won’t accelerate further in 2018 as the year unfolds.

I think industrial 15 is that’s a pretty solid number, I don’t know if I would count on further acceleration from there on a sequential basis. The comps year-over-year are going to change as we go through the year, but we feel really good about the improved demand on them, on the, on the industrial side.

Okay, thanks. And then just any color on China, you know as this pertains to auto. I realized China auto in the grand scheme of your portfolio is small, but this is an important part of auto and your ability to continue to generate a 1000 plus basis points of our growth in China auto and anything you can say about like what types of products that’s coming from.

So I think it’s actually not that small anymore. I mean, that team has been putting up some really strong growth rates for long period of time and as I said for the full year the China automotive business is up 17% and up 14% here in Q4. And when we look at the backlog in terms of further content per vehicle growth that is a sustainable above market growth rate.

Got it. Thank you very much.

Thank you.

Thank you. We show no further questions in queue, but as a reminder for the participants again [Operator Instructions]. One moment, we’ll wait and check for questions.

If not Dale, why don’t we just wrap it up here and I’d like to thank everybody for dialing in today and Karen and I are around if you want to give us a call. Thank you.

That concludes today’s conference. Thank you for your participation. You may now disconnect