Welcome, and thank you for joining ITW's 2019 First Quarter Earnings Call. My name is Cheryl, and I will be your conference operator today. [Operator Instructions]. As a reminder, this conference call is being recorded. I will now turn the call over to Karen Fletcher, Vice President of Investor Relations. You may begin.

Thank you, Cheryl. Good morning, everyone, and welcome to ITW's First Quarter 2019 Call. I'm joined by our Chairman and CEO, Scott Santi, along with Senior Vice President and CFO, Michael Larsen. During today's call, we will discuss first quarter financial results and provide an update on our 2019 full year outlook. Slide 2 is a reminder that this presentation contains our financial forecast for the remainder of the year as well as other forward-looking statements identified on this slide. We refer you to the company's 2018 Form 10-K for more detail about important risks that could cause actual results to differ materially from our expectations. Also, this presentation uses certain non-GAAP measures, and a reconciliation of those measures to the most comparable GAAP measures is contained in the press release. So let's turn to Slide 3 and I'll turn the call over to our Chairman and CEO, Scott Santi.

Thank you, Karen, and good morning, everyone. Overall, we had a solid start to the year, and the first quarter played out about as expected with EPS of $1.81, coming in modestly above the midpoint of our guidance. The ITW team continued to execute well on the things within our control, delivering 100 basis points of benefits from Enterprise Initiatives and an operating margin of 24.3%, excluding 70 basis points of margin impact due to accelerated restructuring investments. We delivered 27.7% after-tax return on invested capital and a 21% increase in free cash flow. Sales started out a little slow across the board in January before picking up the pace in February and March. Organic revenue was down 1.5% or flat excluding the impact of one less shipping day in the quarter. Our auto OEM sales declined 6% as auto production in North America, Europe and China was down a combined 8%. That being said, we are seeing some signs of stabilization in Europe and China auto markets and expect to see some modest improvement in the back half of the year. The 6% decline in auto OEM revenues reduced our Q1 organic growth rate by 1.5% at the enterprise level. One less shipping day was another 1.5% and PLS was 70 basis points as expected. As we discussed on the last call, we had a pretty heavy restructuring agenda in Q1 as we accelerated our 2019 plans into the first quarter, a significant portion of which was directed at our auto OEM business in Europe in order to adjust our costs to current demand levels. As we also discussed on our January call, we knew that the first quarter and, in fact, the first half had some challenges in terms of year-on-year comparisons: the currency translation, accelerated restructuring, a slightly higher tax rate, one less shipping day, tougher organic growth comps and auto production declines in Europe and China. And that these challenges would dissipate and the operating environment would be much more favorable in the back half of the year. Coming out of Q1, things are playing out largely as we anticipated. We are executing well on our long-term enterprise strategy and on our 2019 operating plan. And as a result, we remain firmly on track to deliver on our full year EPS and margin improvement guidance. I'll now turn the call over to Michael who will provide you with some additional detail on our Q1 performance and our outlook for the balance of the year. Over to you, Michael.

Thank you, Scott, and good morning. GAAP EPS of $1.81 came in above our guidance midpoint of $1.78. As expected, year-over-year EPS headwinds included $0.07 of foreign currency impact, $0.06 of higher restructuring costs and $0.03 of higher tax rate, which combined for $0.16 unfavorable EPS impact in the quarter. Excluding these headwinds, Q1 EPS would have been $1.97, an increase of 4% over last year. It is important to note that we expect these specific headwinds to significantly moderate as the year progresses. More on that later in my remarks. In addition, as we mentioned on the last call, Q1 also had 1 less shipping day, which was approximately $0.03 to $0.04 unfavorable impact to EPS and 1.5 percentage point reduction to organic growth. As a reminder, we get that shipping day back in Q3. Organic revenue for the quarter was down 1.5%, below our guidance due to the slower start in January and flat on an equal day basis. Sales trends improved in February and March as March organic revenue was up 2% year-over-year on an equal day basis. In line with our expectations, PLS impact related to 80/20 activities was 70 basis points this quarter. Operating margin of 23.6% improved 20 basis points, excluding 70 basis points of accelerated restructuring impact. Once again, strong execution on Enterprise Initiatives contributed 100 basis points. Another bright spot was stronger pricing and moderating raw material inflation, which resulted in better-than-expected price/cost margin impact in Q1. Cash flow performance was also a highlight as free cash flow increased 21% with a conversion rate of 90%, which is seasonally strong for the first quarter. Return on invested capital was 27.7% and finally, we repurchased $375 million of our shares as planned. As Scott said, the ITW team executed really well on the…

Okay. Thanks, Michael. We're going to open up the lines for questions. [Operator Instructions]. Cheryl, back to you.

[Operator Instructions]. Our first question comes from Andy Kaplowitz.

Scott or Mike, I think you mentioned international being down 1%. What was Europe specifically? In last quarter, you mentioned basically you're just seeing some isolated weakness in Europe mostly in auto. Is that still what you're seeing in Europe and what do you expect for the year there?

Yes, I mean, in Europe, the biggest -- so Europe overall was down 2%. As you point out, the biggest decline by far was the automotive OEM business. If you take that out, we're actually positive in Europe. We're seeing some pretty good performance. I mentioned Construction Products, up 5%; Food Equipment, up 4% and like I said, the biggest delta was really the automotive business.

Okay, that's helpful. And maybe just stepping back. I mean, we like to follow your CapEx-driven businesses like Test & Measurement, ex-Semicon and Welding, they do seem to be hanging there well and you mentioned some improvement in March sales. Did these businesses generally just sort of do well throughout the quarter? Do you have good visibility you think still in the sort of core Test & Measurement and Welding businesses as you move forward?

Yes, I mean, I think we saw pretty consistently across-the-board a slower start to the year as we talked about in January. But from there on, Welding, Test & Measurement, Food Equipment really improved in February and March and are on track to deliver on the organic growth guidance that we provided on the last call. So Food Equipment, up 3% to 5% for the year; Test & Measurement, tough comp, up 1% to 3%; and Semicon is a 2-percentage-point drag. As you know, we risk-adjusted our Semicon exposure and hopefully we have a pretty conservative view for Test & Measurement. Welding, up 10% last year. We expect to be up 3% to 6% this year. So the CapEx businesses, as you pointed out, are performing well. I'd add maybe to that from a pricing standpoint, that's also the case.

I think the only thing I would add is they are -- to your visibility question, Andy, these are book-and-ship businesses, so these are not long lead time businesses. So we are certainly seeing pretty steady performance right now. But these are not businesses where we have long lead times associated with them. So conditions on the ground right now seems to be up hanging in there pretty well.

Our next question comes from Joe Ritchie from Goldman Sachs.

[Technical Difficulty]. First half versus second half? And I know that in the Q, we'll get more information around price/cost. But...

Joe, we were cut off, I think, from the starting part of your question. Can you back up from the beginning, please?

Yes, sure. Sure, no problem. I'll start by again saying good morning. And so -- and so I said that Michael had provided some really good color on the first half, second half. And I was getting to my question which was really around price/cost and I know that this will come in the Q. But maybe if you could just provide a little bit more color around where you're seeing price/cost, what you saw in the segments this quarter and then how you see that progressing? Are there certain segments that are going to be better than others as we progress through 2019?

I'd say across-the-board, Joe, we saw positive price in all segments, including, for the first time in a while, in the automotive business. So pricing was slightly ahead of our expectations for Q1. And similarly on the cost side, we talked about last year moderating raw material costs. That certainly played out in Q1. And so last year, if you recall, total price/cost was 50 basis points of margin impact even though we're certainly positive on a dollar basis. We just did 10 basis points here of negative margin impact in Q1. And these cost dynamic -- price/cost dynamics are trending positive for the balance of the year. In terms of by segment, I would just point out, I mean, auto, as you know, even though positive on price, it can be a little challenging. It takes a little longer as we talked about before to get price there. But really, all the other segments across the board really strong pricing performance.

And maybe the other color I would add is essentially what the environment we are seeing across the board is moderating raw material cost inflation and the impact of prior price moves ultimately continue to play out in terms of the year-over-year comps. So there's always a lag between the costs and the pricing response. And so it's -- given the things continue to stay stable from input cost standpoint, we are picking up some added benefit on the price side. And that's what I think what we saw in Q1 and sitting here to-date, what we would expect to see through the balance of the year.

Okay. Got it. That's helpful. And then maybe just two real quick clarifications. Michael, you talked about flat auto builds as your assumption in the second half of the year. Is there still an outgrowth assumption embedded in your forecast? And then the second quick question clarification was really around corporate. That number was lower than we expected this quarter. How should we think about that than for the rest of the year?

Can you just repeat the second part, Joe?

Yes, the second one was around was...

The second question.

Yes, the corporate number was lower than we expected this quarter.

Yes, I think that's a pretty good -- I would take -- on the corporate side, our corporate costs are pretty much flat year-over-year on an annual basis. It can move around a little bit on a quarterly basis, but I would probably model last year. For the auto question, yes, there is -- for the full year, we're expecting, as we talked about, 2 to 3 percentage points of auto outgrowth, maybe at the lower end of that range here for the second half, just again trying to be a little bit more conservative in a pretty dynamic environment.

Our next question comes from Steve Volkmann from Jefferies.

So Michael, lots of discussion around sort of first half, second half but I noticed you guys didn't provide sort of a specific guide on the second quarter. And the streets got you sort of flattish, I guess, for the next three quarters. And I guess I just wanted to make sure there wasn't a little more detail you wanted to provide around that.

Yes. I think Q2 will look, in terms of organic growth, pretty similar to what we just reported for Q1. I think we do have the shipping day issue goes away in Q2 but this -- the first half is going to be, as we expected, pretty challenging. And so I guess that's the color that I will provide on Q2 and the first half.

Okay, fair enough. And then just a quick follow-up on Test & Measurement. Looks like semiconductor was really sort of what dragged that down. What are you hearing or seeing relative to semiconductor as we go forward?

Yes. So really no change to our view. We have, just as a reminder, about $200 million of Semicon exposure. The assumptions that we built into the plan this year was that to -- for that to be down double digits and we've not changed that view. But like you, we've certainly heard some of the more positive commentary from industry experts and customers as it relates to the back half of the year, but we have not adjusted anything in our guidance for Semicon. And so like I said, hopefully, that, that will turn out just like auto to be a fairly conservative view.

Our next question comes from Jamie Cook, Crédit Suisse.

I guess two questions. The comments that you made about things improving in March, you feel like that's consistent with what we've heard from other industrial companies. Can you just speak to what geographies or segments sort of that was most pronounced in, I guess, is what I would say? And then just my second question on the guide, I know you're taking organic growth down a little and you talked about the shipping days, your EPS -- but your margin expansion of 100 bps is still the same. Just on the like low organic growth, what's -- how do we still get the same margin improvement on sort of somewhat low organic growth would change quarter-to-quarter?

Yes, Jamie, you can do the math yourself and 0.5 point of organic growth in terms of EPS impact is in that mid- to high single-digit EPS impact, and the biggest driver kind of working the other way is the price/cost dynamic that we talked about. It really offsets that plus a couple of other puts and takes. But then it's really improved -- improving price/cost dynamics is why we are holding EPS guidance for the full year despite the lower organic growth. And then to your first question, this February, March dynamic vibe, that was pretty broad-based all segments. And if you look at the major geographies, we really saw the same dynamics in terms of a slower start to the year and then sequential improvements in February and March above our typical seasonality. So that's certainly encouraging and that's how it played out in the first quarter.

Our next question comes from Jeffrey Sprague from Vertical Research.

Just a couple for me. First, just on the trajectory into Q2. Given that it sounds like you exited March a bit better and we're not going to be talking about government shutdown or weather and everything else that was rolling on, why wouldn't you expect some acceleration in the organic growth rate in the second quarter relative to what you printed here today?

Yes, I think, Jeff, it's -- the comp is a little bit tougher. I believe we were up 4% in Q2 last year and so certainly, your points are valid. It's just the comp is a little bit more difficult in Q2.

And then just to clarify on the restructuring, Michael. The $0.09 in the first half, that's just the gross cost of the restructuring or is there some net benefit from the actions already kind of showing up in that number?

That's just the gross number. And that is -- it is the increase year-over-year in restructuring costs. And so I think we -- year-over-year, $0.10 is the higher restructuring cost, and of that, $0.09 are really in the first half of the year.

Okay, got it. And then just on back to price/cost. Are you able to continue to push price higher now in this environment or this is more about kind of analyzing the steps you've made and trying to kind of hold onto it maybe as costs start to slip the other way?

Yes, this is -- I think the big effort was around offsetting raw material costs, including tariff impact and we've essentially done that at this point and we're entering into a more normal pricing environment on a go-forward basis. Certainly, we benefit from the fact, as Scott said, that there was a lag last year. We've kind of -- we've neutralized that and we are trending in a more positive direction. But we also don't expect, to answer your question, that there was going to be price reductions. We will be able to hold on to what we have implemented so far, and we're just benefiting here in the near term from the raw material costs being a little bit better.

Our next question comes from Joel Tiss from BMO.

I wonder if, can you just -- I don't know if you mentioned this or not but the PLS for the year, I know you're jamming a lot into the first half. Is it going to be pretty much done? Or are there more things that you can pull out in the second half if you need to?

Yes, I mean, it's really not a number that we manage at the -- it's sort of...

Certainly, manage over the time.

It's more an outcome of the hundreds of activities and projects going on across the company. And so it was 70 basis points in the first quarter and our view for the year has not changed at 80 basis points.

Okay. And is it too early to frame for us the kind of earnings dilution you might get from divesting those seven underperforming businesses?

Well, we're not going to get the -- I mean, we are going to get some -- these businesses are profitable businesses. And so there are some earnings going away, but we'll more than -- the plan is to make that neutral by offsetting any earnings dilution by incremental share repurchases above the $1.5 billion that is in the plan.

$1.5 billion.

$1.5 billion. Did I say $1.5 million? $1.5 billion that's in the plan.

Our next question comes from Andy Casey from Wells Fargo.

Just wanted to -- the cadence that you talked about, the slow January getting better through March and you mentioned it was pretty broad-based geographically. Could you -- and Jeff kind of touched on some of this in his question. Can you kind of talk about what you were hearing for the reasons behind that in the U.S. and then also for international markets?

Yes. I mean, Jeff mentioned a few of them. I mean, I think it's difficult to quantify things like weather, for example. But we do know that our operations in Wisconsin in our Welding business were closed down for two days and you can -- that's certainly had an impact. But beyond that, it's really difficult too.

I would say there's sort of obvious promise it would have been if this was -- would have been isolated to North America or U.S., it was weather and the government shutdown. The fact that it was pretty consistent in our international business was certainly surprising. And to be honest with you, I don't think we've heard any great answers or theories necessarily other than it was certainly there as a factor seems to have moderated as we move through the quarter. But it was a really -- it's called an interesting early part of the quarter this year.

And then for auto, the EF&C acquisition integration, it seemed to accelerate a little bit from what you can see in the fourth quarter. Is that a correct read and how do you long do you expect that to persist as a headwind to margins?

I would -- these were -- these were planned activities just as we put together the acquisition integration plans. I think if anything, they were planned for this year and we moved them forward by a couple of quarters. But those were activities that were planned all along.

We're pretty focused in Europe, so some of the acceleration is -- although as Michael said, they were planned, some of the acceleration is really around in response to the dip in production rates in Europe. And in addition to that, some other restructuring in our core auto businesses in Europe. But the normal integration process, Andy, is typically 3 to 5 years, so these are essentially normal going forward with EF&C. And so certainly would expect that slowdown in another year or so in terms of specific restructuring around EF&C.

Just a follow-up on that. Should we pretty much expect the sort of a headwind through this year or should it dissipate as the year goes along?

The bulk of the restructuring -- 75% of our restructuring this year will be done in the first half of the year. So there's going to be a benefit when you look at the second half relative to the first half when we get to the second of the year.

In terms of less year-to-year headwind and also in terms of benefits from the investment...

Right, there's two dynamics here. That's a good point. I mean, there's lower restructuring costs in the second half of the year and you're starting to see the benefits from the projects that we are executing right now and that we've approved for the first half of the year and quantified that at $25 million to $30 million. So $0.05 to $0.06 a share of benefit here in the second half relative to the first half.

Our next question comes from Mig Dobre from Baird.

My question is on Food Equipment starting there. So frankly, this was a little bit slower than what I anticipated in terms of your organic growth in the quarter. And I'm wondering if you can provide a little more color here. I understand you mentioned a tough comp in institutional but at least looking back through the data that I've got, it looked to me like from an overall segment perspective, Q1 was really your easiest comp in Food Equipment. And I guess what I'm wondering here, as the comparisons gets tougher as the year progresses, how do you think about growth here and what's happening in front?

It's tough to hear what you were saying, Mig. But I'll do my -- the volume was a little low. But I think Food Equipment, similar to the other segments we talked about, a little bit of a slower start but then picked up good momentum in February and March up 3% equal days after up 5% in Q4. I think in North America, what's encouraging is the restaurant side, and QSR was growing in the mid- to high single digits. Food retail was up significantly year-over-year, which is the grocery stores. And then the challenge was really some comps on the institutional side. And so those are -- those can be bigger projects that move around, were up 10% on the institutional side last year. And so like we said, with current run rates, we've got some new products coming in, anecdotally, quoting activity, backlog, order activity all points to a pretty solid year here with 3% to 5% growth. And like I said, new products, retail is improving, Europe's pretty strong and looking good for the rest of the year. So we're pretty confident with our...

And the service business growing by the best quote, that is growing 4% to 5%.

Yes, service up 4%, it was certainly encouraging. So we're on track here, Mig. It would be our current view.

Okay, okay. I appreciate that. Then switching to Welding. So you mentioned a couple of missed shipping days in Q1. I'm presuming this is, I don't know, as much as 300 basis points worth of growth to that segment. When do you expect to make those up? Is that lost business? Or do you just make it up in subsequent quarters? And of course, comps are getting tougher here as well, especially on a two year stacked basis. Do you think there's enough momentum in this market to allow you to really hit kind of this 3% to 6% guidance?

Yes, I mean, the short answer is yes, we do. We are on track for 3% to 6% organic growth. It's really hard to quantify, of the two days the operation were closed down, how much did we get back in Q1, how much we're going to get back in Q2. I think when we look at -- broad-based, this is still pretty solid. If you look at the equipment up 3%, consumables up 4%, industrial business was up 3% against the tough comp, Commercial was up 5%, national is really good. China up 20%, we don't talk much about that and then Oil & Gas slowed a little bit. But I think some of that, you can maybe point to the rental business specifically and weather, if you want to. But we feel good about the outlook also in Welding for the year.

Our next question comes from Ann Duignan from JPMorgan.

My questions have been answered, but maybe a little bit more of a deep dive into Construction Products, both U.S. and international, just some commentary on what you're seeing in those markets.

Yes. I think I sound like a broken record here, but this was a little bit of a slower start. North America was down, which is not typical. We did have a tough comp last year. The residential remodel side is still pretty solid, I think into the big box, kind of retail channel very good. Commercial was down 4%. That can move around a little bit and has kind of been flattish over the years. I'd say we certainly saw a pickup here in February, March, which is encouraging. We got some new products coming in our cordless technology that's going to get rolled out this year across all geographies. Europe really good, up 5%. And then Australia and New Zealand, as expected, down 6%, just like we did last year in the fourth quarter. And I think there, that's really more of a macro economy than anything else. So...

Okay. And maybe some commentary on North America resi, we're seeing a slowdown in housing. Are you seeing any reacceleration and any color there on the housing side?

There was a little bit of that in Q1. It's -- residential remodel overall was flat. The remodel side is positive, new housing -- new residential is a little slower. But I don't think there's a big macro commentary hear from us. I think we feel pretty good looking into Q2 and the balance of the year.

Our next question comes from Josh Pokrzywinski from Morgan Stanley.

So I know a lot of the questions have already been asked here. But -- and apologize if I missed this one around inventory destocking. We heard from 3M last hour that they saw a pretty good amount of destocking in auto, which I would imagine most of your exposure is more just-in-time. But just trying to get a sense for across the portfolio, anything you saw on a 4Q pre-buy or a 1Q destock that might not make 1Q look quite as slow as what it appears on the page?

I would say in the auto space certainly, as production drops, there is a bit of a compounding effect in terms of inventory at the tiers and even at the OEMs, so -- right? I know that I would call it sort of intentional destocking other than what I would describe it as, from our perspective, it would be just normalizing inventory levels based on lower production rates. But certainly, it's got some compounding effect beyond just the drop in actual end product production. So certainly, in auto, when you talk about declines in the high single digits, some of that was a factor, there's no doubt, in our organic sales in Q1 as well. Beyond that, I'm not aware of any pre-buy or any significant other actions in any of our other segments related to that.

Got it. And do you have any kind of above-normal price increase on Jan 1 that might have supported that even if it wasn't obvious to see that people would've looked at? Or is the pricing calendar was a little different?

From a pricing standpoint, we certainly had price increases in across our 87 divisions, there are certainly pricing actions that were -- that took place in Q4 and in early Q1. I can't say that any of it was so concentrated on January 1 that it wouldn't have had a big impact if were caused a, let's call it, a material pre-buy at the enterprise level anywhere. But at the division level, I'm sure there's was some puts and takes related to that.

Yes, I would just add to that, I mean, the pricing activities have really been going on across the company for the last 6 to 9 months as we've worked to offset the raw material cost inflation. And so I would agree with Scott, we don't think anything unusual here, January 1.

And our next question comes from Walt Liptak from Seaport.

Just a couple of follow-ups that I can go through real quick. One, just to clarify, which segments are getting the restructuring?

So if you look at the first half spend here, close to half of it is directed at auto automotive segment that we talked about. And the balance is really our typical kind of 80/20 front-to-back activities and it's pretty well suited across the segments. I think if you do the math, Construction, Specialty Products, Food Equipment, kind of in that order would be -- but it's pretty broad-based.

Okay, great. And then the divestiture, I may have missed this but the timing of it is in the second quarter that we should expect those?

So I think I more second half would be a realistic view. I think there's quite a bit of work that goes into getting these divestitures done. And so I think we expect second half of the year would expect the first ones to come through.

Our next question comes from Steve Fisher from UBS.

You guys have done a very good job of being able to maintain your EPS despite the organic challenges in recent quarters or years. So I'm just curious if you stress tested that ability. I mean, we can do our own math on buybacks, but it seems like you may have called out some pricing strategies here. Just curious how much organic growth reduction you could phase in and still maintain your EPS guidance. So for example, if we would have to take another point out for the year if the second half didn't really come through. Kind of is that a level of which you could still hold your guidance?

Yes, I think -- I would guess I'd just point to our track record over the last six years that we've done, I think, a pretty good job giving a realistic view of what the year might look like. And then we've executed really well to do better than that and I think we expect to be able to continue to do that.

Okay. And then maybe just a follow-up to Mig's question on Welding. Are you anticipating that the organic growth would hit at or near the top end of the 3% to 6% range in the second half? And if so, is that China continuing that strong double-digit pace? Is it oil improving? How are you thinking about that?

Yes. So as I think for Welding specifically, we are -- like we said, we are comfortable with the 3% to 6% for the year. We have a challenging comp here again in Q2. It gets a little easier in Q4. But beyond that, I can't really give you quarterly numbers for the Welding business in the second half.

We're near the end of the hour. How about we take one more question and end the call.

Our final question will be from Nicole DeBlase from Deutsche Bank.

Just one question on March. Is there any possibility that March is benefiting from the shift in Easter from March to April this year? And I guess maybe a way to talk about that is how is the strength you've seen in March continued into the early weeks of April?

Yes. I mean, I don't have a really good answer to your question other than we saw sequentially better sales trends in February and in March than what we see historically in April, everything appears to be on track as we sit here today.

And then on the price/cost impacts, if we kind of think about how costs are expected to wash through the year, if we assume that there's no major change in input costs from this point, kind of like flat and then the spot rate, is it possible that price/cost turns into a tailwind for you guys by the back half?

Yes, that is a possibility. If -- and this -- I mean, a little bit, Nicole, because things are pretty dynamic, right, still. And so on the cost side, there's still the tariff dynamic, who knows...

And if you lock the cost right now.

To answer your question, no, it's based on cost where they are today and where price is. Mathematically, it should turn positive in the back half of the year from a margin standpoint.

Okay. So with that, we'll end the call on the hour. I know you guys have a busy day today and I'm happy to take any follow-up questions afterwards. So thanks for joining us.

Thank you for participating in today's conference call. All lines may disconnect at this time.