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Edited Transcript of ITW earnings conference call or presentation 25-Apr-19 2:00pm GMT

Q1 2019 Illinois Tool Works Inc Earnings Call

GLENVIEW Apr 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Illinois Tool Works Inc earnings conference call or presentation Thursday, April 25, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* E. Scott Santi

Illinois Tool Works Inc. - Chairman & CEO

* Karen A. Fletcher

Illinois Tool Works Inc. - VP of IR

* Michael M. Larsen

Illinois Tool Works Inc. - Senior VP & CFO

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Conference Call Participants

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* Andrew Alec Kaplowitz

Citigroup Inc, Research Division - MD and U.S. Industrial Sector Head

* Andrew Millard Casey

Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst

* Ann P. Duignan

JP Morgan Chase & Co, Research Division - MD

* Jamie Lyn Cook

Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst

* Jeffrey Todd Sprague

Vertical Research Partners, LLC - Founder and Managing Partner

* Joel Gifford Tiss

BMO Capital Markets Equity Research - MD & Senior Research Analyst

* Joseph Alfred Ritchie

Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst

* Joshua Charles Pokrzywinski

Morgan Stanley, Research Division - Equity Analyst

* Mircea Dobre

Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst

* Nicole Sheree DeBlase

Deutsche Bank AG, Research Division - Director & Lead Analyst

* Stephen Edward Volkmann

Jefferies LLC, Research Division - Equity Analyst

* Steven Fisher

UBS Investment Bank, Research Division - Executive Director and Senior Analyst

* Walter Scott Liptak

Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst

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Presentation

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Operator [1]

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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.

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Karen A. Fletcher, Illinois Tool Works Inc. - VP of IR [2]

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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.

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [3]

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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: 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.

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [4]

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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 things within our control and other than the slow start in January, this was a pretty solid quarter for ITW.

Moving to Slide 4 for some detail on operating margin. Overall, 23.6% operating margin in Q1 as I mentioned. And on the bottom left of the slide, we laid out the positive price/cost trends that I just referenced. Strong pricing across all segments more than offset moderating raw material costs on a dollar basis, resulting in improving price/cost dynamics in Q1 and going forward.

On the right side, Enterprise Initiatives continue to be our most significant and most consistent contributor to margin performance. Our 80/20 initiatives and Strategic Sourcing efforts combined for 100 basis points of margin improvement. And that impact is broad-based. In the quarter, Enterprise Initiatives' benefits ranged from 70 to 130 basis points across each of our 7 segments.

This quarter, revenues were down, resulting in 30 basis points of negative volume leverage, only 10 basis points of margin dilution from price/cost, which was our best performance since the fourth quarter 2016 and 40 basis points of other, which is primarily related to employee costs, specifically our typical annual salary and wage increases. Going forward, we expect to return to our normal run rate of 10 to 30 basis points for this line item in the remaining quarters of 2019.

This brings us to net 20 basis points of margin expansion before adding the impact of 70 basis points from restructuring, which considering the negative volume impact this quarter, is pretty solid performance. Even with the higher restructuring, operating margin was strong at 23.6% and the good news is that we have significantly more runway for improvement as the year progresses and over the next few years, as we shared at our Investor Day in December.

Please turn to Slide 5 for details on segment performance. The table on the left summarizes organic growth both as reported and normalized on an equal days basis. As you can see, 6 segments had flat to positive organic revenue growth on a worldwide basis despite the slower start to the year, with automotive OEM the only segment that declined due to the decline in automotive production this quarter.

On a geographic basis, North America organic revenue was up 1% while international was down 1%. For the year, we're expecting low single-digit growth in all major regions based on current run rates and our risk-adjusted view of auto build forecasts. On that point, IHS forecasts combined auto build growth for North America, Europe and China to be plus 4% in the second half. Our risk-adjusted view puts those combined builds flat for the second half, 4 points lower, which is the scenario embedded in our annual guidance. More on that a little later in my remarks.

This brings us to the right side of this slide on Automotive OEM segment results. Overall, organic revenue was down 6%. IHS data for Q1 build rates in North America, Europe and China combined saw the decline of 8% in the quarter in what remains a pretty dynamic industry environment. That said, there's some optimism in the industry and amongst our teams on the ground that builds would bottom out in the first half. Again, looking at North America, Europe and China combined, IHS projects auto production to be down 6% in the first half, followed by 4% growth in the second half. And as I just mentioned, our current guidance reflects an assumption of only 1 -- flat growth in auto production, no growth in auto production in the back half of the year.

Our North American business was down 6% with Detroit 3 production down significantly. As expected in the quarter, builds were also down in Europe and China. In Europe, the implementation of the WLTP emissions testing procedures last year continues to cause some auto production disruption although this situation seems to be normalizing. And in China, auto retail sales were down double digits in the quarter.

Automotive operating margin declined 350 basis points this quarter. As planned, restructuring related to our adjusting our cost structure in Europe and EF&C acquisition integration reduced margins by 190 basis points. Despite the fact that we're beginning to trend positive on price in this segment and actually getting positive price in the first quarter, price/cost reduced margins by 110 basis points.

Just stepping back for a minute from some of these near-term challenges in the auto market. Our new program wins remain strong as does our new product pipeline. Our annual new program win targets equate to 2% to 3% of above-market organic growth, and we have met or exceeded those targets for each of the last 3 years and expect to do so again in 2019. Overall, we have a strong and focused business operating in a well-defined, highly value-added niche in the auto market. And we deliver a ton of value to our customers in serving that niche as reflected in both our level of profitability and in our organic growth rate over the last 5 years.

As you all know, this is an industry that's going through significant change, and in our view, the trends and changes that will play out in the auto industry over the next decade or so only add to the significant future profitable growth potential that ITW has in this space. There's no question that we're in a challenging point in time with regard to the auto market, and we are taking the appropriate steps to adjust our cost structure accordingly.

In fact, we're performing quite well in the current auto downcycle as reflected in our ability to maintain auto OEM segment operating margins well above 28% despite a meaningful year-over-year revenue decline over the past 2 quarters. We will continue to manage our way through these near-term demand challenges, but our primary focus remains on acting and investing to position ITW to take full advantage of the significant long-term profitable growth potential that we have ahead of us in our niche of the auto market.

Moving on to Slide 6. Food Equipment organic growth was up 3% on an equal days basis, which follows the best quarter in [4] years. You will recall that Q4 organic growth was up 5%. In North America, organic growth was 2% with equipment flat and service up a strong 4%. Growth in independent restaurants and QSR was solid, partially offset by a decline in institutional, where we had a tough comp of 10% growth in the prior year quarter. Food retail was a bright spot, up double digit and we're encouraged to see a sequential recovery taking shape there.

Overall, current run rates, coupled with new product introductions, support our view that sales trends will improve from here as the year progresses. With respect to international markets, Europe grew mid-single digits, primarily on strong performance in our warewash division. Operating margin was almost 25% with Enterprise Initiatives and volume leverage offsetting the impact from restructuring activity in this segment.

Test & Measurement and Electronics had a solid quarter with organic revenue up 1% on an equal days basis against a tough comp of 8% organic growth in the prior year. As expected, Test & Measurement was down 2% on lower sales to semiconductor equipment manufacturers. Excluding semiconductor, Test & Measurement was up 5%. Electronics was up 1% with strong sales in equipment assembly and contamination control, partially offset by a decline in electronic components where we had a 9% growth comp last year. Operating margin expanded 70 basis points to 24.1% with Enterprise Initiatives' benefits the main driver.

On to Slide 7. Welding had a solid quarter despite the fact that organic growth was off to a slow start in January, in part as our main operations in Wisconsin was shut down for 2 days due to weather. Welding ended up 5% on an equal day basis against a tough comp of 8% last year. As you can see on this slide, organic growth was fairly consistent across-the-board with equipment and consumables both up in the 3% to 4% range. North America industrial was up 3% against a comp last year of 15% and Commercial was up 5%. International growth was particularly strong in China, up more than 20%, while Oil & Gas was essentially flat. Based on current run rates, we continue to expect organic growth of 3% to 6% this year against a tough 2018 comp of 10%. Operating margin was 28.1%, up 40 basis points in the quarter.

Polymers & Fluids' organic growth was up 1% on an equal days basis. As we talked about on the last call, we expected auto aftermarket to be down following strong 7% growth in the fourth quarter driven by new product launch. Polymers was up 2% while Fluids was up 1% and operating margin expanded 40 basis points in this segment as well.

Turning to Slide 8. Construction organic revenue was flat on an equal days basis. North America was down 3% due primarily to a tough comp with Q1 last year, up 7%. Residential remodel sales were essentially flat while new construction was impacted by softness in U.S. housing starts. Commercial construction was down 4%. Recent sales trends support our view here that we expect sales to improve going forward as comparisons ease and new products are introduced. Europe grew a strong 5% with robust demand across-the-board. Australia and New Zealand sales were down 6% similar to the fourth quarter with some continued softness in the economy.

Specialty organic growth was flat on an equal days basis with solid organic growth of 6% in the equipment businesses offset by softness in consumables. Specifically, a few divisions internationally, including graphics and appliances. Overall, international was down 6% and North America grew 2%. Operating margin was essentially flat at 26.5%.

Moving on to Slide 9 and an update on 2019 guidance. As you saw this morning, we are reiterating our full year EPS guidance range of $7.90 to $8.20, which represents 4% to 8% growth year-over-year. We now expect organic growth in the range of 0.5% to 2.5%, given the slow start in January. Our guidance is based on current demand run rates and a risk-adjusted second half forecast for auto builds as we talked about. This compares to prior guidance for organic growth of 1% to 3%. And other than the slow start to the year, our outlook for organic growth through the rest of the year is essentially unchanged.

As we talked about on the last call, we fully expected going into 2019 that the first half of the year was going to be more challenging for a number of specific reasons, as many of these challenges would dissipate, such as the operating environment will be more favorable in the back half of the year. As Scott mentioned, this dynamic is pretty much as expected, and our current view of the year is pretty much in line with the organic revenue guidance ranges by segment and the EPS bridge that we provided on our last call.

Because the first half of 2019 will be a little more challenging than what is typical for us in terms of year-over-year comparisons, I'll spend a minute describing how we expect some of these challenges to play out as the year progresses.

On Slide 3, we sized the EPS impact in Q1 from foreign currency translation impact, restructuring costs and tax rate for a total of $0.16 year-over-year. For Q2, we expect currency impact at current rates of about $0.06 and higher restructuring activity of about $0.03 for a total of $0.09 in Q2, which adds up to about $0.25 per share for the first half of 2019. These 3 items are still headwinds year-over-year in the second half but only to the tune of $0.05 to $0.10. In other words, we expect to see an improvement to second half EPS of $0.15 to $0.20 versus the first half on currency, restructuring and tax.

Now let's talk about organic growth. First, in terms of sales comparisons year-over-year, we have one more challenging organic growth comparison ahead of us in Q2 and then comps get significantly easier in the second half. Second, there's 1 extra shipping day in the third quarter, which as I mentioned, adds 1.5 percentage points to our Q3 organic growth rate. Third, auto builds for the combined regions, North America, Europe and China, are expected to improve significantly in the second half. As I mentioned earlier, IHS forecasts builds in these combined regions will be up 4% and our guidance has risk-adjusted this down to builds being flat. Therefore, based on current run rates, easier comps, the extra shipping day and our risk-adjusted view of auto builds, we expect organic growth in the second half will be in the range of 3% to 4%.

Finally, on the margin side, we talked about much improved price/cost dynamics with stronger pricing and more favorable raw material costs. At this point, price/cost margin impact is essentially neutral, and on a dollar basis, price remains significantly higher than the raw material costs. In addition, we expect that restructuring benefits related to the projects that we accelerated into the first half will start to deliver benefits in the second half of the year. The average payback on the projects that we approved in the first half are less than a year, and the savings projected for the second half on these projects are expected to be in the $25 million to $30 million range.

The most significant and consistent driver of margin improvement remains the Enterprise Initiatives where we have clear line of sight to projects and activities that support at least 100 basis points of improvement every quarter going forward and for the full year. And as I said earlier, we're off to a strong start in free cash flow and expect conversion above 100% of net income for the year. And as you know, we've allocated $1.5 billion to share repurchases in 2019.

Before I wrap up my prepared comments, just a few words on our portfolio management activities. Overall, we're on track to complete some of -- of our planned divestitures in 2019, pending Board approval. Given the quality of these ITW businesses, we're seeing solid interest and attractive valuations.

As we complete the project schedule for 2019, they will trigger some pretty significant gains on sale and cash proceeds, all of which are excluded from our current guidance. As we have stated before, the divestiture of these long-term growth challenge divisions, when completed by the end of 2020, are expected to be accretive, favorable to our overall organic growth rate and margins in the tune of 0.5 point of organic growth and 100 basis points of margin expansion. And as a reminder, we're committing to making sure that these divestitures are EPS-neutral, and we plan to offset any EPS dilution with incremental share repurchases above the $1.5 billion in our plan today.

In summary, as we have for the past 6-plus years, we delivered on our quarterly commitments despite some near-term challenges that we continue to expect will dissipate in the back half of the year. Overall, we're set up for a stronger second half in terms of delivering solid organic growth with best-in-class margins and returns, accelerating earnings growth and strong free cash flows.

With that, Karen, back to you.

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Karen A. Fletcher, Illinois Tool Works Inc. - VP of IR [5]

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Andy Kaplowitz.

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Andrew Alec Kaplowitz, Citigroup Inc, Research Division - MD and U.S. Industrial Sector Head [2]

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Scott or Mike, I think you mentioned international being down 1%. What was Europe, specifically, and 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?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [3]

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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.

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Andrew Alec Kaplowitz, Citigroup Inc, Research Division - MD and U.S. Industrial Sector Head [4]

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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?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [5]

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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 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 point out, are performing well. I'd add maybe to that, from a pricing standpoint, that's also the case.

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [6]

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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 hanging in there pretty well.

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Operator [7]

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Our next question comes from Joe Ritchie from Goldman Sachs.

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Joseph Alfred Ritchie, Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst [8]

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(technical difficulty)

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Joseph Alfred Ritchie, Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst [9]

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first half versus second half. And I know that in the Q, we'll get more information around price/cost. But...

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [10]

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

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Joseph Alfred Ritchie, Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst [11]

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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?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [12]

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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 our 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've talked about before, to get price there. But really, all the other segments across the board, really strong pricing performance.

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [13]

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And maybe the other color I would add is essentially, what the environment we're 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 the 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 so year-to-date, what we would expect through the balance of the year.

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Joseph Alfred Ritchie, Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst [14]

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Okay. Got it. That's helpful. And then maybe just to 2 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 then for the rest of the year?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [15]

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Can you just repeat the second part, Joe?

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Joseph Alfred Ritchie, Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst [16]

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Yes, the second one was around was...

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [17]

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The second question.

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Joseph Alfred Ritchie, Goldman Sachs Group Inc., Research Division - VP & Lead Multi-Industry Analyst [18]

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

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [19]

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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.

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Operator [20]

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Our next question comes from Steve Volkmann from Jefferies.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [21]

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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 Street's got you sort of flattish, I guess, for the next 3 quarters. And I guess I just wanted to make sure there wasn't a little more detail you wanted to provide around that.

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [22]

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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.

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Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [23]

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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?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [24]

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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 will turn out, just like auto, to be a fairly conservative view.

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Operator [25]

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Our next question comes from Jamie Cook, Crédit Suisse.

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [26]

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I guess, 2 questions. The comments that you made about things improving in March, I 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 lower organic growth, what's -- how do we still get the same margin improvement on sort of somewhat lower organic growth would change quarter-to-quarter?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [27]

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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 that 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.

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Operator [28]

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Our next question comes from Jeffrey Sprague from Vertical Research.

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Jeffrey Todd Sprague, Vertical Research Partners, LLC - Founder and Managing Partner [29]

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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 shutdowns and weather and everything else that was rolling on, why wouldn't you expect some acceleration in your organic growth rate in the second quarter relative to what you printed here today?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [30]

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Yes, I think, Jeff, it's -- the comp is a little bit tougher. 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.

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Jeffrey Todd Sprague, Vertical Research Partners, LLC - Founder and Managing Partner [31]

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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?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [32]

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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.

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Jeffrey Todd Sprague, Vertical Research Partners, LLC - Founder and Managing Partner [33]

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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 [annualizing] the steps you've made and trying to kind of hold onto it maybe as costs start to slip the other way?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [34]

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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're trending in a more positive direction. But we also don't expect, to answer your question, that there is 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.

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Operator [35]

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Our next question comes from Joel Tiss from BMO.

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Joel Gifford Tiss, BMO Capital Markets Equity Research - MD & Senior Research Analyst [36]

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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?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [37]

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

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [38]

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[It's an outcome of time.]

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [39]

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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.

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Joel Gifford Tiss, BMO Capital Markets Equity Research - MD & Senior Research Analyst [40]

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Okay. And is it too early to frame for us the kind of earnings dilution you might get from divesting those 7 underperforming businesses?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [41]

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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 million (sic) [$1.5 billion] that is in the plan.

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [42]

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$1.5 billion.

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [43]

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

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Operator [44]

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Our next question comes from Andy Casey from Wells Fargo.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [45]

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Just wanted to go -- 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. Could you kind of talk about what you were hearing for the reasons behind that in the U.S. and then also for international markets?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [46]

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Yes. I mean, I think 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 2 days and you can -- that certainly had an impact. But beyond that, it's really difficult to...

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [47]

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Yes, I would say, the sort of obvious premise 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, for sure.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [48]

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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 long do you expect that to persist as a headwind to margins?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [49]

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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.

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [50]

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We're pretty focused on Europe, so some of the acceleration is -- although as Michael said, they were planned, some of the acceleration was 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 normalization process, Andy, is typically 3 to 5 years, so these are not the normal things that would go in year 4 with EF&C. And so we would expect that slowdown in another year or so in terms of specific restructuring around EF&C.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [51]

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

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [52]

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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 back end of the year.

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [53]

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

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [54]

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Right, there's 2 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.

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Operator [55]

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Our next question comes from Mig Dobre from Baird.

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst [56]

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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 get tougher as the year progresses, how do you think about growth here and what's happening in front?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [57]

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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's improving, Europe's pretty strong and looking good for the rest of the year. So we're pretty confident with our...

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [58]

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And the service business growing, by the best quote, that it's growing 4% to 5%.

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [59]

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

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst [60]

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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 2-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?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [61]

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Yes, I mean, the short answer is, yes, we do. We are on track for 3% to 6% organic. It's really hard to quantify, of the 2 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 equipment up 3%, consumables up 4%, industrial business was up 3% against a 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.

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Operator [62]

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Our next question comes from Ann Duignan from JPMorgan.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [63]

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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.

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [64]

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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 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...

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [65]

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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?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [66]

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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 here from us. I think we feel pretty good looking into Q2 and the balance of the year.

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Operator [67]

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Our next question comes from Josh Pokrzywinski from Morgan Stanley.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [68]

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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.

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [69]

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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 I don't 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.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [70]

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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 look a little different?

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [71]

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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 or 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.

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [72]

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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.

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Operator [73]

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And our next question comes from Walt Liptak from Seaport.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [74]

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

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [75]

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So if you look at the first half spend here, close to half of it is directed at 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.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [76]

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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?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [77]

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So I think a 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, we'd expect the first ones to come through.

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Operator [78]

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Our next question comes from Steve Fisher from UBS.

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Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [79]

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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've 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 face and still maintain your EPS guidance. So for example, if you were to have to take another point out for the year if the second half didn't really come through, is that a level at which you could still hold your guidance?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [80]

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Yes, I think -- I would guess I'd just point to our track record over the last 6 years that we've done, I think, a pretty good job of 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.

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Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [81]

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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?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [82]

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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.

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Karen A. Fletcher, Illinois Tool Works Inc. - VP of IR [83]

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

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Operator [84]

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

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Nicole Sheree DeBlase, Deutsche Bank AG, Research Division - Director & Lead Analyst [85]

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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, has the strength you've seen in March continued into the early weeks of April?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [86]

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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.

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Nicole Sheree DeBlase, Deutsche Bank AG, Research Division - Director & Lead Analyst [87]

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And then on the price/cost impact, 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 flatline in the spot rate, is it possible that price/cost turns into a tailwind for you guys by the back half?

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [88]

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Yes, that is a possibility. If -- this -- I mean, I have to say 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...

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E. Scott Santi, Illinois Tool Works Inc. - Chairman & CEO [89]

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And if you lock the cost right now.

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Michael M. Larsen, Illinois Tool Works Inc. - Senior VP & CFO [90]

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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.

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Karen A. Fletcher, Illinois Tool Works Inc. - VP of IR [91]

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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.

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Operator [92]

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