Illinois Tool Works Inc.

Welcome, and thank you for joining ITW's 2018 Fourth Quarter Earnings Call. My name is Cheryl, and I will be your conference operator today. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. Please note, today's conference is being written of investor relations. You may begin.

Thank you, Cheryl. Good morning, everyone, and welcome to ITW's fourth quarter 2018 conference call. I'm joined by our chairman and CEO, Scott Santee, along with Senior Vice President and CFO, Michael Larson. During today's call, we will discuss fourth quarter and full year 2018 financial results, and we'll update you on our 2019 outlook. Slide two is a reminder that this presentation contains our financial forecast for the first quarter and full year 2019, as well as other forward-looking statements identified on this slide. We refer you to the company's 2017 Form 10-K and subsequently filed Form 10-Qs 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 the reconciliation of those measures to the most comparable GAAP measures is contained in the press release. As a reminder, in 2017, we disclosed a $95 million favorable legal settlement and recorded a one-time tax charge in the fourth quarter. Therefore, we provided you with two tables on slides three and four that summarize key financial measures for fourth quarter and full year on a GAAP basis, as well as on an adjusted basis, excluding the legal settlement and tax charge. For the rest of this conference call, our comments and variances exclude these two items, these two one-time items from 2017. So, with that, we can move to slide five, and I'll now turn the call over to our chairman and CEO, Scott Santee.

Scott Santee Thanks, Karen, and good morning, everyone. Greetings from the epicenter of the polar vortex. In the fourth quarter, the ITW team delivered solid earnings growth and margin expansion. Fourth quarter EPS was in line with the midpoint of our guidance and increased 8%, 10% excluding currency, with operating margin up 70 basis points to 24%, and after-tax return on invested capital up 320 basis points to over 27%. For the full year, the ICW team delivered high-quality earnings growth of 15%, record operating income, record operating margin, and record return on invested capital. Cash flow was up 10%, and in addition, we returned more than $3 billion to shareholders in the form of dividends and share repurchases. Throughout 2018, we continued to make significant progress on the execution of our enterprise strategy. as evidenced by 110 basis points of margin improvement from our enterprise initiatives over the course of the year. And we made really good progress on organic wealth acceleration in better than half of our operating divisions. As we discussed at our investor day back in December, our focus now is on getting the other 36 of our divisions that are not yet growing to their potential moving more briskly down that path. And it's a major focus for us in the next couple of years. There's no doubt that 2018 had its challenges, raw material cost inflation, tariff uncertainties, decelerating auto production, and currency headwinds in the back half of the year. Our ability to power through these challenges and deliver another year of record results is evidence of the performance power of the ITW business model and the resilience of our high-quality, diversified business portfolio. As we head into 2019, I'm confident that we are well positioned to deliver another year of meaningful progress down the path to ITW's full potential and to our 2023 performance goals. Before I turn the call over to Michael, let me conclude by recognizing and thanking my ITW colleagues around the world for the great job that they continue to do in serving our customers and executing our strategy with excellence.

Michael, over to you. Thanks, Scott, and good morning. Let's stay on slide five and recap a few more highlights for the fourth quarter. GAAP EPS was $1.83, an increase of 8% as we managed through some international end market softness in two segments with solid execution and delivered earnings per share at the midpoint of our guidance. Organic revenue was up 1% with solid 4% growth in North America, offset by a 2% decline in international markets. I'll provide some additional color in what we saw in North America and international markets in a couple minutes. PLS was 90 basis points this quarter, a little bit above our full year rate of 70 basis points. Operating margin performance was solid as margins improved initiatives, lower price-cost margin dilution headwinds. Finally, free cash flow increased 18% to $727 million. 120 percent of net income, and we repurchased $500 million of our shares in the quarter. Moving to slide six for detail on fourth quarter operating margin. We've expanded operating margin every quarter this year, and the fourth quarter was no different. In fact, we did better than last quarter with 70 basis points of improvement year-over-year versus 30 basis points in Q3. All year, our teams have continued to execute well on enterprise initiatives, consistently contributing 100 basis points or more of margin improvement every quarter. And the impact is broad-based. In the fourth quarter, enterprise initiative benefits ranged from 80 to 120 basis points across each one of our seven segments. As I mentioned, price-cost margin dilution improved, narrowing from 70 basis points in the second quarter to 60 basis points in the third quarter and now 40 basis points in the fourth quarter. Throughout the year, we continue to take decisive pricing actions to offset cost inflation and tariff impact. As planned, on a dollar basis, price more than offset raw material costs this quarter and for the full year. All in, operating margin expanded by 70 basis points in the fourth quarter to 24 percent, the highest Q4 operating margin in ITW's history. Now we'll look at segment performance, starting with slide seven. The table on the left provides some additional color on our fourth quarter organic growth rates by segment and by region. As I mentioned, North America continued its solid growth pattern with 4% this quarter, similar to third quarter and first half of the year. North America has really been steady and strong all year, ending the year up 4%. You can see some really good organic growth numbers in North America with, for example, food equipment and welding, both up 7% in columns of fluids. For the full year, every segment, specifically in two segments, 2% in the first half of the year. The international market challenges that we're experiencing are not broad-based and relate to just two segments, automotive OEM and specialty. Excluding those two segments, our international growth rate in Q2 would have been four points higher at plus 2%. More on that in the next few slides. I should just point out that China overall was down slightly at minus 2% with, again, lower sales in automotive OEMs. and specialty only. The other five segments saw positive demand trends as evidenced by, for example, test and measurement electronics up 12 percent, welding up 22 percent, and polymers and fluids up 9 percent. For the full year, China was up 3 percent. Let's go into the segment details, starting with automotive OEM. Organic growth was down 4 percent this quarter. North America being positive 2% was not enough to offset a meaningful reduction in build rates in Europe and China. For the full year, automotive OEM organic growth was flat as the auto bills in regions that are relevant to ITW all declined. If you look at 2018 full year organic growth compared to bills by region, we delivered significant above market growth in two of our key markets, North America and China. In North America, we grew 3% versus bills down 1%. And in China, organic growth was 3% versus bills down 4%. In Europe, the implementation of mandated new emissions testing procedures in Q3 caused significant auto production disruption in the back half of the year. We're confident that our below build rate revenue declines in the second half are a function of mix, what models pass the new emissions testing procedures and when, and not the result of any material share loss. Our new program wins in Europe in 2018 were very strong, as is our new program pipeline there. We remain confident that our European auto businesses are well positioned to deliver consistent above-market growth and that they will get back to doing so over the next several quarters. With respect to the European market production issues I referenced a minute ago, our auto team on the ground expects that they will work themselves through over the next several quarters. Fourth quarter operating margin declined 150 basis points, almost entirely due to price-cost headwinds.

As you know, pricing actions take longer to implement in the automotive margin of 22.5%.

was down only 30 basis points with the benefits from enterprise. It was a strong quarter and delivered accelerating organic revenue growth of 5%. Its highest quarterly growth in four years as overall demand continued to improve across the board. North America grew 7% with equipment up 9% and service up 4%. Food service was up 11%, and retail, i.e., sales to grocery stores, turned positive, as we've talked about on prior calls. Growth in institutional end markets in the education and lodging categories. International markets were solid, too, up 3% with good growth in both equipment and service. As expected, test and measurement and electronics organic revenue was flat against a tough comp of 9% organic growth in the fourth quarter of 2017. Test and measurement was down 1% due to this difficult year-over-year comparison. Electronics was up 2%. So while this quarter had a tough comp, full-year organic growth was solid at plus 4%. And I should point out that fourth quarter operating margin improved by 140 basis points to 24.8%, a record for the segments. Now on to slide nine. Welding continues its strong run with 8% organic growth this quarter, which is impressive versus a comp of 6% growth last year. Demand was strong across the board with global equipment up 7%.

Industrial and oil and gas up 9%.

Polymers and fluids organic growth was 4%, with 7% growth in automotive aftermarket, which benefited from a new product launch. And polymers was up 4% with strong product sales in Asia Pacific, offsetting a 4% decline in fluids, which included a significant amount of PLS. Turn to slide 10. Construction organic sales were down 1%, as our North American commercial sales were down 10%, primarily due to project timing in our warehouse flooring business. North America residential was essentially flat, with 5% growth in renovation remodel, offset by decline in new construction. Europe was a bright spot, with sales up 6%. Australia and New Zealand sales were down 5%, due to a slowing residential construction market there. Specialty organic sales were down 2% against a tough comp of plus 5% last year. This segment also had over 100 basis points of PLS in the quarter. International organic sales were down 8% with some of the same soft spots that we saw in the third quarter, including appliance components and graphics. Equipment sales were a bright spot, up 4%. And our high cone division, which we saw at our investor day, was up 13%. Moving on to slide 11 and full year 2018 performance. 2018 was a record year for EPS, operating income, operating margin of 24.3%, and after-tax return on invested capital of 28.2%. Operating margin was up 60 basis points, driven primarily by another year of strong execution on enterprise initiatives due to the combination of modestly higher CapEx investments and slightly elevated inventory levels at year end due to higher material costs and increased the dividend by 28% this year. Looking back at 2018, we delivered on the annual EPS guidance that we provided as we entered the year, thus continuing our track record of exceeding our annual guidance for the past six years. The consistency and quality of our financial performance, as summarized here for 2018, are a testament to the power of ITW's proprietary business model, our high-quality diversified business portfolio, and strong execution by the ITW team. Let's now turn to slide 12 and 2019 guidance. Full-year EPS guidance from Investor Day in December. EPS of 790 to 820. with a midpoint of 8.05, which represents 6% growth year-over-year. We now expect organic growth in the range of 1 to 3% compared to a range of 2 to 4% previously.

This reduction is in time to auto bills and semiconductor-related demand in 2021. This range also includes PLAs.

We continue to firm up the projects and activities related to our enterprise initiatives and are confident that they will deliver 100 basis points of operating margin expansion, independent of volume. Also included in our plan, a higher restructuring expense versus 2018, and we have a particularly heavy restructuring agenda in Q1. This is driven to a significant degree by actions we are taking to right-size our automotive OEM and specialty businesses in Europe. The price-cost equation remains pretty dynamic, but margin headwinds should continue to moderate as the majority of raw material costs appear to have stabilized and we have strong pricing momentum heading into the year, with the vast majority of planned pricing actions already implemented. 2019 tariff expectations remain around $60 million, which is based on current and announced tariffs, including the potential impact of List 3 going from 10% to 25% in March. We continue to view the overall tariff impact as manageable, given the fact that we are largely a produce-where-we-sell company and that we only source approximately 2% of our spend from China. Given the differentiated nature of our product offerings across the company, we expect to be able to offset the impact of any incremental raw material cost inflation and tariff impacts that might arise in 2019 with pricing actions on a dollar-for-dollar basis at a minimum, just as we did in 2018. Finally, we expect free cash flow conversion at or above 100% of net income, share repurchases of $1.5 billion, and a tax tax rate in the range of 24.5% to 25.5% up slightly from 24.5% in 2018 due to the non-repeat of discrete items. Taking a closer look at the first quarter, we should point out that we expect that the first half of 2019 will be a little more challenging than what is typical for us in terms of year-over-year comparisons. due to more difficult comps, more currency headwind in the first half versus the second half of the year, and higher Q1 restructuring costs. Specifically, in Q1, we have 7 cents of currency headwind at current rates. The impact of higher restructuring, also 7 cents, and 5 cents of tax rate headwind due to a discrete $14 million tax item that we recognized in Q1 of last year. There's also one less shipping day in Q1, which is another approximately two cents headwind to EPS, and one and a half percent. It's important to note that we have an extra shipping day in Q3 in the range of $1.73 to $1.83 on essentially flat organic growth. However, coming out of Q1, the headwinds I just described start to moderate. Roughly two-thirds or 14 cents of the expected currency headwind this year is in the first half. Restructuring activities, as we discussed, are front-end loaded this year, and price-cost margin impact should moderate as we go through the year. It's important to note that our full year guidance is based entirely on current demand run rates, existing and announced price cost impacts, known enterprise initiative benefits, 2019 demand expectations in auto and semiconductor markets. We do not have any projections of demand improvement versus current levels in our 2019 guidance.

However, given what I just described and the fact that revenue comps are much easier in the second half of the year to EPS growth. Benefits from enterprise initiatives add another $0.25 to $0.35. Lower shares combined, they contribute approximately $0.25 a share. We anticipate that impact is expected in the first half of the year as we talked about. I'm not sure it is in March. in April. These three that there's no accommodations for potential that the baseline presented here assumes portfolio as it is today. We will be completely offset for full year 2019 on slide 14.

These are based on current run rates adjusted for seasonality and are obviously influenced by year-over-year comparisons as we go through the year. It is important to note that there's no expectation of demand acceleration embedded in our guidance. You see solid growth in welding at 3 to 6 percent down from 2018, but just as a function of the more difficult 10 percent comparison year-over-year. Food equipment has good momentum and pretty easy comps in the first half and are expected to be up 3% to 5% for the full year. Construction of 1% to 4%, which also includes a number of meaningful new product launches. Test and measurement incorporates a more cautious sales expectation for equipment related to semiconductor manufacturing. Those sales represent approximately $200 million and are expected to be down double digits in 2019. This creates a drag of two percentage points of organic growth to the test and measurement and electronic segment. Columns and fluids and specialty, all with low single-digit growth expectation. And automotive, as we mentioned, we're being pretty cautious with sales expected to be flat to down 4% despite the fact that third parties such as IHS are expecting positive growth in auto bills in 2019. Lastly, a comment about quarterly guidance. From day one, back in 2013, our strategy has been centered on leveraging ITW's powerful and proprietary business model to its full potential, and in doing so, position the company to deliver solid growth with best-in-class margins and returns over the long term. In the early stages of implementing our strategy, we believed that providing quarterly guidance was constructive given the number and magnitude of the changes and initiatives that we were implementing across the company. We have now progressed far enough in executing our strategy that we believe that providing quarterly guidance is no longer value added, given the long-term performance focus of the company and our core shareholders. As a result, we're discontinuing this practice as of this quarter. We will continue to provide updated five-year performance goals and EPS and organic growth guidance annually. With that, Karen, back to you.

Okay, thanks, Michael. Cheryl, let's open up the lines for questions.

Thank you. Our first question comes from Andy Casey from Wells Fargo Securities. Your line is open.

Thanks a lot. Good morning, everybody.

Morning.

Your guidance is pretty interesting. It looks like top line is more or less consistent with the bear case on the stock, but the bottom line guide is different. Yeah, what you said back in December. So a couple questions on the back-end loaded nature of what you just presented. First, why is price cost negative 50 bps for the year given pricing momentum is carrying over? And from the outside, it looks like you're looking at apparent decreases in some of your raw material input costs. And then, you know, within that, do you expect price cost to improve through the year?

Yeah, so, Andy, price cost was negative 50 basis points from a margin standpoint in 2018. And we're not providing a number for 2019, primarily because it's still a pretty dynamic environment in terms of raw materials as well as potential tariffs. That said, what you are saying is correct. I mean, it is reasonable to assume, based on what we know today, in terms of the price actions we've taken, the expected raw material costs, the tariffs, including the increase in March from 10% to 25%, that may or may not happen. It is reasonable to assume that we will continue to make progress on price costs from a margin standpoint in 2019, and certainly we will continue to be positive on a dollar-for-dollar basis to a degree that's significantly higher, actually, than what we saw in 2018. So I hope that answers your question.

It does. And if I can also follow up on something else, Michael, thank you for that. In your commentary around the first half versus second half, Q1 midpoint, implies about 6% earnings decline year over year, but the rest of the year is up around nine. You sound pretty confident in assuming the current run rates. Is a majority of that confidence really related to the pull ahead of the seven out of 10 for restructuring in the year into Q2? And basically, is that the big part of your confidence?

Yeah. Yeah, I think what we're pulling forward, the restructuring obviously has a pretty big impact here in Q1 of $0.07. Some of those benefits will start to show up in the back end of the year. Many of these projects have one-year payback or better in many cases. In addition to the higher restructuring currency is more of a headwind in Q1. The tax rate is a headwind. And then we do have one less shipping day, as I mentioned, in Q1. That we get back in Q3. That we get back in Q3. So that's why the year looks a little different relative to what you're used to from ITW. But there are some really good reasons behind that. And when you pencil it all out, you can get comfortable. We certainly are comfortable and very confident in our ability to deliver on the guidance that we're providing today.

Okay, sounds good. Thank you very much.

Sure.

Thank you. Our next question comes from Jeffrey Sprague, Vertical Research. Your line is open.

Thank you. Good morning, everyone. Good morning. Good morning. I was wondering if we could just dig into a couple segment-level detailed questions. First on automotive and the whole emissions WLTP kind of logjam in Europe. your view that it doesn't really sort itself out into the second half. Is that kind of well-grounded in what you're hearing from the OEMs, or is that really kind of just kind of caution on the chaos we've seen up to this point, and it's just kind of hard to predict how things play out there?

I think it's a little bit of both, but more the latter. I want to be careful how I say this, but I think the information has In terms of direct customer input, it's been a little up and down just because I think it's a fairly fluid situation. But I think our posture from a planning standpoint, we believe it's definitely on the conservative side. And just to be clear, we're saying that things start to mitigate in the back half or normalize, but certainly aren't all the way corrected probably. And we'll be dealing with some elements of this all the way through the year is our current view.

Okay, and just on the construction side, I'm sorry, can you elaborate on what drove the commercial weakness in North America and in the U.S.? And is there kind of visibility on kind of a recovery plan there?

Yes, there is. So it's a fairly small part of our overall business in North America. Part of what we do is we provide concrete solutions for warehouse flooring. And we had a number of projects that were scheduled to go in Q4 that pushed out to 2019. So it's primarily a timing issue more than a commentary on what's going on in the commercial construction space.

Maybe just one other really quick follow-up. Do you have some additional restructuring kind of on the shelf, for lack of a better term, if kind of the macro environment does begin to fade on us here as 2019 unfolds?

Well, I would say... You know, we normally operate with a fair degree of contingency planning around our plans, whether that's, you know, within a particular segment or at the overall company level. You know, we certainly have the flexibility to make adjustments as we're talking about here related to auto and specialty in the near term. So, and that's been, you know, sort of normal practice for the company for quite a long time. So should things in terms of the sort of external or macro environment play out differently than what we're anticipating now, and again, I think we're taking a pretty conservative posture in terms of our planning approach here, then absolutely we would expect to be able to adjust to that and do it in a relatively short order. As I said, we have a pretty flexible cost structure given how we operate with 80-20. So, you know, we could certainly make those adjustments within a quarter or two. Great.

I appreciate the perspective. Thank you.

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

Hi, good morning. First, I just wanted to better understand if we think about what your preliminary guide at the analyst meeting, the EPS is the same as it is today. You basically reaffirmed it, but your organic growth assumption is one point worse. I don't recall if the restructuring number was in there, and also FX seems to be more of a headwind. So can you just sort of help me understand that? you know, what's offsetting those headwinds relative to what you guys said at the end of the day. And then my second question is just with regards to the organic growth, the 2% for this year. One would argue in 2018 where the economy was relatively strong, you guys put up the same level of organic growth. So just comfort level on you can put together, you can put up another 2% organic growth and a tougher macro. Thank you.

Let me start with the first part, which is a very fair question in terms of the organic growth guide today being lower than what we got in December, really on the back of being more conservative around automotive builds as well as factoring in the latest view on semiconductor-related end markets. As we've gone through these last few months here, we've really firmed up our views in terms of the enterprise savings from the enterprise initiatives to specific projects and activities that will deliver 100 basis points of margin improvement, as well as other discretionary cost items. And so that's really what's driving the majority of our confidence in the ability to maintain the EPS number. In addition to that, I would say, although I'm cautious on this, given what we saw in 2018, the price-cost headwinds are certainly looking more favorable today than at the end of last year. And then just to be precise, the restructuring that we had in our guidance in December is the same number as today, and so that number has not changed. I think the second part, if I remember correctly, was around our ability, confidence to deliver 1% to 3% organic growth this year, similar to last year. And I'll go back to how we model this, which is basically based on current run rates adjusted for seasonality. And if you run that out for the year with the adjustments we made in auto and specialty, you get to a range of 1% to 3% organic growth. We provide a little bit more detail on the last slide, slide 14 in the deck. You can see how it kind of pencils out by segment. And, again, these are, you know, based on current run rates, risk-adjusted in a couple of areas, and in our view, pretty cautious and conservative view overall.

I guess, though, just given it's a weaker macro, there are certain – segments where you are assuming that your market share is above average and that sort of helps the organic growth? I mean, you talked about construction a little. I'm just not sure if market share is contributing more, you know what I mean, relative to the just overall whatever macro. Thanks.

Yeah, I think construction, there's significant new product launches on the docket for this year. I'd say in addition to that, I wouldn't underestimate the impact of price this year relative to 18. And so to add all that up, these are the numbers that make up the guidance by segment and 1% to 3% in total.

Okay. Thank you. I'll get back in queue.

Sure.

Thank you. Our next question comes from Joel Pith, BMO. Please go ahead. Your line is open. Joel Tis, your line is open. And moving along, our next question comes from Andrew Capitalist, Citibank. Please go ahead.

You hear me okay? Yeah, we got you.

Yeah, so Scott or Mike, obviously ITW is relatively strong in Europe, and you did mention that Europe would be up a couple percent instead of down, as a warn for your issues in auto and specialty products. So maybe give us a little more color regarding what's going on in Europe. Construction actually looked quite strong for you guys, given the environment there. So what's the outlook here as we go through 2019 in Europe?

Yeah, I think the issues on the international side are really isolated in the two segments we talked about. I think the other five segments are doing pretty well across the board. If you just look at fourth quarter, certainly auto specialty were down, but we put up some really good numbers in Europe. Construction overall was up 6%, welding up 7%, food up 3%. We've not seen a big impact from Brexit or in the UK. Those markets are pretty stable. So we feel pretty confident going into 2019 in terms of modeling current run rates in that geography.

Just maybe in terms of, I'm sorry, just another data point is, you know, if you net, look at our European sales in Q3 and Q4 net of auto and specialty, it was plus three in Q3 and plus two in Q4. So we're certainly not, you know, which feels pretty stable to us. Not, you know, three to two, I don't know. We're certainly not calling that a trend. But, you know, sort of bouncing single digits, pretty solid. Yeah.

Okay, that's helpful, guys. And then there are a couple of businesses that have been somewhat lethargic over the last couple of quarters that look like they picked up a little bit here in this past quarter. You know, I look at Palmers and Fluids, and you mentioned that new product intro and auto aftermarket. And then within the food equipment, you mentioned retail refrigeration, you know, turning around. Do these businesses have some sustaining power here going forward? In other words, Are you seeing a little bit more CapEx from grocery stores, for instance, in food equipment? And, you know, there's this new product rollout in auto aftermarket. You know, does that give you continuing growth in the segment for the next few quarters?

Yes, I'd say, Andy, that, you know, food equipment certainly feels very good. I think the acceleration really started in the second half. The strength is broad-based on the equipment side. Service put up a pretty good number here as well. On the retail side, just to be clear, we're not seeing a pickup in terms of the capex spend on the grocery side. What we're seeing is these are flat to up slightly on a year-over-year basis as we lap the more difficult comps. But all the benefits that we expected in terms of new product introductions, certainly we're seeing those in the second half of the year, and we expect those to continue into 2019. So food equipment, let's say, three to five feels very good for 2019. You know, palms and fluids, you know, we did benefit from a new product launch in automotive aftermarket. I hesitate to say this, but we were a beneficiary also of some weather-related impact in terms of Rain-X wiper blades. And so that part of the business was up 7% overall That is not a sustainable rate for the full year, obviously. But I'd say also in polymers, you're seeing some good progress there in terms of the overall organic growth rate. And like I mentioned earlier, you're seeing the impact of price. So certainly some good progress in those two segments, and we should expect to continue to see that in 2019 as reflected in the segment outlook we gave you on page 14.

Appreciate it, Gus.

Thank you. Our next question comes from Mick Dobre from Baird. Your line is open.

Yes, good morning, guys. So I want to stick with food equipment here. I mean, 3% to 5% growth, this would probably be the best growth since 14, 15, that time range. I want to make sure that I understand kind of what the moving pieces are here. Retail, you said, feels a little bit better, but it's mostly a factor of calm. So I'm not sure how much you're really expecting this business to grow. Institutional, you mentioned, was quite good. So maybe you can talk a little bit about momentum into 2019. I'm also wondering just your restaurant business, because I think that's pretty meaningful as well, how that's doing international as well as North America.

Yeah, so the demand we saw really here in Q3, Q4 was broad-based. So we talked specifically about food service, which is everything excluding the retail side being up 11%. Retail turned positive In the no single digits, we're not counting on a big pickup in retail in 2019, and it's not that significant a portion of our overall business. We continue to see a lot of strength on the institutional side of double digits. We gave you a couple of categories here really around education, so K-12, universities, as well as lodging. And on the restaurant side, also double-digit growth, including, which for us is a smaller part of the business, on the QSR side. International solid, up 3%. Certainly feel good about the momentum going into 2019. Q4 was best growth rate, I think, in over four years here or so. New product introductions are really taking off and we feel we're very pleased with the progress we're making in food equipment.

Got it. That's helpful. And then sort of going back to the big picture top line guidance. So if you're starting the year flat in Q1 and you're guiding on current levels of plan and your comp is getting offer in Q2 by at least 100 basis points, should we have expectations for an organic decline in Q2 and then acceleration in the second half on easier comps? Is that how we should think about it?

So, Meg, you should definitely think about it as just given the comps, higher growth rates in the back half of the year than in the first half. If you just go back and look at 2018, I think in 2018, We're up 3% organic rounding in the first half. We're up 1% in the second half. That alone is driving some of the higher growth rates, both in terms of organic as well as earnings growth. So really, the swings you're going to see are really a function of what the comps are on a year-over-year basis. Those are the big drivers. Again, there's no demand acceleration assumed here. On the contrary, if anything, we've dialed it back, certainly in auto as well as semi, which we talked about earlier.

But there is not something on the product side or, I don't know, something based on some visibility that you might have that would be able to maybe reassure us that you would be able to buck the tougher comp in Q2 versus Q1?

There's the typical every year new products contribute.

We don't manage for the quarter. The quarterly plans, we'll give you a Q2 update when we get there. Our expectation is, again, as Michael said, we're using current demand levels and projecting them through the year. We'd have to go look at Q2. This was a This is a full year in a Q1 number. I don't recall exactly what the Q2 organic growth rate is embedded in our plan. If we had it, you know.

I appreciate that. I was just trying to make sure that, you know, we have our expectations set in line with what you guys are thinking. That's it.

Yeah, I think the math is, you know, there's nothing funny in the math here. This is really straightforward. As Michael said, you know, we are, if anything, have dialed back relative to current demand rates in a couple of areas where we think there's some potential risk. We're not saying that it's going to play out that way. You know, I think overall that's the smart and prudent approach in terms of our planning. And it, you know, it also highlights the fact that we've got a lot of earnings growth power from the standpoint of enterprise initiatives and other things going on underneath that's not vulnerable to, you know, some further erosion in auto that, you know, if things play out, And ultimately, you know, we've got a plan where we believe there's more upside potential than downside. That's the way we always plan, and that's really what we're, I think, embedded in the approach we're taking in terms of taking the organic rate down a percent relative to where we were in December.

Got it. Thank you, guys. Appreciate it.

Thank you. Our next question comes from John Inch, Gordon Passett. Your line is open.

Thanks. Good morning, everybody. Good morning. Scott, Michael. So, wondering if there's any kind of an update on the divestitures that you've planned for this year, and there's kind of a corollary to that. Michael, if we actually were to have taken the 2019 divestitures that you've got out and invested them at the beginning of the year, kind of pro-forma, would that have any material impact on the 1% to 3% core growth that you're anticipating for 2019?

Yeah, so that's a very good question. So the impact, if these potential divestitures all happen, is an improvement in our organic growth rate of about 50 basis points and improvement in our operating margins by 100 basis points. So assuming that all of those take place this year, that's what you would expect to see in 2020. I think that's a fairly... um you know optimistic assumption i i think we're certainly making good progress um and uh you know i think a more reasonable planning assumption would be that maybe half of them get done this year um but none of that is included in the numbers today so so certainly you see some slightly lower revenues to the uh to the effect that you know if there is eps dilution you'll see higher share repurchases to offset that so that they are eps neutral there's going to be some gains on some of these potential divestitures, those are also not included. But on a pro forma basis, it's a meaningful impact and we're making good progress.

Is there some reason you couldn't, I mean, I know you've said half, but it's not a bad point to pick, but is there some reason if you start to get a cadence going, because I'm assuming you're not doing them sequentially one after another, you've got kind of books out on more than one. I mean, why couldn't these things hit sooner? I guess I don't really understand why, because it's not a lot of companies, right? Why couldn't we get most of this done in 2019?

I will pass that on to the steering committee in charge of the divestiture activities, John. Look, we've prioritized in terms of the biggest impact of the company. We're going to try to get those done first. We're not in a rush here. We're going to be you know, very deliberate and thoughtful in terms of how we execute on this and maximizing the value for the company.

And so... And I'll just quibble a little bit with your perspective in terms of there's a decent amount of work involved in each one in terms of preparing them to separate from ITW and all the things we need to do to... Yeah, we're... I mean, Scott, I live in the ivory tower, so I get it. I don't want to go that far, John, but I was just... I think we've got a good cadence. We've got a good plan that we are finalizing now in terms of being very deliberate and intentional about how we go about it. But as Michael said, I think the reality is it's probably a two-year process to move all the way through. And, of course, anything that we can do to make it happen faster, we would certainly do that. But at this point, that's not the number one priority right now. So we're trying to balance that with everything else that we are trying to work on and make progress on.

So just on the polymers business, I know, Michael, you called out the auto aftermarket, likely not sustaining that cadence. That makes sense. Was there any kind of a pre-buy in that business maybe associated with getting ahead of some cost increases or price increases that's also potentially contributing to the 1% to 3% kind of the flight deceleration?

John, we did not see that in palmers and fluids, and actually in any of our other segments as we went through the fourth quarter here. The quarter played out as it usually does on a monthly basis. There's really nothing unusual as we went through the quarter, including in palmers and fluids.

You know, the other question I had is oil and gas prices have come down, obviously, since the December meeting. know i know we're talking about raw increases but i was wondering about you know the indirect impact or even direct impact of those hydrocarbon pricings coming down i realize you buy a lot of metals right in metal derivatives but is there possibly some sort of once we get the impact of this is there some sort of potential net tailwind that kind of begins to accrue to you later in this year or something

Eventually, the answer is yes. I don't know whether it'll be at the end of this year or not. I mean, there certainly is tailwind today on a dollar-for-dollar basis, and as I said earlier, you know, while raw material costs increases, there's just a carryover from last year, still a pretty significant number in 2019. It's less than 2018, and we are certainly significantly ahead on a dollar-for-dollar basis. So to that extent, it is providing some tailwind here.

Got it. One last one. I mean, companies used to talk about, I think they still do selectively, kind of these cost pressures that are embodied by wages. If you just focus on the U.S., what's actually happening to your U.S. wage costs given, you know, what appear to be tight employment markets? I mean, are wages going up materially in 19? I don't remember if you called that out, materially in 19 versus 18. Is that any kind of a factor here?

We have not. I think there would be, from the standpoint of aggregate North American wages, I am summarizing a lot of individual data points, but things are up tens of decimal points maybe relative to sort of planned increases in prior years, but nothing that I would consider to be material in terms of impact on the overall company at this point.

Got it. All right. Thanks, guys. Appreciate it.

Thank you. And our next question comes from Ross Gilardi. Your line is open.

Yeah, good morning. Thanks, guys. Just on auto, I think you said that you're assuming flat to negative 4% for 19. Can you give us any type of breakdown by region, particularly since you were saying that you're not assuming any acceleration in the second half? I would just think, given what's going on in China right now, to get the flat to negative 4% and just the pressures in that end market globally that you'd have to assume some reacceleration for it not to be down more than that.

Yeah, so there's a lot of uncertainty around the numbers that third parties are providing on a geographic basis. I think the best I can tell you is, you know, when we were together in December, the view was that our auto business would be flat on markets that globally would be down two to three. We gave that a further risk adjustment here, you know, relative to what we said in December, and I can't really give you a view, you know, by quarter here as the year plays out. I'll give you the actuals when we get through Q2, Q3, and Q4, but I can't really give you guidance around that.

Well, we got, you know, people that studied this, like IHS out with, you know, a projection of plus two on bills in China for the year, plus one in North America, and I think down a couple. I think, you know, sort of globally, their plus one were zero to minus four. You know, they're not, this is just one data point, but there are people that study this that have, I would call it an optimistic view, but, you know, I think we're back to the, you know, the comment we were making earlier about making sure that we're appropriately conservative there, where there's Still some uncertainty, but we're not, I don't think we're on the high side of optimism relative to what most of the, at least third parties that we look at that study this market feel like it's going to go on the 19th.

We're on the conservative side of them. Just on the restructuring, the 7 cents and I think the 10 cents for the year, what is it actually for? I mean, is it headcount related or is it your enterprise initiatives? And I think you mentioned before, but where is it again?

So this is primarily focused on right-sizing our footprint in Europe in two businesses, the automotive business as well as the specialty business. And beyond that, we typically don't comment on specific restructuring projects.

Okay. But on that, Michael, I mean, you said that, I mean, clearly there's some pressures tied to what you were describing earlier, but it sounded like you thought things were normalizing, that you're not losing share. and it's kind of a timing issue of when the market actually improves. So why restructure the European auto business if that's the case?

Well, we're just moving faster on some things. We've still got an acquisition that we did two years ago that is restructuring, I would say, is a normal part of the integration of that business. It's a fairly good piece of that. We are accelerating some of that given the environment and this pause in demand. It's a good time to get after some of that. So there's some things that would have been, we would have gotten to anyway, that is the easiest way to describe it, that I would say we have accelerated into the front end of the year, given the pause in the demand. These things are, in some ways, you know, it's better timing if we can get them done when we're not also dealing with some increases in demand. That's probably a better characterization of it. When Michael said front end loading, that's what we're doing.

And then just the last one, on the test and measurement, I mean, you guys eked out 140 basis points of margin expansion with real organic growth in the business in the fourth quarter, which is pretty impressive. But is that type of margin expansion sustainable into 2019 in a flattish environment for that segment?

I think we still have a ways to go in terms of further margin expansion in test and measurement, and that's based on what the – you know, bottoms up what the team is telling us. What you're really seeing is the impact of the enterprise initiatives in test and measurement, and I think it's another data point that supports the view that we have and the confidence that we have in the ability to continue to expand margins in 2019 and beyond, as we talked about in December, we believe we have at least another three to four percentage points of margin expansion ahead of us, and test and measurement has at least that level of improvement ahead of it over the next three to four years.

Okay. Thank you very much.

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

Thank you. Good morning, everyone. Good morning. So just on your WLTP comments from earlier, I just want to make sure that I understand it. If your platforms are being disproportionately impacted, do you have a sense or line of sight on the approval for those platforms getting through the testing requirements? And shouldn't that just reverse itself at some point in 2019?

Well, it should reverse itself at some point. The answer to your question is we don't have great line of sight because it's a new test, and I don't want to speak for the auto OEMs in Europe, but what we're hearing is that there's some uncertainty and some challenges. It's not that it can't be done. It is a new testing procedure, and that the backlog involved in getting all of their models through it has been much more of a challenge than perhaps was expected. I don't know. Again, that's We're drawing some conclusions over around, based on a number of different data points. So, you know, my answer to your question is absolutely it should sort itself out. I think there's still a question of how long it takes to do so. And that's an element of our, let's call it conservatism in terms of our posture around that. You know, there is, you know, people are still buying cars in Europe. There's nothing in terms of For consumption data on auto that gives you a whole lot of reason for pause, at least us at this point, it's much more about the disruption in the production part relative to the, you know, the emissions testing regime. And I don't, I don't think it's sort of smooth sailing from here, let's say, in terms of how all that plays out.

Based on what I know, that's fair, Scott. And I guess just a quick follow-up that I had. You guys gave us guidance on the whole growth outlook for test measurement and electronics. Just wondering, and I know that you guide the current run rates, but the electronics business, I guess we've been seeing you have some soft distance panel and any color on that business specifically and what you're seeing from a current perspective would be helpful.

Yeah, most of our position in the electronics industry space is really more, I would say, MRO related. So we're not, you know, with a couple of exceptions, this one in Semi, we're not sort of upstream in terms of production equipment. So that, you know, from our standpoint, the electronics has been pretty stable. But it's, but we're, you know, the way I would describe it, it's pretty downstream from the standpoint of where we participate there. Yeah, clean room, you know, MRO items.

MRO activities.

Not production items. Right.

Thank you. And our next question comes from . Your line is open.

Hi. Good morning. Morning. Most of my questions have been asked. So just philosophically, I just wanted to ask about pulling the quarterly guidance. I'm just curious about timing and whether you talk through the fact that without quarterly guidance, the probability is that the Southside estimates will be more variable and that you're more likely to miss somebody's expectations and therefore have greater earning volatility, which traditionally meant cutting multiple on a stock. So I'm just curious why you chose now to stop giving quarterly guidance.

Well, since we hadn't missed one in six years, we thought we would try something different. I'm just kidding. I think ultimately we talked to a lot of our shareholders And, you know, there's a fair amount of effort that goes into providing it. There is some philosophical differences around, again, what we think the core investor value proposition for ITW is, which is really around, you know, strength of competitive advantage in the business model, resilience in terms of high-quality diversified portfolio, all of those things are really oriented towards longer time periods of performance. And given all that, I think this is, we felt like we had, you know, as I think Michael said in his remarks, it was, you know, it was valuable early in the process, given, I'm talking about the enterprise strategy now, and then at this point we've progressed far enough where it's not value-added anymore. And the last thing I would say, and this will be a little smirky and I don't intend to be, but we listened to your boss, Jamie Dimon, who told us that in a lot of companies we shouldn't be doing this. I'm just kidding.

And thank you. Our next question comes from Steve Fisher, UBS. Please go ahead. Your line is open.

Thanks. Good morning. Just wanted to follow up. morning. Just wanted to follow up on the oil and gas question more from the revenue side of things. Just wondering to what extent you're seeing any change in momentum in the oil and gas business in the last two, three months or so and how that's filtering into your primarily, I guess, the three to six percent growth in your welding business.

Yeah, our exposure is pretty limited overall to oil and gas. It's primarily on the international side in the welding business. And we've just started to see a pickup in oil and gas here in Q3 and Q4. We gave you the number here. And we haven't seen any changes over the last couple of months, if that's what you're asking.

Thank you. And our next question comes from Nicole de Vlaes, Deutsche Bank. Your line is open.

Yeah, thanks. Good morning. Good morning. Given that some of the, I guess, some of the commentary around why organic growth is a little bit lower for the full year is semiconductors, electronics, I guess I'm curious, you know, I don't think that that came up in your commentary within TNM. Are you guys actually starting to see a slowdown in semiconductor spend, or is that just anticipated to occur throughout 2019?

So we did see a slowdown here in Q4, not entirely unexpected. And again, it's in the portion of test and measurement that sells equipment for the upfront manufacturing in the semiconductor space. And we did see a slowdown here in Q4. In the past, there have been talks about a pause and then a pickup again in the back end of 2019. And we've taken all that out and basically assumed current run rates based on what we saw in Q4, and therefore, in our view appropriately, risk adjusted for any exposure in semiconductor.

And thank you. Our next question comes from Nathan Jones from Stiefel. Your line is open.

Good morning, everyone.

Good morning.

A couple of follow-ups on the welding business there. Obviously some good organic growth, but I know that business does sell a lot of steel. So maybe you could give us some color on what the input is from volume versus price, both in the fourth quarter and what the pricing tailwind to revenue at least is in 2019.

Yeah, so Nathan, so we do not break out price versus volume at the enterprise level or by or by segment, including for welding. So I'm afraid I can't give you that.

Okay, no worries. Just one on the construction business then. You talked about new product releases on the slate for this year. Can you talk about when you expect those to start hitting the market and any color you could give on the anticipated contribution?

Yeah, so it's a pretty long list of new products centered around our cordless technology where ITW is the market leader. They come in throughout the year in various geographies. Typically, the contribution from new products is somewhere in the 1% range in terms of overall revenue growth, and we expect it, just based on what's in the pipeline, to be a little bit higher than that in construction this year.

Thank you. Our next question comes from Josh Pokorinski. From Morgan Stanley, your line is open.

Hi, good morning, guys.

Morning.

Just a follow-up on, you know, Michael, I get part of the answer to the last question that you don't really want to break out price at the enterprise level, but it seems like, you know, some of the confidence in the year comes from maybe, you know, a bit more price yield and perhaps some commercial initiatives that offset some of that auto commentary there. Is that a fair assessment relative to prior years that you guys just feel like outside of perhaps auto that you're carrying a bit more price than usual and able to, you know, kind of hold up at least, you know, any downside scenario?

I don't know if we really thought about it, you know, the way you're articulating it. I mean, but certainly, like I said earlier, in – six out of seven segments, so excluding auto, we've taken pricing actions to offset raw material cost inflation and tariff impact. And so to the extent that we'll probably have a little bit more price coming through in 19 than in 18, and that certainly helps the overall organic growth rate. But we also have price every year. Yeah, we get price every year, you know, maybe a little bit more 19 and 18, but it's not the big driver here.

And thank you. And our next question comes from David Rosso, Evercore ISI. Your line is open.

Hi, good morning. I had another question, but just wanted to circle back first on the organic sales guide. I mean, just want to make sure the takeaway is correct. The idea of the first quarter being flat is, The second quarter, you do expect it to improve. I'm just making sure we all level set. Excuse me. Just given the idea, if it's flat in the first quarter, if the second quarter is not at least one or two, it makes the second half, you know, obviously a little more of a struggle. So I just want to make sure we level set on that so we can give us some perspective. But my real question, food and welding, food and welding are going to be over 55% in dollar terms of your EBIT growth. I mean, sorry, the organic sales growth. In those businesses, it's good to see food pick up, at least on a year-over-year basis, in the fourth quarter. Can you give us any help with a backlog number, an order number, just something kind of looking into 19 that gives us some perspective of the starting point of growth, sort of already booked relative, but just given their significance to the overall growth?

I'll answer the second and throw it back to Michael for the first one. These are all short cycle businesses from the standpoint of we get an order today, we ship it tomorrow. What I can't tell you is book to bill in both businesses in Q4 was positive. So order rates are at or above shipment rates in Q4. These aren't big backlog businesses is my point. These are given the way we deliver. We get an order today, we ship it tomorrow. We don't build backlogs, but from the standpoint of just order rates relative to shipment rates, things in Q4 in both businesses were pretty challenging.

Yeah, that's where I was going to go with this. Welding just grew, again, 8% on a tough comp. They were up 6% in Q4 last year. Food equipment up 5% organic, so good momentum in those two businesses. In terms of the Q1, Q2, Without telling you anything new, really, I mean, we did say that we have one less shipping day in the first quarter, which lowers our overall organic growth rate by mathematically a point and a half. We do not have that headwind in Q2. So I don't know if that helps you in terms of what Q2 might look like.

That's probably the best I can give you. Okay, no, I appreciate it. It's just if you do, you know, zero, two, then it's three and a half, two and a half. It feels a little bit better than zero, zero, zero, one.

That's all. David, keep in mind that one and a half percent in Q1 that mathematically we lose from one last day, we get that back in Q3.

Oh, exactly, exactly. I just want to make sure we weren't starting second quarter, you know, at one or less, or it just gets more challenging. But, no, I appreciate it. Thank you so much.

Sure.

Thank you. Okay. Yeah, thank you, Cheryl. We've run a bit over. If you have any other questions or follow-up, please reach out to me today. And thank you for your time this morning.

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