Illinois Tool Works Inc.

Good morning. My name is Julianne, and I will be your conference operator today. At this time, I would like to welcome everyone to the conference call. 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. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, please press the pound key. For those participating in the Q&A, you'll have the opportunity to ask one question, and if needed, one follow-up question. Thank you. Karen Fletcher, Vice President of Investor Relations, you may begin your conference.

Karen Fletcher Okay. Thank you, Julianne. Good morning, and welcome to ITW's fourth quarter 2020 conference call. I'm joined by our Chairman and CEO, Scott Santee, and Senior Vice President and CFO, Michael Larson. During today's call, we'll discuss ITW's fourth quarter and full year 2020 financial results and provide guidance for full year 2021. Slide two is a reminder that this presentation contains forward-looking statements. We refer you to the company's 2019 Form 10-K and subsequent reports filed with the SEC for more detail about important risks that could cause actual results to differ materially from our expectations, including the ongoing effects of the COVID-19 pandemic on our businesses. This presentation uses certain non-GAAP measures, and a reconciliation of those measures to the most directly comparable GAAP measures is contained in the press release. Please turn to slide three, and it's now my pleasure to turn the call over to our Chairman and CEO, Scott Santee. Scott Santee Thank you, Karen.

Good morning, everyone. The ITW team closed out 2020 with another quarter of strong operational execution and financial performance. From my perspective, the highlights are that KFOR revenues got back to year-ago levels, despite food equipment being down 17%. and that operating income, operating margin, and after-tax ROIC were all Q4 records for the company. It was a pretty solid finish to a year that, needless to say, provided some unique and unprecedented circumstances and challenges and indicates good momentum as we head into 2021. While it was the challenges brought about by the pandemic that dominated our attention in 2020, It was the collection of capabilities and competitive advantages that we have built and honed over the past eight years through the execution of our enterprise strategy that provided us with the options to respond to them as we did. Early on as the pandemic unfolded, we refocused the entire company on only two core imperatives. A, to protect the health, safety, and well-being of our people, and B, to continue to serve our customers with excellence. And in my view, we executed extremely well on both. Our manufacturing operations and customer service teams around the world deserve special recognition for their extraordinary efforts and leadership in support of these two key pandemic priorities. Their dedication and commitment to keeping themselves and their colleagues safe while continuing to deliver excellent service to our customers was truly inspiring. And there's no question that we differentiated ourselves with many of our key customers as a result of our ability to sustain our normal rock-solid quality and delivery performance throughout 2020 as a result of their efforts. We also did our best to take full advantage of ITW's position of strength as we thought through how we should manage the company through the pandemic. Back in the spring, as we analyzed and stress tested the company's performance across a wide range of scenarios, it became clear that the financial and competitive strengths that we had built up over the past eight years had resulted in a very strong and very resilient company. And that as a result, we didn't have to just pull out our old recession playbook and hunker down. That for ITW, this was a unique opportunity to react smartly and to stay focused on the long term. This conclusion led to two key decisions that we made regarding how we were going to manage ITW through the pandemic crisis. First, we chose to leverage the strong financial foundation that we've built over the last eight years to reinforce our commitment to our people. First, by providing full compensation and benefit support to all ITW colleagues through the entirety of Q2 when the economic effects of the pandemic were at their most widespread and severe, and by deciding that we would not initiate any enterprise-wide employment reduction mandates or programs at any point in 2020. These were not obvious or easy decisions given the unprecedented and uncertain circumstances, but we believe that they were the right decisions for our company. And I know that our people will remember them. These decisions also turned out to be the right ones for us operationally, given the pace of demand recovery that we saw beginning in Q3. Second, we chose to leverage our position of strength by implementing our win the recovery agenda and mindset across the company. Win the recovery was not an opportunistic new strategy. What it was and is, is a commitment to staying the course and continuing to prioritize the execution of our long-term enterprise strategy, despite the unique and unprecedented challenges brought about by the global pandemic. When the recovery for us did not mean ignore the pandemic, as across the company, we had to read and react to the realities of the near-term situation as we always do. But it does mean that we are committed to protecting key investments, supporting the execution of our long-term strategy, and that we have, from very early on, given our divisional leadership teams the mandate to continue to think long-term and to remain aggressive through the pandemic. For 2021, our women recovery posture and mindset continues on and serves as the central theme driving the 2021 operating plans for every one of our 83 divisions. Before I turn the call over to Michael for more detail on our Q4 performance and our 2021 guidance, let me close by thanking all of our ITW colleagues around the world for their exceptional performance and dedication in the face of the most challenging and unprecedented circumstances of the past year. The performance that they delivered in 2020 provides another proof point that ITW is a company that has the enduring competitive advantages resilience, and agility necessary to deliver consistent top-tier performance in any environment. Like many of you, I'm sure, we are hopeful for a return to somewhere in the vicinity of normal at some point in 2021, and with that, getting back to giving our full attention to taking ITW all the way to the company's full potential. Between now and whenever that is, We will continue to leverage the full breadth of ITW's capabilities and competitive advantages to keep our people safe, continue to serve our customers with excellence, and execute our long-term enterprise strategy. Michael, over to you. Thank you, Scott, and good morning, everyone. Please turn to slide four. the fourth quarter we continue to see solid recovery progress in many of the end markets that we serve as evidenced by our revenue being up sequentially five percent versus the third quarter the increase is eight percent when you adjust for equal number of days when historically our revenue per day has increased by one percent from q3 to q4 overall we delivered revenue of 3.5 billion operating income of $883 million, an increase of 7% year-over-year, operating margin of 24.4%, free cash flow of $705 million, and gap EPS of $2.02. After-tax return on invested capital improved to 32%. And as Scott mentioned, operating income, operating margin, and after-tax ROIC were fourth-quarter records for the company. Revenue in all major geographies improved sequentially. On a year-over-year basis, North America organic revenue declined 3%, international revenue grew 1%, Europe was down 2%. Similar to Q3, China was the bright spot with 11% growth. As we've talked about before, the operating flexibility that is core to our 80-20 front-to-back operating system also applies to our cost structure, which was on full display through our operating margin performance in Q4. We improved operating margin by 170 basis points to 25.4%, the second highest margin rate in a quarter in the history of the company. And like I said, grew operating income 7% to $883 million, the highest fourth quarter ever. The biggest driver of our margin improvement remains our enterprise initiatives. as the ITW team executed on projects and activities that contributed 130 basis points in Q4. The impact was broad-based with all segments delivering enterprise initiative benefits in the range of 80 to 170 basis points. Gap EPS was $2.02, up 2%, but keep in mind that Q4 last year had 11 cents of one-time gains from divestitures. To exclude those gains, EPS was up 7%, the same as operating income. Working capital performance was excellent and free cash flow of $705 million was solid with a conversion rate of 110% of net income. Finally, the effective tax rate was 22.1% down slightly from last year. In summary, a strong finish to a challenging year and very good momentum as we head into 2021. Let's move to slide five to review fourth quarter's recovery and response by segment. We updated this slide from our last earnings call with Q4 information, and you can see that our segments continue to respond effectively to the increase in demand recovery and improve sequentially on both revenue and operating margin. I will just highlight a few things to illustrate the resilience and adaptability of our businesses. You can see the rapid recovery in our end markets relative to the Q2 bottom of down 27%. In Q4, three of our segments experienced demand levels that were higher than a year ago. The most pronounced recovery has been in automotive OEM, which has more than doubled since Q2 and grew 8% year-over-year in Q4, as did construction products. Polymers and fluids grew 7% while demand in three segments, test and measurement in electronics, welding, and specialty products was only slightly lower year over year. As you would expect, food equipment continues to be impacted by the effects of the pandemic, although we are seeing some sequential improvement. Overall, you can see the benefit of having a high-quality, diversified portfolio and the fact that we're back to demand levels of a year ago, the total revenue essentially flat year-over-year, despite one of our core segments being down organically by 19%. On the right side of the page, you can see the operating flexibility that I just talked about and how it also applies to our cost structure and ultimately shows up in our operating margin performance. At the bottom, in Q2, we still delivered solid operating margins of 17.5%, and only two segments were below 20%. In Q4, we're almost 800 basis points higher at 25.4%, despite no volume growth year over year. And every segment is back above 22%, including food equipment, as six out of seven segments achieved record fourth quarter operating margins. Let's move on to slide six for a closer look at individual segment performance, starting with automotive OEM. The team has continued to execute exceptionally well from a quality and delivery standpoint in responding to customer demand levels that have more than doubled since Q2. In Q4, organic growth of 8% year-over-year was the highest growth rate since the first quarter of 2017. While North America was flat in Q2, it was more than offset by strong demand in Europe, which grew 10%, and China, which grew 20%. As expected, food equipment end markets remained challenged in Q4. Organic revenue was down 19%, a little better than the third quarter, and demand in Q4 was similar to Q3 when you look at it by geography and the end markets. North America was down 20%, international down 18%. Equipment sales were down 20%, and service was down 18%. Institutional demand was down about 30% with restaurants down a little bit more than that. And not surprisingly, the bright spot throughout the year continued to be retail with organic growth of 8%. Moving to slide 7 for test and measurement and electronics. Q4, organic revenue declined 3% with test and measurement down 8% against a tough comparison of plus 6% in Q4-19. Electronics was up 3%. And while demand for capital equipment remained sluggish, the segment benefited from considerable strength in several end markets, including semiconductor, healthcare, and cleanroom. As you may have seen, on January 19th, we announced that we had entered into an agreement with Amphenol to acquire MTS's test and simulation business. The test and simulation business is very complementary to our Instron business, which we highlighted during our 2018 Investor Day. And some of you may have visited our facility outside of Boston. MTS's test and simulation business has similar organic growth potential, and there's substantial opportunity for margin improvement through the application of the ITW business model. Pre-COVID revenues in fiscal year 2019 were $559 million with operating margin of 6%. We expect to get the business to generate ITW-caliber operating margins by the end of year five and generate after-tax RIC in the high teens by the end of year 10. As you saw in the announcement, we expect the acquisition to close in the middle of 2021, and we're very much looking forward to welcoming the MTS test and simulation team to the ITW family. Moving on, please turn to slide eight and welding, where we saw a meaningful pickup in demand as organic revenue improved from being down 10% year-over-year in Q3 to only being down 2% in Q4. Our commercial business, which primarily serves smaller businesses and individual users and accounts for 35% of the revenue in this segment, remained strong and grew 12% year-over-year. Our industrial business showed signs of strong recovery from being down 23% in Q3 to down only 5% in Q4 as customer activity and equipment orders gained strength. Overall, organic revenue for equipment was flat versus prior year, and much improved versus a 10% decline in the third quarter. Polymers and fluids delivered strong organic growth of 7% with fluids up 16% with continued strong demand in end markets related to healthcare and hygiene. The automotive aftermarket business benefited from strong retail sales with organic growth of 5% and polymers grew 4% with solid demand for MRO and automotive applications. Moving to slide nine, construction continued to benefit from strong demand in the home center channel and delivered organic growth of 8% in Q4. Growth was strong across all geographies, with North America up 10%, double-digit growth in the residential renovation market, offset by commercial construction, which represents only about 15% of North America revenue, down 11%. Europe grew 9%, and Australia and New Zealand grew 5% due to strong retail sales. Specialty organic revenue was down 3% this quarter, with North America down 2%, and international revenue down 4%. Demand for consumer packaging remained solid, but it was offset by lower demand in the capital equipment businesses. So that concludes this segment commentary, and let's move on to the full year 2020 summer results on Site 10. And in the face of unprecedented challenges that included temporary customer shutdowns across wide swaths of our end markets during the year, organic revenue was down 10 percent. Still, we delivered operating income of $2.9 billion and a highly resilient operating margin of 22.9 percent, only down 120 basis points year-over-year, despite no major cost takeout initiatives or mandates, and with a strong contribution of 120 basis points from our enterprise initiatives. After-tax ROIC was 26.2%, and free cash flow was $2.6 billion. Throughout the pandemic, one of our priorities was to maintain our financial strength, liquidity, and strategic optionality, and as you can see, we did just that in 2020. ITW's balance sheet is strong, and we have ample liquidity. We did not have a need to issue any debt or commercial paper in 2020, and we ended the year with total debt to EBITDA leverage of 2.5 times, which was only slightly above our 2.25 times target. At year end, we had approximately $2.6 billion of cash and cash equivalents on hand. With 2020 behind us, let's move to slide 11 for discussion of our guidance for 2021. So starting with the caveat that we continue to operate in a fairly uncertain economic environment, we have based our guidance, as we always do, on the current levels of demand in our businesses. Per usual process, we're projecting current levels of demand into the future and adjusting them for typical seasonality. The outcome of that exercise is a forecast of solid broad-based organic growth of 7% to 10% at the enterprise level. Foreign currency at today's exchange rates is favorable and adds two percentage points to revenue for total revenue growth forecast of 9% to 12%. At our typical incremental margins of 35% to 40%, we expect GAAP EPS in the range of $7.60 to $8 a share, up 18% at the midpoint. We're forecasting operating margin in the range of 24% to 25%, which is an improvement of more than 150 basis points year-over-year at the midpoint. Enterprise initiatives are a key driver of operating margin expansion in 2021, as they're expected to contribute approximately 100 basis points. Restructuring and price costs are expected to be approximately margin neutral year-over-year. We're closely monitoring the raw material cost environment, and embedded in our 2021 guidance are the known raw material cost increases in commodities such as steel, resins, and chemicals. 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 increases that might arise in 2021 with pricing actions on a dollar-for-dollar basis. We expect strong free cash flow in 2021 with a conversion rate greater than 100% of net income. I wanted to provide a brief update on our capital allocation plans for 2021. Top priority remains internal investments to support our organic growth efforts and sustain our core businesses. Second, we recognize the importance of an attractive dividend to our long-term shareholders, and we view the dividend as a critical component of ITW's total shareholder return model. Third priority are selective, high-quality acquisitions that supplement our portfolio and reinforce or further enhance ITW's long-term organic growth potential. I should point out that the guidance we're providing today is for the core business only. After the MTS test and simulation acquisition closes, we'll provide you with an update, but we do not expect a material impact in 2021. In line with our capital allocation, we return surplus capital to shareholders, and we are reinstating share repurchases with a plan to invest approximately $1 billion in 2021. We expect our tax rate for the year to be in the range of 23 to 24%. Finally, when it comes to portfolio management, we have decided to defer any divestiture activity until next year and instead focus our time and efforts on the recovery in 2021. While our view regarding the long-term strategic fit of the remaining divestitures hasn't changed, we also believe that given their expected performance this year, they will be more valuable in 2022. Let's turn to slide 12 and the forecast for organic growth by segment. With the caveat, again, that the environment remains fairly uncertain, we are providing an organic growth outlook for each segment. And based on current levels of demand, we are forecasting solid board-based growth as every segment is expected to improve their organic growth rate in 2021. At the enterprise level, it all adds up to solid organic growth of 7% to 10%. To wrap it all up, ITW finished a challenging year strong as we continue to fully leverage the capabilities and competitive advantages that we've built over the past eight years through the execution of our enterprise strategy. Our strong operational and financial performance in 2020 provided further evidence that ITW is a company that has both the enduring competitive advantages and resilience necessary to deliver consistent operative performance in any environment. Looking ahead to 2021, we have good momentum from Q4 heading into the year, and our solid guidance reflects the fact that we remain focused on delivering strong results while continuing to execute on our long-term strategy to achieve and sustain ITW's full potential performance. With that, Karen, I'll turn it back to you.

Okay. Thank you, Michael. Julianne, let's open up the lines for questions, please.

Certainly. At this time, I would like to remind everyone, in order to ask a question, please press star followed by the number one on your telephone keypad. As a reminder, we ask that you please limit yourself to one question and one follow-up question. Thank you. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Andrew Kapolek from Citi. Please go ahead. Your line is open.

Good morning, guys. Good execution as usual.

Morning.

You hear me okay?

Yeah, we got you. We thank you.

So it's been a couple of years now since your last analyst day. So maybe you could update us on where you are in terms of the goal of finishing the job related to enterprise strategy. It seems like your performance in the second half of 20, the 7% to 10% growth guidance you've got for 21 is reflecting full organic growth potential versus your end markets. But maybe give us some color around that and how you're thinking about enterprise strategy coming out of the pandemic. Do you still see 100 days points of margin improvement per year through at least 2023?

Well, I'd say a couple of things, Andy. First of all, this has been a process throughout the entire journey where the further we go with it, the more opportunity we find to continue to improve. And I think one of the remarkable things from my perspective is eight years into this, I don't see that slowing up any. And so we are... focused on continuing to move forward to get better every year, get a little bit better this year than we were last year within the framework of the strategy that we've laid out. And I think there remains ample room to continue on that path for a number of years. We also have some performance goals out there. You're right, it's been a couple years, but I think two years ago is when we updated those goals, and we remain absolutely on track and committed to delivering on those goals. And as we get closer to that, we'll figure out what the next steps are.

Thanks for that, Scott. And then is it right to think that generally you should see more margin improvement from your segments with the largest growth projections for 21? And could you give us, I know you talked, Michael, I know you talked about price versus cost. You sometimes have sort of these lags in some of the segments like auto OEM. Do we get concerned about that at all? And any other call around price versus cost you could give us?

Well, I'd say, Andy, based on Bottoms Up planning process, we expect every segment to improve on their margin performance in 2021. As Scott said, a little bit better every year as we march towards our full potential. I think one of the remarkable things when you look at the margin performance by segment is how how the range has narrowed and where, as we sit here today, the low end is food equipment at 22 and the high end is welding at 29. Very different range from when we started this strategy eight years ago. And I think the fact that we have businesses delivering margins in the high 20s just gives us further confidence in the long-term goals that we've laid out for the company. So the big driver in 21 remains enterprise initiatives. Those are broad-based. In every segment, we'll make progress on AD20 and strategic sourcing. And certainly, we expect also a meaningful contribution from volume leverage as we go through the year here. But I wouldn't single any segment out as having more margin improvement potential than others. I think we expect all of our segments to continue to make progress towards their full potential. Appreciate it, guys. Yeah, Andy, I can give you a little bit on price-cost. So certainly, like I said, we are closely monitoring the raw material cost environment. We are seeing inflationary pressures in commodities such as steel, resins, certain chemicals, You know, by segment, automotive, construction, promise of fluids is probably where we're seeing the more significant increases. In all of our segments, you know, the plan is to offset those cost increases. the ones that we know about and the ones that, you know, may arise this year with price on a dollar-for-dollar basis. As you know, in automotive, just given the nature of the industry, that is a process that takes a little bit longer. But, you know, we're confident that, you know, over time, you know, we're going to be able to offset any raw material cost increases with price, just given the differentiated nature of our product offerings in each one of these segments, so.

Appreciate it, guys.

Your next question comes from Nicole DeBlaze from Deutsche Bank. Please go ahead. Your line is open.

Yeah, thanks. Good morning, guys.

Good morning.

Can we just start with the outlook for auto OEM? When you think about the 14% to 18% that you forecasted for 2021, how does that look in the context of some of these semiconductor supply chain issues that we're seeing? And I guess, you know, are some of those hiccups embedded in your outlook? And with that said, if you could talk maybe a little bit about the potential quarterly cadence for the auto business. I know you guys don't give quarterly guidance, but in this case, it could be kind of a weird year.

Yeah, so thank you, Nicole. I can tell you one thing on the quarterly cadence that Q2 is going to be a lot better this year than it was last year. That's one thing I know for sure, I think. I agree with that. So just on the, you know, there's a lot of talk about the shortage of semiconductor in the automotive OEM space. What I can tell you is, and this is true across all of our businesses, we've not seen a slowdown in demand. And, you know, strong momentum going into the year certainly carried through January. It is possible, though, that we may see some production slowdown here in Q1 at some of our customers. Whether that will impact their demand for our products I think remains to be seen. We view this right now as more of a timing issue, and so certainly this could put a little bit of pressure on the auto business here in the first quarter. But as we sit here today, we would assume that we're going to catch that up in Q2 or, you know, the second half of the year. In terms of the quarterly cadence for the auto business, I think you saw the strong performance here in the fourth quarter of 8%. Like I said, we've not seen anything to suggest that demand is slowing down when we're looking at the January results. So we expect, given how we've planned the business, to be off to a pretty good start with positive organic growth and margin improvement in the first quarter. That typically, you know, sequentially that builds as we go through the year. You know, Q2 will be, as Scott said, the biggest quarter, and the second half, the comps start to get a little bit more challenging. The build numbers are a little bit different, but that's probably as much as I can give you on the automotive business and kind of how this might play out by quarter.

No, thanks. That was actually super helpful. Maybe just as a quick follow-up, when you think about the guidance that you put together for just the full company organic growth in 2021, thinking back to last year when you guys were really talking about opportunities to outgrow as we move into recovery mode, have you factored in some of that market share improvement over peers into the 2021 guidance?

Well, you know, the only way that it's factored in at this point is it's embedded in the impact that those efforts have already made in our current run rates. So we are not baking in any further acceleration. That doesn't mean that we don't have a lot of intention around continuing to, as we talked about before, be aggressive as the recovery continues to accelerate. But from the standpoint of our normal planning practice, We are – what's embedded in our organic growth forecast is exactly what Michael said earlier, that current run rates, daily run rates projected through fall year 2021 with, you know, whatever the normal sort of seasonal impacts are quarter by quarter.

Got it. Thanks, Scott. I'll pass it.

Yeah. Okay. Thanks, Nicole.

Your next question comes from Jeff Sprague from Vertical Research. Please go ahead. Your line is open.

Thank you. Good day, everyone. Two questions. One, kind of following up on that last thread, you know, fully understand your methodology here, kind of just rolling forward current trajectory.

But when you look at the segments, you know, are there one or two kind of either way positive or negative that, I don't know, your astute business sense and long history with these businesses would suggest

you know, are likely to be potentially, you know, better or worse than kind of the exit rate here as we exit 2020? Well, I'm trying to think about that question. You know, the obvious one to point to is food equipment, depending on, you know, sort of the pace of vaccination. Penetration and recovery, that's, you know, obviously we're, even at that 8% to 12% growth rate for the year, we're well below 2019 levels of demand, let alone incremental growth opportunities we have. So that, you know, from the standpoint of the one with the most outside leverage, that's, you know, clearly the case. I don't know that there's anything else that I would say would really stand out. I think the capital equipment businesses you would expect, so welding and test and measurement, that as businesses get more comfortable with both the pace and trajectory and sustainability of the recovery, their comfort level with investment. would uh and their confidence in in in the future would certainly stimulate more um perhaps more demand in those sectors you know maybe as i as i think about your question but you know i think that would be the the two areas that should things continue on in the positive direction they are that that certainly could benefit from uh continue um you know broad-based the broad-based momentum that we're seeing and and also thinking about you know um kind of cyclical versus structural growth, Scott, right?

So the, you know, the effort to kind of pivot the, you know, the businesses, the whole, you know, ready to grow but not growing and the ones that, you know, were outgrowing, do you think there will be, you know, measurable outgrowth, you know, across most of the portfolio?

You know, so like you said, we don't know quite what the world's going to hand us in 2021, but I I just wonder your confidence and visibility on outgrowth. You mentioned new products and food equipment, for example. I'm sure there's things in other segments. Maybe you could just provide a little additional color there. Yeah, I think that's where the proof's got to be in the pudding. I mean, that's what we've been working on. And so, you know, certainly in 2020 and 21, you know, I think to try to get any sense of sort of what the market baselines are, given just the overall volatility and all the, let's say, the corresponding supply chain impacts on demand and inventory levels and all that stuff, it's really, you know, it's almost impossible to tell. But I would absolutely expect that our ability to stay focused and aggressive on the growth agenda through all of this I won't say a better payoff, but it's what we're all about. It's what we've been doing all this stuff for. So I won't tell you that every one of our 83 divisions are all the way there, but I guarantee you that I can say that a good 90% of them are in great position, are doing all the right things, have stayed focused and stayed aggressive through this. We're not in that. We're not using the ready-to-grow and not growing categories anymore. I'll put it that way. I think we're well past that point. Great. Thanks for the color. Good luck this year. Thank you.

Your next question comes from Ann Dignan from J.P. Morgan. Please go ahead. Your line is open.

Hi. Good morning, everybody. Maybe you should give us a... Morning. Maybe you could talk a little bit about your outlook for construction products that might have expected organic growth to have been up a little bit more in 2021, but perhaps it's just on the back of strong renovation in 2020. But just some color there in terms of regional and subsectors that will be helpful.

That's exactly what I told our EVP, I'm just saying that. So what I'll tell you, Ann, is that obviously a strong year for the construction business and finishing Q4 up 8% on a year-over-year basis. A lot of strength in the home centers that we've talked about really since the start. the beginning of the pandemic. We expect that to be, just given the comps, that the growth in the home centers will be in the low single digits. There are some encouraging signs around housing starts, and then we have a great portfolio of highly differentiated products. You put all of that together, you know, I think our view is we should be able to grow in the mid to high single digits here in 2021. And as I said, we're off to a good start here in January.

And any differentiation regionally that you'd like to comment on?

No, I think it's pretty, you know, I think the comps are a little bit easier in Europe maybe than in North America, but we really, on a global basis, we had a good year. So that's really all that I would point to.

Okay, and then as my follow-up, perhaps a similar question on welding, just different customer bases and maybe different regions, what you're seeing there, and I'll hand it over.

Yeah, so I think welding, you know, strong finish to the year, good momentum going into 2021. And I'd say a pretty solid outlook for all end markets, maybe with the exception of the oil and gas piece, which is somewhere in the 15 to – 20% is probably closer to 15% of total revenues. That is expected to remain, you know, soft as we go through the year. But the commercial business has been strong all year, and no signs of that slowing down. The industrial side, so this is what Scott talked about with CapEx maybe picking up as this recovery path is a little clearer. You know, we're expecting a solid year in the welding business with CapEx. Again, continued progress on the margin side, despite the fact that they put up almost 29% here in the fourth quarter.

Yeah, it certainly was impressive. Okay, thank you very much. I'll get back in line. Thank you.

Your next question comes from John Inch from Gordon Haskett. Please go ahead. Your line is open.

Thank you. Good morning, everybody. Hey, picking up... Good morning, guys. This is Karen. Picking up on a couple of the themes of the past few questions, do any of the businesses, Scott and Michael, stand out based on, call it, internal changes they may have pursued in 2020 that position them in your minds really favorably for 2021? And these could be everything from, I don't know, like acceleration of enterprise initiatives, new products line up that they've got ready to kind of tee up here. Maybe new customer sort of supply line or, excuse me, new customer channel initiatives or anything like that that you might call out?

Yeah, I can't really think of anything, you know, particularly given the environment we're in. Other than, you know, I'll point to what we've been talking about throughout, which is we stayed focused on implementing those, you know, the relevant changes, strategic changes, business by business along the lines of what you're talking about. throughout the entirety of 2020. So, you know, I think if anything, the most significant part of what we accomplished in 20 is we stayed ready, we stayed prepared, we stayed in position, and we kept moving the ball. And, you know, so I don't know that there's any big shifts that I can point to as much as the fact that we stayed in there and kept moving forward while dealing with, you know, a pretty unusual set of near-term circumstances, and I expect that that will pay significant dividends, particularly if the rate of recovery continues on as we're seeing right now.

Well, Scott, how significant, as we think in the next couple of years in recovery, are new products emerging? or the introduction of new products going to play in terms of the drive to faster growth? Like, was this an opportunity? I mean, we don't have a view inside the company, right? So was this an opportunity for, yes, to do realignment, cost-cutting, and so forth up to a decentralized level, but for the folks to basically say, you know what, let's push on this initiative or that initiative or launch that as part of kind of your overall emphasis to take share, which was stated kind of early on, right? Yeah.

Yeah, you know, new products are core, you know, it's a core element of our business model, customer-backed innovation. We have been, you know, there's been no change in terms of the central nature of that as our strategy. We are, you know, we're banging out, you know, a couple of thousand patents a year, you know, year in, year out. That certainly continued on in 2020 as it always has. So I don't know that there's been any inflection. or change in terms of our posture there. It is, you know, in my view, it's the only way we outgrow our markets over the long haul. You know, we're going to get some penetration from our service capabilities, from our ability to attract new customers. But in the end, you know, innovation, new products, New technologies attached to existing products is the key and core driver, ultimately, of our ability to outgrow our markets consistently over time. That's not a new concept here. And I would just add, financially speaking, John, you know, our internal investments are New products are top priority from a capital allocation standpoint. And if you look at our new product investment in 2020, it was the same number as in 2019 as we stayed invested in these projects and strategies to drive above-market organic growth. Historically, we've achieved about a percentage point of organic growth every year for new products. And that's kind of what we're counting on in every segment as we move forward.

Makes sense. If I could just sneak in one more. You returned to M&A. The two obvious challenging verticals have been commercial aerospace and oil and gas. Are you guys perhaps thinking you guys are contrarian thinkers? Are these possibly going to present opportunities for M&A? Like would you consider an aerospace deal? And in terms of oil and gas, would that be off limits just because of ESG considerations, which you obviously don't have today?

Yeah, I'd just go back to our – there's basically two criteria. One is that we have to – We're going to make that kind of an investment in terms of not just our capital, but our time, effort, and energy. It has to be in something that we have a lot of conviction about can support or further accelerate the company's long-term growth potential. And we have to also have significant potential for margin improvement from 80-20. You know, you can look at MTS and, you know, that absolutely checks both of those boxes. So I don't, you know, we don't have any, anything that in my view is off limits if those criteria are met. And I'll just leave it at that. Nor would I say, I'll not leave it at that, but I'll also say is nor are we leaning in super hard in one particular sector or another. I think as we've talked about it before, we have, you know, we have a demonstrated ability to perform and execute across, seven businesses today. So, you know, ultimately it's more a function of the individual characteristics of the asset that we're talking about than it is any sort of, you know, sort of outside-in view of, you know, we need to get growthier or play to a certain, you know, theory about, you know, long-term end market growth.

Makes sense. Thank you both. Appreciate it.

Please go ahead. Your line is open.

hi good morning um i guess just two follow-ups one um i know you talked about sort of supply chain and as it relates to the automotive um sector i guess one do you have anything in your guidance embedded for supply chain potentially higher freight costs or whatever that's that's uh you're you're managing for and i guess my second question um you know when you first laid out your strategy in 2020 to go after market share during covid you talked about potentially know your competitors having issues as demand ramps or even managing through the downturn can you talk about whether some of the supply chain issues are impacting your competitors uh you know and whether it's sort of in line with what you thought greater than what you would thought i'm just trying to size that potential opportunity thank you yeah so jamie on your first question um we are seeing an increase uh in freight cost it is not

one of the largest categories when we look at where we're seeing cost pressure, but it is any known increases in terms of freight and logistics are embedded in our plan, in our guidance here today. I think in terms of market share, as a result of being able to maintain delivery and quality. If we were to talk to our segments, they would all be able to come up with lots of examples from their divisions where that is the case. And it's not just in one segment, it's really across the board. You know, we've been able to pick up share. Now, so I will just say we're not doing this you know, with a short-term focus that these have to be, you know, sustainable market share gains, and they have to be at ITW caliber margins for us to be interested in pursuing them. So that's probably the best answer I can give you on that one.

Okay. Thank you.

Thank you.

Your next question comes from Julian Mitchell from Barclays. Please go ahead. Your line is open.

Hi, good morning. Maybe my first question really for Michael around the free cash flow outlook. You know, CapEx was down substantially, I think almost 30% in 2020. what slope of recovery do we see there? Um, and how much of a working capital headwind should we expect as well? I suppose the, the end point here is to try and understand relative to that 2.6 billion of free cash last year. Um, you know, what the Delta is, uh, this year in the context of the earnings guy.

Yeah. So, so Julian, um, Some of the capacity expansions that were planned for 2020 were obviously pushed out as a result of the global pandemic, not as a result of anybody at corporate saying you can't invest in your businesses. This was really our divisions deciding to defer these capacity expansions. And as the recovery progresses, that capex spend increases. will return to normal levels, which is the assumption that's embedded for 2021. We also have in our free cash flow forecast an assumption that we will build up some degree of inventory, receivables, working capital to support almost double-digit growth across the enterprise. So we have about $125 million of working capital coming in, and that is included in our numbers here. And you put it all together, we expect to deliver, you know, another strong year from a cash flow perspective at 100% plus conversion from that income.

Thanks. And then maybe my follow up on the uses of that good cash flow and the big cash balance at the end of December, maybe for Scott. I think, Scott, you sounded somewhat reticent on M&A at the last earnings call and then today we see the buyback placeholder and heard Michael's comments around deferring divestment into 2022. So just wondered what your latest thoughts were on the M&A appetite, if you're more or less optimistic on acquisitions today versus a few months ago.

Yeah, what we talked about last call was really around the fact that what we're interested in is quality assets that we can help, you know, good companies that we can help become even better companies. And the fact is that during times of major disruption that those good companies typically don't want, it's not a good time for them to sell their businesses. You know, so the reticence was not ours from a financial perspective. It was just a statement of reality that the kind of assets that we are interested in acquiring are not available. The, you know, our interest in adding quality assets to ITW that fit our strategy and that meet the criteria that I talked about, you know, that was in my response to another That doesn't go up and down. That is always there. We have plenty of capacity, whether we have cash on hand or whether we need to use the balance sheet. That's just a timing issue. We generate so much cash. We have the ability to improve these assets we buy. We generate great returns. It's just a matter of, you know, we're also very disciplined. So we find we come across an opportunity that we think fits. You know, it's not a situational, you know, Is it the right time or not? It's going to be at ample capacity to do it. But we're not going to just lower our standards because we happen to be sitting on some cash right now. I think that's the best way I can characterize it. MTS is a compelling ad. It has characteristics that are very similar to the Instron business that we bought back in 2005. Entry margins are roughly the same. I think it's drawn through a couple of points higher, you know, similar end market characteristics. You know, it's a terrific fit. You know, it wouldn't matter what time, what year, where we were in the cycle or what time of year it was. You know, if we have another MTS-like opportunity, we will take full advantage, do our best to take full advantage of it. And that's the best way I can, I think, say it. And maybe I'll just, you know, clarify something, Julian. I mean, I think given our track record here, as we just talked about, in terms of consistently generating strong free cash flow, given the strong balance sheet, You know, I don't want you to interpret the fact that the buybacks are coming back as, you know, we don't have capacity to do M&A because that is certainly not the case. I mean, we have ample liquidity. As Scott said, if the right opportunity comes along, we're going to be certainly looking closely at things. So I wouldn't read anything into, you know, the buybacks coming back. We are in the fortunate position where when I talked about the four priorities from a capital allocation standpoint, For us, it's not A, B, C, or D. It's really we can do all of the above. We have the capacity, the financial strength, the balance sheet to do all of the above.

Great. Thank you both.

Your next question comes from David Razzo from Evercore. Please go ahead. Your line is open.

Hi. Good morning. You mentioned on price cost you'd match the higher cost dollar for dollar. just obviously price equaling cost is not helpful to margin. So when I think of the full year guide, the revenue guide, the organic that's up eight and a half, how much of that is actually coming through with no margin? Meaning what percent of the eight and a half is simply price being negated by cost?

Well, so we don't really look at it that way, David. So let me try to answer your question maybe a little bit differently. So I think what I heard you say is we will offset any material cost increases uh with price on a dollar for dollar basis let me just add a clarification that means i'm incremental from here that doesn't mean necessarily in our plan correct that's what yeah so yeah so that's where i was going so and any incremental uh cost increases that we may see as we go through the year will be offset And with price dollar for dollar, obviously... And that really reflects the timing problem. Yeah, not the problem, but the lag. In the long term, we will absolutely catch up, and we typically get more than that. I think what you're talking about is that in the... That does mean if you do the math, which I'm sure you've done, that can be slightly dilutive to operating margins as we go through the year. But that's not... You know, that's not what's in our planning today. And our plan today is we are positive price ahead of cost. And any cost increases that are coming through will be offset, you know, dollar for dollar. There can be a slight lag. We talked a little bit about some of the challenges in automotive. So that's probably the best I can answer your question.

Okay. No, I was just, look, the incrementals are still impressive at 40. And I was just, that's in the guide, and I was just curious. You know, are they even higher than that in a way or in a core fashion because, you know, say 2% of the revenue growth was coming in at no incremental rate, coming at a price versus cost. But overall, you're saying add it all up, we're still getting 40% incrementals. If costs go up from here, yeah, that might be a bit dilutive on the margin. It might be just price equaling cost. I mean, that's all I was trying to get at. I mean, the 40 is still very short. I'm just trying to get the underlying.

Yeah, that's what I think.

And when it comes to the M&A pipeline, I mean, obviously all the SPACs that are out there and the money at wash and private equity, the MTS business that you bought, you know, it seemed like you found something that fits well. Obviously the margins aren't tremendous, so I think you probably got it at one time or less the sales. Are you finding, with all the SPACs out there and so forth, that you can still find businesses like this that are maybe a little off the radar, or it's just going to be you know, a little more challenging to put the money to work just given maybe people are bidding up assets otherwise wanted just given.

Yeah. No, I think it's not a matter of finding things that are off the radar. The ultimate advantage we have, you know, even in a competitive market is the margin improvement potential. You know, that our ability to pay whatever the multiple is, you know, there are certainly, you know, our financial modeling skills I'm not suggesting we can pay any multiple, but certainly our ability to pay market multiple and then triple or quadruple the underlying earnings and knowing that we can do that with a high degree of certainty over some period of time is ultimately what allows us to be competitive. So that's, you know, that's what we've said all along is, you know, we're not going to pay for a fully, you know, buying or acquiring a fully margined business is not interesting for us because it takes that competitive advantage off the table. And from a return standpoint, it makes it all about, you know, where you're right about the growth rate 10 years out, which is a pretty challenging thing to get right. So, you know, we can compete in the right circumstances. We just proved it. I think...

I'm sorry.

Go ahead.

I was just thinking for MTS, and I know you have a framework for hopefully future deals you can do. When you think of some amortization of the intangibles that are coming in, that 6% margin of MTS was a 19, so I would think the margin might have been down in 20. What's the level set for us when we think of modeling that, say, from mid-year on? What's the starting point for all in the margin amortization, the base we're coming off of, and then the ramp to the 20% plus over five years, how much is there a step function in the first full year? And then it's kind of linear from there.

So David, let's close on the deal first and do all the accounting. And hopefully that'll be mid-year. And so when we get on the earnings call, you know, hopefully for Q2 we'll be able to give you a lot more detail in terms of, you know, the questions that you're asking. Our current view based on what we have modeled is that there's not going to be a material impact, you know, in year one. And then, you know, the implementation of the business model takes some time. We didn't buy the business, you know, obviously for the you know, potentially in year one. This is a long-term investment and one we're very pleased with. And we see a clear path to get it to ITW caliber margins and returns over the timeframe that we discussed. So, but if you could wait until we get the deal closed and we'll provide all the detail here. But I'll help you with this part if you want, which is just figure the margin is steady sequential improvement year on year, just like we run the company. There's no big step change. And so the path from 6% or whatever the starting point is to the ITW average is divided by five. It's probably a better model than some hockey stick in the early period, if that helps.

Your next question comes from Steven Volkman from Jefferies. Please go ahead. Your line is open.

great uh thanks for for fitting me and i'll be real quick um scott i think you gave us a couple quarters ago a number that you thought you had won some new contracts because of your window down kind of strategy any update to that kind of for the full year 2020. yeah i'll go back to what michael said you know that at that point we could count them because it was we just started you know we were a couple weeks into it and there was some obviously visible

specific opportunities that we were aware of at this point, it's far too broad based. It's not something that we're sort of tracking across the company necessarily.

Okay. All right. Fair enough. Given the volume. Yeah. Understood. And Michael, I think you said PLS is 50 basis points of headwind in 21. Isn't that kind of what we should consider sort of normal and the run rate for the foreseeable future?

Yeah, I think last time we looked at this, at full potential, we had modeled 30 basis points as kind of the ongoing run rate. So you're pretty close here. Okay, that's all I had. You're right. We modeled 50 here for 2021. That's correct. Appreciate it.

Your next question comes from Ross Gilardi from Bank of America. Please go ahead. Your line is open.

Oh, thanks for squeezing me in. Just on the APS guide, I wanted to clarify, Why wouldn't the low end be $8 plus? I mean, you just earned over $2 in the fourth quarter. You're guiding the 9 to 12. There isn't a lot of seasonality in your business in a normal year. So why wouldn't $2 at minimum be like an appropriate quarterly run rate for EPS in the first half? And if that's the case, are you baking in a meaningful second half slowdown? I mean, any help you can give us on how your guidance looks first half versus second half?

Yeah, so, Ross, let me say first, I hope you're right. And second, I'll just go back to what I said in the prepared remarks in response to one of the questions earlier is that, you know, how we have modeled the top line is really using, you know, current levels of demand in what we're seeing in our businesses. We're projecting that into the year. If you go and look at kind of historically, how a typical year unfolds at ITW in terms of, you know, the earnings in the first half versus the second half. It is remarkably consistent. So I think that's probably a good start to help you maybe understand a little bit better how the things might unfold kind of first half, second half. But to be very clear, again, we are not baking into any of our guidance that demand is going to slow in the second half we're also not baking in that demand is going to accelerate so to the extent you have a more positive view in some of the segments you can certainly model that and see what what answer you get but we are assuming that like i said the demand stays revenue per day stays where it is adjusted for seasonality projected into you know 2021.

But just on that, Michael, I mean, if you're saying you're just taking current demand, I mean, you just earned $2 in the fourth quarter.

Yeah, but you have to look at it. Maybe, Ross, we take this one offline, and I can walk you through how, you know, the historical trends, okay? Okay. I'm not sure how else to answer your question. And, again, I'm not giving you, you know, quarterly guidance. We're giving you a full year. And I think there's enough information to look at the historical trends to figure out how things might play out on a quarterly basis.

Great. Thanks, Michael.

Your last question will come from Joe Ritchie from Goldman Sachs. Please go ahead. Your line is open.

Thanks. Good morning, everybody. Two quick ones for me, and I know we'll get more details on MTS later, but just given that PLS is part of the framework and equation for you guys, how should we think about MTS's revenue trajectory? Will there be some PLS, you think, at the beginning and then growth from there? How should we think about that?

Yeah. Again, like I told David earlier, we'll provide more of a detailed update once the deal has been closed. But you should assume that PLS is a significant component of the overall ITW business model that we'll be implementing. And it happens early, first couple of years. It happens in the first, the way it's modeled in the first two to three years, all the PLS gets done. And then from there on out, you should see the accelerated growth rate with the higher margin profile that we talked about earlier.

Got it. Okay. That makes sense. And then maybe my last question, and I actually can't believe I'm going to ask about it because I don't think I've ever asked a question on polymers and fluids on a conference call, but the growth rate has really picked up in this segment in the last couple quarters, and obviously you have a good outlook for 2021. Just maybe talk a little bit about, you know, how you feel about either new product introductions or sustainability of that growth rate. Just given the segment has gone through several years of PLS, and it seems like it's now seen a turn in growth.

Yeah, I think you're right. I mean, we've done a lot of – the team's done a lot of PLS over the years, a big focus on organic growth. We continue to see certainly good progress in terms of new products. You know, I talked earlier about on average at the company level we get a percentage point from customer-backed innovation. We're actually getting a rate that's double that in palmers and fluids. So certainly the team has executed well on the organic growth framework and made progress on strategic sales excellence. And I think it's certainly helped that some of the end markets were quite favorable in Q4, and the outlook for 21 is pretty good in areas such as health and hygiene. You know, we're seeing a recovery in MRO applications. And the retail side related to automotive aftermarket has been solid, too. So I will pass on your comments to the Parmas and Fluids team.

Okay. Great. Thank you. I'll be thrilled they got a question.

Okay.

I think we're out of time. So I'll just say to everybody, thanks for joining us this morning. And if you have any follow-up, just give me a call. Thank you.

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