Illinois Tool Works Inc.

Good morning. My name is Christy 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, press the pound key. For those participating in the Q&A, you will have the opportunity to ask one question and, if needed, one follow-up question. Thank you. Karen Fletcher, your Vice President of Investor Relations, you may begin your conference.

Thank you, Christy. Good morning, everyone, and welcome to ITW's first quarter 2021 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 first quarter financial results and update our guidance for full year 2021. Slide 2 is a reminder that this presentation contains forward-looking statements. We refer you to the company's 2020 Form 10-K for more detail about important risks that could cause actual results to differ materially from our expectations. 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.

Thanks, Karen. Good morning, everyone. In Q1, we saw continued improvement in both the breadth and pace of the recovery, with six of our seven segments delivering strong growth in the quarter. with revenue increases at the segment level ranging from 6 to 13%, and that's with one less shipping day in Q1 of this year versus last year. At the enterprise level, organic growth was plus 6 in Q1 or plus 8 on an equal days basis, and that was despite the fact that our food equipment segment was still down 10% in the quarter. The fundamental strength of our 80-20 front-to-back business system and the skill and dedication of our people around the world combined with the recovery actions that we initiated over the course of the past year allowed us to meet our customers' increasing needs while at the same time delivering strong profitability leverage as evidenced by our 19% earnings growth, 45% incremental margins, and 120 basis points of margin benefits from our enterprise initiatives in the quarter. Despite rising raw material costs, and a tight supply chain environment, we maintained our world-class service levels to our customers while also establishing several all-time Q1 performance records for the company, including earnings per share of 211, operating income of $905 million, and an operating margin of 25.5%. Based on our first quarter results and our normal practice of projecting current demand rates through the balance of the year, We are adjusting our 2021 guidance. For the full year, we now expect organic growth of 10% to 12% operating margin in the range of 25% to 26%, an EPS of 820 to 860 per share, which at the 840 midpoint represents 27% earnings growth versus last year. At the midpoint of our revised guidance, 2021 full-year revenues would be up 1% versus 2019, and EPS would be up 9%. Now, stating the obvious, there's still a lot of ground to cover between now and the end of the year, and the near-term environment is certainly not without its challenges. That being said, I have no doubt that we are well-positioned to respond to whatever comes our way as we move through the remainder of the year. and to continue to deliver differentiated performance in 2021 and beyond. And with that, I'll turn the call over to Michael to provide more detail on the quarter and our updated guidance. Michael?

All right. Thank you, Scott, and good morning, everyone. The solid demand momentum we had coming out of the fourth quarter continued to gain strength across a broad cross-section of our business portfolio in Q1. Our operating teams around the world responded to our customers' increasing needs, as they always do, and delivered revenue growth of 10%. Organic growth of 6% was the highest organic growth rate for ITW in almost 10 years. And as Scott mentioned, Q1 had one less day this year, and on an equal days basis, organic revenue grew 8%. Organic growth was positive across all major geographies, with China leading the way with 62%. North America was up 4%, and Europe grew 1%. Relative to Q4, the new trend that emerged in Q1 was a meaningful pickup in demand in our CapEx-driven equipment businesses, test and measurement and electronics, which grew 11%, and welding, which grew 6%. Gap EPS of 211 was up 19% and an all-time EPS record for continuing operations. Operating leverage was a real highlight this quarter with incremental margins of 45%. as operating income grew 19% year-over-year. Operating margins improved to 25.5% in the quarter, an increase of almost 200 basis points as a result of volume leverage and a continued strong contribution of 120 basis points from our enterprise initiatives, partially offset by the margin impact of price costs. Excluding the third quarter of 2017, which had the benefit of a one-time legal settlement, operating margin of 25.5% was our highest quarterly margin performance ever. As you know, supply chains around the world are under significant pressure, and ITW's operating teams certainly have to deal with their fair share of supply challenges and disruptions in the quarter. By leveraging our produce where we sell supply chain strategy, our proprietary 8020 front-to-back business system, and supported by the fact that we were fully staffed for this uptick in demand due to our win-the-recovery initiative, we were able to maintain our normal service levels to our customers. And once again, our ability to deal with the impact of some pretty meaningful supply chain challenges and disruptions and still take care of our customers with strong levels of profitability speaks to the quality of the execution at ITW. In the quarter, we experienced raw material cost increases, particularly in categories such as steel, resins, and chemicals. And across the company, our operating teams have already initiated pricing plans and actions that will offset all incurred as well as known but not yet incurred raw material cost increases on a dollar-for-dollar basis as per our usual process. As a result, price-cost is expected to be EPS neutral for the year. As you know, given our high margin profile, offsetting cost increases with price on a dollar-for-dollar basis causes some modest dilution of our operating margin percentage and our incremental margin percentage in the near term. In Q1, for example, our operating margin was impacted 60 basis points due to price costs, and our incremental margin would actually have been 52%, not 45%, if it wasn't for this impact from price costs. For the balance of the year and embedded in our guidance are all known raw material increases and the corresponding pricing actions that have either already been implemented or will be. Again, EPS neutral for the full year. At this early stage in the recovery, our 25.5% operating margins are already exceeding our pre-COVID operating margins. Four of seven segments delivered operating margin of around 28% or better in Q1, with one segment, welding, above 30% in a quarter for the first time ever. I think it says a lot of our operating teams that when faced with the challenges of a global pandemic, they stayed focused on our long-term enterprise strategy and continued to make progress towards our long-term margin performance goal of 28% plus. After-tax return on capital was a record 32.1%, and free cash flow was solid at $541 million with a conversion of 81% of net income in line with typical seasonality for Q1. We continue to expect 100%-plus conversion for the full year. As planned, we repurchased $250 million of our shares this quarter, and the effective tax rate was 22.4%, slightly below prior year. So in summary, the first quarter was solid for ITW with broad-based organic growth of 6%, strong profitability leverage, 19% earnings growth, 45% incremental profitability and record operating margin and EPS performance. So please turn to slide four for the segment performance. And the information on the left side of the page summarizes the organic revenue growth rate versus prior year by segment for Q1 this year compared to Q4 last year. And it illustrates the broad-based demand recovery that we're seeing in our businesses. And obviously, there's a positive impact as the easier comparisons begin on a year-over-year basis. With the exception of automotive OEM, every segment had a higher organic growth rate in Q1 than they did in Q4. And six of our seven segments delivered strong organic growth in the quarter with double-digit growth in construction products and test and measurement in electronics and which are also the most improved segments in this sequential view, going from down 3% in Q4 to up 11% in Q1. Welding improved 8 percentage points, growing 6% in Q1, providing further evidence that the industrial capex recovery is beginning to take hold as visibility and confidence is coming back. At the enterprise level, ITW's organic growth rate went from down 1% in Q4 to up 6%. And I would just highlight that this is 6% organic growth with one of our segments, food equipment, while on its way to recovery, is still down 10% year-over-year. As we go through the segment slides, you'll see that this robust organic growth combined with strong enterprise initiative impact contributed to some pretty strong operating margin performance in our segments. So let's go into a little more detail for each segment, starting with automotive OEM. And the demand recovery in the fourth quarter continued this quarter with organic growth of 8% and total revenue growth of 13%. North America revenue was down 2% as customers continued to adjust their production schedules in response to the well-publicized shortage of certain components, including semiconductor chips. We estimate this impacted our Q1 sales by about $25 million. and it is likely to continue to impact our revenues to the tune of about $50 million in Q2 and another $50 million in the second half of the year. As you can appreciate, the situation is obviously pretty fluid, but as we sit here today, that is our best estimate, and that is also what we embedded in our updated guidance. Looking past the near-term supply chain issues affecting the auto industry, We're pretty optimistic about the medium-term growth prospects as consumer demand remains strong and dealer inventories are very low by historical standards. By region, North America being down in Q1 was more than offset by Europe, which was up 4% and China up 58%. And finally, the team delivered solid operating margin performance of 24.1% and improvement of 320 basis points. Please turn to slide five for food equipment. So revenue was down 7%, with organic revenue down 10%. But like I said, much improved versus Q4. And there are solid signs that demand is beginning to recover, as evidenced by orders picking up and a backlog that is up significantly versus prior year. Overall, North America was down 6%, with equipment down only 1%, as compared to a 22% decline in Q4. Institutional, which represents about 35% of our North American equipment business, was down 7%, with healthcare about flat and education still down about 10%. Restaurants, which represents 25% of our equipment business, was down in the mid-teens, with full-service restaurants down about 30%, but fast casual up low single digits. Retail, which is now 25% of the business, was up more than 20% as a result of strong demand and new product rollouts. International was down 15% and is really a tale of two regions. As you would expect, Europe was down 22% due to COVID-19 related lockdowns. And on the other hand, Asia Pacific was up 44% with China up 99%. Overall equipment sales were down 4% and service down 19%. Test and measurement and electronics delivered revenue growth of 14% with 11% organic growth. Test and measurement was up 7% with continued strength in semiconductors and healthcare end markets now supplemented by strengthening demand in the capital equipment businesses as evidenced by the Instron business growing 12%. The electronics business grew 16% with strong demand for clean room technology products, automotive applications, and consumer electronics. Operating margin of 28.4% was up 330 basis points. Let me just slide six. As I mentioned earlier, we saw strong sequential improvement in welding as the segment delivered organic growth of 6%, the highest growth rate in almost three years. The commercial business, which serves smaller businesses and individual users, usually needs a way in a recovery, and Q1 was their third quarter in a row with double-digit growth, up 17% this quarter. The industrial business continued its sequential improvement trend and was down only 1% with customer capex spend picking up and backlogs building. Overall, equipment sales were up 10% and consumables were flat versus prior year. North America was up 7% and international growth of 4% was primarily driven by recovery in China and some early signs of demand picking up in oil and gas. Solid volume leverage and enterprise initiatives contributed to a record margin performance of 30.3%, which, as I said, marked the first time an ITW segment delivered operating margins above 30%. Palmers and Fluids delivered organic growth of 9%, with Palmers up 16%, driven by strength in MRO applications, particularly for heavy industries. The automotive aftermarket business continued to benefit from strong retail sales with organic growth of 9%, while fluids, which has a larger presence in Europe, was down 1%. Operating margin benefited from solid volume leverage and enterprise initiatives to deliver margins of 25.7%. Moving to slide 7, construction was the fastest-growing segment this quarter with organic growth of 13%. North America was up 12% with continued strong demand in residential renovation and in the home center channel. Commercial construction, which is only about 15% of our U.S. sales, was up 3%. European sales grew 19% with double-digit growth in the U.K. and continental Europe. Australia and New Zealand grew 7% with strength in both residential and commercial markets. Operating margin of 27.6% was an improvement of 420 basis points. Specialty revenues were up 10%, with organic revenue of 7% and positive growth in all regions. North America was up 6%, Europe up 5%, and Asia Pacific was up 24%. Demand for consumer packaging remained solid at 6%. So please turn to slide 8 for an update on our full year 2021 guidance. And per our usual process, And with the caveat that we're only one quarter into the new year and a significant number of uncertainties and challenges are still in front of us, we are raising our guidance on all key performance metrics, including organic growth, operating margin, and EPS. In doing so, we've obviously factored in our solid Q1 results, and per our usual process, we are projecting current levels of demand exiting Q1 into the future and adjusting them for typical seasonality, And as discussed, we've made an allowance for the estimated impact of semiconductor chip shortages on our auto OEM customers. The outcome of that exercise is an organic growth forecast of 10% to 12% at the enterprise level. This compares to a prior organic growth guidance of 7% to 10%. Foreign currency at today's exchange rates adds 2 percentage points to revenue for a total revenue growth forecast of 12% to 14%. As you saw, we're off to a strong start on operating leverage and enterprise initiatives, and we're raising our operating margin guidance by 100 basis points to a new range of 25% to 26%, which incorporates all known raw material cost increases and the corresponding pricing actions. Relative to 2020, our 2021 operating margins of 25% to 26% are 250 basis points higher at the midpoint and they're almost 150 basis points higher than our pre-COVID 2019 operating margins of 24.1%, as we continue to make progress towards our long-term performance goal of 28% plus, as I mentioned earlier. Our incremental margins for the full year are expected to be above our typical 35% to 40% range. Finally, we're raising our GAAP EPS guidance by 60 cents or 8% to a new range of 820 to 860. The new midpoint of 840 represents an earnings growth rate of 27% versus prior year and a 9% increase relative to pre-COVID 2019 EPS of 774. A few final housekeeping items to wrap it up. with no changes to one, the forecast for free cash flow, two, our plan to repurchase approximately a billion dollars of our own shares, and three, our expected tax rate of 23% to 24%. As per our usual process, our guidance is for the core business only and excludes the previously announced acquisition of the MTS test and simulation business. The process to close the acquisition by mid-year remains on track, And once the acquisition closes, we'll provide an update. As we've said before, we do not expect a material financial impact on earnings in 2021. So, in summary, a quarter of quality execution in a challenging environment, and as a result, we're off to a solid start to the year. So, with that, Karen, I'll turn it back to you.

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

Yes. At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Jamie Cook with Credit Suisse.

Hi. Congratulations on a nice quarter. Hi, Jamie.

Hi.

Two questions. Obviously, the organic growth that you saw in the quarter was fairly strong. I'm just trying to understand how much of it is sort of just, you know, end markets recovering versus sort of structural market share gains that ITW has been able to achieve. I guess that's my first question, if you can help us on that. And then my second question, you know, the incrementals that you're putting up, the 45 percent and then 52, if we adjust for price cost, this is above your you know, targeted range with supply chain, sorry, with COVID, just costs and inefficiencies and things like that. I'm just wondering if, you know, we should rethink at some point your targeted incrementals. Thank you.

Okay, Jamie. So, I think on the first one, it's a little too early to tell. I mean, I think we certainly feel very good about how we are positioned with our win-the-recovery strategy and the fact that we stayed invested, giving us the ability to capture market share, as we've talked about. So I think it's a little too early to tell how much of that growth in Q1 is really market versus market share gains. And I'll just add to that, we've also seen an uptake from the contribution of our customer-backed innovation efforts. And so, again, that's a result of being able to stay invested in those. And then I'd point to our supply chain and our ability to maintain our service levels where maybe others are struggling a little bit more. So I think anecdotally, there's certainly lots of evidence. If you were to ask our divisions and our segments that we're picking up share, and again, we're going after sustainable, high-quality, profitable market share gains, not opportunistic. And so we feel really good about the start to the year. on account of those things. I think on the incrementals, I agree with you. That was a real bright spot, significantly above our normal range of 35 to 40. At these early stages in the recovery, we expect to be able to maintain the incrementals above the typical range, so 40% plus is what we're planning for and also embedded in our guidance as you saw today. If you do the math, that's where you end up. I think it's a little premature to update kind of the long term incremental margin expectations. I think we're comfortable with kind of long term in the 35 to 40 range We're certainly making a lot of improvement to the cost structure of the company, but let's revisit that at a later stage in terms of what we think the long-term incrementals might be on a go-forward basis. For now, if you think kind of beyond this year, I would still stick to kind of the 35% to 40%. Okay.

Thank you, and congratulations.

Thank you.

Our next question comes on the line of Jeff Sprague with Vertical Research.

Thank you. Good morning. Good morning. Hey, Scott, I was wondering if you could just update us on what you're thinking on M&A.

Obviously, you've got this MTS deal coming.

I'm sure you could have taken a shot on goal at WellBuild if you wanted to and passed there. Maybe just how you see the pipeline kind of filling out this year. And I understand these things are always kind of idiosyncratic and have their own timing.

But do you see a likelihood that the pace of activity on M&A could be picking up for you over the next six to 12 months?

Well, I think we are really happy with the MTS situation. acquisition that we've got some work to do obviously to get that one over the uh just just to get it closed all that's basically standard and routine but that's um i you know i think a great example of of where i think acquisitions supplement our core growth focus which is really owning great businesses that deliver great value to their customers and that we can grow organically and mps certainly adds and supplements our our capabilities in terms of the test and measurement space and our ability to do so. I'm not going to comment on your specific reference or any other deals that others have announced recently, but I would say that our appetite for additional MTS-like deals remains certainly strong. I think your – I can't remember exactly the term you used, Jeff, but I think the phrase opportunistic is the right way to think about it. It's a combination of ultimately what we're interested in doing, what fits with the availability of assets that fit that profile. And that includes both, you know, their strategic attributes, the attributes that they offer in terms of our ability to improve their inherent financial performance, and all that value that we think makes sense for us and our shareholders in terms of return on not just the capital, but the time, effort, and energy that we're going to expend. So, you know, that's sort of the generic strategic narrative around it. You know, my personal view is I absolutely think, you know, on average one to three MTS kinds of deals a year seems to be a reasonable, something that absolutely is achievable. We're not going to, you know, we're not going to try to, sort of force a deal every year on that. So some years are going to be zero because the circumstances are not going to present. The circumstances that we're looking for are not going to present themselves. But I think there's lots of room for other similar kinds of deals to be additives to what we're doing in a relatively consistent way over, let's say, a five-year period. I think I'll stop there. Thanks. I appreciate that. And also just wondering outside of auto, which, you know, is kind of plain to see with Ford announcements and everything else. Are you seeing these sorts of sounds like your own supply chain you're feeling pretty good about, but, you know, other things going on at customer levels that that may cause top line disruption to you over the balance of the year? I think it's hard to project balance of the year. I would say for sure in the second quarter, there are broader issues than just automotive at play. And I would also say that it's absolutely fair that we are having to work a lot harder in terms of securing our own sources of supply than we would under normal circumstances. You know, we have, for a number of reasons, I think, been able to counterpunch our way through, you know, a much more challenging supply environment in the first quarter. And through the second quarter, I think we're going to be able to do the same. You know, broadly speaking, partly because we source local. You know, we know our suppliers. We source where we produce locally. And I think partly because of the fact that we stayed invested, we hung on to our people, so we're not having to add people back to support this uptick in demand. But no one should take from that that it's been smooth and easy the whole way through. So we're in the soup with everybody else and certainly having to work harder than normal to sustain our ability to supply. But I think so far I feel like We've been able to, as I said, counterpunch our way through it pretty well. And I would also say beyond the automotive space, there are certainly some pockets where we have some of our customers being impacted by some of their own supply chain issues. Plastics are remaining tight in a number of areas. I don't think anything as sort of concentrated and significant as an auto, but it's certainly a scramble right now on a lot of levels. No question. Understood. Yeah, understood. Thanks for the call. Appreciate it. Good luck. Thanks. Thank you.

Our next question comes from Scott Davis with Mellis Research.

Hi. Good morning, guys and Karen. I would echo Jeff's comments on exceptional numbers as they become the usual here. But anyways, not a lot to pick on here. One of the comments you just made, Scott, on price, or maybe it was Mike, price-cost neutral. Is that a comment that you'd make across the entire portfolio, that segment by segment you – expect to be in a cost-neutral position this year, or are there certain segments perhaps that take a little longer to get price or could be behind?

Yeah, I mean, I think the one obvious one, Scott, is the auto business, where just given the nature of the business and how the contracts are structured, getting price takes a little longer and requires a... funnel of new products that are coming in at more attractive margins. So that's the one where in the near term we're seeing the most significant pressure on margins from a price-cost standpoint. And the other six segments, I think there's, given the differentiated nature of the products and services that we provide. We have a long history of being able to offset any cost increases with price. There's typically a little bit of a lag. I will tell you, we learned some things when we went through this in 2018. We are definitely much more focused and on top of things earlier on. And our divisions are taking the actions that are required to kind of stay ahead of things this time around. So while there's certainly some pressure here, you saw 60 basis points of margin percentage impact and 7 percentage points of incremental margin impact. The overall goal here is to offset on a dollar-for-dollar basis, and we're confident that we'll be able to do that

um you know for the year and and in total even with the the pressure and the difficulty in uh in automotive okay that's helpful and just as a follow-up again and just jump on the bandwagon of what jeff was asking about on m a i would think that given the success you've had in kind of multiple different types of businesses your assets Your confidence in going after a bigger asset and implementing 80-20 and really driving value perhaps way above what the PE world could do or other strategics would perhaps widen that scope of ability to be able to do deals on the larger side. How do you guys think about that and applying 80-20 when you think about an M&A model?

Yeah, I don't think size is a barrier at all or a limitation or something that would scare us away. I'd point to NTS as, you know, being a, you know, it's not quite a half a billion dollars in annual revenue, so it's not a small business by any stretch. i think i i tell you a couple of things one is that we have never been more prepared from the standpoint of discipline around integration our the the quality of practice around um our 80 20 front to back operating system you know the depth of town this is all a result of the last you know nine years of work on this so all of that certainly um It's just additive to, you know, I think our ability to, you know, if we find the right opportunity to do a really good job with it. So it's not an issue of size doesn't scare us. I think sometimes what does happen is the larger the size, there tends to be a, you know, to find a sort of a pure play, you know, this is the part of the business, you know, we want it all, you know, the bigger the asset, you know, the more sort of non-strategic, you know, non-desirable stuff you have to deal with sometimes. But, you know, that's also just sort of part of the tactics. But, you know, again, I don't think it's big or small that is the driving benefit to us as much as does it really fit with what we're good at. Does it fit an area of the market we think has, you know, long-term above market organic growth prospects, et cetera? And whether it's large or relatively small, and by that I mean division size, those would be equally attractive options to us.

Makes sense. Thank you, Scott. Good luck, folks.

You bet. Thanks. Thanks.

Your next question comes in the line of John Inch with Gordon Heskett.

Good morning, everybody. Good morning, John. Good morning. Good morning, guys. I'm Karen. Scott and Michael, China up 62% core. Have your factories and operations been able to keep up with that level of demand, which I get the premise of since compares, so it's not completely volume-driven, which presumably this is going to be up as much in the second quarter, just if it compares as well. Anything you would call out there? Because I understand the point that your factories are local and so forth, but that's still a very high growth rate. And I'm just curious how kind of the quarter played out. And did you have to leave any sales on the table, but maybe kind of get picked up later even?

Yeah, I actually probably can't answer that last piece other than to say that, you know, the business for us that's really of the biggest scale in China is auto. And they did a phenomenal job if you look at the kind of volume. Now, that's a big number year on year, but remember that China was way down in the first quarter last year. So from the standpoint of the sequential, I don't have that. I don't know if maybe you did, Michael, but from Q4 to Q1, it wasn't a 58% jump. Right. But I would say overall our decision to hang on to our people, you know, and just be ready for this has certainly, you know, given us an ability to respond that if we were having to not only source and scramble for raw material but also scramble for materials for people, it would certainly be a more difficult challenge than it was.

That's fair. I'm curious. So we all know sort of the constraints around Semicon and auto, Scott, you already talked about. I think I've asked, I mean, I've sort of alluded to these questions in the past about the post-COVID world demand is going to surge pretty aggressively. And I'm curious, we've already started to see that, you know, as evidenced by your own very healthy, robust results. Have your operations experienced any meaningful pinch points as global demand has come back that may have been surprising or that provide, per se, lessons learned, Scott and Michael, that, you know, you're applying as you know presumably this is not a one or two quarter phenomenon this is going to carry forward for a little while here um how how you know is there anything you can share with us in terms of how you're thinking about sort of operations and just you know playing to uh market share wins that sort of thing yeah i'm trying to think about how to how to um

sort of tackle that one, John. It's, you know, maybe the place to start is inheriting in our system is, you know, we always talk about the fact that we produce today what our customers bought yesterday. So inherent in that, what makes that work is the fact that we are always carrying surplus capacity. So on the order of magnitude of 15 to 20% over what current demand is. Because that demand comes in, you know, it's an average, but it varies on a daily basis. So the only way we can produce today what our customers want yesterday as that number moves up and down is to make sure that we have ample extra capacity to flex. So that sort of helps us as things accelerate. We do have a cushion to lean on. We also have, you know, our supplier base is connected into that system in a way that they are also carrying that kind of ability to flex. Now, it works really well. It doesn't work perfectly. You know, certainly with, you know, we have our, you know, sort of rubs and issues along the way, and I'm sure we will. But, you know, there are things that we can overcome and work our way through. But maybe that's the best answer. I don't know if that totally addresses it. But we start with a, you know, sort of level of flex that certainly helps us. responding at even more capacity as, you know, we're seeing, we're pivoting into kind of an environment where the economy is starting to take off.

Well, maybe an example is going to be food equipment. That seems obvious that that's going to come back pretty aggressively in the second half, touch wood. Is there anything you're doing with respect to your operations to make sure that you actually don't, say, lose share or lose a sale because you can't fulfill a product demand or something like that?

Yeah, I'm completely comfortable that they know exactly what to do. You know, I mean, again, we've hung on to all of our people through this. We've hung on to all of our capacity. We are locked and loaded and ready to go. I have no doubt about it in food equipment and, you know, everywhere else in the company.

Got it. Great.

Thank you very much. You bet.

Your next question comes from Melinda Ann Dubnon with JP Morgan. Hi, good morning, everybody.

Good morning.

Could you dig a little deeper into your comments around capital equipment demand picking up? I mean, I know you talked about it in places like welding, but just a little bit more color by region, by application, by segment. We'd just like to hear from you in terms of what specifically you're seeing, because that is a big change. Thank you.

Yeah, and as you're saying, that was kind of the new trend that showed up here in the first quarter. We did see orders and backlog starting to build last year on the equipment side, but really in Q1 here, if you look at the businesses that had the most significant improvement relative to historical run rates, they are test and measurement, as I mentioned. and welding. And so those are businesses that are more driven by investment in CapEx. And I think as the visibility to the recovery and the confidence in the recovery takes hold, our customers are placing orders for, you know, larger equipment. And we saw a little bit of that also in specialty products on the packaging equipment side. um and it's really a broad-based um you know trend so i i don't really have to break down for you on a global basis but really across the board you know we we saw really um nice uh pick up in in demand for the capex uh driven products and those in those three businesses in particular and and i i think with um you know we're off to a good start here in april so i i think we we saw Good momentum coming into Q1, kind of sustained that March was a strong month, and April, everything is on track here.

Okay. I appreciate the color on that. And then just back to the whole maintaining your employee base, and we see what a difference that makes this year. I mean, I don't think that that should be understated, given that almost every other company we cover mentioned that their inability to attract labor as an issue. So, you know, congratulations on that. But what about your customers? I mean, is there any risk that your customers have to defer orders? I mean, it's kind of counter to what you just talked about. But if your employers like the restaurants, for example, if they cannot hire, you know, is there any risk that they will have to defer orders as we go through the year just because they can't get labor?

Yeah, I would be pretty certain it's going to have some impact in terms of the overall pace of the recovery in a number of areas. My personal view, Ann, is that's maybe not even such a bad thing in terms of extending the duration of the recovery and sort of managing the pace a little bit in the short run. So even with these auto, if auto is a real extreme example of that, not so much from labor but from semiconductor chips, You know, Michael talked about the fact that, you know, consumer demand for autos is strong. Dealer inventories are at, you know, I think around the world, historic lows. So the fact that, you know, all of that is not trying to be satisfied in two quarters, and it actually gets spread out. And so I just use that same analogy in places like food equipment, because I don't think it's necessarily a terrible thing that there are some limitations, be they labor or other things, as we move through the recovery phase. In some of our sectors, it doesn't mean demand isn't going to grow. It's not going to be this feeding frenzy of satisfying it in a relatively short period of time. I don't know exactly how it's all going to play out, but I don't think some of those limitations in the near term are necessarily bad things for the long haul, if that makes sense.

Yeah, no, I completely agree with you. It's kind of a forced rationalization of the industry. So, yeah, I appreciate it. I'll get back in line. Thanks. Thanks.

Thank you.

Your next question comes from the line of Andy Kapowitz with Citigroup.

Hey, good morning, guys. Nice quarter. Hi, Andy.

Hi, Andy.

Scott or Michael, you mentioned welding margin now above 30%, which I think is a new record for you. And as you know, welding isn't close to fully recovered yet. If I go back to 2018, your margin at similar levels of revenue was approximately 28%. So if we step back and try and ingest that improvement, we're understanding that we haven't changed the long-term 28% target for the company over the last couple of years. But does it give you confidence that maybe the whole company can even do better than that over time?

Andy, the easy answer to your question is with the types of incrementals that our segments are putting up, you know, the enterprise level 45, welding was also 45. The answer is that margins will continue to improve just from the volume leverage alone. And then we know that there is still a ways to go to reach our full potential from an 80-20 front-to-back implementation standpoint as well. You see these enterprise initiatives continue to come in at 120 basis points at the enterprise level, maybe a little bit less than that in welding, but still a significant contribution from the initiatives. And so I've said this many times, and I'll continue to say this. I mean, we expect... And this is based on the bottoms-up planning that we do. We expect that all of our segments will continue to improve their operating margin performance. Like I said, as demand recovers and maybe more importantly, you know, we still have a lot of things within our own control here that regardless of what happens tomorrow, from a demand standpoint, we can continue to improve the margin performance. While they grow at an accelerated rate organically. While growing. That's the yin and the yang. That's right. We can do both, right? And then I'll just say what I said in my comments is what's really encouraging, I think, is that with everything going on last year and right now with the supply chain as well, the fact that our team's leverage this win-the-recovery strategy. State focused on executing the long-term enterprise strategy, and we're sitting here, really, you could argue, one quarter into the recovery, and we have, you know, a clear path in front of us as we continue to make progress towards our 28%. You said 28%. I thought my comments, I may have said 28% plus, that we continue to make progress towards our long-term margin goal of 28% plus.

Very helpful, guys. And then we talked a little bit about food equipment on the call already, but maybe just focusing on it. Obviously, reopening is happening faster, at least in the U.S. now, and you do have this large institutional business that could benefit from significant stimulus that already has been passed, especially for school cafeterias. So have you seen any of that money start to flow to that business, or have you seen accelerating improvement in your restaurant-focused business yet?

Not yet is the answer. I mean, like I mentioned, we are starting to see a pickup in orders and backlog. As you know, these businesses are not really backlog-driven, but the quoting activity is solid, and it's reasonable to assume that there will be a pickup on the institutional side um as we move forward including uh for schools so i think that's part of what's encouraging is we're not firing on all cylinders yet you know we put up some pretty good results here in q1 and we still have you know food equipment as you mentioned down 10 organic with with a strong recovery ahead of it so i think that's uh that's really encouraging thanks guys appreciate it sure

Your next question comes from the line of Nicole de Blas with Deutsche Bank. Yeah, thanks. Good morning, guys.

Good morning.

Can we talk a little bit about just returning to the issue of price cost? I know you guys said that it's a 60 basis points impact on margins in the first quarter. If we look at the full year, how does that kind of flow from here? Maybe what's embedded for price cost headwind in the full year margin guidance?

Yeah, so let me start by saying I'd be a little cautious on Q2. I think, you know, there's a little bit of a timing issue here. And just given how high our margins are, I think these price-cost pressures will remain with us, you know, particularly in the near terms of Q2. This will be diluted to margin percentage, again, EPS neutral on a dollar-for-dollar basis. So it's purely a margin percentage incremental margin. percentage impact. So 60 basis points in Q2. In Q1, something around that same level, maybe a little worse than that in Q2, based on what we know today. And then it should begin to improve in the second half of the year. And maybe for the full year, we end up somewhere around, you know, 50 to 60 basis points of margin impact.

Okay. Okay. Got it. Understood. And the selling days impact that you guys had in the first quarter, does that normalize throughout the year? Like I think a lot of companies have talked about the selling days impact reversing in 4Q. Is that how it is for ITW as well?

It is not. No. We have 64 days in Q2 and Q3 and 62 days in Q4, which is the same as we had last year. So this was purely a Q1 issue. If you remember, last year was a leap year. So I hate bringing this up, but That's how the calendar works.

Okay. Understood. Thanks, guys. I'll pass it on.

Sure.

Very nice question. Comes from the line of Meg Dober with Baird.

Thank you, and congrats on a really strong start to the year, gentlemen. I guess my... Yeah, my question, Michael, maybe for you. I was observing that SG&A has been relatively flattish year over year on really nice, strong revenue growth in Q1. And I'm just sort of wondering here kind of how you constructed your outlook for the full year because you're obviously guiding full-year revenues now above pre-COVID levels, above 2019 levels. I'm sort of wondering if it's fair for us to sort of expect that SG&A is going to remain relatively muted, or are you essentially kind of baking in a return to more normalized, call them pre-COVID levels? And I'm talking about the full year run right here. Thanks.

Yeah, so I'd say, Meg, I mean, I would expect somewhere around, as our sales grow, obviously the cost to support those sales increases. including things like commissions, are going to grow. And those costs are pretty correlated. And I think the last time I looked at it here a few days ago, I would assume something around 17% of sales in SG&A. And so that's maybe the, from a modeling standpoint, the way to look at it. I would just point to the fact, I mean, what we talked about earlier, you know, the fact that We didn't have lots of people leave the company last year, and now we're hiring and a ton of costs are coming back in. That's not what I'm talking about here. These are simply primarily sales commissions and costs like that that are going to grow in line with as the top line of the company grows this year in the low teens. So that's what you would expect to see.

Got it. That's helpful. So around 17, I mean, that's basically going to be a bit higher than what you've done in Q1. That's probably the volume ramp that you were sort of talking about as the year progresses.

Yeah, I mean, the one thing I know for sure is that there's going to be a big ramp up here in Q2.

Right. And then my follow-up, and folks have been asking about the food equipment business, and I will too, but I guess I'll ask it this way. If I look at your business, it seems to me that this vertical, this segment, is really the one that's probably been transformed the most by COVID in terms of sort of the end customers having to operate differently, having to think about doing business differently. And I'm sort of wondering where that leaves you strategically longer term, right? Because the industry is consolidating. you obviously have an important market position and really good product. How do you think about the next five years from an innovation standpoint, from ability to gain share, and more importantly, you sort of stepping up to the plate and consolidating the industry as well, because there are a lot of smaller players that are still out there. Thank you.

Yeah, I'd be happy to try to address at least some of that. Let me start with the end of your question first. We're not interested in consolidation. We're not an economies of scale company. We're not going to buy anything to consolidate. We're going to own great businesses that deliver value for their customers through the performance of the products and services that they offer. Whether the industry consolidates or not, ultimately we compete based on our ability to deliver superior value to the customers that we choose to target in those industries. And so that's essentially all I'll say is our businesses are very well positioned in this space. We expect that they will continue to grow at an accelerated rate with best-in-class margins and returns in that industry. And absolutely, to your point, we will have to continue to evolve and innovate as our customers evolve and innovate based on COVID or anything else, you know, in terms of what happens in that industry. And I think I'll just leave it there.

All right. Thanks for the call. Thank you.

Your next question comes from the line of Stephen Bogman with Jefferies.

Great. Hi, guys. Thanks for fitting me in. I just had one quick follow-up back on sort of your incremental margin discussion, Michael. If I remember correctly, I think the plan, obviously dollar for dollar on price costs sort of in year one, but then as we move forward, I think the goal is to recover the margin on top of that. So why wouldn't we have a higher incremental margin in 22 than kind of your base case? I think that's a good question.

You know, I think on price-cost, I mean, what we're talking about right now is this pretty significant increase in raw material costs and offsetting those dollar for dollar with price. And in the near term, as I said, that puts pressure on margins. I think once you get past this surge in raw material costs and those start to kind of stabilize or maybe even come down a little bit as as expected frankly for some of these commodities in the back half of the year you're holding on to the price and you're going to end up in a favorable position again from a price cost standpoint that's kind of how this has played out historically and historically that's what's been embedded in that 35 to 40 percent incremental margin rate that we've been able to put up. I think once we go through, David, kind of the planning for 2022, I'll give you a better feel for the ability to maintain incremental margins either above the historical range or in the historical range. But as we sit here today, like I said earlier, I would For modeling purposes, I would stick to the 35 to 40 for now. And we'll give you an update as we go through the year here. But clearly this year and in Q1 and in the near term, really strong incremental margin performance. I don't know if I said this, but we're above the range of 35 to 40, so 40% plus. And that's with price cost for the full year. Headwinds are somewhere around 4 to 5 percentage points. to the incremental margins. So really strong performance here as the recovery takes hold.

Right, yes, I certainly agree with that. It just seems like maybe you get that four or five percentage points back next year. But I will look forward to your update whenever you're ready. Okay, that's fair.

Very nice. Question comes from the line of Stephen Fisher with UBS.

Just want to confirm that you have not baked in any cyclical increase in daily run rate of sales demand into your guidance. I imagine you're going to say you haven't. But just in an accelerating economic growth environment, it seems like your approach would be particularly conservative at this point.

Yeah, I think... That's kind of up to – that's for you to decide. I think the argument you're making is not unreasonable. I think what we do is, you know, we give you kind of the output for the company at current run rates. And if you think that food equipment is going to come back stronger or you think the auto issue is a bigger issue, then you can certainly make those adjustments to your model. And as you know, ITW is – this is a pretty – predictable company, certainly at the enterprise level. And so you can get pretty close to, you know, the models that we're looking at. And so we're really being, we think this is the best way to communicate the outcome for the company and being very transparent. And then it's for you to decide, you know, kind of segment by segment, how you think things might play out based on whatever data points that you look at.

So Fair enough. That's what I thought you would say. I just wanted to confirm. What have you assumed for divestitures and kind of approximate timing on that, if any new updates there?

Yeah, so really no new update. I mean, as you recall, we put this on hold last year really to focus on the recovery here. And the most important thing we have to do is you know, get the organic growth rate and demonstrate that we can grow consistently above market. The view was that working on divestitures is really a distraction from that. And, oh, by the way, we believe, and it's playing out that way, that these businesses are going to be more valuable when we kind of reinitiate the process, which will probably be somewhere at the end of this year, early next year. So from a strategic standpoint, these are still businesses that are not a great fit for ITW that are a much better fit, frankly, with other people, we think. And so that view has not changed, but we've kind of deferred all the activities to later this year, early next year. Perfect. Thanks a lot. Sure. Sure.

Our next question comes from the line of Julian Mitchell with Barclays.

Hi, good morning. Maybe just a question perhaps for Michael around the free cash flow, because there's been a lot of P&L related questions. So the free cash flow I think was flattish in Q1 year on year. The net income was up a good amount. So it seems like maybe there's some working capital Headwind, receivables, perhaps something there. Maybe just help us understand sort of what impact the component and supply chain issues are having on your own sort of working capital management and any cash headwinds associated with that. and how we should think about CapEx this year kind of catching up or ramping back up for IPW. And I understand that that conversion rate metric should fall year on year because you're in a growth year now.

Yeah, I mean, that's exactly what's happening. I mean, we're clearly – as the top line grows 10%, you're going to see – at least in the near term, a corresponding increase in inventory levels, which is part of what Scott talked about. As demand grows, inventory levels are going to grow. The same thing with receivables. The fact that receivables are growing is actually, as you know, it's a good thing. I think what we keep an eye on is You know, the working capital metrics around, you know, inventory months on hand are all trending in the right direction. I'll just point out that if you look at our, you can't see it looking from the outside, but when we look at our receivable aging and our bad debt, we are below pre-COVID levels in a meaningful way. So I think the teams really did an excellent job managing working capital overall, including receivables last year. And I think we talked about on the last call, Working capital headwinds, somewhere around $125 million was in the plan for this year. The growth is a little bit stronger, so it might be a little bit more than that, but it's not going to change. We still are confident we'll get to 100% plus conversion rate, but the goal here really is we generate plenty of cash. The goal here is to grow the company. It would make no sense for us to try to hold back on on inventory levels at this point. So, on CapEx, as you know, last year, some of the capacity expansions were deferred. A lot of those are coming back now. CapEx will be somewhere around 2% of sales, which is where it has been historically. That is not a set number. That's an outcome of how we allocate capital. So, if you pencil in somewhere around $300 million That's directionally. That's probably where we'll end up. That's up, I think, last year we did 236 or something like that. So we're definitely expanding. And you saw the CapEx number move up a little bit here in the first quarter, and that's really as these capacity expansions are. You know, we're adding equipment. We're adding injection molding machines and auto and other places to support our customers as demand recovers.

Great. Thank you. Sure.

Joe Ricci, your line is open.

Oh, thank you. Thanks for putting me in, everybody. To my first question, maybe just focus on organic growth for a second. You raised the outlook for the year. I'm curious, were any segments not raised? So, for example, like some of the headwinds that you talked about in auto OEM and maybe slower starts to year in food equipment?

Yes. So all segments except for auto OEM have raised – and this is based on run ratio, right? So this is a pure mathematical – um you know based on demand relative demand exiting q1 six or seven segments are higher uh in terms of the organic growth forecast for the year and in particular uh you know the capex driven businesses as you might as we talked about right so test and measurement welding um and then in auto just with the uh some of these supply chain issues and the allowance we made in our guidance uh you know they're probably towards the low end of the range that we gave back in January. I think the range back then was 14 to 18, and we're probably at the low end of that. Auto bills are still projected to be up 12 for the year, so we'll see. That's the one area where there's quite a bit of uncertainty, particularly, and I'll just maybe reiterate this, be a little cautious around the second quarter here and not get too excited. But kind of medium term, we're very encouraged by the demand, underlying consumer demand, as well as inventory levels, as we talked about in that segment.

Got it. That makes sense. And then maybe my one follow-on, either for Scott or Michael, if you think about your – you guys used to always talk about your content on a regional basis in the auto segment. I'm just curious, does that change at all with the uptake that we're seeing in EVs?

We talked about it from a long-term opportunity perspective that's actually roughly equivalent. There's a little bit that we do around the powertrain now that obviously wouldn't exist, but there's a whole range of new you know, sort of applications in the EV space. So, you know, I think the last time we looked at it, it was, you know, on a per-car basis, neutral to maybe a little higher with EV. Higher, actually, yeah. You know, to $2 versus to maybe, you know, 5% to 10% higher. So, you know, net-net, we're pretty agnostic. I think the other thing that we have said in the past, and this is not, you know, sort of current data, but roughly... I think it was, you know, less than a quarter of our sales would go away if you, if every car was EV tomorrow, we'd lose, you know, basically 20 or 25% of our revenues are at risk. So, you know, so it's not a, you know, 75% of what we do today goes in either place, and there's certainly plenty of new applications to replace that other 20% or so over time, plus a little bit.

Got it. That's helpful. Have a great weekend, everyone. Thank you.

Thanks, Joe. I think we're out of time now, so I'd like to thank everybody for joining us this morning. Feel free to call me with any follow-up questions, and that concludes our call today.

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