Illinois Tool Works Inc. (ITW) Q1 2021 Earnings Report, Transcript and Summary

Good morning. My name is Christie, 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 [Operator Instructions] Karen Fletcher, Vice President of Investor Relations, you may begin your conference.

Thank you, Christie. Good morning, everyone, and welcome to ITW’s First Quarter 2021 Conference Call. I’m joined by our Chairman and CEO, Scott Santi; and Senior Vice President and CFO, Michael Larsen. During today’s call, we will 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 3, and it is now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

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 is 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 Win 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 $2.11, operating income of $905 million at 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% and EPS of $8.20 to $8.60 per share, which at the $8.40 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 is 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 will turn the call over to Michael to provide more detail on the quarter and our updated guidance. Michael.

Alright. 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 & Measurement and Electronics, which grew 11%; and Welding, which grew 6%. GAAP EPS of 2.11 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 cost. Excluding the third quarter of 2017, which had the benefit of a onetime 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 had 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 80/20 front-to-back business system and supported by the fact that we were fully staffed for this uptick in demand due to our window 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 per 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 per 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 the 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 the global pandemic, they stayed focused on our long-term enterprise strategy and continue 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 4 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 are seeing in our businesses. And obviously, there is 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 & Measurement and Electronics, which were also the most improved segments in this sequential view, going from down 3% in Q4 to up 11% in Q1. Welding improved eight 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 will 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 our 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 continue 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 are 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%, an improvement of 320 basis points. Please turn to Slide 5 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 is 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 & Measurement and Electronics delivered revenue growth of 14% with 11% organic growth. Test & 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 team room technology products, automotive applications and consumer electronics. Operating margin of 28.4% was up 330 basis points. Moving to Slide 6. As I mentioned earlier, we saw a 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 leads the 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%. Polymers & Fluids delivered organic growth of 9%, with polymers 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 are 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 have obviously factored in our solid Q1 results. And per our usual process, we are projecting current levels of demand exit in Q1, into the future and addressing them for typical seasonality. And as discussed, we have 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 two percentage points to revenue for total revenue growth forecast of 12% to 14%. As you saw, we are off to a strong start on operating leverage and enterprise initiatives, and we are 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 are 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 are raising our GAAP EPS guidance by $0.60 and or 8% to a new range of $8.20 to $8.60. The new midpoint of $8.40 represents an earnings growth rate of 27% versus prior year and a 9% increase relative to pre-COVID 2019 EPS of $7.74. 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 $1 billion of our own shares; and three, our expected tax rate of 23% to 24%. As per usual process, our guidance is for the core business only and excludes the previously announced acquisition of the MTS Test & Simulation business. The process to close the acquisition by mid-year remains on-track. And once the acquisition closes, we will provide an update. As we have said before, we do not expect a material financial impact to earnings in 2021. So in summary, a quarter of quality execution in a challenging environment, and as a result, we are off to a solid start to the year. So with that, Karen, I will turn it back to you.

Okay. Thank you, Michael. Christie, let’s open up the lines for questions, please.

[Operator Instructions] Your first question comes from the line of Jamie Cook with Crédit Suisse.

Hi congratulations on a nice quarter. 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 end markets recovering versus sort of structural market share gains that ITW has been able to achieve? I guess that is my first question, if you can help us on that. And then my second question, the incrementals that you are putting up, the 45%, and then 52% if we adjust for price cost. This is above your targeted range with supply with COVID, costs and inefficiencies and things like that, I’m just wondering if we should rethink, at some point, your targeted incrementals? Thank you.

Okay, Jamie. So I think on the first one, it is 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 have talked about. So I think it is a little too early to tell how much of that growth in Q1 is really market versus market share gains. And I will just add to that, we have also seen an uptick from the contribution of our customer-back innovation efforts. And so again, that is a result of being able to stay invested in those. And then I would 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 are certainly lots of evidence, if you were to ask our divisions and our segments that we are picking up share. And again, we are 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 are planning for and also embedded in our guidance, as you saw today. If you do the math, that is where you end up. I think it is a little premature to update kind of the long-term incremental margin expectations. I think we are comfortable with kind of long-term in the 35% to 40% range. We are 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 the kind of the 35% to 40%.

Okay. Thank you and congratulations.

Thank you.

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

Impressive. Scott, I was wondering if you could just update us on what you are thinking on M&A. Obviously, you got this MTS deal coming. I’m sure you could have taken a shot on goal at well build if you wanted to get passed there. Maybe just how you see the pipeline kind of going 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 acquisition, that we have got some work to do, obviously, just to get it closed. All of it is basically standard, new team. But that is I think a great example 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 MTS certainly adds and supplements our capabilities in terms of the Test & 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 we - our appetite for additional MTS-light deals remains certainly strong. I can’t remember exactly the term used, Jeff, but I think the phrase opportunistic is the right way to think about it. It is a combination of, ultimately, what we are interested in doing, what fits with the availability of assets that fit that profile. And that includes both their strategic attributes, the attributes that they offer in terms of our ability to improve their inherent financial performance and all at a value that we think makes sense for us and our shareholders and in terms of return on not just the capital, but the time, effort and energy that we are going to expend. So that is sort of the generic strategic narrative around it. My personal view is I absolutely think, on average, one to three MTS kinds of deals a year seems to be a reasonable - something that absolutely is achievable. We are 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 are looking for are not going to present themselves. But I think there is lots of room for other similar kinds of deals to be additive to what we are doing in a relatively consistent way over, let’s say, the 5-year period. I think I will stop there.

Thanks. I appreciate that. And also just wondering, outside of auto, which is kind of plain to see, Ford announcements and everything else. Are you seeing these sorts of - it sounds like your own supply chain, you are feeling pretty good about, but other things going on at customer levels that may cause top line disruption to you over the balance of the year?

I think it is hard to project the 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 is 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. So we have, for a number of reasons, I think, been able to counter punch our way through a much more challenging supply environment in the first quarter and through the second quarter, I think we are going to be able to do the same, broadly speaking, partly because we source local, that is - we know our suppliers. We source where we produce. And I think partly because of the fact that we stayed invested. We hang on to our people, so we are not having to add people back to support this uptick in demand. But I don’t want to -- no one should take from that, that it is been smooth and easy the whole way through. So we are in it 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 have been able to, as I said, counter punch our way through it pretty well. And I would also say beyond the automotive space, there are certainly some pockets where we have some other - some of our customers being impacted by some of their own supply chain issues. Plastics remain tight in a number of areas. I don’t think anything is sort of concentrated and significant as in auto, but it is certainly a scramble right now on a lot of levels.

Yes, understood. Thanks for the color, I appreciate it. Good luck.

Thank you.

Your next question comes from the line of Scott Davis with Melius Research.

Hi good morning guys and Karen, I would echo Jeff’s comments on exceptional numbers is going to become the usual here. 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 would 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 yes.

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 is the one where, in the near-term, we are seeing the most significant pressure on margins from a price cost standpoint. And the other six segments, I think there is, 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 is 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, say, 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 is certainly some pressure here, you saw 60 basis points of margin percentage impact and seven percentage points of incremental margin impact. The overall goal here is to offset on a dollar-for-dollar basis, and we are confident that we will be able to do that for the year and in total, even with the pressure and the difficulty in automotive.

Okay, that is helpful. And just as a follow-up, I’m just going to jump on the bandwagon of what Jeff was asking about on M&A. I would think that given the success you have 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 - world could do or other strategic 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?

Yes. I don’t think size is a barrier at all or a limitation or something that would scare us away. I would point to MTS as being - it is not quite $0.5 billion in annual revenue. So it is not a small business by any stretch. I would tell you a couple of things. One is that we have never been more prepared from the standpoint of discipline around integration, the quality of practice around our 80/20 front-to-back operating system, the depth of talent. This is all a result of the last nine-years of work on this. So all of that certainly is just additive to, I think, our ability to - if we find the right opportunity to do a really good job with it. So it is not an issue of - size doesn’t scare us. I think sometimes what does happen is the larger the size, there tends to be it is a time to sort of a pure play. This is the part of the business. We want it all. The bigger the asset, the more sort of nonstrategic, non-desirable stuff you have to deal with sometimes. But that is also just sort of part of the tactics. But again, I don’t think it is big or small that is the driving benefit to us as much as does it really fit with what we are good at, does it fit an area of the market we think has long-term above market organic growth prospects, et cetera. And whether it is 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 from the line of John Inch with Gordon Haskett.

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 some compares, so it is not completely volume-driven, which presumably this is going to be up as much in the second quarter, just given 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 is 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 that maybe kind of get picked up later even?

Yes. I actually probably can’t answer that last piece other than to say that the business for us that is 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 is 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, maybe you have, Michael, from Q4 to Q1, it wasn’t a 58% jump, right. But I would say, overall, our decision to hang on to our people and just be ready for this has certainly given us an ability to respond. That if we were having to not only source scramble for raw material, but also scramble for people, it would certainly be a more difficult challenge than it was.

That is fair. I’m curious, so we all know sort of the constraints around semicon and auto, Scott, you already talked about. I mean, I have sort of alluded to these questions in the past about the post-COVID world, demand is going to surge pretty aggres8sively. And I’m curious, we have already started to see that, 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 provides, per se, lessons learned, Scott, Michael, but you are applying as presumably, this is not a one or two quarter phenomenon. This is going to carry forward for a little while here. Is there anything you can share with us in terms of how you are thinking about sort of operations and just playing to the market share wins that sort of thing?

Yes. I’m trying to think about how to sort of tackle that one, John. Maybe the place to start is, inherent in our system is, we always talk about the fact that we produce today what our customers bought yesterday. So what makes that work is the fact that we are always carrying surplus capacity, on the order of magnitude of 15% to 20% over what current demand is. Because that demand comes, it is an average on a daily basis. So the only way we can produce today what our customers bought 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 - 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, certainly with - we have our sort of rubs and issues along the way, and I’m sure we will. But there are things that we can overcome and work our way through. But maybe that is the best answer. I don’t know if that totally addresses it, but we start with a sort of level of flex that certainly helps us respond and add even more capacity as we are pivoting into kind of an environment where the economy is starting to tick off.

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

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

Got it. Great, thank you very much.

You bet.

Your next question comes from the line of Ann Duignan with JPMorgan.

Ho g good morning everybody. Could you dig a little deeper into your comments around capital, like 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. Would just like to hear from you in terms of what specifically you are seeing, because that is a big change.

Yes. I think, Ann, as you are 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 & 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 larger equipment. And we saw a little bit of that also in Specialty Products, on the packaging equipment side. And it is really a broad-based trend. So I don’t really have the breakdown for you on a global basis, but really across the board, we saw really nice pickup in demand for the CapEx-driven products and those three businesses in particular. And I think we are off to a good start here in April. So I think 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 their inability to attract labor as an issue. So congratulations on that but what about your customers? I mean, is there any risk that your customers have to defer orders? I mean, it is kind of counter to what you just talked about. But if your employers like the restaurants, for example, if they cannot hire, is there any risk that they will have to defer orders as we go through the year just because they can’t get labor?

Yes. I would be pretty certain it is 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 is 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 this auto, auto is a real extreme example of that, not so much on labor, but from semiconductor chips. Michael talked about the fact that consumer demand for autos is strong. Dealer inventories are at, I think, around the world, historic lows. So the fact that 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, as I don’t think it is necessarily a terrible thing that there are some limitations, either labor or other things, as we move through the recovery in some of our sectors. It doesn’t mean demand isn’t going to grow. It is not going to be this feeding frenzy of satisfying in a relatively short period of time. I don’t know exactly how it is 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.

Yes. No, I completely agree with you. It is kind of a forced rationalization of the industry. So yes, I appreciate the color. I will get back in line. Thanks.

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

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 to ingest that improvement, 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 - the enterprise level is 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 have said this many times, and I will continue to say this. I mean, and then it 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, we still have a lot of things within our own control here that regardless of what happens from a demand standpoint, we can continue to improve the margin performance...

While they grew at an accelerated rate organically.

While growing...

That is the yin and the yang of the...

That is right. That is right. We can do both, right. And then what I said in my comments is what is really encouraging, I think, is that with everything going on last year and right now, with supply chain as well, the fact that our teams leverage this Win the Recovery strategy, stayed focused on executing a long-term enterprise strategy, and we are sitting here really you could argue one quarter into the recovery, and we have 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 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 is reasonable to assume that there will be a pickup on the institutional side as we move forward, including for schools. So I think that is part of what is encouraging is we are not firing on all cylinders yet. We put up some pretty good results here in Q1 and we still have Food Equipment, as you mentioned, down 10% organic, with a strong recovery ahead of it. So I think that is really encouraging.

Thank guys, I appreciate it.

Welcome.

Your next question comes from the line of Nicole DeBlase with Deutsche Bank.

Can we talk a little bit about, just returning to the issue of price cost. I know you guys said that it is 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 is embedded for price cost headwinds in the full-year margin guidance?

Yes. So let me start by saying I would be a little cautious on Q2. There is 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, particularly in the near-term. So Q2, this will be dilutive to margin percentage, again, EPS-neutral on a dollar-for-dollar basis. So it is purely a margin percentage, incremental 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 50 to 60 basis points of margin impact.

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 52-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. That is how the calendar works.

Okay. Thanks guys. I will pass it on.

Your next question comes from the line of Mig Dobre with Baird.

Thank you and congrats on a really strong start to the year. I guess 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 are obviously guiding for your revenues now above pre-COVID levels, above 2019 levels. I’m sort of wondering if it is 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 it, pre-COVID levels? And I’m talking about the full-year run rate here.

Yes. So I would say, Mig, I mean, I would expect somewhere around - as our sales grow, obviously, the cost to support those sales, 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 is maybe from a modeling standpoint, the way to look at it. I would just point to the fact, I mean, what we talked about earlier, the fact that we didn’t have lots of people leave the company last year, and now we are hiring and a ton of costs are coming back in. That is 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 is what you would expect to see.

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

Yes. I mean I think the one thing I know for sure is that there is 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 will ask it this way. If I look at your business, it seems to me that this vertical, this segment is really the one that is 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 leads 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.

Yes. Well, I would be happy to try to address some of that. Let me start at the end of your question first. We are not interested in consolidation. We are not an economy scale company. We are not going to buy anything to consolidate. We are going to own great businesses that deliver value for their customers through the performance of the products and services that they offer. And so 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 is essentially all I will say 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 in terms of what happens in that industry. And I think I will just leave it there.

Alright. Thanks for the color.

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

Great. 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 cost 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 2022 than kind of your base case?

I think that is a good question. I think on price cost, I mean, what we are 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 the surge in raw material costs and those start to kind of stabilize or maybe even come down a little bit as expected, frankly, for some of these commodities in the back half of the year, you are holding on to the price and you are going to end up in a favorable position again from a price cost standpoint. That is kind of how this has played out historically. And historically, that is what is been embedded in that 35% to 40% incremental margin rate that we have been able to put up. I think once we go through - there is kind of the planning for 2022, I will 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, for modeling purposes, I would stick to the 35% to 40% for now. And we will 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 are above the range of 35% to 40%, so 40% plus, and that is with price/cost for the full-year. Headwinds are somewhere around four to five percentage points to the incremental margin. 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 are ready.

Okay. That is fair.

Your next question comes from the line of Steven Fisher with UBS.

I 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 are 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.

Yes, I think that is for you to decide. I think the argument you are making is not unreasonable. I think what we do is we give you kind of the outlook 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 the models that we are looking at. And so we think this is the best way to communicate the outlook for the company and being very transparent. And then it is for you to decide kind of segment-by-segment how you think things might play out based on whatever data points that you look at.

Fair enough, that is what I thought you would say. I just want to confirm. And then what have you assumed for divestitures and kind of approximate timing on that, if any new updates there.

Yes. So really no new update, I mean, as you recall, we put those on hold last year really to focus on the recovery here. And the most important thing we have to do is 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 by the way, we believe, and it is playing out that way, as 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 we are 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 have kind of deferred all the activities to later this year or early next year.

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

Maybe just a question perhaps for Michael around the free cash flow. There is 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 is 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 ITW. And I understand that, that conversion rate metric should fall year-on-year because you are in a growth year now.

Yes. I mean, that is exactly what is happening. I mean, we are - clearly as the top line grows 10%, you are 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 is a good thing. I think what we keep an eye on is the working capital metrics around inventory months on hand are all trending in the right direction. I will just point out that if you can see you are looking at 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 in 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 is not going to change. We still are confident we will 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 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 is an outcome of how we allocate capital. So if you pencil in somewhere around $300 million, that is directionally, that is probably where we will end up. That is up. I think last year, we did $236 million or something like that. So we are definitely expanding. And you saw the CapEx number moved up a little bit here in the first quarter. And that is really as these capacity expansions we are adding equipment, we are adding injection molding machines in auto and other places to support our customers as demand recovers. So.

Great, thank you.

Sure.

Joe Ritchie, your line is open.

Thanks for squeezing me in everybody. So 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 the maybe slower start to the year in Food Equipment?

Yes. So all segments, except for Auto OEM, and this is based on the [run rate ratio,] right? So this is a pure mathematical, based on demand, one of the demand exit in Q1, six of seven segments are higher in terms of the organic growth forecast for the year. And in particular, the CapEx-driven businesses as we talked about, right so Test & Measurement, Welding. And then in auto, some of these supply chain issues and the allowance we made in our guidance, they are 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 are probably at the low end of that. Auto builds are still projected to be up 12% for the year. So we will see. That is the one area where there is quite a bit of uncertainty particularly. And I will just maybe reiterate this, be a little cautious around the second quarter here and not get too excited. But medium term, we are very encouraged by the 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. As you think about 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 uptick that we are seeing in EVs?

We talked about it from a long-term opportunity perspective, it is actually roughly equivalent. it that we do around the power-train now that obviously wouldn’t exist, but there is a whole range of new sort of applications in the EV space. So I think the last time we looked at it, it was on a per car basis neutral to maybe a little higher with EV.

Higher, actually, yes.

$2 versus maybe 5% to 10% higher. So net-net, we are pretty agnostic. I think the other thing that we have said in the past, this is not sort of current data, but roughly I think it was less than 1/4 of our sales would go away if every car was EV tomorrow, basically 20% or 25% of our revenues are at risk. 75% of what we do today goes in either place, and there is certainly plenty of new applications to replace that other 20% or so over time, plus a little bit.

Got it. That is helpful. Have a good weekend everyone.

Alright. Thank you.

Thank you.

Thanks, Joe. I think we are out of time now. So I would 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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