Q1 2021 Illinois Tool Works Inc Earnings Call
<unk> the call over to our chairman and CEO Scott Santi.
Thanks, Karen and 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 Thats with one less shipping day in Q1 of this year versus last year.
At the price level organic growth was plus six in Q1 of plus eight 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 the back business system.
On the skill and dedication of our people around the world.
Combined with the when 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.
<unk>, 45% incremental margins and 120 basis points of margin benefits from our enterprise initiatives in the quarter.
Despite rising raw material costs and of tight supply chain environment.
We maintain 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 <unk> 11 on.
Operating income of $905 million on 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 per se.
And EPS of $8 1 million to $8 60 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%.
The stating the obvious there's still a lot of ground to cover between now and the end of the year.
In 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 update 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 and measurement and electronics, which grew 11%.
<unk> welding, which grew 6%.
GAAP EPS of <unk> 11 was up 19% and on all the time EPS record for continuing operations.
Operating leverage for the 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 of 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 has to deal with their fair share of supply challenges and disruptions in the quarter.
By leveraging our produce where we sales supply chain strategy.
Our proprietary <unk> front to back business system.
And supported by the fact that we were fully staffed for this uptick in demand due to a win the recovery initiatives.
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 of that ITW.
In the quarter, we experienced raw material cost increases, particularly in categories such as steel.
<unk> 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 the 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 of our operating margin was impacted 60 basis points due to price cost and.
And our incremental margin would actually have been 52% net.
Got 45% if it wasn't for this impact from price cost.
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 of 25, 5% operating margins are already exceeding our pre COVID-19 operating margins.
407 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 a long term enterprise strategy and continue to make progress towards our long term margin performance goal of 28% plus.
After tax return on capital with a record 32, 1%.
And free cash flow was solid at $541 million with the 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 of the first quarter was solid for ITW with broad based organic growth of 6% strong profitability leverage 19% earnings growth of 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 is a positive impact is 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 and electronics, which will also of the most improved segments and the <unk> view.
Going down 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 of Itw's organic growth rate went from down 1% in Q4, two 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.
It 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 the 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% until the 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're pretty optimistic about the medium term growth prospects as consumer demand remains strong.
And dealer inventories of very low by historical standards.
By region, North America being down in Q1 was more than offset by Europe, which was up 4% in China of 58%.
And finally, the team delivered solid operating margin performance of 24, 1% on 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 the demand is beginning to recover.
As evidenced by orders picking up in the backlog 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 health care about flat in.
And education is still down about 10%.
Restaurants, which represents 25 percentage of our equipment business was down in the mid teens with full service restaurants down about 30%.
Casual up low single digits.
Retail, which is now 25 per cent of the business was up more than 20% and the result of strong demand and new product Rollouts.
International was down 15% and it's 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.
The Asia Pacific was up 44% with China up 99%.
Overall equipment sales were down 4% and service down 19%.
Test <unk> measurement and electronics delivered revenue growth of 14% with 11% organic growth.
Test and measurement was up 7% with continued strength in semiconductors and health care 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 on.
Automotive applications and consumer electronics.
Operating margin of 28, 4% was up 330 basis points.
Moving to slide six.
As I mentioned earlier, we saw strong sequential improvement in welding is the segment delivered organic growth of 6% the highest growth rate in almost three years.
The commercial business, which serve smaller businesses on individual users user needs of the way and a recovery in Q1 was the 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 the customer capex spend picking up and backlogs building.
Overall equipment sales of about 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 33%, which as I said Mark the first time in Itw's segment.
Delivered operating margins above 30%.
Part of the fluids delivered organic growth of 9% with palm is up 16% driven by strength in MRO applications, particularly for heavy industries.
The automotive aftermarket business continued to benefit from strong retail sales of of organic growth of 9% while.
The 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 seven.
<unk> 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% on Asia Pacific was up 24%.
Demand for consumer packaging remained solid at 6%.
So please turn to slide eight on 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 a solid Q1 results and per our usual process. We are projecting current levels of demand exiting Q1 into the future and adjusting the political seasonality and.
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 on organic growth forecast of 10% to 12% at the enterprise level.
This compares to our 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're 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 on operating margins of 25% to 26% per 250 basis points higher at the midpoint and then almost 150 basis points higher than our pre COVID-19 2019 operating margins of 24, 1%.
As we continue to make progress towards our long term performance goal of.
Of 28% plus as I mentioned earlier.
Our incremental margins for the full year on.
Expected to be above our typical 35% to 40% range.
Finally, we are raising our GAAP EPS guidance by <unk> 60.
Our 8% to a new range of $8 20 to 860.
The new midpoint of $8 40 represents on earnings growth rate of 27% versus prior year.
In the 9% increase relative to pre COVID-19 2019, EPS of $7 74.
A few final housekeeping items to wrap it up.
With no changes to one of the forecast for free cash flow to our plan to repurchase approximately $1 billion 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.
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 will provide an update but as we've said before we do not expect the material financial impact to earnings in 2021.
So in summary of quarter of quality execution, and the 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 of your question. Please.
At this time.
I'll remind everyone in order to ask the question Press Star then the number one on your telephone keypad, well pause for just a moment to compile the Q&A roster.
Your first question comes from the line of Jamie Cook of Credit Suisse.
Hi, congratulations on a nice quarter.
Are there any questions.
Hi, two questions obviously, the organic growth that you saw on the quarter fairly strong I'm just trying to understand how much of it is sort of kit.
And market recovering versus the sort of structure of market share gain that ITW has been able to you. The key I guess, that's my first question. If you can help us on that and then my second question. The Incrementals that you are putting up to 45% and then 52 of free cash per price cost is the above your yes.
Yes, the targeted range.
The <unk> alright, with with COVID-19 gets the cost and inefficiency and things like that I'm. Just wondering if we should we think at some point youre targeted incremental thank you.
Okay, Jamie So I think on the first one.
As the 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 the low too early to tell how much of that growth in Q1 is really.
On market versus market share gains.
I will just add to that we've also seen an.
On uptake.
From the contribution of our customer.
Customer back innovation efforts and so again Thats the result of being able to stay invested in those.
And then I'd point to our supply chain and our ability to maintain.
On our service levels.
There may be others are struggling a little bit more so I think anecdotally, there's certainly lots of evidence if you ask our divisions and our segments that we are.
Picking up share and again, we're going after sustainable high quality.
The profitable market share gains net of opportunistic.
And so we feel really good about the start of the year.
On account of those things I think on the Incrementals I agree with you that was a real.
Spot.
On significantly above our normal range of 35 to 40.
At these early stages in the recover we expect to be able to maintain.
The incrementals above the.
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 is the.
Of note premature.
Two.
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 from now.
I 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 of vertical research.
Thank you good morning.
Good morning, good morning make more.
Across the.
Scott I was wondering if you pay the.
Just update us on on.
On what Youre thinking on M&A.
Obviously, you got from TS deal coming I am sure you could've taken a shot on goal of well build if you wanted to in past 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.
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've got some work to do obviously to get that one over the just to get it closed the all of its basically standard routine but thats.
I think of 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 in NPI certainly adds and couple of months are.
Our capabilities in terms of the test the test and measurement space in our day to do so.
I am not going to comment on your specific reference or any other deals.
But.
Others have announced recently, but I would say that we our appetite for.
The additional MTS light deals remains.
The strong.
I think your.
I can't remember exactly the terms of use Jeff and I think the phrase opportunistic is the right way to think about it it's a combination of.
Of ultimately what we're interested in doing what fits with the availability of the assets that fit that profile.
That includes both the strategic attributes are the attributes of the offer in terms of our ability to improve the inherent financial performance.
And all of that of value that we think makes sense for us and our shareholders in terms of return on that is the capital, but the time effort and energy that we're going to expense. So.
That's sort of of the generic strategic narrative around it.
The personal view is I absolutely think.
On average of one to three MTS kinds of deals of the year seems to be of reasonable.
Absolutely is achievable, we are not going to we're not going to try it out.
Sort of force of the deal every year on that sort of some years are going to be zero because of the circumstances are or are.
We're not going to present, the circumstances of what we're looking forward on our kind of present themselves but.
I think there is lots of room for other similar kinds of deals to be additive to what we're doing in a relatively consistent way over let's say of the five year period.
I think I'll stop there.
Thanks, I appreciate that and also just wondering outside of auto which.
It's kind of playing to see for the announcements and everything else. The are you seeing the.
These sorts of it sounds like your own supply chain, you're feeling pretty good about but.
The other things going on at customer level debt that may cause the topline disruption of the year over the balance of the year.
I think it's hard to project balance of the year I would say for sure on the second quarter. There are broader issues than just the automotive that play in.
I would also say that it's definitely fair that we are having to work a lot harder in terms of the security on our own.
So from the supply than we would under normal circumstances.
We have for a number of reasons I think been able to counter punch our way through.
On 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.
Broadly speaking, partly because we source of local.
We know our suppliers, we source where we produce.
And I think partly because of our on the fact that we stayed invested we kept we hung on to our people. So we're not having.
Having to add people back to support this.
This uptick in demand, but I don't want to.
No one should take from that that it's been smooth and easy the whole Heathrow.
Throughout the south.
On the soup with everybody else and certainly having to work harder than normal to sustain our ability to supply, but I think so far feel like.
We've been able to as I said counterparts that way through a pretty well on.
I would also say beyond the automotive space. There are certainly some pockets, where we have some other of our some of our customers being impacted some of our some of their own supply chain.
Issues, the plastics remain tight.
The number of areas.
I don't think anything has sort of concentrated and.
Significant is in auto.
It's certainly a scramble right now on a lot of levels.
Understood. Thanks.
Understood. Thanks for the color appreciate it good luck.
Thank you.
Your next question comes from the line of Scott Davis with <unk> research.
Hi.
Good morning.
And Karen.
I would echo Jeff's comments on.
<unk> numbers.
We have become the usual here, but.
Anyways.
I wanted to pick on here one of the.
The the comments.
David Scott on on price from maybe it was Mike.
Price cost neutral.
Is that a comment you'd make.
Across the entire portfolio of that segment by segment U.
<unk> to be in a cost neutral position. This year are there certain segments, perhaps it takes 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.
It takes a little longer and requires.
<unk>.
The <unk>.
Funnel of new products that are coming in at.
More attractive.
Margins. So that's the one where in the near term.
Seeing the most significant pressure.
On margins.
From a from a price cost standpoint than the other.
The other.
Six segments.
I think there is given the differentiated knee.
<unk> of the <unk>.
Products and services that we provide.
We have the long history of being able to offset any.
The cost increases.
The price.
There is typically a little bit of of lag I will tell you we learned some things that when we went through this in 2018, we are.
We are.
Definitely much more.
Focused on on top of things earlier on.
And our divisions are taking.
On 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.
The 60 basis points of.
Margin percentage impact and seven percentage points of incremental margin on impact. The overall goal of areas to offset on a dollar for dollar basis, and we're confident that we'll be able to do debt.
For the year on in total even with the.
The pressure of the difficulty in the.
Automotive.
Okay. That's helpful on and just as a follow up again.
I'll jump on the bandwagon of what.
Jeff was asking about on the M&A.
I would think the given the success you've had in kind of multiple different types of businesses here assets.
Of our confidence in going after bigger asset.
<unk> really.
Driving value, perhaps way above what.
The world could do on our other strategics would.
Perhaps widen that scope of the ability to being able to do deals on the larger side. How do you guys think about that and applying AI.
2020, and when you think about a <unk>.
M&A model.
Yes, I don't think size as of <unk>.
Area at all or a limitation or something that would scare us away I'd point to MTS is.
B the.
It's the.
Not quite half of $1 billion of an annual revenue. So it's 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 the integration or the quality of practice.
Around.
Our 80 20 front the back.
Operating system on the depth of how this is all a result of the last nine years of work on this.
So all of that certainly.
It's just additive.
I think our ability to 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 some of the sometimes.
What does happen is the larger of the size there it tends to be.
It's the fact that sort of a pure play. This is the part of the business we want it all the bigger the asset.
The more sort of non strategic.
Non desirable stuff you have to deal with one times, but.
That's also just sort of part of the tactics, but.
Again, I don't think its.
Bigger smile debt as the driving benefit to us as much as doesn't really fit with what we're good at does it fit in area of the market. We think has long term above market organic growth prospects et cetera.
And whether it's large or relatively small on that division size of those would be equally attractive options to us.
Makes sense, Thank you Scott and good luck.
Thanks.
Your next question comes from the line of John inch with Gordon Haskett.
Good morning, everybody.
Good morning, John Good morning good.
Good morning, guys and Karen.
Hi.
Scott and Michael China up 62% core of your factories and operations enable to keep up with that level of demand, which I get the premise of comps.
<unk>. So it is not yet it's not true.
Let me volume, driven, but which presumably gaming all of this is going be up as much in the second quarter, just taking compares as well.
Anything you would call out there because.
I understand the point that your factories of your local and so forth, but that's still a very.
That's the very very high growth rate I'm, just curious how kind of of the quarter played out in the <unk> did.
Did you have to leave any sales on the table, but maybe you can kind of get picked up later on.
Yes, I actually probably can't answer those debt that last piece other than to say that the.
On 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 of effect now that said John Thats, a big number of year on year, but remember that China was way down in the first quarter last year.
From the standpoint of the sequential.
I don't have that on maybe even do that Michael but from Q4 to Q1, it wasn't a 58% John right.
Sure.
But I would say overall, our decision to hang on to our people and the.
Just be ready for this as certainly.
Given us an ability to respond.
That if we were having not only source scramble for raw material, but also scramble for for our people. It would certainly be a more difficult challenge then it works.
That's fair.
I'm curious so we all know sort of of the constraints around semicon and auto Scott you already talked about.
I think I've asked sort of thought.
Alluded to these questions in the past the about.
The post COVID-19 world demand is putting the surge pretty pretty aggressively and I'm curious if you've already started to see that as evidenced by your own very healthy robust results of your operations.
Any meaningful pinch points of global demand has come back it may have been surprising or debt provides per se lessons learned Scott and Michael but youre applying is.
Is it really just is not a one or two quarter phenomenon. This is going to carry forward for a little while here.
How are you.
Anything you can share with us in terms of how you are thinking about sort of operations and just.
Playing too.
The market share wins that sort of thing.
Yes, Im trying to think about how to how to.
On.
Sort of tackle that one John.
Maybe the type the start.
The inherent in our system as well.
And we always talk about the fact that we produce today, what our customers bought yesterday.
So in hand, and Thats 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 of that demand comes in.
It's an average but of dairy daily basis. So the only way we can produce study of what our customers bought yesterday is that number of moves up and balance to make sure that we have.
Ample extra capacity to flex so that sort of helps us as things et cetera, we do have of Cushing to lean on and we also have.
Our supplier base is connected into that system on a way that they are they are they are also carry of that kind of ability to flex.
It works really well it doesn't work perfectly and certainly we have our.
Sort of rubs and issues, along the way and I am sure we will but they are.
There are things, we can overcome on walk our way through but maybe thats. The best the answer I don't know if that that totally addresses the but we start with a sort.
Sort of level of flex that certainly helps us.
Respond on adding even more capacity as.
We're seeing we're pivoting in some kind of an environment, where the economy is starting to take off.
Well, maybe and examples can be food equipment, that's the obvious that that's going to come back pretty aggressively in the second half.
The touch wood.
Is there anything youre doing with respect of your operations to make sure that.
We actually don't.
They lose share because of.
The sales because you can't fulfill.
Demand or something like that.
On that.
I'm completely comfortable that they know exactly what to do.
Again, we've hung on to all of our people to listen on that to all of our capacity.
We are locked and loaded and ready to Delhi of no doubt about it and from equipment and everywhere else on the company.
Got it alright, thank you very much.
You bet.
Your next question comes from the line of Ann Duignan with JP Morgan.
Hi, good morning, everybody.
Good morning.
Could you dig a little deeper into your comments on brand capital equipment demand picking up I mean, I know you talked about it in places like welding, but.
And just a little bit more color by region by application by segment just like to hear from you in terms of.
Specifically youre seeing because that is the big change. Thank you.
Yes, and as you were saying that was kind of the new.
Trend debt.
Showed up here in the first quarter, we did see orders in 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.
Our test and measurement as I mentioned.
And welding and so those are.
On our businesses that are more driven by investment in Capex and I think as the.
The visibility to the recovery and the confidence in the recovery.
On 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's really a broad base.
Trend, so I don't really of the breakdown for you on a global basis, but really across the board.
We saw really.
The nice pickup in demand for the Capex driven.
Driven products in those in those three businesses in particular.
I think with.
We're off to a good start here in April so I think we saw.
Good momentum coming into Q1 kind of sustain that March was the strong month.
April.
The thing is is on track here.
Okay I appreciate the color on that and then just back to the whole.
On maintaining your employee base and we see what a difference that makes.
And this share I mean, I don't think that that should be understated given the net almost every other company and recover mentioned.
On the ability to attract labor as as the Nishu. So.
Congratulations on that but what about your customers I mean is there any risk that tier customers have to defer orders I mean, thats kind of contract of what you just talked about that.
Hey, John 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 the labor.
Yes.
I would be.
Pretty certain of its going to have some impact in terms of the overall pace of the recovery of the number of areas.
My personal view and maybe not even such a bad thing in terms of extending the duration of the recovery and sort of managing the pace of all of it in the short run so.
Even with these auto auto is the real extreme example of that is not so much from labor but from from.
Semiconductor chips.
Michael talked about the fact that consumer demand for all of the strong.
Dealer inventories are at I think around the world of historic lows, so sort of the fact that all of that of that trying to be satisfied on two quarters on it actually gets spread out and so I just use that same analogy in places like food equipment is I don't think it's necessarily.
A terrible thing that there are some limitations do the labor or other things as we move through the recovery.
And some of our sectors it doesn't demand isn't going to grow.
The other day, that's feeding frenzy of.
Of satisfying in a relatively short period of time on site.
Well I don't know exactly how it's all going to play out, but I don't think some of those limitations of the near term on necessarily bad things for the long haul.
If that makes sense, yes.
Yes.
Completely agree with you it's kind of of course fresh colonization of the industry.
I appreciate the color I'll get back in line of thanks.
Thank you.
Your next question comes from the line of Andy Kaplowitz with Citigroup.
Hey, good morning, guys nice quarter.
Andy.
The Scott or Michael you mentioned, the welding margin now above 30%, which I think is a new record for you and as you know welding is close to fully recovered yet if I. If I go back to chosen 18 and margin at similar levels of revenue was approximately 28%. So if we step back and try and ingest that improvement the 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 meeting of the whole company can even do better than that over time.
And any of the easy answer to your question is.
On the types of Incrementals that our segments are putting up the enterprise level of 45 welding was also <unk>.
<unk> 45, the answer is that margins will continue to improve just from the volume leverage alone.
And then we know that there.
It's 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 of 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.
We will continue to improve.
The operating margin performance.
Like I said.
The 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.
They are on an accelerated rate organically while growing.
And on the gang of the guidance right.
Can do both.
So.
And then I would 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 of the fact that our teams.
Leverage is when the recovery strategy stayed 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.
A clear path in front of us as we continue to make progress towards our.
28%, you said, 28% I thought.
And my comment that we 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 just cut a little bit about food equipment on the call already but maybe just focusing on it on.
The reopening is happening faster or at least in the U S. Now and you do have this large institutional business that could benefit from.
The significant stimulus that already has been passed especially for school cafeteria sales have you seen any of that money starts to flow into that business.
Or have you seen accelerating improvement in your restaurant business yet.
Not yet not yet is the answer.
I mentioned that 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.
As as is.
Solid <unk> and <unk>.
It's reasonable to assume that there will be of pickup on the institutional side.
As we move forward, including for schools. So I think thats part of whats encouraging is we're not.
Firing on all cylinders, yet we put up some pretty good results from Q1, and we still have.
Food equipment as you mentioned down 10 organic with a strong recovery ahead of it so.
I think thats thats really encouraging.
Thanks, guys I appreciate it.
Sure.
Your next question comes from the line of Nicole the Blas.
The bank.
Yeah. Thanks, good morning, guys.
Good morning.
Can we talk a little bit about that.
Turning to the issue of the price cost I know you guys said that it was <unk>.
The basis point impact on margin in the first quarter. If we look at the full year, how does that kind of Wow.
Maybe what the embedded.
Price cost headwinds and the full year margin guidance.
Yes, So let me type of thing that would be a little cautious on Q2 I think.
Like I said, there is a little bit of a timing issue here just given how high our margins are.
Think of these price cost pressures will remain with us.
Particularly in the near terms of Q2 this will be.
Diluted the margin percentage again.
<unk> neutral on a dollar per dollar basis, so it's purely of margin percentage incremental percentage impact so.
60 basis points in Q2 and 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 ended up somewhere around <unk>.
<unk> of 60 basis points of.
The margin impact.
Okay, Okay got it understood and the.
Selling days impact that you guys had in the first quarter or does that normalize throughout the year like I think of lot of companies have talked about the selling day.
The impact of reversing in <unk> is that how it is Brian tw as well.
It is not no.
64 days in Q2, and Q3 and 62 days in Q4, which is the same as we had last year. So this was purely on a Q1 issue. If you remember last year was the leap year, So I think bringing the subprime.
Yes.
That's how the calendar works.
Okay. Thanks.
Thanks, guys I'll pass it on.
Sure.
The next question comes from the line of Mig <unk> with Baird.
Thank you.
Greg on the really strong start the year gentlemen.
I guess my.
Yes.
My question, Michael maybe maybe for you.
I was observing debt SG&A has been relatively flattish year over year on.
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 revenue.
Now above pre COVID-19 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 of pre COVID-19 levels and I'm talking about the full year run rate here.
So I would say maybe I mean.
I would expect somewhere around.
As our sales grow obviously are.
On the cost to support those sales, including things like commissions are going to grow.
And those costs are pretty correlated and.
The last time I looked at it here of a few days ago.
I would.
Assume something around 17% of <unk>.
Sales in the 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 of yet.
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 a ton of cost of coming back in and that's not what I'm talking about here. These are simply primarily.
The sales commissions and costs like that that are going to grow in line with the top line of the company growth 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 of the year progresses.
The one thing I know for sure is that the.
Kind of the big ramp up here in Q2.
Right.
And then.
Yes.
Then my follow up and folks have been asking about the food equipment business.
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-19.
In terms of sort of the.
The end customers, having to operate differently, having to think about doing business differently.
And I'm sort of wondering where that leaves us strategically longer term right because the industry is consolidating.
You obviously have.
An important market position and really good products.
How do you think about the next five years from an innovation standpoint from the ability to gain share and more importantly, you sort of stepping up the the plate and consolidating the industry as well because there are a lot of smaller players that are still out there. Thank you.
Yes.
I'd be happy to try to add.
Address at least some of that let me start with.
On the end of your question first we're not interested in consolidation.
We're not on economies of scale company.
On <unk>.
I go 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 on that ultimately we compete.
Based on our ability to deliver superior value to the customers that we choose the target on those industries and so that's the <unk>.
Since the all I'll say is R. R.
Our businesses are very well positioned in this space.
We expect they will continue to grow at an accelerated rate with best in class margins and the trends 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-19 or anything else on in terms of what happens in that industry at the garden.
Just leave it there.
Alright, thanks for the color.
Q.
Your next question comes from the line of Stephen Volkmann with Jefferies.
Great Hi, guys. Thanks for fitting me in I just had one quick follow up back on sort of of your incremental margin discussion Michael.
If I remember correctly I think the plan obviously dollar for dollar on price costs sort of a year on but then as we move forward I think the.
The goal is to recover the margin on top of that so why wouldn't we have a higher incremental margin in 'twenty two than kind of your base case.
I think that's a good question.
I think on price cost I mean.
While we're talking about right now is this <unk>.
Significant increase in raw material costs.
And offsetting those dollar for dollar the 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 on those start to kind of.
Stabilize or maybe even come down a little bit as is expected frankly for some of these commodities in the back half of the year you are holding on to the price and youre 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%.
Incremental.
Arjun rate that we've been able to put up.
I think once we go through.
David kind of the.
The planning for 2022 I'll give you.
A better feel for the ability to maintain.
The incremental margins.
Either above the historical range or in the historical range, but as we sit here today I think I said earlier I would 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 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% of 40% plus and that's with <unk>.
<unk> cost.
For the full year headwinds are somewhere around 4% to five percentage points to.
The incremental margins, so really strong performance here.
As the recovery takes hold.
Alright, yes, I certainly agree with that it just seems like maybe you get the.
Four of five percentage points back next year, but I will look forward to your update whenever you're ready.
Okay, that's fair.
Your next question comes from the line of Steven Fisher with UBS.
Sure fitting me in here just want to confirm that new of not baked in any cyclical increase in daily run rate of sales demand into your guidance.
So you haven't.
But just in an accelerating economic growth environment it seems like.
The year approach would be particularly conservative at this point.
Yes.
Yes, I think.
That's kind of up to the that's for you to decide I think the.
The <unk>.
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 do you think the auto issue is the bigger issue.
You could certainly make those adjustments to your model and as you know ITW is this is a pretty.
Predictable company of suddenly at the enterprise level, and so you can get pretty close to.
The models the 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 minutes for you to decide.
Kind of segment by segment.
Do you think.
Things might play out based on whatever data points that you look at so.
Fair enough.
I would say just on it's confirmed.
What.
One of you assume.
Or divestitures.
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 too.
Focus on 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 as 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 re initiate the process, which will probably be somewhere at the end of this year early next year.
So from the strategic standpoint, these are still businesses that we are.
Not a great fit for ITW that are of much benefit frankly with with other people we think.
So.
That debt view has not changed but.
Kind of deferred all of the activities.
The two.
Later this year early next year.
Terrific. Thanks, a lot.
Sure.
Our next question comes from the line of Julian Mitchell with Barclays.
Hi, good.
Turning on.
Maybe.
It's the question, perhaps for Michael around the the free cash flow of if there's been a lot of P&L related questions.
On the free cash flow I think it was flattish in Q1 year on year.
On the net income was up a good amount.
It seems like maybe there's some working capital hedge.
Headwind receivable, perhaps something there.
Maybe just help us understand sort.
Sort of what impact the components and supply chain.
She is of having on your own sort of working capital management, and then the cash headwinds associated with that and how we should think about capex. This year.
Kind of catching up on ramping back up.
E W and I understand that that conversion rate metric should fall year on year because of <unk> growth now.
Yes, I mean, that's exactly what's happening I mean, we're clearly.
As the topline grows 10%.
Youre going to see at.
At least in the near term of corresponding increase in the inventory levels, which is part of what Scott talked about as demand grows.
Our inventory levels.
Are going to grow the same thing with receivables.
On the fact that receivable was a growing is actually.
And as you know it's a.
Good thing I think what we keep an eye on us.
The working capital metrics around inventory months on hand are all trending in the right direction.
Just point out that.
If you look at our you can't see it looking from the outside but when we look at our.
On a receivable aging and our bad debt we are.
The low pre COVID-19 levels in a meaningful way. So I think the teams really did an excellent job managing.
Working capital overall of the tool receivables last year and I think we talked about on the last call.
Working capital headwind somewhere around $125 million was in the plan for this year the growth of 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 will get to a 100% plus conversion rate, but the goal here really is.
We generate.
Plenty of cash to go on areas too.
The grow the company.
It would make no sense for us to try to hold back on on inventory levels. At this point. So on the Capex as you know last year some of the capacity expansions were deferred.
Lot of those are coming back now cash.
Opex will be somewhere around 2% of sales, which is where it has been historically that is not a set number thats on the 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 with the $2 36 or something like that so we're definitely.
Expanding.
And you still kept the Capex number move up a little bit here in the first quarter and Thats really as these capacity expansions on our <unk>.
We are adding equipment.
Adding injection molding machines, and auto and other places to support our.
Of our customers as the demand recovers.
Great. Thank you.
Sure.
Yes, Richard your line is open.
Oh, Thank you, thanks, Karen the and everybody.
Hi, My.
My first question.
The focus on organic debt for a second you raised the outlook for the year I am curious did.
Any segment or any segments not raise debt 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.
All segments, except for auto OEM have raised and this is based on run rates right. So this is a pure mathematical.
Based on demand revenue demand exiting Q1 six of seven segments are higher in terms of the organic growth forecast for the year and in particular the cash.
Capex driven businesses as you might as we talked about rights of test and measurement welding.
And then it at all just with the some of these of 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 two of the range back then was 14% to 18 and will probably of the low end of that.
Auto builds are still projected to be up 12 for the year. So we'll see that.
The one area, where there's quite a bit of uncertainty, particularly just maybe reiterate this be a little cautious around.
The second quarter here and not get too excited.
But kind of medium term. This is we're very encouraged by the demand on the.
On consumer demand as well as inventory levels as we talked about in the in that segment.
Got it that makes sense and then many of my one follow on either 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 has that changed at all of that with the uptick that we're seeing in EV.
The.
We've talked about it on it from a.
From a long term opportunity perspective, that's actually of roughly equivalent.
There is there is.
It was a little bit we don't have the but we do around the powertrain now that obviously when the exists, but there's a whole range of new.
In the 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 even higher actually on.
The two box versus maybe 5%, 10% higher so net net we're pretty agnostic.
I think the other thing that we've said in the past the.
This is Matt.
Sort of current data, but roughly.
I think it was less of a quarter of our sales would go away if you.
Every car was EV tomorrow, we'd lose basically 20 of 25% of our revenue or at risk. So.
So it is not.
And over 75% of what we do today goes on either place and there are certainly plenty of new applications to replace that other 20 per cent or so overtime.
Plus a little bit.
Got it that's helpful have a great weekend everyone.
Alright. Thank you. Thank you and thanks to the Joe and I think are out of time now so I would like to thank everybody for joining us. This morning on feel free to call me with any follow up questions and that concludes our call today.
Yes.
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