Illinois Tool Works Q3 2021 Earnings Call Transcript

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Provided by Quartr
October 27, 2021

Key Takeaways

  • In Q3 ITW delivered 8% revenue growth (6% organic) and $2.02 EPS up 10%, led by welding (+22%), food equipment (+19%), Test & Measurement & Electronics (+12%) and Specialty Products (+8%).
  • The Automotive OEM segment fell 11% due to heavier-than-expected production cutbacks and is now forecast down ~15% in H2 and ~20% in Q4, with a stronger recovery expected once supply-chain bottlenecks ease.
  • ITW’s businesses executed timely price adjustments to fully offset raw material and logistics cost inflation on a dollar-for-dollar basis, driving zero EPS headwind from price-cost in Q3 while volume leverage and enterprise initiatives added ~100 bps of margin.
  • For full year 2021 ITW raised GAAP EPS guidance to $8.30–$8.50 (midpoint +27% YoY), with revenues of ~$14.25 billion (+13%, 11–12% organic), ~24% operating margin (+100 bps) and ~90% free cash flow conversion.
  • Excluding Automotive OEM, ITW’s portfolio delivered 11% organic growth, 14% operating income growth and >25% operating margin in Q3, highlighting the resilience of its diversified businesses.
AI Generated. May Contain Errors.
Earnings Conference Call
Illinois Tool Works Q3 2021
00:00 / 00:00

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Operator

Good morning. My name is Tammy, and I will be your conference operator today. At this time, I would like to welcome everyone to the conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press Star followed by the number one on your telephone keypad. If you would like to withdraw your question, press the Pound key. For those participating in the Q&A, you will have the opportunity to ask one question and, if needed, one follow-up question. Thank you. Karen Fletcher, Vice President of Investor Relations, you may begin your conference.

Karen Fletcher
VP of Investor Relations at ITW

Thanks, Tammy. Good morning, and welcome to ITW's third quarter 2021 conference call. I'm joined by our Chairman and CEO, Scott Santi, and Senior Vice President and CFO, Michael M. Larsen. During today's call, we will discuss ITW's third 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 and subsequent reports filed with the SEC for more detail about important risks that could cause actual results to differ materially from our expectations. This presentation uses certain non-GAAP measures, and a reconciliation of those measures to the most directly comparable GAAP measures is contained in the press release. Please turn to Slide three, and it's now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

Scott Santi
Chairman and CEO at ITW

Thank you, Karen. Good morning, everyone. In the third quarter, we saw continued strong growth momentum in six of our seven segments and delivered excellent operational execution and financial results. Revenue grew 8% with organic growth of 6%, and earnings per share of $2.02 was up 10%. At the segment level, organic growth was led by Welding at +22%, Food Equipment at +19%, Test & Measurement and Electronics at +12%, and Specialty Products at +8%. Our Automotive OEM segment continued to be impacted in the near-term by auto production cutbacks associated with the well-publicized supply chain challenges affecting our Auto customers. In Q3, auto production cutbacks ended up being significantly larger than what was projected heading into the quarter.

Scott Santi
Chairman and CEO at ITW

As a result, our Automotive OEM segment revenues were down 11% in Q3 versus the -2% we were expecting as of the end of June. In a very challenging environment, our teams around the world continued to do an exceptional job of executing for our customers and for the company. In Q3, our people leveraged the combination of ITW's robust and highly flexible 80/20 Front-to-Back operating system. The company's close to the customer manufacturing and supply chain capabilities and systems, and our decision to stay fully staffed and invested through the pandemic to sustain world-class service levels for our customers. They also executed appropriate and timely price adjustments in response to rapidly rising raw material costs.

Scott Santi
Chairman and CEO at ITW

As a result, we were able to fully offset input cost increases on a dollar-for-dollar basis in Q3, resulting in $0 EPS impact from price cost in the quarter. Oh, by the way, our teams also managed to continue to drive progress on our long-term strategy, execute on our Win the Recovery positioning initiative, and deliver another 100 basis points of margin improvement benefit from enterprise initiatives. Moving forward, we remain very focused on sustaining our growth momentum and on fully leveraging the competitive strength of the ITW business model and the investments we have made and continue to make in support of the execution of our enterprise strategy.

Scott Santi
Chairman and CEO at ITW

Before turning it over to Michael, I want to thank all of our ITW colleagues around the world for all their efforts and for their dedication to keeping themselves and their ITW colleagues safe, to serving our customers with excellence, and to driving continued progress on our path to ITW's full potential. Michael, over to you.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Thank you, Scott, and good morning, everyone. As Scott said, demand remained strong in Q3, with total revenue of $3.6 billion, an increase of 8% with organic growth of 6%. Growth was positive in six of seven segments, ranging from 3%-22%, and in all geographic regions, led by North America up 9%, Europe up 1%, and Asia up 5%. China was up 2% versus prior year and up 6% sequentially. GAAP EPS of $2.02 was up 10% and included a one-time tax benefit of $0.06. Operating income increased 7% and operating margin was flat at 23.8% despite significant price cost headwinds. Enterprise initiatives were a real positive again this quarter at 100 basis points, as was volume leverage, which contributed more than 100 basis points.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Thanks to a great effort by our businesses, price cost was EPS neutral in Q3, but still diluted to operating margin percentage by 200 basis points as raw material cost increases further escalated in the third quarter. Throughout 2021, our businesses have quickly and decisively responded to raw material and logistics cost inflation with pricing actions in alignment with our policy to fully offset these cost increases with price on a dollar-for-dollar basis. We've talked about this before, but given the current environment, I'll remind you that we don't hedge, so current cost inflation is always moving through our businesses in real time. After tax return on invested capital was 28.5% and free cash flow was $548 million.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Free cash flow conversion was 86%, as our businesses have been very intentional about adding inventory to both support our growth and to mitigate supply chain risk and sustained world-class service levels for our customers. Overall, for the quarter then, strong growth in six of seven segments and excellent operational and financial execution across the board. Let's go to Slide four for segment results. Before we get to the segment detail, the data on the left side of this slide illustrates our strong Q3 results with and without Automotive OEM. I wanted to highlight two key points. The first is the benefit we derive from our high quality, diversified business portfolio in terms of the strength, resilience, and consistency of ITW's financial performance, which is enabling us, in this case, to power through significant near-term headwinds in our largest segment and still deliver top-tier overall performance.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

The second is the accelerating growth momentum with strong core earnings leverage we're generating across the company. Excluding our Automotive OEM segment, given the issues affecting that market right now, the rest of the company collectively delivered organic growth of 11%, operating income growth of 14%, and operating margin of 25%+ in Q3. As you can see on this slide, if you eliminate the price cost impact, our core incrementals were a very strong 52% in the third quarter, which points to the quality of growth and profitability leverage that define the core focus of our business model and strategy. Now let's take a closer look at our segment performance in Q3, beginning with Automotive OEM on the right side of this page. Organic revenue was down 11%, with North America down 12%, Europe down 18%, and China up 2%.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

As Scott mentioned, supply chain related production cutbacks were much larger in Q3 than what we and most, if not all, external auto industry forecasters were expecting headed into the quarter. While conditions in the Auto market are obviously very challenging in the near-term, the really good news from our standpoint is that the eventual and inevitable recovery of the Auto market will be a major source of growth for ITW over an extended period of time once the current supply chain issues begin to improve and ultimately get resolved. Between now and whenever that is, we will remain fully invested and strongly positioned to continue to support our customers and seize incremental share gain opportunities as production accelerates coming out the other side of this situation.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Turning to Slide five for Food Equipment and organic revenue growth that's very strong at 19% as the Food Equipment recovery that began in Q2 continues to gain strength. North America was up 18%, with Equipment up 20% and service up 14%. Institutional revenue, which is about a third of our revenue, increased more than 20% with strength in education up over 40% and healthcare and lodging growth of around 20%. Restaurants were up almost 50% with strength across the board. Strong demand is evident internationally as well, with Europe up 20% and Asia Pacific up 23%. Equipment sales led the way, up 26% with service growth of 8%. In our view, this segment is in the early stages of recovery, as evidenced by revenues that are still below pre-COVID levels.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Test & Measurement and Electronics organic revenue was strong with growth of 12%. Test & Measurement was up 15%, driven by continued strength in customer CapEx spend and in our businesses that serve the semiconductor space. Electronics grew 8% and operating margin was 26.8%. Moving to Slide six, Welding demand continued to be very strong with organic revenue growth of 22%. Equipment revenue was up 25% and consumables grew 18%. Our Industrial businesses increased 32% and the Commercial business, which sells to small businesses and individual users, grew 18%. North America was up 24% and International growth was 12% with continued recovery in oil and gas, which was up 9%. Welding had an operating margin of 30% in the quarter.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Polymers and fluids organic growth was 3%, with demand holding steady at the elevated levels that began in Q3 of last year, and especially had a tough comp of +6% a year ago. In Q3, growth was led by the polymers business, up 8%, with continued strength in MRO and heavy industry applications. Automotive aftermarket grew 4% with sustained strength in the retail channel. Fluids was down 5%, due mostly to a decline in pandemic related hygiene products versus prior year. Margins were 24.2% with more than 250 basis points of negative margin impact from price cost, driven by significantly higher costs for resins and silicone. Moving to Slide 7.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

In a similar situation with construction, where organic growth was also up 3% and also on top of a strong year ago growth rate of +8%. All three regions delivered growth with North America up 2%, with Residential renovation up 1% on top of a +14% comp a year ago, and Commercial was up 10%. Europe was up 8% and Australia and New Zealand was up 2%. Specialty organic revenue was up 8%, driven by continued recovery in North America, which was up 15%, and International was down 4%. Equipment sales were up 10% with consumables up almost 8%. Let's move on to Slide eight for an update on our full-year 2021 guidance.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

As you saw in the press release, we're updating our GAAP EPS guidance to a range of $8.30-$8.50, which incorporates the impact of actual and anticipated lower automotive customer production levels in Q3 and Q4 versus our previous guidance on July 30th. We now expect the Automotive OEM segment revenue to be down about 15% in the second half, including being down 20% in Q4 versus the forecast of roughly flat second half Auto OEM revenues that was embedded in our previous guidance. All other segments remain on track or better versus our previous guidance. Our $8.40 midpoint equates to earnings growth of 27% for the full-year.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

We now expect full-year revenue to be in the range of $14.2 billion-$14.3 billion, which is up 13% at the midpoint, with organic growth in the range of 11%-12%. Of that organic growth rate of 11%-12%, volume growth, including share gains, are 8%, with price of 3%-4%. For the full-year, we expect operating margin of approximately 24%, which is up 100 basis points versus last year. The fact that we're expanding margins at all in this environment is pretty strong performance, considering that we now expect raw material cost to be up 9% or more than $400 million year-over-year, which is more than 4x our expectation coming into this year.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Our businesses are on track to offset raw material cost increases with pricing actions on a dollar-for-dollar basis, which as you know, is EPS neutral, but margin dilutive. As raw material costs and consequently price have gone up more than what we projected in our previous guidance, we now estimate margin dilution percentage impact from price cost for the full-year at about 150 basis points versus our previous expectation of 100 basis points. These margin headwinds, though, will be offset by strong volume leverage of about 250 basis points and another solid contribution from enterprise initiatives of more than 100 basis points. Free cash flow is expected to be approximately 90% of net income as we continue to prioritize sustaining our world-class service levels for our customers in this challenging environment.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

As such, we will continue to invest in additional working capital to support our growth and mitigate supply chain risks. Our updated guidance is based on an expected tax rate for Q4 of 23%-24% for a full -ear tax rate of approximately 19%-20%. As per our usual process, our guidance excludes any impact from the previously announced acquisition of the MTS Test & Simulation business. We are awaiting one final regulatory approval and expect to receive that and close the transaction in Q4. In summary, this will be a record year for ITW with double-digit organic growth, margin expansion, strong cash flow, and EPS growth of 25%+.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

We expect this strong demand momentum to continue in Q4 and well into next year, with an additional boost from Automotive OEM likely at some point in 2022 as the supply chain issues there begin to improve. ITW remains very well positioned to continue to deliver differentiated best-in-class performance as we leverage our diversified high-quality business portfolio, the competitive strength of ITW's proprietary business model, and our team's proven ability to execute at a very high level in any environment. With that, Karen, I'll turn it back to you.

Karen Fletcher
VP of Investor Relations at ITW

Thanks, Michael. Karen, can you please open up the lines for questions?

Operator

Thank you. At this time, I would like to remind everyone in order to ask your question, press Star, then the number one on your telephone keypad. We'll pause for just a moment to compile a Q&A roster. Your first question comes from the line of Jeffrey Sprague with Vertical Research.

Jeffrey Sprague
Founder and Managing Partner at Vertical Research Partners

Thank you. Hey, good morning, everyone.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Morning.

Jeffrey Sprague
Founder and Managing Partner at Vertical Research Partners

Morning. Hey, maybe just on Auto to start. Can you speak to what, if any, kind of, you know, maybe whipsaw effect that's going on as it relates to, you know, to inventories? Just really trying to think about the, you know, kind of how and when your sales might, you know, fully recouple with production, or do you feel like they are fully coupled at this point? Any kind of nuances there to be aware of as we try to chart a path out of this thing?

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Yeah, I don't know a whole lot of new nuances. I know that our customers expect us to be able to, as we've talked many times before, you know, you order today, we ship tomorrow. You know, in the auto space, we are certainly giving quarterly guides from our customers in terms of their production forecasts, and obviously those have been more volatile than normal of late. You know, I would say that we're not. You know, there may be a little bit of inventory cushioning going on if you look at, you know, sort of build rates relative to our sales. You know, I think they're, you know, our sales were actually higher than production declines in Q3 by, you know, sort of an incremental margin of a few percentage points.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

I don't know the exact number, but there may be a little bit of cushion building there just given the overall environment. I would say, you know, once this thing starts to turn around that we should see a pretty immediate effect.

Jeffrey Sprague
Founder and Managing Partner at Vertical Research Partners

Scott, would you speak also just to the activity of your M&A pipeline? It looks like we're close to getting MTS done. Are you working an active pipeline at this point?

Scott Santi
Chairman and CEO at ITW

You know, we've talked about this many times before. We are, you know, a very interested opportunistic acquirer. We get things run by us all the time. We have a very clear and well-defined view of what fits our strategy and our financial criteria, and so there are things that are continuously being evaluated. But it's just a matter of the right opportunity presenting itself as we go forward, and that was certainly the case with MTS, and I expect that there will be others at some point. But I would not speculate as to when.

Jeffrey Sprague
Founder and Managing Partner at Vertical Research Partners

Just one quick housekeeping one for Michael, if I could. You know, the unallocated cost has kind of been running higher all year and bumped up a little bit more. Like, what's going on there, and what should we expect?

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Yeah, I think if you look at our last four quarters, we're averaging about $30 million or so. There are certain costs that we don't allocate out to the segments. You know, an example is, you know, health and welfare costs are going up year-over-year. There's really a laundry list of things there. I would assume that we'll stay somewhere in that $30 million-$40 million range on a go-forward basis.

Jeffrey Sprague
Founder and Managing Partner at Vertical Research Partners

Thank you.

Operator

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

Scott Davis
Scott Davis
Chairman and CEO at Melius Research

Hey, good morning, guys.

Scott Santi
Chairman and CEO at ITW

Good morning.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Morning.

Scott Davis
Scott Davis
Chairman and CEO at Melius Research

I love your slide deck. six real slides, 15 minutes of prepared comments. That's best in class from what I can tell.

Scott Santi
Chairman and CEO at ITW

Thank you.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Thank you.

Scott Davis
Scott Davis
Chairman and CEO at Melius Research

I appreciate the brevity and the information. Anyway, just switching gears a little bit. I mean, it's a little bit hard to perhaps measure, but you know, your comment maintaining world-class service levels. You know, when you think about your on-time deliveries kind of today versus where they were a few quarters ago versus perhaps pre-pandemic, are they back up to kind of comparable levels? Did they ever slip that much? You know, I'm sure your competitors, some of your competitors probably had major problems.

Scott Santi
Chairman and CEO at ITW

Yeah. I you know, it is a bit of a summation of a number of different cases. I would say certainly there are a number of our businesses that have sustained their traditional, you know, order today, ship tomorrow kinds of service levels throughout this environment, although have had to certainly work a lot harder with a lot more brute force, given the environment, to make that happen. You know, in some other cases I'm thinking about, we've gone from you know, ship to ship tomorrow on an order today to ship in a week. You know, I'm also thinking of cases where we've got people we compete with in certain markets that are now quoting deliveries into next year.

Scott Santi
Chairman and CEO at ITW

I, you know, I think from a standpoint of relative advantage, I think we are, again, without, you know, 84 different cases, I can't necessarily cite every exact one of them. But my bet is that the relative advantage that we have is actually increased in that regard in terms of our ability to deliver and our service levels to our customers in this pandemic period.

Scott Davis
Scott Davis
Chairman and CEO at Melius Research

Does that make it, Scott, easier to get price then, given the value promise that you have in delivery and predictability and such, that your customer doesn't have to hold a lot of extra inventory because they can have some faith that you guys are gonna be there for them?

Scott Santi
Chairman and CEO at ITW

I would imagine that's certainly part of it. You know, I think the overall dimension of the value add in terms of the ITW relationship is we try to outserve, you know, to give our customers the best overall value prop in terms of both the performance of the products we supply them, the service we deliver and put around those, and it's not just the delivery service. It's, you know, service in those businesses where we have service positions like Food Equipment. I think in all of that, you know, I think all of our customers are well aware of the raw material environment.

Scott Santi
Chairman and CEO at ITW

You know, I think from the standpoint of overall value delivery, our value to them, the environment that we're in, and the fact that we're just trying to recover on a dollar-for-dollar, we're not trying to get the margin back. I think as we said before, because we're interested in expanding our relationships with those customers, I think all of that speaks to the fact that we've been able to recover dollar-for-dollar.

Scott Davis
Scott Davis
Chairman and CEO at Melius Research

Okay. Best of luck, guys. Thank you.

Scott Santi
Chairman and CEO at ITW

Thank you.

Ann Duignan
Ann Duignan
Managing Director and Equity Research Analyst at JPMorgan

Thank you.

Operator

Next question comes from the line of Jamie Cook with Credit Suisse.

Jamie Cook
Jamie Cook
Managing Director of Equity Research at Credit Suisse

Hi, good morning.

Scott Santi
Chairman and CEO at ITW

Good morning.

Jamie Cook
Jamie Cook
Managing Director of Equity Research at Credit Suisse

Good job given the challenging environment. I guess just my first question, just on the margins on the Construction business. Your sales were up, the margins were down a little. So just trying to get some color there and when we can see sort of margin recovery. Then my second question, can you just, you know, give us an update on sort of what the opportunities are sort of from the M&A pipeline? Could that, you know, further supplement the growth opportunity going forward? Thanks.

Scott Santi
Chairman and CEO at ITW

Hey, Jamie. I think you may have missed it. We just talked about the M&A pipeline a few minutes ago with Jeff, so I'm gonna skip that one.

Jamie Cook
Jamie Cook
Managing Director of Equity Research at Credit Suisse

I'm sorry. I was like six calls back.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

That's okay. Don't worry about it. I mean, I think just the construction as we look at kind of the margins on a year-over-year basis, you know, good enterprise initiative contributions, good volume leverage, and then the headwind is really on the price cost side. You know, we talked in this segment in particular, you know, steel costs are a significant headwind, obviously offset with price on a dollar-for-dollar basis like are in line with

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Our policy here, but still margin dilutive, you know, pretty significantly at, you know, over 300 basis points here in the third quarter. I think once, the timing in terms of when is that gonna be, when is that impact gonna start to diminish, it's difficult to say. What we can say with a high degree of confidence is, and also just point to our track record, our ability to read and react to whatever cost increases come our way and respond, appropriately and decisively with price. I think kind of that track record speaks for itself, and we'll continue to do that. You know, we're certainly hopeful that the worst is behind us, but we're not counting on that as we look forward.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

You'll probably see a little bit of margin pressure in construction again here in Q4 relative to Q3. Q4 has some, you know, we've got a couple of less shipping days, seasonality. Typically, we go down in Q4 relative to Q3. I'd say in terms of the long-term, you know, structurally, Construction margins are gonna be, you know, back in the high twenties, at some point here once these near-term issues, you know, get resolved.

Jamie Cook
Jamie Cook
Managing Director of Equity Research at Credit Suisse

Okay, thank you. I'll get back in queue.

Operator

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

Andy Kaplowitz
Andy Kaplowitz
Managing Director at Citigroup

Good morning, everyone.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Hey, Andy.

Scott Santi
Chairman and CEO at ITW

Good morning.

Andy Kaplowitz
Andy Kaplowitz
Managing Director at Citigroup

I know it's early to talk about 2022, but maybe just big picture, given the growth momentum in your businesses, you know, ex auto up 11%, auto potentially affecting 2022, as you said. At this point, what's your conviction level that ITW can deliver, let's say, continuing above trend levels when we think about your longer-term goal of 3%-5% organic growth? Maybe dovetailing with that. Are any of your businesses actually snapping back faster than expected? You know, food equipment comes to mind. That may continue to lead growth going into 2022.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Well, I think, Andy, like we said, I mean, we certainly have some really good momentum in our businesses, you know, in Q3 and Q4. If you kind of set the auto situation aside, you know, those businesses are up 10% organically. Like you said, there's some really positive momentum, particularly in the more CapEx-oriented businesses. Welding, Test & Measurement, Food Equipment. I think, you know, like we said, you know, once the Automotive production challenges get resolved, I think we're set up really well for a strong recovery down the road. We think, potentially in 2022, we'll see, you know, some positive momentum as well, in automotive OEM.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

We've not rolled out the plans yet fully, embedded the plans fully for 2022 yet, but, you know, and until we've done that, I don't really wanna go comment too much. We'll give you a full update in February like we always do when we provide guidance. But certainly in terms of demand, the volume leverage that goes with that, the momentum still on enterprise initiatives, nine years in, our ability to deal with whatever costs and supply chain issues come our way, I think we're really well set up for 2022 and beyond, so.

Andy Kaplowitz
Andy Kaplowitz
Managing Director at Citigroup

Michael, that's helpful. Then, you mentioned Q4. I mean, there is some normal seasonality. You mentioned less shipping days. Obviously, you know, you're forecasting EPS in the middle of the range to be down a little from Q3. Is there anything else going on? Is it, you know, maybe a lag in how costs still hit the P&L in auto and maybe polymers and fluids? Then would you say that Q4 maybe is the peak negative margin impact from materials and, you know, resins and that kind of stuff?

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Well, I hope so. You know, we're not counting on it. I think.

Andy Kaplowitz
Andy Kaplowitz
Managing Director at Citigroup

If they don't go up anymore.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Yeah. Yeah. You know, look, what I can say just on the materials, I think the rate of increase, you know, from Q2 to Q3, we saw a big step up in our raw material cost inflation. I think it's unlikely we'll see the same thing here in Q4. I mean, we're already through October. Beyond that, who knows? You know, I think, like I said, it's typical seasonality for us. You know, we go down from Q3-Q4. Revenues are down. Margins are down. We've got two less shipping days. You know, Automotive OEM, we said down 20%, you know, year-over-year. The other six segments will all have positive organic growth.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Margin performance in those segments will be similar to Q3, if not a little bit better. You just need to adjust for, you know, the tax rate, the discrete item. You know, we gave you the detail on that in Q3 versus Q4. There is a little bit of currency headwind, which is really more of a rounding, but we have a little bit more currency headwind in Q4 than Q3. You put all that together, you get to, you know, what hopefully is a risk-adjusted, you know, pretty good outlook for the fourth quarter, and you know, we'll see where we go from here.

Andy Kaplowitz
Andy Kaplowitz
Managing Director at Citigroup

Thanks for that. Good to have you back, Michael.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Sure. Thank you. Thank you for letting me back.

Andy Kaplowitz
Andy Kaplowitz
Managing Director at Citigroup

Of course.

Operator

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

Ann Duignan
Ann Duignan
Managing Director and Equity Research Analyst at JPMorgan

They'll get it right. Good morning.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

They'll get it right someday, Ann.

Ann Duignan
Ann Duignan
Managing Director and Equity Research Analyst at JPMorgan

I'm laughing because it's, like, 20 years later.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Right.

Ann Duignan
Ann Duignan
Managing Director and Equity Research Analyst at JPMorgan

Perhaps, you know, just digging a little bit more, I know you've talked a lot about the momentum going into 2022, but you said in your nice brief opening comments, that other than automotive, some of your other businesses were actually doing better than you had expected. If you could just expand on that a little bit.

Ann Duignan
Ann Duignan
Managing Director and Equity Research Analyst at JPMorgan

Then on the Food Service Equipment side, particularly on institutional, is there any risk that there's some pull forward of demand? A lot of institutions got bailed out by the federal government with COVID aid. I mean, are you hearing anything about that driving demand on the institutional side? You know, broadly first and then maybe a little bit more on the drivers of demand in Food Equipment. Thank you.

Scott Santi
Chairman and CEO at ITW

Yeah, I think the, you know, your first question kind of, I think was what improved here relative to expectations. I mean, Food Equipment, and Welding certainly, Test & Measurement. You know, we did talk about on the last call, we had some one-time equipment orders in Q2. If you take those out, the momentum is, you know, really strong as well in the Test & Measurement business on the back of strong demand, on the semiconductor side. No, I'd point to those three as the strongest. You know, in terms of the institutional side, we really don't think that there's a significant impact there. I mean, from pull forwards, you know, overall the institutional side was up, like we said, 20%.

Scott Santi
Chairman and CEO at ITW

Education, you know, was up 40%, but so was healthcare. Healthcare was up, you know, 20%. We don't really think that there's a significant impact. We certainly haven't seen anything slowing down on the institutional side or really any of the other kind of end markets within Food Equipment.

Ann Duignan
Ann Duignan
Managing Director and Equity Research Analyst at JPMorgan

Okay. Just following up then on the Food Equipment side, are you seeing any changes in the types of equipment being demanded coming out of COVID? You know, thinking about the changes to quick serve or to any of the restaurant side. Any notable like secular or structural changes in the types of equipment that are being ordered?

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Not really, Ann. No, I think this is very similar to kind of our normal product mix, if you like. There's no really impact from that.

Ann Duignan
Ann Duignan
Managing Director and Equity Research Analyst at JPMorgan

Okay. Thank you. I appreciate it. I'll leave it there.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

All right.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Thanks.

Scott Santi
Chairman and CEO at ITW

Thank you.

Operator

Your next question comes from the line of Joe Ritchie with Goldman Sachs.

Joe Ritchie
Joe Ritchie
Managing Director at Goldman Sachs

Thank you. Good morning, everyone.

Scott Santi
Chairman and CEO at ITW

Morning.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Morning.

Joe Ritchie
Joe Ritchie
Managing Director at Goldman Sachs

Can we spend a minute just talking about auto OEM margins and pricing? You know, my understanding is that you know, historically you guys price when you win your platforms, and it's difficult sometimes to get back and try to get price from auto OEMs. What I'm trying to understand, I guess, is like, at what point do we start to see kind of the equation turn positive for you from a price cost perspective in thinking about the potential recovery for those margins longer-term?

Scott Santi
Chairman and CEO at ITW

Yeah. I you know, our you know, structurally you're right under normal circumstances that generally the pricing is much more sort of contractually negotiated in the auto space relative to the rest of our businesses. You know, what I would say in regards to this current situation is the you know, the delta, the inflation, raw material cost is certainly one where we're having discussions about with our customers about needing to adjust that. We're not you know, clearly the only ones in that respect with our auto customers. So we're working through that.

Scott Santi
Chairman and CEO at ITW

I would say it certainly remains the segment with the biggest lag in terms of our ability to recover, but ultimately, those, you know, our approach there is the same as it is in the rest of the company, is that we're gonna expect to get full recovery on the dollar amount of the inflation that we're seeing. You know, I'd say the margin issue there is certainly price-cost is somewhat of an issue in the short run, but it's much more volume. You know, so there's a lot of volume leverage there, and as we start, you know, shipments start improving, volumes start to recover given that some of these supply chain snags get resolved, then, you know, we'll have.

Scott Santi
Chairman and CEO at ITW

There's nothing that I see that won't get us back to, you know, sort of prior peak in terms of auto margins and have them go up from there as we grow that business.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Yeah, if it helps, Joe, I'll just add, if you're a little worried about margins in the near-term in auto, I mean, I think we just did 17%, which I think is in this industry is probably, you know, top tier performance, if not best in class. I think in Q4 we expect maybe the typical step down from Q3-Q4, but margins will still be solidly in the mid-teens. You know, overall for the company, I think what's implied in our guidance is operating margins for Q4 in that 22%-23% range. Hopefully that helps you quantify, you know, anything that you may be worried about in terms of the margin performance here.

Joe Ritchie
Joe Ritchie
Managing Director at Goldman Sachs

Yeah, no, that's really helpful. I appreciate that color from both of you. I guess just my one follow-up is just on MTS. You know, it's funny, like I almost had forgotten that you guys had acquired the company or were in the process of acquiring the company. I guess maybe-

Scott Santi
Chairman and CEO at ITW

We haven't forgotten.

Joe Ritchie
Joe Ritchie
Managing Director at Goldman Sachs

Can you elaborate a little bit on what's taking so long? I think it got announced in the first quarter.

Scott Santi
Chairman and CEO at ITW

Yeah.

Joe Ritchie
Joe Ritchie
Managing Director at Goldman Sachs

And then, uh-

Scott Santi
Chairman and CEO at ITW

Yeah, I don't want to do that, Joe. We're at the I don't know, two-yard line, so let's just leave things where they are.

Joe Ritchie
Joe Ritchie
Managing Director at Goldman Sachs

Okay

Scott Santi
Chairman and CEO at ITW

We'll get it over the goal line here soon.

Joe Ritchie
Joe Ritchie
Managing Director at Goldman Sachs

Okay. Is there anything you can tell us about the accretion from the business? 'Cause we have it kind of sized at like roughly, you know, $500 million business with like high 20s% gross margin. Any thoughts on potential accretion into 2022 if it closes this year?

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Well, you know, I think in year one, kind of we've said EPS neutral. We think that's still the case. I mean, there's gonna be a little bit of purchase accounting up front here. You know, we didn't buy this business for what it's gonna contribute to EPS or not in 2022. This is really much more of a long-term play. You know, in terms of size, you can go back and look, you know, pre-COVID. I mean, your numbers are about right, a little over, I think it was $560 million in 2019. The purchase price, $750 million is what we disclosed.

Joe Ritchie
Joe Ritchie
Managing Director at Goldman Sachs

Entry margins.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Entry margins, 6% EBIT, in a space that we know quite well, and I think you're familiar with the Instron business. We're really excited about getting this over the goal line and welcoming the MTS team, you know, to the ITW family and get to work. Maybe the one benefit is we've had a lot of time to get ourselves organized around integration planning, and everything we've seen has confirmed what we saw on due diligence in terms of, you know, the raw material and you know, how well we think this business is gonna perform over the next 3-5+ years.

Joe Ritchie
Joe Ritchie
Managing Director at Goldman Sachs

Okay. Sounds good. Thanks, everyone.

Operator

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

Julian Mitchell
Julian Mitchell
Equity Research Analyst at Barclays

Hi, good morning. Just wanted to follow up on the near-term organic growth outlook. It looks like, I think, implied volume growth year-over-year is maybe down in Q4 for ITW overall year-over-year, if you've got sort of pricing up mid-single-digits. Just wanted to check that that's roughly the right way to think about it on volumes. Is that all auto OEM related? Anything else where the volumes are soft? How confident you feel in that overall sort of market share recapture effort?

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Well, to answer your question, it's all automotive OEM here in Q4, you know, with revenues down 20%. You know, the other six or seven businesses are performing, like I said, at a really high level combined. If you just look at the other six segments, organic growth is almost 10% in Q4, or projected to be 10%. Margins, 25%+, similar to what these businesses did in Q3. It's really this near-term issue in auto OEM that's making the numbers look a little different than what we normally do.

Julian Mitchell
Julian Mitchell
Equity Research Analyst at Barclays

Understood. Thank you. Circling back on the divestment aspect. I think you discussed acquisitions a couple of times. In the recent past, you've talked about divestments maybe being on the table next year. Certainly we've started to see some other industrial companies divesting assets now because valuations are very, very elevated. I just wondered sort of your latest thoughts on that divestment aspect. You know, clearly multiples are high. I just wondered sort of, you know, if you're planning to wait a bit more just to let the operating profit keep growing.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Well, I think maybe just as a reminder, Julian, so as you say, we pulled back on these planned divestitures right when COVID hit. I mean, this was not a good time to sell these businesses, and we had a few other things going on. We really, I think we said this, we thought these businesses would be worth more coming out the other side. That's absolutely gonna be the case, not just in terms of the underlying performance of these businesses is significantly better than you know, before. Then you're right.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

You know, we expect, you know, multiples have certainly gone up, and so we think that, you know, early next year will be a good time to kind of relaunch some of these processes. If you go back to when we announced this program, this plan in 2018, we've got a little less than half of the divestitures completed at this point. We've got another you know, $300 million-$500 million worth of businesses here, revenues that we're taking a close look at.

Julian Mitchell
Julian Mitchell
Equity Research Analyst at Barclays

Great. Thank you.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Sure.

Operator

Your next question comes from the line of Nigel Coe with Wolfe Research.

Nigel Coe
Nigel Coe
Managing Director at Wolfe Research

Thanks. Good morning. Hi Michael.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Good morning.

Nigel Coe
Nigel Coe
Managing Director at Wolfe Research

Good to have you back on the call. Good morning.

Nigel Coe
Nigel Coe
Managing Director at Wolfe Research

Hey.

Nigel Coe
Nigel Coe
Managing Director at Wolfe Research

I wanna just maybe ask Joe's question on auto a slightly different way. I know you have multiyear contracts with the OEMs, but just given the extreme pressure on inflation, do you have any mechanism to pass along that, you know, via surcharges, et cetera? So just curious. The spirit of my question is that if we do see volume recovering to, you know, I don't know, maybe not 2022, but 2023, are we still gonna be, you know, a little bit underwater, on sort of the inflation recovery, assuming you can't price through all the contracts, you know, in a timely manner? So just curious if there's a way to pass along that inflation.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Well, I think Scott talked about the contractual nature of these, you know, of the industry, and so it's taking a little bit longer to get those prices adjusted. It's hard for us to say as we sit here, you know, how exactly that's gonna play out next year. I think what happens ultimately, and if you go back and look at what happened in 2018, which was the last kind of inflationary cycle, and then how we got way ahead of those costs in 2019, that's eventually how this will play out. Exactly when that happens is difficult to say.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

You know, I'll just bring up the point in terms of the benefit we have from, you know, not being an auto company, but being a multi-industry with a high quality, diversified set of businesses that are really differentiated, that have demonstrated again this year that every business can get price when faced with some pretty unprecedented levels of inflation. That'll be no different on a go forward basis. You know, we'll be, you know, I think we're really well positioned to read and react in all of our segments, and then auto will take a little bit longer. I think maybe that's the way to think about it.

Scott Santi
Chairman and CEO at ITW

Yeah, maybe, Nigel, just the one thing I'd add is that, you know, these are, you know, while we talk about sort of the contractual elements of these relationships, they're also cooperative relationships. We've been partners with our customers for a long time. I think given the environment, you know, I don't think it's the contractual provisions that are the ultimate obstacle. It's about what's fair for both parties and each of us working together in the current environment. You know, I wouldn't overly, I don't know if this is a verb, contractualize these relationships. These are long-term relationships with partners who need us and, you know, we wanna do our best to serve them. There's this. It'll all get worked out.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Yeah. I and maybe I'll just add, you know, the price cost equation is one element of the margin expansion here at ITW. I mean, if you look at the volume leverage that we're getting with just a little bit of organic growth, I mean, look at the incremental margins here, once price cost starts to settle down a little bit, and then we still have the enterprise initiative. You know, I wouldn't get too negative on the price cost side as you look into next year. Again, in February, when we get together and give you guidance, we'll give you a lot more detail on this.

Nigel Coe
Nigel Coe
Managing Director at Wolfe Research

Great. Okay, I'll leave it there, guys. You've covered a lot of ground. Thanks a lot.

Michael Larsen
Michael Larsen
Senior VP and CFO at ITW

Thank you.

Scott Santi
Chairman and CEO at ITW

Thank you.

Operator

There are no further questions at this time. I will now turn the call back over to Ms. Karen Fletcher.

Karen Fletcher
VP of Investor Relations at ITW

Okay, thanks, Tammy. Just wanna thank everybody for joining us this morning for our short and efficient call, and have a great day.

Operator

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

Executives
Analysts
    • Andy Kaplowitz
      Managing Director at Citigroup
    • Ann Duignan
      Managing Director and Equity Research Analyst at JPMorgan
    • Jamie Cook
      Managing Director of Equity Research at Credit Suisse
    • Jeffrey Sprague
      Founder and Managing Partner at Vertical Research Partners
    • Joe Ritchie
      Managing Director at Goldman Sachs
    • Julian Mitchell
      Equity Research Analyst at Barclays
    • Karen Fletcher
      VP of Investor Relations at ITW
    • Nigel Coe
      Managing Director at Wolfe Research
    • Scott Davis
      Chairman and CEO at Melius Research
    • Scott Santi
      Chairman and CEO at ITW
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