Illinois Tool Works Q2 2021 Earnings Call Transcript

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Provided by Quartr
July 29, 2021

There are 10 speakers on the call.

Operator

Good morning. My name is Adam, 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 speakers' remarks, there will be a question and Answer Thank you.

Operator

Karen Fletcher, Vice President of Investor Relations, you may begin your conference.

Speaker 1

Thank you, Adam. Good morning and welcome to IPW's Q2 2021 conference call. I'm joined by our Chairman and CEO, Scott Santee and our Vice Chairman, Chris O'Herlihy. Senior Vice President and CFO, Michael Larson is recovering from a sports Related injury and is not available to participate in today's call. We certainly wish Michael all the best and look forward to seeing him next week.

Speaker 1

During today's call, we will discuss ITW's 2nd quarter financial results and update our guidance for the 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 ks 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. So please turn to Slide 3 and it's now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

Speaker 2

Thank you, Karen and good morning everyone. In the Q2, we saw continued recovery momentum across our portfolio and we delivered strong operational execution and financial results. Revenue was up 43% with organic growth up 37% and we saw double digit growth in every segment and geography. Earnings per share of $2.45 was up 143%, 108% if you exclude the one time tax benefit of $0.35 that we recorded in the quarter. In this strong demand environment And in the face of very challenging supply conditions, our teams around the world leveraged our long held close to the customer manufacturing and supply chain approach and the benefits of staying fully staffed and invested through our window recovery positioning to continue providing world class service levels to our customers, while also continuing to execute on our long term strategy to achieve and sustain ITW's full potential performance.

Speaker 2

We're certainly encouraged by our organic growth momentum as order intake rates remain pretty much strong across the board. During the Q2, we saw multiple examples of how our ability to sustain our differentiated delivery capabilities By remaining fully invested through the pandemic resulted in incremental share gain opportunities for our businesses. Well, there's no doubt that the raw material supply environment is as challenging as we have experienced in a long time, Maybe ever in my 38 years at ITW, we are well positioned we are as well positioned as we can be to continue to set ourselves apart through our ability to respond for our customers. We've worked hard over the last 9 years to position ITW to deliver differentiated And I have no doubt that the ITW team will continue to execute at a high level as we move through the balance of the year and beyond. Now for some more detail on our performance in the Q2.

Speaker 2

As I mentioned, organic growth was 37% with Strong performance across our 7 segments. The 2 segments that were hardest hit by the pandemic a year ago led the way This quarter with automotive OEM up 84% and food equipment up 46%. By geography, North America was up 36% and international was up 38% with Europe up 50% and Asia Pacific of 20%. GAAP EPS of $2.45 was up 143% and included a one time tax Benefit of $0.35 related to the remeasurement of net preferred tax assets in the UK Due to a change in the statutory corporate tax rate there, excluding this item EPS of $2.10 grew 108%. It was a Q2 record and was 10% higher than Q2 of 2019.

Speaker 2

Operating income increased 99% and incremental margin was 40% at the enterprise level. Operating margin of 24.3 percent improved 6.80 basis points on strong volume leverage along with 150 basis Points of benefits from our enterprise initiatives. Year to date, our teams have delivered robust margin expansion with incremental margins for our 7 segments from 37% to 48% inclusive of price cost impact. Speaking of price cost, price cost headwind to margin percentage in the quarter was 120 basis points. Response to rising raw material costs since early in the year consistent with our strategy to cover raw material cost inflation with price adjustments on a dollar for dollar basis.

Speaker 2

In Q2, we ended up just short of that goal due to some timing lags and as a result, Net price cost impact reduced EPS by $0.01 in the quarter. We continue to expect price cost impact to be EPS neutral or better for the year. And I'll come back and provide more color on the price cost environment a little later in my remarks. In the quarter after tax Return on invested capital was a record at 30.8%. Free cash flow was $477,000,000 with a conversion of 72 Our strong organic growth.

Speaker 2

We continue to expect approximately 100% conversion for the full year. We repurchased 250,000,000 of our shares this quarter as planned. And finally, our tax rate in the quarter was 10.1% due to The one time tax benefit. Excluding this item, our Q2 tax rate was 23%. Now moving to Slide 4 for an update on price cost.

Speaker 2

We continue to experience raw material cost increases particularly in categories such as steel, Resins and Chemicals and now project raw material cost inflation at around 7% for the full year, which is almost 5 percentage points higher than what we anticipated as the year began. And just for some perspective, this is roughly 2x what we experienced in the 2018 Inflation TerraCycle. We learned a lot from that experience and as a result, The timeliness and pace of our price recovery actions are well ahead of where we were in 2018. As I mentioned, we expect price cost impact to be EPS neutral or better for the full year with pricing actions more than offsetting cost increases on a dollar for dollar basis. Price costs will continue to have a negative impact on our operating margin percentage however in the near term As we saw in Q2 and that impact will likely be modestly higher in Q3 versus Q2 before it starts to go the other way.

Speaker 2

For the full year, we expect price cost impact to be dilutive to margin by about 100 basis points, which is 50 basis points higher than where we were as of the end of Q1. That being said, margin benefits from enterprise initiatives and volume leverage will provide us ample ability to offset the negative effect of price cost on margin percentage and deliver strong overall margin performance for the year. And beyond the near term price cost impact, we remain confident that we have meaningful additional structural margin improvement potential from the ongoing execution of our enterprise initiatives. With that, I'll turn it over to Chris for some comments on our segment performance in Q2. Chris?

Speaker 3

Thank you, Scott, and good morning, everyone. Starting on Slide 5, the table on the left provides some perspectives on the growth momentum in our businesses when we look at sequential revenue from Q1 to Q2. As you would expect, the pace of recovery in our auto OEM segment has been dampened by the well publicized shortage of semiconductor chips Despite very strong underlying demand and for that reason, we added a row to the table to show portfolio demand trends ex auto. Our Q2 revenue ex auto increased 8% versus Q1. This year Q2 had one more shipping date in Q1.

Speaker 3

So on an equal days basis, our Q2 versus Q1 revenue growth ex auto is 6%, which is 2x of our normal Q2 versus Q1 seasonality of +3%. In addition, We added more than $200,000,000 of backlog in Q2. Both of these factors show that demand accelerated meaningfully in Q2 across our portfolio. Now let's go into a little more detail for each segment, starting with automotive OEM. Demand recovery versus prior year was most evident in this segment with 84% organic growth.

Speaker 3

This, of course, was against easy comps versus a year ago When most of our customers in North America and Western Europe were shut down from mid March to mid May. North America was up 102%, Europe was up 106% and China up 20%. We estimate that the shortage of semiconductor chips negatively impacted our sales by about $60,000,000 in the quarter. Operating margin of 18.8 percent was up 26.6 percentage points on volume leverage and enterprise initiatives. Price cost was a significant headwind of more than 200 basis points due to the longer cycle time required to implement price recovery actions in this segment.

Speaker 3

Given the ongoing semiconductor chip supply uncertainty, we now expect full year organic growth in automotive to be approximately 10% versus our original range of 14% to 18% at the beginning of the year. To be clear, this is not lost revenue, but simply delayed into next year. Furthermore, the slower than expected growth in auto is offset by strength elsewhere in the enterprise. Please turn to Slide 6 for Food Equipment. In Food Equipment, organic revenue revounded 46% with recovery taking hold across the board and the backlog that is up significantly versus prior year.

Speaker 3

North America was up 39% with equipment up 42% and service up 33%. Institutional revenue was up more than 30% with healthcare and education growth in the low to mid-30s and lodging up in the mid-20s. Restaurants were up about 60% with the largest year over year increases in full service and QSR. Retail grew in the mid teens and continued solid demand and new product rollouts. International recovery was also Robust at 58% with Europe up 66% and Asia Pacific up 29%.

Speaker 3

Equipment sales were strong up 60 percent with service growth of 39%, which continued to be impacted by extended lockdowns in Europe. Operating margin was 22% with an incremental of 46%. Test and Measurement and Electronics revenue of $606,000,000 was a Q2 record with organic growth of 29%. Test and Measurement was up 20%, driven by solid recovery in customer CapEx spend and continued strength in semicon. Electronics grew 38%, continued strength in consumer electronics and automotive applications and the added benefit in timing of some large equipment orders in electronic assembly.

Speaker 3

Operating margin of 28.1% was 240 basis points It was up 2 40 basis points and the Q2 record. Moving to Slide 7. Weather growth was also strong in Q2 at 33%. Equipment revenue was up 38% and consumables growth of 25% was the first time in positive territory since 2019. Our industrial business grew 52% on increased CapEx spending by our customers and the commercial business remained solid, up 26% following 17% growth in the Q1.

Speaker 3

North America was up 38% and international growth was 13%, primarily driven by recovery in oil and gas. Polymers and Fluids organic growth was 28%, led by our automotive aftermarket business, up 33% on robust retail sales. Polymers was up 34% with continued momentum in MRO applications and heavy industries. Fluids is up 8% with North America growth in the mid teens and European sales up low single digits. Operating margin was an all time record 27.3 percent with strong volume leverage and enterprise initiatives partly offset by price cost.

Speaker 3

Moving to Slide 8. Construction organic growth of 28% reflected double digit growth and recovery in all three regions. North America was up 20% with 16% growth in residential renovation and with 26% growth in commercial construction. Europe grew 61% with strong recovery versus easy comps in the UK and Continental Europe. Australian, New Zealand organic growth was 13% with continued strength in residential and commercial.

Speaker 3

Operating margin in the segment of 27.6 percent was up 3.90 basis points and was a Q2 record. Specialty organic revenue was up 17% with North America up 15%, Europe up 24% and Asia Pacific up 14%. Our flexible packaging business was up mid single digits against tougher comp than the rest of this segment. The majority of our businesses were up to double digits, led by appliance, up more than 50%. Consumable sales were up 19% Sales up 12%.

Speaker 3

And with that, I'll turn it back to Scott.

Speaker 2

Thanks, Chris. Let's move on to Slide 9 for an update on our full year 2021 guidance. We now expect full year revenue to be in the range of $14,300,000,000 to $14,600,000,000 Up 15% at the midpoint versus last year with organic growth in the range of 11% to 13% and foreign currency translation impact of +3%. This is an increase in organic growth of 1 percentage point at the midpoint versus The guidance that we provided at the end of Q1 driven largely by the incremental revenue impact of pricing actions implemented in Q2 in response to accelerating raw material While demand momentum accelerated in Q2 versus Q1 as we noted earlier in our presentation, We are admittedly being conservative in not projecting that forward in our guidance at this point in time given the significant supply chain disruptions that continues to challenge many of our customers in auto and otherwise. We are raising GAAP EPS guidance by $0.35 to a range of $8.55 to $8.95 to incorporate the one time tax benefit realized in the 2nd quarter.

Speaker 2

The midpoint of $875,000,000 represents earnings growth of 32% versus last year and 13% over 2019. Factoring out the one time Q2 tax item, the midpoint of our 2021 guidance is 10% higher than 2019. With regard to margin percentage, as discussed earlier, the incremental cost increases that we saw in Q2 will result in full year margin dilution Of 100 basis points versus the 50 basis points that we projected as of the end of Q1 and we are adjusting our Margin percentage guidance accordingly to a range of 24.5% to 25.5%, which would still be an improvement of more than 200 basis points year over year and an all time record for the company. And again, we expect 0 EPS impact from price cost for the full year. We expect free cash flow conversion to be approximately 100% of net income factoring out the impact of the one time non cash Tax benefit we recorded in Q2.

Speaker 2

Through the first half, we have repurchased 500,000,000 of our shares and expect to repurchase an additional 500,000,000 in the second half. Finally, we expect our tax rate in the second half to be in our usual range of 23% to 24% and for a full year tax rate of around 20%. Lastly, today's guidance excludes any impact from the previously announced acquisition of the MTS Test and business, which we expect to close later this year. And once that acquisition closes, we'll provide you with an update. And with that, I'll turn it back over to you, Karen.

Speaker 1

Okay. Thank you, Scott. Adam, let's open up the line for questions, please.

Speaker 2

Yes, ma'am.

Operator

And your first question comes from the line of Andrew Kaplowitz with Citi.

Speaker 4

Best wishes to Michael.

Speaker 2

Thank you. He's on short term IR, but he'll be back next

Speaker 4

Excellent. So Scott and Chris, you mentioned the raw material cost inflation. We know you said That you sort of put into the guide. So when you look at Q3 and Q4, you have confidence in your forecast. And then 'twenty two, you talked about last quarter, what's the Probability that these price increases are pretty sticky, so you could exceed that 35% to 40% longer term incremental you have?

Speaker 2

Well, on the first question, I think we're very confident that we will cover whatever All the increases that have already been incurred and anything subsequent to that, I would not be comfortable describing the environment as stabilizing at this point. But ultimately, I think we have demonstrated that we look back over the last Going back to 2017 and even in 2018 and certainly this year, So on a quarterly basis, worst impact from price cost and inflationary environments has been a penny, maybe $0.02 1 quarter. I think we're fully comfortable that we'll be able to read and react to whatever might happen from here that the EPS impact The company will be negligible for the full year, but I think as I said, I don't It's not based on an assumption that things are going to stabilize from here for sure. Yes, I don't think we're seeing We've seen enough evidence of that nor am I predicting things are going to continue to reach forward either. I think it's wait and see.

Speaker 3

We saw significant pickup in the pace of inflation in Q2.

Speaker 4

Yes. Guys, maybe I could just ask the question specific to auto in the sense that you gave us the numbers And now 10% for the year. I think this quarter you said 200 basis points of price versus cost. As you know, there's always a lag before you can catch up there. So should we I assume incremental margins still getting a little worse before it gets better in that business and how long would you surmise it takes to get on top of price versus cost in that business?

Speaker 3

Well, price versus cost in auto is always going to be challenging given the nature of the industry. Would say, Andy, in terms of incremental and in the 2nd quarter in auto, we had a 47% incremental and in fact, the 47% incremental for the first half of the year. So, incrementals are strong in auto, no doubt, but there's no doubt that the structure of the industry, the structure of the pricing agreements, it does take a little longer. Hard to say how long it will take

Operator

And your next Question comes from the line of Ann Bignan with JPMorgan.

Speaker 5

Hi, good morning. Good morning. Maybe you could talk a little bit more about Both Construction Products and Test and Measurement where you said you delivered or you did deliver record Q2 operating profit percent. Can you talk about how sustainable those margins are going forward? Was there anything in Q2 mix So anything that we should be aware of that would result in those margins diminishing from here?

Speaker 5

Or are those Sustainable at these levels? Yes.

Speaker 3

So when we say the construction margins are very sustainable, we've been Improving margin in construction for a long time now and certainly for the last few quarters here, we've been in the mid to high 20s in terms of margins and construction. So Despite the price cost environment, we're seeing nice organic growth in construction. We're getting nice price realization. And so we would certainly expect the There are 2 to be sustainable. So really in Test and Measurement.

Speaker 3

Test and Measurement margins, again, trending in the high 20s here have been like that for a long time. Segment that we like out in terms of level of differentiation, I believe it's our customer problems. So we don't see any issue with sustaining margins in either Test and Measurement or Construction.

Speaker 2

I'm sorry, I was just going to add some color commentary that I think I was adding up the time when Chris was reading the comments, but I think we said all time record margins for Q2 and Q3 of our 7 segments, despite the price cost environment. And And I'll just circle back to a comment I made, which is that there's still room to run-in terms of structural margin improvement across the company. We got 150 basis points of Enterprise Initiatives benefit in this quarter. So there's these are certainly Sustainable improvements in performance and we expect to continue to do better as we go forward.

Speaker 5

Okay. I'll leave it there in the interest of time. I appreciate it. Thank you.

Operator

And your next question comes from the line of Steven Volkmann with Jefferies.

Speaker 6

Hi, good morning guys. Maybe just following up on the comment about enterprise initiatives, you're talking about I 100 basis points for the year, but you did 150 this quarter, I think 120 if I have my numbers right last quarter. You've been overachieving, do those slow down for some reason or is there a chance that you do better than 100 this year?

Speaker 3

Yes, I mean, I think we're saying 100 plus. So we will do better than 100 this year. And there's still a lot of Inputs on Enterprise Initiatives, Board and Sourcing and the eightytwenty, these are all initiatives and activities that are very granular Within our segments, within each division, there's a host of activities they are working on and actually have been working on not just this year, but even starting last year. So we entered the year with a fair bit of tailwind in terms of enterprise initiatives. So we would expect to do 100 plus for sure.

Speaker 2

Well, that's like a 100 plus.

Speaker 6

And then maybe just following up on this price cost Kind of question. Just curious about how you think about the policy here. I mean, it doesn't feel like there's a lot of pushback on pricing in any of the Kind of verticals that we touch, why not price for dollars plus margin? Why kind of create that headwind?

Speaker 2

Well, I don't know. The headwind from my perspective is a percentage headwind. It's not an earnings headwind. The overall position that we want is, look, we've created an incredibly Profitable economic engine and the most important job we have is to grow it organically. And so from the standpoint of To the extent we don't have to go up as high as other people do, we're leveraging that strong position and we can translate that into incremental share.

Speaker 2

That's the preferred option. I don't want our people fighting over the next increment. We ought to get the cost back for sure. But then let's get on to talking to our customers about how we can help them Improve their businesses operationally, technically from a sales standpoint. And so that's basically it.

Speaker 2

As we can certainly do more To get all distracted and try to price optimize in the short term, but I don't think that serves our long term interest very well. We make plenty of money. It's

Speaker 3

not a

Speaker 6

Fair point. Thank you. Appreciate it.

Operator

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

Speaker 2

Hey, thanks. Good morning, everyone. Good morning, Jeff. Good morning. Can we just drill a little bit into kind of the whole availability issue?

Speaker 2

We talked about price cost and obviously it's Tied to the availability of supply, but outside of auto, which is very visible And obvious, are there quick places in your portfolio where either you're struggling to meet demand because of availability in your supply Shane or you're feeling it on the customer side, perhaps you can deliver, but they don't want it because they've got problems elsewhere down the line. I just wonder if you could Give us some perspective on that and any color on to what degree if any it may have been limiting the top line here in the quarter or into the balance Yes, I'll give you some overall color and then certainly let Chris give you some segment level, business level specific Some things come to mind for him on this. I would say in terms of overall color as we talk Our businesses around the world, there's no question that it is a daily battle To maintain supply position necessary to service our customers, I would absolutely contend that we are doing better than most For a couple of reasons. One is the fact that we have long had localized supply relationships And then the other factor was what we talked about in our remarks, the fact We kept all our people through the pandemic.

Speaker 2

We have not had to scramble to bring people back. So Normally, our supply chain and our manufacturing operations function in a very simple automated way. It's Definitely taking a lot more, let's call it, brute force for now. But I think we're not hearing any big issues From the standpoint of our own ability to supply our customers, it doesn't mean that there's not an occasional $2 bracket that Shows up late and there's a couple of welding machines that can't go on just making that up. But that's I'm sure that's the case.

Speaker 2

But ultimately, Given the service levels that we're monitoring, the standard part of our operating practices, I would say that I'm very comfortable saying that we're working a lot harder than we normally But ultimately performing pretty well. I would say that the supply chain area beyond auto is much more of an issue for us on the demand side than the supply I'll point to a couple of things. We are seeing a lot of So the timing changes in terms of orders and requirements not because we can't deliver something, but because another supplier can't deliver something to a customer. And I'd also point to the $200,000,000 of backlog, we've talked about this before. We shipped basically today what our customers ordered yesterday and so we operate with very little backlog and the fact that we built a couple of $100,000,000 of backlog.

Speaker 2

I can't analyze Every dollar of it, but my contention would be that that's a lot more due to sort of customer delays than it is our own ability to supply. And look, that was you had the $60,000,000 in auto plus the $200,000,000 in backlog, that's another 10 percentage points of organic growth in the 2nd quarter. Again, I'm not necessarily contending that all of it could have gone, but my bet would be most of it.

Speaker 1

I don't

Speaker 2

know if you have anything you want to add?

Speaker 3

Yes. The other thing I would say in addition to our discussed comments, I think our overall kind of eightytwenty focus here really creates a lot of advantages for us in terms of Much more simplified and streamlined product offerings obviously results in simplification of raw materials and components and that simplification focus also extends to our suppliers. A key part of our strategy and it's worked very well for us for many years is to have these very strong and long lasting supplier partnerships. And We're a key customer for most of our raw material suppliers. This becomes really, really important when supply chains become constrained.

Speaker 3

And we're really seeing that work to

Speaker 2

our benefit here in the last Great. And just a second question. Just on the M and A pipeline, Obviously, you don't have the deal until you've got something to announce. But can you give us a sense of how active your pipeline is? Have you been able to cultivate things, maybe handicap the odds of some other things kind of coming into your strike zone?

Speaker 2

Well, I would tell you that we are excited about NPS. We are working hard to get that one finished off. That is About $650,000,000 of annualized revenue, so that's certainly enough work to do for a little while anyway. I don't want to necessarily comment on the pipeline as much as to say we remain and we'll remain very interested in adding high quality businesses So the company, but so the timing of all that is always a subject of the quality of what Opportunities present themselves. So there's always stuff going on, but it's not a matter of how big or small the pipeline is.

Speaker 2

It's more We're looking for a much narrower set of criteria than I think. So it's more a function of the quality of what's there than the quantity. Okay, understood. Thanks. I'll pass it to Tom.

Operator

And your next question comes from the line of Joe Ritchie from Goldman

Speaker 6

Thanks. Good morning, everyone.

Speaker 4

Good morning, Joe.

Speaker 6

So I know that I know you guys guide to Organic growth trends really not improving or declining and that's just kind of how that's just in your policy going forward. I guess When I think about each of the different segments and how you're thinking about the sequentials from here, I don't really think about a lot of seasonality in your business, which maybe perhaps The construction business, right, being a little bit seasonally weaker in the Q4. How are you thinking about sequential revenue for the segment throughout the rest of the year. Obviously, you've given us the auto guide, but really the other segments.

Speaker 2

Yes. I covered that I think overall in my comments, but we have sort of tamped down the run rate in terms of the guidance relative to the run rate. Chris talked to you about the fact that in the second quarter we saw organic growth rates accelerate by a net 3 percentage points beyond seasonality. And we basically did project that same momentum forward through the balance of the year because of the supply risk involved, the supply chain risk to our customers. So We're playing that pretty conservative.

Speaker 2

And I think that ultimately is going to have more to do with the pace of the organic from here Trends of demand, there's plenty of demand out there. It's a matter of can our customers get enough raw material to support it.

Speaker 6

Got it. And maybe Scott, just following on that, like you mentioned the backlog in the food equipment business. Like where you're building backlog right now, is that are you seeing that as more kind of like a 2022 opportunity Just given what you're seeing from a supply chain standpoint or it is you expect some of that to convert in the second half?

Speaker 2

I'd say some of it converts. I think the only That's probably definitely into 2022 is the one that Chris mentioned in auto where this tick shortage doesn't look like it's going to get resolved anytime soon. But I'd say most of the rest of that backlog that $200,000,000 I would expect to Given our customers can take it because they can get the other components of things they need that could certainly convert in the back half. I think it just doesn't make sense to The revenue guide when everyone is still supply constrained right now. That's I can't say it anymore simply than that.

Speaker 2

And until we see how things play out, it just didn't make sense To take things too far from where they are now in terms of run rate until we see how that all how the supply issues Play out in affecting our customers willingness to ability to take what they've ordered from us and order more. But I would say there's definitely from the standpoint of border rates and the overall demand, there's definitely enough there to do well better than what's in our If the supply chain situation gets significantly better from here forward.

Speaker 5

Okay. Yes, that's helpful.

Speaker 6

I guess maybe one follow-up on price cost. I know we talked about it a little bit. You did mention that 3Q is It's expected to get a little bit worse from 2Q, but you put through some pricing actions in 2Q. So I guess I'm just wondering, does it take a little bit of time for some of those pricing actions to Hold or why would the headwind get worse in 3Q?

Speaker 3

Yes, Joel. I mean, the reason it's getting worse in Q3 Because of the pace of inflation in Q2, we saw a significant pickup in pace in Q2 and obviously there's a little bit of a lag. So we see a little bit of A worsening in Q3 based on what we know today, based on the cost increases we see and the known price increases, we see a little worsening in Q3 from Q2, really on the basis of the pace of inflation in Q2.

Speaker 6

Got it. Okay, great. Thank you both.

Operator

And your next question comes from the line of Jamie Cook with Credit Suisse.

Speaker 7

I guess just Two questions, one following up on the revenue outlook. Understanding why you'd guide sort of conservatively, but is there any way you can help us understand just what you're seeing in terms of Percentage increases on the order intake rate like by segment, just to help us sort of understand what's out there and to what degree are you Is there any sort of double ordering that's happening as customers are worried they can't get stuff? And then I guess my follow-up question, Obviously, the organic growth has performed very strong. Are there particular segments or customers where you are more Sort of confident that some of these this organic growth is associated with market share wins that are actually sort of sustainable from Thank you.

Speaker 3

Sure. So in terms of acceleration of organic growth, we're seeing it obviously we talked about auto work It's going in a different way, but certainly in Food Equipment, Test and Measurement Electronics and Welding are certainly growing faster than we expected earlier in the year. We've seen nice acceleration there. We've no reason to believe that it's not sustainable based on our conversations with our customers, the order patterns and so on. And obviously, as we've often talked about the fact that we've been very busy here in terms of this wind recovery initiative over the last 12 months.

Speaker 3

And while it's still kind of early to quantify this, we're feeling pretty good about how we're positioned. And as you know, we Very intentionally remained fully staffed to serve our customers, protected investments in people and initiatives that customer backed innovation And Sreedhar's excellent and certainly a lot of anecdotal evidence out there that would say that that is turning into real share gains. And if I just maybe highlight some Here are some examples in Lake Food Equipment where high levels of product availability, maintaining service level excellence as Scott talked about and being able to respond in supply where a competitor is enabling several share gain and incremental wins from competition in large chains, both in foodservice and food retail. Another example might be in Farmers and Fluids, automotive aftermarket. And staying invested here, we're able to sustain sales and our sales and innovation focus, Coupled with high service levels means we grew, as I mentioned in the commentary, automotive aftermarket grew by 33% in the quarter.

Speaker 3

And this is well above Customer Point sales growth indicating that we are gaining share in a meaningful way. And even on residential construction in our roofing businesses, Business was up 45% in the quarter. Again, we see very clearly we're gaining share there on competition who have certainly been supply Chain and operationally constrained, extending delivery times and so on, and we continue to maintain differentiated service levels. So Again, somewhat anecdotal, somewhat early in the window recovery strategy, but certainly ample evidence that we seem to be gaining share. And these are just a small selection of illustrated examples of the progress that we're making across our 7 segments.

Speaker 3

Okay. Thank you.

Speaker 7

And then anything on the order rate Intake, if you can share with us just what you're seeing that you saw by segment?

Speaker 3

Yes, it's an acceleration of the 3 segments that I mentioned

Speaker 8

in Orders are pretty much numbers. Yes.

Speaker 2

You know

Speaker 7

what I mean? If you can't, that's fine, folks.

Speaker 2

Yes. Orders pretty much equalize shipments for us because of what I said, Okay. What we our customers order, we ship the next day. I would say that also your question about, I think you used the term double dip ordering In terms of customers trying to hedge order more because they can't get supply, I absolutely can't say that we're not seeing any of that, but I would say that it would be much lower for us because of the fact that our service levels are so good, our customers understand In terms of order to ship, so some maybe certainly ordering more than they would normally because they're concerned about things. But I would think that In terms of our service levels, we wouldn't there wouldn't be anything that that wouldn't be a significant part of the overall demand picture for us.

Speaker 7

Okay. Thank you.

Operator

And your next question comes from the line of Joe Koh with Wolfe Research.

Speaker 9

Thanks. Good morning and best wishes to Mike. Hope you make a speedy recovery. Hi, guys. I want to go back to the supply constraints.

Speaker 9

Where are you kind of most And outside of automotive, which was predictable, but where are you most concerned? I'm thinking about maybe electronics, perhaps So what are you monitoring most closely in terms of not just for Elmer 2 works but for Your supplies, which businesses or geographies are you most concerned?

Speaker 3

Yes, electronics in general Have been fairly constrained, so that impacts segments like Welding, Food Equipment, Test and Measurement Electronics will be one that I would call out. The inflation environment obviously has been across the board in terms of steel, resins, chemicals and electronics, but in terms of supply chain constraints, Electronics, into a certain sense, steel related businesses.

Speaker 2

But beyond that, I don't think there's anything that really concentrates up. I think again, the color from our businesses, It's something different every day. Right. But it's not a it takes a lot more work and it's not even the big dollar stuff. It's Again, the $2 bracket, but it is a real effort right now,

Speaker 9

Because of the higher volume service plan, I wouldn't think exo to freight is a big issue for you, but maybe address those Because that seems to change very quickly. So I'm just wondering what impact from spot purchases and

Speaker 2

Spot purchases, can you explain that a little more?

Speaker 9

I think you and other companies would purchase

Speaker 2

some hedges. Yes, we don't. Yes, we don't hedge, we don't forward back. So everything current costs are flushing through right now.

Speaker 3

And second part of your question, are you looking related to freight and logistics, is that correct? And so with freight and logistics, I mean, obviously, there's an impact for us, but I would say less of an impact And some of our peers may be on the basis that the producer we sell produce and source where we sell philosophy that we've long had has certainly mitigated the impact of freight and logistics on our

Operator

And your next question comes from the line of Scott Davis with Numis Research.

Speaker 6

Good morning, guys.

Speaker 2

Good morning, Scott.

Operator

Hope Mike feels better.

Speaker 2

Must be

Operator

a good story, back story to the sports injury. All team or something, the over 50 football team. Anyways, I only have one question. It's just MTS, when you bring in MTS, how do you cadence eightytwenty? I mean, how do you bring in A deal of this size kind of bring Eightytwenty in without really disrupting it.

Operator

Is there kind of a playbook there you guys can walk through and us understand.

Speaker 3

Yes, absolutely, Scott. So obviously, we've completely reinvigorated E-twenty over the last few years with Front to back process and effectively the process that we will employ on MTS is exactly the same process that we have employed on our 84 divisions across So with Carolina's side on what to do, with Carolina's side on how to do it, and Carolina's side on what the outcome should be when we get it done properly, Coupled with the fact that we've built a tremendous amount of capability in the company of folks who can go in and help Guide MTS on the Eightytwenty generalization. So we feel very confident in the playbook. We feel very confident in our capability. We think the raw materials in MPS are fantastic with respect to Eightytwenty opportunity.

Speaker 3

That's one of the key attractions for us and where we bought it. The other thing I'd say to you is that We've got a very similar business in our portfolio in test and measurement in Instron where we've done this successfully before. So very confident that we can do this and do this successfully.

Speaker 2

The small plant It's probably a 3 to 5 year process and that's part and part of that is not disrupting the It's still

Speaker 3

at the pace that makes sense. We're in no rush here.

Operator

Okay. Super helpful. Good luck. Thank you.

Speaker 2

Thank you.

Operator

And your next question comes from the line of Nick Dobre with Baird.

Speaker 6

Thank Going back to your comments on pricing, Obviously, a lot changed over the past 3 months. And can you maybe clarify for us what Impact pricing had to your adjustment to the overall organic growth guidance? For the year?

Speaker 2

Yes, please. Yes, it's 1%.

Speaker 6

Okay. I'm presuming then that

Speaker 2

That was the 1% we had it towards here. Yes.

Speaker 6

Okay. That's kind of what I figured, but I just wanted to confirm. So if this is impacting the back half of the year primarily, then At least presumably you have a couple of points of growth just from pricing in the back half. If I look at the implied guidance, Right. It's at the high end, we're talking about growing something like 7% organically.

Speaker 6

A couple of points of that is Yes, your incremental price and I mean, look, Scott, you were talking earlier saying, hey, I'm trying to take a conservative approach here. But at least to me, when I'm adjusting out for this pricing element and I think about the comparisons that are still Fairly easy relative to the prior year. It just strikes me that you really are being conservative here in terms of how you're thinking about your business progression on a ex priced call it core basis. So just to kind of clarify this, is it That there is some lack of clarity as to where maybe demand is going to be because of what's happening with the supply chain? Or is it that you're having some second thoughts with regards to how you're going to be able to convert revenue given your some of the disruption that you're having to deal with.

Speaker 6

It's the former not the latter,

Speaker 2

If I understood you correctly, biggest risk for us by far is customer supply chain And what that does to their demand patterns from here on out. It is as I said before, it's about as volatile of a situation As I've seen in my career at ITW and so I don't want to be mysterious about it. I think until we see that start to stabilize, it's just really hard to be comfortable sort of raising I know We're serving the demand we have today really well and sort of run rate from the standpoint that our customers are able to sustain. I think we're comfortable continuing to our ability to do that will continue on for the back half. There is a lot more orders, a lot more demand Then that's again why we built backlog.

Speaker 2

That's there's not a demand question. If we had we We've had sort of unimpaired supply chains right now. We probably had 10 more points in the Q2. And this is It's not a fact, that's just my opinion, but just looking at the backlog. And so I think demand is certainly much stronger right now Given the pace of the recovery, it's just a matter of from the standpoint of all the supply chain issues and risks for our customers, Their pace of being able to what they're ultimately going to need from us, as I said, it's just hard to justify going up with a lot of conference from here, but it's more their supply side than their demand side, if that makes sense.

Speaker 6

Yes, I think it does.

Speaker 2

The follow-up to all of this is, as

Speaker 6

we're starting to think about 2022 And if we're using your framework for the back half of 'twenty one as a starting point in thinking about 2022, it begs the question as to how what growth It's likely to look like next year, right, because at least in theory pricing normalizes next year, so you won't

Speaker 2

We're not thinking about 22 much yet, but I would just So say as a general rule, a lot of the supply chain disruption I think just pushes adds to the duration of the recovery. I think there's plenty of business now and because all of it can't be satisfied, a point of demand now and Chris told you the example of Auto, the $60,000,000 we couldn't ship an auto in the Q2, that's not going away. That's just getting pushed out. We got dealer Tory is at all time lows. I forget what it was less than a month, maybe less than a month, I think I saw.

Speaker 2

And so to the extent, I don't think it's necessarily the worst thing in the world that all the demand that's there right now can't be fully served because it's going to allow us Again, this recovery duration gets extended by another 2 to 4 quarters maybe. And we'll think harder about that as we get to the That part of the year.

Speaker 6

Okay. That's helpful. Lastly for me, on the topic of M and A, you You talked about portions of your business that you consider for divestiture before, you've taken a step back on that this year. I'm sort of curious as activity has picked up multiples are pretty good. Will you reconsider this at a point in time down the line, maybe 2022?

Speaker 6

Yes. Okay. Thank you.

Operator

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

Speaker 6

Hi, good morning. Maybe just the first question around the free cash flow. I don't think that's been touched on yet. Your inventories and receivables are up each sort of $100,000,000 plus sequentially. Just wondered how you see working capital Playing out in the second half and what we should think about that as a sort of cash flow item for the year as a whole.

Speaker 6

And also sort of more broadly On the CapEx side of things, how much is your CapEx coming up this year? And have you revised at all your

Speaker 2

I think the best way to model our working capital requirements is our months on hand and day sales outstanding. So that we manage the metrics on those. Generally speaking, month on hand runs roughly 2.5 months. On a DSO, I can't remember at the top of my head, but whatever the average is, 60 ish maybe. So That's where working capital is going to go.

Speaker 2

Sales go up, months on hand is not going to go up, but the dollars invested Today we stay at that Monsanto and it's going to go up same with receivables and in terms of DSO. So it's not a It's something that happens automatically. We don't have to sort of force that to happen, but as sales go up, inventory is going to go up like the month on hand is a That's how Eightytwenty works. There's some elements of it that give us we want X amount of inventory to be able to provide the ability to react

Speaker 1

and respond to our customers that order

Speaker 2

today, ship tomorrow kind of. So customers that order today, ship tomorrow kind of system. So I think that's the best Guidance, I can give you on working capital is just model that through and whether that's cash flow, it's not going to be when you're jumping up as much as we did in Q2 versus Q1, it's going to obviously require some incremental working capital. And then the other question, I'm sorry. I'm trying to do my best Michael impersonation here, so I'm having to think hard about this.

Speaker 1

No, no, no.

Speaker 6

It was just around capital

Speaker 2

So capital CapEx, I think the plan for the year was up like $300,000,000 or so. It's 3 hundred on target. Yes, for the year. Yes, not up. So there is no incremental CapEx.

Speaker 2

We did defer some incremental capacity investments last year because of the pandemic we didn't need them. Those are certainly all coming back on, but those are We operate with another element of Eightytwenty as we want to be front end loaded on capacity because that's how we serve our customers. As business continues to go forward, we'll continue to invest in staying at sort of an increment meaningful increment ahead of current demand, but that wouldn't be again something Out of the norm of what we always do, it wouldn't be some big sort of lump coming through.

Speaker 6

That's clear. Thank you. And then just a quick follow-up on the auto OEM margins. Is the point that after that step down Sequentially in Q2, the sort of 19 percentage level is a good baseline or floor in the current sort of demand and cost environment. And so from here, they move up sort of slowly given what's going on, but 2019 is

Speaker 3

Yes, I'd say it's a fair assumption. We're seeing a bottom out here and I think it'll be slower recovery. Based on what we see today, Slow recovery from here on out.

Speaker 2

You might remember prior peak margins in auto, Chris, was probably 23. Yes. And so Yes. There's still a lot of volume recovery to go in auto from where we were then. And so I'd say low to mid-20s is certainly achievable over time.

Speaker 3

Thank you very much. Sure.

Operator

And your final question comes from the line of Joel Tiss with BMO.

Speaker 8

Scott, you shouldn't be so hard on yourself. I think you guys sound a little less annoyed by how dumb all our questions are than usual.

Speaker 2

Well, now you know who the gloomy guts of the group is, right?

Speaker 8

So I have like one Topic and just 2 different angles on it. 1, can you give us any sense if you think the food industry is kind of distracted with all the consolidation that's going on. And then can we have a little more color on kind of what customers are back? Are large pieces of your end markets still not really there? I'm thinking like Airports and cafeterias and things like that, can you just give us a little more detail around sort of the share gains and where the customers are?

Speaker 8

Thank you.

Speaker 3

Yes. So I don't know about the distractions and consolidations. I can tell you we're not distracted. We're basically focused on trying to win the recovery here, serve the needs Our customers with innovative new products and so on. So generally, I think we're seeing some real nice recovery in food Actually, we thought at the beginning of the year.

Speaker 3

We're certainly seeing the benefit of staying invested in food. A little bit of price cost impacted food certainly, but obviously that's some of that relates to the fact that The price cost environment, some additional pricing actions here in the second half. In terms of the end markets, I mean, basically with food, we're back to about by the end of this year, we expected back about 90% of the 2019 number. So faster than we thought. In terms of end markets, we're seeing nice pickup in institutional restaurants coming back.

Speaker 3

We mentioned restaurants being up 60%. In terms of stuff that's coming back a little slower, I would say service, if we point to service in Europe as an example, obviously with significant lockdowns, we're still dealing with over there, Probably coming back a little slower there, but at least through the first half, we expect to see that pick up here in the second half. But generally, most end markets are coming back. Lodging is a little slower, I would say.

Speaker 2

Yes. And Transportation.

Speaker 3

And Transportation. Right. Airlines, Airlines, Airlines, Airlines, Airlines, Airline, right.

Speaker 2

For sure.

Speaker 8

That's great. Thank you very much.

Operator

And there are no further questions at this time. I'll now turn it back over to Karen.

Speaker 1

Okay. Thanks, Adam. We appreciate you joining us this morning. And if you have any follow-up questions, please let me know. Have a great

Operator

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

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Earnings Conference Call
Illinois Tool Works Q2 2021
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