Illinois Tool Works Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
October 27, 2021

There are 12 speakers on the call.

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 speakers' remarks, there will be a question and answer session.

Operator

For those participating in the Q and 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.

Speaker 1

Thanks, Tammy. Good morning, and welcome to ITW's Q3 2021 conference call. I'm joined by our Chairman and CEO, Scott Santi and Senior Vice President and CFO, Michael Larsen. During today's call, we will discuss ITW's Q3 financial results and update our guidance for full year 2021. Slide 2 is a reminder that this presentation contains forward looking statements.

Speaker 1

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. 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. Good morning, everyone. In the Q3, we saw continued strong growth momentum in 6 of our 7 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 and Measurement and Electronics at +12% and Specialty Products at +8%.

Speaker 2

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. And as a result, our auto OEM segment revenues were down 11% in Q3 versus the minus 2% we were expecting As of the end of June. In a very challenging environment, our teams around the world continue to do an Exceptional job of executing for our customers and for the company. In Q3, our people leverage the combination of ITW's robust And highly flexible eightytwenty front to back operating system.

Speaker 2

The company is 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. And 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. And by the way, our teams also manage We 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 Benefit from Enterprise Initiatives. Moving forward, we remain very focused on sustaining our growth momentum And I'm 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.

Speaker 2

Before turning it over to Michael, I want to thank all of our ITW colleagues around the world 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.

Speaker 3

Thank you, Scott, and good morning, everyone. As Scott said, demand remains strong in Q3 with total revenue of $3,600,000,000 an increase of 8% with organic growth of 6%. Growth was positive in 6 or 7 segments ranging from 3% to 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 point 0 $6 Operating income increased 7% and operating margin was flat at 23.8% despite significant price cost headwinds.

Speaker 3

Enterprise initiatives were real positive again this quarter at 100 basis points as was volume leverage, which contributed more than 100 basis points. Thanks to a great effort by our businesses, price cost was EPS neutral in Q3, but still dilutive to operating margin percentage by 200 basis points We 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. And we've talked about this before, but given the current environment, I'll remind you that we don't hedge. So current cost inflation As always moving through our businesses in real time. After tax return on invested capital was 28.5% and free cash flow $548,000,000 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.

Speaker 3

Overall for the quarter then strong growth in 6 or 7 segments and excellent operational and financial execution across the board. Let's go to Slide 4 for segment results. And before we get to the segment detail, the data on the left side of the slide illustrates our strong Q3 results with and without Automotive OEM. I wanted to highlight 2 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.

Speaker 3

The second is the accelerating growth momentum with strong core earnings leverage we're generating across the company. Excluding our auto 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% plus in Q3.

Speaker 4

And As you

Speaker 3

can see on this slide, if you eliminate the price cost impact, our core incrementals were a very strong 52% in the 3rd 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%. And 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 We're expecting heading 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.

Speaker 3

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 Coming out the other side of this situation. Turning to Slide 5 for Food Equipment. And organic revenue growth is 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%.

Speaker 3

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. Test and Measurement and Electronics organic revenue was strong With growth of 12%, test and measurement was up 15% driven by continued strength in customer CapEx spend And in our businesses that serve the semiconductor space.

Speaker 3

Electronics grew 8% and operating margin was 26.8%. So moving to Slide 6, 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%.

Speaker 3

Welding had an operating margin of 30% in the quarter. Polymers and Fluids organic growth was 3% With demand holding steady at the elevated levels that began in Q3 of last year and as such we had a tough comp Up plus 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.

Speaker 3

Margins were 24.2 percent with more than 2 50 basis points of negative margin impact from cost driven by significantly higher costs for resins and silicone. Moving to Slide 7, And 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 plus 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%.

Speaker 3

Equipment sales were up 10% with consumables up almost 8%. Let's move on to Slide 8 for an update on our full year 2021 guidance. As you saw in the press release, we're updating our GAAP EPS guidance to a range Of $8.30 to $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 30. 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.

Speaker 3

Our $8.40 midpoint equates to earnings growth of 27% for the full year. We now expect full year revenue to be in the range of $14,200,000,000 to $14,300,000,000 It is up 13% at the midpoint with organic growth in the range of 11% to 12%. Of that organic growth rate of 11% to 12%, Volume growth including share gains are 8% with price of 3% to 4%. For the full year, we expect operating margin of approximately 24%, which is up 100 basis points versus last year. And the fact that we're expanding margins at all in this environment is pretty strong performance.

Speaker 3

Considering that we now expect raw material cost to be up 9% Or more than $400,000,000 year over year, which is more than 4 times our expectation coming into this year. 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 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 These margin headwinds though will be offset by strong volume leverage of about 2 50 basis points And another solid contribution from enterprise initiatives of more than 100 basis points. Free cash flow It's 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. And 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 And expected tax rate for Q4 of 23% to 24% for a full year tax rate of approximately 19% to 20%.

Speaker 3

And as per usual process, our guidance excludes any impact from the previously announced acquisition of the MTS Test and Simulation We are awaiting one final regulatory approval and expect to receive that and close the transaction in Q4. So 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% plus. 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 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 has proven ability to execute at a very high level in any environment. With that, Karen, I'll turn it back to you.

Speaker 1

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

Operator

Thank you. Your first question comes from the line of Jeffrey Sprague with Vertical Research.

Speaker 5

Thank you. Hey, good morning, everyone. Good morning. Good morning. And maybe just on auto to start, could you speak to what if any kind of Maybe whipsaw effect that's going on as it relates to inventories.

Speaker 5

Just really trying to think about Kind of how and when your sales might fully recouple with production or do you feel like they are fully coupled at this point? So any kind of nuances there to be aware of as we try to path out of this thing?

Speaker 2

Yes, I don't know A whole lot of nuances. I know that our customers expect us to be able to, as we've talked many times before, you order today, we ship tomorrow. In the auto space, we are certainly giving quarterly guides from our customers in terms of their production forecast and obviously those have been more volatile than normal Of late, I would say that we're not there may be a little bit of inventory cushioning going on. If look at sort of build rates relative to our sales, I think our sales were actually higher than production declines in Q3 by Sort of the incremental margin of a few percentage points. I know the exact number, but so there may be a little bit of cushion building there just Given the overall environment, but I would say once this thing starts to turn around that we should see a pretty immediate effect.

Speaker 5

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

Speaker 2

We've talked about this many times before. We are And it's a very interesting opportunity to acquire. 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 MCS and I expect that there will be others at some point, but I would not Speculate as to why.

Speaker 5

And just one quick housecleaning one for Michael, if I could. 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?

Speaker 3

Yes, I think through the last four Quarters we're averaging about $30,000,000 or so and there are certain costs that we don't allocate out to The segments example is health and welfare costs are going up year over year and there's really a laundry list of things there. I would assume That will stay somewhere in that 30 to 40 range on a go forward basis.

Speaker 2

Thank you.

Operator

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

Speaker 6

Hey, good morning guys. Good morning.

Speaker 2

Good morning.

Speaker 6

I love your slide deck. Six real slides, 15 minutes of prepared comments. That's best in class

Speaker 3

From what I can

Speaker 2

tell. Thank you. Thank you.

Speaker 6

I appreciate the brevity and the information. Anyways, just switching gears a little bit. I mean, it's a little bit of hard to perhaps measure, but Your comment maintaining world class service levels, 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? I'm sure your competitors, some of your competitors probably had major problems.

Speaker 3

Yes. It is a bit of a Summation of

Speaker 2

a number of different cases, but I would say certainly there are a number of our businesses that have sustained their Order today, ship tomorrow kinds of service levels throughout this environment, although I've had to certainly work A lot harder with a lot more brute force given the environment to make that happen. In some other cases, I'm thinking about we've gone from ship Ship tomorrow and in order today to ship in a week, but 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. So I think from a standpoint of relative advantage, I think we are again without 84 different cases, I can't necessarily cite every exact one of them, but my bet is that we are But the relative advantage that we have is actually increased in that regard in terms of our ability to deliver in our service levels to our

Speaker 6

And does that make it, Scott, easier to get price than 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

Speaker 3

going to be there for them?

Speaker 2

I would imagine that's certainly part of it. I think the overall dimension The value adds in terms of the ITW relationship as we tried out serve to give our customers the best overall value prop in terms Both the performance of the products we supply them, the service we deliver and put around those and it's not just delivery service, it's Service in those businesses where we have service positions like food equipment. And so I think in all of that, I think all of our customers are well aware of the raw material environment. So 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 And expanding our relationships with those customers, I think all of that speaks to the fact that we've been able to recover

Speaker 3

dollar for dollar.

Speaker 6

Okay. Best of luck guys. Thank you.

Speaker 2

Thank you. Thank you.

Operator

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

Speaker 7

Hi, good morning. Good morning. Good morning. 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.

Speaker 7

So just trying to get some color there and when we can see sort of margin recovery. And then my Can you just give us an update on sort of what the opportunities are sort of in the M and A pipeline and could that help could that to supplement the growth opportunity going forward. Thanks.

Speaker 3

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

Speaker 7

I'm sorry, like 6 calls. It's okay. Don't worry

Speaker 3

about it. Yes, don't worry about it. I mean, I think in terms of construction, as we look at kind of the margins on a year over year basis, Good enterprise initiative contributions, good volume leverage and then the headwind is really on the price cost side. So we talked in this segment in particular, steel costs Our significant headwind obviously offset with price on a dollar for dollar basis like In line with our policy here, but still margin dilutive, pretty significant debt over 300 basis points Here in the Q3. I think once the timing in terms of when is that going to be When is that impact going to start to diminish, it's difficult to say.

Speaker 3

What we can't 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. And we're certainly hopeful that the worst is behind us, but we're not counting on that as we Look forward. And so you'll probably see a little bit of margin pressure in construction again here in Q4 relative to Q3. Q4 has some we've got a couple of less shipping days seasonality.

Speaker 3

Typically, we go down in Q4 relative to Q3. I'd say in terms of the long term structurally construction margins are going to be back in the high 20s at some point here once these near term Issues get resolved.

Speaker 7

Okay. Thank you. I'll get back in queue.

Operator

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

Speaker 8

Good morning, everyone.

Speaker 2

Hi, Andy. Good morning.

Speaker 8

So I know it's early to talk about 2022, but maybe just big picture, given the growth momentum in your businesses, Ex auto up 11%, auto potentially reflecting 2022 as you said. At this point, what's your conviction level that ITW can deliver, Let's say continuing above trend levels and we think about your longer term goal of 3% to 5% organic growth. And maybe dovetailing with that, are any of your businesses actually snapping back Faster than expected, food equipment comes to mind that may continue to lead growth going into 'twenty two?

Speaker 3

Well, I think Andy, like we said, I mean, we certainly have some really good momentum in our businesses in Q3 and Q4. If you kind of set the auto situation aside, those businesses are up 10% organically. And like you said, there's Some really positive momentum, particularly in the more CapEx oriented businesses. So welding, test and measurement, Food equipment and then I think like we said, once the automotive production challenges get resolved. I think we're set up really well for a strong recovery down the road.

Speaker 3

We think potentially in 2022 we'll see some positive momentum as well In automotive OEM. So we've not rolled up the plans yet fully, embedded the plans fully for 2022 yet. But And until we found that, I don't really want to 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 on still on enterprise initiatives 9 years in, our ability to deal with whatever cost and supply chain issues come our way, I think we're really well set up for 2022 and beyond, so.

Speaker 8

Michael, that's helpful. And then, you mentioned Q4. For I mean there is some normal seasonality, you mentioned less shipping days. Obviously, you're forecasting EPS in the middle of the range to be down a little In Q3, is there anything else going on? Is it maybe a lag in how costs still hit the P and L in auto and maybe polymers and fluids?

Speaker 8

Then would you say that Q4 maybe is the peak negative margin impact from materials and resins and that kind of stuff?

Speaker 3

Well, I hope so. And we're not counting on it. I think But they don't go up anymore. Yes. Look, what I can say just on the materials, I think the rate of increase from Q2 to Q3, we saw a big step up in our raw material cost inflation.

Speaker 3

I think it's unlikely we'll see the same thing here in Q4. I mean we're already through October, but beyond that who knows. I think like I said, it's typical seasonality for us. We go down from Q3 to Q4, revenues are down, margins are down. We've got 2 less Automotive OEM, we said down 20% year over year.

Speaker 3

The other 6 segments will all have positive organic growth. Margin performance in those segments will be similar to Q3, if not A little bit better. And then you just need to adjust for the tax rate, the discrete item. We gave you the detail on that in Q3 versus Q4. And then 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.

Speaker 3

So You put all of that together, you get to what hopefully is a risk adjusted, Pretty good outlook for the Q4 and we'll see where we go from here.

Speaker 8

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

Speaker 2

Sure. Thank you.

Speaker 3

Thank you for letting me back. Of course.

Operator

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

Speaker 2

They'll get it right someday, Ann.

Speaker 9

I'm laughing because it's like 20 years later. Perhaps 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. And then on the foodservice On the 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 Broadly first and then maybe a little bit more on the drivers of demand in food equipment.

Speaker 3

Yes, I think your first question kind of I think was what improved here relative to expectations in food equipment And Welding certainly. Test and Measurement, we did talk about in the last call, we had some one time equipment orders in Q2. If you take those out, the momentum is Really strong as well in the Test and Measurement business on the back of strong demand on the semiconductor side. So I'd point to those 3 as the strongest. In terms of the institutional side, we really don't think that there's a significant impact there.

Speaker 3

I mean, From pull forwards, overall, the institutional side was up, like we said, 20%. Education was up 40%, but health so was healthcare. Healthcare was up 20%. So We don't really think that there is a significant impact and 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.

Speaker 9

Okay. And then 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, thinking about the changes to QuickServe or to any The restaurant side, any notable like secular or structural changes in the types of equipment that are being ordered?

Speaker 3

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

Speaker 9

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

Speaker 3

Thank you.

Operator

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

Speaker 10

Thank you. Good morning, everyone.

Speaker 2

Good morning. Good morning.

Speaker 10

Can we spend a minute just talking about auto OEM margins and pricing? So my understanding is that 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. And so 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 and thinking about the potential recovery for those margins longer term.

Speaker 2

Yes. Our 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. What I would say in regards to this current situation is the delta of inflation raw material cost is certainly one where We're having discussions about with our customers about needing to adjust that and we're not clearly the only ones in that Respect with our auto customers. So we're working through that. I would say it certainly it remains this segment with The biggest lag in terms of our ability to recover, but ultimately those we're going to

Speaker 3

our approach there is the same as it is in

Speaker 2

the rest of the company is We're going to expect to get full recovery on that dollar amount of inflation that we're seeing. And 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. Yes, there's a lot of volume leverage there and as we start shipments start improving, volumes start to recover given as some of these supply chain snacks get resolved Then we'll have there's nothing that I see that won't get us back to sort of prior peak in terms of auto margins and having go up from there as we grow that business.

Speaker 3

Yes. And 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 top tier performance, if not best in class. And I think in Q4, we expect maybe The typical step down from Q3 to Q4, but margins will still be solidly in the mid teens. Overall for the company, I think what's implied in our guidance is operating margins for Q4 in that 22%, 23 And so hopefully that helps you quantify anything that you may be worried about in terms of the margin performance here.

Speaker 10

Yes. No, that's really helpful. I appreciate that color from both of you. And I guess just my one follow-up is just on MTS. It's funny, like I almost had forgotten that you guys had acquired the company or We're in the process of acquiring the company.

Speaker 10

I guess, Can you elaborate a little bit on what's taken so long? I think you've got announced in the Q1 and then

Speaker 2

Yes, I don't want to do that, Joe. We're at The I don't know, 2 yard line. So let's just leave things where they are and we'll Getting over the goal line here soon.

Speaker 10

Okay. Is there anything you can tell us about the accretion from the business because we have it kind of sized at like roughly You know, a $500,000,000 business with like high 20s type gross margin. So any thoughts on potential accretion into 2022

Speaker 3

if it closes this year? I think in year 1, kind of we've said EPS neutral. We think that's still the case. I mean, there's going to be a little bit of purchase accounting upfront here. And we didn't buy this business for what is going to contribute to EPS or not in 2022.

Speaker 3

This is really much Long term play. In terms of size, you can go back and look pre COVID, I mean, your numbers are about right, a little over, I It was $560,000,000 in 2019, the purchase price $750,000,000 is what we disclosed. Entry margins, 6% EBIT in a space that we know quite well and I think you're familiar with the Instrum business. So we're really excited about Getting this over the goal line and welcoming the MTS team to the ICW family and get to work. And 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 in due diligence in terms of The raw material and how well we think this business is going to perform over the next 3, 5 years plus.

Speaker 10

Okay. Sounds good. Thanks everyone.

Operator

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

Speaker 4

Hi, good morning. Just wanted to follow-up on the near term organic growth Outlook. So it looks like I think implied volume growth year on year is maybe down in Q4 For ITW overall year on 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 and is that all auto OE related, anything else where the volumes are soft And how confident you feel in that overall sort of market share recapture effort?

Speaker 3

Well, to answer your question, it's all automotive OEM here in Q4 with revenues down 20%. The other 6 or 7 businesses are performing Like I said, a really high level combined. If you just look at the other six segments, organic growth is Almost 10% in Q4 are projected to be 10%. Margins, 25% plus, similar to what they these businesses did in Q3. And so it's really this near term issue in auto OE that's making the numbers look a little different than what we normally do.

Speaker 4

Understood. Thank you. And then just circling back on the divestment aspect, I think you Gus, acquisitions a couple of times. In the recent past, you've talked about divestments maybe being on the table next And certainly we've started to see some other industrial companies divesting assets now because valuations are Very, very elevated. Just wondered sort of your latest thoughts on that divestment aspect.

Speaker 4

Clearly multiples are high. Just wondered sort of if you're planning to wait a bit more just to let the operating profit keep growing.

Speaker 3

Well, I think maybe just as a reminder, Julian. So as you said, we pulled back on these planned divestitures right when COVID hit. I mean, just as a This was not a good time to sell these businesses and we had a few other things going on and we really, and I think we said this, we thought these businesses would be worth More coming out the other side and that's absolutely going to be the case, not just In terms of the underlying performance of these businesses is significantly better than before. And then you're right, we expect multiples have And so we think that 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.

Speaker 3

So we've got another $300,000,000 to $500,000,000 worth of businesses here, revenues that We're taking a close look at.

Speaker 10

Great. Thank you.

Speaker 3

Sure.

Operator

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

Speaker 11

Thanks. Good morning. And Michael, good to have you back on the call. Good morning. I want to just maybe ask Joe's question on auto slightly different way.

Speaker 11

I know you have multi year contracts with the OEMs. But just Given the extreme pressure on inflation, do you have any mechanism to pass along that via surcharges, etcetera? So just curious. And the spirit of my question is that if we do see volume recovering to maybe not 2022, but 2023, Are we still going to be a little bit underwater on sort of the inflation recovery, assuming you can't price through All of the contracts in the timing manner. So just curious if there's a way to pass on that inflation?

Speaker 3

I think Scott talked about the contractual nature of these of the industry. And so it's Taking a little bit longer to get those prices adjusted. And so it's hard for us to say as we sit here, exactly that's going to 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.

Speaker 3

I'll just bring up the point in terms of the benefit we have From 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 we every business can get price When faced with some pretty unprecedented levels of inflation, and that will be no different on a go forward basis. We'll be 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. So I think maybe that's

Speaker 2

the way to think about it. Yes, maybe just the one thing I'd add is that these are while we talk about Sort of the contractual elements of these relationships, they're also partnering with it. These are cooperative relationships. We've been partners With our customers for a long time, so I think given the environment whether and 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. So I wouldn't overly I don't know if this is a bird.

Speaker 2

Contractualize these relationships. These are long term relationships with partners who need us and we want to do our best to serve them. And so there's it'll all get worked out.

Speaker 3

And maybe I'll just add, 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 initiatives. So I wouldn't get too negative on the price cost side As you look into next year. And again, in February when we get together and give you guidance, we'll give you a lot more detail on this.

Speaker 11

Great. Okay. I'll leave it back guys. You cut it lower, Graham. Thanks a lot.

Speaker 3

Thank you. Thank you.

Operator

And there are no further questions at this time. Will now turn the call back over to Ms. Karen Fletcher.

Speaker 1

Okay. Thanks, Tammy. Just want to thank everybody for joining us this morning for our short

Operator

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 Q3 2021
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