Illinois Tool Works Inc (ITW) — Q2 2021 Earnings Call Transcript

Thank you, Adam. Good morning and welcome to ITW’s Second Quarter 2021 Conference Call. I’m joined by our Chairman and CEO, Scott Santi; and our Vice Chairman, Chris O'Herlihy. Senior Vice President and CFO, Michael Larsen is recovering from a sports-related injury and is not able to participate in today’s call. We certainly wish Michael all the best and look forward to seeing him next week. During today’s call, we will discuss ITW’s second quarter financial results and update our guidance for the full year 2021. Slide two 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. So please turn to slide three, and it’s now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

Thank you, Karen, and good morning everyone. In the second quarter, 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%. 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 win and recovery positioning continue to provide world-class service levels to our customers while also executing on our long-term strategy to achieve and sustain ITW's full potential performance. We're certainly encouraged by our organic growth momentum as order intake rates remain strong across the board, and during the second quarter, 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. While there is no doubt that the raw material supply environment is as challenging as we have experienced in a long time, possibly ever in my 38 years at ITW, we are as well positioned as we can be to continue to stand out through our ability to respond to our customers. We worked hard over the last nine years to position ITW to deliver differentiated performance in any environment, and I have no doubt that the ITW team will continue to execute at a high level as we move to the balance of the year and beyond. Now for some more detail on our performance in the second quarter. As I mentioned, organic growth was 37% with strong performance across our seven segments. The two 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 up 20%. GAAP EPS of $2.45 was up 143% and included a one-time tax benefit of $0.35 related to the re-measurement of net deferred tax assets in the U.K. 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 in Q2 of 2019. Operating income increased 99% and incremental margin was 40% at the enterprise level. Operating margin of 24.3% improved 680 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 seven segments ranging from 37% to 48%, inclusive of price cost impact. Speaking of price cost, the price cost headwind to margin percentage in the quarter was 120 basis points. While the pace of raw material cost increases accelerated in the second quarter, our businesses have been active in implementing pricing actions in 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. In Q2, we ended up just short of that goal due to some timing lags, and as a result, the net price cost impact reduced EPS by $0.001 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 million with a conversion of 72% of net income adjusted for the one-time tax benefit I mentioned earlier, and that was due to the additional working capital investments necessary to support our strong organic growth. We continue to expect approximately 100% conversion for the full year. We repurchased $250 million of our shares this quarter as planned, and finally our tax rate in the quarter was 10.1% due to a one-time tax benefit. Excluding this item, our Q2 tax was 23%. Now moving to slide four for an update on price cost. We continue to experience raw material cost increases, particularly in categories such as steel, resins, and chemicals. We 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. For some perspective, this is roughly two times what we experienced in the 2018 inflation Terra Cycle. We learned a lot from that experience, and as a result of the timeliness and pace of our price recovery actions, we 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, the net impact will likely be modestly higher in Q3 versus Q2 before it starts to go the other way. 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 at the end of Q1. That being said, margin benefits from enterprise initiatives and volume leverage will provide us with ample ability to offset the negative effect of price cost and margin percentage and deliver strong overall margin performance for the year. 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.

Thank you, Scott, and good morning everyone. Starting on slide five, the table on the left provided some perspectives on the growth momentum in our businesses when we look at sequential revenue from Q1 to Q2. I 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 excluding auto. Our Q2 revenue excluding auto increased 8% versus Q1. This year Q2 had one more shipping date than Q1, so on an equal day basis, our Q2 versus Q1 revenue growth excluding auto was 6%, which is two times our normal Q2 versus Q1 seasonality of plus 3%. In addition, we added more than $200 million 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 the prior year was most evident in this segment with 84% organic growth. This of course was against easy comparisons 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 million in the quarter. Operating margin of 18.8% 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 long recycle time required to implement price recovery actions in this segment. 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 six for Food Equipment. In Food Equipment, organic revenue rebounded 46% with recovery taking hold across the board and the backlog that is up significantly versus the prior year. North America was up 39% with equipment up 42% and service up 33%. Institutional revenue was up more than 30% with health care 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 Food 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%. Equipment sales were strong 66%, 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 & Measurement and Electronics revenue of $606 million was a Q2 record with organic growth of 29%. Test & Measurement was up 20%, driven by solid recovery in customer CapEx spend and continued strength in semiconductor. Electronics grew 38%, continuing the strength in consumer electronics and automotive applications, with the added benefit in timing of some large equipment orders in Electronic Assembly. Operating margin of 28.1% was up by 240 basis points and a Q2 record. Moving to slide seven, welding 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 first quarter. North America was up 38% and International growth was 13%, primarily driven by recovery in oil and gas. Polymers & Fluids organic growth was 28%, led by our automotive aftermarket business up 33% on robust retail sales. Polymers were 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 of 27.3% with strong volume leverage and enterprise initiatives partially offset by price cost. Moving to slide eight, Construction organic grew 28%, reflecting double-digit growth and recovery in all three regions. North America was up 20% with 16% growth in residential renovation and 26% growth in commercial construction. Europe grew 61% with strong recovery versus easy comparisons in the UK and Continental Europe. Australia and New Zealand organic growth was 13% with continued strength in residential and commercial. Operating margin in the segment of 27.6% was up 390 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 comparisons than the rest of the segment. The majority of our businesses were up double digits, led by appliances up more than 50%. Consumable sales were up 19% and equipment sales up 12%. And with that, I'll turn it back to Scott.

Thanks Chris. Let's move on to slide nine for an update on our full year 2021 guidance. We now expect full year revenue to be in the range of $14.3 billion to $14.6 billion, up 15% at the midpoint versus last year, with organic growth in the range of 11% to 13% and foreign currency translation impact of plus-3%. This is an increase in organic growth of one percentage point at the midpoint versus the updated 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 cost increases. 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 continue to challenge many of our customers in auto and otherwise. We are raising our 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 second quarter. The midpoint of $8.75 represents earnings growth of 32% versus last year and 13% over 2019. Factoring out the one-time Q2 tax side, 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 earlier. We expect margin to be in 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 zero 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. Through the first half, we have repurchased $500 million of our shares and expect to repurchase an additional $500 million 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 our full year tax rate of around 20%. Lastly, today’s guidance excludes any impact from the previously announced acquisition of the MTS Test & Simulation business, which we expect to close later this year. Once that acquisition closes, we’ll provide you with an update. And with that, I'll turn it back over to you, Karen.

Okay, thank you, Scott. Adam, let's open up the lines for questions please.

Best wishes to Michael!

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

Excellent! So Scott or Chris, you mentioned the raw material cost inflation. We know when you said inflation will be as usual better for the year. Do you see the inflationary pressure stabilize enough where you can have a handle on these increases that you sort of put into the guide? So when you look at Q3 and Q4, do you have confidence in your forecast? And then in ‘22 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?

On the first question, I think we're very confident that we will cover whatever increases 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. We’ve looked back over the last few years, and on a quarterly basis, the worst impacts on price costs and inflationary environments have been around $0.01, may be $0.02 one quarter. So I think we're fully comfortable that we will be able to respond to whatever might happen from here and that the EPS impact on the company will be negligible for the full year. But as I said, it’s not based on an assumption that things are going to stabilize from here for sure. I don't think we're seeing enough evidence of that, and normally, I’d predict that things are going to continue to remain forward either. I think it’s a wait and see.

We saw a significant pickup in the case of inflation in Q2, yes.

Guys, maybe I could just ask the question specific to auto in the sense that you know you give us the numbers, you know now 10% for the year. I think this quarter you said 200 basis points to price risk cost. As you know there is always a lag before you can catch up there. So should we assume incremental margin is 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 risk costs in that business?

Well, price versus cost in auto is always going to be challenging given the nature of the industry. I would say in terms of incremental in the second quarter in auto, we had a 47% incremental impact for the first half of the year. So incrementals are strong in auto, no doubt about it, but there is no doubt that the structure of the industry and the structure of the pricing agreements take a lot longer. Hard to say how long it will take for us to catch up there with that.

Thanks guys.

Hi! Good morning.

Good morning.

Maybe you could talk a little bit more about both construction products and Test & Measurement where you said you delivered or you did deliver a record Q2 operating profit footprint. Can you talk about how sustainable those margins are going forward? Was there anything in Q2 mix or anything that we should be aware of that would result in those margins diminishing from here, or are those sustainable at these levels?

Yes, so I would say the construction margins are very sustainable. We’ve been improving via construction for a long time now and certainly for the last few quarters, we've been in the mid to high 20s in terms of margin and construction. So despite the price cost environment, we’re seeing nice organic growth in construction. We are getting nice price realization, and we expect the margins there to be sustainable. Surely in Test and Measurement, margins again are currently in the high 20s here and have been like that for a long time. The segment that we like in terms of level of differentiation, I believe, has our customer problems. So we don’t see any issue with sustaining margins in either Test & Measurement or Construction.

I was 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 seven segments despite the price cost environment. I’ll just circle back to a comment I made, which is there is still room to run in terms of structural margin improvement across the company. We got 150 basis points of enterprise initiative benefit in this quarter. So these are certainly sustainable improvements and performance, and we expect to continue to do better as we go forward.

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

Hey! Good morning, guys. Maybe just following up on the comment about Enterprise Initiatives. You know you're talking about I think 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. Did those slow down for some reason, or is there a chance that you did better than 100 this year?

Yeah, I mean, I think we are saying 100 plus, so we will do better than 100 this year. And there's still a lot of interest in our pricing initiatives around sourcing and in 2020. You know these are all initiatives and activities that are very granular within our segments. Within each division, there is a host of activity that we are working on and 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 better than 100 for sure.

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. You know why not price $4 plus margin, you know why kind of create that headwind?

Well, I don't know. You know the headwind from my perspective is a percentage headwind, it's not an earnings headwind. You know the overall position that we wanted, we’ve created an incredibly profitable economic engine and the most important job we have is to grow it organically. So from the standpoint of – to the extent we don't have to go up as high as other people do, we are leveraging that strong position and we can translate that into incremental share; that’s the preferred option. I don’t want our people fighting over the next incremental. We ought to get the cost for sure, but then let’s get on to talk with our customers about how we can help them improve their business from operational, technical, and sales standpoints.

Fair point, thank you. Take care.

Hey, thanks. Good morning everyone.

Good morning, Jeff.

Good morning. Could we just drill a little bit into the availability issue? We talked about price cost, and obviously it's tied to the availability of supplies, but outside of auto, which is very visible and obvious, are there clear places in your portfolio where either you're struggling to meet demand because of availability in your supply chain, or you're feeling on the customer side, perhaps you can deliver, but they don't want it because they've got problems elsewhere down the line? Just wondering if you could give us some perspective on that, and any color on to what degree if any it may affect the top line here in the quarter or into the balance of the year.

I’ll give you some overall color, and then certainly let Chris give some segment level, sort of business-level specifics if some things come to mind for him. I would say, in terms of overall color, as we talked to our businesses around the world, there's no question that it is a daily battle that we maintain supplier division as we 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-held localized supply relationships with local manufacturing facilities, serving our customers locally. And then the other fact is what I – we talked about in our remarks, the fact that we kept all our people through the pandemic. We have not had to scramble to bring people back. Normally, our supply chain manufacturing operations function in a very simple automated way. It’s definitely taking a lot more effort, but I think we are 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 part that shows up late and there are a couple of other machines that can’t go on just making that out, but that’s a reality. Ultimately given the service level that we are now entering as a standard part of our operating practices, I would say that I’m very comfortable saying that we are working a lot harder than we normally have to, 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 side. I’d point to a couple of things: we are seeing a lot of timing changes in terms of orders and requirements, not because we can't deliver something, but because another supplier might deliver something to a customer. I’d also point to the $200 million of backlog we’ve talked about. You know what we should – basically today is what our customers ordered yesterday, and so we operate with very little backlog. The fact that we built a couple of hundred million dollars of backlog, I can’t analyze every dollar of it, but my contention would be that that's a lot more due to customer delays than to our own ability to supply. We see the $60 million in auto plus the $200 million in backlog, that’s another 10 percentage points of organic growth in the second quarter. I’m not necessarily contending that all of it could have gone, but I do believe that most of it was achievable.

The only thing I would say is just our cost comparisons, I think all over its going to be 18-24, because it creates a lot of the packages for us in terms of a more simplified and streamlined cost offerings. It results in simplification of raw materials and components, and that simplification and focus also extends to our suppliers. The key part of our strategy and it has worked for us for many years is to have these very strong and long-lasting supplier partnerships, and we are a key customer for most of our raw material suppliers. This becomes really, really important when supply chains become constrained and releasing that work to our benefit here in the last 12 months.

Great! And just a second question. Just on the M&A pipeline, obviously you don't have the deal until you've got something to do it now. But you know can you give us a sense of how active your pipeline is? Have you been able to cultivate things, you know maybe handicap the odds of some of the things coming in your strike zone?

Well, I would tell you that we are excited about MPS. We are working hard to get that one finished off, and you know that represents about $50 million of annualized revenue, so that’s certainly enough work to do for a little while anyway. I don’t want to unnecessarily comment on the pipeline as much as to say we remain and will remain very interested in adding high-quality businesses to the company. The timing of all that is always a subject of the quality of what opportunities present themselves. So there’s a lot of stuff going on, but it’s not a matter of how big or small the pipeline is; 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 this on.

Thanks. Good morning everyone.

Good morning Joe.

So I know that, I know you guys guide to organic growth trends, you know really not improving or declining, and that’s your powerhouse, 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, but maybe perhaps the construction business, right, being a little bit seasonally weak during the fourth quarter. How are you thinking about sequential revenue for the segments throughout the rest of the year? We see obviously you've given us the auto guide, but really the other segments?

Yeah, you know I covered that I think overall in my comments, but you know we have sort of camped down the run rate relative to the guidance. You know 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 signal manning forward through the balance of the year because of the supply risks involved, the supply chain risk to our customers, so we’re playing that pretty conservatively. I think that ultimately is going to have more to do with the pace of the organic from here than 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.

Got it. And maybe Scott, just following on that, like is there – you know you had mentioned about involving the Food Equipment business. Are you seeing that as more kind of like a 2022 opportunity given what you're seeing from a supply chain standpoint, or do you expect some of that to convert in the second half?

I'd say some of it is to convert. I think the only one that's probably definitely pushed into 2022 is the one that Chris mentioned, but the rest of the backlog, that $200 million, I would expect that to convert in the back half if our customers can receive it, because they need the other components they require. It just doesn't make sense to raise the revenue guide when everyone is so supply constrained right now. I can't say it any more simply than that, and that's how we see how things play out. It just doesn’t make sense to shift things too far from where they are now in terms of run rate until we see how that all unfolds regarding the supply issues affecting our customers' willingness to take more from us.

Okay, yeah, no, that's helpful. I guess maybe one follow-up on price cost. I know we talked about it a little bit. You did mention that Q3 is expected to get a little bit worse from Q2 because of the pricing actions you put through in Q2. So, I guess I’m just wondering, does this take a little bit of time for those pricing actions to take hold, or why would the headwind get worse in Q3?

Yeah Joe, I mean the only reason it’s getting worse in Q3 is because of the pace of inflation in Q2. We saw a significant pick-up 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 and the known price increases. We see a little worsening in Q3 from Q2 based on the pace of inflation in Q2.

Got it. Okay, great. Thank you both.

Hey! 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 concerned? Is there any sort of double ordering that's happening as customers are worried they can't get stuff?

In terms of the acceleration of organic growth, you know we're seeing it. Obviously, we talked about all our work, it's going in a different way, but certainly in Food Equipment, Test & Measurement, electronics, and welding are certainly growing faster than we expected earlier in the year, so we’re seeing a nice acceleration there. And we have no reason to believe that it's not sustainable based on our conversation with our customers, the order patterns, and so on and you know as we want to talk about the factor – it’s already been busy here in terms of this winged recovery initiative over the last 12 months, and you know it is still kind of early to quantify this. We’re feeling pretty good about how we’re positioned and we – as you know, we're very intentionally remain fully staffed to serve our customers, protect the investments, and given the customer-backed innovation and suite of excellence. Certainly, there’s a lot of anecdotal evidence out there that would say that we are turning into share gains and if I ever just maybe highlight some, get the sort of examples in tech products where we are maintaining service level excellence as Scott talked about and being able to respond in supply where a competitor could not is enabling several share gain and incremental wins from competition in large chains, both in food service and food retail. Another example might be in our automotive aftermarket; staying invested here we will sustain our sales and innovation focus, coupled with high service levels that means we grew as I mentioned in the commentary, automotive aftermarket grew by 33% in the quarter and this is well above customer point sales growth indicating that we are getting share in a meaningful way. And in our measurements and construction in our roofing businesses, in association with 45% in the quarter, again we see it very clearly we're gaining share there on competition who have 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 regaining share and these are just a small selection of illustrative examples of our products that we’re making across our seven segments.

Okay, thank you. Anything on the order intake if you can share with us just what you're seeing, that you saw that by segment.

You know we saw in acceleration the three segments that I mentioned in…

I was just trying to get numbers. You know I mean if you can’t, that’s fine.

Yeah, orders pretty much equalize shipments for last because of what I said; what our customers ordered yesterday is shipped tomorrow. I would say that also is closer to about – I think you used the term double dip ordering in terms of customers trying to hedge orders more because they can’t get supply. I actually 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, and our customers understand orders shipped. So you know some may be certainly ordering more than they would normally, because they are concerned about things, but I think that our service levels wouldn’t contribute significantly to the overall demand picture for us.

Okay, thank you.

Thanks, good morning and best wishes to Michael, hoping he gets a speedy recovery.

Thanks Nigel.

That’s okay. I want to go back to the supply constraint. Where are you kind of most – I thought of automotive which was predictable, but where are you most concerned? I’m thinking about maybe electronics perhaps tools you know with the barriers, but what are you monitoring most closely in terms of, not just for Illinois Tool Works, but for your supply chain, which business or geography are you most concerned?

Yeah, I would say electronics in general have been fairly constrained, so that impacts segments like well in Food Equipment, Test & Measurement, and electronics will be one that I would call out. The supply chain issues have been across the board in terms of steel, resins, chemicals, and electronics, but in terms of supply chain constraints, electronics and certainly steel-related businesses.

But beyond that I don't think there's anything that really concentrates us. You know I think again the input from our businesses indicates it's something different every day, but it’s not a major issue. It takes a lot more work, and it's not even the big dollar stuff. It's again those small brackets, but it is a real challenge right now, significantly more than before.

I'm curious about the two best offices because of the high volume service plan. I don't anticipate it causing a major issue for you, but could you address those two points? Given that changes can occur rapidly, I'm wondering what impact there is from the spot purchases and the three times betting.

Spot purchases, if you can explain that a little more Chris.

I think given another company would purchase them with some hedges…

Yeah, we don’t have that and we don’t forward buy, so everything – the current costs are reflecting through right now, yeah.

And the second part of your question is I think related to freight and logistics, is that correct? So obviously there's no impact for us, but I don’t see a lesser impact than some of our peers maybe based on the premise that the produce what we sell – the produce and so what we sell, the philosophy that we’ve long had that certainly mitigated the impact of freight and logistics on our cost structure and availability.

Thanks guys.

Hey, good morning guys.

Good morning Scott.

Hope Mike feels better. There must be a good story, backstory to the sports injury.

It’s his to tell.

Hopefully he didn’t join some sort of football team or something, you know the over 50 football team. Anyways, I only have one question. It’s just on MTS. When you bring in MTS, how do you – how do you cadence 80/20? You know I mean how do you bring in a deal of this size, kind of bring 80/20 in without really disrupting it? Is there kind of a playbook there you guys can walk through and help us understand?

Yeah, absolutely Scott. So obviously, we’ve completely reinvigorated 80/20 over the last two years with this front to back process, and the fact that we – the process that we will employ on MTS is exactly the same process that we have employed on our 84 divisions across the company. So we can’t really decide on what to do, we can’t really decide on how to do it, and we can’t really decide 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, our folks can guide MTS on the 80/20 journey. We feel very confident in the playbook, we feel very confident in our capability. We think the raw material in MTS are fantastic with respect to 80/20 opportunity; that’s one of the key attractions for us and when we bought it. The other thing I’d say is that we got a very similar business in our portfolio, in Test & Measurements, and we’ve done this successfully before. So we are very confident that we can do this and do this successfully. It's probably a three to five-year process, and part of that is not disrupting the business.

It’s really the pace that makes sense; we are in no rush here.

Okay, super helpful. Good luck! Thank you.

Thank you.

Thank you. Good morning everyone. Going back to your comments on pricing, obviously a lot changed over the past three months. Can you maybe clarify for us what impact pricing had to your adjustment to the overall organic growth guidance?

For the year? Yeah, it's 1%.

Okay, I'm presuming then that.

That was the 1% we added to organic, yeah.

Okay, that's kind of what I figured, but I just wanted to confirm. So you know if this is impacting the back half of the year primarily, then at least presumably you’ll have a couple of points of growth just from pricing in the back half. If I look at the implied guidance, credits, the high-end we are talking about growing something like 7% organically; a couple of points of that is just your incremental price. 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 fixed price, on a core basis.

It’s the former, not the latter, if I understand you correctly. Taking a 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, about as volatile of a situation as I've seen in my career at ITW, and so I don't – I'm not trying 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 are serving the demand we have today really well and running in that regard, our customers are able to sustain, and I think we are comfortable continuing to – our ability to do that will continue in the back half. There is a lot more orders and a lot more demand and that’s again why we built a backlog; there is not a demand question. If we had, we – our customers had sort of unimpaired supply chains right now, we would have probably had 10 more points in the second quarter on this. It’s not a fact, that’s just my opinion. But looking at the backlog, I think demand is certainly much stronger right now given the pace of the recovery; it’s just a matter of all the supply chain issues and the risks for our customers’ pace of being able to – you know what they ultimately need from us. As I said, it’s just hard to justify going up with a lot of confidence from here, but it’s more their supply side than their demand side, if that makes sense.

Yeah, I think it does. The follow-up to all of this is that we're starting to think about 2022, and if we're using your framework for the back half of ‘21 as a starting point and thinking about 2022. It begs the question as to how well growth is likely to look like next year, right, because there’s nothing we can do when pricing normalizes next year, so you won't have the kind of tailwinds you have this year on that.

We are not thinking about ‘22 much yet, but I would just 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 is plenty of business now, and because all of it can't be satisfied, a point of demand now and Chris will give an example of auto. This $60 million we couldn't ship in the auto in the second quarter, that's not going away, that's just getting pushed out. We have dealer inventories at all-time lows; I forget what it was, less than a month, maybe less than a month I think I saw. To the extent, I don't think it's necessarily the worst thing in the world that all this demand that’s there right now can’t be fully serviced, because it’s going to allow us to – again, this recovery duration gets extended by another two to four quarters maybe. We’ll think harder about that as we get to that part of the year.

Okay, that's helpful. Lastly from me, on the topic of M&A, you talked about portions of your business that you consider for divestiture before, and that 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 down the line, maybe 2022?

Yes.

Okay, thank you.

Hi! Good morning. Maybe just a first question.

Good morning.

Maybe just a first question around the free cash flow. I don’t think that’s been touched on yet. You know your inventories and receivables are up each sort of 100 million 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. And also sort of more broadly on the CapEx side of things, you know how much is your CapEx coming up this year and have you revised at all your sort of median-term CapEx planning assumptions because of these constraints?

I think the best way to model our working capital needs is by looking at our months on hand and days sales outstanding. We manage those metrics closely. Usually, our months on hand is about 2.5 months, and while I can't recall the exact days sales outstanding right now, it tends to hover around 60 days. As sales increase, the months on hand won’t necessarily rise, but the total investment will. We mentioned that the months on hand may increase. Similarly, the receivables will reflect changes in days sales outstanding. This process isn't automatic; we don’t need to force it, but as sales rise, our inventory will also increase, which ties back to how the 80/20 principle operates. We need to maintain sufficient inventory to meet customer demand, enabling us to fulfill orders quickly. This is the best insight I can provide on working capital. As for cash flow, when we see significant growth like we did in Q2, our first quarter will require some additional working capital.

Okay, thank you, Scott. We are going to take your last question here.

No, it was just about the capital spending and the rate of spending.

So CapEx, I think the plan for the year was up like $300 million or so. We target $300 million for the year.

$300 million is our target.

Yeah, for the year. So there is no incremental CapEx. 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 we operate with another element of 80/20 as we want to be front-end loaded on capacity; that’s how we serve our customers. So as business continues to go forward, we will continue to invest and stay in that increment ahead of current demand, but that wouldn’t be again something out of the norm of what we always do and it wouldn’t be some big sort of lump coming through.

That’s clear, thank you. And then just a quick follow-up on the auto OEM margins. Is the point that, you know after that step down sequentially in Q2, the sort of 19% level is a good baseline or flow in the current demand and cost environment, and so from here they move up slowly given what's going, but 19% is where they should have bottomed out for now?

Yeah, that’s a fair assumption. But we are seeing a bottom out here, and I think it will be a slow recovery.

You must remember peak margins in auto prior; they were around 23% maybe. There are still a lot of recovery elements to capture in auto from where we were. I’d say low to mid-20s is certainly achievable over time.

Thank you very much.

Sure.

Hey there! 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 usually.

Now you know where the group is.

So, I have like one topic and just two different angles on it. One, 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? You know 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? Thank you.

Yes, so I don’t know about this distraction from consolidation. I can tell you we are not distracted, and we are basically focused on trying to win the recovery here, serve the needs of our customers with innovative new products and so on. Generally, I think we're seeing some real nice recovery in food, faster than we actually thought at the beginning of the year. We are certainly seeing the benefit of staying invested in food. Even obviously on price cost, in fact, there’s some uncertainty, but obviously that relates to the price cost environment, some of these pricing actions here in the second half. In terms of the end markets, we are seeing a nice pickup in institutional, restaurants coming back, 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, we’re still dealing with significantly lockdowns over there, and we’ll probably see that come back a little slower, but at least for the half. We think we’ll 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 and transportation, right, and airlines.

Transportation, for sure.

That’s great. Thank you very much.

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 day!