Illinois Tool Works Q1 2023 Earnings Call Transcript

Presentation

[Operator]

Good morning. My name is Rob, and I'll be your conference operator today. At this time. I would like to welcome everyone to the ITW's First Quarter Earnings Conference Call. [Operator Instructions] Karen. Fletcher, Vice President of Investor Relations, you may begin your conference.

[Karen Fletcher, Vice President of Investor Relations at Illinois Tool Works]

Okay, thank you, Rob. Good morning, and welcome to ITW's First Quarter 2023 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 first-quarter financial results and provide an update on our outlook for the full-year 2023. Slide two is a reminder that this presentation contains forward-looking statements. We refer you to the company's 2022 Form 10-K and subsequent reports filed with the SEC for more detail about important risks that could cause actual results to differ materially from our expectations. This presentation uses certain non-GAAP measures, and a reconciliation of those measures to the most directly comparable GAAP measures is contained in the press release. Please turn to slide three.

And it's now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

[Scott Santi, Chairman and Chief Executive Officer at Illinois Tool Works]

Thank you, Karen. And good morning, everyone. As you saw from our earnings release this morning, we delivered a solid start to the year. With results coming in largely in-line with our expectations heading into the quarter.

Starting with the topline, organic growth was 5% with four of seven segments delivering positive organic growth, led by Food Equipment up 16%, welding of 10%, automotive OEM up 8%, and Test and Measurement and Electronics up 6%. Polymers and Fluids was flat, construction was down 1%, and specialty was down 5%. Operating margin expanded 150 basis-points to 24.2%. With a 100 basis-point contribution from enterprise initiatives. GAAP earnings per share increased 10% to $2.33, which was a new Q1 record for the company. Our free-cash flow conversion rate was 86% of net income, which was in-line to modestly above normal Q1 levels.

Looking ahead at the balance of the year, while there is of course some uncertainty with regard to the macro-environment. I have no doubt that my ITW's colleagues around the world will continue to read, react and execute at a high-level to whatever comes our way. I will now turn the call over to Michael to discuss our Q1 performance in more detail and our updated full-year guidance.

Michael?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Thank you, Scott. And good morning, everyone. ITW delivered another solid quarter operationally and financially. Starting with organic growth of more than 5%. Foreign currency translation headwind and divestitures reduced revenue by 2% and 1% respectively. On the bottom-line, operating income grew 9% with incremental margins of 98%. Operating margin improved 150 basis-points to 24.2%, with enterprise initiatives and price-cost contributing 100 basis-points and 190 basis-points respectively. In addition to higher wages and benefit costs, year-over-year, we're funding our growth investments, including headcount in the areas that support our organic growth strategies and initiatives, and we still delivered 150 basis-points of margin improvement in the quarter. GAAP EPS grew 10% to $2.33, which included foreign currency translation headwind of $0.06 and our Q1 tax-rate was 22.6%. And as Scott said, it was encouraging to see our free cash flow performance return to normal levels. Overall for Q1, excellent operational execution across-the-board and strong financial performance, including record EPS.

Please turn to slide four. Starting with positive organic growth in all of our major geographies, including North-America, which represents about 55% of total revenues and grew 5%, and Europe was up 6%. Asia-Pacific grew 2% despite a 6% decline in China due to COVID related headwinds in Q1.

Moving on to segment results, starting with Automotive OEM and solid organic growth of 8%. North America was up 3% and Europe grew 16%. China was down 5% due to COVID related headwinds in Q1, and we're seeing the expected bounce-back here in Q2. In terms of automotive OEM margins, we are beginning to recover the price-cost margin impact that has diluted margins in this segment by about 450 basis-points over the last two years. As a result, we expect price-cost margin impact to turn positive starting in Q2, which combined with positive volume leverage and contributions from enterprise initiatives will lead to higher margins sequentially and year-over-year starting in Q2 and for the balance of the year.

Turning to slide five. Food equipment delivered another strong quarter with organic growth of 16% as North America led the way with organic growth of 21%. Institutional end-markets were up more than 50%, with particular strength in education and lodging. In addition, restaurants were up more than 30%. International revenue grew 9% with Europe up 11%, and Asia-Pacific was down 6% due to China. Strong progress on margins with Q1 operating margin of 26.7%, an increase of more than 400 basis-points year-over-year.

Test & Measurement and Electronics delivered organic growth of 6%, despite a double-digit slowdown in semiconductor related revenues, which represent about 20% of segment revenue. On the other hand, demand for our capital equipment remained strong as evidenced by Instron, for example, which was up 22%. Overall, Test and Measurement grew 12% organically, Electronics was down 4%.

Moving on to slide six. Welding delivered double-digit organic growth of 10% in Q1 on top of 13% in Q1 last year, as equipment grew 10% and consumables were up 11%. Industrial sales remained strong, with organic growth of 17%, while the commercial side was down 2%. North America grew 10% and international grew 12%, driven by strength in the oil and gas business, which was up 15%. Operating margin expanded 110 basis-points to 31.9%, a new record for the segment and the company. Organic growth in Polymers & Fluids was about flat against a difficult comparison, plus 13% last year. Automotive aftermarket was down 1%, Polymers grew 1%, Fluids was also up 1%. On a geographic basis, North America grew 1% and international declined 2%.

Turning to slide seven, organic revenue and construction was down 1% against a tough comparison of plus 21% last year. Residential construction was down 1% and commercial construction, which represents a little less than 20% of the business in North America was up 5%. Europe was down 9% and Australia, New Zealand was up 3%. Finally, specialty, organic revenue was down 5%, which included three percentage points of headwind from product-line simplification. On a geographic basis, North America was down 4% and international was down 6%.

Okay, let's move to slide eight for an update on our full-year 2023 guidance. And as you saw this morning, we raised GAAP EPS guidance by $0.05 to a new range of $9.45 to $9.85, which considers the lower projected tax-rate for the full-year in the range of 23.5% to 24%. Given the level of macroeconomic uncertainty going-forward, we're essentially holding our operational guidance and adjusted EPS to reflect the lower projected tax-rate. Our organic growth projection of 3% to 5% reflects current levels of demand with some risk adjustment for further slowing in certain end-markets. Combined, foreign currency translation impact at current rates and divestitures are projected to reduce revenue by 1%. Operating margin is projected to expand by more than 100 basis-points at the midpoint of our range, which includes approximately 100 basis-points from enterprise initiatives and positive price-cost margin impact.

Like I said, we're off to a solid start to the year with some positive momentum heading into Q2, and we remain well-positioned to continue to outperform in whatever economic conditions emerge through the balance of 2023.

With that, Karen, I'll turn it back to you.

[Karen Fletcher, Vice President of Investor Relations at Illinois Tool Works]

Okay, thank you, Michael. Rob, let's open up the lines for questions please.

Questions and Answers

[Operator]

Certainly. [Operator Instructions] And your first question comes from the line of Andy Kaplowitz from Citigroup. Your line is open.

[Andy Kaplowitz, Analyst at Smith Barney Citigroup]

Hey, good morning, everyone.

[Scott Santi, Chairman and Chief Executive Officer at Illinois Tool Works]

Good morning, Andy.

[Andy Kaplowitz, Analyst at Smith Barney Citigroup]

Michael, can you give us a little more color into how you're thinking about the company's margins for the year? I know you didn't change your forecast, but margin, as you said, was up 150 basis-points in Q1. I think you guided us to 100 basis-points and you said price versus cost in Q1, I think you said it was 190 points. I know you're thinking about 100 basis-points for the year. So you're thinking that should be materially higher now, especially given your comps return in automotive. So what held you back from not increasing your margin forecast for the year?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Well, I think Q1, Andy, came in right along with our plan, really across the entire income statement and also on free cash flow. So, Q1 margins expanded 150 basis-points. That's typically the low-point for the year. And so, if you go back and look historically, you would expect margins to improve from here in Q2, again, in Q3 and Q4. And based on our current planning, we expect about 100 basis-points of margin improvement year-over-year in each one of the remaining quarters. And actually, across our segments, we are seeing similar trends in terms of margins improving from here.

We are, if you look at kind of the bridge, and we talked about this last quarter as well, we're certainly seeing some positive operating leverage from our organic growth this year. We're seeing about 100 basis-points of contribution from enterprise initiatives. That's well within our own control based on projects and activities that are going on inside the company. We are starting to see price cost margin impact being positive. That really started in Q4. And as you said, another step forward here in Q1. We expect that to remain positive for the remainder of the year. As you know, we've diluted margins about 250 basis-points at the enterprise level over the last two years, and maybe we'll recover about half of that this year. So maybe a little bit more than 100 basis-points from price-cost.

And then, the delta is what we talked about in terms of the investments that we're making to support our organic growth, and including in our people. And so, we're certainly seeing some increases there in terms of wages and benefit increases that everybody else is seeing. So, that's kind of the margin picture for the year. Andy, I hope that answers your question.

[Andy Kaplowitz, Analyst at Smith Barney Citigroup]

Yes, Michael. That's helpful. And then, last quarter you said that 25% of your -- ITW's businesses were slowing, is that still the case? And did those businesses end-up slowing at the run-rate you projected? Maybe better or worse than you projected? And Q1 is a bit higher than you predicted in terms of seasonality, you still thinking, so that 49%, 51% in terms of EPS break-down for the year?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes. I think we're -- if you look at the -- what we talked about last quarter was about 25% of the company's revenues slowing down. And so, just to maybe remind everybody, we're talking about residential construction and we're talking about commercial Welding and the Automotive aftermarket being down here in Q1 and kind of in the low single digits. Our appliance components business and specialty products being down in the high single-digits. And then, semiconductor, we talked about orders coming down, we're now seeing that translate into revenues coming down in that 10 to 15 range, primarily in the Test and Measurement segment. So, Q1 was actually in-line with plan in terms of what we expected. We do expect some further slowing, primarily in these -- this handful of businesses that I mentioned. And what I would just say --

[Scott Santi, Chairman and Chief Executive Officer at Illinois Tool Works]

And that's not new. That's in our plan.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes, that was in our plan and that's included in our guidance and our plan for the rest of the year. I would just say there's a lot of strength in other parts of the company. Obviously, the vast majority of our businesses are still seeing solid demand. We're always going to have some headwind and tailwind and it kind of all nets out to some pretty solid performance, as you saw in Q1 and we'd expect the same for the remainder of the year. I'll just say this, I mean, the environment, obviously is pretty uncertain at this point, things can change pretty quickly, but based on what we know today, we remain really well-positioned to deliver solid performance here in Q2 and for the balance of the year.

[Andy Kaplowitz, Analyst at Smith Barney Citigroup]

Michael, are you still thinking that 49%, 51% split?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes, from a planning standpoint, I think that's still a good assumption and in-line with really what we have done historically.

[Andy Kaplowitz, Analyst at Smith Barney Citigroup]

Thank you.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Thank you.

[Operator]

Your next question comes from the line of Tami Zakaria from JP Morgan, your line is open.

[Tami Zakaria, Analyst at JP Morgan Cazenove]

Hi, good morning. Thank you so much for taking my question. So you mentioned sequentially expect automotive margins to get better from here on. How about sales? Should we also expect the first-quarter sales to be the lowest of the year and then build from here? Or is there some seasonality that we should be modeling?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

I mean there is very little improvement from here on out. I mean, I think it's really the growth rates year-over-year are more driven by the comparisons. So if you look at Q2 of last year was, there was a meaningful decline in or a lower number in auto builds. That's going to be higher this year as we will see some good growth in Q2 on a year-over-year basis, but sequentially you're not going to see a significant -- and certainly not an assumption baked-in here in terms of significant revenue growth sequentially.

[Tami Zakaria, Analyst at JP Morgan Cazenove]

Got it. Thank you so much. I'll pass it on to the next person.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Sure. Thanks, Tammy.

[Operator]

Your next question comes from the line of Jeff Sprague from Vertical Research Partners. Your line is open.

[Jeff Sprague, Analyst at Vertical Research]

Hey, thank you. Good morning, everyone. Maybe two separate topics from me. If you think about the parts of the portfolio that are still resilient and you have visibility, I think one of the uncharacteristic things, maybe you saw in the last year or so is backlog build where you wouldn't typically get backlog build. I just wonder if you could speak to that kind of your forward visibility on some of the things that are a bit later longer-cycle where the backlog's holding, you're starting to burn into them? Any color on orders there would be interesting.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes. I mean, I think, as you point out, Jeff, we're not necessarily a backlog-driven company. And while backlogs have come down a little bit, they're still significantly higher today than kind of pre-COVID levels. So, maybe not running at two times, three times, but at least 50% higher in businesses like Welding and Food Equipment where we're still seeing a fair bit of backlog.

The other thing we talked about, Jeff, obviously, you know this, as supply-chain continues to moderate here in terms of the challenges, we're going to see backlogs come down and that's exactly what we're seeing across the company.

[Jeff Sprague, Analyst at Vertical Research]

And I wonder if you could speak longer-term to auto margins? I think you said kind of 450 basis-point hit from just the price-cost arithmetic and the gain [Phonetic] catch-up there. The margins are down only about 300 basis-points, right, over the last year or so. Are you actually pointing us to kind of higher structural margins in auto on the other side of this? I know we won't get it all in 2023, but are we headed to a higher place than we were a year or two ago in auto margins?

[Scott Santi, Chairman and Chief Executive Officer at Illinois Tool Works]

Yes, I'm not sure, Jeff, the exact comp you're referring to. I think it's safe to say that auto margins, we see a low to mid 20s business over the next two or three years. And it's a combination of great growth prospects there, the fact that all the new programs that we had our margin positive. And in fact, just to put in a plug for our Investor Day in a couple of weeks, we're going to spend some time detailing out sort of the margin path in auto in more substance.

[Jeff Sprague, Analyst at Vertical Research]

Great. That'd be interesting. I'll see you in Boston.

[Operator]

Your next question comes from the line of Scott Davis from Melius. Your line is open.

[Scott Davis, Analyst at Melius Research]

Hey, good morning, Scott, Michael and Karen.

[Karen Fletcher, Vice President of Investor Relations at Illinois Tool Works]

Hey, Scott.

[Scott Davis, Analyst at Melius Research]

I was wondering if you guys could give us a little bit of a window into what's going on in China. I think the April PMI came in a little lighter than what folks were expecting, a back down contraction level, but they should be reopening. And I think January was probably the toughest month you had in the quarter, but you've had a chance, I'm guessing by now to see at least an early look at April. What are you seeing there kind of just from a macro perspective and perhaps into each of the businesses, if that makes sense?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes. I mean, I think we are -- to answer your question, we're seeing a bounce-back here in April, which supports a double-digit growth rate on a year-over-year basis in China here in the second-quarter. We did see here in the first-quarter, as you point out, particularly in January, several of our customers, the automotive OEMs, as well as our restaurant food equipment businesses were slower to open up. So we were definitely down in automotive OEM,I think we said 5%. We were down in Food Equipment. Polymers and Fluids was also down kind of in that 15% to 20% range. And those businesses are all coming back pretty strong here in the second-quarter. You'll see some big build numbers in automotive OEM China. That business could be up significantly or will be up significantly on a year-over-year basis.

Also, the comps are easier here. So we're looking at a 40% to 50% growth rate in the automotive China business. Food Equipment is coming back, Polymers & Fluids, the Welding business. So it all adds up to something Q2 year-over-year up somewhere around 20%, which obviously includes the bounce-back from January, and they're maybe a little bit slower than expected to be opening here in the first-quarter.

[Scott Davis, Analyst at Melius Research]

All right. That's helpful. And I want to go back to Jeff's question, and I don't want to blow up your Investor Day, but feel free to pun [Phonetic], but is the era of price de-escalators or price downs and the auto contracts, is that era over with? And we're -- at least over the next five years, you envision more of a flattish price environment? Or is nothing really changed, and at the end of the day, we're going to be back into that kind of usual down 1%, 2% price dynamic?

[Scott Santi, Chairman and Chief Executive Officer at Illinois Tool Works]

Yes. I think it's more the latter, to be honest here. I think the industry has not really changed in terms of how these contracts are structured, where you get a lot of price upfront. And so, the key there is to continue to innovate and solve problems for customers in ways that nobody else can. And so, as you win new programs and get new content on vehicles, that has to come in at a higher price. But in terms of the structure of price-downs every year, that has not changed at this point.

[Scott Davis, Analyst at Melius Research]

Okay, thank you for the integrity of answer. I'll pass it on.

[Scott Santi, Chairman and Chief Executive Officer at Illinois Tool Works]

Yes. Always.

[Operator]

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

[Joe Ritchie, Analyst at The Goldman Sachs Group]

Thanks. Good morning, guys.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Hi, Joe.

[Joe Ritchie, Analyst at The Goldman Sachs Group]

Hey, can we talk about your position in the Chinese like auto OEM market? There seems to be a real change that's happening there and I'm just curious, how do you think your position is today? Do you need to do anything to kind of help scale the business? Just any thoughts around that would be helpful.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Well, I think as you'll see again at Investor Day, there's been a pretty dramatic shift in that -- in what's been a very successful automotive business in China. The fastest-growing OEMs are our local to local Chinese OEMs, and particularly on the EV side. And so, we'll detail also at the Investor Day some of the investments that we're making to support that growth and make sure that we have enough capacity and resources in terms of our innovation efforts to continue to win in the Chinese automotive business. So, it is a very different business from five, 10 years ago, but still very successful. And frankly, the organic growth prospects there in terms of above-market organic growth are really some of the best inside the company. So, we'll -- Joe, that's -- again, we'll spend a little more time on this at Investor Day, but we're certainly very optimistic on that business.

[Joe Ritchie, Analyst at The Goldman Sachs Group]

That's great to hear. I'm looking forward to learning more about it. I guess the follow-on question, and I know we've talked a little bit about the margin recovery in autos and we'll get more at Investor Day, I'm just curious, though, can you help maybe quantify how much of an impact price-cost was to the margins this quarter on a year-over-year basis? And I know that you're now forecasting for sequential improvement and year-over-year improvement as the year progresses, but how much of a benefit is it expected to be as we progress through the quarters?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes. So, I think, it was a slightly negative price cost margin impact in automotive in Q1. And like I said, we're expecting this to begin to turn positive here in the second-quarter. We are seeing overall deflation on more of the commodities, including resins, nylon and acetyl, those more basic commodities, those prices are coming down. And so, that's part of what's helping us, along with, like we said, new content coming in at higher margins. And so, those combined will lead to the beginning of cost recovery, price cost margin recovery this year. But, as Scott said, this could take two to three years. This takes a little bit longer in automotive OEM than in other parts of the company.

[Scott Santi, Chairman and Chief Executive Officer at Illinois Tool Works]

And I'd just point out, following up on Michael's comments that our auto business still outperforms the peer benchmarks by a margin factor of 2.5 times, the returns on capital we generate are absolutely terrific and right in line with what we do elsewhere in the company. So from a long-term standpoint, these are short-term issues that we'll deal with, but it's not terrible by any stretch, the business still performs really well.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

That's true.

[Joe Ritchie, Analyst at The Goldman Sachs Group]

Great. Thanks, guys.

[Operator]

Your next question comes from the line of Steve Volkmann from Jefferies. Your line is open.

[Steve Volkmann, Analyst at Jefferies Financial Group]

Hey, good morning, everybody. Michael, you sort of answered a small part of my question, but I'll ask the broader one. I'm curious what you're seeing across the company in terms of the cost side specifically? I think you mentioned a few of these commodities down maybe for automotive. Are there any other areas where you're seeing deflation on the cost side? And then, the follow-on is any risk, or how do you plan that going forward relative to your price? Is there any risk that kind of price follows that back down as that goes down? Thanks.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Well, so I think, Steve, we're seeing -- I wouldn't say we're seeing significant deflation at this point. It's just costs are not going up anymore. There's maybe a little bit of deflation, like I said, in kind of the basic commodities that we mentioned. On components, so, assembled parts, machine parts that have labor content, I think the costs are going to be a little stickier there, again, because of the labor component.

In terms of our planning, consistent with how we always do this, our planning assumptions are based on all known cost increases and decreases, as well as the price that we have either implemented or announced. I think we are kind of lapping these more inflation-driven price increases, and we're kind of back to normal price increases.

In terms of will those price increases stick as material costs potentially come down, I think we have only 5% of our revenues roughly is tied to an index. So the vast majority we would expect to certainly be able to maintain our historical price premium. And at the same time, we want to compete and we want to gain market share, which is really the -- one of the big priorities, if not the number one priority of our enterprise strategy, which is strategic share gains to consistently grow organic growth above market. So, that's how I would -- I think we'd frame that.

[Steve Volkmann, Analyst at Jefferies Financial Group]

Great. Okay. Thank you. And then, just a quick follow-up on the construction products. Margins were quite a bit higher than I think some of us were looking for. Anything to call out there that was kind of margin goodness and how that sort of goes going-forward?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes. I mean when you see something really unusual, the answer is usually price cost. So that's another segment that's been hit really hard over the last two years. Actually, a little bit more than the automotive segment from a margin standpoint. And here what you're seeing is we are beginning to recover the margin impact, which is what we talked about is about to start happening in the automotive business. So, that combined to positive price cost combined with a significant contribution from enterprise initiatives, actually above the average of the company, I think they were the highest inside the company at 170 odd basis points of contribution of enterprise initiatives. So, those were the two big drivers in the construction business.

And what's really encouraging is as we look kind of forward, this is not a onetime kind of Q1 impact, we expect to -- based on what the team is telling us to sustain those margins in the high 20s, which is pretty remarkable when you think about where we started pre-enterprise strategy, somewhere around 12%. So, we expect to sustain those high-20 margins certainly in the near-term and medium-term.

[Steve Volkmann, Analyst at Jefferies Financial Group]

All right. I appreciate it. Thanks.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Sure.

[Operator]

Your next question comes from the line of Jamie Cook from Credit Suisse. Your line is open.

[Chigusa Katoku, Analyst at Credit Suisse Group]

This is Chigusa Katoku on for Jamie. Thanks for taking my question. So, on organic growth, you maintain the 3% to 5% guide, but I was just wondering if the outlook by segment adjust [Phonetic] around at all?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

And actually -- so of course, we looked at this. I mean, I think we're very close to what we told you on our last call when we gave guidance for the full year. We are seeing a lot of strength in Automotive, Food Equipment, Test and Measurement, Welding, Construction, maybe a little bit better than what we had planned. But overall, kind of grand scheme of things, we are right in-line with the assumptions that we gave you at the enterprise level, when was that, three months ago, yes, last quarter.

[Chigusa Katoku, Analyst at Credit Suisse Group]

Okay. Great. Thanks. And then, on price cost, so you mentioned that it was 190 basis points positive this quarter. And you remembered, you expect it to be positive for the remainder of the year. But I was wondering how we should think about cadence just because I thought there would probably be some puts and takes with auto just beginning to recover onward?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes. I think 190 basis points from price cost is not -- that's not your normal contribution. So I think we'll have -- based on what we know today, another similar contribution in the second-quarter, and then it will come down in the second half of the year, just as we run into some of the comparisons around price. But like I said, net-net, we -- you would expect somewhere around 100 to 150 basis points for the full year in terms of price-cost margin impact, based on what we know today, which obviously, there's a fair bit of uncertainty in the environment, but based on what we know today, that would be the expectation.

[Chigusa Katoku, Analyst at Credit Suisse Group]

Okay, great. Thank you.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Sure.

[Operator]

Your next question comes from the line of Andrew Obin from Bank of America. Your line is open.

[Sabrina Abrams, Analyst at Bank of America]

Hey, you have Sabrina Abrams on for Andrew Obin. Thanks for taking my questions. I think you guys were talking about seeing further slowing through the rest of the year is embedded in the guidance, particularly in the 25% of businesses that you've already pointed to slowing. Are there other areas of the business that you would flag as maybe the next shoe to drop maybe based on current order activity?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

I'm not sure I understood the first -- you said CA slowing -- what?

[Sabrina Abrams, Analyst at Bank of America]

Just like the 25% of the businesses that you've pointed to slowing and I think you said those would be the -- where you see particularly further slowdown in the rest of the year. I'm just wondering if there's any incremental signs of softness you're seeing in other parts of the portfolio?

[Scott Santi, Chairman and Chief Executive Officer at Illinois Tool Works]

I think that's a simple answer. The other 75% demand rates continue to be very strong.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yeah I think. I think it's mean another way maybe to think about it is that there's a lot of strength in the more. Capital equipment businesses, Food Yes. I think, Sabrina, the way maybe to think about it is there's a lot of strength in the more capital equipment businesses; Food equipment, Test and Measurement, Welding. There's a lot of strength in the automotive business on the top line, which is kind of on its own cycle. And then, the more consumer-oriented, more interest rate sensitive, and then semi is where there is some softness. And we've been calling out that softness really -- if you go back and look, I mean, since last summer, we started to see a slowdown in construction, and it's played out in Q1, at least exactly like we thought it would. And so far, Q2 is off to a pretty good start.

[Sabrina Abrams, Analyst at Bank of America]

Got you. And then, you talked about reinvesting in the business, can you talk about where adding headcount has been more of a focus?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Well, I think it's really across the enterprise. So it's -- we're not favoring one segment over another. Every business, every operating unit inside the company has significant organic growth opportunities in front of them, and they make the decisions in terms of where to allocate headcount or where to add headcount to support -- in support of their organic growth strategies. So there's not really one or two segments that are favored over another one. It's -- every one of our 84 divisions, like I said, have significant organic growth opportunities in front of them and they're going after those by investing in innovation, commercial resources and capacity to support those customers.

[Scott Santi, Chairman and Chief Executive Officer at Illinois Tool Works]

And I'll just add that I can reiterate something you said before, which is in all cases, those investments are self-funded, i.e., margins in every segment will continue to go up.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes. I mean, this is all part of our -- you look at our long-term incremental margins in that 35% to 40% range, that's after making all the investments necessary to take full advantage of the organic growth opportunities that are in front of us.

[Sabrina Abrams, Analyst at Bank of America]

Great. Thanks.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Sure.

[Operator]

Your next question comes from the line of Joe O'Dea from Wells Fargo. Your line is open.

[Joe O'Dea, Analyst at Wells Fargo & Company]

Hi, good morning. Thanks for taking my questions. I wanted to start just on consumables trends and what you're seeing. I think if we look at sort of polymers and specialty products and construction products, those tend to have some of the relatively higher consumables exposure across the businesses. Those are where we've seen some of the softer year-over-year organic trends. And so, is that really just a function of consumer exposure? Or also, any signs of seeing some destocking maybe tied to some of these consumables? And if that is the case, any visibility on what inning we might be in terms of sort of inventory correction?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes. I mean there's certainly some inventory correction going on this quarter. Last quarter, we saw that -- and again, it's not like we're selling directly to the consumer. These are all B2B businesses, but the end market, the end consumer -- or the end customer is a consumer. And those are the ones where we're seeing a little bit more softness, as you said. So I don't know if I have a whole lot more that I can add to that.

[Joe O'Dea, Analyst at Wells Fargo & Company]

Okay. And then, also just wanted to circle back on the earnings cadence over the year and talking about the 49%, 51% split, I mean, it seems like it would actually imply maybe a little bit lower than normal weighting in the second-quarter. Maybe the answer is you're talking about 100 bps, and it's overly nitpicking, but I just want to make sure it's not -- it doesn't sound like you're seeing sort of slowing relative to what you thought earlier in the year, such that we wouldn't see kind of a normal-ish second-quarter?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

No. I think last quarter, we -- on this call, we talked about 49%, 51%. I think it's still kind of in our planning assumption, 49%, 51%. And again, I'll just reiterate, that's based on what we're seeing today. I think there's a fair bit of uncertainty that everybody is dealing with right now, but that's kind of our -- that's our base planning assumption. And like I said, so far, Q2 is off to a good start.

[Joe O'Dea, Analyst at Wells Fargo & Company]

Got it. Thank you.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Sure.

[Operator]

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

[Nigel Coe, Analyst at Wolfe Research]

Thanks, good morning. Thanks for the question. A couple on the ground, but I did want to dig into Food Equipment because that continues to just really outperform quite nicely. So just curious where we are on the post reopening refresh cycle, upgrade cycle? Any thoughts there on sort of the in-store base and share gains, et cetera?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Well, I think we've gained a lot of share in this business based on our ability to service and supply our customers with lead times when others maybe struggled. I think there's really nothing unusual going on in terms of the recovery. The equipment side, we'd say we have largely recovered at this point. And then, on the service side, we're still picking up momentum, maybe an area where we're a little constrained in terms of our ability to take care of everybody on the service side. But overall, we are -- just continue to see some really strong demand trends in this business. This is an area -- we talked about backlog earlier, where the backlog is, two times our normal levels, which gives us a little bit more visibility than what we're normally -- well, what we were used to.

In terms of the end markets, as you know, our business is more focused on the institutional side, and we're seeing a lot of strength there, whether it's healthcare or education or lodging but also restaurants up 30% plus. I think we said this in the prepared remarks. So overall, really a lot of solid momentum here. China was a little softer in Q1 as we talked about, I think that business was down about 20%, and so that's going to come back here in Q2 and for the remainder of the year. But certainly, a business that's performing at a very high level, including on the margin side, it's really encouraging to see the margins back in the high 20s again. So overall, I think a solid quarter and really well positioned for the remainder of the year.

[Nigel Coe, Analyst at Wolfe Research]

No question. And then --

[Scott Santi, Chairman and Chief Executive Officer at Illinois Tool Works]

Just to make another plug for -- sorry, Nigel. I was just going to.

[Nigel Coe, Analyst at Wolfe Research]

No. Please go ahead. Go ahead.

[Scott Santi, Chairman and Chief Executive Officer at Illinois Tool Works]

That we will be featuring Food Equipment as one of the segments at our Investor Day in a couple of weeks, so just to make another plug for that event.

[Nigel Coe, Analyst at Wolfe Research]

That would be great. And then, just my follow-on is just going back to order margins, you've talked about price cost, I understand that. North America was 3% growth, Europe was 17%. Just wondering if there's a mix issue as well that maybe just accentuated that margin to the downside, and when you talk about sequential improvement in order margins in Q2, do you think that continues into the back half of the year, so we have a nice cadence Q-over-Q from here?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

The latter, the answer is yes, that's the current planning assumption that margins continue to improve from here on out in automotive. I think North America, you can't read too much into the quarterly build numbers, but if you look at overall builds were up, I think, about 10% in North America in Q1. But as you know, we are more concentrated with the D3 auto OEMs. So, the builds there were up, I think about 2% in the quarter. So I don't think that has a significant margin impact necessarily. As I think we've talked about before, our margins are pretty comparable across customers, as well as by geography. So not a huge mix issue, if you want.

[Nigel Coe, Analyst at Wolfe Research]

Okay, that's great. Thanks very much.

[Operator]

And our last question comes from the line of Julian Mitchell from Barclays. Your line is open.

[Julian Mitchell, Analyst at Barclays]

Good morning. And thanks for squeezing me in. I just wanted to circle back to the organic sales guide for the year. Because in Q1, I think you did 5%, the year sort of guided at 4%. At the midpoint, the price cost tailwind shrinks through the year, and I'm assuming therefore that the price revenue tailwind does as well. So you're essentially assuming sort of flat volume growth or sort of steady volume growth Q2 to Q4 with Q1, or even an acceleration perhaps. But you've talked about a quarter of the business seeing a slowdown. So maybe help us understand what's the sort of the quarter of the business that's accelerating volume-wise from Q1 to offset the 25% that's slowing more?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes. I think what we talked about, Julian, on the last call was our guide of 3% to 5% organic, we expect that that being organic growth in the first half of the year, being closer to 5%, and the second half closer to 3%, and that's really more of a comp year-over-year phenomenon than anything else. There's no assumption here built in, in terms of things accelerating in the back half. Our typical seasonality is Q1 is kind of the low point from a revenue standpoint. Q2, we see a step up, and then again in Q3 -- and then, Q4 is kind of similar to Q3. So that's -- again, those are the planning assumptions based on what we're able to kind of extrapolate as we sit here today. And I would just add, Julian [Speech Overlap] I would just add, that haven't changed. I mean, I think Q1 came in right along with our expectations. And so, we're kind of still right in line with that full year plan.

[Julian Mitchell, Analyst at Barclays]

And is it fair to assume sort of firm-wide that price tailwind does taper through the year just as the sort of the price cost margin tailwind tapers?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Yes. Maybe with the exception of the one business we talked a lot about today, which is the automotive OEM business, that's just beginning to recover. We do expect that one to pick up here starting in the second quarter, and then again in the second-half of the year.

[Julian Mitchell, Analyst at Barclays]

That's helpful. And then, just my follow-up would be on the Test and Measurement business, where I don't think there's been many questions, but some of the peers like say, Tektronix, or Fortive or something. They were growing 20% plus in Q1. They're guiding to exit the year at flat. Just wondered on the sort of the core Test and Measurement piece, leaving aside Electronics, how you're thinking about the balance of the year in terms of that rate of slowdown?

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Well, I think general industrial demand for Test and Measurement equipment remains really strong. I think I mentioned Instron up 22%, another plug for our Investor Day, MTS, which we'll give you kind of a progress report, was up 14% year-over-year in Q1. So those businesses are even more in line with some of the numbers that you were quoting. And really, the only challenges here are on the semi side, which is only about 20% of the segment. And like we said, those semi revenues are now down in that 10% to 15% range in Q1. We expect some further softness here in Q2 in that part of the business. But overall, I mean, I think organic growth of 6%, margins kind of in the mid-20s after digesting a lower-margin acquisition, and some really good progress in this segment.

[Julian Mitchell, Analyst at Barclays]

That's great. Thank you.

[Michael Larsen, Senior Vice President and Chief Financial Officer at Illinois Tool Works]

Thank you.

[Karen Fletcher, Vice President of Investor Relations at Illinois Tool Works]

So, that wraps things up. I want to thank everybody for joining us this morning. And just a reminder, we look-forward to seeing you at our Investor Day in Boston on May 18.

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

• Karen Fletcher, Vice President of Investor Relations
• Scott Santi, Chairman and Chief Executive Officer
• Michael Larsen, Senior Vice President and Chief Financial Officer

Analysts

• Andy Kaplowitz, Smith Barney Citigroup
• Tami Zakaria, JP Morgan Cazenove
• Jeff Sprague, Vertical Research
• Scott Davis, Melius Research
• Joe Ritchie, The Goldman Sachs Group, Inc.
• Steve Volkmann, Jefferies Financial Group Inc.
• Chigusa Katoku, Credit Suisse Group AG
• Sabrina Abrams, Bank of America Co.
• Joe O'Dea, Wells Fargo & Company
• Nigel Coe, Wolfe Research
• Julian Mitchell, Barclays PLC