Erin Linnihan:

Thank you, Audra. Good morning, and welcome to ITW's second quarter 2024 conference call. Today, I'm joined by our President and CEO, Chris O'Herlihy; and Senior Vice President and CFO, Michael Larsen. During today's call, we will discuss ITW's second quarter financial results and provide an update on our outlook for full year 2024. Slide 2 is a reminder that this presentation contains forward-looking statements. We refer you to the company's 2023 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 3, and it's now my pleasure to turn the call over to our President and CEO, Chris O'Herlihy. Chris?

Michael Larsen:

Thank you, Chris, and good morning, everyone. In Q2, revenue declined 1% with organic revenue down 0.1%, essentially flat year-over-year, and a slight improvement from being down 0.6% in Q1. As Chris said, demand moderated sequentially as total company revenues grew 2% from the first quarter to the second quarter, a point below our historical run rate growth of 3%. Faced with moderating demand, the ITW team, as usual, did a great job in terms of reading and reacting to the environment and delivered record margin and profitability performance in the second quarter, as evidenced by 4.5% operating income growth and operating margins of 26.2%, an improvement of 140 basis points as enterprise initiatives were once again the largest margin and profitability driver contributing 140 basis points this quarter with more to come in the second half. GAAP EPS of $2.54 increased 2% or 5% excluding a 2023 one-time tax item. Our free cash flow was $571 million which was a 75% conversion of net income, slightly below our historical conversion in the 80% range, as we continue to focus on reducing our inventory months on hand to pre-pandemic levels without impacting customer service levels. We repurchased $375 million of our own shares during the quarter as planned, and the effective tax rate was 24.4% compared to 21.4% in the prior year, which lowered EPS by $0.10. In addition, foreign currency translation was approximately a $0.05 headwind year-over-year. In summary, strong execution and Q2 results as the impact of a moderating short cycle demand environment was offset by strong margin and profitability performance. Please turn to Slide 4 for a look at organic growth by geography. The 2% decline in North America was an improvement over the first quarter's 3% decline. Europe grew 1% and Asia Pacific grew 3%, with China up 5%. Moving on to segment results, the Automotive OEM segment delivered flat organic growth in the second quarter against a tough comparison of plus 16% in the year-ago quarter. North America was down 4%, Europe was down 2%, and China was up 7%. In the first half, Automotive Builds were flat, and our Automotive OEM segment grew 2% above market. For the full year, we continue to expect solid above-market growth with our typical penetration gains of 2% to 3% and continued outgrowth in China. In our guidance, we have now factored in the most recent automotive build projections, which have declined to negative 2% for the full year. As you may recall, when we issued our initial guidance in February, Automotive Builds were expected to be flat for the year. On a positive note, the segment delivered strong operating margin performance of 19.4%, a 260 basis points improvement, as we continue to work towards our goal of achieving operating margins in the low to mid-20s by 2026. Turn to Slide 5, Food Equipment organic revenue grew 2.5% against a comparison of plus 7% in the second quarter of last year. Equipment grew 1% and service grew 5% against a comparison of plus 16% last year. By region, North America increased 2% with service up 3%. Organic growth in the institutional market was up mid single digits, and the retail market was up high single digits. International revenue was up 3.5% led by Europe. As we talked about last quarter, the current margin performance reflects the fact that we're making focused capacity investments in the first half of 2024 to support and accelerate continued above-market organic growth in our very attractive service business. Looking forward, we expect margins to continue to improve sequentially as we go through the year. Turning to Test & Measurement and Electronics, organic revenue was down 3% with continued softness in semiconductor, electronics, and CapEx-sensitive end markets. Both Test & Measurement and Electronics were down 3% in the quarter. Moving on to Slide 6, Welding was down 5% in Q2, as Equipment declined 5% and consumables were down 3%. By region, North America declined 6% with industrial sales down 7% and the commercial side down 6%. International grew 3% with some strength in Europe. Operating margin was 32.9% with a solid contribution from enterprise initiatives. Organic revenue in Polymers & Fluids increased 3%, led by Polymers up 10%, and Fluids was up 4%. Automotive aftermarket was down 2% in the quarter. On a geographic basis, North America declined 4% and international grew 13%. Operating margin of 28.2% improved more than 200 basis points. Turn to Slide 7. Demand trends in construction products continue to be challenging on a global basis as organic revenue declined 4% in Q2 in a market that we believe is down in the mid to high single digits. North America was down 2% as the residential and renovation business was down 2% and commercial was down 9%. International markets remain soft as Europe was down 7% and Australia and New Zealand was down 4%. Finally, specialty products had a strong quarter with organic revenue growth of 7% due to significant strength in our aerospace equipment division as well as pockets of increased demand across our portfolio. As a result, international was up 10% and North America was up 5%. As previously discussed, results can be a bit choppy as we continue to work to reposition the Specialty segment for consistent above-market organic growth, including strategic portfolio work and more significant product line simplification, which included 230 basis points in Q2. Operating margin improved 590 basis points to 31.9% with strong contributions from enterprise initiatives and operating leverage. With that, let's move to Slide 8 for an update on our full year 2024 guidance. Despite a challenging first half macro demand environment, the ITW team found a way to deliver solid operational and financial results. And excluding one-time items, we grew operating income 4% in the first half as margins improved by 130 basis points to 25.8% with 140 basis points from enterprise initiatives. GAAP EPS was up 10% -- up 5% excluding one-time items. Looking ahead to the second half in our updated guidance, we do not expect the short cycle demand environment to improve. Per usual process, we are adjusting our full year guidance in line with conditions on the ground as they exist today. Current run rates exiting Q2 adjusted for typical seasonality and the most recent automotive build forecast projected through the remainder of the year would result in approximately flat organic growth for the year in markets that we believe are down in the low single digits. This compares to a prior organic growth guidance of 1% to 3% and impacts EPS by approximately $0.25. The lower top line guidance is partially offset by stronger margin and profitability performance, which is expected to continue into the second half, including a significant contribution of more than 100 basis points from enterprise initiatives. As a result, we raised margin guidance to 26.5% to 27% as we continue to make solid progress towards our goal of 30% operating margin by 2030. The higher margins impact EPS favorably by about $0.10. The net of these two factors, as you saw this morning, is that we lowered the top end of the range of our full-year GAAP EPS guidance to a new range of $10.30 to $10.40, which is a reduction of $0.15 or 1% at the midpoint from $10.50 to $10.35 with 6 months to go in the year. To wrap things up, we delivered a solid Q2 and first half in a challenging demand environment, and we've updated our full year guidance per usual process to reflect current levels of demand. Given the strength of our competitive advantages, the resilience of the ITW business model, and our diversified high-quality portfolio, we're well-positioned for whatever economic conditions emerged through the second half of the year. With that, Erin, I'll turn it back to you.

Operator:

[Operator Instructions] We'll go first to Andy Kaplowitz at Citigroup.

Christopher O'Herlihy:

Good morning.

Andy Kaplowitz:

Good morning. Chris and Michael, you continue to have unusually strong results in specialty products in Q2 after I think you said in Q1 that it was a bit unusual and Q2 would normalize. I know you mentioned aerospace. I don't think I've heard that particular business mentioned before. So could you give us more color on what's going on there and what is the probability that segment could continue to outperform?

Andy Kaplowitz:

Very helpful. And then Chris and Michael, you mentioned that demand continues to moderate in Q2, but could you give us a little more color regarding the cadence of the demand you saw? Has demand stabilized at lower levels across your short cycle businesses, or would you say it's still getting worse? And then with the understanding that you're forecasting the exit rate of Q2, you do have much easier comps in the second half. So just at the enterprise level, are you digging in any conservatism or is it really just on run rates?

Andy Kaplowitz:

Appreciate all the color.

Operator:

We'll move next to Scott Davis at Melius Research.

Michael Larsen:

Good morning.

Scott Davis:

I know I probably asked this in prior quarters, but M&A is, I assume, no change in strategy there, more bolt-ons? Or we have heard of some larger assets that are going to become available, would you guys be comfortable casting a wider net there?

Scott Davis:

Okay. Fair enough, Chris. And then I was just looking back at your investor deck and your growth, your long-term growth targets, 4 to 7, 2 to 3 points of that were coming from customer-backed innovation, and you did mention that in your prepared remarks. But are you still confident that you can drive that kind of growth from customer-backed innovation? It seems like a lot to me, but you guys would have a better feel for that.

Scott Davis:

Okay, thank you, Chris. I'll pass it on, appreciate it.

Operator:

Next, we'll go to Tami Zakaria at JPMorgan.

Christopher O'Herlihy:

Good morning.

Tami Zakaria:

So my first question is -- morning. So, my first question is North America saw negative, I think you said 2% organic growth while other regions are positive. Are you still seeing destocking headwinds in North America or any other region? Or is the market softening now more a function of just demand rather than destocking?

Tami Zakaria:

Got it. That's helpful. And then just a bit clarity on the new operating margin guide. So operating margin expected up about 165 basis points on flattish organic growth. Can you help me understand that 165 basis points, how much of that is enterprise initiatives versus the 140 you saw in the first half? And then is there any price cost or volume or anything else that's adding to that 165 basis points year-over-year?

Tami Zakaria:

Understood. Thank you.

Operator:

We'll go next to Joe Ritchie at Goldman Sachs.

Christopher O'Herlihy:

Good morning, Joe.

Joe Ritchie:

Can we go back to Specialty for a second? You guys talked about the strategic positioning efforts there and when I think about that business, it's a hodgepodge of a bunch of different businesses that seemingly don't have a lot to do with each other. And so I'm just trying to understand like what's the kind of like overall strategy with the businesses within Specialty. And then what are you guys really doing to kind of drive this margin expansion sustainably higher over the long-term?

Joe Ritchie:

Okay, great, Chris. And then maybe just to follow-up to that is, sometimes companies will go through this, addition by subtraction exercise, and it sounds like you guys are in the process of improving the margins. The margins are already good. But it also kind of seems like there's an opportunity then for you guys to potentially divest some of those assets going forward, whether it's in the specialty business or beyond in the rest of your portfolio, how are you guys thinking about that equation in the divestiture side?

Joe Ritchie:

Okay. Thank you.

Julian Mitchell:

Hi, good morning.

Julian Mitchell:

Maybe just a question around the free cash flow conversions, because I think it's sort of 67% in the first half, the year's guided a 100 plus. Doesn't seem like there should be a lot of working cap liquidation in the second half because the quarterly revenue run rate is kind of stable at $4 billion. So maybe just to flesh out the confidence in the cash conversion step up, please.

Julian Mitchell:

That's helpful. Thank you. And then just my second question would be around the sort of, it looks like the second half run rate on the total company sales and margins, very similar to Q2, as you normally guide, with sort of 26% margin, $4 billion revenue a quarter. You mentioned, Michael, the day sales effect in Q3, Q4, but just wondered, anything else in terms of seasonality for total company you'd remind us of for the third versus the fourth quarter? Any big moving parts on the segment margin as we step into the back half? I think Specialty, you've talked about Polymer & Fluid, I'm also curious about the margin outlook there, please.

Julian Mitchell:

Great. Thank you.

Operator:

And we'll take our final question from Walt Liptak at Seaport Research.

Christopher O'Herlihy:

Well, yes, I think, Walt, June was -- things continued to moderate, particularly Auto Builds were softer in June. And then on the CapEx side, Welding, I think consistent with commentary you may have heard from some of our peers in the welding space. And then Test & Measurement, I think while we have not seen a pickup in semiconductor or electronics or CapEx, I would say semi also has not gotten worse. So it's kind of bumping along. And I would just add that we remain like really well-positioned for the inevitable recovery down the road. And I think if you look at, some of the segments with positive organic growth here in Q2, so you look at Specialty, you look at Polymers & Fluids, the operating leverage that we generate of fairly modest organic growth is pretty remarkable. So we're really well-positioned for that. We continue to invest, a lot of focus on new products, but we've not seen a pickup in those markets yet. But again, really well-positioned for the inevitable recovery down the road here, whenever that may happen.

Christopher O'Herlihy:

Yes, I mean, I think the retail growth similar to in the first quarter, I think up 9% here in the second quarter, and it's all driven by new products. So this is all way and wrap equipment and new product rollouts. And I'd say our customer base is not part of the population that you may be alluding to that's having trouble financially. I mean, these are all the big grocery store, retailers, chains that you would expect. And so we're not seeing any impact there from them being in trouble financially. Quite on -- quite the contrary.

Christopher O'Herlihy:

All right, thank you.

Christopher O'Herlihy:

Thank you, Erin, and good morning everyone. While the near-term demand environment across the majority of our segments was certainly challenging as we anticipated, the ITW team delivered a solid start to the year as our first quarter results came in as expected. And we remain solidly on track to deliver on our 2024 performance targets.

Michael Larsen:

Thank you, Chris, and good morning, everyone. In Q1, we delivered a solid start to the year with some high-quality execution in a pretty challenging demand environment as expected.

Michael Larsen:

Thank you, Karen. And with that, Erin, I'll turn it back to you.

Operator:

[Operator Instructions] Your first question comes from Jamie Cook from Truist Securities.

Karen Fletcher:

Thank you, Jamie.

Jamie Cook:

I know, but that's every quarter, so I get...

Christopher O'Herlihy:

No. I would just, I guess, accentuate the point of differentiation aspect of the service business within food with unique captive manufacturer. And this is a necessary investment at this point to capitalize on what is an undoubtedly stellar growth opportunity on the service side for us.

Karen Fletcher:

Thanks, Jamie.

Tami Zakaria:

First off to Karen, I'll definitely miss you, but I wish you all the best of luck. And welcome aboard, Erin. Looking forward to working with you.

Tami Zakaria:

Of course. So my first question is, just wanted to get a little color here. I think you expect organic growth to be positive throughout the balance of the year. Does that mean you expect 2Q organic growth to be within that full year range of 1% to 3% growth?

Operator:

Your next question comes from Steve Volkmann with Jefferies.

Karen Fletcher:

Thank you.

Michael Larsen:

Yes. I think as you pointed out, Steve, the big driver is obviously our Automotive OEM business, up 23%. And the team there is doing a great job growing content on new vehicles, including on the EV side, and gaining market share. Even excluding those, as I said, China was still up 7% year-over-year.

Michael Larsen:

Yes. I mean, I think, I wouldn't expect a lot of regression from where we are. These are absolutely sustainable here in the 19%-plus range. And I think that's probably where we'll end up for the year, maybe a little bit better in the back half. Some of that depends on the build assumptions. There might be a little bit of restructuring here in the second quarter. But big picture, I'd say, Automotive, really solid progress here on a year-over-year basis. We expect full year margins in the 19%, almost 20% range, an improvement of 240 basis points on a year-over-year basis, and lots of room to go as we work through our margin enhancement plan.

Michael Larsen:

Yes. So nothing unusual in terms of the margins in Q1, and sustainable, but lots of room for improvement from here.

Andrew Kaplowitz:

Karen, congratulations. We'll miss you.

Andrew Kaplowitz:

So Michael, probably, I'm guessing you don't want to reset your organic growth guides for your segments every quarter, but just higher level, you had Construction, Specialty forecast to be down, I think 1 of 3, while the other segments were projected to be up between 2 and 4 and 3 and 5. Specialty was actually much better. Has that changed the segment's outlook at all? I know you talked about a little bit of a pull forward in some equipment orders. And were any of the other segments like weaker than you thought, to start?

Michael Larsen:

Yes. I think the big driver here is really the comparisons year-over-year. That's driving the growth rates as we go forward. And so just like I said, for the total company, for Welding, it's also true that as we go through the year, these comparisons get easier. 10% growth in Welding in the first quarter last year is obviously not a sustainable growth rate. And so it wasn't really a big surprise that organic revenue was down 3%.

Operator:

Your next question comes from Andrew Obin with Bank of America.

Karen Fletcher:

Thanks, Sabrina.

Michael Larsen:

Yes. I think there's not a lot of change from what we talked about on the last call. We are maintaining our operational guidance here kind of big picture at 1% to 3% organic growth. There is some positive operating leverage. We expect slightly more than 100 basis points of enterprise initiatives, which is based on the strong performance here in Q1 at 140 basis points.

Michael Larsen:

Well, so I think it's a little bit of a mixed picture there. I think last year, we talked a lot about the challenges in the semi-related businesses. Last year, those were down order of magnitude 20% to 25%. Now -- we're talking about just to kind of size things. These businesses represent about 15% of the Test & Measurement and Electronics segment, 3% of total ITW revenues. So just to kind of put things in context.

Mircea Dobre:

And I'll join the chorus here. Karen, all the best in retirement and really appreciate all the help over these years.

Mircea Dobre:

One question I had was about EMEA, which frankly came in a little bit better than I would have guessed. I guess one of the themes during this earnings season has been that Europe, frankly, has not been that great. So I'm kind of curious what you're seeing there? Is it just a function of the Specialty kind of onetime items that might have helped Europe in the quarter? Or is there kind of more green shoots to talk about in Europe?

Michael Larsen:

Yes. I think overall, actually, if you think about Construction, the performance in North America I think is a good example of illustration of how the business is outperforming in a very challenging down market. Only to be down 3% in a market that, if you look at all the key metrics, is certainly down a lot more than that is pretty impressive. Residential/remodel, we said down 1%. I mean the home centers are actually down a little bit more than that.

Operator:

Your next question comes from Julian Mitchell with Barclays.

Michael Larsen:

The short answer is yes. And I think one of the reasons, as I said in the prepared remarks that Test & Measurement margins were down in the first quarter is really the strong performance of the MTS business, which grew at 20% plus organic, which is certainly great performance. But due to the fact that we're only 2 years in, in terms of implementing the ITW business model, margins are in the mid-teens in that business. And so there's a negative mix effect that diluted the margins in Test & Measurement by about 250 basis points.

Christopher O'Herlihy:

Yes. In Test & Measurement and Electronics, I would just add that there's an extremely fertile environment for innovation, which will underpin margin progression going forward in that segment.

Matthew Pan:

Got it. And just a quick follow-up. The free cash flow was down year-over-year in Q1. Is that just a working capital build? And then what are your thoughts on Q2? Is that up year-over-year?

Operator:

That concludes our question-and-answer session. And with that, that does conclude today's conference call. Thank you for your participation, and you may now disconnect.

Karen Fletcher:

Thank you, Eric. Good morning, and welcome to ITW's fourth quarter 2023 conference call. I'm joined by our President and CEO, Chris O'Herlihy; and Senior Vice President and CFO, Michael Larsen. Also with us today is Erin Linnihan who joined our Investor Relations team last month as Vice President. Erin, welcome to ITW. During today's call, we'll discuss ITW's fourth quarter and full-year 2023 financial results and provide guidance for full-year 2024. Slide 2 is a reminder that this presentation contains forward-looking statements. Please refer 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 3, and it's now my pleasure to turn the call over to our President and CEO, Chris O'Herlihy.

Michael Larsen:

Thank you, Chris, and good morning, everyone. In Q4, the ITW team delivered a solid finish operationally and financially to a strong year for the company. Starting with the topline, the soft market demand for CapEx that we talked about on our Q3 earnings call continued into the fourth quarter. In addition, customer and channel inventory reductions and the automotive industry strike reduced our organic growth rate by approximately 1.5%, resulting in essentially Fed revenue and organic growth on a year-over-year basis. That said, we finished the year with stable to slightly improving demand on a sales per day basis, as evidenced by sequential revenue growth of plus 2.5% from Q3 into Q4 compared to our historical sequential growth of plus 1.5%. Foreign currency translation added 1.2% to revenue and divestitures reduced revenue by 0.4%. GAAP EPS was $2.38 and included $0.04 impact from the devaluation of the Argentine currency. On the bottom line, operating income was a Q4 record of $988 million and operating margin was flat year-over-year as enterprise initiatives of 150 basis points and 60 basis points of price, cost, margin benefit, net of year-over-year inventory revaluations were offset by a combination of growth investments including headcount ads, higher employee-related costs, such as wages and benefits, as well as increased restructuring expenses year-over-year. Free cash flow grew 39% to a fourth quarter record of 908 million with a conversion to net income of 127%. Overall for Q4, solid operational execution and financial performance in a pretty challenging environment. Please turn to Slide 4, starting with one of the highlights for Q4 and the year. Our free cash flow performance on the left side of the page. And as you can see, our full-year free cash flow was up more than a $1 billion to a record $3.1 billion as our inventory months on hand metric continued its slide path to pre-COVID levels. Now let's move to the segment results starting with automotive OEM, which led the way with organic growth of 8%, despite North America being down 9% due to the impact of the automotive strike. Meanwhile, Europe's organic growth rate was plus 11%, and China was up 31% driven by strong market share and penetration gains in the rapidly growing EV market. Operating margin was 19.2% excluding 160 basis points of headwind from higher 80/20 front-to-back restructuring expenses as the automotive OEM team continues to work toward its margin goal in the low to mid-20s over the next two to three years as outlined at our Investor Day. Looking forward, we expect automotive OEM to grow 3% to 5% in 2024, based on an assumption of essentially flat global auto bills year-over-year, plus our typical penetration gains of 2% to 3% and continued above market organic growth in China. Turn to Slide 5. Food equipment delivered organic growth of 3% against a tough comparison of plus 17% in Q4 last year. Equipment grew 1% and service was very strong, up 7% for the quarter. By region, North America grew 4% with institutional end markets up in the mid-teens, retail up mid-single digits and restaurants down in the high-single digits. Europe and Asia Pacific both grew 1%. Test and measurement and electronics, organic revenue was down 1% due to continued softness in semiconductor-related end markets. While test and measurement grew 5%, electronics declined 14%. Moving on to Slide 6. Slower demand in welding resulted in an organic revenue decline of 7%. Equipment was down 8% and consumables were down 6%. Industrial sales declined 11% versus a tough comparison of plus 23%. Commercial was down 2% and oil and gas was down 3%. Overall, North America was down 7% and international was down 6%. Polymers & Fluids, organic revenue declined 2% with our automotive aftermarket down 3%, Polymers grew 6% and Fluids was down 7%. Operating margin expanded 270 basis points to an all-time high of 28.5% for the segment. Turning to Slide 7. In a tough housing market, construction products, organic revenue declined 4% as North America was essentially flat with residential renovation flat and commercial construction up 3%. International markets have been soft all year and in the fourth quarter, Europe was down 9% and Australia, New Zealand was down 5%. Specialty products, organic revenue was down 5% as North America was down 6% and international declined 5%. Consumables were down 10% and equipment revenue grew 8%. Moving to Slide 8 and full-year 2023 results. And as Chris said, throughout the year, our colleagues around the world did an exceptional job of delivering for our customers and responding decisively to a challenging and volatile market demand environment. As a result of their efforts, ITW delivered record financial performance in 2023 with solid organic growth of 2% on top of 12% growth in both 2021 and 2022. Best-in-class margins of more than 25% and after-tax return on invested capital of more than 30%. And we delivered these results while continuing to fully fund projects to accelerate above market organic growth and sustain productivity in our highly profitable core businesses. We raised our dividend 7% and return more than $3 billion of shareholders in the form of dividends and share repurchases. Let's move to Slide 9 and our guidance for full-year 2024. And looking ahead, we definitely see some positives in terms of moderating headwinds in the external environment from supply chain, input cost inflation, and customer channel partner inventory reductions. But there are certainly some challenges, including lower automotive bills that I talked about earlier for example. For our usual process, our topline guidance of revenue growth of 2% to 4%, an organic growth of 1% to 3% is based on current levels of demand adjusted for typical seasonality and incorporate current foreign exchange rates. Operating margin is expected to improve by about a 100 basis points to a range of 25.5% to 26.5%, which includes a 100 basis points contribution from our enterprise initiatives. After-tax return on invested capital is expected to remain firmly at 30% plus, and we expect strong free cash flows again with conversion greater than net income. For 2024, we are projecting GAAP EPS in the range of $10 to $10.40, which includes headwinds of about $0.10 of higher interest expense and $0.20 of higher income tax expense with an expected tax rate in the range of 24% to 24.5%. In terms of cadence for the year, we expect our typical first half, second half EPS split of 49% and 51%. Our capital allocation plans for 2024 are consistent with our longstanding disciplined capital allocation framework that we discussed at last year's Investor Day. Our top priority remains internal investments to support the organic growth initiatives associated with the next phase of the enterprise strategy and sustained productivity in our highly profitable core businesses. Second priority is an attractive dividend that grows in line with earnings over time, which remains a critical component of ITW's total shareholder return model. Third, selective high quality acquisitions that enhance ITW's long-term profitable growth potential, have significant margin improvement opportunity from the application of our proprietary and powerful 80/20 front to back methodology and can generate acceptable risk adjusted returns on our shareholders' capital. And finally, ITW's surplus capital is allocated to an active share repurchase program as we plan to buy back $1.5 billion of our own shares in 2024. Turn to our last slide, Slide 10 for our 2024 organic growth projections by segment. And as you can see, five of seven segments combined are projecting organic growth of approximately 4% at the midpoint, partially offset by some unique challenges in construction and specialty products. These segment projections are the outcome of the bottom up planning process that we completed in January, and a combination of several factors including current levels of demand, deep underground market and customer insights from our divisions, market share gain expectations, and the growing contribution from our customer-back innovation efforts and the associated new product launches in every one of our divisions. Consistent with ITWs continuous improvement, never satisfied mindset, every segment is projecting to improve their operating margin performance again in 2024 with another solid contribution from enterprise initiatives across the Board. So overall, we are heading into the first year of our next phase enterprise strategy, well positioned to continue to outperform in whatever economic conditions emerge as we move through 2024. With that, Karen, I'll turn it back to you.

Operator:

[Operator Instructions] Your first question comes from the line of Tami Zakaria with JPMorgan. Your line is open.

Michael Larsen:

Well, I think, you'll see improvement in the year-over-year organic growth rates as the comparisons get easier as we move through the year. But by and large, the projections here track kind of typical seasonality from Q4 into Q1 and so forth. So there's really nothing unusual there. The other thing to keep in mind is while the guidance at the enterprise level is essentially based on current run rates as we talked about. It's a much more granular projection at the segment level, which includes also significant contribution again from new products as well as our normal pricing less drag from the inventory reduction that we've been talking about really all year. And so really give a better kind of number as we look at the segments. So that's how I would think about it.

Michael Larsen:

Yes. I think Tami, we've got fairly modest kind of revenue growth that we're calling for here, 1% to 3%. And our incremental margins embedded in the guidance are higher than our typical long-term 35% to 40%, which is what I would still use in terms of long-term modeling. The reason why is a 100 basis points contribution from enterprise initiatives that give us a higher incremental margin in 2024. As part of our planning process that I just described, we've now had a chance to go through all the projects and activities that contribute to a 100 basis points of enterprise initiatives, again in 2024. And I might add, these are largely independent of volume. So regardless of what volume does, we're seeing another significant contribution here, which is certainly a nice thing to have in your hip pocket in what we would describe still as a fairly uncertain and volatile environment.

Michael Larsen:

Sure.

Stephen Volkmann:

Great. Good morning, everybody. I actually wanted to ask – excuse me – I wanted to ask the margin question a little bit differently, Michael, because if you have a 100 basis points from enterprise, and that's kind of the total that we're looking for, I suppose there must be some offsets in maybe some other costs or something because we're not really getting underlying incrementals. We're sort of getting it all from the enterprise initiatives, if you follow me. So just any detail on that would be great.

Stephen Volkmann:

Super. Okay. Thanks for filling that in. And then maybe if I could just follow-up, the food guide, the bottoms up food sort of outlook of 3% to 5% seems like a bit of an acceleration from sort of recent trends, and we don't have super easy comps, I don't think. So what are you seeing in that end market?

Stephen Volkmann:

Understood. Thank you.

Andrew Kaplowitz:

Good morning, everyone.

Andrew Kaplowitz:

Michael, when we look at your 1% to 3% organic growth forecast for 2024, you have a nice acceleration dialed into for your CapEx businesses such as welding and T&M. You're saying you're basing your guidance and current run rates. So you obviously did mention some improvement in sequential demand in Q4. Could you give us more color on what you're seeing in these CapEx businesses that's allowing you to forecast what you're forecasting? I would imagine you're dialing an improvements in semicon and electronics, for instance, in T&M, but that goes into now what you usually do. I'm just curious as to what's flushing out.

Andrew Kaplowitz:

Very helpful color, Michael. And then Chris or Michael, you mentioned unique challenges in specialty equipment and construction products. Maybe you could elaborate on what you're seeing in these segments. Doing more PLS in specialty, for example, what's the outlook or frame the outlook for 2024?

Andrew Kaplowitz:

Helpful, guys. Thank you.

Operator:

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

Christopher O'Herlihy:

Good morning. Yes.

Michael Larsen:

Yes. I mean, I think the tone from customers has been pretty cautious all year, particularly on the CapEx side of things as we talked about. If you go back to our Investor Day last year, we talked a lot about accelerating our efforts to drive high quality above market organic growth primarily fueled by, as Chris said earlier, our customer-back innovation efforts. And so those are the areas, all growth related headcount ads that we're making to make sure that we have all the capability we need in terms of innovation, commercial, sales and marketing resources to drive continued progress and deliver on our above market organic growth commitments.

Michael Larsen:

Yes. I think by and large, if you go back historically, we haven't had great visibility to the levels of inventory in the channel and with our customers. I think we have much better visibility today, given that we've been talking about it all year. Overall, it's been a drag of a percentage point on our growth rate for the year. It was 1.5% in Q3, 1% in Q4, and I think several of our segments, we are back to kind of normal inventory levels and this is largely behind us. And then there's maybe a few other areas where there might be some continued, but certainly less headwind as we go into Q1 and Q2. And then I think at that point, we'll give you an update. I think we'll be able to say this is now completely behind us.

Michael Larsen:

Well, there's a little bit. I mean, obviously if you look at our run rates, it is included in our run rates at a higher level than what we might reasonably expect. So if that plays out the way we expect, that would be certainly favorable to the run rate and to the guidance that we just gave you.

Operator:

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

Michael Larsen:

Hey, Sabrina.

Michael Larsen:

Well, I think, Sabrina, we've talked about this before, we want to maintain our price premium based on the quality and the customer service, the lead times that ITW is uniquely positioned to provide, but we also want to compete and we want to gain market share. That's kind of central to our overall enterprise strategy and the focus I just talked about around organic growth. So that's said, I think we expect a normal contribution from price here in 2024. These inflation-driven price increases are now behind us. Input cost inflation, that big wave we've been dealing with, as we sit here today, we'd say is largely behind us. And so we're entering into a normal pricing environment across the portfolio. I think that is a fair statement. If you just look at, we've now essentially recovered the margin impact from that price costs, the price cost dynamics, and we're entering into a normal environment in 2024.

Christopher O'Herlihy:

Well, I think welding, so we're not counting on a market acceleration, just to be clear. This is if you look at in a normal market environment, just assume for a minute, let's assume the market is flat. The contribution from new products and normal price very quickly gets you to something in the low-single digits. So I just want to be clear around that. The other thing I'd say, just on the margins. We talked a little about the year-over-year inventory revaluations. That's what caused the margins to drop in the fourth quarter, below 30%. And we expect that to be back above 30% here in the first quarter as that one-time kind of year-over-year inventory impact is behind us. So we would expect margins to kind of remain in that 30% plus as we go through 2024. And as I said earlier, that's not unusual. Every one of our segments told us as part of this bottom up planning process that they are on target to improve their operating margin performance in 2024.

Christopher O'Herlihy:

Yes. Thank you.

Steven Fisher:

Well, thanks. Good morning.

Steven Fisher:

This has been asked in a few ways about the segments, but really just trying to think about the 1% to 3% organic growth in the context of your sort of 4% to 7% CAGR through 2030. I guess what's the buildup of market growth and price versus market penetration and customer-back innovation? I know again, there's lots of different segment dynamics here, but when you roll it all up, are you basically assuming that it is kind of like flat markets and a couple of points of penetration and innovation. Is that the way to think about it?

Steven Fisher:

That's really helpful. And just to follow-up, sort of the macro level of the pace of economic growth seems to be diverging between Europe and North America increasingly. So can you just give us a sense of what you've factored in on the European economy and how you're thinking about that? I know you talked about the construction side, and I guess similarly on China, how are you thinking about China in 2024 sort of a net positive for you, I think in 2023, maybe different for some other companies. So how are you thinking about that in 2024?

Steven Fisher:

Really helpful. Thank you so much.

Operator:

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

Christopher O'Herlihy:

Good morning.

Michael Larsen:

I'd say it's about the same, Julian. I mean, I think we – as Chris said, we just delivered 2% organic growth in 2023 in a pretty challenging environment as we talked about. And that included a point of inventory reduction impact. And I might add a point of drag from semi since it came up earlier. So if those two don't repeat, which is what we're saying, then you go from 2% to 4% pretty quickly. And we're not saying that destocking continues at the same level in the first half, which I think is what you said. We do expect it to be less of a drag in the first half. We also said the comps year-over-year are certainly more challenging in the first half than they are in the second half. So I think we're confident because when we look at everything going on inside the company and this focus on driving above market organic growth, a big focus on customer-back innovation, we look at the pipeline and new products that are being launched in every one of our divisions across the company. We look at a kind of a normal pricing environment. We feel pretty confident based on what we're seeing, as we sit here today. Now, we also said this is a pretty uncertain and volatile environment, things can change quickly. And so the thing that we have a lot of confidence is our ability to continue to read and react to whatever conditions our divisions are dealing with on the ground and deliver strong performance as we go through 2024. So we're not economists. We're not trying to forecast where the global economy is going. We're kind of basing our guidance on all the things we just talked about. And that's how we end up in that 1% to 3% range for 2024, which to us doesn't seem like a moonshot based on everything we just talked about.

Michael Larsen:

Yes. Price cost, I think we're kind of in a normal environment for 2024. It's not going to be a material driver of our performance. It'll be a modest contribution to margins and EPS in 2024 based on everything that we know today from a pricing and inflation standpoint. In terms of the investments, I think, our investments grow in line with our sales over time, and that's true both for customer-back innovation, it's also true for our capacity CapEx improvements that – that are all of these investments, about $800 million in 2024 are geared and centered around driving above market organic growth in every one of our divisions. And the biggest headwind, I think to margins this year was not so much the investments necessarily not just in growth, but we saw inflation in our employee-related costs just like everybody else including wages and benefits. And we expect that part of the equation to moderate here in 2024 based on some of the actions we're taking to manage those costs in 2024. So that's not going to be an increased headwind as we go forward.

Michael Larsen:

Sure.

Mircea Dobre:

Thank you for taking our question. Good morning.

Mircea Dobre:

On the topic of outgrowth, it sounds like you're seeing about 2% this year. You're aiming for maybe 3 percentage points. I guess what I'm curious, when you're looking at your portfolio, presumably we don't have this outgrowth notion being sort of evenly distributed, what portions of your portfolio are generating outgrowth at the pace that you need it to be? And where else do we need to see further investment or further adjustments needed to be made?

Michael Larsen:

I would just add to that, Mig. We've talked a lot about the individual segments today. I think you got to look at ITW as the beneficiary of a highly diversified, high quality portfolio. All of our segments with margins in the high-20s, we're working through automotive, and so you're always going to have some puts and takes, which is what we're talking about. But this portfolio really gives us a level of resilience and a real competitive advantage relative to others, and puts us in a great position to perform, continue to perform at a high level in any type of demand environment over the long-term. Now, we never said that we were going to be the fastest grower. There's always going to be certain end market trends, whether it be aerospace or electrification or whatever it maybe. But you put this portfolio together in its totality. We have all the firepower that we need to deliver a 4% plus average annual organic growth as we go forward. And by the way, five of our segments are doing that, as we said earlier in 2024. So I wouldn't lose sight of the fact that, we're a business model centric company and a huge beneficiary of this high quality diversified portfolio.

Christopher O'Herlihy:

Yes. Sure, Mig. So effectively, we are very much sticking to our disciplined portfolio management strategy, which is very consistent in terms of – we are certainly interested in high quality acquisitions where we can find them that extend our long-term growth potential to grow at a minimum 4% plus at high quality. That's the primary kind of lens, we look at acquisitions. We've been able to leverage the business model to improve margins. And so we certainly review opportunities on an ongoing basis, but we're pretty selective here about acquisitions, given the fact that we believe we've got a lot of organic growth potential that we're going to execute on here over the next few years. If I think about MTS as an example of the typical – attractive candidate, we look at and ticked all the boxes in terms of strategic attraction, in terms of differentiation, solving customer pain points, opportunity to leverage the business model to improve margins. And having owned that business now for just over two years because we stuck to the characteristics that we believe in with respect to acquisitions. This is an acquisition that's turning on to be a home run and will be a great ITW business in the long-term. So it's a real blueprint for how we think about acquisitions and how we'd be thinking about acquisitions going forward.

Christopher O'Herlihy:

Sure.

Karen Fletcher:

Okay. Thanks, Krista. Good morning, and welcome to ITW's third quarter 2023 conference call. I'm joined by our Chairman and CEO, Scott Santi; Vice Chairman, Chris O'Herlihy; and Senior Vice President and CFO, Michael Larsen. During today’s call, we’ll discuss ITW’s third quarter financial results and provide an update on our full year 2023 outlook. Slide 2 is a reminder that this presentation contains forward-looking statements. Please refer 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 3, and it’s now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

Christopher O'Herlihy:

Thank you, Scott, and good morning, everyone. First, I want to thank Scott and our Board of Directors for their trust and confidence in electing me as ITW's next CEO. I'm incredibly humbled by the opportunity to lead this great company, our exceptionally talented leadership team and our 46,000 dedicated colleagues around the world. As Scott said, as a result of the work done over the last 11 years in executing our enterprise strategy to leverage the ITW business model to its full potential, our company has never performed better or been better positioned for the future. The central focus of the next phase of our enterprise strategy is to elevate high quality organic growth and customer back innovation as key ITW differentiators on par with our best-in-class operational capabilities and financial performance. Our leadership team and I are deeply committed to doing just that in delivering on ITW's 2030 Enterprise Performance Goals. Now, let's turn to our Q3 performance. The strength and resilience of ITW's proprietary business model and high-quality diversified portfolio once again drove strong operational execution and financial performance this quarter. Starting with the top line, organic growth was 2% on an equal days basis, as demand for CapEx slowed down in test and measurement and electronics and welding. Our margin and income performance continues to be very robust. Operating margin improved 200 basis points year-over-year to 26.5% as enterprise initiatives contributed 140 basis points. Quarterly operating income grew 9% to $1.1 billion. GAAP EPS grew 9% to $2.55 and free cash flow was up 40%. With three quarters behind us, we are narrowing our EPS guidance to a range of $9.65 to $9.85, which now incorporates a $0.12 adjustment to the impact of the auto strike in Q4. Looking ahead at the balance of the year, the company remains well positioned to deliver another year of differentiated performance. I'll now turn the call over to Michael to discuss our Q3 performance and full year guidance in more detail. Michael.

Karen Fletcher:

Thank you, Michael. Krista, please open the lines up for questions.

Scott Davis:

Good morning Scott and Chris and Michael and Karen.

Scott Santi:

Good morning.

Michael Larsen:

Yes. So let me give you a little bit of context here. So we are definitely on track to recover the margin impact now from more than two years of unprecedented inflation, which now appears to have stabilized. There's definitely still some pressure on the cost side, on the labor side, components as well as energy. That said we've made some good progress. Price/cost was positive 190 basis points in Q1, 216 in Q2, which was the peak and then 210 here in the third quarter. And we're now looking at somewhere around 150 basis points in Q4, and that would put us around 200 basis points recovery for the full year. Price is holding, and we're seeing a little bit of deflation on the -- more on the commodity side. So these would be the metals, in particular, which drove the stronger performance here on price/cost in the third quarter.

Christopher O'Herlihy:

Yes. So Scott, I would say, in general, our plan is very much in line with what we outlined at our Investor Day in terms of really ensuring that we continue to strengthen our foundation, which is our business model and obviously then building organic growth as a core strength on par with our operational capabilities and financial performance over time. I think the first 90 days I'm just learning the job, just go out and pretty good understanding of our businesses already, but obviously, working with our businesses to make sure that our strategy is well part of dominant businesses, which, of course, it is, that's really the plan for the first 90 days, I would say. But it's really in the context of being very committed to this -- the strategy for the next phase, which is to sustain the strong foundation we have around our business model, we're really leaning in and continuing to build our organic growth capabilities to be on par with our operational capabilities and our financial performance.

Scott Santi:

Thank you.

Tami Zakaria:

Hi. Good morning. Thank you so much. So my first question is, I wanted to understand the operating margin expansion a bit better, 200 basis points, enterprise initiative 140, price/cost 210. So what was the drag to get to the 200 basis points expansion. I remember you were investing in labor and compensation this year. Is that still there? And when do you expect that to taper off, especially as you look into 2024?

Tami Zakaria:

Does that 150 basis points headwind continue in the fourth quarter and maybe in the next several quarters, how should we think about that headwind?

Tami Zakaria:

Got it. Can I ask one more quick one? The $0.12 headwind from the auto strike you're calling out for the fourth quarter. Does that assume the strike continues through the end of the quarter? And what does that mean in terms of organic growth headwind for the fourth quarter?

Tami Zakaria:

Great. Thank you, so much.

Operator:

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

Michael Larsen:

Good morning.

Michael Larsen:

Hi Andrew, so there's definitely some puts and takes. I think, for example, if you had asked me that question last quarter, I would have said automotive OEM -- automotive aftermarket would be in that category. They were up 10%. So just an example of things moving in and out. So I'm not sure it's really that relevant to look at. But if you just look at what we would say now is kind of slowing to 25% on a combined basis, those businesses were down year-over-year, 3% in the third quarter. However, sequentially, they did improve from the second quarter by a percentage point, which I would say fairly stable. Talking about electronics and semi specifically, I think consumer electronics remains fairly weak. On the semiconductor side, you will recall that we've talked about an expectation from industry experts, I'll call them as well as our customers that there would be a reacceleration of demand here in the second half of this year. And that now looks like it's been deferred probably until sometime next year. Now obviously, we remain, as we now do on an ongoing basis, committed to those businesses. We continue to invest and really position ourselves for the inevitable recovery down the road, which hopefully comes next year in 2024 and making sure that we're well positioned to take full advantage of the long-term growth opportunities that we believe are right in front of us in that part of our businesses, so.

Michael Larsen:

Well, there's a lot of work that's going on in those businesses to deliver these results. Obviously, I'd say the categories you're familiar with, the first one is the ongoing contribution from the enterprise initiatives. And so both the segments that you mentioned had a significant contribution from enterprise initiatives as well as favorable price/cost impact. So those are really the two big drivers in those businesses. And I think it is pretty remarkable that they're putting up record quarterly margin performance given, frankly, not a lot of volume growth, not a lot of volume leverage. So you can imagine once we get the volume leverage going again, as Chris was talking about at incrementals kind of in that 35 to 40 range, there's even more runway for margin improvement.

Michael Larsen:

Sure.

Steven Fisher:

Thanks. Good morning, and congratulations, Scott. Within the Welding segment, it seemed like the year-over-year was a little weaker on the industrial side relative to last quarter and maybe a little better on the commercial. Is that something that you're projecting at least in the near term? And to what extent is there a margin mix difference between those two subsegments that you could be aware of?

Steven Fisher:

Okay, that's helpful. And then when would you get an idea of how your price versus cost is going to shape up for 2024? I'm getting the sense broadly in industrial it is going to be pretty tight. Would you agree with that? And is that something you can sort of 80/20 to kind of tilted in your favor?

Steven Fisher:

Thanks. I appreciate the thoughts. Thank you.

Julian Mitchell:

Thank you. Good morning. Maybe one area was interested in was Test & Measurement and Electronics. Also, in light of sort of progress on the integration of the acquisition, how that's gone as it's been in the portfolio several quarters now? And also just on the base business, very mixed to reads some of various peers in that market. Any color you could give us or kind of expectations for Q4 on Electronics versus, say, Test & Measurement within that, please?

ChristopherO'Herlihy:

Yes. So, I would say, Julian, that certainly the assumptions we made when we acquired the MTS business in terms of strategic fit and financial rationale have been very much validated by our two years of owning the business. The business has performed very well. We are currently in the process of implementing our business model. We're already starting to see some real nice results accruing from that. But we strongly feel this is going to be a very, very successful ITW acquisition. In fact, we are taking our Board of Directors up to MTS later this week for them to witness firsthand the level of progress that we've made on the integration in terms of implementing our business model. But like I say, two years in, so far so good. Great people, great brands, great technology, great opportunity to improve the business model, and like I said, this is going to be a great ITW business in the long term.

Julian Mitchell:

That's helpful. Thank you. And good to hear on MTS. Maybe just a broader question, perhaps amidst the sort of the CEO transition that was announced and congratulations to both Scott and Chris. But maybe on the sort of thinking about the top line a little bit and it looks like maybe some of the share gains that ITW had enjoyed just after COVID maybe have eased to-date or eased in the last 12 months or so. I realize there's some destocking noise in various channels and so looking at market share in that context may not be that helpful. But just wanted sort of perspectives on market share across the larger ITW businesses and whether there's perhaps a need to redeploy a greater share of enterprise initiatives or price/cost savings into sort of organic reinvestment in the base business?

Christopher O'Herlihy:

Yes, I would echo everything Michael just said in terms of the quality of our portfolio, in terms of the amount of room we have to grow in each segment customer-facing performance and so on and the focused investments that we've made in areas like sales and innovation, coupled with the fact that we've seen a nicely improving yield on customer-back innovation. All this gives the credence to what we're hearing from our businesses that we are getting share in most of our key markets in relation to our competition.

Operator:

[Operator Instructions] Your next question comes from the line of Mig Dobre from Baird. Please go ahead. Your line is open.

Michael Larsen:

Yes. So again, Mig, you're right. This is on the residential renovation remodel side of things. So these are typically sales through big box retailers, names that you'd be familiar with. And I think if you look at I think somebody asked earlier about market share, this is a great example of really strong market share gains in this particular end market, because I agree with you, if you just look at the underlying data, you might be a little surprised that, that part of the business is up 7% year-over-year in the current interest rate environment. And like I said, this is essentially all volume and share gain through the big box retailers.

Michael Larsen:

Well, I think that overall construction in North America actually remains fairly stable. I'd say maybe a little bit more concern on the international side, which has been weak. The market demand has been a lot softer on the international side. But North America – keep in mind that in the fourth quarter, typically, we talked about seasonality by segment, I said Test & Measurement usually does better. Construction is one where, for obvious reasons, the fourth quarter is typically a little bit lower than the third quarter. But in terms of the share gains and our – the strength in this particular part of the business, that absolutely has staying power.

Michael Larsen:

So Mig, just from a lead time perspective, I would say that a natural outcome of our business model is best-in-class lead times and customer-facing performance. And we are very much back to where we were pre-pandemic in terms of our ability to supply our customers. In terms of the channel, yes, I think it's an area where there is a little bit of inventory in the channel. We're seeing that coming down. It's probably still out there. It's one of the segments that has been impacted, I think, by channel inventory likely to come down over the next couple of quarters here, but it's fair for sure.

Mig Dobre:

All right. Appreciate it. Thank you.

Operator:

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

Michael Larsen:

I'd say this is trending right in line with expectations that we kind of laid out on the last call. Like I said, the drag on the organic growth rate of 1% to 1.5% was pretty broad-based, every segment had some impact, very similar Q3 as Q2, and we think this will probably be with us for a few more quarters. And I'd just say, if you just look at our own inventory levels, we are currently running slightly above three months on hand, where typically we're running at low-twos. And we estimate that in our case, it will take us probably until kind of early mid next year to get back to normal inventory levels as we work through the exact same things that our customers and channel partners are working through. And I might just add here that that's obviously going to continue to drive some really strong free cash flow performance for ITW as inventory levels, working capital continues to normalize, as a result of supply chain having stabilized.

Michael Larsen:

I think it's really hard to tell. I mean, I think overall, the demand environment, as we said there's, clearly some uncertainties here in the near-term. Inventory as part of that, the interest rate environment, everybody being maybe a little bit more cautious on the CapEx side and then in of our segments, particularly, the auto strike. So there's, a lot of things going on here. It is a pretty dynamic environment, it can change pretty quickly. The only thing we know for sure is that, the ITW team will continue to read and react to whatever conditions are on the ground. And I think if you just look at our track record, we'll continue to deliver differentiated long-term performance. And so that's really our focus is on continuing to do just that.

Michael Larsen:

Thank you.

Karen Fletcher:

Thanks, Rob. Good morning, and welcome to ITW’s second 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’ll discuss ITW’s second quarter financial results and provide an update on our full year 2023 outlook. Slide 2 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 3, and it’s now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

Michael Larsen:

Thanks, Scott, and good morning, everyone. Q2 revenue grew by 2% with organic growth of 3%, and divestitures reduced revenue by 1%. Foreign currency translation impact was neutral and not a headwind for the first time since the third quarter of 2021. Underlying demand remains stable across the majority of our end markets with some softness in about 25% of our portfolio. As Scott mentioned, our businesses estimate that inventory reduction efforts by our end customers and channel partners reduced organic growth by 1% to 1.5% at the enterprise level. By geography, North America was flat, Europe grew 5%, Asia Pacific grew 11%, with China up 22%. On the bottom line, operating income grew 9%, exceeding $1 billion for the first time ever. Operating margins were a real highlight this quarter as they improved to a new Q2 record of 24.8% with Enterprise Initiatives contributing 130 basis points. Price/cost margin impact contributed 260 basis points in Q2, while higher wages and benefit costs lowered margins by around 100 basis points. In addition, we continue to fund our growth investments, including headcount additions to support our organic growth strategies and initiatives. All in, we delivered 170 basis points of margin improvement in the quarter, with margin expansion in six of our seven segments, three of them, welding, food equipment and construction products, recorded all-time highs. GAAP EPS was $2.48, an increase of 5%, and excluding one-time tax items in both years, EPS grew 9%. Our cash performance was strong as free cash flow grew 68% to $705 million, a new Q2 record. Free cash flow was 94% of net income, about 10 percentage points above our historical Q2 average, helped by an inventory reduction of 6% since year-end. Like our end customers and channel partners, our divisions are also beginning to reduce inventory levels as supply chains normalize. That being said, we added almost $1 billion of inventory over the last two years to mitigate supply chain challenges and it would likely take us until the first half of next year to get our inventory levels from currently 3.2 months on hand back to our normal months on hand levels of about two. We expect that it will be much the same for many of our channel partners and customers. Overall, for Q2, excellent operational execution and financial performance across the board, including record operating income, operating margin and GAAP EPS. Turning to Slide 4. We wanted to spend a minute on ITW’s operating margin performance in Q2. Like I said, one of the highlights of the quarter. Not only did margins significantly expand year-over-year and quarter-over-quarter, but at 24.8% margins and are now also solidly above pre-pandemic levels, and we are back on track in terms of making progress towards our goal of 30% in 2030. Let’s move to the segment results, starting with automotive OEM, which led the segments with strong organic growth of 16% and positive growth in all regions. North America was up 3% and Europe grew 18%. China grew 51%. Operating margin expanded 250 basis points to 16.8%, and price/cost margin impact turned positive for the first time in more than three years as this segment continues on the margin recovery and improvement path that we laid out at our 2023 Investor Day. As a reminder, we’re executing a plan to get auto OEM margins solidly back into the 20s over the next three years. Organic growth in this segment in the second half reflects some tougher comparisons, and we expect continued meaningful sequential improvement in operating margins in Q3 and Q4. Turning to Slide 5. Food equipment also delivered strong organic growth of 7% with North America up 8%. Institutional end markets were up 13%, with continued strength across the board. International revenue grew 5%, with Europe up 5% and Asia Pacific up 2%. A real highlight was service revenue, which grew 16%, the ninth quarter in a row with double-digit growth as we continue to support existing customers, new product installations and gain market share. Operating margin expanded 310 basis points to 27.8%, an all-time record for the food equipment segment. Test and measurement and electronics delivered positive organic growth of 1%. The slowdown in semiconductor-related revenues, which represent about 20% of the segment, reduced the segment growth rate by 6 percentage points. Test and measurement grew 10% with continued strong demand for capital equipment as evidenced, for example, by Instron, which grew 30%. Electronics declined 13% on semiconductor softness, which is, however, beginning to show some signs of bottoming out. Moving on to Slide 6. Welding delivered 1% organic growth against a tough comparison of plus 22% in the prior year. Equipment revenue was essentially flat and consumables were up 2%. Industrial sales were really solid with organic growth of plus 5% on top of 27% in the prior year, while the commercial side was down 9%, about as expected against the comparison of 19% last year. North America revenue was flat and international grew 5%. This quarter’s highlight was definitely operating margin expansion of 460 basis points to 33.9%, a new record for the segment and for the company. And the fact that our highest margin segment continues to improve margins and not just by a little bit, is a good example of the never satisfied continuous improvement mindset and is so core to the ITW culture and mindset across the company. Polymers and fluids organic revenue was down 1% against a difficult comparison of plus 10% last year. Divestitures impacted revenue by 6%. Automotive aftermarket was up 1%, polymers down 2% and fluids down 1%. On a geographic basis, North America grew 1% and international declined 3%. Turning to Slide 7. Organic revenue in construction was down 6% against a comparison of plus 15% last year. North America was down 3% with U.S. residential construction down 2% and commercial construction, which represents about 15% of the region, down 5%. Europe was down 14%, and Australia and New Zealand was down 4%. Despite some challenging end market conditions, operating margin expanded 170 basis points to 29.3%, an all-time record for the Construction Products segment. Finally, Specialty organic revenue was down 4%, which included 1 point of headwind from product line simplification and an estimated 3 percentage points from end customer and channel inventory reduction efforts. North America was down 7% and international grew 4%. Equipment revenue, which represents about 20% of the segment, was up 23%, and consumables were down 9%. With that, let’s move to Slide 8 for an update on our full year 2023 guidance. As you saw this morning, we raised our GAAP EPS guidance by $0.10 with a new midpoint of $9.75 based on our strong first half performance with record first half GAAP EPS of $4.81 and the expectation for stable underlying demand and continued strong margin and profitability performance through the balance of the year. Our organic growth guidance of 3% to 5% includes our expectation that end customer and channel inventory normalization activities will continue to modestly impact overall demand through at least the balance of the year. Operating margin is projected to expand by more than 100 basis points at the midpoint of our range of 24.5% to 25.5%, which includes a contribution of more than 100 basis points from enterprise initiatives. We’re also projecting strong free cash flow performance with a conversion of over 100% of net income. Finally, on the tax rate, our first half rate was 22%, and we expect our typical 24% in the second half for an expected full year rate of around 23%. In summary, a strong first half, both operationally and financially. And as we head into the second half, we are in a strong position to continue to deliver differentiated performance through the balance of the year. With that, Karen, I will turn it back to you.

Operator:

[Operator Instructions] And our first question comes from the line of Jeffrey Sprague from Vertical Research. Your line is open.

Scott Santi:

Hello Jeff.

Michael Larsen:

Yes, sure, Jeff. So I think overall, on price-cost, we’d say we’re on track to recover the margin impact from a period over the last two years of unprecedented inflation, which has now stabilized. So, in the first quarter, price-cost was positive 190 basis points, Q2 260 basis points and for the balance of the year, we’re looking at a more normalized 130 to 150 basis points range. And for the full year, we should recover somewhere around 150 to 200 basis points at the enterprise level. I think what was encouraging is every segment is now margin positive, including Automotive OEM and we expect that for [indiscernible] your question specifically to remain the case for the back half of the year. And combined with enterprise initiatives, we expect sequential improvement in Q3 and Q4 in the Automotive segment, and we should end up somewhere in the high teens as we exit 2023. We’re still a long way to go over the next two to three years to get back to kind of the low to mid-20s, which is the path that we laid out at Investor Day.

Michael Larsen:

Yes, I think, similar to what we talked about on the last call, supply chain performance continues to improve. And as that happened, our backlogs are also starting to come down. And at this point, we’re still above our normal levels. If you look at the businesses where we do carry some backlog Food Equipment, for example, we’re running at 2x normal levels, and the same is true in Welding. But as I said, those backlogs are coming down pretty quickly as supply chain performance improves.

Michael Larsen:

Sure.

Jamie Cook :

Hi, good morning. Two questions. A follow-up on the inventory reductions from your customers and channel partners. Exactly what’s embedded in the back half of the year, is it another visit 1 to 1.5 points and in the guide in the back half of the year? And then as a follow-up to that, you are maintaining your revenue guide despite this, so what’s doing better than expectations? And sort of my last question is Construction margins were very impressive considering the sales decline. So any color on that? Thank you.

Scott Santi:

By you.

Scott Santi:

Yes.

Jamie Cook :

Thank you.

Operator:

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

Scott Santi:

Good morning.

Scott Santi:

I think overall, it’s been remarkably stable. If anything, we saw some firming up in the second quarter based on some trends in the first quarter that we talked about relative to 25% of our portfolio. I think the one place we saw things continue to weaken was in Europe on Construction between Q1 and Q2, but for the rest of the portfolio, I think, at this point, the best description is pretty firm.

Michael Larsen:

Yes, I mean the big driver continues to be the Enterprise initiatives. The work around eighty-twenty front-to-back and strategic sourcing efforts, we expect at least 100 basis points of contribution there in the second half. And then price-cost, we still expect a meaningful contribution as we talked about a few minutes ago. So, all of that means that as we look at kind of the second half, we expect margins to continue to improve sequentially from Q2 to Q3 and from Q3 to Q4, maybe somewhere around 50 to 60 basis points each quarter of sequential improvement. I think we talked in the past about 100 basis points of improvement year-over-year. That’s still looking very good. So, like I said in the prepared remarks, we’re really well positioned here in terms of our margin and profitability performance through the balance of the year and frankly into next year. So, I’ll leave it at that.

Operator:

And your next question comes from the line of Tami Zakaria from JPMorgan. Your line is open.

Scott Santi:

Good morning.

Michael Larsen:

So, I think you know this, Tami, we don’t break out price and volume. And I’d say both elements contributed and it’s a little different equipment versus service, but certainly some really strong activity. North America, I think, we said up 8%, that has Equipment up 5%, services up 15%, by end market institutions up 13%, health care up 18%, restaurants, still really strong performance there. Retail a little softer. That can be a little lumpy, international side, up 5%. So, I think really strong quarter by Food Equipment and actually looking really good for Q3. I think that they should be putting up another really strong quarter. There might be a little bit of – if you go back and look, the comparisons are a little bit challenging on a year-over-year basis. But overall, the underlying demand in food equipment remains really healthy and really well positioned again for the second half.

Michael Larsen:

There is something else going on in there, Tami. So, it’s a similar answer to what I said for Construction. I mean I think there is a healthy dose of enterprise initiatives. And then we’re still recovering the margin impact on price/cost. So, those are the main drivers here. And like I said, I mean, price/cost, we expect that to normalize in the second half, but the Enterprise initiatives and we expect that to continue into the – through the balance of the year and into next year.

Operator:

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

Michael Larsen:

Good morning.

Michael Larsen:

So let me do the semi portion first. I mean, I think, there has been this view that the second half would be a step-up from the first half. Really, we talked about this going into the year.

Michael Larsen:

And I was going to say, the customer feedback has now become even more supportive of that view along the lines of get ready for orders to come back here in the second half and make sure you have the capacity to support us, which, of course, we do. So, that’s kind of the color commentary around semi. And similar to what you’re hearing from other...

Michael Larsen:

That’s a good point. None of that is baked in. So I think that’s...

Michael Larsen:

Exactly like we normally do; none of that would be in our run rates, obviously. And so we’d be happy to see that here late Q3, Q4, if we get those – if that really comes to fruition. On the 25% of the portfolio, I think maybe to give you a little bit more detail, I think what was really encouraging this quarter is if you look at the performance of those businesses, and there are some puts and takes. There are some businesses that are no longer slowing, that have moved out and others, I think Construction Europe was an example that maybe have moved in, but it’s still about 25% of the company. Those businesses were down 7% year-over-year in the first quarter, and they were only down 3% in the second quarter. And actually, if you look at it sequentially, the businesses as a group improved 2% sequentially. And that includes in that 25% is also at least a portion of our semi revenues. So I think that’s certainly encouraging as we look to the back half of the year.

Michael Larsen:

Yes. I think, Andy, the big driver for us in China is auto, and that’s our largest businesses. We talked about this on the last call, we expected a strong Q2 in China. Based on some of the COVID-related slowing in the first quarter, we bounced back in the second quarter with auto up more than 50% in Q2 and all of China up 22%. I think a better way to look at China is maybe if you look at the first half, our China business was up 7% on a year-over-year basis, and that’s maybe a more accurate representation of kind of the underlying levels of demand. And so for the second half, we’d expect something kind of in the mid-single digits out of that region. But again, it’s all driven by the auto business that’s doing a phenomenal job frankly, gaining share and launching new products particularly on the EV side with domestic local Chinese OEMs that are winning big time, as we talked about at Investor Day. So really well positioned, not just for the second half but for many, many years to come here in our China business and in auto particularly.

Michael Larsen:

Sure.

Joe Ritchie:

Hey guys. Good morning.

Joe Ritchie:

Can we maybe just double-click a little bit on the longer-term service opportunity in Food Equipment? Clearly, 16% growth in that business is very robust, and I’m sure it carries a pretty good margin for you guys as well. Can you just maybe kind of talk a little bit about how you’re increasing the growth rate today and then what the expectations are going forward?

Scott Santi:

I was going to say that I’m not current on the exact – what our businesses estimate is our share of our installed base, but last time I had the conversation I think it was sort of well into the low-20s at best maybe and don’t sort of take that as possible, but at the point is that we have a lot of room to grow within – with just doing – giving more penetration with our current installed base globally.

Scott Santi:

Yes. And that’s been an active strategy for the last – really coming – really from before COVID. So some of it is coverage, some of it is programming. When you actually service the equipment you sell, we have lots of opportunity to integrate service offerings at the point we sell the equipment, which is part of the – why we think this is a big competitive advantage for us. So it’s essentially all of the above, but there’s no way to do service remotely. So we got to have service techs on the street. We’ve got, I think, north of 1,500 in North America and the same in Europe. And given the profitability of the business and how much runway we have we’ll certainly continue to invest. That’s part of what Michael talked about; continue to invest in our organic growth strategies that’s certainly a good example.

Scott Santi:

Yes, I’d say that there’s been no change. We continue to get sort of apple flow in terms of people wanting us to take a look at things. And as we’ve talked about for a long time and certainly updated at our Investor Day, the aperture through which we will strike on those opportunities is pretty narrow given all the potential in our core business, but we’ve done MTS recently, and we will continue to opportunistically be aggressive. But from the standpoint of overall flow, is it up or down, I’d say it’s been pretty stable.

Operator:

And your final question comes from the line of Julian Mitchell from Barclays. Your line is open.

Michael Larsen:

Yes. I think, Julian, I think I said this earlier, we do expect as we typically do, if you look at our historical sequential lift from Q2 to Q3 of about 1%. The thing to keep in mind is that Q3 has one less shipping day relative to prior year and relative to Q2, so that is going to have a little bit of an impact. So don’t expect a big jump here in Q3. But certainly based on current run rates, some progress on the top line, progress on the bottom line with margin expansion. I think we talked about that somewhere along the lines of 50 plus basis points from Q2 to Q3. And I might just add that in terms of our typical cadence kind of first half, second half, if you look at our full year EPS, we’re typically 49% to 51%, and we are – as we see today, right in line with that, based on our – if you look at our $4.81 GAAP EPS for the first half the midpoint of our guidance of $9.75, you can calculate what’s left to go, and you’ll see it’s a lift from the first half to the second half. That’s right in line with our historical averages, which gives us a lot of confidence as we head into the second half here.

Michael Larsen:

Well, so Julian, I wouldn’t agree with how you characterize this in terms of no volume gains year-to-date. I think we have a lot of confidence that we continue to take market share not just as we talked about through the pandemic. But on an ongoing basis, I mean, I think if you look at our organic growth rates relative to peers in these – in some of these segments, you’ve got some good comps. You can certainly take a look at that. And I think we’re continuing to invest here in all of our organic growth strategies and efforts, including headcount to continue to take market share. So we have a high degree of confidence that we continue to take share.

Julian Mitchell:

No, I think these...

Michael Larsen:

Yes. And I think the other thing, I mean, the biggest driver as we talked about at Investor Day, Julian, I think you were there is going to be our customer-back innovation efforts. We’re signing a bright light on our CBI efforts, and we’re – the whole company is focused on continuing to drive up the contribution to organic growth from our innovation efforts. And so you put all of that together we’re highly confident we can deliver our long-term kind of 4% plus organic, which is given our high levels of profitability, that’s all we need to grow, EPS kind of high-single digit, low-double digit. You add an attractive dividend yield on top of that, and you’re getting that 11 to 13 TSR over the long-term, not every year, this year, yes, but not every year. That’s what you should expect from ITW. And it’s much more about that than it is a quarterly market share number, which is, I think, what you’re asking about.

Michael Larsen:

Sure. You’re welcome.

Karen Fletcher:

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 2 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 3, and it's now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

Michael Larsen:

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, our operating income grew 9% with incremental margins of 98%. Operating margin improved 150 basis points to 24.2% with enterprise initiatives and price costs contributing 100 basis points, and 190 basis points respectively. In addition to higher wages and benefit costs year-over-year, were 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 a 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 is 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 at 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 5. 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 remains strong as evidenced by Instron, for example, which was up 22%. Overall, Test & Measurement grew 12% organically and electronics was down 4%. Moving on to Slide 6. 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 and Fluids was about flat against a difficult comparison of plus 13% last year. Automotive aftermarket was down 1%, Polymers grew 1% and Fluids was also up 1%. On a geographic basis, North America grew 1% and international declined 2%. Turn to Slide 7. 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 3 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. 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 adjusting 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.

Operator:

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

Michael Larsen:

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'd 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're seeing similar trends in terms of margins improving from here. We are -- if you look at kind of the bridge and we talk about this last quarter, as well we're certainly seeing some positive operating leverage from our organic growth this year. We're seeing at 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 are 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-end. I hope that answers your question.

Michael Larsen:

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. We're talking about commercial welding and the automotive aftermarket being down here in Q1 and kind of into 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 & 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...

Michael Larsen:

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, this 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.

Michael Larsen:

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

Operator:

Your next question comes from the line of Tami Zakaria from JPMorgan. Your line is open.

Michael Larsen:

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

Operator:

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

Michael Larsen:

Yes. I mean I think as you point out, Jeff, we are 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 2x, 3x, 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, 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.

Scott Santi:

Yes. I'm not sure, Jeff, the exact comp that you're referring to, but 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 add are 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.

Scott Davis:

Hey, good morning. Scott, Michael and Karen, 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 back down a 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?

Scott Davis:

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 point. 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 5 years, you envision more of a flattish price environment? Or has 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 Davis:

Okay. Thank you for the integrity of answer.

Joe Ritchie:

Thanks. Good morning, guys. 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.

Joe Ritchie:

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?

Scott Santi:

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 2.5x the returns on capital we generate are absolutely terrific and right in line with what we do also 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 stress. The business still performs really well.

Joe Ritchie:

Great. Thanks, guys.

Steve Volkmann:

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.

Steve Volkmann:

Great. Okay. Thank you. And then just a quick follow-up on the construction products. Market 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?

Steve Volkmann:

I appreciate. Thanks.

Chigusa Katoku:

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 just at around at all?

Chigusa Katoku:

Okay. Great. And then on price/cost. So you mentioned that it was 190 basis points positive this quarter. And you remember, 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?

Operator:

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

Michael Larsen:

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

Scott Santi:

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

Sabrina Abrams:

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

Scott Santi:

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.

Operator:

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

Michael Larsen:

Yes. I mean there's certainly some inventory correction going on this quarter or 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 I can add to that.

Michael Larsen:

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.

Nigel Coe:

Thanks, good morning. Couple of ground, but I just want to dig into food equipment because that continues to suggest to 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?

Scott Santi:

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

Scott Santi:

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

Michael Larsen:

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 those -- they 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.

Julian Mitchell:

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 1/4 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.

Julian Mitchell:

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

Julian Mitchell:

That's helpful. And then just my follow-up would be on the Test & Measurement business, where I don't think there's been many questions, but some of the peers like say, Tektronix, 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 aside electronics, how you're thinking about the balance of the year in terms of that rate of slowdown?

Julian Mitchell:

That’s great. Thank you.

Operator:

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

Karen Fletcher:

Thank you, Cheryl. Good morning, and welcome to ITW's Fourth Quarter 2022 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 fourth quarter and full year 2022 financial results and provide guidance for full year 2023. Slide 2 is a reminder that this presentation contains forward-looking statements. We refer you to the company's 2021 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 3, and it's now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

Michael Larsen:

Thank you, Scott, and good morning, everyone. The demand growth that we've experienced all year continued into the fourth quarter as revenue grew 8% with organic growth of 12%. On an equal day’s basis, organic growth was 14% as the fourth quarter this year had one less shipping day compared to prior year. We finished the year with strong growth momentum as evidenced by our sequential organic revenue growth of plus 4% from Q3 into Q4 on a sales per day basis as compared to our historical sequential of plus 2%. By geography, every major region grew double digit, with North America up 13%, Europe up 11% and China up 10%. Foreign currency translation headwind reduced revenue by 5%, and the net impact from acquisitions and divestitures was plus 1%. GAAP EPS grew 53% to $2.95 and included a $0.61 gain from two divestitures, which I'll provide more detail on in a moment. Excluding those gains, EPS increased 21% to $2.34, which included $0.12 of EPS headwind from foreign currency translation. So, on an apples-to-apples basis, eliminating both divestiture gains and currency headwind, EPS increased 27%. On the bottom line, operating income grew 18%, with strong incremental margin performance of 52% and operating margin improved 210 basis points to 24.8%. Operating margin in our base businesses, excluding MTS, was 25.2%. In the fourth quarter, we achieved favorable price/cost margin impact of 70 basis points. And as Scott said, this was the first quarter with favorable margin impact from price/cost since the third quarter of 2020. Enterprise Initiatives contributed 110 basis points. As you saw in the press release, we completed two divestitures in the fourth quarter, resulting in a combined pretax gain on sale of $197 million recorded in nonoperating income and an EPS impact of $0.61. By utilizing capital loss carryforwards to offset taxes on the divestiture gains, the overall tax rate for the company was 19.1%. So overall, for Q4, excellent operational execution across the board, strong financial performance and what remains a pretty uncertain and volatile environment. Okay. Please turn to Slide 4, starting with our progress on organic growth. And as you know, we've been aggressively executing a very focused growth strategy to build consistent above-market organic growth into a core ITW strength on par with our operational 80/20 front-to-back capabilities. As you can see from the data on the left side of the slide, ITW's 12% organic growth rate for each of the last two years compares favorably to our proxy peers at about 9% both years, suggesting that while we're not there yet in terms of realizing ITW's full potential organic growth performance, we're making some very solid progress. Moving on to the segment results, starting with Automotive OEM, which led the way with organic growth of 20%. Year-on-year revenue growth was, of course, helped by supply chain challenges in the industry last year. North America was up 15% and Europe grew 23%. China was up 17% with particularly strong growth in electric vehicles. On a full year basis, ITW Automotive OEM revenues were up 12% versus 6% growth in car builds. Looking forward, we expect Automotive OEM to grow 5% to 7% in 2023 based on a risk-adjusted auto build assumption in the low single digits plus our typical penetration gains of 2% to 3%. Turning to Slide 5. Food Equipment delivered another very strong quarter with organic growth of 17%. North America grew 25% with double-digit growth in all major categories and end markets. Institutional was up more than 40% with strength across the board, restaurants were up 30% and retail grew 20%. International revenue grew 7%, with Europe up 9% and Asia Pacific was flat with some near-term softness in China. The Food Equipment team also delivered excellent progress on margins, with Q4 operating margin of 27.6%, an increase of almost 500 basis points year-over-year. So obviously, strong momentum in this segment, and we expect Food Equipment to grow 8% to 10% in 2023. Test & Measurement and Electronics revenue grew 15%, with organic growth of 10%. Test & Measurement grew 12% organic, excluding the acquisition of MTS, with continued strong demand for capital equipment as evidenced by Instron, which grew 24%. Electronics was up 7%. While our semi-related businesses, which represent combined annual revenues of about $550 million or approximately 20% of the segment, grew 17% in the quarter. We are beginning to see a slowdown in demand after three years of very strong growth. So, embedded in our 2023 organic growth projection of 2% to 4% for this segment is anticipated further slowing in semi-related end markets. Moving on to Slide 6. Welding delivered strong organic growth of 15% in Q4, with equipment up 17% and consumables up 13%. Industrial sales remained very strong with organic growth of 25%. On the commercial side, which is more consumer-oriented, demand continued to slow and organic growth was down 1%. On a geographic basis, North America grew 15%, and international grew 17%, driven by strength in the oil and gas business, up 19%. Operating margin was up 160 basis points to 31.6%, a new record for the segment and for the company. Looking forward, we expect revenue to grow 5% to 7% in 2023, which includes some anticipated further slowing on the commercial Welding side. Polymers & Fluids delivered organic growth of 11%, with the automotive aftermarket business up 13% with some seasonal strength in wiper blades. Polymers grew 11% with continued strength in industrial applications, and Fluids was up 5%. North America grew 11% and international was up 10%. Looking forward, we expect Polymers & Fluids to grow 3% to 5% in 2023, which is based on current levels of demand and anticipated further slowing in the more consumer-oriented automotive aftermarket business. Turning to Slide 7. Overall demand in Construction slowed to an organic growth rate of plus 4%. North America was still up 9%, with residential up 11% and commercial construction was down 6% due to a tough comparison of plus 21% last year. Europe was up 3% and Australia and New Zealand was down 4%. As you know, Construction is our most interest rate sensitive segment, and we are projecting further slowing in 2023 and a negative organic growth rate of minus 5% to minus 3%. Specialty organic growth was 3% as supply chain shortages eased up in Q4, and the equipment businesses had a strong finish to the year with organic growth of 8%. Consumables were up 2%. And on a geographic basis, North America grew 1% and international grew 7%. Looking forward, we expect Specialty organic revenue of negative 1% to plus 1% in 2023, which is based on current levels of demand and anticipated further slowing in the appliance components business. So, let's turn to Slide 8 for a recap of a very strong 2022. As throughout the year, our teams around the world did an exceptional job of delivering for our customers, while responding quickly and decisively to rapidly rising input costs, navigating supply chain disruptions and aggressively executing our Win the Recovery strategy. As a result, for the full year, ITW grew organic revenue by 12% with double-digit growth in five of seven segments. And despite significant price/cost margin pressures and thanks in part to 90 basis points contribution from our enterprise initiatives, our base businesses expanded operating margin by 30 basis points to 24.4%. GAAP EPS of $9.77 was a record for ITW with EPS growth of 15% on top of 28% EPS growth in 2021. Excluding divestiture gains and negative currency translation impact, EPS grew 12% in 2022 on an apples-to-apples basis. In 2022, we also invested more than $700 million to accelerate organic growth and to sustain productivity in our highly profitable core businesses. Raised our dividend 7%, marking the 59th year of consecutive increases. Returned $3.3 billion to shareholders in the form of dividends and share repurchases and made solid progress on the integration of a very high-quality acquisition in the MTS Test and Simulation business. And most importantly, we delivered these results while continuing to make meaningful progress on our path to ITW's full potential through the execution of our long-term enterprise strategy. So, let's move to Slide 9 for an update on our full year 2023 guidance. And while we certainly see some positives in terms of supply chain easing and moderating input cost inflation, there's also no doubt that the economic outlook and demand picture is becoming increasingly uncertain. On our last Q3 earnings call, we pointed to pockets of slowing demand at approximately 20% of our business portfolio. And today, we would add semiconductor-related end markets to the mix bringing the total to about 25% of ITW's portfolio. In our view, it therefore made sense to take a more cautious approach to our top line guidance this year by basing it not just on current levels of demand, adjusted for seasonality as we typically do, but rather anticipating further slowing in end markets related to construction, commercial welding, auto aftermarket, appliances and semiconductor. As a result, our organic growth rate projection for 2023 of 3% to 5% is lower than our typical run rate approach. Operating margin is expected to improve by 100 basis points or more to a range of 24.5% to 25.5%. This includes approximately 100 basis points contribution from enterprise initiatives and positive price/cost margin impact based on all known and implemented price and cost actions. After tax return on invested capital should improve to 30% plus, and we expect strong free cash flow with conversion greater than net income. For 2023, we expect GAAP EPS in the range of $9.40 to $9.80, which also includes $0.15 to $0.20 of higher interest expense on our short-term debt and $0.25 of increased income tax expense as our tax rate will revert to our normal, approximately 24% versus 22% in 2022, excluding the tax impacts from our divestitures. In terms of cadence for the year, we're now back to our typical first half, second half EPS split of 49% and 51%. Our capital allocation plans for 2023 are consistent with our long-standing disciplined capital allocation framework. Our top priority remains internal investments to support our organic growth initiatives and sustain our highly profitable core businesses. The second priority is an attractive dividend that grows in line with earnings over time, which remains a critical component of ITW's total shareholder return model. Third, selective high-quality acquisitions, such as MTS, that enhance ITW's long-term profitable growth potential and have significant margin improvement potential from the implication of our proprietary 80/20 front-to-back methodology and can generate acceptable risk-adjusted returns on our shareholders' capital. And finally, surplus capital will be allocated to an active share repurchase program, and we expect to buy back approximately $1.5 billion of our own shares in 2023. Turning to our last slide, Slide 10, for our 2023 organic growth projections by segment. And you can see that we're expecting solid to mid -- solid mid- to high single-digit organic growth in four of our seven segments, offsetting some lower growth rates in Test & Measurement and Electronics, which is due to semiconductor demand, as well as in Construction and Specialty resulting in an overall organic growth rate at the enterprise level of 3% to 5%, which is on top of 12% organic growth in each of the last two years. Overall, we're heading into 2023 with strong momentum, and we're very well positioned to continue to outperform in whatever economic conditions emerge as we move through 2023. And so, with that, Karen, I'll turn it back to you.

Operator:

[Operator Instructions] Your first question is from Jamie Cook of Credit Suisse. Your line is open.

Michael Larsen:

Okay. That was a lot there, Jamie. I'll do my best, okay? So, I think the color on semi is really the -- we're coming off a three year very strong growth cycle with growth in the high teens or better than that over those three years. And we are starting to see a slowdown in the order intake really in Q4. So, it hasn't really showed up in our numbers in a meaningful way yet, but we do expect that to continue into 2023. We think it's more of a near-term slowdown. And like you said, that is the addition to the portfolio we've said before, 20% is slowing. Demand is slowing now. It's 25%, and semi is really the incremental 5% this quarter. But it's important to keep in mind that the balance, the other 75% of the portfolio, continues to perform at a really high level. And I'll just point to the 12% organic we put up in Q4 and for the full year. And then if you look at our guidance on Slide 10, by segment, you can see mid- to high single-digit growth in Automotive OEM, Food Equipment, Welding, mid-single digit in Polymers & Fluids and then a little bit lower in Test & Measurement. And then of course, Construction is the one that's a little bit projected to be down year-over-year and Specialty about flat. I'll also say, if you just look at from Q3 to Q4, we -- typically, our sales per day go up 2%, we actually went up 4%. So, we're more than offsetting some of the slowing that we're seeing in 25% of the portfolio. So good momentum, really well positioned going into next year. I think on the price/cost side, we were really encouraged. We talked about this on the last call and an expectation of being positive -- slightly positive on margins on price/cost in Q4. This was a little bit better, driven by both sides of the equation really price and cost, but it was certainly great to see that turn positive for the first time since I think I said the third quarter 2020. So, first time in eight quarters, so really encouraging heading into 2023.

Scott Davis:

Hey, good morning. Congrats on another strong year in '22.

Michael Larsen:

Thank you.

Michael Larsen:

Well, I think we are certainly lapping some bigger price numbers. There's no doubt about that. And I think, as you know, we don't break out price and volume separately for all the reasons we've talked about in the past. But there's both price and volume in the numbers that we've laid out for 2023. And the 3% to 5% organic, I'll just say it's a risk-adjusted number. If you do a pure run rate, you end up at a higher number. We just thought given the -- everything we talked about, it was probably reasonable to take a more cautious approach given the environment.

Michael Larsen :

Yes. I think that's reasonable. I think certainly materials and components in that order, we are seeing -- I wouldn't say price are coming -- costs are coming down in a significant way, and they're remaining at a fairly elevated level. And then I think on -- our labor costs, certainly we're experiencing the same labor cost inflation as others. But -- and so maybe a little bit higher than typical, but nothing really that significant. We're still expanding margins by 100 basis points or better here in 2023. So hopefully, that answers your question.

Michael Larsen :

Sure. Thank you, Scott.

Tami Zakaria :

Good morning. Congrats on the great results. So I have a couple of quick ones. The first one is how should we think about your EBIT margin progression throughout the year? Is the 25.5% to -- 24.5% to 25.5% range going to be fairly consistent in all the quarters?

Tami Zakaria :

Got it. That's fantastic color. Thank you. And I'm just going to ask the question and I hope I get lucky and get a number. But can you share what organic growth is trending quarter-to-date? Any segments trending negative right now?

Tami Zakaria:

Okay, awesome. Thank you.

Andy Kaplowitz :

Good morning, everyone. Michael, when we think about margin expectations for '23 across your segments, does the lag in price versus cost flipped the most in Auto OEMs, so you could see a nice jump in margin in that segment? Or should we generally think that your segment margin will trend with who has the highest growth forecast versus the weakest growth forecast in '23?

Andy Kaplowitz :

Very helpful, Michael. And then can you give us an update on the longevity of enterprise initiatives? ITW continues to I think we might begin to get a little spoiled here that it could last indefinitely. So how are you thinking about enterprise strategy? Do you still see a long runway of initiatives across your segments? And where will the focus of enterprise strategy be across your segments in '23?

Scott Santi :

Yes, go ahead, you start.

Scott Santi :

We were wrong.

Scott Santi :

I would just add in terms of perspective that I think one of the real strengths of our operating methodology and our business model is it's there's no one definition of perfection. There is always room to get better. We use the business model as the core tool that our 84 divisions used to identify and prioritize opportunities to get better. And I don't see that stopping for quite a while.

Andy Kaplowitz:

Appreciate all the color, guys.

Unidentified Analyst :

You have Sabrina Abrams [ph] on for Andrew Obin. So first on the margin guide, the 70 bps to 170 bps of year-over-year expansion includes the 100 bps of enterprise initiatives. And then, I guess, the remainder is 20 bps of price/cost at the midpoint. I'm just trying to think, is this a conservative approach? Should you had 70 bps of benefit in 4Q? Is there potential upside here?

Unidentified Company Speaker :

Got it. That's helpful. And so China, I guess, was strong in Auto OEM in 4Q. Just trying to think what's incorporated in your guide for China reopening next year?

Unidentified Company Speaker:

Great. Thank you so much. I’ll pass it on.

Jeff Sprague:

Thank you. Good morning, everyone. Solid results. Just back to enterprise, I've often kind of thought of it maybe incorrectly as reflecting a little bit of a trade-off between margin and growth. And maybe originally, it was more cost oriented, but the organic growth here recently would suggest you're not trading growth for margin. And I wonder if you could just kind of comment on that. Obviously, the growth has enjoyed a cyclical lift the last couple of years. So I don't want to overstate the point, but it does seem that the system has thrown up at organic growth than it had historically? And just any context on that, I think, would be interesting.

Jeff Sprague :

And would -- Michael gave that piece of the bridge, wage and growth investment. Is that number other than kind of the inflationary pressures that you mentioned? Is that structurally moving higher? Or can that sort of be funded within the normal incremental margin construct and other levers that you're attempted for?

Jeff Sprague:

Great. Thanks for that context.

Stephen Volkmann :

Good morning, guys. Most of my questions have been answered. A couple of quick follow-ups. Is there a portion of your portfolio where you would expect to give back price once the sort of lower energy and transportation and raw material costs kind of work their way through?

Stephen Volkmann :

Great. I appreciate it. Pretty minimal then. And then just sort of maybe the obligatory question on capital deployment relative to your thinking on any sort of further divestiture opportunities or M&A pipeline, anything to kind of call out there?

Stephen Volkmann :

Great. And M&A pipeline, sorry.

Scott Santi :

Yes, maybe just a little color on top of that, that's more sort of topical near term. What I would say generally is that we are not looking to acquire broken businesses, we're looking to acquire good businesses and help them be great businesses. And in environments where the sort of economic -- the macro is uncertain, those good businesses, it's really not a good time to sell. So if anything, I'd say the environment until the macro trajectory gets a little bit more clear, I would expect that the opportunities might be a little less than normal this year, at least through the first half, but we'll see.

Operator:

Your next question comes from the line of Dan Donner of BMO Capital Markets.

Michael Larsen :

Well, I'll take a stab. I think we're not really doing anything different than we have over the last five years in the Food Equipment business. We've continued to invest in differentiated products, including the categories that you mentioned. And we've been putting up -- the team has been putting up some really great numbers as a result of executing on their strategy. And so if you add up the organic growth rate here, over 17% coming out of the pandemic 23% last year, this year, high single digit, double digit, and that's really as a result of us innovating and growing all product categories.

Michael Larsen :

Yes, definitely, I think this has been an area where kind of back to our win the Recovery positioning and the decision to carry enough inventory to service our customers with the same level of excellence in difficult supply chain on the different supply chain conditions has paid off in a big way. And so I think if you get the sense that the Food Equipment team is in a good mood. I think that's because they're gaining share and putting up some really strong numbers, including on the margin side, if you look at that almost 400 -- almost 500 basis points of improvement on a year-over-year basis. So that business, like we said, has got a ton of momentum going into 2023, and we're very bullish on the future here.

Operator:

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

Scott Santi :

Yes. I guess I'll -- my response would be that there's no way that we can break this apart into various pieces. What I can say is that the proof is in the pudding. Ultimately, it's in the performance and our ability to consistently outperform. We're not claiming victory here. We're not -- we've got a lot of room to go across the company in terms of our ability to consistently deliver the kind of organic growth that we're capable of. But what we are saying is that we put a couple of years on the board, where we are growing our peers in the aggregate. Now what percent of that is our market exposures versus theirs or different approaches to pricing or supply capability? I'd say all of the above. In the end, it doesn't matter as long as we're able to consistently outgrow our peers and outgrow our markets and that's really the goal.

Michael Larsen :

Yes, I think, Joe, from the beginning, the Win the Recovery positioning was all about strategic share gains focused primarily on our existing customers. And we were not interested in opportunistic onetime orders. And so we're pretty confident with that direction. These share gains are going to stick. I think the pandemic and the supply chain kind of disruptions were a great opportunity for ITW to demonstrate how differentiated our supply chain capabilities are for those customers that didn't know. And so I think that's been really -- that's what's contributing also to the outgrowth relative to peers. I mean that's one more element of the equation as you talked about with Scott.

Michael Larsen :

Well, I think we're not a backlog-driven company. As you know, we don't carry a lot of backlog. And as you also say, it's hard to parse out what was backlog versus new orders. So I'm not sure I can give you a great answer. What I can tell you is that, typically, our sales per day go up by 2%. If you go back and look in time, and they went up by 4%. And so things are definitely not slowing. And we've got some great momentum going into Q1 and 2023.

Operator:

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

Michael Larsen :

It's all in the comparisons year-over-year, Julian. So like I said, we expect the year to play out from a revenue standpoint, in line with our typical cadence. And so Q1 starts out a little bit lower and then we kind of improve from there. But there's nothing baked in, in terms of a big acceleration in the back half or deceleration in the back half. We've kind of done our best here to model current levels of demand risk adjusted for the areas where we're seeing some slowing in demand and we come up with 3% to 5%. I think if you run the math, you'll see kind of the first half is the growth rates are maybe towards the higher end of that 3% to 5% and the second half is towards the lower end, and that's all driven by the comps on a year-over-year basis.

Michael Larsen :

I mean the big driver, Julian, is the housing market, new housing. And so the residential side is about 80% of our business here in North America, and that's where we're seeing some slowing, which we've talked about since the summer, I think. So there's nothing new here. And that's the big driver here.

Michael Larsen :

Right. I mean...

Michael Larsen :

Yes. It's going to be down a little this year, but it's also been a business that's really performed well for us when other parts of the macro have been challenged. So...

Operator:

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

Karen Fletcher:

Okay. Thank you, Rob. Good morning and welcome to ITW’s third quarter 2022 conference call. I am 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 third quarter financial results and our updated guidance for full year 2022. Slide 2 is a reminder that this presentation contains forward-looking statements. We refer you to the company’s 2021 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 3 and it’s now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

Michael Larsen:

Thank you, Scott and good morning everyone. In Q3, revenue grew 13% to $4 billion, with strong organic growth of 16%. The MTS acquisition contributed 3% to revenue. Foreign currency translation was a 6% headwind compared to a 4% headwind last quarter. And despite $0.13 of year-over-year EPS headwind from foreign currency translation, GAAP EPS was $2.35, an increase of 16%. Excluding MTS, incremental margin in our base business was 39%, which as Scott said, was a welcome return to our normal historical incremental margin rates. As a result of our strong revenue and margin performance, operating income increased 16% to $983 million, which was an all-time quarterly record. Operating margin was 24.5%, with operating leverage of almost 300 basis points and 110 basis points of enterprise initiatives. Excluding 60 basis points of margin impact from the MTS acquisition, operating margin expanded 130 basis points to 25.1%. Free cash flow was solid at $612 million, an increase of 46% versus Q2 and 12% year-over-year. The conversion rate of 84% is lower than our typical Q3 performance as we remain committed in the near term to intentional working capital investments to support double-digit organic growth, mitigate supply chain risk and sustain service levels to our key customers. Finally, share repurchases in Q3 were $500 million and our effective tax rate was 24% versus 21% in the prior year. With that, let’s turn to Slide 4 and starting with organic growth by geography. We delivered growth in the mid-teens across all major geographies, led by North America up 17%. Europe, which represents about 23% of our sales, grew 14%, led by automotive OEM up 26% and food equipment, up 15%. China grew 15%, led by Test & Measurement and Electronics, up 32% and automotive OEM was up 29%. Price/cost was accretive to income in Q3 and slightly dilutive by 40 basis points to margin. As we have said before, our business teams around the world have done an exceptional job of adjusting price to offset cost increases throughout the most significant inflationary cycle in over 40 years. And should the pace of raw material cost inflation continue to moderate, we expect price/cost to be accretive to income and slightly accretive to margin in Q4. As Scott mentioned, throughout this unprecedented 2-year inflationary cycle, the company has absorbed as much as 250 basis points of margin dilution impact from price/cost, which we expect to fully recover of the succeeding six to eight quarters after input prices stabilize. Moving on to the segments. Automotive OEM delivered strong organic growth of 25%, with North America up 21% and Europe up 26%. China was up 29%, which included some sequential recovery from the lockdown impact in Q2. When looking at these year-over-year growth rates, keep in mind that the comparisons are against the Q3 last year when the chip shortage led to a low point for auto production. We continue to make good progress on our content per vehicle growth as evidenced by our year-to-date organic growth rate of 9% compared to auto builds of 7%, in line with our long-term market outgrowth target of 2 to 3 percentage points. Consistent with our guidance all year, we do not expect a meaningful improvement in the chip shortage situation impacting automotive production until next year. And we continue to take a more conservative approach to our guidance, which assumes that automotive production essentially remains around current levels through the balance of this year. And as we have said before, as supply chain issues eventually get resolved down the road, we remain confident that the automotive OEM segment is well positioned to be a very meaningful contributor to the overall organic growth rate of the enterprise for an extended period of time. And as that plays out, we also expect that the automotive OEM segment returns to its typical historical operating margin rates in the low to mid-20s. Turning to Slide 5. Food Equipment delivered strong organic growth of 23% as North America grew 30% with double-digit growth in every major category and end market. Growth in institutional markets was 50% plus with strength across several categories, most notably lodging. Restaurants were up around 40% and retail growth was in the mid-teens. International revenue grew 14% with Europe up 15% and Asia Pacific up 9%. Test & Measurement and Electronics revenue grew 29%, with organic growth of 17% as Test & Measurement grew 20% and Electronics was up 14%. Growth was broad-based with continued strength in semiconductor and CapEx spending as evidenced by organic growth of 13% in the Instron business. Moving on to Slide 6, welding grew 14% organically, with equipment up 13% and consumables up 15%. Industrial was the standout with organic growth of 32%. The commercial side of the welding business, which sells to smaller businesses and individual users, was down 10% due to lower demand and inventory destocking in the channel. However, due to the strength on the industrial side, North America still grew 14% and international grew 12%. Sales to oil and gas customers were up 12% in the quarter. Operating margin improved 150 basis points to 31.5%, which was a new record for the Welding segment. Polymers & Fluids grew 8% organically, with Polymers up 21% on continued strength in industrial applications. Softening demand due to higher gas prices and the impact on consumer discretionary spend impacted the automotive aftermarket business, which was up 2%. Fluids was up 5% and overall North America grew 5%, international was up 14%. Construction delivered organic growth of 17% with continued strength in North America, which was up 35%. U.S. residential grew 42% and commercial was up 17%. That said, we did see some signs of slowing towards the end of the quarter and we expect that to continue in Q4, which we have reflected in our updated guidance. The international side of construction is slowing, with Europe down 1%. Australia and New Zealand was up 7% against an easy comparison. Specialty growth was essentially flat as product line simplification activities resulted in the elimination of a product line in one of our consumer packaging businesses. Excluding PLS, the segment would have been up 3%. Demand in our appliance components division slowed, which we have reflected in our updated guidance. On a geographic basis, North America was down 2% and international grew 4%. Looking on Slide 8 for an update on the year and starting with the top line, we are raising our full year organic growth guidance to 11% to 12% due to the strength of our Q3 organic growth performance and projecting current levels of demand, which remains strong across most of our businesses. But we are also anticipating further slowing in the end markets we talked about, including global residential construction, automotive aftermarket, commercial welding and appliance components, that combined represent about 20% of total company revenue. The MTS acquisition is expected to add 3% to revenue and at current exchange rates, currency translation will reduce revenue by 5%, resulting in total revenue for the year up 9% to 10%. For Q4, we are well positioned to deliver a strong finish to a very strong year with organic growth of approximately 10% and GAAP EPS growth of about 40%. In Q4 and consistent with our previously announced plan to divest certain business units, we completed the sale of a division within the Polymers & Fluids segment, with an estimated after-tax gain of $0.45 per share. We have included this Q4 gain in our updated full year guidance. And per our usual process, we have narrowed the range for the year with one quarter to go and updated our guidance to reflect current foreign exchange rates, which results in additional foreign currency headwind versus our prior guidance. So as a result of including the gain on sale and updating guidance with current foreign exchange rates, our updated full year GAAP EPS guidance range is $9.45 to $9.55. We are projecting operating margin of approximately 24% for the full year, which includes approximately 100 basis points contribution from enterprise initiatives, about 200 basis points contribution from volume leverage and estimated 100 basis points of negative margin impact from price/cost and about 50 basis points of margin dilution from the acquisition of MTS. We expect free cash flow conversion of approximately 80%, which, as we have talked about, is below our typical 100% plus conversion rate due to the intentional near-term working capital investments that support the company’s double-digit revenue growth, mitigate supply chain risk and sustained customer service levels. And finally, share repurchases are now expected to be $1.75 billion for the full year, an increase of $250 million versus prior guidance. Looking forward, we are obviously not immune to the macro challenges and uncertainties that may lie ahead. But through the execution of our enterprise strategy, we have positioned this company to deliver top-tier results in any environment, as reflected in our differentiated performance at the depth of the pandemic and in the very dynamic and challenging conditions that have characterized the recovery over the last 2 years. We remain confident that the combination of the powerful competitive advantages we derive from ITW’s proprietary business model, our high-quality business portfolio and our team’s proven ability to consistently execute at a very high level ahead well prepared to continue to outperform in whatever economic conditions emerge in 2023 and beyond. With that, Karen, I will turn it back to you.

Operator:

[Operator Instructions] Your first question comes from the line of Scott Davis from Melius Research. Your line is open.

Scott Santi:

Good morning.

Michael Larsen:

That is correct. So we are going – we’re expecting that if inflation stays where it is, and so based on the known increases and decreases and based on the price that we expect to realize in the fourth quarter, that price/cost will be accretive on an EPS basis and also, for the first time in a while, accretive on a margin basis as well.

Scott Santi:

Well, we’ve talked about this before, but one of the fundamental elements of 80/20 is that we are – that we have a very flexible cost structure. So we are – we do a lot of outsourcing upstream. We want to assemble. We want to control the manufacturing elements that really matter from the standpoint of control of quality-controlled delivery. But we don’t necessarily have to bend all the metal. We don’t have to necessarily do all the upstream work. And so what that gets us fundamentally, in fact, we prefer not to, and what ultimately that gives us is a relatively flexible cost structure. So we are a read and react company. Our businesses are going to respond to whatever the demand is that sits right in front of them. We’ve talked about that before. We don’t do a lot of forward forecasting. We are producing today what our customers bought yesterday. And as demand rates start to decline in places like construction, then those adjustments will take place real time.

Scott Santi:

Thank you.

Tami Zakaria:

Hi, good morning. How are you?

Tami Zakaria:

So I have two quick ones. The first one is, can you comment on which end markets you’re anticipating for this slowdown? Meaning the 10% implied fourth quarter organic growth, are you currently run-rating above that but you’re anticipating further slowdown and hence, you’re guiding to about 10%?

Tami Zakaria:

Are you able to share like what the current run rate is?

Tami Zakaria:

Got it, got it. Okay, that’s helpful. And then the second one, can you comment on the price versus volume you saw in the third quarter? Because the last time you raised organic growth guidance earlier this year, I think you had mentioned that you saw some volume pickup. Did that sustain? Like what’s the expectation for price versus volume in the fourth quarter?

Tami Zakaria:

Got it. And you expect volume to sort of sustain in most of these end markets in the fourth quarter as well?

Tami Zakaria:

Okay, perfect. Thank you so much.

Operator:

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

Scott Santi:

Hi, Andy.

Michael Larsen:

Well, I think what we’ve seen is primarily a slowdown on the residential side, which is about 80% of our business. And we talked about softening on the international side here on our call last quarter. And so we did see Europe down 1%. I think that’s pretty broad-based, UK, Continental Europe at this point, given some of the challenges, that’s probably what you would expect. Australia and New Zealand is also slowing here. And as the comps get a little more difficult, you’re going to see those growth rates start to come down. I think in North America, there is still a fair bit of, obviously, strength in the business. And then late in the quarter, we’re really starting to see the order rates starting to come down on the residential side, so…

Andy Kaplowitz:

Totally understand. And then maybe just backing up, what you’re seeing across your industrial businesses, I mean, you talked a lot about the consumer businesses. Obviously, most of those businesses in the 20% are consumer facing. Have you seen any incremental weakness in your CapEx type businesses? Are they generally holding up?

Andy Kaplowitz:

Good enough. Thanks, guys.

Joe Ritchie:

Thanks. Good morning, everyone.

Joe Ritchie:

So nice to see the incremental margins ex MTS come back. Just given the comments that you’re making around price/cost and turning positive, if inflation kind of holds at these levels and we’re closer to peak inflation, would you expect to continue to achieve the same type of incremental margins going forward?

Joe Ritchie:

Okay, okay. Great. And then you mentioned, Michael, that 23% of your business in Europe, obviously, there is a lot of concern out there as we head into the winter on rising energy costs and potential recession in the region. I know that you guys have given already some color around trend, but just maybe anything else that you can kind of tell us about that region and then specifically from a cost perspective, how that impacts your business?

Joe Ritchie:

Okay, great. Thank you.

Jamie Cook:

Hi, good morning. Congrats on a nice quarter. I guess my first question, I know on the top line, you addressed the trends that you were seeing in construction. I was surprised a little bit on the margin in the quarter. So if you could first provide a little color around that, that would be helpful. And then I’ll...

Jamie Cook:

Okay. And then I know you didn’t want to answer in terms of as we’re thinking about the organic growth, which surprised on the upside. I know you don’t want to answer what you’re seeing in terms of price versus volume, but is there any update you can provide on which segments you’re seeing the most success in terms of gaining market share and how sustainable you think this market share is going forward? Thank you.

Jamie Cook:

Okay, thank you.

Joe O’Dea:

Hi, good morning.

Joe O’Dea:

Can you talk about the raw materials and sourced components waiting within COGS? And then sort of what you anticipate in terms of the timing of seeing each of those start to sort of flow through with maybe a more favorable situation in the P&L?

Scott Santi:

I think just – I think the question was more in terms of our cost of goods, what percentage of those are material costs.

Joe O’Dea:

Just kind of – yes. So all that was helpful. And I guess related to this, just with raw mats coming right, will raw mats flow through perfectly…

Joe O’Dea:

I think as components that you source, will you get cost down on that or do you think that’s a trickier dynamic?

Joe O’Dea:

Yes, okay. And then I wanted to ask one about the fourth quarter margin, excluding the divestiture. I’m getting something like a 50 basis point sequential decline from 3Q to 4Q. If that’s accurate, can you just help with the bridge? I assume there is a little bit of sort of sequential decremental on lower revenue, but then price/cost should be more favorable. Just any other items to kind of consider in that bridge?

Joe O’Dea:

Got it. Thank you.

Steven Fisher:

Thanks. Good morning. Just wanted to clarify on the construction side of things, you mentioned the slowing in Q4 on the U.S. residential piece. But I didn’t hear any follow-up comments on the commercial piece. Is that expected to slow too?

Scott Santi:

On the commercial?

Steven Fisher:

Okay. So, maybe that would be something more like a 2023. I guess related to that, have you done any analysis to kind of look at the various stimulus programs that have been put in place and kind of to assess how that might end up flowing through your businesses?

Steven Fisher:

Okay. And just one clarification maybe on the last question about the margin in Q4. I guess are there any particular segments that you anticipate margins actually improving in the fourth quarter or any that stand out kind of one direction or the other?

Steven Fisher:

Okay. Thank you very much.

Stephen Volkmann:

Hey. Good morning guys. Sorry, maybe beating a bit of a dead horse here. But I just wanted to make sure I get this right because it feels like there is a lot of declining prices in various inputs from commodities to transportation, even energy. Are you seeing any of your input costs actually declining yet?

Stephen Volkmann:

Okay. That makes sense. Thank you. And then just curious, can you update us on where you are with the various divestitures? Is there – should we be expecting more here? Are you kind of ramping that back up or is it just kind of whenever it happens?

Stephen Volkmann:

Got it. Thank you.

Julian Mitchell:

Thanks very much and good morning. Maybe one element I just wanted to dial into again was around sort of inventories and the cash flow outlook. So, the conversion only around, I think 80% now this year, which is obviously somewhere below your very high standards. I think Michael, you were quite guarded as to the pace of when that cash flow conversion comes back up. So, maybe help us understand how you see inventories at the customer level, the pace of your own inventory liquidation and how you are thinking about capital spending within the cash flow.

Michael Larsen:

Yes, obviously. So, it’s not a matter of whether or not we are going to benefit from working capital coming back down to normal levels. That we are sure of, we just don’t know when. And in the near-term, we are absolutely committed to what Scott talked about, which is intentional working capital, including inventory to support double-digit growth and significant market share gains. So, we will update you if and when that changes. And then we will let you know what we think exactly the – how it might play out from a free cash flow standpoint.

Michael Larsen:

Well, CapEx, I mean I think we have always funded every good project inside of the company, including during the pandemic, and I think that’s going to continue. We are really fortunate that we are not a capital-intensive business, not – we are a pretty asset-light business model, as Scott described earlier. And so at maybe less than 2% of sales, CapEx doesn’t suck up a significant amount of our total cash flow. So, we are very comfortable with continuing to invest in the business as we have done for many years, including throughout the pandemic.

Michael Larsen:

Well, yes. So, we think that the growth is sustainable. We have not seen anything to suggest that it’s slowing down. We are obviously a big beneficiary from all the growth on the semi side of things. But also on the CapEx side with our Instron business, which I think you are familiar with, we are seeing double-digit growth. On the – everybody’s electronics business, I think is a little bit different. I think when I just look at the businesses in there, including electronic assembly, contamination control, the pressure-sensitive adhesives, we are still showing really solid double-digit growth. North America up 18%, international up 16%. So, there is still some supply chain issues, but I think the team is doing a great job staying on top of those and gaining share. And so we feel very good about the outlook for the Test & Measurement and Electronics business.

Operator:

Your next question comes from the line of Mig Dobre from Baird. Your line is open.

Michael Larsen:

Yes. I don’t know, Mig, that I can tell you something I didn’t say already. I think if you take our full year guidance and the fourth quarter kind of implied, as we said, organic growth of about 10%, solid incrementals in our normal range, maybe a little bit higher than that. Operating margins improved more than 100 basis points on a year-over-year basis. We would expect another 100 basis points from enterprise initiatives. Price/cost goes from negative to slightly positive from a margin standpoint and also positive accretive to income, as I have said. So, those are kind of the high-level view on the fourth quarter. And again, we are not – we have adjusted our run rates on the top line, which is a little bit different than in prior years. We are just wanting to be a little conservative, hopefully, and account for some of the softness we are seeing in about 20% of the company, but also incorporate a lot of strength in the businesses that we talked about, including Auto, Food Equipment, Test & Measurement, Welding. And so that’s maybe – those are kind of the key elements of the fourth quarter.

Michael Larsen:

I think I said this earlier, Mig. The reason why we are taking the EPS number down is incremental foreign currency headwind by incorporating current foreign exchange rates like we always do. So, that’s what’s accounting for the EPS adjustment.

Operator:

And your final question comes from the line of David Raso from Evercore ISI. Your line is open.

Scott Santi:

Yes. Go ahead. I was just going to say, David, we don’t – it’s a little early in the planning cycle for us in terms of ‘23, number one. Number two, I would say, given our sort of traditional delivery and lead times, which are relatively short, we don’t get a lot of forward visibility even in our CapEx businesses. So, regardless of what anybody has to say in terms of their outlook for the year, that’s going to certainly be a number that’s going to move around. In our sort of core operating MO is that we are going to produce what – based on what orders we are getting today, we are not going to sort of bite on our forecast on how optimistic or pessimistic, and we have the flexibility in our systems to do that. So, I don’t have a lot of forward, we don’t – coming back to our businesses and our customers, we don’t have a lot of input in terms of strong points of view one way or the other at this point.