Q2 2022 Illinois Tool Works Inc Earnings Call
Okay.
Good morning, My name is David and I'll be your conference operator today at this time I'd like to welcome everyone to the ITW second quarter earnings Conference call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you'd like to ask a question. During this time simply press. The Starkey followed by the number one on your telephone keypad, if you'd like to withdraw your question Press Star one once again for those participating in the Q&A, you'll have the opportunity to add.
One question and if needed one follow up question.
Thank you Karen Fletcher Vice President of Investor Relations you May begin your conference.
Thank you David.
Morning, and welcome to ITW second 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 second quarter financial results and update our guidance for full year 2022.
Slide two is a reminder, that this presentation contains forward looking statements. We refer you to the company's 2021 and 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 our press release.
Please turn to slide three and it's now my pleasure to turn the call over to our chairman and CEO Scott Santi. Thank you Karen and good morning, everyone.
The ITW team delivered another quarter of strong operational execution and financial performance with organic growth of 10, 4%.
Operating margin of 23, 1%.
After tax return on invested capital of 27, 8% and GAAP EPS of $2 37.
In the second quarter, we saw continued strong demand across our portfolio.
Supported by our 80 20 front to back driven operational capabilities. Our teams continued to do an exceptional job of delivering for our customers and aggressively executing our win the recovery strategy to accelerate profitable market penetration and organic growth.
As a result of our Dana just operational execution and delivery performance, we are being rewarded with meaningful additional shared by our customers.
As evidenced by our 10, 5% organic growth in the first half of this year.
While input cost inflation and supply chain issues remained challenging we did see some stabilization on both fronts in Q2.
In fact for the first time with two years price cost margin dilution headwind improved sequentially.
Negative 250 basis points in Q1 to negative 160 basis points in Q2.
As our business has continued to do an excellent job of adjusting price to offset input cost inflation.
And the pace and magnitude of input cost increases moderated somewhat.
Importantly, our teams delivered these strong operational and financial results, while continuing to drive meaningful progress on the execution of our long term enterprise strategy.
They delivered another 90 basis points of margin improvement from enterprise initiatives in the quarter.
Based on our first half results and projecting current demand and supply rates through the balance of the year, we are maintaining our guidance for full year 2022 with organic growth of eight 5% at the midpoint.
Margins in the range of 24% to 25%.
And GAAP EPS of $9 20 at the midpoint, which would be an all time record for the company.
Excluding one time tax items in both years this represents EPS growth of 12%.
While the near term environment remains challenging and the global macro is certainly uncertain.
<unk> remains strongly positioned to continue to deliver differentiated performance for our shareholders differentiated service to our customers and continued progress on our path to Itw's full potential performance through the back half of the year and beyond.
And with that I'll turn the call over to Michael who will provide more detail on the quarter and our full year outlook Michael.
Michael Thank.
Thank you Scott and good morning, everyone.
In Q2 quarterly revenue grew 9% and exceeded $4 billion for the first time since 2012 with strong organic growth of 10, 4%.
The MTS acquisition contributed 3% of revenue.
Foreign currency translation was a 4% headwind.
Despite 10 cents of year over year, EPS headwind from foreign currency translation, and <unk> <unk> of higher restructuring expense.
EPS was $2 37, and the second highest quarterly EPS ever.
By geography, North America grew 14% and international grew 6%.
With 6% growth in Europe , and 3% growth in Asia Pacific.
China organic revenue was down 4%.
And we estimate that the China lockdowns reduced our organic growth rate by about one percentage point at the enterprise level, which we fully expect to recover in the second half.
Operating margin was 23, 1% with operating leverage of 200 basis points and 90 basis points of enterprise initiatives.
Margin headwinds included 50 basis points, each from the MTS acquisition and higher restructuring expense related to 80 20 front to back projects.
And the margin dilution impact from price cost was 160 basis points.
Free cash flow was $420 million, an increase of 69% versus Q1.
So we remain committed to intentional working capital investments to support growth mitigate supply chain risk and sustained service levels for our key customers.
The routine resolution of a U S tax audit resulted in a onetime tax benefit of <unk> 16 cents.
And as you May recall Q2 last year had at 35, one time tax benefit.
As a result, our Q2 tax rate. This year was 18, 3% as compared to 10, 1% last year.
Excluding these onetime tax benefits the effective tax rate was 23, 9% this year and 23% last year.
Please turn to slide four with a look at price cost.
At the beginning of the improvement trend in margin dilution that Scott mentioned.
Thanks to our businesses decisive price actions throughout this inflationary cycle. We have stayed ahead of inflation on a dollar per dollar basis.
And the seemingly endless barrage of cost increases over the last 12 months appear to have leveled off such that we are beginning to recover the margin dilution impact.
Based on all known cost and price increases. This positive trend is projected to continue such such that the margin impact is expected to be neutral in the second half.
Throughout this two year inflationary cycle, while we have more than covered cost increases on a dollar for dollar basis, we have absorbed as much as 250 basis points.
The margin dilution impact.
As raw material cost inflation begins to moderate on a year over year basis, we are confident.
And we're going to recover this margin impact hopefully starting in 2023.
Moving onto the segments automotive OEM delivered solid organic growth of 6% with 18% growth in North America.
Europe was down about 1% and China was down 11%.
At this point and consistent with our prior guidance, we do not expect a meaningful improvement in the chip shortage situation impacting auto production until 2023.
And in fact, our guidance assumes that automotive productions remains around current levels for the second half.
Well, we are getting positive signals from several of our customers in terms of preparing for a Q3 and Q4 ramp up in auto production. We are taking a more conservative approach to our guidance per our usual process.
And even with revenue around current levels keep in mind that the year over year comps ease in the second half.
Which sets the automotive OEM segment up as a meaningful contributor.
So the overall organic growth rate of the enterprise through the balance of the year.
Operating margin was 17% when excluding 270 basis points.
820, <unk> tabak restructuring impact this quarter.
As supply chain issues get resolved down the road and auto production ramps up we're confident that we'll see some strong organic growth rates for an extended period of time.
And a return to the segments historic margin rates in the low to mid twenties.
Let's turn to slide five for food equipment, which led the way this quarter with an organic growth rate of 25%.
Record quarterly revenues of $614 million and operating margin of 24, 7%.
North America grew 27% with double digit growth in every major category and end market.
Both restaurants and institutions were up around 40% and retail growth was in the mid teens.
International revenue grew 23% with Europe up, 25% and Asia Pacific up 11%.
Orders remained very strong in this segment.
Test and measurement and electronics revenue grew 15%.
With organic growth of 1%, which as you know is uncharacteristically low for this segment and entirely due to the timing of a large equipment order for an.
In electronics customer in Q2 last year.
Adjusted for that order segment organic growth would have been about 7%, which.
Which is a more accurate representation of how strong the order intake is.
Test and measurement organic growth was 8% with continued strong demand for capex as evidenced by installing in strong growth of 5% as well as continued strength in semiconductor related end markets.
Moving to slide six.
On another positive note welding as organic growth was also strong at plus 22% with equipment up 24% and consumables up 19%.
Industrial grew 29% in the commercial business was up 19%.
North America, which is about 80% of our sales grew 25%.
Oil and gas was up 8%.
Sequentially from Q1 revenue was up 8% with continued strong order intake operating margin improved 80 basis points to 29, 3%.
Polymers and fluids grew 10% organically with polymers up 25% on continued strength in MRO and heavy industry applications Automd.
Automotive aftermarket was up 4% in fluids grew 3%.
On a geographic basis, North America grew 8% and international was up 13%.
While sequential revenue grew from Q1, we did see some slowing demand in our automotive aftermarket business as consumers are dealing with rising inflation and gas prices.
On to slide seven.
And construction delivered strong organic growth of 15% with continued strength in North America, which was up 29%.
U S residential grew 34% and commercial was up 20%.
While Europe , and Australia, and New Zealand were up 5% and 4% respectively. The international businesses started to show some signs of slowing in their order rates towards the end of the quarter.
Specialty was the only segment that didn't grow with organic revenue down 2% as supply chain constraints caused a delay in the delivery of some larger international equipment orders that are now on track for the second half.
On a geographic basis, North America was up 5%, while international was down 13%.
Okay, let's turn to slide eight for an update on our full year 2022 guidance, which remains unchanged.
Per our usual process our guidance is based on our actual results year to date.
And our projection of current levels of demand through the balance of the year.
As a result, our organic growth projection of 7% to 10% remains unchanged.
The acquisition of MTS is projected to add 3% of revenue.
And based on current foreign exchange rates the headwind from foreign currency translation is now 4% versus our prior expectation of one 5%.
We are maintaining our full year GAAP EPS guidance range of $9 to $9 40.
And compared to our prior guidance on May 3rd the one time favorable tax benefit of <unk> 16 in Q2 was offset by <unk> 20 of additional EPS headwind.
Foreign exchange, which is now embedded in the outlook.
Our operating margin margin guidance is unchanged at 24% to 25% with about 100 basis points contribution from enterprise initiatives.
Price cost margin dilution impact is unchanged at 100 basis points, which implies that the second half margin dilution impact is about neutral as compared to 200 basis points of headwind.
In the first half.
Finally, there is no change to free cash flow generation or share repurchases of $1 5 billion.
And our tax rate for the full year is expected to be in the range of 22% to 23%.
We've often talked about the fact that Itw's account company that can deliver top tier results in any environment.
And this year is no exception.
We're obviously not immune to the macro challenges and uncertainties that may lie ahead, but we remain confident that ITW is very well positioned to continue to deliver differentiated best in class performance.
As we leverage our diversified high quality business portfolio, the competitive strength of Itw's proprietary business model and.
And our team's proven ability to execute at a very high level in any environment.
With that Karen I'll turn it back to you Okay. Thanks, Michael and David Let's open up the lines for questions. Please.
Thank you at this time I'd like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad as a reminder for those participating in the Q&A you will have the opportunity to ask one question and if needed one follow up question, we'll pause for just a moment to compile the Q&A roster.
Will take our first question from Andrew Kaplowitz with Citi. Your line is now open.
Hey, good morning, everyone.
Andy.
Scott or Mike could you give us a little more color on underlying demand trends youre seeing in your more consumer versus capital goods businesses. I know you mentioned just tough comparison electronics some slowing in auto aftermarket, but you know obviously, we all have an increased focus on macro slowdown are you seeing signs of moderating demand or is consumer still holding up.
I'll go ahead go ahead.
I think Michael.
Told you exactly where we're seeing it which is a couple of pockets.
One is the auto aftermarket business for reasons that are pretty logical related to the gas prices and consumers' discretionary spending.
Net.
Arena and then the other is our international construction businesses that we did see a little bit of a pullback.
Those two are those businesses combined represent I think less than 15% of the company's overall revenues and for the other 85% we see things remain very strong.
That's helpful. Scott and then Michael I think you had talked about 200 basis points of price cost impacting in Q2, and I think I read out at 160 <unk>. So maybe you can give us a little more color on how you're thinking I know you said neutral for the second half of the year, but obviously commodity prices have come down pretty significantly lately. So how long does it take for that to read through it.
Is there maybe some upside to that second half neutral forecast.
Well I think I explained Andy kind of how we do this I mean based on all of the known price and cost increases as we sit here today.
We expect.
And decreasing and decreases in certain cases.
All of those things are cost decreases to all of those things are baked into our.
Assumption today, and when you project that in a pretty mechanical calculation. So theres no assumption here that things get better or worse, it's based on what we know today.
That margin dilution impact is.
Is essentially neutral here in the second half of the year and that's how you get that 200 basis points swing.
In the second half of the year relative to the first half of the year.
I tried I appreciate it Michael.
Yes.
Next we'll go to Tami Zakaria with Jpmorgan. Your line is open.
Hi, good morning, Thanks for taking my questions.
A quick follow up on what you said.
I think you mentioned some weakness in international construction.
And market is that focus on both whereas the non drowsy for you.
Yeah. The biggest positions we have in both of those markets is by far residential so.
Mostly speak too.
What's going on in those markets in the residential side in both Europe , and Australia, and I would just add to that I mean, we are also seeing.
A lot of strength in other parts of the company, so while less than 15% may be experiencing a little bit of a slowdown.
Some of the other segments food equipment welding test <unk> measurement electronics.
We are off to a really strong start here in Q3.
If you just look at our July numbers overall for the company on a year over year basis were up 18%.
So that is the highest monthly organic growth rate.
We've seen all year sequentially from June .
We are up in July where typically we are down.
And actually five of seven segments are growing double digit so theres a lot of strength.
In other parts of the company that at.
At least for the month of July are offsetting some of the slowing we've seen in the parts of the company that we've talked about.
Got it got it that's super helpful color and along the same line.
Has your expectation for overall.
Organic growth in Europe chains.
Since the beginning of the yes. The reason I ask it seems like some people are thinking Europe would be in a recession in the back half.
Does that alter your expectations for the region in the near term.
I think we are pretty close to where we were on our last call, which I think we said, we expect kind of low single digit type growth rates.
In in Europe based again on current run rates as you know we're not.
Assuming any change in the macro other than kind of what we're seeing today.
We are in Europe , I should say we are hearing.
Some positive.
We are getting some positive signals like I said in the script from our automotive customers in terms of potential ramp up in production here in <unk>.
In September and Q4.
And likewise, that's not baked into our guidance as we sit here today. So I hope you get the sense, there's a lot of puts and takes across the company and overall were.
We're on track to a really strong second half for the company.
Great. Thank you so much sure.
Okay next we'll go to Jeff Sprague with vertical research. Your line is now open.
Hey, Thanks, good morning.
Before my question, how can we just clarify Michael interesting color on July actually that we set in July .
The 85% that's not under pressure is up 18% for the total company is up 18%.
The total company.
Yeah on any one of those.
Basis.
No other company is up 18% here in July .
That's interesting and surprising good to hear.
I'm just curious on welding.
I would've guessed perhaps that.
Seeing that.
While the number and welding that maybe oil and gas would have been stronger than up 8%. So it sounds like it must have been pretty broad based strength across.
Most of the markets that you can kind of see into but maybe you could give a little bit of color there what's going on in welding.
From a vertical market standpoint, and any color on what's going on maybe in the channels yes.
As you know 80% of our business is North America, and Thats, where the strength was up 25%.
And really.
You heard equipment up 24, consumables up 19 strength in industrial and commercial and then the international side.
Was up 8% and that's where our primary oil and gas exposure resides.
Europe was up 20% and then.
The China business was down which was the Lockdowns again, so down about 6% and we like I said earlier I fully expect to recover that here in the in the back half of the year, but a lot of strength.
In the North American business for sure and I would be remiss, if I didn't point out the margin performance.
Of north of 29% operating margin, so a really strong quarter for the welding.
Business and in Q3 is looking.
Is looking really good so far.
Just maybe a little additional color on the real strength there in Q2 was the industrial side.
Think Jeff part of your question was related to the channel and Thats, not a product or category of products that typically is inventory and AR.
Significant degree the channel these are.
Larger more complex products machines and systems and are typically sold into end users for.
Specific projects, so theres not a lot of channel inventory at any point on those products.
Great appreciate the color thanks, guys sure.
Next we'll go to Scott Davis with Melleous Research. Your line is now open.
Good morning, everybody.
Good morning, Scott.
Just to be clear.
You don't disclose price explicitly but is price still going up net realized price still going up.
Yes.
Okay.
We are still.
There is a lag here.
As you know from the time, we see the cost increases to the price is being realized that is somewhere between one to two quarters and we are still.
In catch up mode here in the second half of the year.
Obviously on a margin basis, we talked about that and also on a dollar basis.
Okay, that's what I thought I just wanted to clarify and then yes.
I know obviously, the FX has a translation impact, but it can have a trade impact can you remind us what businesses.
We are doing much export.
We do almost done.
Yes, sorry.
Sorry.
Got it and let you finish your question I was just going to say we are we are producing locally and sell locally we do very little cross border commerce, either on the input side or the export side.
There's a little bit here and there but.
Lesson.
Based on our revenue overall it sounded like.
2% of our imports.
China, I mean, it's really de Minimis, where produce where we sell company. Our suppliers are local our customers are local so our exposure is largely translation. So we are sourcing the same currency that we are producing and selling in.
And the vast majority of cases right.
Alright helpful. I'll pass it on good luck. Thank you. Thank you.
Next we'll go to Joe O'dea with Wells Fargo. Your line is open.
Hi, good morning, Thanks for taking my questions.
I wanted to start on the consumer and for the <unk>.
Less than 15% that you were talking about it and I think you've talked previously where it may be over half of revenue.
Broadly tied to consumer but can you help kind of segment that a little bit in terms of where you might have consumer exposure that would be a little bit more tied to something like overall consumer confidence and where you would have exposures that are a little bit more maybe durable in terms of demand trends and not as tied to what we would think about as sort of pressures related to abroad.
Consumer slowdown.
Yes, I think Joe we really highlighted the two big ones, which is construction and residential.
And then the automotive aftermarket business.
The other one that I would add is in our specialty business, we do a fair amount of consumer packaging still beverages.
And resealable.
Closures for things like Chi.
Cheese and other food products that I think is generally proven to be pretty resilient.
During times of economic contraction consumer Staples basically.
Okay.
Got it.
And then on supply chain.
PMI yesterday.
For July means still showing very extended lead times I think you talked to stabilization, but I'm, assuming that means exactly that not that things are getting better.
You talk about sort of any any visibility that you have into timing of supply chain starting to improve a little bit from a point of stabilization.
What I would say overall as we have no visibility to any improvement we are not planning on it I'm sure that it will get better at some point I think we have been in our business has been very resilient in terms of working their way through.
Various issues and challenges.
Computer chips, you name it and we're finding a way to serve our customers and that's that remains I think the posture that we have.
And.
Until it changes, we're not changing what we're doing and I think we're on it but.
It's still not easy.
I appreciate it thanks.
Next we'll go to Stephen of Volkman with Jefferies. Your line is open.
Hi, Good morning, guys I was wondering maybe if we could just go back to the price cost margin dilution charge.
I'm, assuming there's some sort of a linear relationship here in the <unk> is probably still a small headwind and the exit rate for <unk> is probably a tailwind is that a reasonable.
Expectation.
As we sit here today, I think thats, a reasonable expectation yes.
And so Michael I'm trying to think a little bit further into 'twenty, three and just rather than think about volumes there'll be whatever they are but youre going to have a few things kind of moving here in terms of sort of price cost in them.
Dilution from MTS and some of the restructuring that you've done any way to start to think about what incremental margins in 'twenty three might look like sort of when all of a sudden done.
Yes, I think youre right in that there is a lot going on what I can tell you is that as we kind of peel back the onion on our incrementals. So adjusting for all of the things you just talked about MTS restructuring and price cost.
We are right back at our core incremental margins in that 35% range right now and we wouldn't expect anything different.
In 2023, obviously, we haven't done the planning yet but.
That's kind of a long term.
What you should expect from US is incrementals in that 35% range.
Great. That's helpful. Thank you guys sure.
Okay.
Next we'll go to emerge Dougray with Baird. Your line is open.
Yes, thanks for taking the question.
Hey, Mitch.
We're doing this for a while but my name is always push hard on these earnings calls.
Maybe to kind of follow up.
On Steve's question here thinking about 'twenty three.
I'm curious as you're looking at the amount of pricing that you had to put through this year.
Is there a good way to think about the carryover. It that's going to go into 'twenty three relative to 'twenty two from a topline perspective contribution to the topline.
I think it's a little too early Mig I mean, clearly there will be some carryover but.
To try and quantify that right now for you.
I don't think it would be helpful. We've got to get into our planning process, which is really we're talking about November ish before we'll have a <unk>.
Reasonable view on that and I think thats the appropriate time, yes, I think the only thing I would point back to what I've said in the prepared remarks is that.
If you add up the price cost margin dilution impact.
During this cycle.
Over this year and last year of about 250 basis points to expectation as that.
As things begin to normalize we will recover that margin impact.
Overtime now how exactly that will play out and the timing around that is is not entitled here as we sit here today, but there will be.
I think it's reasonable to assume that some of that impact will be in 2023.
Okay.
I guess.
If I may follow up on this.
Probe a little bit about your degree of confidence that the business overall will be able to outgrow industrial production as we're thinking 23.
And beyond.
This has been a big topic right over the past few years, you've talked about winning the recovery.
Investing through the downturn so.
I'm curious if you can maybe update us a little bit on your degree of confidence that we can continue to see outgrowth.
Well I don't know.
Actually what I can do to reassure you other than to tell you that it continues to be the number one dominant priority.
Remember of ITW from.
From China to Europe to North America, and South America.
As it is.
It is.
Certainly.
We've got a terrific opportunity going forward we have.
<unk> done a lot of things in terms of investing.
And positioning ourselves to execute on it and the proof will be in the pudding.
Yes.
But it's already happening.
Yes, I agree with that maybe I mean, I think if you look at the results we've put up.
So far and granted there's some recovery in here, but last year organic was up 12.
The first half is up 10%.
Organic this year.
I think relative to peers.
Certainly closing the gap compared to what we were kind of.
Just a few years ago, So I think yes.
Yes, the proof will be in the organic growth rate numbers that we're going to put up.
But I also will tell you there is a high degree of confidence that we are making significant progress lots more to do but certainly we are headed in the right direction here for sure.
Alright, thank you.
And we will take our final question from Julian Mitchell with Barclays. Your line is open.
Julian.
Julien Your line is open.
Julian Mitchell your line is open.
And maybe on mute.
So sorry about that good morning.
Just wanted to clarify on the margin outlook, because I suppose the margin rate until the margin guide for the year implies.
The fourth quarter margins, there may be up.
Three 400 basis points year on year or something.
I just wanted to confirm that that's roughly the right way to think about the back half guide and maybe what are the main drivers of that big fourth quarter margin uplift.
Yes, I mean, the big driver for the second half year as well.
Just talked about which is 200 basis points of.
Price cost margin dilution impact in the first half that's not projected to repeat in the second half. So that's.
Yeah.
Probably the biggest driver I think you also have to factor in.
If you just run rate if you just take our current.
Revenues and project those into Q3 and Q4, because the comps are easing.
On a year over year basis will be putting up some meaningful organic growth rates.
With all of the operating leverage in the Incrementals that are returning to something.
A lot closer to our historical incrementals in the back half of the year and so those are kind of the big.
The big drivers here less price cost margin.
Headwind.
<unk>.
Significant organic growth year over year with with.
More normal.
Incremental margins.
And that 35%, maybe plus range for the back half of the year.
I understand thank you and then just to follow up on free cash flow.
Thank you will you'll sort of 90%.
Conversion guide for the year on free cash.
That implies I think sort of 50% growth in the free cash year on year in the second half. So just help us understand how did you get that monstrous sort of free cash flow expansion.
Massive sort of inventory destock because supply chains are easing maybe just any color around that because it is a it is a big move for us.
This company is.
Bigger than usual I mean, as you know historically, our second half cash flows are always significantly higher than the first half, it's a little bit more this time.
We've talked about the fact that we've been very.
Intentional in terms of our working capital investments to support the growth that we're seeing double digit growth.
Topline mitigate supply chain risk, which is still.
A reality and then sustained the service levels for our customers. So we will carry whatever inventory we need to do those things.
If you look at our months on hand, we're running right around three months on hand, and we really only need as a slight improvement in that in the months on hand to get to those free cash flow number. So as we sit here today, we do have line of sight to a ramp up in the second half.
But like I said, we think it's a smart use of with this balance sheet.
To support everything we're trying to do from an organic growth standpoint by taking care of our customers and I will say this if we come in at the low end of the range. It won't change anything in terms of our capital allocation plans for the year, we will still do the buyback will still do.
Obviously investments will still do the dividend and so theres really no tradeoff here, but obviously we.
Like to hit that free cash flow number and we have we have line of sight to doing that.
For the back half of the year and we are obviously aware that its a little bit more of a ramp than what we normally have so.
Okay.
Understood. Thank you very much alright, thanks Julien.
Yes.
This concludes today's conference call you may now disconnect.
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Okay.
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Sure.
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