Q3 2024 Illinois Tool Works Inc Earnings Call
Kathleen: Good morning, my name is Kathleen and I will be your conference operator today. At this time I would like to welcome everyone to the ITWU's third quarter earnings conference call.
Kathleen: All lines have been placed on mute to prevent any background noise.
Kathleen: After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number 1 on your telephone keypad. And if you would like to withdraw your question, just press the star 1 again.
Kathleen: For those participating in the Q&A, you will have the opportunity to ask one question and, if needed, one follow-up question.
Speaker Change: Thank you. Erin Linnihan, Vice President of Investor Relations. You may begin your conference.
Erin Linnihan: Thank you Kathleen.
Erin Linnihan: Good morning, and welcome to ITW's third quarter 2024 conference call. Today, I'm joined by our president and CEO, Chris OHerlihy, and senior vice president and CFO, Michael Larsen.
Erin Linnihan: During today's call, we will discuss ITW's third quarter financial results and provide an update on our outlook for full year 2024.
Erin Linnihan: Slide 2 is a reminder that this presentation contains forward-looking statements. Please refer 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.
Erin Linnihan: This presentation uses certain non-GAP measures, and a reconciliation of those measures to the most directly comparable GAP measures is contained in the press release.
Speaker Change: Please turn to slide 3 and it's now my pleasure to turn the call over to our President and CEO Chris OHerlihy.
Chris OHerlihy: Thank you, Erin, and good morning, everyone.
Chris OHerlihy: As you saw in our press release this morning, during the third quarter, the market demand environment continued to moderate across our portfolio, with further softness in the automotive and construction markets.
Chris OHerlihy: Overall, third quarter revenues came in at approximately half a percentage point, or $25 million below what they would have been had demand held at the level we were seeing exiting the second quarter.
Chris OHerlihy: That said, the slowdown in Q3 was less than in Q2, where revenue came in approximately one percentage point, or $50 million below run rate.
Chris OHerlihy: As a result, third quarter organic revenues declined 1%, with five segments down year over year, partially offset by growth in two segments.
Chris OHerlihy: This 1% revenue decline compares to our end markets which we believe were down in the low to mid single digits.
Chris OHerlihy: As we have all year, the ITW team continue to successfully navigate and overcome these market challenges with strong operational execution.
Chris OHerlihy: Those efforts resulted in operating income of 1.05 billion dollars with operating margin of 26.5 percent, which included a 130 basis point contribution from Enterprise Initiatives.
Chris OHerlihy: With little operating leverage, six of seven segments still increased operating margin, resulting in segment operating margin expansion of 110 basis points.
Chris OHerlihy: Thank you for tuning in. We'll see you next time.
Speaker Change: EPS grew 4% to $2.65 excluding the gains from a divestiture that Michael will review in more detail.
Speaker Change: https://www.kenhub.com
Speaker Change: The continued contribution from Enterprise Initiatives, regardless of volume, speaks to the power and resilience of our business model.
Speaker Change: And it is notable that for the first time, three of our segments delivered operating margin above 30% in the quarter.
Speaker Change: and we are well on our way to achieve our goal of 30% operating margin for the company by 2030.
Speaker Change: Our continued focused execution and typical operational excellence have enabled ITW to effectively counter persistent market headwinds and achieve increased profitability while we continue to invest to maximize growth and performance over the long term.
Speaker Change: Consistent with our long-term commitment to return surplus capital to shareholders by an attractive and growing dividend, on August 2nd we announced our 61st consecutive dividend increase.
Speaker Change: Raising our dividend by 7%.
Speaker Change: And year to date, we have repurchased more than 1.1 billion dollars of our outstanding shares.
Speaker Change: Thank you.
Speaker Change: Today we are raising our full year gap EPS guidance by $1.33 from a range of $10.30 to $10.40 to a new range of $11.63 to $11.73 to incorporate the impact of the divestiture gain and a lower projected tax rate for the full year.
Speaker Change: While the ITW team is on a commendable job managing the short-term challenges this year, perhaps more importantly, we continue to deliver solid progress on our next phase enterprise strategy priorities.
Speaker Change: As we outlined to you a year ago, the central focus of the next phase of our enterprise strategy is to elevate high quality organic growth and customer-backed innovation as key ITW differentiators.
Speaker Change: on par with our best-in-class operational capabilities and financial performance.
Speaker Change: This quarter, we made further progress in our journey to achieve this strategic goal.
Speaker Change: We believe that Customer Backed Innovation, or CBI as we call it, is the most impactful driver of our ability to consistently grow revenue above market.
Speaker Change: In essence, the customer-backed innovation revenue of today fuels the ability to drive market penetration and share gain in the future.
Speaker Change: and Christopher OHerlihy.
Speaker Change: Over the past few years, we've made progress on expanding our revenue from CBI from less than a percent in 2017 to approximately 2% today.
Speaker Change: And at our September Leadership Conference, we launched the Next Phase CBI Framework for our 84 divisions around the world.
Speaker Change: https://www.youtube.com or the link in the description to watch another video.
Speaker Change: Just as we successfully focused the entire organization on 80-20 front-to-back over a decade ago, we are now doubling down on customer-backed innovation.
Speaker Change: And I for one can feel the energy, excitement and momentum from our team as they implement this strategy at each division.
Speaker Change: Thank you. Thank you.
Speaker Change: With our continued laser focus and our typical do-what-we-say execution, it is with strong conviction that I know we will build above-market organic growth fueled by customer-backed innovation into a defining ITW strength.
Speaker Change: In concluding my remarks, I want to thank all of our ITW colleagues around the world for their exceptional efforts and dedication in serving our customers with excellence and driving continuous progress on our path to ITW's full potential.
Speaker Change: I now turn the call over to Michael to discuss our Q3 performance and full year guidance in more detail. Michael. Thank you, Chris, and good morning, everyone.
Michael Larsen: Starting on slide three, as expected, the third quarter ended up looking a lot like the second quarter, with continued strong operational execution in a moderating demand environment.
Michael Larsen: Total revenue declined 1.6% with organic revenue down 1.4%.
Michael Larsen: Foreign currency translation reduced revenue by 0.4% and acquisitions increased revenue by 0.2%.
Michael Larsen: On a geographic basis, organic revenue declined about 3% in North America.
Michael Larsen: Europe was down half a percent, and Asia-Pacific was down one percent, with China essentially flat.
Michael Larsen: In this environment, the ITW team continue to focus and execute well on the things that we can control, as evidenced by six of our seven segments.
Michael Larsen: expanding operating margin, driven primarily by enterprise initiatives that contributed between 70 and 180 basis points to each segment, and 130 basis points at the enterprise level.
Michael Larsen: Third quarter operating margin was 26.5 percent, up 30 basis points sequentially from the second quarter, and flat with the prior year due to a tough comparison.
Michael Larsen: As you may recall, last year's Q3 margin of 26.5% expanded to 100 basis points.
Michael Larsen: compared to 2022 due in part to the favorable impact of a few corporate items that we discussed on the call last year including a one-time insurance recovery.
Michael Larsen: Excluding those one-time items last year and looking just at segment operating margin, which is included in the press release tables, our segment operating margin increased by 110 basis points compared to the prior year, which is more in line with our typical margin expansion on a quarterly basis.
Michael Larsen: Thank you. Thank you. Thank you.
Speaker Change: GAP EPS of $3.91 was up 53% and included a $1.26 gain from the divestiture of our non-controlling equity interest in WilsonArt.
Speaker Change: Excluding this gain, EPS of $2.65 was an increase of 4% year-over-year.
Speaker Change: I wanted to spend a minute on the previously announced Willis-Knott divestiture.
Speaker Change: The proceeds from the transaction, net of transaction costs, were approximately $395 million, which we used to reduce our commercial paper balance.
Speaker Change: The transaction resulted in a pre-tax gain of $363 million.
Speaker Change: of $107 million related to the utilization of capital loss carry-forwards, which resulted in the favorable gap EPS impact of $1.26.
Speaker Change: Free cash flow was $783 million, which was a 102% conversion of adjusted net income.
Speaker Change: And as Chris mentioned, in the third quarter we raised our dividend by 7% to an annualized payout of $6 per share.
Speaker Change: which marks our 61st consecutive year of increases.
Speaker Change: And, as planned, we repurchased $375 million of our own shares during the quarter.
Speaker Change: The effective tax rate in the quarter of 14.9% was below our typical tax rate in the 24-25% range.
Speaker Change: As you can see from the reconciliation and the press release, the tax rate was favorably impacted by several discrete items in the quarter, including the WilsonR transaction.
Speaker Change: Excluding these discrete items, our core tax rate was 23.7%.
Speaker Change: So, in summary, the third quarter looked a lot like the second quarter with moderating but also stable demand and solid operating margin and profitability performance as we continue to focus and execute well on the things that we can control.
Speaker Change: Please turn to slide four for a look at our year-to-date segment margin performance.
Speaker Change: And as you can see from the table on the left side, 6 of our 7 segments have expanded their already best-in-class margins year-to-date, and 3 segments by more than 100 basis points.
Speaker Change: Food equipment is a bit of an outlier due to the growth investments in our service business.
Speaker Change: and specifically the near-term inefficiencies associated with onboarding of new service technicians to support accelerated organic growth in this business.
Speaker Change: This margin headwind is now largely behind the food equipment segment, as evidenced by 110 basis points of margin improvement in the third quarter.
Speaker Change: Total company margin is up 180 basis points, which in fairness includes 100 basis points from the one-time LIFO adjustment in the first quarter, but still solid performance.
Speaker Change: in the current environment.
Speaker Change: Thank you. Thank you.
Speaker Change: Moving to the segments and starting with automotive OEM, organic revenue declined 3% in the third quarter as industry build rates continue to come down.
Speaker Change: North America was down 6% as the D3 customer bills were down 9%. Europe was down 5%.
Speaker Change: and China was down 2%.
Speaker Change: Compared to the automobile industry bill data, the segment has outperformed bills by about 200 basis points year-to-date.
Speaker Change: and we expect similar outperformance in the fourth quarter.
Speaker Change: The segment also delivered solid operating margin performance of 19.4%, and 50 basis points increase.
Speaker Change: despite lower volume, and we expect more progress.
Speaker Change: in the fourth quarter and next year as we continue to work towards our long-term goal.
Speaker Change: of Achieving Operating Margins in the Low to Mid-20s by 2026.
Speaker Change: in the segment [inaudible]
Speaker Change: Thank you.
Speaker Change: Turn to slide 5, Organic Revenue and Food Equipment was about flat against a tough comp of plus 6% last year.
Speaker Change: as equipment was down 4%.
Speaker Change: and Offset by Service, which grew 7%.
Speaker Change: Regionally, North America was down 2% after being up 10% last year. With institutional sales about flat
Speaker Change: as health care was up mid single digits and restaurants were down about 10%.
Speaker Change: International was solid, up 3%, with the service business up 8%, and Europe up 4%.
Speaker Change: Operating margin improved 110 basis points due to the service margin normalizing and a solid contribution from enterprise initiatives.
Speaker Change: As we mentioned last quarter, we expect margin to continue to improve.
Speaker Change: as we go through the year.
Speaker Change: Test and measurement and electronics organic revenue was down only 1% after being down 3% last quarter.
Speaker Change: with stable demand in semiconductor, electronics,
Speaker Change: and CAPEX Sensitive End Markets.
Speaker Change: While test and measurement was down 3%, electronics was up 1% in the quarter after being down 3% last quarter.
Speaker Change: and this marked the first quarter of positive growth in electronics since the end of 2022.
Speaker Change: And we're beginning to see increased semiconductor customer activity, suggesting that perhaps we are near a bottom for this market.
Speaker Change: As we've discussed before, we remain very well positioned to capitalize on the growth opportunities in this space when the inevitable recovery does happen.
Speaker Change: Operating margin expanded by 190 basis points in the quarter to 25.7%.
Speaker Change: Moving on to slide 6.
Speaker Change: Welding's organic revenue declined 1%, a meaningful improvement from being down 5% in the second quarter, as both equipment and consumables revenue declined 1%.
Speaker Change: North America revenue was down 2%, but international was up 6%.
Speaker Change: with Solid Growth in Europe and China.
Speaker Change: As we talked about at the beginning of the year, the welding team was planning on a solid contribution to the top line from the launch of new products.
Speaker Change: which in the third quarter resulted in a 3% plus contribution to growth.
Speaker Change: This is just one of many examples inside the company that illustrates how continued progress
Speaker Change: on CBI, as Chris was talking about, gives our segments the ability to gain share and outgrow their end markets.
Speaker Change: Operating margin of 32.3% was the third quarter record for the welding segment.
Speaker Change: Thank you.
Speaker Change: Polymers and fluids organic revenue grew 1% with polymers up 10% due to international strength and fluids was up 3%.
Speaker Change: Automotive aftermarket, which as you know, is tied closely to consumer discretionary spending, was down 3% in the quarter. On a geographic basis, North America declined 5% and international grew 11%.
Speaker Change: with Europe again showing solid demand.
Speaker Change: Thank you. Thank you. Thank you.
Speaker Change: as construction and markets took a sizable step back from the second quarter, with new housing starts down 10% on an annualized basis as compared to down 6%.
Speaker Change: in the second quarter.
Speaker Change: As a result, North America declined 10%, with residential down 12%.
Speaker Change: and Commercial Construction down 7%.
Speaker Change: Europe was down 4% and Australia and New Zealand was down 11%.
Speaker Change: Despite the lower volume, operating margin of 30.2% was a record for the segment.
Speaker Change: with another significant contribution from Enterprise Initiatives.
Speaker Change: Finally, Specialty Products had a solid quarter with organic revenue growth of 6%, with strength across the portfolio as both equipment and consumables were up 6%.
Speaker Change: North America was up 8% and international grew 2%.
Speaker Change: The 6% growth rate for this segment included about 200 basis points.
Speaker Change: PLS or product line simplification in the quarter as we continue to make progress on repositioning some of our specialty products divisions for consistent above-market organic growth.
Speaker Change: We expect about 300 basis points of PLS in the fourth quarter, and that the segment will be flat to up low single digits for the full year.
Speaker Change: A third quarter record for the segment with strong contributions from operating leverage and enterprise initiatives.
Speaker Change: Moving to slide 8 in our updated full year 2024 guidance.
Speaker Change: As you've seen all year, the ITW team continues to execute at a very high level and find a way to leverage our business model and high quality, diversified business portfolio to deliver solid operational and financial results in a challenging demand environment.
Speaker Change: Looking ahead at the fourth quarter, we do not expect the near-term demand environment to improve. And as usual, our guidance is based on current levels of demand, seasonally adjusted, and foreign currency exchange rates.
Speaker Change: As a result, we're maintaining our previous projection for revenue and organic growth to be approximately flat for the year.
Speaker Change: We're also maintaining our full year operating margin guidance, which is projected to be between 26.5 and 27 percent, an improvement of 165 basis points at the midpoint, with enterprise initiatives contributing more than 100 basis points.
Speaker Change: http://TheBusinessProfessor.com
Speaker Change: As you saw in the press release, we incorporated the impact of the Wilson R. divestiture gain and a lower projected effective tax rate of 21.5% for the full year into our EPS guidance.
Speaker Change: as we raised GAP EPS guidance from a range of $10.30 to $10.40 per share by $1.33 to a new range of $11.63 to $11.73 per share.
Speaker Change: excluding the WilsonArt gain, the EPS range is $10.37 to $10.47 per share or $10.42 at the midpoint.
Speaker Change: So in summary, while the overall demand environment remains pretty uncertain and challenging in the near term, we remain laser focused on leveraging ITW's unique strengths and capabilities to optimize our ability to deliver differentiated performance.
Speaker Change: over the long term.
Speaker Change: And with that, Erin, I'll turn it back to you.
Erin Linnihan: Thank you, Michael. Kathleen, will you please open the queue for questions?
Kathleen: At this time, I would like to remind everyone, for you to ask a question, please press star, then the number 1 on your telephone keypad. We will pause for just a moment to compile the Q&A roster.
Speaker Change: and Christopher OHerlihy.
Speaker Change: Karen Fletcher, Erin Linnihan, Christopher OHerlihy
Speaker Change: And your first question comes from the line of Jeff Sprague of Vertical Research Partners. Your line is now open.
Jeff Sprague: Hello. Good morning, everyone.
Jeff Sprague: Morning, Jack. Morning. Hey, I just wanted to sort of pick up sort of where you left off there, Michael, with kind of the trends into the fourth quarter. I don't know, unless my math is right, I think kind of sequentially you're looking at revenues up maybe four or five percent, but normally they decline slightly.
Jeff Sprague: So, you know, was your exit rate in September or your early read in October, you know, kind of better than what we saw in the quarter and aggregate, or maybe you could just clarify if I'm missing anything there.
Speaker Change: Yeah, sure Jeff. So, let me start by saying, as you know, we don't give quarterly guidance.
Speaker Change: Based on our year-to-date performance and our full-year guidance, you can get pretty close in terms of figuring out Q4. But maybe let me try to help out a little bit. So I'd say at a high level, Q4 looks a lot like...
Speaker Change: Q3, you know typically what we see from a seasonality standpoint is a sequential improvement in revenues from Q3 to Q4 about a point to a point and a half and that's going all the way back to
Speaker Change: 2017. So at current run rates...
Speaker Change: Typically, we're up a point to a point and a half. We do have easier comparisons in the fourth quarter. And for what it's worth, there's also an extra shipping day in the quarter. So you add all that up, we get to about...
Speaker Change: flat revenues on a year-over-year basis.
Speaker Change: We expect, again, our typical margin improvement.
Speaker Change: The Enterprise Initiatives and then factoring in a more kind of normal tax rate for us in that 24-25 percent range and you get to EPS at the midpoint
Speaker Change: And I'm just doing the math, I'm not giving guidance that's in that 251 range for the fourth quarter. So, I'll just add, while we're talking about the fourth quarter, we do expect...
Speaker Change: A strong quarter again from a free cash flow standpoint, and we're projecting some meaningful improvement on our inventory levels in the fourth quarter, which is not easy in the current demand environment. So hopefully that's helpful, Jeff.
Jeff Sprague: That's very helpful. Thanks for that color. And then just kind of secondarily,
Jeff Sprague: You know, your business in China is not huge. It's very important for auto though. And it was just kind of interesting that China welding was solid. A lot of cross currents there. Like we had some pretty ugly China numbers out of train and Otis today. Those are different businesses.
Speaker Change: But maybe this is for Chris, can you just maybe give you give us your bigger picture view on what's going on there and
Speaker Change: You know, also just kind of given the importance of auto, anything in this kind of China, Europe, you know, tariffs spat around automotive, you know, influence your view or outlook at all?
Chris OHerlihy: Yeah, so I think from an auto or China standpoint, Jeff, I mean, China bills this year in auto are expected to be up 1%, we expect to be up 8%, so our businesses continue to penetrate very successfully in China.
Chris OHerlihy: Eevee obviously is a large part of the story.
Chris OHerlihy: given the fact that China is producing about 60% of the world's EBs but we're making very strong penetration gains in EB in China as evidenced by the market growth.
Chris OHerlihy: In Ottawa in general we expect to be up a couple of percent against flat bills this year, or sorry, flat versus negative down two bills, so up two percent I would say, as we have been kind of historically and would expect to be on into the future.
Chris OHerlihy: and that strength has been pretty much across all three geographies, Europe, North America, but especially in China.
Chris OHerlihy: https://www.youtube.com
Chris OHerlihy: So maybe we'll just add a little bit of color, Chris. So I think if you'll go to the third quarter.
Chris OHerlihy: about flat.
Chris OHerlihy: with AUTO as we head down to...
Chris OHerlihy: and certainly some challenges also in test and measurement down single digit, low single digits.
Chris OHerlihy: Same in food equipment.
Chris OHerlihy: So strength in welding, which is tied to oil and gas, LNG, transportation, and also some strength in our specialty products appliance business. So you oil that up, you get to about flat for the quarter.
Speaker Change: 6% yitter date, we think, in the fourth quarter. As Chris said, we'll see a pickup on the automotive side, continued strength in welding, and so Q4 should be kind of flat, maybe up.
Speaker Change: low single-digit and the full year, you know up in that 5% range. So as we sit here today, I think we feel pretty good about China. I know there's a lot of talk about
Speaker Change: Stimulus and so forth. We haven't seen a lot of that yet. So if that's still to come that would certainly be You know Helpful, but as we sit here today, we feel pretty good about China
Speaker Change: Okay, thank you for the color. Sure.
Speaker Change: Thank you.
Speaker Change: Your next question comes from the line of Jamie Cooke of Truist Securities. Please go ahead.
Speaker Change: Hi, good morning. I have two questions. One, I was impressed with the specialty growth in the quarter despite headwinds from PLS, and I know specialty is special because there's a lot of different businesses in there, but can you just sort of break down
Speaker Change: you know, what you're seeing within that business, you know, what segments drove sort of the, you know, organic growth? That would be my first question, and then I'll give you my follow-up after that.
Speaker Change: Yes, so Jimmy, I think a good part of the specialty story is strength in aerospace. We have one particular business that's focused on aerospace and again we saw about 30% growth in that business this quarter. We saw, I'd say, pockets of strong demand I think throughout the segment. It was like consumer packaging, consumer packaging equipment were also, you know, pretty strong and we did have some favorable comms in specialty versus last year.
Speaker Change: But, you know, even with all that, we expect special to be, especially to be...
Speaker Change: up kind of low single digits you know for the full year
Speaker Change: And it's really strengthening our conviction that on the basis of the strategic portfolio positioning we've been doing in that segment, which involves some, as we said before, some pipeline pruning throughout the segment, which is certainly choppy and it's creating a bit of a drag, as Michael just indicated.
Speaker Change: a couple hundred basis points this year, but what it does, what this is all doing is really strengthening our conviction that the objective to make a specialty a four percent grower in the long term is well on track here and everything we've seen this year gives us a strong belief that we can do that.
Speaker Change: And I think the only thing I'd add is, Jamie, if you look at the margin performance, you can see what happens at ITW, and this is not unique to specialty, when you get a little bit of operating leverage, you know, suddenly you're in that 31% plus range.
Speaker Change: 30% target at the enterprise level with three segments this quarter above 30%, which is that's the first time that's happened. And again, that's with very little operating leverage. So that's certainly a really, really
Speaker Change: Pretty encouraging as we look also into next year in terms of momentum around the margin performance of the company continues.
Speaker Change: challenging for you guys to do. So it's nice to see that. I guess one more follow-up, Chris.
Speaker Change: You talked about market outgrowth in auto. You talked about, you know, welding from the new product introductions and even on food, you know, the increased service effort. As you go through CVI and you're now, you know, you've been with ITW forever, but CEO, you know, for a longer period of time, are there any businesses that you're considering are more challenged, like over the longer term that you think is going to be tough to get to the organic growth targets that you have? You don't have to say which ones, but just understanding if there's any difference in how you're thinking about the portfolio relative to when you first took over. Thanks.
Speaker Change: Not at all Jamie, I think if we go back to investor day last year we were very overt in our comments that we felt that all seven of our segments have the capability to grow four percent plus and we certainly believe that today and even more so.
Speaker Change: with respect to CBI, the CBI opportunity.
Speaker Change: I think it's very relevant across all seven segments. We're at different points in terms of the development around that, but I think everything we've seen would indicate that all these segments have a pretty fertile innovation environment, have critical customer pain points that are there to be solved. We're certainly mobilizing the company around that. In a very similar way,
Speaker Change: to the way we mobilized the company front to back, you know, 10-12 years ago, with the same kind of capability build and investment and resources.
Speaker Change: a much higher level of leadership, kind of time and focus around CBI. We have lots of great innovation practice across the company and we've now codified that into a very effective innovation framework and this is the exact same approach.
Speaker Change: that we took on 80-20 front to back, which as we know was very successful.
Speaker Change: And we've seen this, I mean this is not something that's starting today. We've been working on this for a couple of years now in terms of focused investment and resources in CBI. And we've seen that in terms of the improvement in yield that we've seen from CBI.
Speaker Change: So there is a lot of conviction here that the yield improvement from 1 to somewhere over 2 today will be north of 3 in due course and we have a very clear path to doing that and like I say that's going to result in improvements in every one of our segments on the ultimate journey to having every one of these segments growing at 4+.
Speaker Change: Thank you.
Speaker Change: Your next question comes from the line of Andy Kaplowicz at CD Group. Please go ahead.
Speaker Change: Good morning, everyone.
Speaker Change: Morning, Andy.
Andy Kaplowicz: Christopher, Michael, I know you've been hopeful about a turn in test and measurement for much of this year, and you did mention maybe more positive discussions with semiconductor customers, and you did see electronics turn positive, so maybe you can give us some more color on the conversations you're having, you know, the outlook, obviously, you're always going to predict run rates, but as you go into 25, do you see a better outlook for the segment?
Speaker Change: Thank you for joining us.
Speaker Change: I think based on the customer conversations that we are having, we're starting to see a bottoming, particularly in SEMI. Just to characterize, SEMI is about 15% of test and measurement, it represents a couple of percent of ITW's revenues.
Speaker Change: Just to put it in context, but there's no doubt that we saw a bottoming and a slight improvement in this, I think, in the third quarter. Electronics, similarly, had been down for quite a while, significantly down earlier this year.
Speaker Change: is starting at the bottom there as well. And then I think an important kind of bellwether for us, the Instron business, which is a critical business within test and measurement, had very solid growth during the quarter. And that's certainly encouraging as we look here for the balance of the year and on into next year.
Speaker Change: Helpful, Chris. And then, Michael, I think you mentioned, I think what you call the solid step back in construction markets in Q3. Do you see any hint of stabilization as you go toward the end of the year in those markets? I mean, obviously,
Speaker Change: and we started a U.S. rate-cutting cycle. Maybe what changed in Q3 versus Q2 in your businesses that led to this step-down?
Michael Larsen: Well, I think, Andy, we're talking about our most interest rate-sensitive segment. So, you know, I think what we're seeing here is a market that's, you know, down in the low teens.
Michael Larsen: our business in North America. Maybe we're a little bit better than that. And then we're seeing similar type of softness in Australia and New Zealand, which is a meaningful part of our business. So I think at this point it's really too early to point to any...
Michael Larsen: signs or indicators that things are getting better here over the long term, you know, certainly the fact that interest rates.
Michael Larsen: has been a leading indicator, but we've not seen anything to suggest that things are picking up in construction at this point. And I'll just say, in that context, I think it's even more remarkable that the team put up margins.
Michael Larsen: of 30% plus here in the third quarter in an environment that's certainly pretty challenging. And about as challenging as we see across the company at this point in the cycle.
Speaker Change: Appreciate it, guys.
Speaker Change: Sure. See you, Andy.
Speaker Change: Your next question comes from the line of Tammy Zakaria of J.P. Morgan. Your line is now open.
Tammy Zakaria: Hi. Good morning, Team ITW.
Tammy Zakaria: Thank you. So my first question is on margins. Very nice margin performance in the quarter. I'm curious, what was price-cost?
Tammy Zakaria: in the quarter, and more broadly, how are you thinking about enterprise?
Tammy Zakaria: initiative and related margin improvement potential in 2025. It seems like almost like an endless well at this point and I mean it positively. So any forward-looking comments about enterprise initiatives and what you're expecting for next year would be helpful.
Speaker Change: Let me do price-cost and then Chris, you can add some commentary on enterprise initiatives. But I think at this point, Tammy, as we said before, price-cost has kind of normalized.
Speaker Change: in 21, 22, and 23. At this point,
Speaker Change: Price dollars are ahead of costs on a dollar basis and modestly Positive from a margin standpoint now that just to be clear doesn't mean that Costs are coming down particularly You know electronics
Speaker Change: energy in certain geographies, components that have labor content. We're also seeing it in our employee costs, health and welfare, and other pockets, overhead costs, such as
Speaker Change: just point out rental.
Speaker Change: expense, leases, software licenses. So we have to continue to be very diligent in this area.
Speaker Change: and make sure that we get price to offset all of these pressures. But overall, nothing...
Speaker Change: Significant to point to on the price-cost equation and then maybe on the enterprise initiatives Chris. Sure.
Chris OHerlihy: So Tami, as you said, enterprise initiatives continue to be an important contributor to results. And how we think about these initiatives is that, you know, these initiatives, they are independent of volume and they're really an outcome of the continuous improvement mindset that's very much part now of ITW's DNA, I would say.
Chris OHerlihy: and this is what really drives this divisional kind of quality of practice and 80-20 front to back in sourcing.
Chris OHerlihy: and you know the typically very bottom-up initiatives driven by you know our talented people in our divisions at a very granular level. Most of these initiatives are in the couple hundred thousand dollar range.
Chris OHerlihy: in terms of individually, but when you have 84 divisions these add up to a very meaningful number. So the divisions have a lot of visibility, ownership and accountability on these and as the track record has indicated over the last 11 years, our divisions can do what they say when they forecast these.
Chris OHerlihy: and the strong continuous improvement mindset that I that I refer to that's really hard word into our divisions at this point.
Chris OHerlihy: And in the case of 8020, as we know, this is the gift that keeps on giving. So with that, we certainly see an ongoing contribution from enterprise initiatives going forward, including in 2025, and this is a fundamental part of how we drive differentiated execution in any environment.
Speaker Change: Got it. That is very helpful. Thank you. And my second question is,
Speaker Change: more strategic, so there's a lot of optimism around.
Speaker Change: You know, data centers, AI, power generation, power demand, so on and so forth. How do you assess these opportunities internally? Do you see an opportunity for ITW to increase its exposure to some of these trends, maybe organically or through acquisitions? So how do you evaluate some of these themes?
Speaker Change: So I think as it relates to data centers specifically, we have standard characteristics of businesses that we would pursue for acquisition based on sustainable differentiation.
Speaker Change: If an opportunity came along that was data center related and met our normal criteria, then we'd be all in based on the characteristics of having a business that could grow above market, that we could leverage our business model, and we could acquire at the right valuation. And that applies to everything, not just data centers. So we don't have a specific focus on data centers. We kind of look at all these things on an equal basis.
Speaker Change: in terms of their long-term attractiveness for us.
Speaker Change: Got it. Thank you.
Speaker Change: Your next question comes from the line of Joe Odia from Wells Fargo. Please go ahead.
Joe Odia: Hi, good morning.
Joe Odia: First just wanted to ask on and kind of specific to North America But but interested in kind of CAPEX versus OPEX trends and I think you know appreciating a pretty quick
Joe Odia: book and ship model. I'm not sure how much you would see this, but we do hear about inquiry activity being better than order activity out there.
Joe Odia: And so, curious the degree to which you see some of that or hear some of that from your Salesforce and customer tone. As you think about rates starting to come down, I think some folks waiting for getting post-election.
Joe Odia: and just the idea that you're getting a sense that there is some pent-up demand that hasn't moved forward with some uncertainty overhang and thoughts on that potentially moving forward nearer term.
Speaker Change: Well, I think, Joe, I'd start by saying, you know, we're not economists, and we're not trying to...
Speaker Change: predict the impossible here, which is where the economy is going. We are, as you said, much more short cycle. Our divisions do a great job kind of reading and reacting to what's going on in their respective end markets. I'll just make a broader comment based on what we saw.
Speaker Change: in the third quarter, which is some stability in the more CAPEX-sensitive businesses. So I'll point to welding. As I mentioned, I'll point to test and measurement, including our Instron business.
Speaker Change: which was up in a meaningful way on a year-over-year basis and improved kind of quoting and order activity.
Speaker Change: So, um...
Speaker Change: Maybe that squares with what you were talking about and then the softness in Q3 was really much more tied to you know construction and automotive production specifically with our customers with the T3 customers, but
Speaker Change: Certainly some stability in CAPEX, and we'll see where it goes from here. We're modeling based on...
Speaker Change: current run rates so based on what we're seeing in our businesses today and we'll see how it all plays out as as we go into 2025 and and interest rates maybe would be a little helpful if they if they came lower for sure so
Speaker Change: I just wanted to ask on CBI as we think about it becoming sort of a growing initiative, what it means on the R&D side and the degree to which you can keep R&D relative to sales.
Speaker Change: at sort of similar levels or what you're doing there, as we would think, you know, to drive more innovation, you might need to allocate a little bit more there.
Speaker Change: Yeah, so for us, you know, spending in R&D or innovation is largely an outcome of basically requests more divisions.
Speaker Change: basically we fund all the good projects. We've been making over the last three or four years making very focused investments.
Speaker Change: in areas like innovation and strategic marketing. We expect that to continue, but if that number was to go up, that's not a problem for us. It's really an outcome of funding all these good projects, and our teams are really focused.
Speaker Change: on their AD opportunities in their markets with their key customers.
Speaker Change: and Alessandro Serrato.
Speaker Change: So will the R&D dollar spend? And you know we don't foresee any significant change in that as we go forward as Chris said
Speaker Change: We really fund every project that our divisions put forward.
Speaker Change: put forward, and that's important to them. And so that's how we approach it here, really in terms of it's an outcome of this process that Chris described.
Speaker Change: I appreciate it. Thank you. Sure.
Speaker Change: Title Microsoft Office Word Document MSWordDoc Word.Document.8
Speaker Change: Your next question comes from the line of Sabrina Abrams of Bank of America. Please go ahead.
Speaker Change: Hi, good morning. Good morning.
Sabrina Abrams: Are you on track for that this year and I understand it's relevant to all seven segments but maybe if you could provide any color on which segments you think are more mature in this journey?
Speaker Change: Yeah, so we're very much on track to do 3% plus in line with our target by 2030, if not indeed before that, based on the progress that we are making.
Speaker Change: We're at varying levels of accomplishment currently across our seven segments. I would point to welding as an example. This year, as we've highlighted, Michael highlighted in his commentary.
Speaker Change: Our welding business is suffering some significant end market challenges, but we're getting north of 3% contribution of CBI in welding, as we forecasted at the beginning of the year, several new product launches.
Speaker Change: being developed, all of which require to be tested, increasing stringency in areas like R&D and in quality control, all of which requires more and more sophisticated testing equipment, which really speaks to our competitive advantages. And then the other one I'd highlight is food equipment.
Speaker Change: Food Equipment, Sustainability, and Areas of Excellence.
Speaker Change: energy savings, water savings, is a very fertile innovation environment and we've managed to leverage that for several years. And the other one of course I point to is auto. Auto given the disruptive nature of auto right now, particularly with the
Speaker Change: increased penetration of electric vehicles provides enormous opportunity for innovation and we're capitalizing on that as evidenced by the fact that our electric vehicle, you know, penetration into electric vehicles is higher than the market average. So feel pretty good about all seven segments but those are the four that I highlight right now.
Speaker Change: I don't know. I don't know. I don't know. I don't know.
Christopher OHerlihy: Thank you.
Speaker Change: And it seems some of the above-average PLS and specialty products is behind us and that business is growing nicely. You guys got rid of WilsonArt.
Speaker Change: Moving past some of this portfolio rationalization, is there more appetite to do M&A, given some of these divestitures are behind us?
Speaker Change: Thank you.
Speaker Change: Yes, I would say our posture on M&A hasn't changed since we outlined this at the Leadership Conference.
Speaker Change: We've got a pretty disciplined portfolio strategy. We believe a clear and well-defined view of what fits our strategy.
Speaker Change: And then obviously, you know...
Speaker Change: acquiring the business at the right valuation to provide a decent long-term return for our shareholders.
Speaker Change: We review opportunities on an ongoing basis, but we're very selective on the basis of these criteria. And if I could point to MTS as an example, MTS was an example of an acquisition we did two and a half years ago, which fulfilled all of our criteria. And thanks to very strong execution, that's now turning out to be a home run on the basis of...
Speaker Change: You know, being pretty selectable, the criteria going in, strong execution when we acquire it. I know we've got a business that in the long term will be a superb ITW business.
Speaker Change: Thank you.
Speaker Change: Your next question comes from the line of Julia Michalof-Marquis. Please go ahead.
Julia Michalof-Marquis: Thank you.
Julia Michalof-Marquis: Hi, good morning. I was hoping this might be one call I could escape AI data sensors, but I think they got dragged in.
Julia Michalof-Marquis: We didn't bring it up, just for the record. No, totally fair, totally fair. If we think just for a second, Michael or Chris, about sort of ...
Speaker Change: Inventories, you know, just curious about your own levels and those of your customers or distributor partners. I think your own inventories, dollar-wise, are pretty steady sequentially this year, but still running a little bit high as a share of revenue versus pre-COVID, you know, maybe 11 percent versus something like 8 percent five years ago, six years ago. Is 11 sort of a good...
Speaker Change: run right from here.
Speaker Change: Oh, no, it should come down over time, but gradually, just as the revenue picks up. And then, how do you assess the sort of state of play of inventories that your distributors and customers, are they kind of generally right size now after two years of being leaned out?
Speaker Change: Yeah, I think that's right, Julian. Let's start there. The channel, I think those inventory levels are, have normalized. You know, our channel doesn't carry a lot of inventory because
Speaker Change: They're used to our kind of place an order today, we ship you tomorrow. So with that level of customer service, there's no incentive for them to carry a lot of inventory.
Speaker Change: And then I was kind of pivoting to our own inventory levels. I'd say just more broadly on free cash flow, it was good to be, you know, above 100% again here in the in the third quarter, which is more in line with the typical levels that you expect from us.
Speaker Change: And we expect to continue to make meaningful progress again in Q4 on inventory and free cash flow.
Speaker Change: The difference here is in that $300 to $400 million range of additional inventory that we'll expect to come out Q4 and then into next year.
Speaker Change: We view that, I think the same way you do, as a big opportunity to drive above-average free cash flow for the company here in the near term. I think we've made some progress, you know, down, I think it's 6% year over year. Last year inventories came down.
Speaker Change: 17%, but we agree that there's some opportunity here, and we want to reduce our maternal levels while maintaining those customer service levels, which is where I started, because we believe they're a real competitive advantage for us. And the last thing I'll say is...
Speaker Change: All of this, the fact that maybe we're a little bit lower this year on free cash flow than
Speaker Change: in prior years, you know, doesn't impact our capital allocation plan.
Speaker Change: We're investing in our businesses for growth and productivity. All new products are funded.
Speaker Change: We raised the dividend 7% in August, and we're buying back $1.5 billion of our shares this year as planned. But I agree with you that there's definitely an opportunity here, and we're going after it in every one of our 84 divisions in a meaningful way here.
Speaker Change: That's a very good answer. Thank you. And then just my follow-up.
Speaker Change: Sort of thinking again about that question of customer-backed innovation and driving up organic growth and market share
Speaker Change: I think as you said, R&D to sales is pretty steady, so maybe flattish dollars year-to-date versus last year. CapEx was sort of flattish year-to-date, down somewhat in the third quarter year-on-year. So when we're thinking about kind of...
Speaker Change: you know the levers of getting that market share up and it's in the context of a sort of decentralized operating structure where you know you're sort of letting the businesses ask you for R&D dollars
Speaker Change: Maybe give us, you know, one or two examples of how you're driving up that share. You know, how does that interplay work between trying to get more dollars of spend into different businesses with a high return?
Speaker Change: versus that kind of decentralized nature. Any sort of examples around that might be helpful for me at least.
Speaker Change: Yes, I would say, Julian, that our spend in innovation has been rising over the last two or three years. I mean, we've seen double-digit increases in spend on the basis of...
Speaker Change: pretty focused investments in strategic marketing and innovation across the portfolio. But a lot of this goes beyond spend. It really comes down to a much higher level of, I think, leadership time and focus. As I said, we're really doubling down on this in the same way we doubled down on 80-20 front to back last time.
Speaker Change: and we've been investing in building capability really for the last few years here.
Speaker Change: And I think you can see that in the increased yield that we've had since like 17-18 where it was about 1% to now where it's about 2%.
Speaker Change: So we're already seeing the investments and this capability build is both in our divisions but also at our segment level, to really enable our businesses to be able to achieve this.
Speaker Change: A lot of this comes down to the quality of the framework. We have a lot of great innovation practice across the company. We've codified that and now we want to make sure that it resides everywhere in every division in ITW and this is the exact same approach.
Speaker Change: that we took on 80-20 front to back that was, you know, very successful in the last phase of our strategy. So, we're on a great path here. We've already seen the outcomes. We expect to see a continuous improvement in CVI contribution every year from here on out, starting in 2025.
Speaker Change: Thank you for joining us.
Speaker Change: That's great. Thanks Chris. Sure, thank you.
Speaker Change: Your next question comes from the line of Nathan Jones of Stifel. Please go ahead.
Speaker Change: Hey, good morning. This is Adam Farley on for Nathan. I wanted to follow up on welding. You know, what impact do you believe the upcoming election is having on the sentiments and the underlying industrial market?
Speaker Change: We've potentially seen an improvement in 25 maybe post-election.
Speaker Change: https://www.youtube.com
Speaker Change: Yes, so at a high level, Nathan, I would say, look, you know, we're a short cycle company, so we're kind of reading and reacting to what's in front of us. There's nothing overt or specific that we're hearing from our customers related to the election, I would say.
Speaker Change: Yeah, I would agree with that. I think there's some, other than anecdotes, anecdotes, there's really nothing specific that we can point to. And, you know, I think that's, we'll kind of leave it at that.
Speaker Change: Okay, fair enough.
Speaker Change: I know it wasn't called out in the press release, but was there any hurricane impact at your sites or maybe at your customer sites?
Speaker Change: No, not in our sites. I can't speak for all of our, you know, thousands of customers in those affected regions, but there was no impact on our facilities or, and thank God, on our people in those areas.
Speaker Change: [inaudible]
Speaker Change: Okay, thank you for taking my call. All right, thanks Adam.
Speaker Change: And Kathleen, I think that ends the call for us today.
Speaker Change: There are no further questions at this time. Thank you everyone for participating in today's conference call. All lines may disconnect at this time.
Speaker Change: Thank you for watching!