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. [Operator Instructions] Thank you, Karen Fletcher, Vice President of Investor Relations. You may begin your conference.

Thank you, David. Good morning, and welcome to ITW's 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 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.

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 continue 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 advantaged operational execution and delivery performance, we are being rewarded with meaningful additional share 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 remain challenging, we did see some stabilization on both fronts in Q2. In fact, for the first time in 2 years, price/cost margin dilution headwind improved sequentially from negative 250 basis points in Q1 to negative 160 basis points in Q2 as our businesses continue 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. And 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 8.5% 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 onetime 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, ITW 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?

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% to revenue. Foreign currency translation was a 4% headwind. Despite $0.10 of year-over-year EPS headwind from foreign currency translation and $0.05 of higher restructuring expense, GAAP EPS was $2.37, 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 1 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 sustain service levels for our key customers. The routine resolution of a U.S. tax audit resulted in a onetime tax benefit of $0.16. And as you may recall, in Q2 last year had a $0.35 onetime 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 4 with a look at price/cost and the beginning of the improvement trend on margin dilution that Scott…

Okay. Thanks, Michael. David, let's open up the lines for questions, please.

[Operator Instructions] We'll take our first question from Andrew Kaplowitz with Citi.

Scott or Mike, could you give us a little more color on underlying demand trends you're seeing in your more consumer versus capital goods businesses? I know you mentioned just tough comparison Electronics, some slowing in auto aftermarket. But obviously, we all have increased focus on macro slowdown. Are you seeing signs of moderating demand as consumer demand still holding up?

Go ahead, Scott.

I was going to say, 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 in that arena and then the other is our international construction businesses that we did see a little bit of a pullback. Those 2 -- 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 it read out of $160 million. 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? And is there maybe some upside to that second half neutral forecast?

Well, I think I explained, Andy, can how we do this. I mean, based on all the known price and cost increases as we sit here today, we expect --

And decrease --

And decreases in certain cases. That's all of those things are cost decreases. All of those things are baked into our assumption today. And when you project that in a pretty mechanical calculation, so there's no assumption here that things get better or worse, it's based on what we know today, that margin dilution impact is essentially neutral here in the second half of the year. And that's how you get that 200-basis point swing in the second half of the year relative to the first half of the year.

Next, we'll go to Tami Zakaria with JP Morgan.

Just a quick follow-up on what you said earlier. I think you mentioned some weakness in international construction end markets. Is that focused on both resi and non-resi for you?

Yes. The biggest positions we have in both of those markets is by far residential. So I think they mostly speak to what's going on in those markets in the residential side in both Europe and Australia.

Yes. 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 & Measurement, Electronics 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, we're up 18%. So that is the highest monthly organic growth rate that we've seen all year. Sequentially, from June, we are up in July, where typically we are down and actually, 5 of 7 segments are growing double digits. So there's a lot of strength in other parts of the company that 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.

That is super helpful color. And along the same line, has your expectation for overall organic growth in Europe changed since the beginning of the year? 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 expectation for the region in the near term? A –Michael Larsen: 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 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 September and in 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, we’re on track to a really strong second half for the company.

Next, we'll go to Jeff Sprague with Vertical Research.

Before my question, can we just clarify, Michael, interesting color on July, thanks for that. When you say in July the 85% that's not under pressure is up 18% or the total company is up 18%.

The total company. Yes, on an EBITDA basis, the auto company is up 18% here in July.

That's interesting and surprising. Good to hear. I'm just curious on Welding. I would have guessed perhaps that seeing that stronger number in 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. So maybe you could give a little bit of color there what's going on in Welding, both from a vertical market standpoint? And any color on what's going on maybe in the channels?

Yes. I mean, as you know, 80% of our business is North America, and that's 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, are fully expecting to recover that here in the back half of the year. But a lot of strength in the North America 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 Q3 is looking really good so far.

And just maybe a little additional color. The real strike there in Q2 is the Industrial side. I think, Jeff, part of your question was related to the channel, and that's not a product -- a category of products that typically is inventory in a significant degree of the channel. These are larger, more complex products, machines and systems and they are typically sold into end users for specific projects. So there's not a lot of channel inventory at any point on those products.

Next, we'll go to Scott Davis with Melius Research.

Just to be clear, guys, I know you don't disclose price explicitly, but is price still going up and net realized price still going up?

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 1 to 2 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 what -- I know, obviously, the FX has a translation impact, but it can have a trade impact. Can you remind us what businesses you are doing much export --

We do almost -- yes. Sorry to cut you off, Scott. I'll let you finish your question. I was just going to say, we are producing locally to 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 less than 5% of our revenue. It's something like. Yes, it's something like 2% of our imports are from China. I mean, it's really de minimis. We are produced where we sell a company. Our suppliers are local, our customers are local so our exposure is largely translation. So we are sourcing in the same currency that we are producing and selling in the vast majority of cases.

Next, we'll go to Joe O'Dea with Wells Fargo.

I wanted to start on the consumer and sort of the less than 15% that you were talking about. And I think you've talked previously where maybe over half of revenue kind of 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 or 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 a broad consumer slowdown?

I think, Joe, we really highlighted the 2 big ones, which is construction, residential and then the automotive aftermarket business. The other one maybe that I would add is in our specialty business, we do a fair amount of consumer packaging. So beverages and resealable closures for things like cheese and other food products that I think have generally proven to be pretty resilient during times of economic contraction, consumer staples basically.

And then on supply chain, I mean the PMI yesterday for July, I mean, 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. Can you talk about sort of 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 is 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 -- our business has been very resilient in terms of working their way through various issues and challenges, computer chips, you name it. And we are 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.

Next, we'll go to Stephen Volkmann with Jefferies.

I was wondering maybe if we could just go back to the price/cost margin dilution chart. I'm assuming there's some sort of a linear relationship here and that 3Q is probably still a small headwind and the exit rate at 4Q is probably a tailwind. Is that a reasonable expectation?

I think as we sit here today, I think that's a reasonable expectation, yes.

And so Michael, I'm trying to think a little bit further into '23 and just rather than think about volumes, they'll be whatever they are, but you're going to have a few things kind of moving here in terms of sort of price/cost and dilution from MTS and some of the restructuring that you've done. Any way to start to think about what incremental margins in '23 might look like sort of when all is said and done?

Yes. I think you're right, Steve. 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 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 long term what you should expect from us is incrementals in that 35% range.

Next, we'll go to Mig Dobre with Baird.

I've been doing this for a while, but my name is always butchered on these earnings calls. Maybe to kind of follow up on Steve's question here thinking about '23. 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 that's going to go into '23 relative to '22 from a top line perspective, contribution to the top line?

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 would be helpful.

We've got to get it to our planning process, which is really we're talking about November-ish before we'll have a reasonable view on that, and I think that's the appropriate time.

Yes. I mean, I think the only thing I would point back to is what I said in these 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, the expectation is that as things begin to normalize, we will recover that margin impact over time. Now how exactly that will play out and the timing around that is not entire clear 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. I'm trying to 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 talked about winning the recovery and 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 out growth.

Well, I don't know exactly what I can do to reassure you other than to tell you that it continues to be the #1 dominant priority of every member of ITW from China to Europe to North America to South America, and it is, certainly, we think we've got a terrific opportunity going forward. We have done a lot of things in terms of investing and positioning ourselves to execute on it and the proof will be in the pudding. But it's already happening.

Yes. I agree with that, Mig. I mean, I think if you look at the results we 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, we're certainly closing the gap compared to where we were kind of just a few years ago. So I think 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.

And we'll take our final question from Julian Mitchell with Barclays.

Sorry about that. Just wanted to clarify on the margin outlook because I suppose the margin rate or the margin guide for the year implies the fourth quarter margins are maybe up 300, 400 basis points year-on-year or something. 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 here is what we 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 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, we'll be putting up some meaningful organic growth rates with all the operating leverage and 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 drivers here, less price/cost margin headwind and significant organic growth year-over-year with more normal incremental margins in that 35%, maybe plus range for the back half of the year.

I understand. And then just a follow-up on free cash flow. I think your sort of 90% odd 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 do you get that monstrous sort of free cash flow expansion. Is that just a mass of sort of inventory destock because supply chains are easing? Maybe just any color around that because it is a big move for a sort of a company.

It's a little 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 at the top line, mitigate supply chain risk, which is still a reality and then sustain 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 3 months on hand. And we really only need a slight improvement in that in the months on hand to get to those free cash flow numbers. So as we sit here today, we do have a line of sight to a ramp-up in the second half. But like I said, we think it's a smart use of 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'll still do the buyback. We'll still do, obviously, investments. We'll still do the dividend. And so there's really no trade-off here. But obviously, we'd like to hit the free cash flow number, and we have line of sight to doing that for the back half of the year. And we are obviously aware that it's a little bit more of a ramp than what we normally have.

This concludes today's conference call. You may now disconnect.