Illinois Tool Works Inc. (NYSE:ITW) Q1 2023 Earnings Call Transcript May 2, 2023

Illinois Tool Works Inc. beats earnings expectations. Reported EPS is $2.33, expectations were $2.23.

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

Karen Fletcher: Okay, thank you, Rob. Good morning, and welcome to ITW’s first quarter 2023 Conference Call. I’m joined by our Chairman and CEO, Scott Santi; and Senior Vice President and CFO, Michael Larsen. During today’s call, we will discuss ITW’s first quarter financial results and provide an update on our outlook for the full year 2023. Slide 2 is a reminder that this presentation contains forward-looking statements. We refer you to the company’s 2022 Form 10-K and subsequent reports filed with the SEC for more detail about important risks that could cause actual results to differ materially from our expectations. This presentation uses certain non-GAAP measures, and a reconciliation of those measures to the most directly comparable GAAP measures is contained in the press release. Please turn to Slide 3, and it’s now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

Scott Santi: Thank you, Karen. And good morning everyone. As you saw from our earnings release this morning, we delivered a solid start to the year, with results coming in largely in line with our expectations heading into the quarter. Starting with the top line, organic growth was 5% with four of seven segments delivering positive organic growth, led by Food equipment up 16%, Welding up 10%, Automotive OEM up 8% and Test & Measurement and Electronics up 6%. Polymers & Fluids was flat, Construction was down 1% and Specialty was down 5%. Operating margin expanded 150 basis points to 24.2% with 100 basis point contribution from enterprise initiatives. GAAP earnings per share increased 10% to $2.33, which was a new Q1 record for the company.

Our free cash flow conversion rate was 86% of net income which was in line to modestly above normal Q1 levels. Looking ahead at the balance of the year. While there is of course some uncertainty with regard to the macro environment, I have no doubt that my ITW colleagues around the world will continue to read react and execute at a high level to whatever comes our way. I will now turn the call over to Michael to discuss our Q1 performance in more detail and our updated full year guidance, Michael?

Michael Larsen: Thank you Scott. And good morning everyone. ITW delivered another solid quarter operationally and financially, starting with organic growth of more than 5%. Foreign currency translation headwind and divestitures reduced revenue by 2%, and 1%, respectively. On the bottom line, our operating income grew 9% with incremental margins of 98%. Operating margin improved 150 basis points to 24.2% with enterprise initiatives and price costs contributing 100 basis points, and 190 basis points respectively. In addition to higher wages and benefit costs year-over-year, were funding our growth investments including headcount in the areas that support our organic growth strategies and initiatives. And we still delivered 150 basis points of margin improvement in the quarter.

GAAP EPS grew 10% to $2.33, which included foreign currency translation a headwind of $0.06, and our Q1 tax rate was 22.6%. And as Scott said, it was encouraging to see our free cash flow performance return to normal levels. Overall for Q1, excellent operational execution across the Board and strong financial performance including record EPS. Please turn to Slide four, starting with positive organic growth in all of our major geographies. Including North America, which represents about 55% of total revenues, and grew 5%, and Europe is up 6%. Asia Pacific grew 2%, despite a 6% decline in China due to COVID related headwinds in Q1. Moving on to segment results, starting with Automotive OEM and solid organic growth of 8%. North America was up 3% and Europe grew 16%.

China was down 5% due to COVID related headwinds in Q1. And we’re seeing the expected bounce back here at Q2. In terms of automotive OEM margins, we are beginning to recover the price cost margin impact that has diluted margins in this segment by about 450 basis points over the last two years. As a result, we expect price cost margin impact to turn positive starting in Q2, which, combined with positive volume leverage and contributions from enterprise initiatives, will lead to higher margins sequentially and year-over-year starting in Q2 and for the balance of the year. Turning to Slide 5. Food Equipment delivered another strong quarter with organic growth of 16% as North America led the way with organic growth of 21%. Institutional end markets were up more than 50% with particular strength in education and lodging.

In addition, restaurants were up more than 30%. International revenue grew 9%, with Europe up 11% and Asia Pacific was down 6% due to China. Strong progress on margins with Q1 operating margin of 26.7%, an increase of more than 400 basis points year-over-year. Test & Measurement and Electronics delivered organic growth of 6% despite a double-digit slowdown in semiconductor-related revenues, which represent about 20% of segment revenue. On the other hand, demand for our capital equipment remains strong as evidenced by Instron, for example, which was up 22%. Overall, Test & Measurement grew 12% organically and electronics was down 4%. Moving on to Slide 6. Welding delivered double-digit organic growth of 10% in Q1 on top of 13% in Q1 last year as equipment grew 10% and consumables were up 11%.

Industrial sales remained strong with organic growth of 17%, while the commercial side was down 2%. North America grew 10%, and international grew 12%, driven by strength in the oil and gas business, which was up 15%. Operating margin expanded 110 basis points to 31.9% a new record for the segment and the company. Organic growth in Polymers and Fluids was about flat against a difficult comparison of plus 13% last year. Automotive aftermarket was down 1%, Polymers grew 1% and Fluids was also up 1%. On a geographic basis, North America grew 1% and international declined 2%. Turn to Slide 7. Organic revenue and construction was down 1% against a tough comparison of plus 21% last year. Residential construction was down 1% and commercial construction, which represents a little less than 20% of the business in North America was up 5%.

Europe was down 9%, and Australia, New Zealand was up 3%. Finally, Specialty organic revenue was down 5%, which included 3 percentage points of headwind from product line simplification. On a geographic basis, North America was down 4% and international was down 6%. Okay, let’s move to Slide eight, for an update on our full year 2023 guidance. As you saw this morning, we raised GAAP EPS guidance by $0.05 to a new range of $9.45 to $9.85, which considers the lower projected tax rate for the full year in the range of 23.5% to 24%. Given the level of macroeconomic uncertainty going forward, we’re essentially holding our operational guidance and adjusting EPS to reflect the lower projected tax rate. Our organic growth projection of 3% to 5% reflects current levels of demand with some risk adjustment for further slowing in certain end markets.

Combined, foreign currency translation impact at current rates and divestitures are projected to reduce revenue by 1%. Operating margin is projected to expand by more than 100 basis points at the midpoint of our range, which includes approximately 100 basis points from Enterprise Initiatives and positive price/cost margin impact. Like I said, we’re off to a solid start to the year with some positive momentum heading into Q2, and we remain well positioned to continue to outperform in whatever economic conditions emerge through the balance of 2023. With that, Karen, I’ll turn it back to you.

Karen Fletcher: Okay. Thank you, Michael. Rob, let’s open up the line for questions, please.

Q&A Session

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

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

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

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

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

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

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

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

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

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

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

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

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