Illinois Tool Works Inc.

Welcome, and thank you for joining ITW's 2019 Second Quarter Earnings Call. My name is Cheryl and I will be your conference operator today. At this time, all participants have been placed in a listen-only mode. After the speakers' remarks, there will be a question and answer session. For those participating in the Q&A, you will have the opportunity to ask one question and, if needed, one follow-up question. As a reminder, this conference call is being recorded. I will now turn the call over to Karen Fletcher, Vice President of Investor Relations. Karen, you may begin.

Thanks, Cheryl. Good morning and welcome to ITW's Second Quarter 2019 Conference Call. I'm joined by our Chairman and CEO Scott Santee, along with Senior Vice President and Michael Larson. During today's call, we will discuss Second Quarter financial results and provide an update on our 2019 full-year outlook. Slide 2 is a reminder that this presentation contains our financial forecast for the remainder of the year, as well as other forward-looking statements identified on this slide. We refer you to the company's 2018 Form 10-K for more detail about important risks that could cause financial results to differ materially from our expectations. Also, this presentation uses certain non-GAAP measures, and a reconciliation of those measures to the most comparable GAAP measures is contained in the press release. So, with that, I'll turn the call over to our Chairman and CEO Scott Santee.

Thank you, Karen, and good morning. As you saw in our report this morning, during the Second Quarter, we experienced a deceleration in demand across our portfolio. At the total company level, Second Quarter revenues came in two percentage points, or approximately $85 million below what they would have been, had demand helped at the level we were seeing exiting Q1. Q2 revenues were down across all seven of our segments versus Q1 run rates, with higher declines in capex-related products, such as welding equipment. EPS came in at $1.91, down from $1.97 last year. In addition to external market factors, known headwinds, primarily foreign currency translation and accelerated restructuring expense, reduced EPS by 8% year over year in the quarter. Excluding the impact of these headwinds and a couple of small divestitures this quarter, EPS would have been $2 or an increase of 2%. As usual as the quarter progressed, the ITW team executed well on the elements within our control, operating margin held solid at 24.1%, supported by more than 100 basis points of benefits from enterprise initiatives. Despite negative volume leverage and excluding 30 basis points of restructuring impact, operating margin improved 10 basis points year on year. The team also managed working capital well as we delivered a 14% increase in free cash flow this quarter. And after tax return, uninvested capital was 28.6%. Based on the data available to us and the fact that we've only seen these flowing conditions for a couple of months, it is difficult to draw any conclusions as to whether this is a pause related to some near-term business tentativeness or something that may turn out to be more protracted. And in terms of visibility for us keeping in mind that as a result of the service levels that we provide to our customers, the majority of our divisions are ordered today, shipped tomorrow businesses, and as a result we carry very little backlog across the company. That said, we have had contingency planning discussions with our segment leadership as to the adjustments that need to be made to our plans for the remainder of the year in light of the current operating environment. And as we always do, we are adjusting our guidance in line with conditions on the ground as they exist today. Current run rates exiting Q2 projected through the remainder of the year would result in an organic revenue decline of 1 to 3% for the full year. And as a result, we are reducing our full year EPS guidance by 4% at the midpoint. All other assumptions are essentially unchanged and we continue to expect a stronger second half on a relative basis. As first half headwinds from foreign currency translation and higher structuring expenses dissipate. While the combination of a declining global auto market, slowing manufacturing capex spending and significant business uncertainty has us operating in a challenging macro environment near term, our efforts over the last seven years have been focused on leveraging the strength and resilience of the ITW business model to position the company for long term through the cycle performance. To that end, I would point out that despite the external challenges of the moment, in Q2 we delivered the third highest quarterly EPS in the 107 year history of the company. Looking ahead to the remainder of the year, while we will be prudent in making appropriate adjustments based on the near term demand environment and continue to drive quality execution on the elements within our control, we remain focused on managing and investing to maximize the company's growth and performance over the long term. Our teams are executing aggressively on our finish the job strategy agenda and we continue to make solid and consistent progress in positioning the company to achieve our 2023 enterprise performance goals. With that, I will now turn the call back over to Michael to give you more detail on our quarter. Michael?

Thank you, Scott, and good morning. In the second quarter, organic revenue declined .8% year over year as demand slowed across our portfolio versus demand levels exiting Q1 to the tune of approximately 2 percentage points. Compared to Q1, Q2 year over year organic growth rates slowed in all segments with the most significant slowdown in welding. By geography, North America was down 2% and international was down 4% in both Europe and Asia Pacific. Of note, China was down 5% with automotive the main driver and excluding automotive, China was up 1%. You'll recall that we previously talked about the first half of the year and Q2 being challenging due to a number of known headwinds, namely currency and restructuring. Those items played out as we expected. Gap EPS of $1.91 included six cents of unfavorable foreign currency translation impact, two cents of higher year over year expense and a penny loss related to two small divestitures in specialty products. We continue to expect that these first half headwinds moderate in the second half and I'll provide more detail on the first half, second half dynamics on slide nine. Excluding these three items, EPS would have been $2, an increase of 2% versus Q2 last year, which you might recall was a record quarter with EPS of $1.97, which was up 17% versus the prior year. As usual, our execution on the elements within our control was strong. Operating margin of .1% improved 10 basis points, excluding 30 basis points of accelerated restructuring impact. As you may recall in Q1, we made the decision to accelerate this year's planned restructuring projects into the first half of the year, a decision that sets us up well for the second half. The price was well ahead of cost on a dollar basis and margin neutral for the first time since 2016 as pricing actions continue to more than offset moderating material costs. Enterprise initiatives were the largest driver again in terms of margin expansion and contributed 110 basis points this quarter with more to come. Free cash flow increased 14% and conversion was 98%, seasonally strong for second quarter. In terms of capital structure, we opportunistically refinanced our short-term debt and locked in annualized interest expense savings equivalent to 7 cents a share, and we repurchased $375 million of our shares as planned. Overall, in a softer macro environment than we expected entering into the quarter, the ITW team executed well to essentially hold operating margins despite a 6% decline in revenues, grow free cash flow double digits, and deliver EPS of $1.91, the third highest in our company's history, the highest ever being Q2 last year. Let's go to slide four for some detail on operating margin. Like I said, operating margin was a solid .1% as enterprise initiatives contributed 110 basis points. Setting aside the impact from higher restructuring year over year, operating margin was 24.4%, a 10 basis point improvement from last year despite negative volume leverage of 60 basis points. Price-cost margin impact was neutral this quarter thanks to strong pricing and moderating costs. You can see the sequential price-cost trends on the bottom left side of the slide, and if things stay broadly as they are, price cost is on track to turn margin positive in the second half. The other category has a negative 40 basis points this quarter and includes 20 basis points of one-time items. Going forward, we expect the other category to normalize in the 10 to 30 basis points range in line with historical. In summary, strong execution and margin performance with enterprise initiatives contributing 110 basis points again. The enterprise initiatives impact is broad-based, ranging from 70 to 160 basis points across all seven segments. In fact, in a few slides, you'll see some very strong margin performance in the segments including problems of fluids, up 160 basis points, test and measurement electronics up 100 basis points, and construction up 50 basis points, just to name a few. Turning to slide five for details on segment performance. As we talked about on our last call, we expected Q2 to be pretty similar to Q1 based on the levels of demand we were seeing at the time we exited Q1. Based on historical data, we expected sales to be up approximately 3% from Q1 to Q2. In actuality, they were up only 1% as we experienced a broad-based deceleration in demand as the quarter progressed. The chart on the left illustrates that point. This is a summary of segment organic growth rates year over year in Q1 versus Q2. To make it apples to apples, we equalized the number of shipping days in Q1. You can clearly see the impact of slowing market conditions across the board with the largest decline in welding, which was up 5% in Q1 and down 2% in Q2. At the enterprise level, while we were essentially flat year over year in Q1, Q2 ended up being down almost 3%. The decelerating demand occurred from May and June. After only two months, we don't have enough data points to tell whether this is a pause or potentially more of a sustained slowdown. That said, our standard approach is to recalibrate our full year expectations and guidance based on the demand levels that we're seeing exiting the quarter, which essentially means that there's no second half re-acceleration built into our guidance. We'll get into that in more detail on slide 10. Now, let's go into a little more detail for each segment, starting with automotive OEM. Similar to Q1, organic revenue was down 7% compared to the most recent IHS builds, down 9% for North America, Europe, and China combined. Despite the fact that this quarter included 130 basis points of product line simplification, nearly half of which related to the ongoing integration of our European-based acquisition, the segments still outgrew the underlying markets by a comfortable margin. North America was down 6% as builds at the Detroit 3, where we have our highest content per vehicle, were down 6% in the quarter. In Europe, organic revenue was down 8%, essentially in line with Q1 and beginning to show some signs of stabilizing. In China, organic revenue was down 12%. On a positive note, we continue to take full advantage of the long-term growth opportunities in this segment, and our new product pipeline and new program wins remain strong, positioning us for 2% to 3% of above-market organic growth on a sustained basis. The segment is performing well in the current auto down cycle, as evidenced by 22% plus margins, despite some pretty sizable clients in revenue over the last four quarters. Operating margin was 22.1%, with a significant contribution from enterprise initiatives again this quarter. We'll continue to manage our way through these near-term challenges, adjusting our cost structures appropriate, and focus on positioning the segment for the long term. Looking forward to the second half, even though IHS is forecasting that auto builds for North America, Europe, and China combined will be flat, versus down 8% in the first half, we are using current run rates, which equate to a decline in builds of approximately 5% in the second half. Moving on to slide six. Food equipment organic growth was solid, up 2%, with strong performance in our service business, which was up 4%, and equipment up 1%. In North America, results were similar to the first quarter, with 2% organic growth, with modest growth on the equipment side, and service of 4%. Growth in independent restaurants and QSR was solid, up double digits, offset by a decline in institutional, where we had a tough comp of 20% plus growth in the prior year quarter. Food retail was a bright spot again this quarter, also up double digits, as the recovery here appears to be taking hold. International organic growth was up 2%, mostly on strength in Europe, which was up 4%, offset by weakness in China. Operating margin expanded to 25.6%, with enterprise initiatives the main driver. Test and measurement and electronics organic revenue was down 1%, excluding lower sales to semiconductor equipment manufacturers, which represent approximately $200 million. This segment organic growth would have been up 2%. As we have talked about before, we planned for semiconductor related sales to be down double digits this year, and so far things are playing out as expected. Test and measurement was down 3%, up 4%, excluding semiconductor, and electronics was up 1%. Operating margin expanded 100 basis points to 24.5%, with enterprise initiatives the main driver. Turning to slide 7. In welding, as we talked about earlier, we experienced significant deceleration in demand as the quarter progressed. Organic revenue declined by 2% against a challenging -over-year comparison. Equipment sales globally were down 4%, and the decline was broad-based by end market. Consumables were flat. North America was down 3%, with equipment sales down 5%, while filler metals were up 5%, suggesting that underlying welding activity in North America is still fairly solid, which is certainly a positive sign. International markets were flat, and operating margin was the highest of our segments at 28.8%. Polymers and fluids organic growth was flat, with polymers up 2%. Automotive aftermarket was flat, fluids were down 3%. Operating margin was up 160 basis points driven by enterprise initiatives. Moving to slide 8. Construction organic revenue was down 1% due to market softness in Australia and New Zealand, offset by pretty good results in North America, which was up 2%, with commercial construction up 5%, and residential remodel up 3%. Europe was stable of 1%, and operating margin expanded 50 basis points due to enterprise initiatives. In specialty, organic revenue was down 6% versus a tough comparison of 4%, driven in large part by PLS and the performance of potential divestitures in this segment. PLS was almost a point and a half, of which two-thirds relates to a plant closure and the continuation of that product line. Organic growth in potential divestitures was lower in the quarter and reduced the overall organic growth rate for the segment by a little more than 2% points. The remaining, call it core specialty, was down about .5% against an -to-apples comparison of plus 8% in the second quarter last year. By geography, international was down 8%, and North America was down 5%. Operating margin declined due to negative volume leverage and higher restructuring. So let's move to slide 9 for a summary of first half financial performance and how that sets us up for a stronger second half. As we've talked about before, we fully expect that the first half to be pretty challenging due to known headwinds and some tough comparisons versus prior year, including the fact that the first half last year was the most profitable first half ever in the history of the company as EPS increased 20%. As you can see, EPS for the first half was $3.72, which included approximately 20 cents of -over-year headwinds from both foreign currency translation impact and higher restructuring expense, both factors that will moderate in the second half. At this point, we have completed about 70% of our planned restructuring for the year, and at current FX rates, the headwinds from currency begin to dissipate in Q3 and are essentially gone in Q4. As a result, the 20 cents -over-year headwind in the first half is approximately 5 cents in the second half, so a net positive of 15 cents from these two items alone. In addition, we have a number of tailwinds to EPS in the second half, starting with restructuring savings of about 5 cents from the first half projects that were accelerated. These are projects with typically less than one year payback, and other than the acquisition integration we talked about in our last call, they relate to our typical 80-20 -to-back activities and are pretty well distributed across the segments. Furthermore, price-cost dynamics are favorable, interest expense is lower, as I mentioned earlier, and comparisons -over-year get easier, and we have one extra shipping day in Q3. So overall, solid performance in the first half with a more challenging near-term environment, and importantly, a better setup for the second half with organic growth at the enterprise level in line with the first half at current run rates, margin expansion -over-year at the enterprise level and across the majority of our segments, strong cash flows, and mid- to -single-digit EPS growth -over-year. In terms of the quarterly splits in the second half, we expect Q3 and Q4 to be fairly similar in terms of EPS. Q3 does have one more day, but Q4 has favorability from lower restructuring expense and higher restructuring benefits, as well as no -over-year currency headwind at current rates. Now let's talk about our updated 2019 guidance on slide 10. As per our usual process, we're updating full-year guidance to reflect current levels of demand. Run rates exiting Q2, adjusted for normal seasonality, project that full-year organic revenue will be down 1 to 3 percent. This compares to our prior organic growth guidance of 0.5 to 2.5 percent. The reduction in organic growth rate from a midpoint of 1.5 to down 2 percent impacts EPS by approximately 35 cents. As a result, we now expect EPS to be in a range of 755 to 785, with the midpoint of 770 up slightly 1 percent versus 760 last year. Lower organic growth also translates to lower volume leverage, and as a result, we now expect operating margin will be flat to up 50 basis points. As you saw, we're off to a strong start on cash flow in the first half, and the full year is expected to be strong with conversion well ahead of net income, and we expect to repurchase approximately 1.5 billion of our own shares for the full year. Now a brief update on our portfolio management activities. Our divestiture activities are progressing well, and we remain on track to complete about half of potential divestitures in 2019. Interest is strong, and we expect to realize significant gains and cash proceeds upon divestiture, all of which is excluded from our guidance. As we have stated before, the positive impacts from the expected divestitures when completed by the end of 2020 include approximately 50 basis points of structural improvement to our overall organic growth rate, and 100 basis points to operating margin. Not counting the gains on sale, we're planning for divestitures to be EPS neutral, as any EPS dilution will be offset by incremental share repurchases above and beyond the approximately 1.5 billion that I just mentioned. Before I hand it back over to Karen, let me just reiterate something that Scott said earlier. Given the strength of our core competitive advantages, the resilience of the ITW business model, our diversified high-quality portfolio of businesses, and our team's ability to execute at a high level, we are well positioned to outperform across a wide range of economic scenarios. In terms of the near-term macro, after only two months, it's too early to tell where near-term demand is headed, and so we're assuming current run rates will extend through the second half. And as we go forward, we'll continue to make the appropriate adjustments, incorporating current market conditions, and also remain focused on managing ITW and investing for the long term. So with that, Karen, back to you.

Okay, thanks, Michael. Cheryl, please open

up the lines for questions. Thank you. Our first question is from Jeff Sprague from Vertical Research. Your line is open.

Thank you. Good morning, everyone.

Good

morning. Hey, just two questions from me. And first for Scott, actually just picking up where we ended on the call, like what is the complexion of this cycle? You know, I clearly understand the point that it's very early. You know, you and I have both been around the block a few times. You know, looking at what you're seeing in some of your leading indicator type businesses or just customer behavior, could you share a little bit of context of, you know, how this looks or feels relative to other slowdowns that you've seen? You know, what maybe looks like a point of worry or what looks like, you know, reason to have some level of confidence that this might just be a pause in what otherwise is a very long extended cycle?

Yeah, I think, you know, as I look across what we saw in the second quarter, it looks a lot more to me overall like some short-term tentativeness. I think Michael talked about the welding business data as probably the most tangible data point where we saw big deceleration in capital investment in the equipment side. But the filler metal business was up, you know, solidly mid-single digits in the quarter, which says that our customers are still welding. You know, the activity level is very high. And I think that's, you know, if we look at the employment rate in the US, you look at a lot of, you know, it's an environment where overall it looks much more like, you know, a short-term pause, some tentativeness, certainly impacting capital investment decisions. You know, it's certainly difficult for me to say after a couple of months that that is, that turns into something larger at this point. But, you know, we all know that it's a pretty uncertain environment right now given all of the things going on from the standpoint of global trade issues and concerns and all that. So I think it's, you know, a couple of months in, it certainly was a meaningful, you know, delta between Q1 and Q2 in terms of overall demand rates. But, you know, it is only a couple of months and it certainly looks in terms of that data point of welding and some other things like it is, you know, some, a bit of a pause. But I, you know, I don't see anything that says this is the front end of, you know, the end of the expansion cycle for sure.

Okay, and I'm just wondering, Michael, if you could clarify the comment you gave us on headwinds and tailwinds as it relates to FX and restructuring, saves and the like. I believe those were sequential comments. Can you just clarify that and maybe put that in context of what the -over-year would be?

Yeah, so the first half headwinds from restructuring and from foreign exchange are 20 cents a share on a -over-year basis. In the second half, those same items, the headwind from that is only five cents. So incrementally, we get 15 cents -over-year better in the second half versus the first half. And that is, as always, assuming that foreign exchange rates stay where they are today.

And that's just relative to restructuring costs, correct? And we've got benefits to think of. Yeah, that is good.

That's a good catch. That's just the cost side. We are getting an incremental five cents of benefits from the restructuring activities, the projects that were implemented in the first half of the year as part of this acceleration that we've talked about before. So there's another five cents there. If you want to go down to this price cost is beginning to turn positive if things stay where they are. We also have lower interest expense. I said seven cents annualized, so we'll get about half of that in the second half of the year. We obviously have easier comps -over-year, even though the organic growth rate is the same at current run rates, first half, second half. And then we have one extra day in Q3 that we've talked about a number of times. The straight math on that is that's worth about three to four cents.

Great. Thank you for the time. I'll pass with the time.

Thank you. Our next question comes from Andy Kaplowitz from Citi. Your line is open.

Good morning, guys. Michael, we know you usually use current run rates when forecasting organic growth going forward. But just to clarify, you do have easier comparisons. You mentioned the extra day in Q3. So is it really just you're being conservative around auto builds because your forecasts were declined in the second half and similar to your forecast in the first half. So you're being conservative for auto builds and then everything else kind of stays the same as June, basically, is how you're doing it?

I wouldn't say we're being conservative. I think this is a purely a mathematical calculation. We're taking existing run rates, exiting Q2, projecting those into the back half of the year. And if you do that, we get to, if you do the math, our first half is down 2% organic. We're saying the full year will be down 2%. And therefore, the second half will also be down 2%. But there's no subjective input to that calculation. Keep in mind, Q1

was flat. So we're basically projecting exit Q2 run rates, not first half. That's right. These are Q2 run rates, which is why you get to even year on year with the extra day.

Yeah, okay. That's fair. And then if you look at specialty products, you talked about the vestiges there. But maybe you give us a little more color. Obviously, the decimals there are a little bit weaker than the segments. I think in the past, you've talked about some tariff-related headwind on that business. So could you talk about sort of what you're seeing specific to your appliances there? What's going on in that business?

Well, I think we, you know, similar to the other businesses, we did see a slowdown in demand. But really, the bigger delta, which is down 6%, is what I was trying to explain with the higher PLS, the divestitures, and the core business being down 2.5%. On the margin side, I mean, the enterprise initiatives were good. The drag is really volume leverage, and then higher restructuring. And those are the key drivers of the margin performance. You know, there's really no real trends that we can point to inside of these businesses that that we can tie back to some macro factor. It's really broad-based, lower demand in those businesses with a lot of PLS. We're working on the divestitures. And so that's kind of the story on specialty.

But to step back, Michael, you haven't seen, you know, with the 25% tariff, any more impact on the margin side, components or whatever. It's just, you know, there's obviously uncertainty out there on the sales side, but no impact on the margin side in that segment.

That's correct. I mean, this latest round of this three going from 10 to 25 really had immaterial impact on the company overall. We're talking pennies of EPS and well-managed. And really, that goes back to, you know, we're largely a -we-sell company, and that's also true for specialty products.

Thanks, guys.

Thank you. Our next question comes from Ann Dignan from JPMorgan. Your line is open.

Hi. Good morning, everyone.

Morning.

I'm just curious if you comment on price cost and by segment, what's your thought on how your ability to hold pricing in an environment where demand is weakening and some of your input costs are probably declining, particularly into 2020. Is there any segment in particular where we might see pressure on the business to give up pricing in the lower volume environment?

No, I mean, we do have a number of divisions with index pricing. Of course, those will have to be in the lower volume, but there's really, when we look across the board here, price continues to improve in Q2 relative to Q1 on a dollar basis, and that is true across the board. As you know, automotive is a little bit more challenging just given the way the contracts are structured, but across the board, we're really pleased with the price performance, and we're entering into more of a normal pricing environment, I'll say. You know, we've neutralized the cost impact, including the modest tariff impact we just talked about, and this issue for now, as things stay as they are, is essentially behind us, and to be very specific, there's no actions to give price back. Really, all we were trying to do was cover our material cost increases as those increases went through.

Okay, thank you.

We expect to hang on to most of it. Going forward.

Okay, that's helpful. And then maybe you could comment on, you know, what you're seeing at the marketplace. I know you talked about maybe a pullback in capital spending, but it was interesting to see that your automotive aftermarket business was flat, and I would have thought that that was tied to consumer discretionary spending, which has remained resilient versus maybe business capex. So maybe you could just talk about what you're seeing in that business in particular.

Yeah, I mean, there's not much automotive aftermarket has been, you know, a grower in the low single digits here, and I think there were a couple of things. There's a small portion of their sales that is tied to overall automotive production, but beyond that, this business correlates more to miles driven than anything else, and we didn't really see much of a, no big changes in this business in the quarter.

Okay, so no sign of the consumer slowing down, I think is what we can

take from that. Yeah, and the thing I would add is that there is some, within quarters in that business, there are some impacts from the launch of new programs or new product launches. So I think overall the demand there is, you know, our view is pretty positive overall on Q2. We can certainly go back and take a look at whether there's a specific issue related to a prior launch, but it's, I think, as Michael said, the longer, you know, sort of full year trends there are, you know, fairly solidly.

Okay, I appreciate it. I'll get back in Q. Thanks.

Thank you. Our next question comes from Joe Richie from Goldman Sachs. Your line is open.

Thank you. Good morning, everyone. Morning. So my first question, maybe just high level, and, you know, if we were to just go into a little bit more of a prolonged downturn, you guys historically have done a great job of taking costs out. I'm just wondering, like, how do you guys think about, you know, how much there's left within the organization to continue to take costs out? And secondly, just from a strategy perspective, do you feel like you need to shift it all from, you know, really like that the focus on growth to really cost at this point of the cycle?

Well, you know, I think overall, you know, we have a couple of things going for us in, you know, when they're, when we're under, we're seeing some pressure in the marketplace. The first is that we have a very flexible cost structure. We've talked about that before, given our 80-20 operating model. And the historic performance that you referenced is really built around the fact that we have the ability to move up or down, capacity up or down. You know, I won't call it easily, but I would say, you know, we have the ability relatively quickly to adjust our costs to the current environment. I think we showed that to some degree in Q2 and certainly will, I would expect that we will going through the back end of the year. So, you know, I would describe that as tactical. I would also describe, you know, our ability from a cashflow generation standpoint and the margin profile that we've now got as a company that will allow us in a downturn to stay invested in the things that we think are really critical to the long-term growth and performance of the company. And that's a very different dynamic perhaps than we, from an overall position standpoint that we might have had in some of the prior downturns. So, you know, I'm certainly very comfortable in our view is that we will make prudent tactical adjustments in the near term and be able to both do that and stay invested in the things that we really think are the important things for us to be focused on and investing in a long-term perspective.

I guess, and Scott, maybe just following on on that question, you're really just from the cost levers. Like, where do you think that there is still kind of opportunity within the organization? I know you guys have highlighted, you've simplified the organization, you've highlighted sourcing as an opportunity before. So, where do you see the opportunities today?

Well, I think we've talked about before, we're kind of certainly a waste from the standpoint of our enterprise initiatives. You know, we are, we've got 100 basis points this quarter. You know, there's easily several more years of work there and opportunity there. It depends on your, you know, if we're talking about the next two or three years, that certainly is a lever that we will continue to access. And as I said before, the other is that we will adjust our capacity very flexibly and the cost associated with supporting that capacity. So, I think we've plenty of levers. And, you know, I, it also depends on sort of the magnitude of the sort of environment and the ups and downs that we're dealing with here. So, our, you know, what we would do, I think is, is our intent is to be very responsive to the environment as we see it in the short term while staying invested in the things that we think are really critical to the long-term performance of the company. And I don't know how to be more specific about that.

Yeah. No, no, that makes sense. If I could ask one question just quickly on growth, you know, you guys, I like the slide that you had showing Q1 versus Q2. The, I'm just curious, you know, it sounds like, you know, June certainly took a leg down to the extent that you guys can kind of quantify, and I may have missed this earlier, just the order of magnitude that June was down, that would be helpful.

Yeah, so June was, we really started to see the decline in May and in June, you know, mid-single digit, I would say in June year over year. And at the same time, you know, going into July here, we are starting to see things certainly not get worse and stabilizing maybe from what we saw exiting Q2, which again supports, you know, our view that run rates are a good way to look at this on a go-forward basis. So until we see something different. Until we see something different, yeah. So, you know, June was the more significant leg down, July looks like things are stabilizing as we sit here today.

Got it. Thank you both.

Sure.

Thank you. Our next question comes from Steve Volkman from Jeffreese. Your line is open. Steve Volkman, your line is open. If you're on mute, please unmute your line. And we'll move along. Our next question comes from Joel Tiss from BMO.

I can't believe I made it. How's it going, guys? Two questions. Just one, I know you said that it's a little bit too early to tell. And I just wondered if, you know, the way you're characterizing sort of, you know, a little bit of amplification, a slowdown in May and June and stabilizing in July, is there any way to tell, and I know you guys are hand to mouth, but is there any way to tell if your customer's demand was sort of from inventory de-stocking or there's not really any way to tell? You know what I mean? So that the underlying demand in the markets is better than what the numbers show.

I think we're a tough barometer for you on that. You know, the fact that we deliver at the kind of level of responsiveness that we do means our customers have to carry relatively little amounts of inventory. So to the extent there was any inventory adjustment, it's probably not a particularly material number for us.

But I meant for them, like your customer demand went down because their customers are reducing inventories. Okay.

We can't tell.

Too much of a tangent. Okay, can you give us a little bit of an update on your pivot to acquisitions and where we stand and what you're thinking and, you know, how your team is building and how you're seeing, you know, flow and prices and all that. Thank you.

Sure. I don't want anyone to get carried away here, but we have, you know, certainly as we talked going back to our last investor day, we have certainly begun the process of starting to explore and we certainly are ready to, as we talked about, begin to supplement the portfolio with nice high quality acquisitions. I would say and have made appropriate efforts in terms of communicating that update of our strategy to the appropriate people and have had, you know, pretty interesting change in terms of flow of ideas and opportunities. So we are certainly looking at a number of things. You know, the pipeline is sort of quickly rebuilt. I don't want that to in any way give anybody an indication that there's anything imminent there, but we're certainly starting to explore, you know, a range of potential opportunities and we expect that over the next 12 months or so that we will generate some activity there. But it's all function of quality fit and, you know, sort of affordability. Can we get good fit at what we think is the right value for our shareholders?

And thank you. Our next question comes from Andy Casey from Wells Fargo. Your line is open.

Thanks. Good morning. Top line question during the quarter and going back to Investor Day, you talked about the 6% of revenue in divestiture process last year, you know, to date up to the Investor Day, seeing a .6% drop with the latest weakening. Did that pool of revenue associated with the divestitures, did that see a sharper decline than the overall?

Yeah. So, Andy, these are rightfully characterized as long-term growth challenged and we're certainly seeing a performance in those businesses that are below the kind of core ITW. And that you talked about specifically in specialty. Yeah. Specialty is a good example of that where we called it out.

Okay. And then the gross margin was flat in the quarter year over year despite, you know, the revenue drop. I'm just wondering, did any of the restructuring fall into gross profit?

Yeah. So, I think there's both the 80-20 activities and obviously the sourcing activities. And so, I think it goes back to what we talked about earlier, just the resilience of ITW with, you know, 6% decline in revenues, half of which organic, the other half currency, we're holding margins above 24% and we're holding gross margins. We generate more cash in terms of the conversion rate. And so, I wouldn't say we were, that was not a big surprise to us we were able to do that. That's kind of, that's how we run the railroad here.

Okay. All right. I'll pass it on. Thank you. Sure.

Thank you. Our next question comes from Mick Dobre from Baird. Your line is open.

Good morning, guys. I'm not sure if you're by there. I don't know if I missed this, but when you were talking about the back half of the year, by the way, I'm looking at slide four right now at your price cost discussion there. What exactly is embedded in your guidance at this point for price cost tailwind? And can you help us in Q3 versus Q4? Is that kind of how your assumptions play out?

Yeah, I think if you look at the trend at the bottom left of the slide, we would probably expect that trend to continue into the back half of the year if things stay the way they are, you know, from a cost standpoint.

All right. But is this going to be like the 50 basis points tailwind? Is it 100 basis points?

What's

the right magnitude?

Yeah, I think a more realistic view is that it begins to turn slightly positive in the second half here. And beyond that, I can't really give you a number.

Okay, well, I mean, I figured that you'd know since obviously this is one of the key elements in terms of the swing, the first half versus back half, and I get it, it's hard to forecast it perfectly, but... Well, Nick, let me just...

Nick, just because I don't answer your question specifically doesn't mean I don't know the answer. I just want to be clear. So it's just... So we have never provided quarterly guidance on price cost. And given the dynamic environment we're in, you know, and it's... I would put it this way, overall, it's not going to be a material driver to our performance in the back half, but it certainly contributes. And relative to where we've been over the last three years, it's no longer a drag, which I think that's really the big story here, that price cost has been neutralized. In terms of price dollars, we are significantly ahead of, you know, the material cost side, including the tariffs we talked about. So hopefully that helps. Okay. No,

it does. Clear enough. I had to try. Then let me ask my follow-up on growth, right? I think everybody kind of understands what's going on with auto, but I was running some numbers here. Even if I take out auto, I think your organic growth was down something like .7% year to date. And, you know, I look at this and that almost feels like a recession type environment. So I guess I'm wondering, from your perspective, when you're looking at the remaining businesses, excluding auto, you know, how much of this decline is generated, has been generated by businesses that you're actually looking to exit, for Andy's question from earlier, versus what's going to stay, what's going to remain in a portfolio. And you sort of feel like you've got kind of the right portfolio mix and the right geographical exposure at this point, or do you need to make maybe some more significant adjustments down the line? Thank

you. Well, I think in terms of the big, you know, if you look at it by segment, automotive accounts for the vast majority of the decline in revenues year over year, I think that's well understood. You know, we're kind of being hit by a number of things here, including, you know, we've talked about semi and now the slowdown in welding. So, you know, I think it's a little bit of a, you know, a little bit of an unusual time for us. Usually we have things kind of moving in different directions. But like I said, auto is the majority. Then we have this unique situation in specialty where the divestitures are underperforming. We're still doing a lot of product line simplification. And then welding took a step down here in Q2. So, yeah. And

I'll answer the same question from a longer term perspective, which is, you know, if you look at the margins we generate in every one of these seven businesses, what that tells me is we deliver a lot of value for our customers in those, in every one of those businesses. In every one of those businesses, we have significant share and penetration gain potential. And we expect, as we've said many times before, and we are working on it like crazy, every one of those businesses to outgrow the underlying markets by one to two percentage points plus. Some have the potential to do more, some less, but every one of them should outgrow their underlying market growth. And we are working through, you know, sort of lots of, all things we've talked about before in our path to get there. But I have no doubt we will get there.

All right. Thank you.

Thank you. And supplement it with a couple of nice bolt-ons when we get there as well, a year maybe.

Thank you. Our next question comes from Jamie Cook from Credit Suisse. Your line is open.

Hi. Good morning. Just two follow-up questions. You know, just one on the welding side. Could you provide some color which markets were, and markets were hit hardest? And then I was impressed with the ability to hold the margins. I mean, they were down modestly over the year, but given the organic growth decline, I thought margins would have deteriorated more. So was there anything unusual in that number and how to think about margins for the year? Thank you.

Yeah. So I think on welding, you know, the decline was fairly broad-based. If you look at, you know, the equipment side down four, consumables flat and the filamentals up five, like we talked about. So that's certainly a positive. You know, the industrial side of welding in North America was down kind of in the mid-single digits and was the biggest driver overall. You know, the commercial side, as we've talked about before, you know, did relatively better than that. And then the last data point, oil and gas, kind of was flat in the quarter.

So what I would add is in the equipment decline, industrial was certainly, you know, the bigger decline relative to the commercial line. Yeah. So manufacturing.

Yeah. I mean,

it's really the

industrial economy here is what we're seeing the softening demand. And because we are short a cycle and welding is one of these, you know, receive the order today and ship tomorrow. We see it maybe faster than other companies that carry more of a backlog. You have to keep in mind that in welding, since we're on that topic, you know, we carry less than two weeks backlog because of the -in-class service levels that we provide in that business. So, and then I think on margins, I'm not, well, you're talking about welding specifically. I mean, I think certainly if you, margins at 28.8, if you take out the restructuring and welding, they were actually positive in the quarter as well, up year over year. And there was about 60 basis points of restructuring in the quarter. And I think it's back to the resilience of, you know, of ITW. And given how we're organized, you know, our teams on the ground, when they see things slowing, they are able to react quickly and make appropriate adjustments and deliver. You know, if you look at the decrimetals for ITW in the quarter, we're, you know, in the mid-20s, which is, you know, given that we saw the slowdown late in the quarter, I think it's pretty strong performance. And as we talked about earlier, we expect that to continue as we go into the balance of the year.

Okay. Thank you.

Sure.

Thank you. Our next question comes from Nigel Ko from Wolf Research. Your line is open.

Thanks. Good morning. Morning. Hey, Michael, your decrimetals are 24.3, just to be precise. So, they're pretty good. So, in that regard, you know, as we kind of, you know, went through the quarter, you know, how satisfied are you that you're preserving the investment spending to, you know, to kind of, you know, accelerate growth when the markets return to growth? Or are we sort of in the zone now where it's all about, you know, margin preservation and some of this investment spending, you know, kind of gets deferred? I mean, how do you think about that?

We are, you know, we talked about our contingency planning discussions that we had with each one of our segments. And the first topic was the conversation around what are the things that we are going to absolutely stay fully invested in as we go through this little bit of a rough patch in terms of demand. And again, I'd sort of go back, Nigel, to what I said earlier, is sitting here with mid-20s EBIT margins with a business that as we model it would have to shrink by a third in some, you know, unprecedented economic depression for our margins to drop below 20%, you know, suggest to us, you know, or not it puts us in a position where we are absolutely able to ride these cycles, power our way through these cycles and stay invested for the long haul. So I am, you know, there are certainly tactical adjustments that can be made in terms of managing capacity appropriately in the short run race around demand. Again, I talk about our flexible cost structure that helps us move up or down and that from that standpoint as demand moves up and down, but from the standpoint of capacity to invest and desire to stay invested. We are not trying to be a hero based on a decremental percentage. We are trying to build a company that over a five and ten year period can outperform based on, you know, the core strengths that we have in terms of the business model, the details on this, but the things we have talked about in terms of, you know, sales capability building in terms of new product innovation, all of those things are part and parcel of the conversations that we have had with each of our segments in terms of the things we are absolutely going to stay invested in as we ride this out.

Great, thanks, Gulp. And then just a quick follow up on kind of taking a different approach to the price cost question. Looking at gross price and, you know, have you seen any pushback or, you know, increasing sort of investments, incentives in any of the businesses? And I am thinking here about, you know, auto is obviously going through a real rough patch and, you know, how is pricing looking in that end market? And then welding is another one where we have seen some chatter about the salaration in pricing. Maybe just address those two and perhaps overall as well.

Yes, I think overall this is, you know, this is a general statement with

millions of

products, but I think that, you know, all the work that we have done on the portfolio, we have talked about this before, we are in many, you know, in the majority of our businesses, we are in spaces where we are doing something unique and value added for our customers, which gives us some ability to price based on the value we deliver and not based on a commodity reference point. You know, it is not to say that there are pressures in certain end markets, as you talk about, but our response is to try to find a way to give the customer better value, not necessarily reduce the price that we are saying we are serving. So we are doing things in auto every day to design products that help our customers be more efficient in how they manufacture, to give them, you know, better performance in terms of features and benefits. So, you know, we are not certainly immune to the pressures of the moment as much as I would say we have from the standpoint of the differentiated nature of the product portfolio. We have multiple responses in ways that we can respond to that over time that, again, deliver value to our customers. We still get paid for the value that we deliver.

Right. And I will just add, you know, one data point for, and there was a question earlier, and if I didn't say it clearly, you know, our year by year price, if you look at in dollar terms, was higher in the second quarter than in the first quarter. So if there is some nervousness around the ability to maintain price, hopefully that data point is helpful.

Okay. Thanks, Scott.

Thank you. Our next question comes from John Inch from Gordon Haskett. Your line is open.

Good morning, everybody. Good morning, John. Good morning, Michael, Scott, and Karen. So the 55% of the ready to grow growing, presumably have some auto in there, obviously, if you were to strip that out, how did that, roughly speaking, how did that do in the second quarter? What's kind of the growth rate there for those businesses and sort of how are you thinking about them in the second

half? Yeah, I think it's a good question, John. You know, when we talked about this at Investor Day last year, I think we described it as a journey. And so what we're going to do is report on our progress on an annual basis. I can tell you we're certainly making progress in those businesses. We are having movement of businesses that were not ready to grow, not growing category that are moving up. You know, maybe the service business and food equipment is a good example of that where we're now putting solid three to four percent organic growth on the board at, by the way, really attractive margins, as I'm sure you know. But I

would

also say that that list was chock full of welding businesses. So to Michael's point, to try to calibrate this on a single quarter, given the macro influences, it's, you know, this is a data point that we are certainly comfortable being accountable for and reporting out. But, you know, on an annual basis is a better way to reflect. Progress in that regard.

OK, that's fair. Well, it's fair to say, though, the choppiness, the capex deferrals, et cetera, that are going on. Is that making it harder to do deals? Meaning is the sort of the end market demand choppiness and there's obviously project pushouts not applicable per se to your company, but it's affecting capex. Is that causing for a little bit of deal disruption in terms of the discussions you're having or looking to begin to have?

Not yet. And there's no prediction when I say not yet, it hasn't really been a major focus. But again, it's been a couple of months.

OK, just just lastly, Michael, you said that, you know, the guide doesn't assume a re acceleration. But what if there's a deceleration, obviously, which I realize you can't forecast. Nobody really can. But it holds to reason things sometimes move in trends. And Scott, your I take your comments, you know, obviously, I get it, right? This is probably ultimately just some kind of pausing. But if it's not, how should we think about sort of ITW's resilience or what kind of sensitivity is there if in fact there's further deceleration?

Yeah, I mean, I think if things decelerate from here, we will give you an update in the third quarter. I think what you saw in terms of kind of the decrementals, you know, are a good way to think about how the company would that we saw in the quarter, a good way to think about how the performance might play out. There's one other data point in the materials today. You saw we adjusted our organic growth guidance down. Every point of organic growth is approximately 10 cents a share. So then you can and I think we're pretty transparent in terms of all the information we provide, including at the segment level, and then you can build your own models. And those declerations, by the way, are fairly similar across all of our segments. So hopefully that helps you model the sensitivities around the top line.

It does. Thanks very much. Appreciate it.

No problem.

Thank you. I'll now turn the call back to Karen Fletcher for closing remarks.

Okay. Thanks, Cheryl. And thanks everybody for joining us this morning. And if you have any follow-up questions, I'm happy to take them offline. Thank you. And thank you for participating in today's conference call.

All lines may disconnect at this time.