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Text: 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 third quarter 2020 financial results and provide an update on our strategy for managing through the global pandemic.
We saw a solid recovery progress in many of the end markets that we serve in the third quarter as evidenced by our revenue being up 29% sequentially versus the second quarter.
In fact, demand levels returned to rates approximating year ago levels in five of our seven segments.
With two of those, Construction and Polymers & Fluids, delivering meaningful growth in the third quarter.
On the flip side, demand levels in our Food Equipment and Welding segments continue to be materially impacted by the effects of the pandemic, although we did see good sequential improvement in both in Q3 versus Q2.
We talk often about the flexibility and responsiveness inherent in our 80/20 front-to-back operating system, and those attributes were clearly on display in our Q3 performance.
Supported by our decision early on as the pandemic unfolded, to refrain from initiating staffing reductions and to focus on positioning the company to fully participate in the recovery, our people around the world responded to a rapid acceleration in demand by leveraging the ITW business model to provide excellent service to our customers, while keeping themselves and their co-workers safe.
Perhaps the most pronounced example was our Auto OEM segment where our team executed flawlessly from both of quality and delivery standpoint in responding to demand levels that essentially doubled in Q3 versus Q2 and with a demand -- a very demanding customer base.
Across all seven of our segments, our teams can site numerous examples of how our ability to sustain high levels of service in the phase of rapidly accelerating demand resulted in incremental business for the company in Q3.
In addition to leveraging our best-in-class delivery capabilities, our divisions remain laser focused on leveraging our strengths to capture sustainable share gain opportunities that are aligned with our long-term enterprise strategy.
These efforts are just beginning to take hold and I'm confident that they will contribute meaningfully to accelerating our progress toward our long-term organic growth goals.
The operating flexibility that is core to our 80/20 front-to-back operating system also applies to our cost structure, which show through in our operating margin performance in Q3.
Operating margin of 23.8% in the quarter, included meaningfully higher restructuring expenses versus a year ago in Food [Phonetic] segment specific one-time items, which Michael will provide more detail on in a few minutes.
Excluding these factors, operating margin was 25.3% in Q3.
The second highest in the history of the company.
Overall, the pace of recovery in the third quarter exceeded our expectations heading into the quarter, as we delivered revenue of $3.3 billion, operating income of $789 million, free cash flow of $631 million, and GAAP earnings per share of $1.83.
In addition, after-tax return on invested capital improved to 29.6%, an all-time high for the company.
It goes without saying that I cannot be more proud of how the ITW team is managing through this challenging period.
In the face of unprecedented challenges and circumstances, our operational and financial performance over the last few quarters supports our decision to remain fully invested.
And the key initiatives supporting the execution of our long-term enterprise strategy and provides further evidence that ITW is a company that has both the enduring competitive advantages and the resilience necessary to deliver consistent upper tier performance in any economic environments.
Looking forward, we remain focused on delivering strong results, while continuing to execute on our long-term strategy to achieve and sustain ITW's full potential performance.
Since the beginning of the pandemic, maintaining ITW's considerable financial strength, liquidity, and strategic optionality has been a priority.
Our objective was to fully leverage the strong financial foundation and resilient profitability profile that we have built in the last seven years to position ITW for maximum participation in the recovery.
And as the recovery progressed, ahead of our expectations going into the quarter, we were ready to meet customer demand and we delivered strong financial results.
Q3 revenue was up 29% or almost $750 million sequentially versus Q2.
And on a year-over-year basis, organic revenue declined only 4.6% compared to a 27% decline in Q2.
The impact of last year's divestitures was 1% and was essentially offset by 0.7% of favorable currency impact.
Product Line Simplification was 30 basis points in the quarter.
Despite the negative volume leverage and our decision to stay invested in our key strategic priorities, Q3 operating margin was 23.8%, down only 120 basis points compared to prior year.
If you set aside the impact of higher restructuring expenses and two one-time segment items that I will describe in a moment, operating margin would actually have increased year-over-year to 25.3%.
Strong execution on our enterprise initiatives was a big contributor once again at 120 basis points, as all segments delivered benefits in the range of 70 basis points to 190 basis points.
As expected, our decremental margins were a little higher than normal at 46% in the third quarter.
Excluding the two one-time items that I just mentioned and the higher restructuring expense, our decremental margins would have been about 20%, significantly better than our historical decrementals of 35% to 40%.
Operating income was $789 million, and GAAP earnings per share was $1.83, with an effective tax rate of 21.3%, in line with last year's 21.6%.
Solid working capital performance contributed to free cash flow of $631 million and a conversion rate of 108% of net income.
On a year-to-date basis, free cash flow was $1.9 billion, with the conversion rate of 127% compared to 105% last year.
We now expect free cash flow to end the year significantly above $2 billion.
Our balance sheet remains strong.
At quarter end, we had $2.2 billion of cash on hand, no commercial paper, and a $2.5 billion undrawn revolving credit facility, tier 1 credit ratings, and total liquidity of more than $4.7 billion.
In terms of our debt structure, you can see an increase of $350 million in the short-term debt, which is simply a reclassification from long-term to short-term as our 2021 bonds are coming due in less than 12 months.
So in summary, a very good quarter operationally and financially as the recovery progressed well ahead of our previous expectations.
Moving on to Slide 4, for a closer look at the third quarter recovery and response by each segment.
You can see that every segment responded effectively to the increase in demand recovery and improved sequentially on both revenues and operating margin.
I would highlight just a few things that Scott mentioned, including the fact that our Automotive OEM segment was able to essentially double their volumes in a quarter or just 90 days as operating margins went from negative to 20% plus.
In addition, six of seven segments had operating margins, not segment margins, operating margins above 20%.
In fact, Food Equipment was just below 20%, but we expect them to get above 20% in Q4, despite the fact that they are operating in a pretty challenging environment.
Next to Slide 5, starting with a quick look at organic revenue by geography.
As you can see customer demand improved in every region.
North America declined by only 5% in Q3 compared to down 26% in Q2.
Europe also improved significantly down only 8%, a sequential improvement of almost 30 percentage points.
Asia-Pacific turned positive this quarter, up 3% and China was the standout, up 10%, as the recovery continues to take hold.
In China specifically, Automotive OEM, Polymers & Fluids, and Specialty products all grew double-digits.
So in summary, broad-based geographic recovery in the quarter.
Now let's walk through each segment, starting with the one that experienced the most pronounced recovery Automotive OEM.
In a matter of weeks, our customers went from being shutdown to operating close to full capacity and the team responded by leveraging their experienced workforce, local supply chains, and flexible operating system, to quickly ramp up and meet customer demand.
Overall, organic revenue was still down 5% year-over-year, with North America now 10% and Europe down 5%.
China, which had already turned positive last quarter at 6% also improved sequentially and was up 15% this quarter.
Lastly, as we discussed on our last call, we did initiate a few restructuring projects that were part of our 2020 plan pre-pandemic, which will lead to a reduction in operating margins of 150 basis points, to 20.8%.
Turning to Slide 6.
As expected, Food Equipment was the hardest hit segment in the quarter as organic revenue declined 20%, a significant improvement though from being down 38% in Q2.
North America and international organic revenue were both down about 20%.
Equipment sales were down 21% and service was down 17%.
Institutional demand was down about 30% and restaurants, including QSR were down a little bit more than that.
On a positive note, retail, which includes grocery stores, grew more than 30% supported by the rollout of new products.
Despite the significant negative volume leverage and higher restructuring expense, operating margin was still 19.6%.
Excluding the higher restructuring impact, margins would have been 21.4%.
And I think it's worth noting that in this most challenging environment, the segment generated almost $19 million in operating income.
In Test & Measurement and Electronics, organic revenue declined only 2% with Test & Measurement down 6% and Electronics, up 2%.
While demand for capital equipment remains soft, the segment benefited from considerable strength in a number of end markets including semiconductor, healthcare, and clean room technology.
As you can see from the footnote, the reported operating margin of 23.7%, include a 350 basis points of unfavorable impact from removing a potential divestiture from assets held for sale.
Given the current environment, we simply decided to defer this divestiture for now.
Speaking of divestitures, let me make a broader comment on our portfolio management efforts and specifically the 2018 decision to divest seven businesses that we determine no longer fit our enterprise strategy framework, with revenue of approximately $1 billion.
We expect that the completion of these divestitures will improve our overall organic growth rate at the enterprise level by approximately 50 basis points and increase enterprise operating margins by 100 basis points.
In 2019, we made good progress completing four divestitures, with revenues of approximately $150 million and we are seeing the benefits in our financials this year including 20 basis points of operating margin impact.
While the pandemic put a hold on our efforts this year, our view regarding the long-term strategy fit of the remaining divestitures has not changed.
Accordingly, we will resume the sale process for these businesses when market conditions normalize.
Okay, turning to Slide 7.
In Welding, demand for capital equipment was down year-over-year as organic revenue declined 10%.
However, the commercial business, which accounts for about 35% of revenue and serves primarily smaller businesses and individual users, was up 11%.
In Industrial, customers were holding back on capital spending and organic revenue was down more than 20% this quarter.
Operating margin, though was remarkably resilient at 27.9%.
On a positive note, Polymers & Fluids reported record organic growth of 6% in the quarter.
The Automotive Aftermarket business benefited from strong retail sales to grow 10%, with double-digit growth in tire and engine repair products.
Fluids was up 6%, strong sales into healthcare and hygiene end markets.
As a result of the volume leverage and strong incremental margins of 78%, operating margin expanded by 250 basis points to a record 26.6%.
Moving to Slide 8, Construction had a remarkable quarter, benefiting from continued strong demand in the home center channel to deliver record organic growth of 8%.
All geographies were positive, with North America up 12%, with double-digit growth in the residential and renovation market offset by commercial construction, down 10%; Europe was up 6%, with double-digit growth in the Nordic region; and Australia/New Zealand revenues grew 3% and were positive for the first time in more than two years.
As a result of the volume leverage and strong incremental margins of 59%, operating margin expanded by 300 basis points to a record 28.1%.
And some of you may remember, when we launched enterprise strategy in 2012, Construction had the lowest operating margins in the company, seemingly stuck right around 12%.
Certainly, good performance in industry, but not really ITW caliber.
The fact that the construction segment delivered the highest margins inside of ITW in Q3 at more than 28% is therefore pretty remarkable.
Specialty organic revenue was down 5%, with North America down 4% and international revenue down 7%.
Demand for consumer packaging remains solid, but was offset by lower demand in the capital equipment businesses.
Operating margin was 25.2% and included a one-time customer cost sharing settlement.
Excluding the impact of this one-time item, operating margins would have been 28%.
Let's move to Slide 9, for an updated outlook at our full-year 2020.
As I mentioned earlier, the demand recovery in Q3 exceeded the high end of our expectations going into the quarter.
And as a result, we're updating our financial outlook for the year.
As we sit here today, we expect organic revenue for the full year to be down 11% to 11.5%, operating margin to be in the range of 22% to 22.5% and operating income in the range of $2.7 billion to $2.8 billion.
As I mentioned free cash flow performance continues to be strong and we expect to end the year well above $2 billion.
As you think about Q4, keep in mind the typical seasonality from Q3 to Q4 and that Q4 has two less shipping days.
Also, please note that we expect a slightly higher tax rate in Q4 versus Q3 and our full-year tax rate is expected to be in the 22% to 23% range.
With respect to our outlook for 2021, we expect to reinstate annual guidance when we release full-year 2020 results early next year.
With that, Karen, back to you.

user
compname reports q3 gaap earnings per share of $1.83.
q3 gaap earnings per share $1.83.
q3 revenue $3.3 billion versus refinitiv ibes estimate of $3 billion.

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