Edited Transcript of ITW earnings conference call or presentation 5-May-20 3:00pm GMT

As Karen noted, I have asked our Vice Chairman, Chris O’Herlihy, to join Michael and me on the call this morning as I thought that it would be helpful for you to hear perspectives from all 3 of us on how we are managing through the near-term challenges of the containment period we’re currently in and on the actions we are taking now and will take over the coming weeks and months to ensure that the company is positioned to participate fully in the recovery.

Before we jump in, I want to offer our heartfelt thanks to all of our ITW colleagues around the world. We talk often about the fact that our decentralized entrepreneurial culture is a key element of ITW’s secret sauce. It is core to who we are as a company and it is never more valuable than during times of significant, and in this case, rapid change. The proactive teamwork, ingenuity and selflessness of our people in quickly adapting to rapidly changing conditions and tackling new challenges that seemingly arise daily at the moment is ITW at its finest. We thank all of our colleagues for the incredible level of care and commitment they are bringing to keeping their coworkers safe while continuing to serve our customers with excellence. The fact that the ITW team has responded exactly as we expected they would doesn’t make it any less extraordinary.

Now on to first quarter results. Total revenue declined 9% year-on-year with organic revenue down 6.6%; currency, a 1.5% headwind; a negative 1% impact from divestitures; and 40 basis points of PLS. The majority of the organic revenue decline occurred in the last 2 weeks of March, where we saw organic revenue down more than 20%. By geography, North America was down 5% and Europe was down 7%. China was down 24% for the quarter but appears to have bottomed in February and was flat year-on-year in April, an encouraging sign.

In the face of a challenging demand environment, we continue to execute well on the elements within our control. Despite a 9% decline in revenues, operating margin was flat at 23.6%. 5 of our 7 segments expanded margins in the quarter due largely to benefits from Enterprise Initiatives, which contributed 120 basis points to operating margin at the enterprise level. The after-tax return on invested capital is 27% and free cash flow was $554 million with a conversion rate of 98% of net income.

Lastly, as noted in our press release this morning, given the uncertainties regarding the impact and duration of the COVID-19 pandemic, we are suspending our previously announced guidance for full year 2020. We will resume guidance once end markets stabilize and the recovery path becomes more clear.

Now let’s shift gears and talk about how we will manage ITW through the global pandemic. Please turn to Slide 4. Despite the unusual, and in some cases, unprecedented challenges of the moment, we continue to execute at a high level and with our usual degree of focus and discipline across the company. As a result of all the work we have done over the last 7 years in executing our enterprise strategy and the progress we have made on the path to our full potential performance, ITW is today in a position of significant strength in dealing with the effects of the global pandemic.

Today’s ITW was centered on our powerful and proprietary business model. And our people are better trained and more skilled at executing it than ever before in the history of our company. ITW’s 80/20 front-to-back methodology and the laser-like focus that it drives on the relative handful of critical performance difference makers in every one of our businesses has served the company extremely well in times of both opportunity and challenge for a long time now. I have no doubt that this unique ITW skill will be a significant asset to us as we work our way through the COVID-19 pandemic and its aftermath.

In addition, as I mentioned earlier, we are very fortunate to have a decentralized operating structure and an entrepreneurial culture that has been developed, nurtured and protected over many years. Our people think and act like owners. They are accountable and they deliver. They are deeply trained in our business model, our strategy and our values. And I assure you that even in unprecedented times such as these, none of them are waiting around to be told what to do.

In addition, in today’s ITW, we have worked hard in shaping our portfolio and driving consistent high-quality execution across every business in it, both to position the company to deliver consistent upper-tier long-term earnings growth when global conditions are favorable and to build in a margin cushion and level of diversification that makes us highly resilient during those periods when they are not. And it follows from there that the robust free cash flow we generate due to our strong margin profile and the unique attributes of our business model, combined with our very disciplined capital allocation strategy, gives us an extremely strong balance sheet and Tier 1 credit ratings.

So with these elements as our foundation, our strategy for managing through the pandemic and its aftermath is to focus on the following 4 priorities: first, to protect the health and support the well-being of our ITW colleagues; second, to continue to serve our customers with excellence; third, to maintain financial strength, liquidity and strategic optionality; and fourth, to leverage ITW’s strengths to position the company to fully participate in the recovery. Chris will give you some additional color on priorities 1 and 2. Michael will cover priority 3, and I will come back and cover priority 4. And then we’ll open it up for your questions.

Chris? Good morning. Over to you.

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Christopher A. O’Herlihy, Illinois Tool Works Inc. – Vice Chairman [4]

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Thank you, Scott, and good morning, everyone.

This is a challenging time for all of us as the world continues to grapple with the effects of the global pandemic. At this point, I’m sure that every one of us is being impacted by this situation in ways that were unimaginable just a few months ago. And ITW as a company and a community is certainly being affected. Having said that and as Scott referenced, our divisional leaders think and act like owners and are able to react quickly and take the necessary actions to protect our people and serve our customers, which is a particular advantage of the company in times of significant challenge.

Let’s move to Slide 6 and the actions we’re taking to protect the health and support the well-being of our colleagues. We developed and deployed a number of practices to minimize exposure and prevent the spread of COVID-19 and keep our colleagues safe. We have followed CDC, WHO and local government guidelines in doing so. Our ITW colleagues have redesigned production processes to ensure proper social distancing practices, adjusted shift schedules and assignments to help colleagues who have childcare needs due to school closings and implemented aggressive new workplace sanitation practices to minimize infection risk. We are also providing full compensation to employees who have to be quarantined.

In addition, our strategic sourcing team is heavily engaged in helping our businesses by coordinating the procurement of personal protective equipment to ensure all our employees receive the protection they need. I’m pleased to say that as a result of our containment efforts, to this point, we have largely been able to restrict infections to single cases in a minority of our locations, which is a testament to the actions our colleagues have taken to implement sound sanitation practices and social distancing and to protect one another to the best of their abilities.

Turning to Slide 7, let’s shift to another important stakeholder group and how we continue to serve our customers with excellence. To support our customers, our teams have worked diligently to keep our factories open and operating safely. In areas around the world where governments have issued shelter-in-place orders, the vast majority of ITW businesses have been designated as critical or essential businesses, and as such, they are needed to remain open and operational. In some cases, this is because our products directly impact the COVID-19 response effort. For example, our welding equipment is used to manufacture hospital beds. Our construction products are utilized to build temporary medical facilities. Our test and measurement products test medical and laboratory equipment. Our polymers and fluids products sanitize workplaces. And our foodservice equipment is used to feed people in hospitals.

In other cases, our businesses are designated as critical because they play a vital role in serving and supporting industries that are essential to the physical and economic health of our communities. Although some facilities are subject to mandatory shutdowns, roughly 95% of our global manufacturing capacity is currently available to be deployed to serve customers.

The same is true for our service networks, particularly in food equipment and test and measurement, which we continue to keep fully available in order to ensure that we can help keep essential businesses and health care facilities in operation. In both cases, across all segments, we continue to maintain best-in-class performance for product and service quality and availability.

Finally, we are rigorously managing our supplier base to both mitigate near term supply risk for critical raw materials and components and ensure that we are positioned to win in a wide range of recovery scenarios going forward.

And with that, I’ll turn the call over to Michael.

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [5]

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Okay. Thank you, Chris, and good morning, everyone.

While not the primary objective of our enterprise strategy, an important byproduct, if you will, of all the work done over the last 7 years is that ITW is in a position of considerable financial strength to deal with highly disruptive events such as this global pandemic. In many ways, ITW was built for times like this. And through the pandemic, we will manage the company to maintain our financial strength, liquidity and strategic optionality so that we can leverage our strong financial foundation and resilient profitability profile to position the company for maximum participation in the recovery.

Turning to Slide 9. There’s no question that in Q2, we will see an unprecedented level of demand contraction due to the complete shutdown of wide swaths of the global economy. ITW has more than enough financial strength and resilience to withstand this kind of shock to the system that the global economy is going to experience over the next several months. We are prepared for it. We’ll get through it and we’ll come out the other side, strongly positioned for the recovery.

As we sit here today 1 month into the quarter, we’re estimating that Q2 revenues will be down 30% to 40% on a year-over-year basis. Obviously, there’s a fair amount of uncertainty around how May and June actually play out, but that is our current view. As you would expect, given that most of our automotive OEM customers in North America and Western Europe have been essentially shut down since mid-March, and are only beginning to restart production in early to mid-May, our automotive OEM business will be the hardest hit, with revenues potentially down 60% to 70% year-over-year.

An abrupt decline of this magnitude in the quarter is pretty unprecedented. As difficult as it may look, if it plays out this way, we expect that ITW would still make operating profit in the $200 million to $400 million range, generate free cash flow of more than $500 million, and end the Q2 with cash on hand of about $1.5 billion.

On to Slide 10. Knowing that we have the financial strength to withstand whatever comes our way over the next few months, our #1 priority becomes positioning to play offense in the recovery, and this is an area where our strong margin profile really helps us. Whether the pace of recovery is fast or slow, V shaped or U shaped, over the next few quarters it doesn’t really impact us that much.

Under a fairly fast-paced recovery, we end up down 15% for the full year and margins are 19% to 21%. Under a much slower recovery, revenues are down 25%, yet our margins are still a very strong 17% to 19%. This is against the backdrop where most of the companies that our divisions compete with came into the pandemic with margins at half of ours or less. As a result, a number of them may have to retrench in a major way in order to get through the pandemic, potentially creating some significant share gain opportunities for us in the recovery.

With our margin cushion, we aren’t concerned with how quickly demand is going to recover in Q3 or Q4. We can be fairly certain that it will be incrementally better than Q2. But beyond that, it really doesn’t affect us a whole lot, which allows us to think long-term and position for maximum participation in the recovery. Making sure that we are in a strong position to fully support our customers as their businesses begin to reaccelerate and that we are in an equally strong position to take share from competitors who can’t is the central imperative of our pandemic response planning for every one of our divisions.

We will, of course, need to manage our businesses smartly across our portfolio and make some meaningful capacity and cost structure adjustments in businesses where we expect prolonged recovery periods or maybe even permanent demand impacts from the pandemic. But as we always do, we will leave those decisions in the hands of our division leaders as they are in the best position to assess the pace and slope of the recovery in each of their respective businesses.

Turn to Slide 11. The financial benefits of our enterprise strategy, combined with the work done to optimize our capital efficiency, capital structure and capital allocation over the years, has put ITW in a very strong position going into this crisis. At quarter end, we had more than $1.4 billion of cash and cash equivalents on hand. At the end of Q1, and it’s still the case as of today, we have essentially no short-term debt and we have not issued any commercial paper. Why, you might ask? Simply put, because we don’t need the cash. We have a $2.5 billion undrawn credit facility available to us if needed in the future, bringing our total liquidity to about $4 billion as we sit here today. Our net leverage is only 1.7x and our next maturity is fairly small, $350 million and not until September 2021.

High quality of earnings and strong free cash flow are hallmarks of ITW. As you know, we consistently generate significantly more cash than we need for internal purposes and our annual conversion rate from net income is consistently above 100%. We expect that to continue to be the case as we manage our way through the pandemic. As evidenced by our Tier 1 credit ratings that are the highest in our peer group, we continue to have excellent access to credit markets in the event that we need it.

During this time of market volatility, it’s also worth mentioning that our pension plans have remained in great shape. Over the years, we have consistently funded and derisked our plans. And as we sit here today, our largest U.S. plan is funded at 104%.

Turn to Slide 12. So how do we think about and adjust our capital allocation approach during the pandemic? First, with regard to the dividend. We recognize the importance of ITW’s dividend to our long-term shareholders. We have a long history, with more than 56 years of growing the dividend, and we are part of a small group of so-called dividend aristocrats and 1 of about 18 companies that has increased its dividend for more than 50 years. And we view the dividend as a critical component of ITW’s total shareholder return model. Since 2012, we have increased the annualized dividend from $1.52 per share to currently $4.28 per share, a cumulative annual growth rate of 16%. Simply put, we remain strongly committed to our dividend. And as we sit here today, we do not see a scenario where we would have to reduce the dividend.

In terms of strategic optionality, we are clearly in a position of strength with ample balance sheet capacity, and we are certainly open to the possibility that opportunities might emerge as a result of the pandemic. It could be in the form of more reasonable valuation opportunities for assets that we were already interested in, as well as some unique opportunities with quality companies that may not have the financial strength to weather the pandemic. Given our financial strength and ample capacity, we will be in a strong position to react to any high-quality strategic opportunities that may emerge.

We will continue to fully fund all internal investment and CapEx projects that meet our criteria like we always have. But the number will likely come down in terms of aggregate spend in the near term, simply due to the fact that we don’t need any capacity expansion projects for the next several quarters.

Finally, I think it comes as no surprise to anyone that we have suspended share repurchases until end markets stabilize and the recovery path becomes clearer. With that, I’ll turn it back over to Scott.

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [6]

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Thank you, Michael. And on to priority 4, which is all about leveraging our strengths to make sure that every one of our businesses are strongly positioned to fully participate in the recovery. In short, we are going to be there to serve every bit of our customers’ needs as their businesses begin to reaccelerate and be well prepared to capture any share gain opportunities that may come our way. Our financial strength and margin cushion gives us the ability to prioritize playing offense in the recovery over playing defense in the contraction.

I see no benefit in ITW winning the contraction phase. Beyond ensuring that we maintain ample financial strength and liquidity, my focus is not on what our results are going to be over the next couple of quarters. Rather, winning the recovery phase is what matters, and that is what we’re going to be focused on throughout.

We’ve defined 3 principles around which we’re going to plan and execute our way forward in order to do just that. First, we will make thoughtful and appropriate capacity, cost structure and investment adjustments based on recovery phase reality, not containment phase distortions. In the face of an unprecedented demand contraction in Q2, as Michael commented earlier, we will still generate operating income in the hundreds of million dollars and generate over $500 million in free cash flow. We will manage discretionary expenses prudently, but we don’t need to start cutting muscle immediately. And we certainly want to avoid doing so before we have some level of indication as to the shape and slope of the recovery in each of our businesses.

With this principle in mind, to this point, we are providing full compensation and benefit support to all ITW colleagues around the world, and we’re going to do our best to sustain that level of support for all of our people through at least the end of Q2. We are doing it because we are in a position to support our people at a time of great personal and family stress and uncertainty, and we think that it’s the right thing to do. But we’re also doing it to protect the significant investment we have made in training and developing great ITW people and great ITW leaders over the past 7 years.

As Michael mentioned, it is likely that we will need to make some staffing adjustments to align with prolonged or permanently lower demand in some of our businesses as a result of the pandemic. But we are committed to being there for all of our people during the worst of this, and we will take the time to make whatever longer-term adjustments need to be made thoughtfully.

The second principle is that we’re going to lean into the upside by remaining invested in structure to capture incremental demand. Given the profitability of our core businesses and the strength of our financial position, what’s the bigger risk for ITW? Carrying more costs than it turns out we need for a few months or cutting too much and not being able to fully serve the needs of our customers and take share from our competitors as the recovery accelerates? Obviously, we believe short shooting the upside potential of the recovery would be the far bigger mistake for ITW, and we’re going to plan and execute our recovery strategies accordingly.

The third principle is that we’re going to leverage the strength of ITW to protect investments in areas of strategic importance for the execution of our long-term strategy. We are early in our planning around all of these areas, but as one example, prior to the pandemic we invested 2-plus years in our strategic sales excellence initiative that included significant investments in new sales and sales leadership talent. We have the financial capacity to protect these types of long-term strategic investments. And doing so is worth a lot more over the long-term to the company than our few extra decremental margin points in the short term. That being said, decremental margins should likely be in our normal 35% to 40% range in Q4. Between now and then, we’re going to focus on making sure ITW is in a strong position to fully participate in the recovery.

Turning to Slide 14. This is just a reminder that our long-term strategic priorities remain unchanged, that we are committed to achieving and sustaining ITW’s full potential performance and continuing on our quest to firmly establish ITW as one of the world’s best performing, highest quality and most respected industrial companies.

Now let’s move on to Slide 15 to wrap things up. Once again, on behalf of Chris, Michael and I and our entire executive leadership team, we thank our ITW colleagues around the world for the exceptional job they are doing under the most challenging of circumstances. As of right now, there is no way to know how severe this crisis will be, how long it will last or how quickly our customers and end markets will recover. What I do know is that the strength and resilience of ITW’s business model and our people put us in about as strong of a position as an industrial manufacturing company can be in to deal with whatever will unfold over the coming weeks and months. I have every confidence that ITW will rise to the challenge as we always have over the course of our 108-year history. Our strong financial position and margin profile give us the ability to make strategic moves now to position the company to fully participate across a range of recovery scenarios, and to come out the other side ready to continue on our path to ITW’s full potential performance.

With that, Karen, I’ll turn it back to you.

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Karen A. Fletcher, Illinois Tool Works Inc. – VP of IR [7]

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Okay. Thanks, Scott. As a reminder, please see the appendix in today’s slide deck for the usual segment details for the first quarter. So Julianne, let’s open up the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Ann Duignan from JPMorgan.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division – MD [2]

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Scott, maybe you could talk a little bit about your various businesses and whether you would anticipate that any of the businesses might be permanently impaired rather than just cyclical? And I’m thinking welding, oil and gas, I’m thinking Food Equipment, et cetera, et cetera. How are you thinking about that as we look forward?

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [3]

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Yes. I’d say, Ann, overall, it’s just way too early to tell. I think — I don’t see anything — we have a division that provides support equipment to the airline industry is probably among the ones that I would say would see — have the longest tail in terms of recovery. But from where we sit today, as early as it is in this whole process, it’s — I don’t see anything that would be sort of obvious or apparent in terms of permanent change or damage, if you will, from this pandemic. There may be, but we’ll deal with it.

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Christopher A. O’Herlihy, Illinois Tool Works Inc. – Vice Chairman [4]

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Yes. I might just add, Ann, if you — specific to oil and gas, if you look at the enterprise level, our sales into oil and gas are in the low single digits. And maybe as you were pointing out, primarily in welding, maybe 15% to 20% of welding depending on what year you’re in, primarily on the international side. But as Scott said, it’s really too early to tell what the recovery path might look like in that part of the company.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division – MD [5]

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Perfect. And then maybe just a follow-up on the strategic M&A and the opportunities to be at maximum participation when the recovery occurs. Could you just expand on that a little bit? It is interesting to hear you comment on that.

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [6]

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Well, I think there is — this is no — nothing I would characterize as a change in strategy. We had certainly talked for some time about the addition of some incremental growth from acquisitions as a core part of our strategy. I think there’s — it’s not rocket science to anticipate that there are going to be, either from the standpoint of a reset on valuation and/or given the level of financial stress that’s going to be out there, that there might be some opportunities emerge as a result. And our only commentary is that we are going to preserve our ability to access those. It doesn’t change the criteria one bit. This is not a matter of looking at things that we would have not looked at otherwise, but the sort of relative availability of things that would fit, I would expect, would be perhaps more enhanced as a result of the situation.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division – MD [7]

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So we shouldn’t anticipate you stepping up and making a larger-than-expected acquisition in a new platform or anything like that. Is that what you’re saying, that there’s no change in the strategy, just the opportunities might be more?

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [8]

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Yes. Well, I don’t — I’m not sure I would limit it based on size. I think it’s a function of fit with our strategy. Obviously, we’ve talked about that criteria in the past. We’re — we’ve got an opportunity that — on a business that has high value-added content in terms of their products and the way their products impact their customers and where we see a significant ability to impact the performance of the business through the application of our business model. That’s what I’m saying is the same as it’s always been. Whether that’s big or small will be a function of the quality of the asset less than the size.

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Operator [9]

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Your next question comes from John Inch from Gordon Haskett.

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John George Inch, Gordon Haskett Research Advisors – MD & Senior Analyst of Multi-Industrials [10]

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Scott, Michael and Chris, given that there’s no centralized cost containment actions that you guys are announcing today, I’m wondering if the decrementals you’ve presented include assumptions that the businesses preserve respective cost containment actions? Or are they more of a kind of a worst-case scenario?

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Christopher A. O’Herlihy, Illinois Tool Works Inc. – Vice Chairman [11]

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I’m trying to interpret the question. I think, John, I think if I’m going to paraphrase here, I think you’re asking what is included from a restructuring standpoint for the balance of the year. Is that…

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John George Inch, Gordon Haskett Research Advisors – MD & Senior Analyst of Multi-Industrials [12]

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Sure. Recognizing that you’re not doing it centrally, it’s coming from the businesses’ base.

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Christopher A. O’Herlihy, Illinois Tool Works Inc. – Vice Chairman [13]

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Yes. I mean, absolutely. I mean, I think the honest answer is, until we know what the recovery path looks like and the divisions have had a chance to really interpret division by division what that path is and therefore what capacity and cost adjustments need to be made, we don’t know what the restructuring is going to be. But obviously, we have included in the numbers that we’re showing you today, a placeholder for an educated guess, I hope, for what restructuring might be. But it really is, John, as you might appreciate, too early to tell at this point.

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [14]

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Yes. And I think the sort of core planning mandate on this and everything we’ve just tried to articulate is we’re going to spend the next couple of quarters really making sure that we’re in the right position to fully support our customers and access any incremental growth opportunities that might emerge from this recovery phase. We’ll do what we always do. We’ll adjust our cost structure smartly. We’re not going to do it through some edict from on high. We’re going to do it business by business. That’s no different than we’ve always done it. The difference now is that we are in a position from the standpoint of entry margins and the final — the cushion that we have is we can take the time to plan our way through it in a way that doesn’t — that does our best to protect the upside potential. And that’s really all we’re saying. I said in my comments that we’ll be back to our normal incremental by Q4. But there’s really no benefit to us that I see of trying to, as I said, win the containment phase and how fast we can cut costs is not something that we have to worry about. We have the luxury of building this position. It doesn’t mean we’re not going to be smart. It doesn’t mean we’re not going to have to adjust our cost structure over time, but we’re going to do it from a position of much greater clarity business by business as to how this is likely going to play out. That clarity doesn’t exist today. It’s very hard to see until we get much further down through Q2 and into Q3.

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John George Inch, Gordon Haskett Research Advisors – MD & Senior Analyst of Multi-Industrials [15]

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Based on the way you’re — well, I’m going to say, Scott, based on the way you’re standing up for your people, I bet you, you’re going to get an awful lot of people knocking — very qualified people knocking on your doors wanting to work for ITW as this whole thing progresses.

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [16]

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Kind of you to say, John. Thank you.

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John George Inch, Gordon Haskett Research Advisors – MD & Senior Analyst of Multi-Industrials [17]

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Well, no. But it’s — other companies are not following this attack. So I think it’s worth calling out. My question is — hold on, I don’t have COVID. Just coming out of this, because there’s been no broader, centralized temporary cost actions that have to kind of get layered back, because other companies are talking when we model 2021, please don’t assume very high incrementals because we have to layer in all these costs that have to come back that are temporary. Could you possibly infer that — I don’t know, you talked about the decrementals going back to 30%, 35% in the fourth quarter. Because there’s no big centralized temporary actions, could the incrementals in 2021 be closer to 40% coming out of this, if not even a little bit higher?

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [18]

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I’d see no reason why they wouldn’t be your normal 35% plus.

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Operator [19]

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Your next question comes from Andrew Kaplowitz from Citibank.

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Andrew Alec Kaplowitz, Citigroup Inc, Research Division – MD and U.S. Industrial Sector Head [20]

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As you know, one of the main topics that you’re going to talk about at your Investor Day that was canceled by the pandemic was to give us more color on ITW’s overall portfolio in terms of its ability to outgrow the markets. So when you look at the 30% to 40% drop in Q2, we know a lot of it is auto related. But even excluding auto, it appears you’re thinking about 20% to 30% decline for the rest of the businesses. So are any of these businesses still expected to underperform their markets? Or is it really that ITW is simply levered to some end markets right now, such as auto and Food Equipment where the markets are just challenged by the pandemic?

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [21]

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Well, I’d say a couple of things, specifically around Q2. One is that certainly in auto and you know what’s going on in restaurants right now, Food Equipment, and the whole sort of CapEx environment, why would — most companies are certainly pulling back big time in any sort of CapEx until they have more clarity as to what the future will hold.

What I would say also is in Q2, that’s certainly a significant multiplier is all the supply chain. The brakes go on. There’s a multiplying effect of both — beyond just the consumption of whatever the products are. It’s related to the reduction — radical reduction in inventories to support a significant double-digit drop. So I’m not sure there’s a lot of comparisons to the market that are valid in Q2 for that reason. Let’s get through it. Let the smoke clear a little bit and see how things are starting to normalize in Q3 before we make any assessments in terms of relative growth.

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Andrew Alec Kaplowitz, Citigroup Inc, Research Division – MD and U.S. Industrial Sector Head [22]

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And Scott, maybe if I could follow-up on that. You usually guide to run rates. So is that kind of what your April run rate is? And then maybe…

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [23]

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If we use Q2 for run rates, we’d all quit.

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Andrew Alec Kaplowitz, Citigroup Inc, Research Division – MD and U.S. Industrial Sector Head [24]

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So maybe you can talk about sort of what you’re seeing in April. And then pecking order. You mentioned — we talked about Food Equipment. We know auto is going to be the worst. So any sort of more color on which markets may outperform or which markets may be weaker with the understanding that auto and Food Equipment are going to be (inaudible).

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [25]

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I’m going to let Michael address for April and sort of the relative Q2 performance across the segments.

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [26]

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Yes. I think, Andy, as we pointed out, the hardest hit segment, as you might expect, is the one that we’re calling out specifically with automotive down 60% to 70%. And I think, as you called out, that is a 10-point drag on our overall enterprise top line. So if you were to say ex auto, the balance of the businesses is down in that 20% to 30% range. Food Equipment, certainly one of the more challenged businesses here in the short term, particularly in the restaurant side, without going into too much detail. But we’re seeing a lot more resilience in food within — on the institutional side, whether it be health care or education, as well as on the retail side, as you might imagine. So — but overall, Food Equipment will certainly be more challenged than the average, probably down in that 35% to 45% range here in the near term. And recovery will depend on all the things that you’re aware of in terms of when these restaurants are able to open back up again, when we’re more able to service the equipment and so forth.

Welding, certainly challenged on the CapEx side. We talked a little bit about the oil and gas exposure there. Welding will be down, probably in line with the average of the company. And then from there, there is some pretty good resilience in places like Test & Measurement, specialty, it will probably be down in that 10% to 20% range. So I think — this is as difficult of a Q2 as certainly we’ve seen and it happened, as you know, very quickly. And I’ll just point back to the overall profitability of the company. I mean, even with these numbers I just went through, we are going to be very profitable. We’re going to generate more than $0.5 billion of free cash flow. We’ll have, at the enterprise level, double-digit operating margins that will be higher than some of our peers going into before this whole pre-COVID situation.

So it’s a real position of strength. Even with this macro shock that we’re dealing with, we’ll get through the near-term and we’ll be much stronger when we come out the other end. So that’s kind of by segment, a little bit of detail for you.

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Andrew Alec Kaplowitz, Citigroup Inc, Research Division – MD and U.S. Industrial Sector Head [27]

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And April?

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [28]

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Yes, April is tracking. I think we had a forecast going into — we developed early April that we thought we’d be down 30 to 40, and April is tracking. April and May will be difficult months. There are some indications that things are starting to improve. I think Scott mentioned by region, China for example, we had a bottom probably in the month of February, down in the mid-30s, and April was flat. So — and the automotive business might be flat in Q2 here in China. So there’s certainly some early signs that things have bottomed here in April and May. And like I said, difficult, and then we’ll see June. But obviously, all of this with the usual caveats. This is a highly uncertain situation. But I’d say, as we sit here today, pretty confident that we’re seeing the worst of it right now, and we’ll get through this. And we’ll see what the second half of the year is going to look like in terms of the recovery.

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Operator [29]

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Your next question comes from Jamie Cook from Crédit Suisse.

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Jamie Lyn Cook, Crédit Suisse AG, Research Division – MD, Sector Head of United States Capital Goods Research, and Analyst [30]

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I hope everyone is healthy. Glad everyone is healthy and well. I just want to ask a question on the market share opportunity. I thought that’s very interesting, sort of coming out of the downturn here. So when you think about your market share strategy, will it be more focused on certain businesses that you view as more attractive within your portfolio broad based? And then historically, how has — where do you see the biggest opportunities in downturns historically? What was the type of market share the ITW usually gets? And just sort of how sticky is that market share?

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [31]

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Well, I think this is certainly — I’m not sure — certainly, from my own perspective, how much past history is really relevant or valid. We’re a very different company today than we were under — in any prior contraction. And I would say the other element is this is a harder, faster, more challenging decline than any of us — anybody has ever been through. So from the standpoint of the kinds of potential impacts it may have on a number of companies and what that might do ultimately to — think about a sort of a hard crash and a relatively robust kind of recovery, there’s going to be a lot of — you’re going to have to be able to respond quickly all the way through the supply chain, not just your own capacity. So there’s going to be a lot of challenges around all of that, depending on different industries and how they ultimately recover the pace. So I can’t certainly predict or say that we have any view that one part of our company is going to be more ripe for those kinds of opportunities than others at this particular stage. What I am saying is we’re going to be prepared in every one of our businesses to be there, to be able to seize those opportunities if and when they emerge. And I think that’s all I can say. We are — I think we’ve done a lot of work on the portfolio. To say there’s any part of our portfolio that we don’t want to grow incrementally at this point is not the way I would characterize it.

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [32]

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I would also say that we are not going to — we’re not interested in superficial gains here. We’re interested in share gains in areas where we’re already focused that fit the way we’re trying to serve and grow our positions in these markets for the long haul. So we’re not going to be looking for a quick sale and bailing out a competitor in an area that’s not of interest to us long term. And that’s a lot of what we’re going through in the planning right now, is to not only make sure we have the capacity to support those incremental opportunities, but to make sure that our divisions have real clarity in terms of exactly where they’re looking to grab those opportunities and where they’re not.

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Operator [33]

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Your next question comes from Josh Pokrzywinski from Morgan Stanley.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division – Equity Analyst [34]

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I just wanted to echo the earlier comment on kind of that refreshing approach on preserving the employee base and kind of being far sighted on this. It’s certainly not very common as what we’ve heard so far.

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [35]

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Thank you.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division – Equity Analyst [36]

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I guess, Scott, just to follow-up on Jamie’s question there. When you think about what that means in terms of being able to attract more market share as we exit — and it probably varies business by business, but is it competitors who have guided the sales force? Is it product development? What exactly does that — maybe it’s probably not capacity, but what does that mean to you in terms of the means by which to do that? Yes. Like I said, I can imagine that it’s probably not raw capacity issues. So where do you think ITW will have the biggest advantage based on what you’re doing today?

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [37]

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Well, again, I think it’s hard to sort of characterize in one description a range of scenarios. But I do think the productive capacity is actually a big part of it that has — as these markets turn, to the extent you haven’t kept cushioning your supply chain, cushioning your capacity. Again, you can have the machine sitting around, but if you don’t have the people there, you don’t have the suppliers there ready to go. Think about a scenario where in the second quarter, businesses in an industry is going to be down 30%. If it’s down only 15% in Q3, that’s a sequential improvement at a clip like nobody ever has to manage before. And so I think those are — I wouldn’t discount sheer ability to deliver and supply as a core part of where these opportunities might emerge.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division – Equity Analyst [38]

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Got it. And then just specifically on Food Equipment. Obviously, a business that 3 or 6 months ago, people wouldn’t have had a contingency plan the way they are today. What percentage of the weakness would you just attribute to kind of customers being closed, i.e. when the lights come on, maybe there is a new normal, but that’s not particularly robust, but kind of a step function improvement. I understand it’s a fragmented market, so maybe hard to give visibility, but just any additional color you might be able to provide.

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Christopher A. O’Herlihy, Illinois Tool Works Inc. – Vice Chairman [39]

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Yes. So if we think about Food Equipment and specifically with the restaurant side of the business, so 25%, 30% of our business. And the recovery there is going to not just depend on lifting of shelter in place restrictions, but also in terms of core shelter in place, what additional restrictions will be on the business in terms of occupancy and so on. Clearly, a very, very uncertain environment. It’s very difficult to predict what that will look like. But for us, we are somewhat comfortable by the fact that the other parts of our business, as Michael mentioned, the institutional piece, particularly health care, higher education is doing quite well. Retail is doing quite well, as you would expect. The typical deli counter business is thriving right now. We are being slightly a little bit in terms of being able to put in installations because they are so busy, but the long-term demand trends there are pretty healthy.

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [40]

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And then service.

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Christopher A. O’Herlihy, Illinois Tool Works Inc. – Vice Chairman [41]

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And in service is the other business where we continue to, to Scott’s point, keep our service organization fully employed here. I mean we’ve taken a huge investment over the years in ensuring that we had a highly developed, highly trained service force. And the last thing we want to do is let those folks go, acknowledging that even though capacity is down right now, that will recover in the medium term.

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Operator [42]

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Your next question comes from Jeff Sprague from Vertical Research.

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Jeffrey Todd Sprague, Vertical Research Partners, LLC – Founder & Managing Partner [43]

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Two from me. First, before we look any further forward, let’s — just looking back one more time on Q1, right? I mean, the margin improvement across the board on down revenues, it actually is pretty impressive. Just wondering how to put some context around this. We see kind of a big slug from the kind of the margin enhancement initiatives across the portfolio. Perhaps it’s some of the PLS really shining through. I know every division is different, but perhaps we can focus on polymers or the electronics business where the margin performance was surprisingly strong.

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [44]

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Yes. Thanks for the kind words, Jeff. I mean I think this was a good example in Q1 of what Scott was talking about that nobody is sitting around in our divisions that are waiting for somebody to tell them what to do. They react quickly — the team reacts quickly when they see changes in demand. And so I think with revenues down 9%, the fact that margins were flat up in 5 or 7 segments, the big driver continues to be, for us, after 7-plus years, the enterprise initiatives at 120 basis points. And price cost, no longer an issue for us. And then, of course, the volume leverage, we were able to offset some pretty meaningful headwind there to hold margins flat.

So we expect the enterprise initiatives to continue as we go through the year. With lower volume, the overall contribution might be a little less than what you’ve seen in Q1 and last year in the 100-plus range, but it will still be a meaningful lever within our own control as we go through the worst of it here in Q2 and then head into the recovery in Q3 and Q4.

I don’t know if you want to talk about anything specifically. But by segment, the biggest driver is — remains enterprise initiatives and that’s 70 to 160 basis points range by segment. And like I said, we expect that to continue to be a meaningful contribution as we go forward.

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Jeffrey Todd Sprague, Vertical Research Partners, LLC – Founder & Managing Partner [45]

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Yes. So maybe just to — a little bit forward then, I mean, fully understand when revenues go down 30% or 40%, it does some pretty disruptive things to the decremental margins, and there’s not a kind of a corporate-wide initiative. But it looks like you’re kind of implying 45% decrementals here in Q2. Wouldn’t each one of these organizations, divisions individually, even though they’re not cutting heads, right, they may be doing some pretty dramatic things on T&E and other discretionaries, kind of levers that they can pull. I know it maybe doesn’t roll up cleanly to the parent that you can kind of view with real clarity. But maybe just kind of frame that, just kind of…

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [46]

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Yes. I can frame it. The big difference between Q1 and Q2 is the magnitude of the revenue decline, right? So we handled a 9% decline in Q1, 7% organic. And certainly, those business level tactical adjustments, as Michael said, showed up very strong. The difference in Q2 is the magnitude of revenue decline is significantly greater. Those tactical adjustments are still there and ongoing. That’s what we talk about managing the business prudently, all of that is still in place. But we’re also saying to our businesses, let’s not react to this Q2 — unprecedented Q2 that’s not going to be reality beyond Q2. And we’ve — as we’ve talked about a number of different levels here, we’re going to preserve our ability to structure ourselves appropriately going forward and not react or overreact to the short-term conditions in Q2.

Could the decrementals be better in Q2 if we wanted to drive something at that? Sure. But do we think that’s the right thing to do for our company? Absolutely not.

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Jeffrey Todd Sprague, Vertical Research Partners, LLC – Founder & Managing Partner [47]

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So the corporate role here in Q2 is actually to give the divisions license not to do anything damaging to their business.

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [48]

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100%. 100%.

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Operator [49]

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Your next question comes from Andy Casey from Wells Fargo Securities.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division – Senior Machinery Analyst [50]

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Question on the supply chain. Are you hearing about any suppliers that may run into liquidity issues?

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Christopher A. O’Herlihy, Illinois Tool Works Inc. – Vice Chairman [51]

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Yes. So Andy, so with respect to the supply chain, no major issues to date for us with suppliers or some of the — obviously, an issue we’re managing very closely. We would feel certainly that our produce where we sell approach has served us pretty well here. We would also say that the fact that we’re decentralized helps us to provide — helps us as it provides 80 different kind of touch points, which enables us to kind of stay well informed and react quickly. So something we’re rigorously managing, as we talked about in the presentation and not seeing any issues right now, but something we’re very attuned to.

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [52]

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And I think that we’ve always been a source local company. So from the standpoint of the diversity of our supply base that we are not dependent on one single-source relationships of finance globally, that we’ve got some level of risk mitigation and ability to shift and move.

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [53]

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Right.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division – Senior Machinery Analyst [54]

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And then you made mention of, Scott, I think it was your radical inventory reduction. I’m presuming that’s broadly speaking in the distribution channel. If we look outside of auto, how deep a reduction in inventory are you actually seeing in the channel? And does that suggest — who knows when it happens, but does that suggest you may see a fairly big restock if end market volume starts to sequentially improve?

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [55]

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I would say that we have almost no visibility near-term in terms of how inventories have been adjusted. I think it’s a safe assumption to say that anybody in the distribution business is certainly managing that aspect of their business very carefully. And ultimately, again, there are — there’s a sort of magnitude of decline and potentially magnitude of correction the other way that there are going to be factors here in terms of how companies are positioned to ultimately handle it. But I don’t think we have any ability to say whether inventories are too high or too low still in the channel across most of our businesses at this point.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division – Senior Machinery Analyst [56]

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Okay. And then if I could squeeze one more in. You kind of touched on it earlier. But end markets, specifically in Europe and North America, some other companies have talked about stabilization. I know it’s granular, but in the last 2 weeks of April, outside of auto and Food Equipment, have you seen anything similar to that? Or is it just kind of still really, really weak?

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [57]

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It’s still challenged, Andy. I mean I think the closest you can get to talking about something stabilized are the data points that we provided on China, where, like I said, in February, our sales were down, I think 36% was the number. And in April, we’re flat. So that’s probably the best I can give you. I think as we look at the regional numbers here for Q2, company — total company down 30 to 40. North America will probably be at lower end of that in terms of down in that 25% to 35% range, and Europe will be higher than that. And then China, like we said, flat for the quarter, maybe a little bit better. But not to get into a sort of pick-and-choose situation. But I would say also, things are not as bad in some cases as any of us expected. It’s not terrible. It’s a unique situation, but we’ve got parts of our portfolio that are certainly stabilizing. And I’m thinking of some elements of our business that are certainly — I mean, they’re all under some challenge. But I don’t want to — we’re still serving customers, and we’re still in business. So we’ll get through it.

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Operator [58]

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Your next question comes from Joel Tiss from BMO.

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Joel Gifford Tiss, BMO Capital Markets Equity Research – MD & Senior Research Analyst [59]

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I just wanted to — most of my questions have been answered. But I wonder if you’re seeing any sort of pressure points or give us a little more granularity on some of the opportunities for new rounds of enterprise initiatives, or to further automate your factories and that sort of thing. Like how does — how do you evolve from what you’re seeing and execute turning some of this pandemic into strength?

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [60]

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I don’t know if that changes a whole lot. We are highly automated in certain parts of the company because that’s the right thing for the business in terms of not just the cost productivity but also level of quality that we need to build into the product. We have — as we’ve talked about forever, we have never been constrained from the standpoint of capital investment. So I don’t know that I have any view that says because of the pandemic, we’re going to have a shift in strategy under — within the framework of 80/20 front-to-back in our business model. I think, certainly, that business model helps us a great deal as we work our way through a lot of the issues and challenges that will come about. But it doesn’t — I’m trying to think about your question, I can’t think of anything [final].

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Joel Gifford Tiss, BMO Capital Markets Equity Research – MD & Senior Research Analyst [61]

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I understand. As there were changes, I mean, those will be conceived at the divisional level, depending on local circumstances that made sense for them given the operating environments that they’re in.

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [62]

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Yes. And I was going to say all the projects and activities that add up to the enterprise initiative savings, those projects are still there. And so nothing has really changed from that standpoint.

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Joel Gifford Tiss, BMO Capital Markets Equity Research – MD & Senior Research Analyst [63]

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And there’s nothing like product line level that you see some stresses that maybe you didn’t see before, that maybe there are businesses that don’t fit any more or need a little more restructuring than what you thought before? Or everything is kind of — it’s just unusual times, and it’s not a good — not a good reason to make a different decision.

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [64]

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I think we’ve got to let the smoke clear a little bit here. To answer your question, I don’t know. I certainly — will there be some businesses that there’s some fundamental change in the overall demand profile based on the impact of the pandemic? I’m sure across 85 divisions, we’ll have some of that. We’ll have some others that will have a — as we’ve talked about a lot, some incremental growth opportunities that we’ll have to support with some investments. So we’ll get to all that stuff. It’s really hard sitting here in…

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [65]

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Historically…

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [66]

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In the early May, given all that’s going on there. We need to have any clarity or view on that.

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Operator [67]

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Your next question comes from David Raso from Evercore ISI.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division – Senior MD & Head of Industrial Research Team [68]

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In trying to think through the margin recovery potential for ’21, I’m trying to understand the 2020 cadence a little bit better. It sounds like you feel the second quarter will be the worst of it, and the decremental margins implied are 45%. But if I look at your scenarios for the year, if I use the middle scenario, it implies that decrementals get worse in the second half. They’re actually 49%. And if you’re saying the fourth quarter will be back to 35%, it’s really implying a well over 50% decremental in the third. So I guess the question is, why would it get worse on the decrementals because the comp isn’t that different? And maybe the answer is, and Michael, you alluded to it, what’s the placeholder for the restructuring? And is that mostly in 3Q?

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [69]

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You just answered your own question. So that’s exactly right.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division – Senior MD & Head of Industrial Research Team [70]

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I was trying to have it quantified so…

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [71]

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I know, it’s a nice try.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division – Senior MD & Head of Industrial Research Team [72]

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So is the third quarter restructure, I mean, it’s…

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [73]

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It’s a nice try, David. I mean, like I said earlier, we just don’t know yet. I mean — and this is not — this company is a bottoms-up company. And the restructuring will be what our VP GMs and division leader teams decide that they need to do once they have a clear view of what the demand picture is. At that point, we have plenty of capacity and funding for all the investments we want to make, and — including some of the restructuring that may be required as we go forward. So — but that’s really the best I can give you right now.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division – Senior MD & Head of Industrial Research Team [74]

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All right. So no quantification, but it feels more 3Q heavy based by that math on the cadence of the decrementals. Is that at least fair?

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Michael M. Larsen, Illinois Tool Works Inc. – Senior VP & CFO [75]

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That’s fair. I think the math (inaudible).

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Operator [76]

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Your next question comes from Ross Gilardi from Bank of America.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division – Director [77]

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I’m glad to hear from you guys as well. Hope everybody is well. I would just love to hear ITW’s view on onshoring more of your production to the U.S., more of your supply chain. What are your — your western customers that are doing a lot of international business saying on that, particularly in China? And just your overall perspective, is there enough onshoring that could happen in the overall industrial economy in the next year or 2 that could make a difference in the actual pace of economic recovery in the States, as you see it? Just any views on that would be really interesting.

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E. Scott Santi, Illinois Tool Works Inc. – Chairman & CEO [78]

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Yes. I can only speak for ITW in that regard, largely, which is that we have always been a produce-where-we-sell company, and we’ve talked about that often. And so from the standpoint of how any of this impacts our footprint from the standpoint of where we produce and where we source, none of this changes any of that. I certainly think that there is likely to be, directionally, more movement for all the reasons you talked about amongst global manufacturers around localizing their production. I think there certainly are going to be some lessons learned from the standpoint of the need to balance both lowest cost, the low-cost, lowest cost country sourcing. Lowest cost with resilience and redundancy. And so I absolutely think that will play itself out.

From our standpoint, I don’t know that, that presents any more or less opportunities. We’re serving our customers globally. It will certainly, perhaps, affect some of our supply points into those customers from a geography standpoint, but none of it, that’s going to have that, that I would say would result in any significant shift for us one way or the other.

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Operator [79]

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Unfortunately, we are out of time for questions today. I would like to turn the call back over to Karen Fletcher for closing remarks.

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Karen A. Fletcher, Illinois Tool Works Inc. – VP of IR [80]

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Okay. Thanks, Julianne. I just want to thank everybody for joining us this morning. We’re available through the rest of the day for additional follow-up. Stay well, everyone. Thank you.

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Operator [81]

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