Illinois Tool Works Inc.

Good morning. My name is Julianne, and I will be your conference operator today. At this time, I would like to welcome everyone to the conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, please press the pound key. For those participating in the Q&A, you'll have the opportunity to ask one question, and if needed, one follow-up question. Thank you. Karen Fletcher, Vice President of Investor Relations, you may begin your conference.

Karen Fletcher Okay. Thank you, Julianne. Good morning, and welcome to ITW's fourth quarter 2020 conference call. I'm joined by our Chairman and CEO, Scott Santee, and Senior Vice President and CFO, Michael Larson. During today's call, we'll discuss ITW's fourth quarter and full year 2020 financial results and provide guidance for full year 2021. Slide two is a reminder that this presentation contains forward-looking statements. We refer you to the company's 2019 Form 10-K and subsequent reports filed with the SEC for more detail about important risks that could cause actual results to differ materially from our expectations, including the ongoing effects of the COVID-19 pandemic on our businesses. This presentation uses certain non-GAAP measures, and a reconciliation of those measures to the most directly comparable GAAP measures is contained in the press release. Please turn to slide three, and it's now my pleasure to turn the call over to our Chairman and CEO, Scott Santee. Scott Santee Thank you, Karen.

Good morning, everyone. The ITW team closed out 2020 with another quarter of strong operational execution and financial performance. From my perspective, the highlights are that KFOR revenues got back to year-ago levels, despite food equipment being down 17%. and that operating income, operating margin, and after-tax ROIC were all Q4 records for the company. It was a pretty solid finish to a year that, needless to say, provided some unique and unprecedented circumstances and challenges and indicates good momentum as we head into 2021. While it was the challenges brought about by the pandemic that dominated our attention in 2020, It was the collection of capabilities and competitive advantages that we have built and honed over the past eight years through the execution of our enterprise strategy that provided us with the options to respond to them as we did. Early on as the pandemic unfolded, we refocused the entire company on only two core imperatives. A, to protect the health, safety, and well-being of our people, and B, to continue to serve our customers with excellence. And in my view, we executed extremely well on both. Our manufacturing operations and customer service teams around the world deserve special recognition for their extraordinary efforts and leadership in support of these two key pandemic priorities. Their dedication and commitment to keeping themselves and their colleagues safe while continuing to deliver excellent service to our customers was truly inspiring. And there's no question that we differentiated ourselves with many of our key customers as a result of our ability to sustain our normal rock-solid quality and delivery performance throughout 2020 as a result of their efforts. We also did our best to take full advantage of ITW's position of strength as we thought through how we should manage the company through the pandemic. Back in the spring, as we analyzed and stress tested the company's performance across a wide range of scenarios, it became clear that the financial and competitive strengths that we had built up over the past eight years had resulted in a very strong and very resilient company. And that as a result, we didn't have to just pull out our old recession playbook and hunker down. That for ITW, this was a unique opportunity to react smartly and to stay focused on the long term. This conclusion led to two key decisions that we made regarding how we were going to manage ITW through the pandemic crisis. First, we chose to leverage the strong financial foundation that we've built over the last eight years to reinforce our commitment to our people. First, by providing full compensation and benefit support to all ITW colleagues through the entirety of Q2 when the economic effects of the pandemic were at their most widespread and severe, and by deciding that we would not initiate any enterprise-wide employment reduction mandates or programs at any point in 2020. These were not obvious or easy decisions given the unprecedented and uncertain circumstances, but we believe that they were the right decisions for our company. And I know that our people will remember them. These decisions also turned out to be the right ones for us operationally, given the pace of demand recovery that we saw beginning in Q3. Second, we chose to leverage our position of strength by implementing our win the recovery agenda and mindset across the company. Win the recovery was not an opportunistic new strategy. What it was and is, is a commitment to staying the course and continuing to prioritize the execution of our long-term enterprise strategy, despite the unique and unprecedented challenges brought about by the global pandemic. When the recovery for us did not mean ignore the pandemic, as across the company, we had to read and react to the realities of the near-term situation as we always do. But it does mean that we are committed to protecting key investments, supporting the execution of our long-term strategy, and that we have, from very early on, given our divisional leadership teams the mandate to continue to think long-term and to remain aggressive through the pandemic. For 2021, our women recovery posture and mindset continues on and serves as the central theme driving the 2021 operating plans for every one of our 83 divisions. Before I turn the call over to Michael for more detail on our Q4 performance and our 2021 guidance, let me close by thanking all of our ITW colleagues around the world for their exceptional performance and dedication in the face of the most challenging and unprecedented circumstances of the past year. The performance that they delivered in 2020 provides another proof point that ITW is a company that has the enduring competitive advantages resilience, and agility necessary to deliver consistent top-tier performance in any environment. Like many of you, I'm sure, we are hopeful for a return to somewhere in the vicinity of normal at some point in 2021, and with that, getting back to giving our full attention to taking ITW all the way to the company's full potential. Between now and whenever that is, We will continue to leverage the full breadth of ITW's capabilities and competitive advantages to keep our people safe, continue to serve our customers with excellence, and execute our long-term enterprise strategy. Michael, over to you. Thank you, Scott, and good morning, everyone. Please turn to slide four. the fourth quarter we continue to see solid recovery progress in many of the end markets that we serve as evidenced by our revenue being up sequentially five percent versus the third quarter the increase is eight percent when you adjust for equal number of days when historically our revenue per day has increased by one percent from q3 to q4 overall we delivered revenue of 3.5 billion operating income of $883 million, an increase of 7% year-over-year, operating margin of 24.4%, free cash flow of $705 million, and gap EPS of $2.02. After-tax return on invested capital improved to 32%. And as Scott mentioned, operating income, operating margin, and after-tax ROIC were fourth-quarter records for the company. Revenue in all major geographies improved sequentially. On a year-over-year basis, North America organic revenue declined 3%, international revenue grew 1%, Europe was down 2%. Similar to Q3, China was the bright spot with 11% growth. As we've talked about before, the operating flexibility that is core to our 80-20 front-to-back operating system also applies to our cost structure, which was on full display through our operating margin performance in Q4. We improved operating margin by 170 basis points to 25.4%, the second highest margin rate in a quarter in the history of the company. And like I said, grew operating income 7% to $883 million, the highest fourth quarter ever. The biggest driver of our margin improvement remains our enterprise initiatives. as the ITW team executed on projects and activities that contributed 130 basis points in Q4. The impact was broad-based with all segments delivering enterprise initiative benefits in the range of 80 to 170 basis points. Gap EPS was $2.02, up 2%, but keep in mind that Q4 last year had 11 cents of one-time gains from divestitures. To exclude those gains, EPS was up 7%, the same as operating income. Working capital performance was excellent and free cash flow of $705 million was solid with a conversion rate of 110% of net income. Finally, the effective tax rate was 22.1% down slightly from last year. In summary, a strong finish to a challenging year and very good momentum as we head into 2021. Let's move to slide five to review fourth quarter's recovery and response by segment. We updated this slide from our last earnings call with Q4 information, and you can see that our segments continue to respond effectively to the increase in demand recovery and improve sequentially on both revenue and operating margin. I will just highlight a few things to illustrate the resilience and adaptability of our businesses. You can see the rapid recovery in our end markets relative to the Q2 bottom of down 27%. In Q4, three of our segments experienced demand levels that were higher than a year ago. The most pronounced recovery has been in automotive OEM, which has more than doubled since Q2 and grew 8% year-over-year in Q4, as did construction products. Polymers and fluids grew 7% while demand in three segments, test and measurement in electronics, welding, and specialty products was only slightly lower year over year. As you would expect, food equipment continues to be impacted by the effects of the pandemic, although we are seeing some sequential improvement. Overall, you can see the benefit of having a high-quality, diversified portfolio and the fact that we're back to demand levels of a year ago, the total revenue essentially flat year-over-year, despite one of our core segments being down organically by 19%. On the right side of the page, you can see the operating flexibility that I just talked about and how it also applies to our cost structure and ultimately shows up in our operating margin performance. At the bottom, in Q2, we still delivered solid operating margins of 17.5%, and only two segments were below 20%. In Q4, we're almost 800 basis points higher at 25.4%, despite no volume growth year over year. And every segment is back above 22%, including food equipment, as six out of seven segments achieved record fourth quarter operating margins. Let's move on to slide six for a closer look at individual segment performance, starting with automotive OEM. The team has continued to execute exceptionally well from a quality and delivery standpoint in responding to customer demand levels that have more than doubled since Q2. In Q4, organic growth of 8% year-over-year was the highest growth rate since the first quarter of 2017. While North America was flat in Q2, it was more than offset by strong demand in Europe, which grew 10%, and China, which grew 20%. As expected, food equipment end markets remained challenged in Q4. Organic revenue was down 19%, a little better than the third quarter, and demand in Q4 was similar to Q3 when you look at it by geography and the end markets. North America was down 20%, international down 18%. Equipment sales were down 20%, and service was down 18%. Institutional demand was down about 30% with restaurants down a little bit more than that. And not surprisingly, the bright spot throughout the year continued to be retail with organic growth of 8%. Moving to slide 7 for test and measurement and electronics. Q4, organic revenue declined 3% with test and measurement down 8% against a tough comparison of plus 6% in Q4-19. Electronics was up 3%. And while demand for capital equipment remained sluggish, the segment benefited from considerable strength in several end markets, including semiconductor, healthcare, and cleanroom. As you may have seen, on January 19th, we announced that we had entered into an agreement with Amphenol to acquire MTS's test and simulation business. The test and simulation business is very complementary to our Instron business, which we highlighted during our 2018 Investor Day. And some of you may have visited our facility outside of Boston. MTS's test and simulation business has similar organic growth potential, and there's substantial opportunity for margin improvement through the application of the ITW business model. Pre-COVID revenues in fiscal year 2019 were $559 million with operating margin of 6%. We expect to get the business to generate ITW-caliber operating margins by the end of year five and generate after-tax RIC in the high teens by the end of year 10. As you saw in the announcement, we expect the acquisition to close in the middle of 2021, and we're very much looking forward to welcoming the MTS test and simulation team to the ITW family. Moving on, please turn to slide eight and welding, where we saw a meaningful pickup in demand as organic revenue improved from being down 10% year-over-year in Q3 to only being down 2% in Q4. Our commercial business, which primarily serves smaller businesses and individual users and accounts for 35% of the revenue in this segment, remained strong and grew 12% year-over-year. Our industrial business showed signs of strong recovery from being down 23% in Q3 to down only 5% in Q4 as customer activity and equipment orders gained strength. Overall, organic revenue for equipment was flat versus prior year, and much improved versus a 10% decline in the third quarter. Polymers and fluids delivered strong organic growth of 7% with fluids up 16% with continued strong demand in end markets related to healthcare and hygiene. The automotive aftermarket business benefited from strong retail sales with organic growth of 5% and polymers grew 4% with solid demand for MRO and automotive applications. Moving to slide nine, construction continued to benefit from strong demand in the home center channel and delivered organic growth of 8% in Q4. Growth was strong across all geographies, with North America up 10%, double-digit growth in the residential renovation market, offset by commercial construction, which represents only about 15% of North America revenue, down 11%. Europe grew 9%, and Australia and New Zealand grew 5% due to strong retail sales. Specialty organic revenue was down 3% this quarter, with North America down 2%, and international revenue down 4%. Demand for consumer packaging remained solid, but it was offset by lower demand in the capital equipment businesses. So that concludes this segment commentary, and let's move on to the full year 2020 summer results on Site 10. And in the face of unprecedented challenges that included temporary customer shutdowns across wide swaths of our end markets during the year, organic revenue was down 10 percent. Still, we delivered operating income of $2.9 billion and a highly resilient operating margin of 22.9 percent, only down 120 basis points year-over-year, despite no major cost takeout initiatives or mandates, and with a strong contribution of 120 basis points from our enterprise initiatives. After-tax ROIC was 26.2%, and free cash flow was $2.6 billion. Throughout the pandemic, one of our priorities was to maintain our financial strength, liquidity, and strategic optionality, and as you can see, we did just that in 2020. ITW's balance sheet is strong, and we have ample liquidity. We did not have a need to issue any debt or commercial paper in 2020, and we ended the year with total debt to EBITDA leverage of 2.5 times, which was only slightly above our 2.25 times target. At year end, we had approximately $2.6 billion of cash and cash equivalents on hand. With 2020 behind us, let's move to slide 11 for discussion of our guidance for 2021. So starting with the caveat that we continue to operate in a fairly uncertain economic environment, we have based our guidance, as we always do, on the current levels of demand in our businesses. Per usual process, we're projecting current levels of demand into the future and adjusting them for typical seasonality. The outcome of that exercise is a forecast of solid broad-based organic growth of 7% to 10% at the enterprise level. Foreign currency at today's exchange rates is favorable and adds two percentage points to revenue for total revenue growth forecast of 9% to 12%. At our typical incremental margins of 35% to 40%, we expect GAAP EPS in the range of $7.60 to $8 a share, up 18% at the midpoint. We're forecasting operating margin in the range of 24% to 25%, which is an improvement of more than 150 basis points year-over-year at the midpoint. Enterprise initiatives are a key driver of operating margin expansion in 2021, as they're expected to contribute approximately 100 basis points. Restructuring and price costs are expected to be approximately margin neutral year-over-year. We're closely monitoring the raw material cost environment, and embedded in our 2021 guidance are the known raw material cost increases in commodities such as steel, resins, and chemicals. Given the differentiated nature of our product offerings across the company, we expect to be able to offset the impact of any incremental raw material cost increases that might arise in 2021 with pricing actions on a dollar-for-dollar basis. We expect strong free cash flow in 2021 with a conversion rate greater than 100% of net income. I wanted to provide a brief update on our capital allocation plans for 2021. Top priority remains internal investments to support our organic growth efforts and sustain our core businesses. Second, we recognize the importance of an attractive dividend to our long-term shareholders, and we view the dividend as a critical component of ITW's total shareholder return model. Third priority are selective, high-quality acquisitions that supplement our portfolio and reinforce or further enhance ITW's long-term organic growth potential. I should point out that the guidance we're providing today is for the core business only. After the MTS test and simulation acquisition closes, we'll provide you with an update, but we do not expect a material impact in 2021. In line with our capital allocation, we return surplus capital to shareholders, and we are reinstating share repurchases with a plan to invest approximately $1 billion in 2021. We expect our tax rate for the year to be in the range of 23 to 24%. Finally, when it comes to portfolio management, we have decided to defer any divestiture activity until next year and instead focus our time and efforts on the recovery in 2021. While our view regarding the long-term strategic fit of the remaining divestitures hasn't changed, we also believe that given their expected performance this year, they will be more valuable in 2022. Let's turn to slide 12 and the forecast for organic growth by segment. With the caveat, again, that the environment remains fairly uncertain, we are providing an organic growth outlook for each segment. And based on current levels of demand, we are forecasting solid board-based growth as every segment is expected to improve their organic growth rate in 2021. At the enterprise level, it all adds up to solid organic growth of 7% to 10%. To wrap it all up, ITW finished a challenging year strong as we continue to fully leverage the capabilities and competitive advantages that we've built over the past eight years through the execution of our enterprise strategy. Our strong operational and financial performance in 2020 provided further evidence that ITW is a company that has both the enduring competitive advantages and resilience necessary to deliver consistent operative performance in any environment. Looking ahead to 2021, we have good momentum from Q4 heading into the year, and our solid guidance reflects the fact that 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. With that, Karen, I'll turn it back to you.