Illinois Tool Works - Earnings Call - Q3 2020

Transcript

Speaker 2

Good morning. My name is Julian, 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 speakers are marked, 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's keypad. If you would like to withdraw your question, press the pound key. For those participating in Q&A, you will 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.

Speaker 0

Okay. Thank you, Julian. Good morning, everyone, and welcome to ITW's Third Quarter 2020 conference call. I'm joined by our Chairman and CEO, Scott Santi, and Senior Vice President and CFO, Michael Larsen. During today's call, we will discuss ITW's Third Quarter 2020 financial results and provide an update on our strategy for managing through the global pandemic. Slide 2 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 business. This presentation uses certain non-GAAP measures, and the reconciliation of those measures to the most comparable GAAP measures is contained in the press release.

Please turn to Slide 3, and it's now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

Speaker 3

Thank you, Karen, and good morning, everyone. We saw 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 and 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 coworkers safe. Perhaps the most pronounced example was our auto OEM segment, where our team executed flawlessly from both a quality and delivery standpoint in responding to demand levels that essentially doubled in Q3 versus Q2, and with a very demanding customer base. Across all seven of our segments, our teams can cite numerous examples of how our ability to sustain high levels of service in the face 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 am confident that they will contribute meaningfully to accelerating our progress towards 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 showed 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, and two 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 EPS 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 could not be more proud of how the ITW team is managing through this challenging period, and I want to sincerely thank my 45,000-plus ITW colleagues around the world for their continued exceptional efforts and dedication in serving our customers and executing our strategy with excellence.

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 in 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 environment. Moving 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. I'll now turn the call over to Michael for more detail on our Q3 performance. Michael?

Speaker 1

Thank you, Scott, and good morning, everyone. 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 over the last seven years to position ITW for maximum participation in the recovery. 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. 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 certification 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 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 EPS 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 a 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-one 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. 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 swung from negative to 20% plus.

In addition, six of seven segments had operating margins, not segment margins, operating margins above 20%. FEG, 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 continued to take hold. In China specifically, automotive OEM, polymers and fluids, and specialty products all grew double digits. 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 shut down 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 down 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 discussed on our last call, we did initiate a few restructuring projects that were part of our 2020 plan pre-pandemic, which led 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%. I think it is worth noting that in this most challenging environment, the segment generated almost $19 million in operating income.

In test and measurement and electronics, organic revenue declined only 2%, with test and measurement down 6% and electronics up 2%. While demand for capital equipment remained 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% included 350 basis points of unfavorable impact from removing a potential divestiture from assets held for sale. Excluding this impact, the operating margin would have been 27.2%, which is a much more accurate representation of the underlying profitability of the segment. 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 determined 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 and 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%, with 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 and 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%. Some of you may remember that when we launched the enterprise strategy in 2012, construction had the lowest operating margins in the company, seemingly stuck right around 12%. Certainly good performance in the 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 remained 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 look 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 11-11.5%, operating margin to be in the range of 22-22.5%, and operating income in the range of $2.7 billion-$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 22-23% 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. Okay, thanks, Michael.

Julianne, let's open up the lines for questions, please. Certainly. At this time, I would like to remind everyone in order to ask a question, press star then the number one on your telephone keypad. Your first question comes from Jamie Cook from Credit Suisse. Please go ahead. Your line is open. Hi, good morning and nice quarter. I guess two questions, sort of one strategically as we're getting through COVID. Can you sort of speak to where you've had a good opportunity to grow faster than the market, or which markets do you see best positioned to grow faster than the market as you sort of take advantage of the opportunity right now and an update on how the M&A is trending? I guess my second question is we think about 2021, understanding you don't want to talk about incrementals yet outside of volumes.

Is there anything that you can help us with, headwinds versus tailwinds? I guess you do not have some of the salary cuts that other people will be comping or structuring. I am just trying to think of the puts and takes and your ability to put up outsized incrementals. Thank you. Maybe let me take the sort of strategic questions and then ask Michael to comment on your second question. What I would say overall is this is very much a dynamic situation that is still playing its way out. We are certainly responding from a tactical standpoint pretty well at this point. Our ability to remain invested is certainly and with the mission of focusing on making sure we serve our customers extremely well through this period and also that we are in position to seize opportunities that come our way. We remain focused on that.

I think at this point, it's way too early to sort out the sort of priorities of the rank order of opportunities other than I'll refer back to the comment I made in my opening remarks that every one of our segments can point to solid examples in the third quarter of where their ability to have immediate availability to respond to a customer need resulted in incremental business for the company. It remains a priority, but I think the situation in the near term is just too dynamic in terms of having any real view at this point of what parts of the company have more opportunity than others. I think the thing we want to be clear about is we are focused on it and expect those opportunities to continue to play out as we go forward.

From an M&A perspective, all I would really say at this point is what we've said in the past is from the standpoint of the long-term strategy of the company, we remain very open to the good opportunities that come our way. I would also marry that up with the fact that in this environment, for the flip side of our own experience on the divestitures, this is not a particularly good time for quality business to sell. We're not in the market for distressed assets. We're interested in bringing quality companies into the company, into ITW, that we think we can portray our strategy and ultimately that we can help be even better companies. In this kind of environment, this is not necessarily a great time to sell.

On a medium to long-term basis, as we have said repeatedly in prior forums, it remains a core part of the overall growth strategy and profile of the company. From a tactical standpoint, short term, it's not a big focus right now. All right, thanks, Scott. On your second question, Jamie, as we've talked about before, the planning process inside of ITW is very much a bottoms-up planning process, and we simply haven't gone through that process yet with our businesses. I can't really comment in great detail. I promise that when we provide guidance on our next earnings call, I'll be able to address your specific questions in a lot of detail. I mean, I'll just point to the obvious ones at this point that the comparisons in terms of year-over-year growth are obviously what they are, which is fairly easy.

Specific to your question around incrementals, our long-term incrementals are still in that 35-40% range. I will say that as you saw this quarter in both Polymers and Fluids and Construction, when we get a reasonable amount of organic growth, the incremental margins tend to be significantly higher. It is certainly in the near term. You may see some of that when we get into detail for 2021. Okay, thank you. I appreciate the caller. Your next question comes from John Inch from Gordon Haskett. Please go ahead. Your line is open. Thanks. Good morning, everybody. Good morning, guys. Hey, Scott, what are you and your auto team saying toward the prospects to return to sustainable growth in North America and Europe?

In other words, how much pent-up demand cyclically is creating for a runway, do you think, beyond sort of a quarter or two of the pent-up stuff or kind of backtracking? I am just wondering if you also think a couple of companies have commented on this, and it seems intuitive the public is avoiding mass transit in big cities and driving more as they did in China during their experience. Do you think that adds some juice to the potential recovery in auto next year? Certainly potentially. I would say our thinking on that is not yet particularly deep. We are still in the tactical mode.

I think beyond what you the situation that you just talked about or the shift in demand related to this COVID experience on a medium basis that might result from what you talked about, we also are looking at dealer inventories that remain at five-year-plus lows. There's certainly, so I don't know that in our own thinking we're sort of out yet long-term. We'll do some of that as part of our planning process and as we think about how we want to adjust our positioning around that sort of trend long-term. I do think that based on just the sort of more current conditions in the marketplace, that certainly Q4 we expect to be solid and into Q1 at this point. We will have a better view when we announce our results and have our 2021 and 2022 plans baked in early January. No, that's fair.

I just wanted to also just follow that up and stick with the auto team. I've got a couple of contacts at OEs. What they tell me is right now there's pretty substantial problems with supplier quality. A lot of it may actually have to do with the fact that a lot of workers are booking off time and they're just not coming into work. It's creating a lot of stress in the system for requirements for the OEs to work overtime and do rework and stuff like that. Firstly, are you seeing quality issues with respect to your own supply chain who feed ITW's plants? Secondly, is this actually, I'm wondering, creating an opportunity because you guys can leverage 80/20 to drive some incremental share just based on the fact that you can fulfill with quality versus perhaps what others are doing?

I realize your auto business is kind of program by program, but that's why I'm kind of asking the question. You're not Delphi or whatever. Just there's something going on there. No, it's program by program, but we are not full-sourced in a lot of the programs that we participate in. Certainly, some of the issues that you talked about were absolutely present and were part of our overall results in auto in the third quarter, and we expect that to certainly continue to be an incremental opportunity. There are certainly lots of parts of the auto OE supply chain that we don't participate in, so we're not going to solve the problem.

Certainly, in the areas that we serve our customers, we are laser-focused on making sure they're aware that we remain in a very strong supply position, that we're there to help them to the best of our ability, deal with some of the issues that you talked about. From a quality standpoint, we've talked in the past about the fact that this company operates with localized supply chains, strong commitments to long-term relationships with our key suppliers. Going back to the second quarter, our plan throughout has been to make sure that that supply chain for us remains in position, robust, and ready to flex with us. That's not a new thing for us. That's inherent in our business model and the way we operate.

So far, I actually should have probably also thanked our supply base in my opening comments because they've been remarkable to date. Got it. Thanks, Scott. Appreciate it. Your next question comes from Julian Mitchell from Barclays. Please go ahead. Your line is open. Hi, good morning. Maybe a question first for Michael just around the free cash flow outlook. I think you'd mentioned on the previous call that you should have a big step down in second-half free cash, $600 million or so. In Q3, certainly, the free cash flow looking pretty robust. Just wondered if you had any updated thoughts around sort of working capital management and what kind of pressures that could put on the cash flow and how well you think you're managing that working capital now as the sales are starting to improve. Yeah, it's a good question, Julian.

I mean, I think as a result of the fact that the recovery progressed ahead of our expectations into the quarter, our free cash flow performance was also significantly better than what we expected going into the quarter. We expect something similar here in the fourth quarter. Like I said, year to date, we're at $1.9 billion, and we should end the year significantly above $2 billion. I will say this. I think the working capital performance inside the company, given the recovery here in Q3, was pretty remarkable. The teams did an excellent job focusing particularly on the receivable side. Early on, we put some focus on our credit and collection efforts.

As a result of that, if you look at our—you cannot see that from the outside, but inside the company, when you look at our past due performance, we are right in line with where we are historically, which, given the pressures here during the pandemic, is quite remarkable. You should expect to continue strong free cash flow performance, and we expect to end the year well above 100% if things stay the way they are here in the fourth quarter. Thanks. Just a quick follow-up, perhaps for Scott. You have mentioned the very low inventories in the auto OEM vertical. Just wondered, looking across the disparate portfolio at ITW, how do you characterize the state of inventories at channel partners and customers when you are looking at the other businesses? Are you seeing much restocking, for example, in general?

Yeah, we've talked about this in the past. We have very little visibility there. The auto comment I made was more around dealer inventories, which is obviously a step removed, and their approaches there are certainly their own. It is a number that's reported and is obviously very visible. In terms of most of our other channel partners, given the fact that you order from us today, we ship it to you tomorrow, there's very little buffer in terms of inventory. I think from the standpoint of destock, restock, it's not a big factor for us really ever. Great. Thank you. Your next question comes from Andy Casey from Wells Fargo. Please go ahead. Your line is open. Thanks a lot. Good morning, everyone. Good morning, Andy. A question on the outlook.

If I take the midpoint of the numbers that you provided, it seems to imply Q4 revenue kind of flattish with both Q3 and last year. But the margins are expected, if I'm doing the math right, to decline to about 22-23% from Q3's adjusted 25.3% and then last year's 23.8%. Is that entirely mixed, or should we consider something else? Yeah, I think the major driver of the guidance we're providing or the framework we're providing for Q4 is really the fact that if you go back and look historically, Q4 tends to be lower than Q3 from a revenue and margin standpoint, really primarily as a result of the fact that there are two less shipping days in the fourth quarter.

What I can tell you in terms of the underlying sales trends is that we obviously saw significant sequential improvement here as we went through the third quarter. Those have remained on trend as we sit here in October. That is certainly encouraging. The margin performance, again, there is nothing unusual here in the fourth quarter. I will say that I pointed to some one-time items here in the third quarter. Obviously, we do not expect those to repeat in the fourth quarter. Hopefully, we have provided enough information here for you to put together your own view of what the fourth quarter might look like with your own assumptions. What is reflected on the page and the deck is really our current view as we sit here today for the full year. Okay. Thanks, Michael.

If I may, last quarter, you gave us some information about market share win benefit to annualized revenue. Would you be willing to share where the company stands on that metric, meaning did it increase this past quarter? If so, by magnitude, about how much? I think what we gave you last quarter was just a couple of two or three real examples that had already started to play out as we were reporting our results. This is not a list that we're keeping inside the company. This is certainly a major focus across all seven of our segments. I guarantee you that our segments are tracking it very diligently.

At this point, I would assume it's certainly continued to broaden out, and it would just be impossible given the thousands and thousands of customers that we have that if we were keeping a running tab of all this stuff and reporting on it, it just wouldn't be practical, nor would it be accurate, probably. Okay. I'll pass them along. Thank you. Thank you. Your next question comes from Andy Kapalits from Citigroup. Please go ahead. Your line is open. Good morning, guys. Next quarter. Morning. Scott, Michael, if you look at a couple of your segments in the quarter, such as construction or polymers and fluids, growth rates we rarely ever see in these segments. We know much of the growth is coming from your strength, for instance, in construction renovation or auto aftermarket.

You've also done a lot of PLS in these segments, which you mentioned are helping the margin side. Are we also seeing the fruits of the labor on the revenue side too, or is this just pandemic-related recovery? What could that mean for the sustainability of growth in these particular segments in 2021? Yeah, my answer to Andy is it's some of both. There are certainly certain market sectors or product categories within both of those segments that are benefiting from some pandemic-related demand. We actually talked about that very question with the leaders of both of those businesses. Beyond those sort of pandemic-related benefits in the near term, both of their results also reflect solid progress in terms of improving the overall growth posture and profile in those two segments. Scott at Telefon, then maybe about food equipment.

Could you give us more color in the sense you mentioned institutional was down 30%, with restaurants down a little more than that, but grocery stores were up 30%. As you look out over the next few quarters, do you see continued recovery in institutional and sustained strength in grocery? Can you see your food equipment sales continue to recover if the restaurant-facing portion of the business stays weak? Yeah, Andy, we think that the recovery here will probably be on the slow side of things. It'll take a while. As you look across the portfolio, food equipment is probably the segment where the recovery, for obvious reasons, will take a little bit longer. I can give you a little bit of detail maybe on the quarter in terms of the end markets.

The institutional side down about 30%, which was the same as in the second quarter. Within that, healthcare is doing slightly better, and the drag really is on the lodging side, as you might expect. Restaurants, QSR did improve sequentially versus the second quarter, obviously a big improvement here on the retail side. Support, part of that was market, and part of it was new product rollouts, share gains. That is why that business was up almost 40% on the retail side. To answer your question, this will be, as we sit here today, we think this will be a fairly slow recovery in food equipment in the near term.

I think in the long term, our view hasn't changed in terms of how attractive this business is, both in terms of our ability to grow above market and our ability to do so at very attractive margins. I think you saw in the quarter here for this business to already be back at 20% operating margin and generating $90 million of income, given the environment that they're dealing with, it's a pretty remarkable accomplishment. Near-term slow, but long-term, we are very bullish on this business. Helpful, Michael. Thank you. Your next question comes from Anne Dignan from JPMorgan. Please go ahead. Your line is open. Yeah, good morning. Thank you. Most of the short-term questions have been answered at this point. I thought maybe I could ask about the automotive business in terms of what you're seeing out there for future programs.

I know you bid on platforms many years in advance. Are you beginning to see more RFQs or RFPs coming out for electric vehicles and electric platforms? How does that change the dynamics within the team, especially maybe in Europe ahead of the U.S.? Thanks. Yeah, I'd say a couple of things in terms of new program activity generally. Things certainly got pushed out just based on the pandemic impact. A lot of that activity in the second quarter pretty much disappeared, as you would expect, but that in the third quarter has picked up nicely in terms of our engagement with our customers around their future platforms and areas of opportunity for us to participate. We've talked about the on the EV question, we've talked about that a lot.

We remain pretty agnostic from the standpoint of internal combustion versus EV from the standpoint of the overall opportunity profile for ITW in terms of the types of solutions where we can add value. In fact, it's still slightly higher on EV on a per-vehicle basis. As you would expect, on a relative basis, it's not as big as the volume of projects on the internal combustion side at this point, but certainly from the standpoint of the growth in the number of projects that we're engaging on in EV, for all the reasons you would expect, it is certainly coming up the curve fast. Okay. That's helpful, Color. Thank you. I appreciate that. Could you talk about China and what you're seeing there beyond just automotive?

We read a lot about what's going on in automotive in China, but maybe you could talk us through what you're seeing in the other segments in China specifically. Thank you. Yeah, maybe just to take a step back. If you go back to the first quarter, our sales in China were down 24%. In the second quarter, flat, positive 1%. In Q3, as the recovery continued to take hold, that business actually grew 10% year over year. Auto is actually not the fastest-growing business in China, but auto was up 15%, as was specialty. Our polymers and fluids business was up 30% here in the third quarter in China. As you'd expect, there's still a slower recovery on the food equipment side, down kind of in the mid-single-digit range.

But certainly encouraging trends as the recovery continues to take hold in China. Okay. I appreciate that. I'll leave it there and turn it over. Thank you. Thank you. Your next question comes from Scott Davis from Melius Research. Please go ahead. Your line is open. Hey, good morning, guys. Scott? The results obviously in construction were really amazing overall. Can you give us a little bit of color on whether you put up those numbers despite maybe some product shortages, weather product shortages? I guess kind of a natural follow-up is that what role did price play in the strong results? I assume you might have been able to get a little bit of price given the supply-demand environment. Yeah. The results in construction were driven by our ability to supply some of the most demanding customers that we deal with. There were no shortages.

As Scott said earlier, I mean, I think a lot of credit to the operating team and a lot of credit to our own supply chain, our local supply chains, and their ability to respond and meet some really strong activity in the home centers. If you look at the residential renovation business, it was up almost 20% in Q3 after a strong Q2. Like I said, this goes all the way back to our decision, I think, to not initiate aggressive headcount reductions in Q2 and focus instead on winning the recovery. That is what you are seeing here in construction, our ability to supply and take care of customers and do so at record margins, which, by the way, are not driven by price. They are driven by a range of things in this quarter, in particular. Volume leverage was certainly helpful.

The enterprise initiatives continued to contribute in a big way, and price was really not a factor in this. Is price something that you generally put through towards kind of the end of the year, most regular cycle on price, or is it more optimistic? It's more a planned process. It's an annual cycle. Yeah, it's certainly not something that we are in the position to be very tactical about. No. And the goal is to, Scott, offset any raw material cost inflation, and there's very little of that in the current environment. And so price was really not, to answer your question, a significant factor here. Okay. Okay. That's good. I'll pass it on. Good luck, guys. Thank you. Thank you. You too. Your next question comes from Joe Ritchie from Goldman Sachs. Please go ahead. Your line is open. Thanks. Good morning, everyone. Hey, Joe.

Maybe just starting off just on kind of the near term and thinking about that Q4 implied growth number. Michael, I think you mentioned in your prepared comments that there's going to be two less shipping days. I just want to be clear. The two less shipping days, is that on a year-over-year basis, or is that versus Q3? And does that account really for the deceleration? Yes. It's versus the third quarter. I think there's 64 days in Q3. There's 62 in Q4. That is exactly the same setup as last year. On a year-over-year basis, there's no—and I would add, and it's very tactical, but some of those shipping days between Christmas and the New Year holiday are typically, let's just say, not very robust. Yeah. Yeah. I think more than two.

I think maybe what you're really asking is, are you seeing—are you implying that things are decelerating? I think that's certainly not the case. I think we have not seen anything to suggest that things are slowing here in the fourth quarter. Got it. Okay. That's helpful. I wanted to dig into the food equipment segment for a second. You mentioned the retail part of your business was up 30%, and some of that was driven by product rollouts. I'd love a little bit more color on what you're doing there specifically and whether there was any benefit that you saw from just pent-up demand for not being able to potentially shift into Q2. I'm just trying to understand that 30% number in food equipment. Yeah. We went with some of that.

I think in Q2, it was a little difficult to get in there with the product rollouts. This is part of the annual cycle in food equipment where we roll out new products with added features. I also think if you were to ask our team, they would certainly suggest that there were some pretty significant share gains here in the third quarter as a result of these new products being rolled out. Hopefully, that answers your question. Yeah. Yeah. That's helpful. Thanks, guys. I'll get back in Q. Okay. Your next question comes from Jeff Sprague from Vertical Research. Please go ahead. Your line is open. Thank you. Good morning, everyone. Maybe just one more around the kind of short-term tempo. It looks like you did not really see any inventory whipsaw effect, and Scott, you explained quite clearly how your business operates.

Did you get a sense that everybody was caught off guard here in Q3, and there's just a fair amount of catch-up from Q2 in Q3? It may not be an inventory effect per se, but it's just kind of a snapback that does, in fact, create some letdown as we move into Q4. It sounds like you're not seeing that yet, but just wondering your kind of antenna on the ground, is there any sense that there's that kind of dynamic at play here? This is not going to be a helpful answer, but it's really hard to tell, Jeff. I think at this point, this is obviously a fairly unprecedented situation on so many respects. All we can do is stay in position. Somebody better pet the dog. It's not here. Some of it may very well be a factor. It's just impossible to tell.

All we can do is what's within our control, which is to stay in position to serve our customers. Third quarter was certainly the first part of the recovery from a completely unprecedented complete shutdown of wide swaths of our customer base and the economy. I wouldn't certainly rule out any and all of the above in terms of it impacting the conditions right now, and we'll see how they play out from here. All we can tell you is what I'll go back to what Michael said earlier, is at least through, obviously, through the third quarter and through October, we've seen no pulling back. Great. Yeah. I'm doing my part here to help the economy. I got a construction guy showing up, and my dog's barking at him, so. Can you also just give us an update on your thinking on share repurchase here?

It sounds like M&A is probably sliding to the right. The cash is obviously gushing. It doesn't look like you did anything in the quarter. Maybe I'm wrong, but what's your current thinking? Thanks. Yeah. At this point, our primary focus is really on running the business and getting our plans together for next year. We suspended the buyback back in Q1. We spent $706 million at somewhere around $167 a share, and we're essentially done for the year. Our focus really is on running the business and getting our plans together. When we kind of give you our thoughts on what 2021 might look like, we'll give you an update at that point also on share repurchases. Great. Thanks for the color. Your next question comes from Stephen Volkmann from Jefferies. Please go ahead. Your line is open. Hi. Good morning, gentlemen. Karen.

Morning. Just a couple of quick follow-ups, if I could. In terms of the strategy to sort of win the recovery, it seems like maybe automotive might be amongst the most fertile ground as you're able to fill orders that maybe competitors can't. I'm just curious, maybe it's way too early for this, but is it potentially possible to think about your historical wins relative to the auto build increasing? Is it too early to think about that? I think what I would say, Jeff, is this gives us an opportunity to demonstrate to our customers the value equation. I'm sorry, Steve. That was Jeff's last word. Thanks, Karen. Sorry. Sorry, Steve. It was the dog. The dog is still throwing me. My apologies.

What I was saying is I think this is a phenomenal opportunity for us to demonstrate the value equation around ITW's role in the auto OEM supply chain from the standpoint of a comprehensive our ability to serve you through thick and through thin. I would expect that our customers' experience with us through this particular period will certainly be contributing to our ability as we go forward to secure more business based on the sort of full range of the value add that we can bring, including our ability to supply when things are dicey. Okay. All right. Fair enough. Just quickly on specialty product, I think, Michael, you mentioned something about cost sharing. I'm just curious if there's any detail there, anything we should be thinking about going forward.

This is a one-time item, and it relates to an agreement with a customer that, for obvious reasons, I can't give you a ton of detail on. I think the important thing is this was a one-time item, and you're not going to see it again. Got it. Thank you, guys. Thank you. Your next question comes from Nicole DeBlase from Deutsche Bank. Please go ahead. Your line is open. Yeah. Thanks for the question. Good morning, guys. Hi, Nicole. Hi there. Maybe we can start with just the cadence of the quarter. Did you see continued improvement throughout the quarter, or was the organic growth kind of similar across each month? Yeah. I think the sales trends in Q3 were pretty strong right out of the gate in July.

I think we talked about that on our last earnings call and really remained that way through August, September, and so far what we've seen of October. Okay. Okay. Got it. Just an update on the restructuring. I know that on the last call, you guys kind of noted that you expected to spend around $60 million in the back half. Given that top line is kind of coming in probably better than you would have expected, is $60 million still the plan for the second half? If so, can you maybe parse out what was done in 3Q and what you expect to do in the fourth quarter? Yeah. You're right, Nicole. We now expect it to be a little bit lower than the $60 million that we talked about on the last call.

Let me just say first that just a reminder that the projects that we're doing this year are essentially the projects that were in the pre-pandemic plan, if you like. There is very little specific tied to the pandemic from a restructuring standpoint. Part of the reason for that is, obviously, the recovery is now progressing, at least in the third quarter, at a pace that exceeded our expectations. We have done $37 million year to date, and we expect to end up somewhere around $50 million for the full year. Okay. That probably means then that you guys were kind of expecting one-to-one payback as we think about the impact of 2021. I also suspect then that the payback is more like $50 million for next year. Is that fair? Yeah. I mean, if I—yeah.

I mean, I think the payback, as we've talked about before on these projects, and these are really the projects that are coming out of our front-to-back process, are typically less than 12 months. That would be a reasonable assumption. Okay. Got it. Thanks. I'll pass it on. Your next question comes from Mick Dobray from Baird. Please go ahead. Your line is open. Hey, great. Thanks for squeezing me in. Good morning, everyone. Good morning. Just a quick question on margin here, especially sort of the margin algorithm going forward. As I'm looking at gross margins, it was very nice to see them above 42% again.

I'm wondering here, just conceptually, as volumes—we get back to volume growth at a point in time—do you see opportunity to continue to expand to drive gross margin, or is this mostly an exercise of leverage on SG&A in terms of driving the incremental margin? I think we've demonstrated over the last seven years that we have a pretty good track record in terms of continuing to drive improvement in our cost structure, both on the variable side as well as on the SG&A side. We would expect both. I should have said this upfront as we begin to think about 2021. That is—and the enterprise initiatives specifically, we didn't talk a lot about that, but they contributed 120 basis points of margin expansion here in the third quarter. Year to date, we're above 100 basis points, and we're seven years into this.

I think it's certainly a lot of positive momentum going into not just the fourth quarter, but also into next year as these enterprise initiatives continue to contribute to our margin improvement in a meaningful way, both variable and on the SG&A side, on the fixed cost side. Got it. Okay. My follow-up, going back to welding, and I appreciate the call that you guys gave there. I'm wondering if you can provide a little bit more in terms of kind of what you're seeing going forward. Arguably speaking, some of your customers in areas like heavy equipment and such might be seeing some of these production schedules bottom out. Do you have any sense for how demand might progress here and at what point in time we could be seeing this segment return back to growth?

I think maybe as you look at Q4, I think Q4 will, if that's your question, look a lot like Q3, probably. I think we haven't done the plans yet for next year, and when we get together next year, we'll give you a little more color by segment, including welding. It's really a little too early to tell at this point. I mean, as I said upfront, the comparisons year over year are going to be relatively easy. Just on that basis, that's certainly helpful as we think about next year. We'll give you a better answer, Mick, when we provide guidance for 2021, okay? Appreciate it. Good luck. Thank you. Your last question comes from Nigel Cohle from Wolfe Research. Please go ahead. Your line is open. Oh, thanks. Good morning, everyone. Thanks for—Hey, Nigel. Hi, guys. Obviously, we've covered a lot of ground here.

I did want to go back to restructuring. That $50 million this year, does that support the 100 basis points for next year, or does that provide some upside potential to that number? I think I'm not going to let you pin me down on the number yet for next year because we haven't gone through the specific projects and activities that support that number for next year. I think it's reasonable to assume a meaningful contribution again next year from our enterprise initiatives, which includes the 80/20 work as well as the work that's being done on the strategic sourcing side. That's probably the best I can do right now is expect another meaningful contribution from the enterprise initiatives next year. Okay. That's fair. And then a quick one on tools. I mean, obviously, very impressive performance.

I was surprised because I think I'm right in saying that you have exclusively a pro channel. There's very limited DIY exposure there. It seems like this is all driven by new residential construction renovation with a beam, I assume, still quite anemic. Is that the case? What do you see in terms of new builds versus renovation trends? I think your view—let's change your assumption. Renovation, we've got a lot of exposure. Our residential construction exposure is both on new and remodel. The remodel is really where a lot of the strength was in Q3. Yeah. That's exactly right. Just to add maybe a little more color, Nigel, since you had to wait until the end to get your question in, we did see some builder activity also picking up in other parts of the business. Hopefully, that's helpful. Oh, it is.

Yeah. No, just that the channel checks suggest pro demand remains quite anemic. I was a little bit surprised. That's helpful. Thank you very much. I would now like to turn the call back over to Ms. Karen Fletcher for any closing remarks. Okay. Thanks, Julian. Thank you, everybody, for joining us this morning. Have a good day. This concludes today's conference call. Thank you for your participation. You may now disconnect.