Illinois Tool Works Inc (ITW) Q2 2020 Earnings Call Transcript

Illinois Tool Works Inc (NYSE: ITW) Q2 2020 earnings call dated July 31, 2020

Corporate Participants:

Karen Fletcher — Vice President, Investor Relations

E. Scott Santi — Chairman and Chief Executive Officer

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Analysts:

Andrew Alec Kaplowitz — Citigroup Inc — Analyst

Jamie Lyn Cook — Credit Suisse — Analyst

Scott Reed Davis — Melius Research — Analyst

John George Inch — Gordon Haskett — Analyst

Andrew Millard Casey — Wells Fargo Securities — Analyst

Ann P. Duignan — JPMorgan Chase — Analyst

Jeffrey Todd Sprague — Vertical Research Partners — Analyst

Joel Gifford Tiss — BMO Capital Markets — Analyst

Nigel Edward Coe — Wolfe Research — Analyst

Nathan Hardie Jones — Stifel, Nicolaus — Analyst

Ross Paul Gilardi — BofA Merrill Lynch — Analyst

Presentation:

Operator

Good morning. My name is Julienne, and I will be your conference operator today. At this time, I would like to welcome everyone to the conference call. [Operator Instructions] Thank you. Karen Fletcher, Vice President of Investor Relations, you may begin your conference.

Karen Fletcher — Vice President, Investor Relations

Okay. Thank you, Julienne. Good morning, and welcome to ITW’s Second 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 second quarter 2020 financial results and provide an update on our strategy for managing through the global pandemic. 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 potential effects of the COVID-19 pandemic on our business. This presentation uses certain non-GAAP measures and a reconciliation of those measures to the most comparable GAAP measures is contained in the press release. Please turn to slide three, and it’s now my pleasure to turn the call over to our Chairman and CEO, Scott Santi.

E. Scott Santi — Chairman and Chief Executive Officer

Thank you, Karen. Good morning, everyone. While things are far from normal for any of us or our businesses at present, I’m extremely proud of how the ITW team is managing through the unprecedented and challenging circumstances brought about by the pandemic. I want to begin by sincerely thanking my ITW colleagues around the world for the effort, dedication and selflessness that they continue to demonstrate daily and protecting the health and safety of their colleagues while continuing to serve our customers with excellence. As I have said many times, the power of the ITW business model and of our decentralized entrepreneurial culture are never more valuable than during times of significant and rapid change. And we are leveraging both to position the company to participate across a wide range of recovery scenarios while continuing to execute on our long-term strategy to achieve and sustain ITW’s full potential performance. Over the last seven years, we have made significant progress in executing our strategy to take full advantage of our unique strengths to clearly establish ITW as one of the world’s best-performing, highest-quality and most respected industrial companies, and in doing so, building a company that has both the enduring competitive advantages and the resiliency necessary to deliver consistent upper tier performance in any economic environment.

Well, needless to say, the resilience component of that equation is now being tested in ways that were hard for many of us to even imagine six to seven months ago. And as evidenced by our second quarter results, this company and our team of over 45,000 dedicated professionals are arising to the challenge. In the second quarter, in the face of an unprecedented 29% decline in revenues, ITW delivered $449 million in operating income, $681 million in free cash flow and operating margins of 17.5%. We leveraged our flexible cost structure to reduce operating expenses by more than $140 million without any centralized cost takeout mandate from corporate while providing full compensation and benefit support to every ITW team member, sustaining investments in key long-term growth strategies and positioning for full participation in the recovery. As we outlined during our first quarter earnings call, we have an integrated 4-pronged strategy for managing the company through the pandemic: protect and support our people, continue to serve our customers with excellence, maintain our financial strength and strategic optionality and win the recovery. These four priorities comprise the central near-term planning and execution focus for the whole of ITW and for every one of our operating divisions.

Read management/analysts’ comments on quartely results

We’ll come back to them at the end of our presentation, but first, let me turn the call over to Michael, who will provide you with additional detail on our Q2 performance. Michael, over to you.

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Okay. Thank you, Scott, and good morning, everyone. Let’s turn to slide five. As Scott mentioned, priority number three for managing through the pandemic is to maintain ITW’s considerable financial strength, liquidity and strategic optionality. In the second quarter, we did just that. And going forward, we will continue to deliver on that priority as we leverage our strong financial foundation and resilient profitability profile to position ITW for maximum participation in the recovery. On our last earnings call, we shared our expectation for an unprecedented level of demand contraction due to the complete shutdown of wide swathes of the global economy. And indeed, organic revenues declined an unprecedented 27%. As expected, Automotive OEM and Food Equipment were the hardest hit segments. Other segments fared much better, providing another proof point for the benefit of ITW’s diversified high-quality business portfolio.

At the enterprise level, total revenues declined 29% as organic revenues declined 27%, and foreign currency and last year’s divestitures further reduced revenues by about one point each. Nevertheless, our businesses still generated $449 million of operating income and delivered resilient operating margin performance of 17.5%, with operating expenses down more than $140 million and enterprise initiatives contributing 100 basis points. As expected, free cash flow was strong at $681 million, an increase of 12% year-over-year and 213% of net income. Q2 cash flow performance did benefit from the delayed timing of U.S. income tax payments of $158 million, which were paid in the third quarter. Our divisions stepped up their credit monitoring and collection efforts early in the quarter, and as a result, our receivable performance has continued to remain in line with historical norms. The balance sheet and our liquidity remained strong throughout the containment phase as we ended the quarter with $1.8 billion of cash on hand, essentially no short-term debt, no commercial paper, a $2.5 billion undrawn revolving credit facility, Tier one credit ratings and total liquidity of more than $4.3 billion.

As expected, ITW had more than enough financial strength and resilience to withstand the shock to the system that the global economy experienced in Q2. We were prepared for it, we managed our way through it effectively, and today, we’re strongly positioned for the recovery. With that, please turn to slide six for a retrospective look at second quarter revenue, starting with organic revenue by geography. As you can see, the demand contraction was global as North America declined 26%, Europe was down 37% and Asia Pacific was down 7%. On a positive note, China was up 1% after being down 24% in Q1 as the early phase of their recovery began to take hold. On the right side of the slide, we’re sharing average revenue per working day by month as we moved through the quarter and we compared it to last year. You can see that April was the bottom, and then we experienced a sequential acceleration in May and in June as the global economy began to reopen. This trend has continued in July.

Now let’s go to slide seven for segment performance. And on the left side, you can see the most and least affected segments in terms of organic revenue and operating margin. For comparative purposes, I should point out that these margin numbers are fully loaded operating margins, not segment margins. It is also notable that five of seven segments delivered operating margins above 20% despite organic revenue declines ranging from 9% to 25%. And the two segments overcame the significant negative volume leverage to actually expand operating margin year-over-year. Turning to the right side of slide seven. As expected, given that most of our Automotive OEM customers in North America and Western Europe essentially shut down in mid-March and only began to restart production in May, June, our Automotive OEM business was the hardest hit. Overall, organic revenues were down 53% year-over-year, although we did see a significant uptick in June that is continuing in July. North America was down 62%; Europe, down 59%; and China was the bright spot with organic revenue up 6%.

Importantly, as auto production continues to ramp up in Q3, our local, close to the customer manufacturing positions remain fully resourced and in position to continue to serve our customers every step of the way and with the same world-class quality and delivery that they have come to expect from us. Turning to slide eight. Also, as expected, the second hardest hit segment was Food Equipment as organic revenue declined 38%. North America organic revenue was down 33% and international declined 44%. Equipment sales were down 38% and service was down 37%. Institutional sales, including health care facilities and hospitals were slightly more resilient, down about 30%. And not surprisingly, restaurants, QSR were down about 45%. Relatively speaking, sales to grocery retail customers held up better, down only 14%, with some equipment orders being pushed out due to COVID concerns, and retail service sales were flat with prior year. Test & Measurement and Electronics organic revenue declined 11%, with Test & Measurement down 12% and Electronics down 9%.

While demand for capex equipment dropped, sales were up double digits in end markets tied to semiconductor, health care and clean room technology. And despite negative volume leverage, operating margin improved 120 basis points to 25.7% with excellent cost management and enterprise initiatives as the main contributors. Turning to slide nine. In Welding, demand slowed significantly as organic revenue declined by 25% with equipment sales down 28% and consumables down 21%. Industrial end markets declined 40% while commercial end markets were fairly resilient, down only 11%. That said, despite a 29% decline in revenues, Q2 operating margin was 21.6%. Polymers & Fluids organic revenue was down 14%. Polymers was down 20%, in line with industrial and MRO trends. Auto Aftermarket was down 14%, with retail sales improving in a meaningful way as stores opened back up as the quarter progressed. Fluids had the best performance, with organic revenue down only 5% helped by product sales into health and hygiene end markets. Operating margin was up 30 basis points to 23.1%, driven by enterprise initiatives and strong tactical cost management. Moving to Slide 10. Construction organic revenue was down 9% with North America, which is almost half the segment, up 1%, with double-digit growth in the residential renovation market served through the home center channel. This strength was partially offset by a 21% decline in the North America commercial business and internationally as Europe was down 28%, reflecting a more restrictive quarantine protocol. Australia and New Zealand sales were down only 3%. Specialty organic revenue was down 16%, with North America down 15% and the international side down 19%. Demand for consumables in our consumer packaging businesses, such as Zip-Pak, were up double digits, offset by orders for packaging equipment being pushed out and some lower sales into the appliance and aviation industry.

So let’s move to Slide 11 for an update on some full year 2020 performance scenarios. On our last call, we provided three financial scenarios to illustrate the fact that we have the financial strength and margin profile to withstand whatever comes our way over the near term. And therefore, our number one priority is positioning to play offense in the recovery. With Q2 in the books, we’re updating these scenarios for our key operating metrics, organic revenue, operating margin and operating income. The caveat that we discussed during our Q1 call still apply. i.e., this is the time of extraordinary and unprecedented uncertainty and accepting any significant recurrence of major economic shutdowns. As you can see, we are narrowing the range of likely full year outcomes based on our second quarter performance and current demand trends across the company. And what stands out is that in all three scenarios, ITW’s operating performance is strong in terms of operating income and operating margin. And while we’re not providing formal guidance as we sit here today, we are tracking closest to the mid scenario, with second half organic revenues down about 12%, which would translate into a full year organic decline of approximately 14.5% and operating margins of 20% to 22%. And in an unprecedented year like this, should this scenario hold, we would still make somewhere in the neighborhood of $2.5 billion of operating income and generate more than $1.8 billion in free cash flow. As demand recovers, we want to be in a strong position to fully support our customers as their businesses begin to reaccelerate.

As a result, we expect an increase in working capital and, therefore, lower free cash flow of about $600 million in the second half of the year. Importantly though, we are going to make sure that we’re in a strong position to both respond to our customers’ needs and take share from competitors who can’t throughout the recovery. As we discussed on the last call, we’re going to make some fairly modest capacity and cost structure adjustments based on projects submitted by our division leaders who have now had a chance to better assess the pace and slope of recovery in each of their respective businesses. We currently project that we will spend about $60 million in restructuring projects in the second half of the year, including $45 million of 80/20 front-to-back projects that were already planned for 2020 that we placed on a temporary hold as the early stages of the pandemic unfolded. As a reference, we spent about $80 million on restructuring in 2019 and about $30 million of that was in the second half of the year. It is worth noting that the average payback for these projects is projected to be less than 12 months. Finally, just some brief comments on capital allocation and to let you know that our position has not changed from our last call. First, with regard to the dividend, we recognize the importance of our dividend to our long-term shareholders. We continue to view it as a critical component of ITW’s total shareholder return model, and we remain strongly committed to the dividend. In terms of strategic optionality, we are clearly in a position of strength with ample liquidity and balance sheet capacity and strong credit ratings. We remain open to the possibility that opportunities might emerge as a result of the pandemic. And we’re in a strong position to react to high-quality strategic opportunities that are aligned with our enterprise strategy. Lastly, we suspended share repurchases until end markets stabilize and the recovery path becomes clearer. So let’s move on to slide 12, and I’ll turn it back over to Scott to share some more thoughts on our recovery phase strategy. Scott, back to you.

E. Scott Santi — Chairman and Chief Executive Officer

All right. Thank you, Michael. So moving forward, while significant end market disruption and uncertainties remain, we will continue to leverage our financial strength and the performance power of our business model to prioritize playing offense in the recovery over playing defense in the contraction and to ensure that every one of our businesses is strongly positioned to fully participate in the recovery. Job one is to protect our people while continuing to serve our customers with the world-class quality and delivery performance that they expect from us. Thus far, our people have done a superb job on both fronts, and across the company, we will remain intensely focused on these two mission-critical imperatives.

Second, we are going to lean in hard to the upside by remaining invested in staff to support anticipated demand two to three quarters out, so that we have ample cushion to fully support our customers as their businesses reaccelerate and to capture incremental share gain opportunities that we expect might emerge along the way. In that regard, core to the recovery planning process in every one of our 84 divisions is the identification and actioning of specific pandemic-related share gain programs and opportunities that are aligned with our long-term enterprise strategy. Finally, we will leverage our advantaged financial position to sustain the investments we’ve made to support the execution of our enterprise strategy. We are taking the long view, and from that perspective, win the recovery as an execution component of our long-term enterprise strategy. It is not a separate strategy. It is about every one of our divisions identifying specific opportunities to aggressively accelerate progress in executing key aspects of their enterprise strategy agenda due to the effects of the pandemic, things such as new or changing customer needs, competitor distress, ability to stay invested, etc. In fact, we’re already seeing areas of opportunity emerging in our businesses and these are some of the early themes. First, ITW’s undisrupted ability to supply and deliver during these times of tremendous volatility and disruption is a significant asset. In the last quarter, we landed new programs worth a combined $105 million annually with a handful of key customers based largely on our ability to provide immediate supply.

Second, many companies, including many of our existing customers are moving away from low-cost country sourcing strategies and looking to localize their supply chains in response to risks and challenges exposed first by trade and tariff-related disruptions and now by the effects of the pandemic. Our long-standing commitment to local, produce where we sell manufacturing has uniquely positioned ITW to support existing and new customers in making this transition. Just recently, one of our businesses was awarded nearly $10 million in new business as a result of one of their key customers moving to build more local supply capability. In addition, a number of our Automotive OEM customers are implementing strategies to localize their supply chains, and we are in a very strong position to support them in this regard. And third, we are already benefiting from remaining committed to our strategic sales excellence and customer-backed innovation investments. Our ability to stay the course means that the people that we have invested in, in these critical areas remain in place and that they are not distracted by downsizings, reorganizations, top-down mandates or shifting priorities. They remain focused on serving customers, seizing new opportunities and continuing to innovate. As just one illustration, in the second quarter, our new patent filings were up 24% over last year.

So in closing, on behalf of Michael and I and our entire executive leadership team, we offer our deepest thanks to our ITW colleagues around the world for their exceptional efforts and dedication always but especially during this period of unprecedented circumstances and challenges. While there is obviously a lot that we will have to work our way through in the months ahead, I have no doubt that the strength and resilience of ITW’s business model, our diversified high-quality business portfolio and our people position us extremely well to seize the opportunities and respond to the challenges that lie ahead.

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

Karen Fletcher — Vice President, Investor Relations

Okay. Thank you, Scott. Julienne, let’s open up the lines for questions.

Questions and Answers:

Operator

[Operator Instructions] Your first question comes from Andrew Kaplowitz from Citi. Your line is open.

Andrew Alec Kaplowitz — Citigroup Inc — Analyst

Good morning, everyone. Hope everyone is well. Scott or Mike, maybe you can help us with the color on business conditions by region a little more. China turning positive is encouraging as you said, but for many companies in Q2, we saw some improvement, maybe a little faster in Europe than the U.S. You guys were down a little bit more in Europe. So maybe you can talk about what held you down in Europe? And then you mentioned you were down about 20% in terms of average daily sales in June and that you continue to see improvement in July. And in terms of the rate of the decline, did it continue at the same rate of recovery as you saw by month in Q2 and July?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

All right, so let’s start with your question on Europe specifically, which represented 25% of our sales in the quarter and saw, as you pointed out, the most significant decline year-over-year at 37%. By far, the most significant decline was in the Automotive business, as you might expect, down 59%, followed by Food Equipment down 48% and then construction down 28%. In terms of the kind of the framework that we’re providing for the second half here and your question around how the dynamics might play out by region, I think we’re anticipating. Again, in a very dynamic environment here, North America and Europe down both in that 10% to 15% range year-over-year. And then Asia Pacific and China, as you pointed out, better than that, flat, maybe slightly positive as we look at the second half here. A lot of how the thinking around how the second half plays out ties back to your first or second question, which was around July and the trends. So the trends that we saw sequentially in the second quarter was certainly encouraging. April, the bottom, acceleration in May, June, and those trends have continued into July. I wouldn’t read too much into one month here. I think this remains a really, like I said, uncertain environment. And the best way to think about this is really the second half framework that we’ve provided as you look at how this might play out. But certainly, encouraging kind of near-term demand trends that continued into Q2.

Andrew Alec Kaplowitz — Citigroup Inc — Analyst

Michael, just one follow-up on how you’re thinking about forecasting Auto OEM. Obviously, one of your tougher businesses but relatively quicker recovery that we’re seeing there. You mentioned the shutdowns impacting your business, but is it harder to adjust ITW’s cost base in that business? And in the past, it’s been hard to change, move pricing around. So is that what hurts you in the quarter? And do you expect that business to turn profitable again in Q3?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Well, I think the short answer, Andy, is no. I mean I think, as you know, we’re not an auto company. We’re really benefiting in Q2, in the second half, from this high quality, highly diversified portfolio. So we don’t have to get the forecast 100% right in Automotive because we know we’re going to have offsets one positive or negative in other parts of the company. We’re as you know, we’re very much a read and react company. We don’t have a lot of backlog. We don’t have great visibility beyond two to three weeks in Auto, for example. But we do have the ability to respond very quickly to changes in demand. We expect a challenging second half in Automotive, certainly better than Q3. And to just give be transparent with you in terms of what Auto might look like in the second quarter based in the second half based on feedback from customers, current demand trends, we’re looking at being down about 15% in the second half of the year for Automotive. Of course, a lot of that depends on how quickly production ramps up, what auto sales do in the second half of the year, but maybe that gives you a sense for how that might play out.

E. Scott Santi — Chairman and Chief Executive Officer

Just the other thing I would add on the cost side is we were very intentional in not decimating the business. I mean this was the hardest shutdown across our portfolio and we clearly knew that was going to take place. Production stopped from mid-March through mid-May. And ultimately, we made a choice not to do anything that would impair. We also expected that once those hard shutdowns were over that things would recover, maybe not certainly not back to their prior demand levels but a long way from 0, which is where they were for those 60 days or so. So I think there was a lot of intention in, if your reference point as to the fact we lost money in that business, that was we certainly could have mitigated some of that if we wanted to worry about that, but ultimately, it’s our decision. And our biggest concern was making sure that we were there to support our customers on the other side of that.

Michael M. Larsen — Senior Vice President & Chief Financial Officer

And then maybe just to you asked around what the second half might look like in terms of profitability. We fully expect based on what we’re seeing now that the business will be profitable in the second half, and we will be returning to double-digit margins as we go through this beginning recovery here in Automotive.

Andrew Alec Kaplowitz — Citigroup Inc — Analyst

Thanks guys.

Operator

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

Jamie Lyn Cook — Credit Suisse — Analyst

Okay. I guess just my first question. Can you just talk about Andy has the question on Auto, Food was also the business that was hit harder. So can you just talk about the margin trajectory as we think about the second half of the year in that business? And then I guess my follow-up question just is sort of on the market share opportunity. Can you talk about sort of early conversations with customers if you think you’ll be able to gain market share? And is that embedded as you think about sort of the sales outlook for the back half of the year?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Yes. So specific on Food will probably be the hardest hit segment here in the second half of the year. We’re looking at potentially being down somewhere around 25%. But even with that sort of kind of unprecedented decline, we expect that business to continue to be profitable, and we expect margins to continue to improve from where they were in Q2 and being back into double-digit territory here in Q3 and Q4. I think in terms of the market share, rather than talking about specific customers, I think I’ll go back to the themes that Scott talked about and the fact that we have a high degree of confidence that there are real market share opportunities, there are discussions with customers that are taking place every day in every single one of our divisions. And we pointed to over $100 million of new business generated here in the second quarter just as a result of that, the first element, which is our ability to continue to supply and deliver for existing and for new customers. So I think we that’s maybe how we think about the market share opportunities.

E. Scott Santi — Chairman and Chief Executive Officer

Yes. And I think the only thing I would add, Jamie, is it just in terms of impact on the balance of the year, I don’t we’re not really that focused on that. We’re looking for long-term opportunities that are sustainable ultimately. The programs that I referenced, will they have some incremental benefit in the back half? Sure. But ultimately, we’re not looking for I guess the point I’m trying to make is we’re not looking for quick hits that are opportunistic. We’re looking for opportunities to move faster on opportunities that we would want even in normal times and expect that certainly, based on the second quarter, we’re certainly optimistic that those will continue to pop up as we move forward.

Jamie Lyn Cook — Credit Suisse — Analyst

Thank you. I appreciate the color.

Operator

Your next question comes from Scott Davis from Melius Research. Your line is open.

Scott Reed Davis — Melius Research — Analyst

Couple of questions here. But Test & Measurement margins were strong. Were there was there mix? Any support on mix there? Was it restructuring that the guys were doing on a localized basis? So it’s just really quite remarkable to have mid-20s margins in a revenue environment like this.

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Yes. I think it’s I think I may have mentioned this, it’s the continued execution on the enterprise initiatives contributing in a meaningful way, including all the front-to-back projects, they really carry over from last year since we put a halt on restructuring, essentially in the first half of the year, and then just really good tactical management of our operating expenses, $140 million at the total company level. And in every segment, including in Test & Measurements. So and then I think the other thing I’ll point to there, their top line was maybe a little more resilient than some of the other segments. We talked about the strength in semi, in health care, clean room technology, and they certainly benefited in Test & Measurement.

Scott Reed Davis — Melius Research — Analyst

Okay, that’s helpful. And then as a follow up, I mean in such a big demand hit in a couple of your businesses, obviously, but how many of your own facilities remain idled? Are they are most of I mean I was going to say, are they all back up and running in some level of capacity? Or do you still have a number of facilities that are 100% shut down?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

We are essentially 100% open, and all of our divisions are serving customer needs at this point so.

Scott Reed Davis — Melius Research — Analyst

Around the world?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Around the world, yes.

Operator

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

John George Inch — Gordon Haskett — Analyst

Hey, Michael, did July I know it’s not going to be definitive, but did it still exhibit an uptrend in terms of average daily sales? And how are you both thinking about sort of the potential for channel restocking, kind of given the way markets have transcended and your own commentary for expectations around the back half?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

So the first part of July is up sequentially from June, to answer your question. I think in terms of the channel, we’ve talked about this before, John. We really are given how short cycle we are and how our businesses are set up, really, we talk about very little backlog. We get the order today, we ship tomorrow. We replenish the inventory the day after. We don’t have great visibility to what the channel has in terms of inventory. They don’t need to carry it out of inventory because they know that if they place the order with us, we’re shipping it tomorrow. So it’s not really a big driver in terms of how our sales might be reacting here.

John George Inch — Gordon Haskett — Analyst

Even in, say, construction products? I’m just I agree with you, obviously, but I was just curious if there might have been some sort of preemptive build or anticipate a build in the back half or something like that.

Michael M. Larsen — Senior Vice President & Chief Financial Officer

No. I mean they really don’t need to. And that’s construction. Every segment, every division is run the same way here, so the answer is no.

John George Inch — Gordon Haskett — Analyst

Okay. And then how are you guys thinking about the $140 million of cost saves, which is actually pretty impressive, considering that you didn’t touch employee comp. How are you thinking about that, Michael and Scott, maybe bleeding back into the organization, will be matched against kind of revenues, so you kind of keep the costs in check? Or how are you thinking about sort of the cadence of those costs coming back over the course of the second half of the next year?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Yes, John, I mean, everything other than the structural costs that we had already planned to take out this year, which are the kind of the front-to-back savings, those are structural savings but everything else is essentially temporary. And so this was a response to current levels of demand as the recovery continues to take hold during the second half of the year, the majority of these costs will come back in again. Certainly, we’ll continue to remain our divisions disciplined and focused in terms of cost management, but these are essentially temporary costs that with the exception of 80/20 projects, will come back in as demand recovers.

John George Inch — Gordon Haskett — Analyst

That makes sense. I mean would you say the $140 million in terms of saves as kind of the high watermark and then maybe next quarter, it’s a little bit lower? I mean I’m not trying to be that precise. I’m just trying to understand. I think you said, “Hey, we’re going to keep these costs in for the rest of the year.” And others have said, “No, they might start coming back sooner.” So just wondering where you guys fall out.

E. Scott Santi — Chairman and Chief Executive Officer

Well, I think given our margin profile, they’re going to they’ll start to, let’s call it, sort of sprinkle back in based on how the revenue recovers. So I think as we’ve said throughout, we are leaning into the investment side of the opportunity profile and the recovery doesn’t mean that we’re going crazy. But ultimately, as Michael said, the tactical cost savings in Q2 was in response to revenue levels that were down 29%. They will come all the way back in the third quarter, but they’ll I think I would assume a fairly linear sort of redeployment of some of those resources as things go forward based on linear, in line with revenue.

John George Inch — Gordon Haskett — Analyst

Yeah. Makes Sense thanks.

Operator

Your next question comes from Andy Casey from Wells Fargo Securities. Your line is open.

Andrew Millard Casey — Wells Fargo Securities — Analyst

Within construction, you talked about U.S. nonresidential down in Q2. Would assume that probably impacted some other segments like Welding as well. What are you hearing from your customers about the second half? Is it getting worse or is there really no change visible?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Are you talking, Andy, specifically on the commercial construction side, which is a fairly small portion of our business in North America or construction overall?

Andrew Millard Casey — Wells Fargo Securities — Analyst

Construction overall ex resi.

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Yes. I mean I think we don’t expect a significant level of improvement on the commercial construction side here in the second half based on what we’re seeing so far. The strong demand is really, like we said, on the residential side through the home center channel. That’s where we saw significant growth in Q2. And we do that seems to be holding up fairly well here in the near term but not on the commercial side.

Andrew Millard Casey — Wells Fargo Securities — Analyst

Okay. And then on business wins from your ability to deliver the $100 million is pretty impressive. Did that come from things like Auto or was it more prevalent in what might be shorter-cycle business wins?

E. Scott Santi — Chairman and Chief Executive Officer

Some of each, but I’m trying to Auto was maybe 20% of it.

Andrew Millard Casey — Wells Fargo Securities — Analyst

Pretty good. Okay, thanks very much.

Operator

Your next question comes from Ann Duignan from JPMorgan. Your line is open.

Ann P. Duignan — JPMorgan Chase — Analyst

I appreciate the color on the half two outlook for Automotive and food service, at least directionally. Could you give us some color on the other segments, what you’re contemplating in the back half for those businesses?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Yes. So Ann, these are with all the caveats again, in terms of being bottom-up projections and back to we don’t have a lot of backlog. These are our business model is much more kind of a read and react. But with all that said, I think on the Welding side, we still expect a fairly challenging second half, particularly industrial side and probably down in the second half, somewhere around 15% year-over-year. The Test & Measurement, Specialty businesses should perform a little bit better than that based on kind of current demand trends with some strength in consumer packaging. We talked about semi, health care, clean room. Those two segments could be down somewhere in the neighborhood of about 10%. And then construction as well as Polymers & Fluids maybe down in the mid-single digits, somewhere around that. But I just want to make the point again around the real advantage that ITW has in terms of this highly diversified, high-quality set of businesses and the fact that there’s room in these numbers because we know that some will perform have worse revenues than what I just told you and some will have better. And you put all that together, that’s what gives us the confidence in the second half scenarios that we laid out in the presentation. But hopefully, this is helpful in terms of additional transparency.

Ann P. Duignan — JPMorgan Chase — Analyst

Absolutely, and I appreciate everything you said. But we’re not locking you down to decimal points here, just directionally, it’s helpful to understand what you’re thinking or seeing. And just a quick follow-up. You mentioned that Automotive OEMs are pursuing more strategies of supply within country of demand. But I thought Automotive OEMs had already gone that route. And so maybe you could give us some examples of where? Are there opportunities for OEMs to source locally again that they’re not already doing? I think last quarter, you might have mentioned OEMs considering moving back from Mexico potentially. Is that an opportunity? I’m just curious as to…

E. Scott Santi — Chairman and Chief Executive Officer

Yes. No, I think I without I’m trying to think about how much I want to offer here out of from the standpoint of our need to obviously keep things our interactions with our customers confidential. But let me say that Europe represents probably an area from the standpoint of localization of some significant potential shift.

Ann P. Duignan — JPMorgan Chase — Analyst

Okay. I’ll leave it there…

E. Scott Santi — Chairman and Chief Executive Officer

Not just U.S.

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Yes.

Ann P. Duignan — JPMorgan Chase — Analyst

Not just U.S. And have you heard any comments from OEMs about relocating from Mexico to U.S.? Or is that just chatter in the supply chain?

E. Scott Santi — Chairman and Chief Executive Officer

I have not personally, no.

Operator

Your next question comes from Jeff Sprague from Vertical Research. Your line is open.

Jeffrey Todd Sprague — Vertical Research Partners — Analyst

Two from me. First on the restructuring side, certainly interesting, right? $60 million, $45 million of it, you probably would have just eaten on a pay-as-you-go basis without even kind of pointing it out if we were in normal times. So the business has given kind of, hopefully, like a once-in-a-lifetime pandemic shot on goal for restructuring came up with $15 million. I that’s a shockingly low number but I guess it’s kind of a testament to what you’ve told us before about how these businesses are operating. There’s just not a lot of stuff laying around to do. Any other perspective on that and how quickly these actions might pay back?

E. Scott Santi — Chairman and Chief Executive Officer

Well, I think the perspective on your comment is just that, A, we’ve been working on sort of margin and operating efficiency for seven years. So there’s and we can always get better, that’s the $45 million, right? Every year, we’re trying to be a little bit better. The other half of it though, in terms of the $15 million the limited amount of incremental that’s pandemic-related is goes back to what we said in the commentary, which is we’re staying structured to support demand two to three quarters out. And we don’t have any that’s an advantage that we have. Given the margin cushion, given the cash flow profile, we expect the economy just to revert to growth at some point. I can’t tell you exactly when but I think nobody is betting against the global economy long term. And we’re going to stay we’re certainly not. And so the $50 million is a response to the strategy that we’ve agreed on with all of our divisions that says we’re going to stay invested and we’re going to stay focused on making sure we can serve our customers and lean into growth as these businesses recover. And I’m not predicting necessarily a fast recovery. I’m just saying it’s going to recover eventually.

Michael M. Larsen — Senior Vice President & Chief Financial Officer

And the only thing I’d add to that, Jeff, maybe from a modeling perspective is that of the $60 million, we expect that to be more weighted towards Q3, maybe somewhere around 2/3 of it in the third quarter. And then I think the overall payback on these projects, what’s really encouraging is it’s projected to be less than 12 months, which supports again continued improvement, as Scott referenced on the margin front in 2021. And I’ll just point, you saw the enterprise initiatives again here this quarter, 100 basis points and a significant chunk of that are these 80/20 projects, which is the bulk of what we’re talking about that are driving continued margin improvement.

Jeffrey Todd Sprague — Vertical Research Partners — Analyst

And then secondly, maybe kind of a little bit more strategic, Scott, but very clear what you’re saying about positioning to gain share to outperform in the recovery. But also just looking at your portfolio, right? I’m sitting here kind of in the light of this pandemic and thinking about opportunities to kind of pivot in a different direction or a weakness exposed in a business that you hadn’t previously thought about. Is there anything that really kind of comes to mind where you’re really thinking about kind of portfolio positioning that you might want to alter as we look forward? Even if you don’t want to call the business by name, it would be interesting to as you look at just…

E. Scott Santi — Chairman and Chief Executive Officer

Yes. This would be the perfect place to disclose that. So…

Jeffrey Todd Sprague — Vertical Research Partners — Analyst

No, you don’t have to engage. You don’t have to engage.

E. Scott Santi — Chairman and Chief Executive Officer

No. Yes. No, I appreciate the question. I actually I sort of I think if anything, it’s reinforcing the value of this diversified portfolio. And let’s just sort of focus on what happened in Auto this quarter. Auto has been our fastest-growing it’s one of our fastest-growing segments for the last five to seven years. I think before we did the acquisition, we peaked out at sort of solid mid-20s margins. And I would honestly tell you, given the dynamics in the industry and the way we support that industry on a long-term basis, it’s probably one of the segments that we think has the best long-term growth prospects. And the fact that we can absorb the kind of hit that we took in that business in the quarter and had that be offset by at least five or seven Food Equipment, the other similar example, I think that’s the kind of capability that allows us to stay invested where we want to stay invested to ride the sort of short-term ups and downs and not have to manage the portfolio based on some sort of view of the future that we were guessing at. We started and end with, is there are a lot of value-add that we can create in an industry? The margins ultimately are the proof point on that. And ultimately, we don’t want to be in shrinking industries, but GDP, GDP plus a little bit industries are great businesses for us. And when we’ve got those characteristics and we can sink our teeth into those industries for 10 or 15 or 20 years, that’s a great position. So I don’t nothing has been exposed in my mind from this in terms of any part of our any one of our seven businesses that has created any problems for us or things that we would want to make any changes in any way. I think we clearly said that we could run seven businesses pretty well. They don’t work all in the same cycles. They don’t they aren’t all affected by the pandemic in exactly the same way. And all of that together says to me it’s more about work, let’s go find the eighth one at some point, not about we got to get out of one of these. So that’s the big announcement today.

Operator

Your next question comes from Joel Tiss from BMO. Your line is open.

Joel Gifford Tiss — BMO Capital Markets — Analyst

Just to follow up on that last idea you threw out there. Are acquisitions, are they popping up? Are they getting a little more attractively priced or anything you’re starting to come a little closer on feeling like it’s time to do something?

E. Scott Santi — Chairman and Chief Executive Officer

I would just comment and say that I think if you are a business that is not in distress during these times, this is not a time a good time to sell your business. So I think the kinds of opportunities that may emerge are some quarters out and have less to do with sort of near-term financial distress and perhaps relative to more strategic merits over the long haul. So we’re not spending a lot of time on trying to build the pipeline right now at all because it’s again, if you’re a good quality business, this is probably not a you’re not going to sell with your numbers where they are today. Something came our way tomorrow that we thought was a real fit, we would certainly be willing to take a real serious look at it. So it’s not an issue of our it’s not an issue of demand, it’s more an issue probably of supply in the near term of the kinds of things that we would want we would be interested in.

Joel Gifford Tiss — BMO Capital Markets — Analyst

Okay. And you’ve given us a couple of pieces of some of the highlights on acting to stay ahead of the curve and to benefit to win in the recovery. Can you kind of pull it all together? Staying there for your customers is one thing you’ve highlighted a couple of times. Are there any other pieces that we should be thinking about?

E. Scott Santi — Chairman and Chief Executive Officer

Well, we talked about sort of supply chain localization. We talked about staying invested in our innovation programs, our strategic sales excellence. So I don’t think there’s a whole lot beyond those broad categories. And yet, I think there’s probably some pretty good potential for some significant substance in those broad categories. This is not an easy period to manage your supply, your cash flow during this kind of stress on the down and then on the recovery side. And there’s a lot of disruption right now. And so our ability to stay the course, we happen to believe is, A, the right thing to do for our customers long term, makes us even stickier with them, the fact that they can count on us through thick and thin. And certainly, there ought to be some opportunities where perhaps, people we compete within various businesses aren’t able to be that consistent that may spin off some opportunities for us. That’s about as complicated as it is.

Operator

Your next question comes from Nigel Coe from Wolfe Research. Your line is open.

Nigel Edward Coe — Wolfe Research — Analyst

Yes. So the comment about taking advantage of distress, I think, is really interesting. It’s not something that we hear from some other companies that we cover. So I’m just curious if you are seeing some real signs of your distress amongst the competitors. And perhaps Food Equipment and pockets in the Auto channel might be the more obvious places, but I’m just wondering if you’re seeing that now. Or is this something that you’re expecting to see maybe from inventory shortfalls or inability to ramp up? I mean any more color there would be really helpful.

E. Scott Santi — Chairman and Chief Executive Officer

Yes. I would say in the near term, it’s probably too early. Right now, volumes are just starting to recover. We’re not seeing a lot of distress, a lot of the programs that I referenced in my commentary that are new or are related to new opportunities. And that there’s no I can I’m trying to pick through the list, there’s no competitor distress component to any of those. But there were people we competed with for those programs that weren’t able to commit to the same delivery timetable that we could that ultimately won us the business a bit. So that, I’m trying to make that distinction in the short run. But look, I would certainly say that there is from the standpoint of product availability, the impact of cash flow, working capital, as the cycle starts to go to and everybody gets in the growth mode, there’s going to be some cash flow constraints on people, their ability to fund working capital at the rate we can certainly and keep up as things accelerate. I think that’s more where those opportunities start to emerge.

Nigel Edward Coe — Wolfe Research — Analyst

Right. No, there’s no question about that. And then my follow-up is, it seems when I look at your kind of your framework for revenues and OI for this year, it looks like you’re still planning for decrementals around about gross margin rates in the back half of the year. Correct me if I’m wrong, Michael. But does that imply that when you’re getting on the side of this and you don’t have a lot of these discretionary costs come back in that others do have, that your incrementals can be higher on recovery? Normally, you have 35%-plus in price savings. Does that look more like a 40%-plus, plus ES going forward? Or I mean, any color there will be good as well.

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Yes. I think that’s a fair comment, Nigel. I think that when the recovery when demand really starts to pick up on a year-over-year basis, you’re going to see some higher-than-usual incremental margins from ITW. I think in terms of the second half question, if you just look at the framework we provided and again, we’re not really focused on managing to a decremental margin number here in the near term. I think as we said, it’s much more around positioning for the long term. But decrementals, kind of in the low 40s for the second half, a little bit higher than that in Q3 as a result of the restructuring. And then in Q4, like we said on the last call, we expect to be back in kind of a more normal decremental margin in the 35% to 40% area. But really, the most important part of your question is when we do expect higher incrementals when things begin to accelerate here in a meaningful way.

Operator

Your next question comes from Nathan Jones from Stifel. Your line is open.

Nathan Hardie Jones — Stifel, Nicolaus — Analyst

I just wanted to ask a question on the Food Equipment side of this. You’re seeing a lot of restaurants closing down permanently, operating at lower capacity. What’s your view on the likelihood that there’s going to be a fair amount of used equipment in the market? Some customers here are going to be stressed, maybe not looking to buy the high-quality ITW equipment in the short-term here. And whether or not that could even have any impact to used equipment in the market on the institutional side of the business over the next few quarters here?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Yes. I think if you look at the product lines that we compete with kind of at the top tier, the used equipment market is not really an issue for us. It’s much more an impact to the mid-tier competitors and not to people like ITW. In terms of where restaurants might end up, I think that’s an open question. I mean I think clearly, we’ve seen a meaningful decline in the near term here on the restaurants and the QSR side. And we’ll continue to stay close to it and we’ll be there to support our customers every step of the way, including with the service side of things, which is a really important part of opening these restaurants back up again. It really starts with a service call to make sure that all the equipment is operational and does what it’s supposed to do for our customers. So that’s really how I would think about that, Nathan.

Nathan Hardie Jones — Stifel, Nicolaus — Analyst

That’s helpful color. You just commented that you’re not spending a lot of time building the M&A pipeline at the moment. You have suspended the share repurchase program. Given very strong cash flow, good outlook for free cash flow for the rest of the year, what are your thoughts about the timing of reinstating the share repurchase program?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

Yes. I think Nathan, it’s a fair question, just given how strong the free cash flow performance is and how strong the liquidity and the financial position of the company is. At this point, it’s still early stages in terms of the recovery, and our position is we’re going to wait until this recovery path is a little bit clearer until we reinstate share repurchases. So for now, we remain kind of on hold until we see how things might play out a little more clearly going forward.

Operator

Your last question comes from Ross Gilardi from Bank of America. Your line is open.

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Ross Paul Gilardi — BofA Merrill Lynch — Analyst

I mean most of mine have been answered and I don’t know that you will answer this one. So just a follow-up on M&A and just your preferences with the current portfolio on what you might want to add to. And I’m just wondering, has the relative attractiveness of the various end markets shifted at all in this new environment? And I’m thinking specifically about Food. I think this is an area that most of us from the outside might have assumed that ranked higher in the pecking order in terms of areas that you might like to add to in the future. I don’t think I’m going out on a big limb there. In reality, in this type of downturn, it’s turned out to be your most cyclical business, whereas a market like construction, which is supposed to be most cyclical, was down the least in the third quarter in the second quarter, I think, because of what’s happening at the home centers and consumers investing in the home and so forth. So really just asking, has the relative pecking order changed at all? Or do you just still look at the kind of the exact same way that you would have before?

E. Scott Santi — Chairman and Chief Executive Officer

Well, I think your commentary sort of almost answers the question from my perspective, which is everything you said that nobody saw coming. And the next time we go through some contraction, I’m sure it will absolutely not be not work exactly this way. So I think in terms of relative attraction, in every one of our businesses every one of the seven, given the margin and return on capital profile there, if we had the right opportunities, we would certainly think about adding to all of them. And that’s again, we’re taking a long-term view so that’s independent of where they are in terms of their near-term relative distress. So we wouldn’t be afraid to add scale anywhere, but it’s going to have to be we don’t need I’m talking about scale in terms of the size of our position. We don’t we get no benefit from scale in terms of cost, given the way we run 80/20. So we would only act if we had an opportunity to add to one of our positions, really differentiated products, access to a new market, a new end market, a new geography, etc. So there has to be some long-term benefit. But I don’t think we’d shy away from any. I wouldn’t necessarily rank any sort of higher priority, lower priority across the seven.

Ross Paul Gilardi — BofA Merrill Lynch — Analyst

Okay, got it. And just one quick housekeeping one just for, I think, for Michael. Just Michael, on your scenario analysis, the slide, the $60 million of restructuring spend and the $45 million from 80/20, is that baked into your various margin scenarios or are your margin scenarios excluding those costs?

Michael M. Larsen — Senior Vice President & Chief Financial Officer

It’s included. So we’re as you become accustomed to, we don’t adjust numbers here, so this is really these are the GAAP numbers that we’re showing on the page and everything is included here, including the restructuring.

Operator

We have no further questions. I’d like to turn the call over to Ms. Karen Fletcher for closing remarks.

Karen Fletcher — Vice President, Investor Relations

Thanks. I just want to thank everybody for joining us this morning, and stay well.

Operator

[Operator Closing Remarks]