ILLINOIS TOOL WORKS : Administration’s Dialogue and Evaluation of Monetary Situation and Outcomes of Operations (kind 10-Ok)

0
250

INTRODUCTION

Illinois Tool Works Inc. (the “Company” or “ITW”) is a global manufacturer of a
diversified range of industrial products and equipment with 83 divisions in 52
countries. As of December 31, 2020, the Company employed approximately 43,000
people.

The Company’s operations are organized and managed based on similar product
offerings and end markets, and are reported to senior management as the
following seven segments: Automotive OEM; Food Equipment; Test & Measurement and
Electronics; Welding; Polymers & Fluids; Construction Products; and Specialty
Products.

Due to the large number of diverse businesses and the Company’s decentralized
operating structure, the Company does not require its businesses to provide
detailed information on operating results. Instead, the Company’s corporate
management collects data on several key measurements: operating revenue,
operating income, operating margin, overhead costs, number of months on hand in
inventory, days sales outstanding in accounts receivable, past due receivables
and return on invested capital. These key measures are monitored by management
and significant changes in operating results versus current trends in end
markets and variances from forecasts are discussed with operating unit
management.

THE ITW BUSINESS MODEL

The powerful and highly differentiated ITW Business Model is the Company’s core
source of value creation. The ITW Business Model is the Company’s competitive
advantage and defines how ITW creates value for its shareholders. It is
comprised of three unique elements:

•ITW’s 80/20 Front-to-Back process is the operating system that is applied in
every ITW business. Initially introduced as a manufacturing efficiency tool in
the 1980s, ITW has continually refined, improved and expanded 80/20 into a
proprietary, holistic business management process that generates significant
value for the Company and its customers. Through the application of data driven
insights generated by 80/20 practice, ITW focuses on its largest and best
opportunities (the “80”) and eliminates cost, complexity and distractions
associated with the less profitable opportunities (the “20”). 80/20 enables ITW
businesses to consistently achieve world-class operational excellence in product
availability, quality, and innovation, while generating superior financial
performance;

•Customer-back Innovation has fueled decades of profitable growth at ITW. The
Company’s unique innovation approach is built on insight gathered from the 80/20
Front-to-Back process. Working from the customer back, ITW businesses position
themselves as the go-to problem solver for their “80” customers. ITW’s
innovation efforts are focused on understanding customer needs, particularly
those in “80” markets with solid long-term growth fundamentals, and creating
unique solutions to address those needs. These customer insights and learnings
drive innovation at ITW and have contributed to a portfolio of approximately
18,500 granted and pending patents;

•ITW’s Decentralized, Entrepreneurial Culture enables ITW businesses to be fast,
focused, and responsive. ITW businesses have significant flexibility within the
framework of the ITW Business Model to customize their approach in order to best
serve their specific customers’ needs. ITW colleagues recognize their unique
responsibilities to execute the Company’s strategy and values. As a result, the
Company maintains a focused and simple organizational structure that, combined
with outstanding execution, delivers best-in-class services and solutions
adapted to each business’ customers and end markets.

ENTERPRISE STRATEGY

In late 2012, ITW began its strategic framework transitioning the Company on its
current path to fully leverage the compelling performance potential of the ITW
Business Model. The Company undertook a complete review of its performance,
focusing on its businesses delivering consistent above-market growth with
best-in-class margins and returns, and developing a strategy to replicate that
performance across its operations.

ITW determined that solid and consistent above-market organic growth is the core
growth engine to deliver world-class financial performance and compelling
long-term returns for its shareholders. To shift its primary growth engine to
organic, the Company began executing a multi-step approach.

19
——————————————————————————–

•The first step was to narrow the focus and improve the quality of ITW’s
business portfolio. As part of the Portfolio Management initiative, ITW exited
businesses that were operating in commoditized market spaces and prioritized
sustainable differentiation as a must-have requirement for all ITW businesses.
This process included both divesting entire businesses and exiting commoditized
product lines and customers inside otherwise highly differentiated ITW
divisions.

As a result of this work, ITW’s business portfolio now has significantly higher
organic growth potential. ITW segments and divisions now possess attractive and
differentiated product lines and end markets as they continue to improve
operating margins and generate price/cost increases. The Company achieved this
through product line simplification, or eliminating the complexity and overhead
costs associated with smaller product lines and customers, while supporting and
growing the businesses’ largest / most profitable customers and product lines.

•Step two, Business Structure Simplification, was implemented to simplify and
scale up ITW’s operating structure to support increased engineering, marketing,
and sales resources, and improve global reach and competitiveness, all of which
were critical to driving accelerated organic growth. ITW now has 83 scaled-up
divisions with significantly enhanced focus on growth investments, core
customers and products, and customer-back innovation.

•The Strategic Sourcing initiative established sourcing as a core strategic and
operational capability at ITW, delivering an average of one percent reduction in
spend each year from 2013 through 2020 and continues to be a key contributor to
the Company’s ongoing enterprise strategy.

•With the initial portfolio realignment and scale-up work largely complete, the
Company shifted its focus to preparing for and accelerating organic growth,
reapplying the 80/20 Front-to-Back process to optimize its newly scaled-up
divisions for growth, first, to build a foundation of operational excellence,
and second, to identify the best opportunities to drive organic growth.

ITW has clearly demonstrated superior 80/20 management, resulting in meaningful
incremental improvement in margins and returns as evidenced by the Company’s
operating margin and after-tax return on invested capital. At the same time,
these 80/20 initiatives can also result in restructuring initiatives that reduce
costs and improve profitability and returns.

PATH TO FULL POTENTIAL

Since the launch of the enterprise strategy, the Company has made considerable
progress to position itself to reach full potential. The ITW Business Model and
unique set of capabilities are a source of strong and enduring competitive
advantage, but for the Company to truly finish the job and reach its full
potential, every one of its divisions must also be operating at its full
potential. To do so, the Company remains focused on its core principles to
position ITW to perform to its full potential:

•Portfolio discipline
•80/20 Front-to-Back practice excellence
•Full-potential organic growth

Portfolio Discipline

The Company only operates in industries where it can generate significant,
long-term competitive advantage from the ITW Business Model. ITW businesses have
the right “raw material” in terms of market and business attributes that best
fit the ITW Business Model and have significant potential to drive above-market
organic growth over the long-term.

The Company focuses on high-quality businesses, ensuring it operates in markets
with positive long-term macro fundamentals and with customers that have critical
needs and value ITW’s differentiated products, services and solutions. ITW’s
portfolio operates in highly diverse end markets and geographies which makes the
Company more resilient in the face of uncertain or volatile market environments.

The Company routinely evaluates its portfolio to ensure it delivers sustainable
differentiation and drives consistent long-term performance. This includes both
implementing portfolio refinements and assessing selective high-quality
acquisitions to supplement ITW’s long-term growth potential.

The Company previously communicated its intent to explore options, including
potential divestitures, for certain businesses with revenues totaling up to $1
billion. The Company expects any earnings per share dilution from divestitures
would be
20
——————————————————————————–

offset by incremental share repurchases. In the fourth quarter of 2019, the
Company completed the divestitures of three businesses and continues to evaluate
options for certain other businesses. However, due to the COVID-19 pandemic in
2020, the Company has deferred any further significant divestiture activity
until market conditions normalize. Refer to Note 3. Divestitures in Item 8.
Financial Statements and Supplementary Data for more information regarding the
Company’s divestitures.

80/20 Front-to-Back Practice Excellence

The 80/20 Front-to-Back process is a rigorous, iterative and highly data-driven
approach to identify where the Company has true differentiation and the ability
to drive sustainable, high-quality organic growth. The Company simplifies and
eliminates complexity and redesigns every aspect of its business to ensure
focused execution on key opportunities, markets, customers, and products.

ITW will continue to drive 80/20 Front-to-Back practice excellence in every
division in the Company, every day. Driving strong operational excellence in the
quality of 80/20 Front-to-Back practice across the Company, division by
division, will produce further customer-facing performance improvement in a
number of the Company’s divisions and additional structural margin expansion at
the enterprise level.

Near-term Priorities

While it was the challenges brought about by the COVID-19 pandemic that
dominated the Company’s attention in 2020, it was the collection of capabilities
and competitive advantages that have been built and honed over the past eight
years through the execution of ITW’s enterprise strategy that provided the
Company with the options to respond. This, coupled with the proprietary and
powerful ITW Business Model, diversified high-quality business portfolio and
diligent execution put the Company in a position of strength in dealing with the
global pandemic.

From the early days of the pandemic, the Company focused its efforts on the
following priorities: (1) protect the health and support the well-being of ITW’s
colleagues; (2) continue to serve the Company’s customers with excellence to the
best of its ability; (3) maintain financial strength, liquidity and strategic
optionality; and (4) leverage the Company’s strengths to position it to fully
participate in the recovery.

“Win the Recovery” is an execution component of the Company’s enterprise
strategy, not a separate initiative, with every one of the Company’s divisions
identifying specific opportunities presented by the pandemic to capture
sustainable share gains that are aligned with the ITW long-term enterprise
strategy. These efforts are just beginning to take hold and the Company expects
them to contribute meaningfully to accelerate its progress toward full-potential
organic growth. The Company continues to focus on delivering strong results in
any environment while executing its long-term strategy to achieve and sustain
ITW’s full potential performance.

Full-Potential Organic Growth

Reaching full potential means that every division is positioned for sustainable,
high-quality organic growth. The Company has clearly defined action plans aimed
at leveraging the performance power of the ITW Business Model to achieve
full-potential organic growth in every division, with specific focus on:

•”80″ focused Market Penetration – fully leveraging the considerable growth
potential that resides in the Company’s largest and most differentiated product
offerings and customer relationships
•Customer-back Innovation – strengthening the Company’s commitment to serial
innovation and delivering a continuous flow of differentiated new products to
its key customers
•Strategic Sales Excellence – deploying a high-performance sales function in
every division

As the Company continues to make progress toward its full potential, the Company
will explore opportunities to reinforce or further expand the long-term organic
growth potential of ITW through the addition of selective high-quality
acquisitions, such as the recently announced agreement with Amphenol Corporation
(“Amphenol”), whereby the Company will acquire the Test & Simulation business of
MTS Systems Corporation (“MTS”) following the closing of Amphenol’s acquisition
of MTS. Upon completion of this acquisition, this business will be reported
within the Company’s Test & Measurement and Electronics segment.

21
——————————————————————————–

TERMS USED BY ITW

Management uses the following terms to describe the financial results of
operations of the Company:

•Organic business – acquired businesses that have been included in the Company’s
results of operations for more than 12 months on a constant currency basis.
•Operating leverage – the estimated effect of the organic revenue volume changes
on organic operating income, assuming variable margins remain the same as the
prior period.
•Price/cost – represents the estimated net impact of increases or decreases in
the cost of materials used in the Company’s products versus changes in the
selling price to the Company’s customers.
•Product line simplification (PLS) – focuses businesses on eliminating the
complexity and overhead costs associated with smaller product lines and
customers, and focuses businesses on supporting and growing their largest
customers and product lines; in the short-term, PLS may result in a decrease in
revenue and overhead costs while improving operating margin. In the long-term,
PLS is expected to result in growth in revenue, profitability, and returns.

Unless otherwise stated, the changes in financial results in the consolidated
results of operations and the results of operations by segment represent the
current year period versus the comparable period in the prior year.

CONSOLIDATED RESULTS OF OPERATIONS

In early 2020, an outbreak of a novel strain of coronavirus (COVID-19) occurred
in China and other jurisdictions. The COVID-19 outbreak was subsequently
declared a global pandemic by the World Health Organization on March 11, 2020.
In response to the outbreak, governments around the globe have taken various
actions to reduce its spread, including travel restrictions, shutdowns of
businesses deemed nonessential, and stay-at-home or similar orders. The COVID-19
pandemic and the measures taken globally to reduce its spread have negatively
impacted the global economy, causing significant disruptions in the Company’s
global operations starting primarily in the latter part of the first quarter of
2020 as COVID-19 continued to spread and impact the countries in which the
Company operates and the markets the Company serves.

The Company delivered solid financial results in 2020 despite the extraordinary
challenges posed by the COVID-19 pandemic, as the Company experienced solid
recovery progress in many of its end markets in the third and fourth quarters of
2020 versus the second quarter. The primary driver of the Company’s financial
performance is the continued successful execution of enterprise initiatives and
continued focus on the highly differentiated ITW Business Model. In 2020,
despite the decline in operating revenue of 10.9 percent, the Company generated
operating income of $2.9 billion, operating margin was 22.9 percent, free cash
flow was $2.6 billion and after-tax return on average invested capital was 26.2
percent. Additionally, all segments, other than the Food Equipment, Automotive
OEM and Welding segments, which had more pronounced impacts from the COVID-19
pandemic, had operating margins that improved compared to the prior year. Refer
to the Cash Flow and After-tax Return on Average Invested Capital sections of
Liquidity and Capital Resources for a reconciliation of these non-GAAP measures.

For the duration of the COVID-19 pandemic, the Company is focusing on the
following priorities: (1) protect the health and support the well-being of ITW’s
colleagues; (2) continue to serve the Company’s customers with excellence to the
best of its ability; (3) maintain financial strength, liquidity and strategic
optionality; and (4) leverage the Company’s strengths to position it to fully
participate in the recovery phase. To support ITW’s colleagues, among its many
actions and initiatives, the Company redesigned production processes to ensure
proper social distancing practices, adjusted shift schedules and assignments to
help colleagues who have child and elder care needs, and implemented aggressive
new workplace sanitation practices and a coordinated response to ensure access
to personal protective equipment to minimize infection risk. To support its
customers, the Company has worked diligently to keep its facilities open and
operating safely. The Company has adapted customer service systems and practices
to seamlessly serve its customers under “work from home” requirements in many
parts of the world.

In areas around the world where governments issued stay-at-home or similar
orders, the vast majority of ITW’s businesses were designated as critical or
essential businesses and, as such, they remained open and operational. In some
cases, this is because the Company’s products directly impact the COVID-19
response effort. In other cases, the Company’s businesses are designated as
critical because they play a vital role in serving and supporting industries
that are deemed essential to the physical and economic health of our
communities.

22
——————————————————————————–

While the vast majority of the Company’s facilities remained open and
operational during the pandemic in 2020, many of these facilities were operating
at a reduced capacity. The full extent of the COVID-19 outbreak and its impact
on the markets served by the Company and on the Company’s operations and
financial position continues to be highly uncertain. A prolonged outbreak will
continue to interrupt the operations of the Company and its customers and
suppliers. A description of the risks relating to the impact of the COVID-19
outbreak on the Company’s business, operations and financial condition is
contained in Part I, Item 1A. Risk Factors.

Separately, the Company does not believe that tariffs imposed in recent years
have had a material impact on its operating results. The Company will continue
to evaluate the impact of enacted and proposed tariffs on its businesses, as
well as pricing actions to mitigate the impact of any raw material cost
increases resulting from these tariffs.

The Company’s consolidated results of operations for 2020, 2019 and 2018 were as
follows:

2020 compared to 2019

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
Acquisition/ Foreign
2020 2019 Inc (Dec) Organic Divestiture Restructuring Currency Total
Operating revenue $ 12,574$ 14,109 (10.9) % (9.8) % (0.9) % – % (0.2) % (10.9) %
Operating income $ 2,882$ 3,402 (15.3) % (16.0) % (0.3) % 1.1 % (0.1) % (15.3) %
Operating margin % 22.9 % 24.1 % (120) bps (160) bps 10 bps 30 bps – (120) bps

•Operating revenue decreased due to lower organic revenue, the impact of 2019
divestitures and the unfavorable effect of foreign currency translation.
•Organic revenue decreased 9.8% primarily due to disruptions in the Company’s
global operations resulting from the COVID-19 pandemic as organic revenue
declined in six of the seven segments. The Construction Products segment grew
1.5% primarily due to growth in North America. Product line simplification
activities reduced the Company’s organic revenue by 30 basis points.
•North American organic revenue decreased 9.7% as a decline in six segments,
primarily driven by the Automotive OEM, Food Equipment and Welding segments, was
partially offset by growth in the Construction Products segment.
•Europe, Middle East and Africa organic revenue decreased 13.8% as all seven
segments had a decline in organic revenue primarily driven by the Automotive OEM
and Food Equipment segments.
•Asia Pacific organic revenue decreased 2.0% as a decline in the Food Equipment,
Welding, Specialty Products and Construction Products segments was offset by
growth in the Automotive OEM, Test & Measurement and Electronics and Polymers &
Fluids segments. China organic revenue grew 0.3% as an increase in the
Automotive OEM, Polymers & Fluids and Test & Measurement and Electronics
segments was partially offset by a decline in the Food Equipment, Welding,
Specialty Products and Construction Products segments.
•Operating income of $2.9 billion decreased 15.3% primarily due to lower organic
revenue. Additionally, operating income for 2019 included $11.8 million related
to the businesses divested in 2019.
•Operating margin of 22.9% decreased 120 basis points primarily driven by
negative operating leverage of 230 basis points and product mix, partially
offset by benefits from the Company’s enterprise initiatives of 120 basis points
and lower overhead expenses, such as travel and bonuses, and lower restructuring
expenses.
•The effective tax rate was 22.0% in 2020 compared to 23.3% in 2019. The 2019
effective tax rate benefited from a discrete tax benefit of $21 million in the
third quarter for the U.S. federal provision to return adjustment resulting
primarily from changes in estimates related to the “Tax Cuts and Jobs Act.”
Additionally, the effective tax rates for 2020 and 2019 included $27 million and
$28 million, respectively, related to excess tax benefits from stock-based
compensation. Refer to Note 6. Income Taxes in Item 8. Financial Statements and
Supplementary Data for further information.
•Diluted earnings per share (EPS) were $6.63 for 2020.
•Free cash flow was $2.6 billion for 2020. Refer to the Cash Flow section of
Liquidity and Capital Resources for a reconciliation of this non-GAAP measure.
•The Company repurchased approximately 4.2 million shares of its common stock in
2020 for approximately $706 million. The Company temporarily suspended its share
repurchase program starting in March 2020 due to the COVID-19 pandemic.
23
——————————————————————————–

•The Company increased the quarterly dividend on common stock from $1.07 to
$1.14 per share in 2020, or from $4.28 to $4.56 per share on an annualized
basis. Total cash dividends of approximately $1.4 billion were paid in 2020.
•After-tax return on average invested capital was 26.2% for 2020. Refer to the
After-tax Return on Average Invested Capital section of Liquidity and Capital
Resources for a reconciliation of this non-GAAP measure.

2019 compared to 2018

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
Acquisition/ Foreign
2019 2018 Inc (Dec) Organic Divestiture Restructuring Currency Total
Operating revenue $ 14,109$ 14,768 (4.5) % (1.9) % (0.3) % – % (2.3) % (4.5) %
Operating income $ 3,402$ 3,584 (5.1) % (1.3) % (0.1) % (1.4) % (2.3) % (5.1) %
Operating margin % 24.1 % 24.3 % (20) bps 10 bps – (30) bps – (20) bps

•Operating revenue declined due to the unfavorable effect of foreign currency
translation, lower organic revenue and divestitures.
•Organic revenue decreased 1.9% primarily driven by a decline in the Automotive
OEM, Specialty Products, Welding and Construction Products segments. Product
line simplification activities reduced organic revenue by 60 basis points.
•North American organic revenue decreased 1.8% as a decline in the Automotive
OEM, Specialty Products, Welding and Polymers & Fluids segments was partially
offset by growth in the Food Equipment, Test & Measurement and Electronics and
Construction Products segments.
•Europe, Middle East and Africa organic revenue decreased 2.2% as five segments
declined, partially offset by growth in the Food Equipment and Construction
Products segments.
•Asia Pacific organic revenue declined 1.6% as a decrease in the Construction
Products, Automotive OEM, Food Equipment and Test & Measurement and Electronics
segments was partially offset by an increase in the Welding, Polymers & Fluids
and Specialty Products segments.
•Operating income of $3.4 billion decreased 5.1% primarily due to unfavorable
foreign currency translation, higher restructuring expenses and lower organic
revenue.
•Operating margin of 24.1% decreased 20 basis points. Excluding the unfavorable
impact of higher restructuring expenses of 30 basis points, operating margin
increased 10 basis points primarily due to benefits from the Company’s
enterprise initiatives that contributed 120 basis points and favorable
price/cost of 10 basis points, partially offset by negative operating leverage
of 50 basis points, product mix and higher employee-related expenses.
•The effective tax rate for 2019 was 23.3% compared to 24.5% in 2018. The 2019
effective tax rate benefited from a discrete tax benefit of $21 million in the
third quarter for the U.S. federal provision to return adjustment resulting
primarily from changes in estimates related to the “Tax Cuts and Jobs Act.” The
2018 effective tax rate benefited from a discrete tax benefit of $37 million in
the third quarter related to the release of a valuation allowance against the
deferred tax assets of a non-U.S. subsidiary, which was partially offset by a
discrete tax charge of $22 million in the third quarter related to foreign tax
credits. Additionally, the effective tax rates for 2019 and 2018 included $28
million and $10 million, respectively, related to excess tax benefits from
stock-based compensation. Refer to Note 6. Income Taxes in Item 8. Financial
Statements and Supplementary Data for further information.
•Diluted earnings per share (EPS) of $7.74, an increase of 1.8%, included a
$0.09 gain in 2019 from the disposal of businesses.
•Free cash flow was $2.7 billion for 2019. Refer to the Cash Flow section of
Liquidity and Capital Resources for a reconciliation of this non-GAAP measure.
•The Company repurchased approximately 9.8 million shares of its common stock in
2019 for approximately $1.5 billion.
•The Company increased the quarterly dividend by 7.0% in 2019. Total cash
dividends of approximately $1.3 billion were paid in 2019.
•After-tax return on average invested capital was 28.7% for 2019. Refer to the
After-tax Return on Average Invested Capital section of Liquidity and Capital
Resources for a reconciliation of this non-GAAP measure.

24
——————————————————————————–

RESULTS OF OPERATIONS BY SEGMENT

The reconciliation of segment operating revenue and operating income to total
operating revenue and operating income is as follows:

Operating Revenue
In millions 2020 2019 2018
Automotive OEM $ 2,571$ 3,063$ 3,338
Food Equipment 1,739 2,188 2,214

Test & Measurement and Electronics 1,963 2,121

2,171
Welding 1,384 1,638 1,691
Polymers & Fluids 1,622 1,669 1,724
Construction Products 1,652 1,625

1,700

Specialty Products 1,660 1,825

1,951

Intersegment revenue (17) (20) (21)
Total $ 12,574$ 14,109$ 14,768

Operating Income
In millions 2020 2019 2018
Automotive OEM $ 457$ 659$ 751
Food Equipment 342 578 572
Test & Measurement and Electronics 507 542 523
Welding 376 453 474
Polymers & Fluids 402 381 369
Construction Products 421 383 414
Specialty Products 432 472 522
Total Segments 2,937 3,468 3,625

Unallocated (55) (66) (41)
Total $ 2,882$ 3,402$ 3,584

Segments are allocated a fixed overhead charge based on the segment’s revenue.
Expenses not charged to the segments are reported separately as Unallocated.
Because the Unallocated category includes a variety of items, it is subject to
fluctuations on a quarterly and annual basis.

AUTOMOTIVE OEM

This segment is a global, niche supplier to top tier OEMs, providing unique
innovation to address pain points for sophisticated customers with complex
problems. Businesses in this segment produce components and fasteners for
automotive-related applications. This segment primarily serves the automotive
original equipment manufacturers and tiers market. Products in this segment
include:

•plastic and metal components, fasteners and assemblies for automobiles, light
trucks and other industrial uses.

25
——————————————————————————–

The results of operations for the Automotive OEM segment for 2020, 2019 and 2018
were as follows:

2020 compared to 2019

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2020 2019 Inc (Dec) Organic Acquisition/Divestiture Restructuring Foreign Currency Total
Operating revenue $ 2,571$ 3,063 (16.1) % (16.0) % – % – % (0.1) % (16.1) %
Operating income $ 457$ 659 (30.6) % (32.3) % – % 1.5 % 0.2 % (30.6) %
Operating margin % 17.8 % 21.5 % (370) bps (420) bps – 40 bps 10 bps (370) bps

•Operating revenue declined due to lower organic revenue.
•Organic revenue declined 16.0% versus worldwide auto builds which decreased
16%. Product line simplification activities reduced organic revenue by 80 basis
points.
•North American organic revenue decreased 22.3% compared to North American auto
builds which declined 20% due to customer mix. Auto builds for the Detroit 3,
where the Company has higher content, decreased 23%.
•European organic revenue was down 16.8% compared to European auto builds which
decreased 22%.
•Asia Pacific organic revenue increased 0.7%. China organic revenue grew 6.1%
versus China auto builds which decreased 4%. Auto builds of foreign automotive
manufacturers in China, where the Company has higher content, decreased 8%.
•Operating margin of 17.8% in 2020 decreased 370 basis points primarily due to
negative operating leverage of 330 basis points, product mix and unfavorable
price/cost of 20 basis points, partially offset by benefits from the Company’s
enterprise initiatives and lower restructuring expenses.

2019 compared to 2018

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2019 2018 Inc (Dec) Organic Acquisition/Divestiture Restructuring Foreign Currency Total
Operating revenue $ 3,063$ 3,338 (8.2) % (5.4) % – % – % (2.8) % (8.2) %
Operating income $ 659$ 751 (12.2) % (7.0) % – % (2.6) % (2.6) % (12.2) %
Operating margin % 21.5 % 22.5 % (100) bps (40) bps – (60) bps – (100) bps

•Operating revenue declined due to lower organic revenue and the unfavorable
effect of foreign currency translation.
•Organic revenue declined 5.4% versus worldwide auto builds which decreased 6%.
Auto builds for North America, Europe and China, where the Company has a higher
concentration of revenue as compared to other geographic regions, declined 6%.
Product line simplification activities reduced organic revenue by 120 basis
points. Additionally, organic revenue was negatively impacted by approximately
100 basis points due to unexpected customer shutdowns in North America in the
second half of 2019.
•North American organic revenue decreased 7.8% compared to North American auto
builds which were down 4% due to customer mix. Auto builds for the Detroit 3,
where the Company has higher content, decreased 8%. Additionally, 2019 was
negatively impacted by unexpected customer shutdowns.
•European organic revenue declined 4.5% compared to European auto builds which
declined 4% in 2019 due to customer mix.
•Asia Pacific organic revenue declined 2.2% in 2019. China organic revenue
declined 1.0% versus Chinese auto builds which declined 8% in 2019.
•Operating margin was 21.5% in 2019. The decrease of 100 basis points was
primarily due to negative operating leverage of 90 basis points, unfavorable
price/cost of 60 basis points, higher restructuring expenses and product mix,
partially offset by benefits from the Company’s enterprise initiatives.

26
——————————————————————————–

FOOD EQUIPMENT

This segment is a highly focused and branded industry leader in commercial food
equipment differentiated by innovation and integrated service offerings. This
segment primarily serves the food service, food retail and food
institutional/restaurant markets. Products in this segment include:

•warewashing equipment;
•cooking equipment, including ovens, ranges and broilers;
•refrigeration equipment, including refrigerators, freezers and prep tables;
•food processing equipment, including slicers, mixers and scales;
•kitchen exhaust, ventilation and pollution control systems; and
•food equipment service, maintenance and repair.

The results of operations for the Food Equipment segment for 2020, 2019 and 2018
were as follows:

2020 compared to 2019

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2020 2019 Inc (Dec) Organic Acquisition/Divestiture Restructuring Foreign Currency Total
Operating revenue $ 1,739$ 2,188 (20.5) % (20.6) % – % – % 0.1 % (20.5) %
Operating income $ 342$ 578 (40.9) % (41.1) % – % (0.1) % 0.3 % (40.9) %
Operating margin % 19.6 % 26.4 % (680) bps (680) bps – – – (680) bps

•Operating revenue declined due to lower organic revenue.
•Organic revenue declined 20.6% as equipment and service organic revenue
decreased 21.8% and 18.5%, respectively.
•North American organic revenue declined 19.2% as equipment organic revenue
decreased 20.4%, primarily driven by lower demand in the restaurant and
institutional end markets, partially offset by growth in the food retail end
markets. Service organic revenue decreased 17.3%.
•International organic revenue decreased 22.5%. Equipment organic revenue
declined 23.5% primarily due to lower demand in the European warewash, cooking
and refrigeration end markets and lower demand in Asia. Service organic revenue
decreased 20.4%.
•Operating margin of 19.6% in 2020 decreased 680 basis points primarily due to
negative operating leverage of 540 basis points and product mix, partially
offset by benefits from the Company’s enterprise initiatives and favorable
price/cost of 50 basis points.

2019 compared to 2018

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2019 2018 Inc (Dec) Organic Acquisition/Divestiture Restructuring Foreign Currency Total
Operating revenue $ 2,188$ 2,214 (1.2) % 1.1 % – % – % (2.3) % (1.2) %
Operating income $ 578$ 572 1.1 % 4.5 % – % (1.2) % (2.2) % 1.1 %
Operating margin % 26.4 % 25.8 % 60 bps 90 bps – (30) bps – 60 bps

•Operating revenue declined due to the unfavorable effect of foreign currency
translation, partially offset by higher organic revenue.
•Organic revenue increased 1.1% as equipment organic revenue decreased 0.2% and
service organic revenue increased 3.5%.
•North American organic revenue grew 1.1%. Equipment organic revenue declined
0.4% primarily driven by lower demand in the restaurant and institutional end
markets, partially offset by higher demand in food retail. Service organic
revenue increased 3.6%.
27
——————————————————————————–

•International organic revenue grew 1.1% as equipment organic revenue increased
0.2% primarily due to higher demand in the European warewash, cooking and retail
end markets, partially offset by lower demand in Asia. Service organic revenue
increased 3.5%.
•Operating margin of 26.4% in 2019 increased 60 basis points primarily driven by
benefits from the Company’s enterprise initiatives, favorable price/cost of 40
basis points and positive operating leverage of 30 basis points, partially
offset by product mix, higher employee-related expenses and higher restructuring
expenses.

TEST & MEASUREMENT AND ELECTRONICS

This segment is a branded and innovative producer of test and measurement and
electronic manufacturing and maintenance, repair, and operations, or “MRO”
solutions that improve efficiency and quality for customers in diverse end
markets. Businesses in this segment produce equipment, consumables, and related
software for testing and measuring of materials and structures, as well as
equipment and consumables used in the production of electronic subassemblies and
microelectronics. This segment primarily serves the electronics, general
industrial, industrial capital goods, automotive original equipment
manufacturers and tiers, energy and consumer durables markets. Products in this
segment include:

•equipment, consumables, and related software for testing and measuring of
materials, structures, gases and fluids;
•electronic assembly equipment;
•electronic components and component packaging;
•static control equipment and consumables used for contamination control in
clean room environments; and
•pressure sensitive adhesives and components for electronics, medical,
transportation and telecommunications applications.

The results of operations for the Test & Measurement and Electronics segment for
2020, 2019 and 2018 were as follows:

2020 compared to 2019

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2020 2019 Inc (Dec) Organic Acquisition/Divestiture Restructuring Foreign Currency Total
Operating revenue $ 1,963$ 2,121 (7.4) % (4.9) % (2.8) % – % 0.3 % (7.4) %
Operating income $ 507$ 542 (6.5) % (5.2) % (1.3) % (0.2) % 0.2 % (6.5) %
Operating margin % 25.8 % 25.6 % 20 bps (10) bps 40 bps (10) bps – 20 bps

•Operating revenue declined due to lower organic revenue and the impact of a
2019 divestiture, partially offset by the favorable effect of foreign currency
translation.
•Organic revenue decreased 4.9% in 2020.
•Organic revenue for the test and measurement businesses decreased 7.2%
primarily driven by the impact of a soft capital spending environment in North
America and Europe, partially offset by higher semi-conductor demand in North
America. Instron, where demand is more closely tied to the capital spending
environment, had an organic revenue decline of 14.1% in 2020.
•Electronics organic revenue declined 2.1%. The electronics assembly businesses
decreased 6.9% primarily due to lower demand in North America. The other
electronics businesses, which include the contamination control, static control
and pressure sensitive adhesives businesses, grew 0.9% primarily due to an
increase in North America, partially offset by a decrease in Europe and Asia
Pacific.
•Operating margin of 25.8% in 2020 increased 20 basis points primarily due to
the net benefits from the Company’s enterprise initiatives and cost management,
the impact of a 2019 divestiture and favorable price/cost of 30 basis points,
partially offset by negative operating leverage of 130 basis points and the
recapture of amortization and depreciation expense related to a business
previously classified as held for sale.

28
——————————————————————————–

2019 compared to 2018
For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2019 2018 Inc (Dec) Organic Acquisition/Divestiture

Restructuring Foreign Currency Total
Operating revenue

$ 2,121$ 2,171 (2.3) % (0.3) % (0.2) % – % (1.8) % (2.3) %
Operating income $ 542$ 523 3.7 % 5.7 % – % (0.2) % (1.8) % 3.7 %
Operating margin % 25.6 % 24.1 % 150 bps 140 bps 10 bps – – 150 bps

•Operating revenue declined due to the unfavorable effect of foreign currency
translation, lower organic revenue and a divestiture.
•Operating revenue for 2019 included $58 million related to the business
divested in 2019.
•Organic revenue decreased 0.3% in 2019.
•Organic revenue for the test and measurement businesses decreased 0.8%
primarily driven by lower semi-conductor end market demand in North America.
Excluding semi-conductor, the test and measurement businesses increased 3.5%.
Instron, where demand is more closely tied to the capital spending environment,
had organic revenue growth of 6.4%.
•Electronics organic revenue grew 0.4%. The other electronics businesses, which
include the contamination control, static control and pressure sensitive
adhesives businesses, grew 1.5% primarily due to growth in North America and
Asia, partially offset by a decline in Europe. The electronics assembly
businesses decreased 1.4% primarily due to lower demand in Asia.
•Operating margin of 25.6% in 2019 increased 150 basis points primarily driven
by benefits from the Company’s enterprise initiatives, lower intangible asset
amortization expense and favorable price/cost of 50 basis points.

WELDING

This segment is a branded value-added equipment and specialty consumable
manufacturer with innovative and leading technology. Businesses in this segment
produce arc welding equipment, consumables and accessories for a wide array of
industrial and commercial applications. This segment primarily serves the
general industrial market, which includes fabrication, shipbuilding and other
general industrial markets, and energy, construction, MRO, automotive original
equipment manufacturers and tiers, and industrial capital goods markets.
Products in this segment include:

•arc welding equipment; and
•metal arc welding consumables and related accessories.

The results of operations for the Welding segment for 2020, 2019 and 2018 were
as follows:

2020 compared to 2019

For the Years Ended
Dollars in millions December 31,

Components of Increase (Decrease)
Acquisition/
2020 2019 Inc (Dec) Organic Divestiture Restructuring Foreign Currency Total
Operating revenue $ 1,384$ 1,638 (15.5) % (11.8) % (3.7) % – % – % (15.5) %
Operating income $ 376$ 453 (17.1) % (16.8) % (1.6) % 1.4 % (0.1) % (17.1) %
Operating margin % 27.1 % 27.7 % (60) bps (160) bps 60 bps 40 bps – (60) bps

•Operating revenue decreased due to lower organic revenue and the impact of a
2019 divestiture.
•Organic revenue declined 11.8% driven by decreases in equipment of 12.2% and
consumables of 11.2%, primarily due to lower demand in the industrial end
markets.
•North American organic revenue decreased 10.8% primarily due to a decline in
the industrial end markets of 19.8%, partially offset by growth in the
commercial end markets of 2.1%.
29
——————————————————————————–

•International organic revenue decreased 16.4% primarily due to a decline in the
European oil and gas end markets.
•Operating margin of 27.1% in 2020 decreased 60 basis points primarily driven by
negative operating leverage of 220 basis points and product mix, partially
offset by benefits from the Company’s enterprise initiatives, the impact of a
2019 divestiture and lower restructuring expenses.

2019 compared to 2018

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2019 2018 Inc (Dec) Organic Acquisition/Divestiture Restructuring Foreign Currency Total
Operating revenue $ 1,638$ 1,691 (3.1) % (1.2) % (1.1) % – % (0.8) % (3.1) %
Operating income $ 453$ 474 (4.4) % (2.1) % (0.4) % (1.7) % (0.2) % (4.4) %
Operating margin % 27.7 % 28.0 % (30) bps (20) bps 20 bps (50) bps 20 bps (30) bps

•Operating revenue decreased due to lower organic revenue, the impact of
divestiture activity and the unfavorable effect of foreign currency translation.
•Operating revenue for 2019 included $62 million related to the business
divested in 2019.
•Organic revenue decreased 1.2% as equipment declined 2.6%, partially offset by
growth in consumables of 0.8%.
•North American organic revenue declined 1.1% as a decrease in the industrial
end markets was partially offset by growth in the commercial and oil and gas end
markets.
•International organic revenue decreased 1.6% primarily due to a decline in
Europe, partially offset by higher demand in Asia in the oil and gas end
markets.
•Operating margin of 27.7% decreased 30 basis points compared to the prior year
primarily driven by higher restructuring expenses of 50 basis points, product
mix, negative operating leverage of 20 basis points and higher employee-related
expenses, partially offset by benefits from the Company’s enterprise initiatives
and favorable price/cost of 70 basis points.

POLYMERS & FLUIDS

This segment is a branded supplier to niche markets that require value-added,
differentiated products. Businesses in this segment produce engineered
adhesives, sealants, lubrication and cutting fluids, and fluids and polymers for
auto aftermarket maintenance and appearance. This segment primarily serves the
automotive aftermarket, general industrial, MRO and construction markets.
Products in this segment include:

•adhesives for industrial, construction and consumer purposes;
•chemical fluids which clean or add lubrication to machines;
•epoxy and resin-based coating products for industrial applications;
•hand wipes and cleaners for industrial applications;
•fluids, polymers and other supplies for auto aftermarket maintenance and
appearance;
•fillers and putties for auto body repair; and
•polyester coatings and patch and repair products for the marine industry.

The results of operations for the Polymers & Fluids segment for 2020, 2019 and
2018 were as follows:

2020 compared to 2019

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2020 2019 Inc (Dec) Organic Acquisition/Divestiture Restructuring Foreign Currency Total
Operating revenue $ 1,622$ 1,669 (2.8) % (1.4) % – % – % (1.4) % (2.8) %
Operating income $ 402$ 381 5.6 % 5.2 % – % 1.5 % (1.1) % 5.6 %
Operating margin % 24.8 % 22.8 % 200 bps 150 bps – 40 bps 10 bps 200 bps

30

——————————————————————————–

•Operating revenue decreased due to lower organic revenue and the unfavorable
effect of foreign currency translation.
•Organic revenue declined 1.4% in 2020. Product line simplification activities
reduced organic revenue by 50 basis points.
•Organic revenue for the polymers businesses decreased 5.3% primarily driven by
a decline in the heavy industrial end markets in North America and Europe.
•Organic revenue for the automotive aftermarket businesses declined 0.5%
primarily driven by a decrease in the car care and body repair businesses in
North America and the additives businesses in Europe, partially offset by growth
in the tire and engine repair businesses in North America.
•Organic revenue for the fluids businesses grew 3.3% primarily due to an
increase in the industrial maintenance, repair, and operations end markets in
Europe and North America.
•Operating margin of 24.8% in 2020 increased 200 basis points primarily due to
the net benefits from the Company’s enterprise initiatives and cost management,
favorable price/cost of 50 basis points and lower restructuring expenses,
partially offset by negative operating leverage of 30 basis points.

2019 compared to 2018

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2019 2018 Inc (Dec) Organic Acquisition/Divestiture

Restructuring Foreign Currency Total
Operating revenue

$ 1,669$ 1,724 (3.2) % – % (0.4) % – % (2.8) % (3.2) %
Operating income $ 381$ 369 3.1 % 7.9 % (0.1) % (1.5) % (3.2) % 3.1 %
Operating margin % 22.8 % 21.4 % 140 bps 170 bps – (30) bps – 140 bps

•Operating revenue decreased primarily due to the unfavorable effect of foreign
currency translation.
•Organic revenue was flat as growth in the polymers businesses was offset by
declines in the automotive aftermarket and fluids businesses.
•Organic revenue for the automotive aftermarket businesses declined 0.7%
primarily due to lower demand in the tire repair businesses in North America and
the additives businesses in Europe, partially offset by stronger demand in the
car care businesses in North America.
•Organic revenue for the polymers businesses increased 2.4% primarily driven by
growth in Asia and North America, primarily in the heavy industrial end markets.
•Organic revenue for the fluids businesses decreased 2.0% primarily due to a
decline in the industrial maintenance, repair, and operations end markets in
North America.
•Operating margin of 22.8% increased 140 basis points primarily due to the net
benefits from the Company’s enterprise initiatives and cost management,
partially offset by higher restructuring expenses.

CONSTRUCTION PRODUCTS

This segment is a branded supplier of innovative engineered fastening systems
and solutions. This segment primarily serves the residential construction,
renovation/remodel and commercial construction markets. Products in this segment
include:

•fasteners and related fastening tools for wood and metal applications;
•anchors, fasteners and related tools for concrete applications;
•metal plate truss components and related equipment and software; and
•packaged hardware, fasteners, anchors and other products for retail.

31
——————————————————————————–

The results of operations for the Construction Products segment for 2020, 2019
and 2018 were as follows:

2020 compared to 2019

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2020 2019 Inc (Dec) Organic Acquisition/Divestiture Restructuring Foreign Currency Total
Operating revenue $ 1,652$ 1,625 1.7 % 1.5 % – % – % 0.2 % 1.7 %
Operating income $ 421$ 383 10.0 % 8.4 % – % 1.5 % 0.1 % 10.0 %
Operating margin % 25.5 % 23.6 % 190 bps 160 bps – 30 bps – 190 bps

•Operating revenue increased due to higher organic revenue and the favorable
effect of foreign currency translation.
•Organic revenue grew 1.5% as an increase in North America was partially offset
by declines in Europe and Asia Pacific.
•North American organic revenue grew 7.8% as increases of 11.4% in the United
States residential end markets and 13.0% in Canada were partially offset by a
decrease of 11.4% in the commercial end markets.
•International organic revenue decreased 3.3% in 2020. Asia Pacific organic
revenue decreased 0.7% primarily due to a decline in the commercial end markets
in Australia and New Zealand. European organic revenue decreased 5.5% driven by
a decline in continental Europe and the United Kingdom.
•Operating margin of 25.5% in 2020 increased 190 basis points primarily driven
by the net benefits from the Company’s enterprise initiatives and cost
management, positive operating leverage of 30 basis points and lower
restructuring expenses, partially offset by unfavorable price/cost of 50 basis
points.

2019 compared to 2018

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2019 2018 Inc (Dec) Organic Acquisition/Divestiture Restructuring Foreign Currency Total
Operating revenue $ 1,625$ 1,700 (4.4) % (1.0) % – % – % (3.4) % (4.4) %
Operating income $ 383$ 414 (7.4) % (3.1) % – % (1.2) % (3.1) % (7.4) %
Operating margin % 23.6 % 24.3 % (70) bps (50) bps – (30) bps 10 bps (70) bps

•Operating revenue decreased in 2019 due to the unfavorable effect of foreign
currency translation and lower organic revenue.
•Organic revenue declined 1.0% in 2019.
•North American organic revenue was flat as an increase of 1.9% in the United
States residential end markets was offset by a decline of 3.2% in the commercial
end markets and a decline in Canada.
•International organic revenue declined 1.8%. Asia Pacific organic revenue
decreased 5.1% primarily due to a decline in Australia and New Zealand across
all end markets. European organic revenue increased 1.3% driven by growth in
continental Europe.
•Operating margin of 23.6% decreased 70 basis points primarily driven by
unfavorable price/cost of 40 basis points, higher restructuring expenses,
product mix and negative operating leverage of 10 basis points, partially offset
by benefits from the Company’s enterprise initiatives.

SPECIALTY PRODUCTS

This segment is focused on diversified niche market opportunities with
substantial patent protection producing beverage packaging equipment and
consumables, product coding and marking equipment and consumables, and appliance
components and fasteners. This segment primarily serves the food and beverage,
consumer durables, general industrial, industrial capital goods and printing and
publishing markets. Products in this segment include:

•line integration, conveyor systems and line automation for the food and
beverage industries;
•plastic consumables that multi-pack cans and bottles and related equipment;

32
——————————————————————————–

•foil, film and related equipment used to decorate consumer products;
•product coding and marking equipment and related consumables;
•plastic and metal closures and components for appliances;
•airport ground support equipment; and
•components for medical devices.

The results of operations for the Specialty Products segment for 2020, 2019 and
2018 were as follows:

2020 compared to 2019

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2020 2019 Inc (Dec) Organic Acquisition/Divestiture Restructuring Foreign Currency Total
Operating revenue $ 1,660$ 1,825 (9.1) % (8.2) % (0.8) % – % (0.1) % (9.1) %
Operating income $ 432$ 472 (8.5) % (11.2) % 0.7 % 2.2 % (0.2) % (8.5) %
Operating margin % 26.0 % 25.9 % 10 bps (90) bps 40 bps 60 bps – 10 bps

•Operating revenue decreased primarily due to lower organic revenue and the
impact of 2019 divestitures.
•Organic revenue decreased 8.2% as equipment sales declined 17.7% and
consumables declined 5.2%. Additionally, product line simplification activities
reduced organic revenue by 30 basis points.
•North American organic revenue decreased 7.3% primarily due to a decline in the
ground support equipment, appliance and specialty films businesses, partially
offset by an increase in the consumer packaging businesses.
•International organic revenue decreased 10.0% primarily due to a decline in the
consumer packaging, ground support equipment, appliance, specialty films and
marking coding businesses in Europe.
•Operating margin of 26.0% in 2020 increased 10 basis points primarily due to
benefits from the Company’s enterprise initiatives, lower restructuring expenses
and the impact of 2019 divestitures, partially offset by negative operating
leverage of 180 basis points, unfavorable price/cost of 60 basis points and the
unfavorable impact of a one-time customer cost-sharing settlement.

2019 compared to 2018

For the Years Ended
Dollars in millions December 31, Components of Increase (Decrease)
2019 2018 Inc (Dec) Organic Acquisition/Divestiture Restructuring Foreign Currency Total
Operating revenue $ 1,825$ 1,951 (6.5) % (4.1) % (0.6) % – % (1.8) % (6.5) %
Operating income $ 472$ 522 (9.7) % (7.6) % – % (0.5) % (1.6) % (9.7) %
Operating margin % 25.9 % 26.8 % (90) bps (100) bps 20 bps (10) bps – (90) bps

•Operating revenue decreased in 2019 due to lower organic revenue, the
unfavorable effect of foreign currency translation and the impact of divestiture
activity.
•Operating revenue for 2019 included $14 million related to the businesses
divested in 2019.
•Organic revenue decreased 4.1% in 2019. Consumables declined 5.8% primarily due
to lower demand in North America and Europe. Equipment sales increased 2.2%
primarily due to higher demand in North America, partially offset by a decline
in Asia. Product line simplification activities reduced organic revenue by 100
basis points.
•North American organic revenue decreased 3.1% primarily due to a decrease in
the specialty films, labels and appliance businesses, partially offset by growth
in the ground support equipment business and consumer packaging businesses.
•International organic revenue decreased 5.6% primarily due to a decline in the
specialty films, graphics, appliance and foils businesses in Europe.
•Operating margin of 25.9% decreased 90 basis points primarily due to negative
operating leverage of 90 basis points, product mix and higher employee-related
expenses, partially offset by benefits from the Company’s enterprise
initiatives.
33
——————————————————————————–

OTHER FINANCIAL HIGHLIGHTS

•Interest expense was $206 million in 2020, $221 million in 2019 and $257
million in 2018. Interest expense in 2020 was $15 million lower than the
previous year primarily driven by the repayment of the $700 million notes due
April 1, 2019 and the $650 million notes due March 1, 2019, and outstanding
commercial paper in 2019, partially offset by the issuance of the €1.6 billion
Euro notes in June of 2019. Interest expense in 2019 was $36 million lower than
2018 primarily due to the repayment of the $700 million notes due April 1, 2019
and the $650 million notes due March 1, 2019.
•Other income (expense) was income of $28 million in 2020, $107 million in 2019
and $67 million in 2018. The income in 2020 decreased $79 million compared to
the previous year primarily due to the net pre-tax gain on the disposal of
operations and affiliates of $44 million in 2019, lower interest and investment
income, and lower pension other net periodic benefit income. The income in 2019
increased $40 million compared to 2018 primarily due to the net pre-tax gain on
the disposal of operations and affiliates in 2019.
•The effective tax rate was 22.0% in 2020, 23.3% in 2019 and 24.5% in 2018. The
2019 effective tax rate benefited from a discrete tax benefit of $21 million in
the third quarter for the U.S. federal provision to return adjustment resulting
primarily from changes in estimates related to the “Tax Cuts and Jobs Act.” The
2018 effective tax rate benefited from a discrete tax benefit of $37 million in
the third quarter related to the release of a valuation allowance against the
deferred tax assets of a non-U.S. subsidiary, which was partially offset by a
discrete tax charge of $22 million in the third quarter related to foreign tax
credits. Additionally, the effective tax rates for 2020, 2019 and 2018 included
$27 million, $28 million and $10 million, respectively, related to excess tax
benefits from stock-based compensation. Refer to Note 6. Income Taxes in Item 8.
Financial Statements and Supplementary Data for further information.
•The impact of the Euro and other foreign currencies against the U.S. Dollar in
2020 versus 2019 decreased operating revenue and income before taxes by
approximately $20 million and $3 million, respectively. The impact of the Euro
and other foreign currencies against the U.S. Dollar in 2019 versus 2018
decreased operating revenue and income before taxes by approximately $339
million and $84 million, respectively.

NEW ACCOUNTING PRONOUNCEMENTS

Information regarding new accounting pronouncements is included in Note 1.
Description of Business and Summary of Significant Accounting Policies in Item
8. Financial Statements and Supplementary Data.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s primary sources of liquidity are free cash flow and short-term
credit facilities. As of December 31, 2020, the Company had $2.6 billion of cash
and equivalents on hand, no outstanding borrowings under its $2.5 billion
revolving credit facility, and no commercial paper outstanding. The Company also
has maintained strong access to public debt markets. Management believes that
these sources are sufficient to service debt and to finance the Company’s
capital allocation priorities, which include:

•internal investments to support organic growth and sustain core businesses;
•payment of an attractive dividend to shareholders; and
•external investments in selective strategic acquisitions that support the
Company’s organic growth focus and an active share repurchase program that the
Company temporarily suspended starting in March 2020 due to the COVID-19
pandemic.

Also, for the duration of the COVID-19 pandemic, the Company has made the
strategic decision to aggressively manage its discretionary costs and working
capital, while staying invested in its businesses, people and strategies, so
that the Company is positioned to fully support its customers in the recovery
phase and can continue executing its long-term strategy to deliver
differentiated long-term performance and returns.

The Company believes that, based on its operating revenue, operating margin,
free cash flow, and credit ratings, it could readily obtain additional
financing, if necessary. A description of the risks related to the impact of the
COVID-19 outbreak on the financial and capital markets and the related potential
risks to the Company is contained in Part I, Item 1A. Risk Factors.
34
——————————————————————————–

Cash Flow

The Company uses free cash flow to measure cash flow generated by operations
that is available for dividends, share repurchases, acquisitions and debt
repayment. The Company believes this non-GAAP financial measure is useful to
investors in evaluating the Company’s financial performance and measures the
Company’s ability to generate cash internally to fund Company initiatives. Free
cash flow represents net cash provided by operating activities less additions to
plant and equipment. Free cash flow is a measurement that is not the same as net
cash flow from operating activities per the statement of cash flows and may not
be consistent with similarly titled measures used by other companies. Summarized
cash flow information for the years ended December 31, 2020, 2019 and 2018 was
as follows:

In millions 2020 2019 2018

Net cash provided by operating activities $ 2,807 $

2,995 $ 2,811
Additions to plant and equipment (236) (326) (364)
Free cash flow $ 2,571$ 2,669$ 2,447

Cash dividends paid $ (1,379)$ (1,321)$ (1,124)
Repurchases of common stock (706) (1,500) (2,000)
Acquisition of businesses (excluding cash and
equivalents) – (4) –
Proceeds from sale of operations and affiliates 1 120 1
Net proceeds (repayments) of debt (4) 422 (851)
Other 61 100 49
Effect of exchange rate changes on cash and
equivalents 39 (9) (112)

Net increase (decrease) in cash and equivalents $ 583 $

477 $ (1,590)

Stock Repurchase Programs

On February 13, 2015, the Company’s Board of Directors authorized a stock
repurchase program which provided for the repurchase of up to $6.0 billion of
the Company’s common stock over an open-ended period of time (the “2015
Program”). Under the 2015 Program, the Company repurchased approximately 6.1
million shares of its common stock at an average price of $91.78 per share
during 2015, approximately 18.7 million shares of its common stock at an average
price of $107.17 per share during 2016, approximately 7.1 million shares of its
common stock at an average price of $140.56 per share during 2017, approximately
13.9 million shares of its common stock at an average price of $143.66 per share
during 2018 and approximately 3.1 million shares of its common stock at an
average price of $143.23 per share during 2019. The 2015 Program was completed
in the second quarter of 2019.

On August 3, 2018, the Company’s Board of Directors authorized a new stock
repurchase program which provides for the repurchase of up to an additional $3.0
billion of the Company’s common stock over an open-ended period of time (the
“2018 Program”). Under the 2018 Program, the Company repurchased approximately
6.7 million shares of its common stock at an average price of $158.11 per share
during 2019 and approximately 4.2 million shares of its common stock at an
average price of $167.69 per share in the first quarter of 2020. As of
December 31, 2020, there were approximately $1.2 billion of authorized
repurchases remaining under the 2018 program. In 2020, due to the COVID-19
pandemic, the Company temporarily suspended its share repurchase program
starting in March and intends to resume purchases in 2021.

35
——————————————————————————–

After-tax Return on Average Invested Capital

The Company uses after-tax return on average invested capital (“After-tax ROIC”)
to measure the effectiveness of its operations’ use of invested capital to
generate profits. After-tax ROIC is a non-GAAP financial measure that the
Company believes is a meaningful metric to investors in evaluating the Company’s
financial performance and may be different than the method used by other
companies to calculate After-tax ROIC. For comparability, the Company excluded
the third quarter 2019 discrete tax benefit of $21 million from the effective
tax rate for the year ended December 31, 2019. Additionally, the Company
excluded the third quarter 2018 net discrete tax benefit of $15 million from the
effective tax rate for the year ended December 31, 2018. Average invested
capital represents the net assets of the Company, excluding cash and equivalents
and outstanding debt, which are excluded as they do not represent capital
investment in the Company’s operations. Average invested capital is calculated
using balances at the start of the period and at the end of each quarter.
After-tax ROIC for the years ended December 31, 2020, 2019, and 2018 was as
follows:

Dollars in millions 2020 2019 2018
Operating income $ 2,882$ 3,402$ 3,584
Tax rate 22.0 % 24.0 % 24.9 %
Income taxes (633) (815) (893)
Operating income after taxes $ 2,249$ 2,587$ 2,691

Invested capital:
Trade receivables $ 2,506$ 2,461$ 2,622
Inventories 1,189 1,164 1,318
Net assets held for sale – 280 –
Net plant and equipment 1,777 1,729 1,791
Goodwill and intangible assets 5,471 5,343

5,717

Accounts payable and accrued expenses (1,818) (1,689) (1,795)
Other, net (385) (481) (519)
Total invested capital $ 8,740$ 8,807$ 9,134

Average invested capital $ 8,576$ 9,028$ 9,533
After-tax return on average invested capital 26.2 % 28.7 %

28.2 %

After-tax ROIC decreased 250 basis points for the twelve month period ended
December 31, 2020 compared to the prior year period as a result of a 13.1%
decrease in after-tax operating income versus a 5.0% decrease in average
invested capital. After-tax ROIC increased 50 basis points for the twelve month
period ended December 31, 2019 compared to the prior year period as a result of
a 5.3% decrease in average invested capital versus a 3.9% decrease in after-tax
operating income.

A reconciliation of the 2019 effective tax rate excluding the third quarter 2019
discrete tax benefit of $21 million is as follows:

Twelve Months Ended
December 31, 2019
Dollars in millions Income Taxes Tax Rate
As reported $ 767 23.3 %
Discrete tax benefit related to third quarter 21 0.7 %
As adjusted $ 788 24.0 %

36

——————————————————————————–

A reconciliation of the 2018 effective tax rate excluding the third quarter 2018
net discrete tax benefit of $15 million is as follows:

Twelve Months Ended
December 31, 2018
Dollars in millions Income Taxes Tax Rate
As reported $ 831 24.5 %
Net discrete tax benefit related to third quarter 15 0.4 %
As adjusted $ 846 24.9 %

Refer to Note 6. Income Taxes in Item 8. Financial Statements and Supplementary
Data for further information regarding the discrete tax items noted above.

Working Capital

Management uses working capital as a measurement of the short-term liquidity of
the Company. Net working capital as of December 31, 2020 and 2019 is summarized
as follows:

Increase
Dollars in millions 2020 2019 (Decrease)
Current Assets:
Cash and equivalents $ 2,564$ 1,981$ 583
Trade receivables 2,506 2,461 45
Inventories 1,189 1,164 25

Prepaid expenses and other current assets 264 296

(32)
Assets held for sale – 351 (351)
6,523 6,253 270
Current Liabilities:
Short-term debt 350 4 346

Accounts payable and accrued expenses 1,818 1,689

129
Liabilities held for sale – 71 (71)
Other 421 390 31
2,589 2,154 435
Net Working Capital $ 3,934$ 4,099$ (165)

As of December 31, 2020, a significant portion of the Company’s cash and
equivalents was held by international subsidiaries. Cash and equivalents held
internationally may be subject to foreign withholding taxes if repatriated to
the U.S. Cash and equivalents held internationally are typically used for
international operating needs or reinvested to fund expansion of existing
international businesses. International funds may also be used to fund
international acquisitions or, if not considered permanently invested, may be
repatriated to the U.S.The Company has accrued for foreign withholding taxes
related to foreign held cash and equivalents that are not permanently invested.

In the U.S., the Company utilizes cash flows from operations to fund domestic
cash needs and the Company’s capital allocation priorities. This includes
operating needs of the U.S. businesses, dividend payments, share repurchases,
acquisitions, servicing of domestic debt obligations, reinvesting to fund
expansion of existing U.S. businesses and general corporate needs. The Company
may also use its commercial paper program, which is backed by long-term credit
facilities, for short-term liquidity needs. The Company believes cash generated
by operations and liquidity provided by the Company’s commercial paper program
will continue to be sufficient to fund cash requirements in the U.S.

37
——————————————————————————–

Debt

Total debt as of December 31, 2020 and 2019 was as follows:

Increase
In millions 2020 2019 (Decrease)
Short-term debt $ 350$ 4$ 346
Long-term debt 7,772 7,754 18
Total debt $ 8,122$ 7,758$ 364

As of December 31, 2020, short-term debt included $350 million related to the
3.375% notes due September 15, 2021. As of December 31, 2019, short-term debt
included $4 million related to the 4.88% notes due through December 31, 2020,
which were repaid by the due date. There was no commercial paper outstanding as
of December 31, 2020 and 2019. The increase in total debt as of December 31,
2020 was primarily due to the revaluation of the Company’s Euro-denominated
notes. Refer to Note 10. Debt in Item 8. Financial Statements and Supplementary
Data for additional details regarding the Company’s Euro notes.

The Company may issue commercial paper to fund general corporate needs, share
repurchases, and small and medium-sized acquisitions. During the third quarter
of 2019, the Company entered into a $2.5 billion, five-year revolving credit
facility with a termination date of September 27, 2024 to support the potential
issuances of commercial paper. No amounts were outstanding under the revolving
credit facility at December 31, 2020. The Company did not have any commercial
paper outstanding during 2020.

As of December 31, 2020, the Company’s foreign operations had authorized credit
facilities with unused capacity of $195 million.

Total Debt to EBITDA

The Company uses the ratio of total debt to EBITDA as a measure of its ability
to repay its outstanding debt obligations. EBITDA and the ratio of total debt to
EBITDA are non-GAAP financial measures. The Company believes that total debt to
EBITDA is a meaningful metric to investors in evaluating the Company’s long term
financial liquidity and may be different than the method used by other companies
to calculate total debt to EBITDA. The ratio of total debt to EBITDA represents
total debt divided by net income before interest expense, other income
(expense), income taxes, depreciation, and amortization and impairment of
intangible assets on a trailing twelve month basis. Total debt to EBITDA for the
years ended December 31, 2020, 2019 and 2018 was as follows:

Dollars in millions 2020 2019 2018
Total debt $ 8,122$ 7,758$ 7,380

Net income $ 2,109$ 2,521$ 2,563
Add:
Interest expense 206 221 257
Other income (28) (107) (67)
Income taxes 595 767 831
Depreciation 273 267 272

Amortization and impairment of intangible assets 154 159

189
EBITDA $ 3,309$ 3,828$ 4,045
Total debt to EBITDA ratio 2.5 2.0 1.8

38

——————————————————————————–

Stockholders’ Equity

The changes to stockholders’ equity during 2020 and 2019 were as follows:
In millions 2020 2019
Beginning balance $ 3,030$ 3,258
Net income 2,109 2,521
Cash dividends declared (1,398) (1,335)
Repurchases of common stock (706) (1,500)
Other comprehensive income (loss) 63 (28)
Other 84 114
Ending balance $ 3,182$ 3,030

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

The Company’s significant contractual obligations as of December 31, 2020 were
as follows:

2026 and
Future
In millions 2021 2022 2023 2024 2025 Years
Principal payments on long-term debt $ 350$ 611$ 611$ 1,433 $ – $ 5,193
Interest payments on debt 199 187 176 156 142 1,537
Noncurrent income taxes payable 49 49 91 122 151 –
Operating lease liability 58 49 37 25 14 15

Total contractual obligations $ 656$ 896$ 915$ 1,736$ 307$ 6,745

As of December 31, 2020, the Company had recorded noncurrent liabilities for
unrecognized tax benefits of $216 million. The Company is not able to reasonably
estimate the timing of payments related to the liabilities for unrecognized tax
benefits. The Company did not have any significant off-balance sheet commitments
at December 31, 2020.

CRITICAL ACCOUNTING ESTIMATES

The Company has three accounting estimates that it believes are most important
to the Company’s financial condition and results of operations, and which
require the Company to make judgments about matters that are inherently
uncertain. Management bases its estimates on historical experience, and in some
cases on observable market information. Various assumptions are also used that
are believed to be reasonable under the circumstances and form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates.

The Company’s critical accounting estimates are as follows:

Income Taxes- The Company provides deferred income tax assets and liabilities
based on the estimated future tax effects of differences between the financial
and tax bases of assets and liabilities based on currently enacted tax laws. The
Company’s deferred and other tax balances are based on management’s
interpretation of the tax regulations and rulings in numerous taxing
jurisdictions. Income tax expense, assets and liabilities recognized by the
Company also reflect its best estimates and assumptions regarding, among other
things, the level of future taxable income, the effect of the Company’s various
tax planning strategies and uncertain tax positions. Future tax authority
rulings and changes in tax laws, changes in projected levels of taxable income
and future tax planning strategies could affect the actual effective tax rate
and tax balances recorded by the Company.

Goodwill and Intangible Assets- The Company’s business acquisitions typically
result in recording goodwill and other intangible assets, which are a
significant portion of the Company’s total assets and affect the amount of
amortization expense and impairment charges that the Company could incur in
future periods. The Company follows the guidance prescribed in the accounting
standards to test goodwill and intangible assets for impairment. On an annual
basis, or more frequently if triggering events occur, the Company compares the
estimated fair value of its reporting units to the carrying value of each
reporting unit to determine if a potential goodwill impairment exists. If the
fair value of a reporting unit is less than its
39

——————————————————————————–

carrying value, a goodwill impairment loss is recorded for the difference. In
calculating the fair value of the reporting units or specific intangible assets,
management relies on a number of factors, including business plans, economic
projections, anticipated future cash flows, comparable transactions and other
market data. There are inherent uncertainties related to these factors and
management’s judgment in applying them in the impairment tests of goodwill and
other intangible assets.

As of December 31, 2020, the Company had total goodwill and intangible assets of
approximately $5.5 billion allocated to its reporting units. Although there can
be no assurance that the Company will not incur additional impairment charges
related to its goodwill and other intangible assets, the Company generally
believes the risk of significant impairment charges is lessened by the number of
diversified businesses and end markets represented by its reporting units that
have goodwill and other intangible assets. In addition, the individual
businesses in many of the reporting units have been acquired over a long period
of time, and in many cases have been able to improve their performance,
primarily as a result of the application of the Company’s 80/20 Front-to-Back
process. The amount of goodwill and other intangible assets allocated to
individual reporting units ranges from approximately $238 million to $1.1
billion, with the average amount equal to $545 million. Fair value
determinations require considerable judgment and are sensitive to changes in the
factors described above. Due to the inherent uncertainties associated with these
factors and economic conditions in the Company’s global end markets, impairment
charges related to one or more reporting units could occur in future periods.

Pension and Other Postretirement Benefits- The Company has various
company-sponsored defined benefit retirement plans covering a number of U.S.
employees and many employees outside the U.S. Pension and other postretirement
benefit expense and obligations are determined based on actuarial valuations.
Pension benefit obligations are generally based on each participant’s years of
service, future compensation, and age at retirement or termination. Important
assumptions in determining pension and postretirement expense and obligations
are the discount rate, the expected long-term return on plan assets, life
expectancy, and health care cost trend rates. Future changes in any of these
assumptions could materially affect the amounts recorded related to the
Company’s pension and other postretirement benefit plans. See Note 11. Pension
and Other Postretirement Benefits in Item 8. Financial Statements and
Supplementary Data for additional discussion of actuarial assumptions used in
determining pension and postretirement health care liabilities and expenses.

The Company determines the discount rate used to measure plan liabilities as of
the year-end measurement date for the U.S. primary pension plan. The discount
rate reflects the current rate at which the associated liabilities could
theoretically be effectively settled at the end of the year. In estimating this
rate, the Company looks at rates of return on high-quality fixed income
investments, with similar duration to the liabilities in the plan. A 25 basis
point decrease in the discount rate would increase the present value of the U.S.
primary pension plan obligation by approximately $40 million. The Company
estimates the service and interest cost components of net periodic benefit cost
by applying specific spot rates along the yield curve to the projected cash
flows rather than a single weighted-average rate. See Note 11. Pension and Other
Postretirement Benefits in Item 8. Financial Statements and Supplementary Data
for information on the Company’s pension and other postretirement benefit plans
and related assumptions.

The expected long-term return on plan assets is based on historical and expected
long-term returns for similar investment allocations among asset classes. For
the U.S. primary pension plan, a 25 basis point decrease in the expected return
on plan assets would increase the annual pension expense by approximately $4
million.

© Edgar Online, source Glimpses