Q3 2025 Earnings Call Contradictions: Tariff Strategy, 2026 Guidance, and Demand Outlook

Date of Call: October 24, 2025

Financials Results

• Revenue: Total revenue up ~2%+ in Q3 (CFO: 'increased by more than 2%'; CEO: 'increased 3%, excluding a 1% reduction from strategic product line simplification'); organic growth 1%, FX +2%
• EPS: $2.81 GAAP EPS in Q3, up ~6% excluding a prior‑year divestiture gain
• Operating Margin: Record operating margin 27.4% in Q3, up 90 bps year‑over‑year; enterprise initiatives contributed ~140 bps; full‑year guidance 26%–27%

Guidance:

• Full‑year organic growth 0%–2%; total revenue projected up 1%–3% (current FX rates).
• Operating margin guidance 26%–27%; enterprise initiatives expected to contribute ~125 bps to full‑year operating margin.
• GAAP EPS guidance narrowed to $10.40–$10.50 (midpoint $10.45); full‑year tax rate ~23% (Q4 tax ~24%–25%).
• Tariff‑related pricing and supply‑chain actions expected to more than offset tariff costs and favorably impact EPS/margins.
• Q4 revenue expected to be modestly up sequentially (~+1 point) driven largely by Test & Measurement, offset partially by Construction seasonality.

Business Commentary:

* Revenue and Earnings Performance: - Illinois Tool Works Inc. reported that revenue for the third quarter of 2025 increased by more than 2%, driven in part by 1% organic growth. - The growth was supported by favorable foreign currency translation, which contributed 2% to revenue. - The company achieved a GAAP EPS of $2.81, grew operating income by 6%, and expanded operating margin by 90 basis points to 27.4%.

• Segment Performance Variability:
• The automotive OEM segment led with a 7% revenue increase and 5% organic growth, while the construction segment showed a 1% revenue decline but improved operating margin by 140 basis points.
• Growth in automotive was driven by increased content per vehicle and gains in the EV market, while the construction segment's margin improvement was attributed to portfolio quality and strategic management.

• Noteworthy was the Test & Measurement and Electronics segment, which experienced a 1% decrease in organic revenue due to a choppy demand for capital equipment.

• Strategic Growth and Innovation:

• Illinois Tool Works emphasized its commitment to customer-backed innovation, with CBI contributing more than 3% to revenue, representing an ongoing improvement in the quality of innovation execution.
• The company's strategic product line simplification efforts reduced revenue by over 1% due to strategic divestitures, but these actions are aimed at improving long-term growth and profitability.

• The company's ability to leverage enterprise initiatives contributed 140 basis points to operating margin, indicating effective execution of its strategic objectives.

• Guidance and Margin Expectations:

• The company maintained an organic growth outlook of 0% to 2% for the full year, despite trending towards the lower end of their revenue guidance range.
• The operating margin guidance for the full year remains at 26% to 27%, supported by ongoing enterprise initiatives and pricing actions that effectively offset tariff costs.
• Despite challenging market conditions, the company demonstrated confidence in managing profitability drivers and maintaining high-quality execution across all controllable factors.

Sentiment Analysis:

Overall Tone: Positive

• Management emphasized strong execution and resilience: 'team continues to perform at a high level, successfully outpacing underlying end market demand,' reported record operating margin of 27.4%, GAAP EPS $2.81, and free cash flow growth of 15% to >$900M; they narrowed EPS range and stated confidence in delivering guidance.

Q&A:

• Question from Jeffrey Sprague (Vertical Research Partners): Construction margins keep rising despite 11 quarters of organic revenue declines — what's behind that and can margins move up further when revenues inflect?
  Response: Margins reflect operating in the most attractive submarkets plus strong execution; management is confident margins can improve further and will deliver high‑quality growth when markets recover.

• Question from Jeffrey Sprague (Vertical Research Partners): You have visibility on Test & Measurement improving in Q4 — what are you seeing in orders/end markets?
  Response: Expect a typical seasonal/cyclical Q4 improvement as tariff‑related CapEx delays unwind and semiconductor demand stabilizes.

• Question from Andrew Kaplowitz (Citigroup): You kept organic growth guide unchanged though second half implied 2%–3% — is Q4 upside largely pricing laddering or other businesses improving?
  Response: Q4 should be ~+1 point vs Q3 driven mainly by Test & Measurement, partially offset by seasonal Construction weakness; margins may decline modestly (~50 bps) sequentially and a normal tax rate is a ~$0.10 EPS headwind.

• Question from Andrew Kaplowitz (Citigroup): Auto margins are already near low‑mid 20s territory — can you push to the higher end over the next years?
  Response: Yes; management expects to reach low‑to‑mid‑20s by 2026 driven by enterprise initiatives, product‑line simplification and accelerating customer‑backed innovation (CBI).

• Question from Jamie Cook (Truist Securities): With FX and a lower tax rate providing tailwinds, why is guidance not higher?
  Response: They adopted a measured/cautious stance because of choppy demand and one quarter remaining; FX impact is small (pennies) and other minor offsets (restructuring timing) temper the net benefit.

• Question from Tami Zakaria (JPMorgan): Does U.S. onshoring of auto production present a material opportunity given your global footprint?
  Response: Limited incremental benefit — ITW already produces where customers are located, so onshoring mainly shifts production to U.S. plants without a large net gain.

• Question from Tami Zakaria (JPMorgan): PLS is ~1% headwind — will that persist or fade over the next few years?
  Response: PLS is a bottom‑up, ongoing 80/20 activity driven by divisions; magnitude will vary year‑to‑year and isn’t centrally fixed, but it remains a value‑creating, recurring process.

• Question from Joseph Ritchie (Goldman Sachs): Any early color on 2026 framework — what should we expect?
  Response: No formal guidance yet; expect run‑rate exiting Q4 to form the top‑line, continued CBI and market‑share gains yielding above‑market organic growth, and further enterprise‑driven margin improvement with strong incrementals.

• Question from Joseph Ritchie (Goldman Sachs): How are you thinking about leverage, buybacks and M&A going forward?
  Response: Target leverage ~2x EBITDA; surplus cash funds the $1.5B buyback after investing in the business and growing the dividend, and the balance sheet has ample capacity for attractive M&A.

• Question from Stephen Volkmann (Jefferies): On price/cost — are you seeing suppliers raise prices and can you cover costs dollar‑for‑dollar or on margin?
  Response: Tariffs were the main cost driver and were addressed via pricing and supply‑chain actions; price/cost was positive in Q3 both in dollars and margins, and management is confident in managing future cost increases.

• Question from Stephen Volkmann (Jefferies): China was strong — what's driving that outperformance?
  Response: Strength is driven primarily by automotive EV penetration and higher content per vehicle (China auto ~+15% YTD) plus CBI‑led gains across Test & Measurement, Electronics, Polymers & Fluids and Welding.

• Question from Julian Mitchell (Barclays): On next‑year margins — will enterprise initiatives and prior restructuring drive a big step‑up and how should we think about incrementals?
  Response: Enterprise initiatives remain the primary driver (historically ~100bps); incremental margins in Q3 were well above historical 35%–40% (65% in Q3) and management expects incrementals for next year likely above the historical range.

• Question from Julian Mitchell (Barclays): Net spread between CBI (positive) and PLS (headwind) — should that widen over time?
  Response: Yes — CBI is trending higher (2.3%–2.5% now toward 3%+ by 2030) while PLS is bottom‑up and maintenance‑level long term; net spread should become increasingly positive driven by CBI.

• Question from Joseph O'Dea (Wells Fargo): Tariff impact — earlier implied pricing needs up to ~2%, now less than 1% — is tariff overhang primarily uncertainty rather than demand hit?
  Response: They've largely offset tariff costs via pricing and supply‑chain actions; any initial demand freeze from tariff uncertainty is receding and tariffs are no longer the main event.

• Question from Joseph O'Dea (Wells Fargo): What is the key to unlocking better demand in this protracted weak environment?
  Response: A cyclical recovery is needed; ITW expects to outgrow markets when cycles turn thanks to portfolio differentiation, higher incrementals and focused execution.

• Question from Joseph O'Dea (Wells Fargo): For Test & Measurement, will customers investing in CBI drive equipment demand?
  Response: Yes — long‑term secular drivers (new materials, higher testing standards, biomedical demand) make Test & Measurement a fertile growth area despite near‑term CapEx softness.

• Question from Nigel Coe (Wolfe Research): Any unusual distributor behavior around price increases/tariffs and did first‑half 'restructuring' benefits fully flow in Q3 or are there benefits left for Q4?
  Response: No clear distributor pattern; the 'restructuring' spend (~$40M/year) funds 80/20 projects, is level‑loaded across quarters, and pays back quickly—benefits are ongoing rather than a single one‑time effect.

• Question from Nigel Coe (Wolfe Research): Welding: Equipment up but Consumables down — why the divergence?
  Response: Equipment growth is driven by CBI and industrial demand; consumables lag due to more consumer‑discretionary exposure, producing a mixed picture across end markets.

• Question from Avinatan Jaroslawicz (UBS): Why leave the revenue range unchanged and wider than usual if you’re trending to the lower end — where would upside come from?
  Response: They left the range since they're still within it and took a measured posture with one quarter remaining; Q4 upside would likely come from Test & Measurement while Construction will seasonally decline; auto build revisions are already factored in.

• Question from Mircea Dobre (Robert W. Baird): How reliant are above‑normal incrementals on PLS and could you throttle back PLS to prioritize faster organic growth?
  Response: PLS is one element of 80/20 but not the sole driver of incrementals; it's bottom‑up, varies by segment (some have minimal PLS), and removing it would undermine the 80/20 process that supports both margin and focused organic growth.

Contradiction Point 1

Impact of Tariffs

It involves the company's strategy and effectiveness in managing tariff-related costs, which can significantly impact profitability and operational efficiency.

What is the impact of recent supply chain disruptions on Q2 revenue and how will you mitigate these effects? - Stephen Volkmann(Jefferies LLC)

2025Q3: We've effectively managed tariff-related costs with pricing and supply chain actions. Cost increases from tariffs are largely offset, and we feel confident managing future costs. - Michael Larsen(CFO)

Did the business experience any impact from tariff uncertainty in Q2? How disruptive could future tariff disruptions be? - Mircea Dobre(Robert W. Baird & Co Incorporated)

2025Q2: Tariffs have limited direct impact due to high domestic production. We managed the tariff costs effectively and would expect to manage future tariffs equally well. - Christopher O’Herlihy(CEO)

Contradiction Point 2

Guidance for 2026

It involves expectations and strategic outlook for the following year, which is crucial for investor confidence and strategic planning.

How should we assess the FX impact on EPS guidance, given the shift from a $0.30 headwind to a modest tailwind? - Julian C.H. Mitchell(Barclays Bank PLC)

2025Q3: 2026 should see continued progress on strategic initiatives, market share gains, and margin improvement. Above-market organic growth is expected with enterprise initiatives and strong incremental margins. - Michael Larsen(CFO)

How to assess the FX impact on EPS guidance, from a $0.30 headwind to a modest tailwind? - Julian C.H. Mitchell(Barclays Bank PLC)

2025Q2: We have a strong sense of confidence in what we need to deliver the business results for '25 and '26. - Christopher O’Herlihy(CEO)

Contradiction Point 3

Pricing Strategy and Tariff Management

It involves the company's strategy to offset tariff-related costs, which directly impacts financial performance and investor expectations.

What are your expectations for price-cost trends and how do you plan to offset costs? - Stephen Volkmann (Jefferies LLC, Research Division)

2025Q3: We've effectively managed tariff-related costs with pricing and supply chain actions. Cost increases from tariffs are largely offset, and we feel confident managing future costs. - Michael Larsen(CFO)

How are you thinking about overall pricing expectations for this year compared to 2025, and is there a different approach to offsetting inflationary pressures this time? - Unidentified Analyst

2025Q1: The strategy is to offset tariffs with appropriate pricing, driven by the differentiation of our products. We expect the price cost equation to be manageable based on our high levels of differentiation. We allow our businesses to make pricing decisions based on their market knowledge, and we expect to offset the tariff cost impact to be EPS neutral or better. - Christopher A. O’Herlihy(CEO)

Contradiction Point 4

Demand Environment and Volume Expectations

It involves the company's outlook on the demand environment and volume expectations, which are crucial for assessing financial performance and strategic planning.

You're still at the lower end of your full-year organic growth guidance. What factors are embedded in your guidance? Did FX turn positive or remain neutral last quarter? - Andrew Kaplowitz (Citigroup Inc., Research Division)

2025Q3: In Q3, organic revenues decreased by 2%, with demand from certain automotive and semi-capital equipment markets materially below expectations. - Michael Larsen(CFO)

Are there any Q2 updates that differ from typical seasonality? - Stephen Volkmann (Jefferies)

2025Q1: Topline organic growth is expected to be flat year-over-year, with margins improving from Q1 to Q2. The guidance includes contributions from enterprise initiatives and assumes no additional restructuring charges beyond what's been planned. - Michael M. Larsen(CFO)

Contradiction Point 5

Tax Rate Guidance and Impact on Financial Outlook

It involves changes in tax rate guidance and their impact on the company's financial outlook, which are key indicators for investors.

Why isn't your guidance better given the positive/neutral FX and lower tax rate benefits? - Jamie Cook (Truist Securities, Inc., Research Division)

2025Q3: The lower tax rate benefit is offset by the top line trending to the lower end of guidance ranges. Q3 had a strong July, but August was slow. The fourth quarter is expected to align with a normal tax rate, and auto builds are projected to be lower than Q3. - Michael Larsen(CFO)

How did Q1's tax rate benefit impact tax rate guidance? - Stephen Volkmann (Jefferies)

2025Q1: We are modestly lowering our guidance for the tax rate to 24% from 24.25%. This is to derisk our guidance due to the uncertain environment. - Michael M. Larsen(CFO)