Illinois Tool Works Inc. (ITW) Q3 2017 Earnings Report, Transcript and Summary

Welcome to the ITW’s Q3 2017 Earnings Conference. At this time, all participants all participants are in a listen-only mode until the question-and-answer session of today's conference. [Operator Instructions] This call is being recorded. If you have any objections, you may disconnect at this time. Now, I’ll turn the call over to Mr. Michael Larsen, Senior Vice President and Chief Financial Officer. Please go ahead.

Thank you, Nancy. Good morning, and welcome to ITW’s third quarter 2017 conference call. I am Michael Larsen, ITW’s Senior Vice President and CFO. Joining me this morning is our Chairman and CEO, Scott Santi. During today’s call, we will discuss our third quarter financial results and update you on our 2017 earnings forecast. Before we get to the results, let me remind you on slide two that this presentation contains our financial forecasts for the fourth quarter and full year 2017 as well as other forward-looking statements identified on this slide. We refer you to the company’s 2016 Form 10-K for more detail about important risks that could cause actual results to differ materially from our expectations. Also, this presentation uses certain non-GAAP measures, and a reconciliation of those non-GAAP measures to the most comparable GAAP measures is contained in the press release. With that, I’ll turn the call over to Scott.

Thanks, Michael, and good morning, all. In the third quarter, the ITW team continued to execute at a very high level and as a result, delivered another quarter of strong financial results. Q3 earnings were $1.85 per share, which includes a $0.14 per share benefit from a favorable legal settlement that Michael will discuss shortly. Excluding the impact of this legal settlement, earnings per share increased 14% year-on-year, and operating margins increased 130 basis points to 24.4%, with Enterprise Initiatives contributing 110 basis points of improvement. In addition, we continue to make good headway on organic growth acceleration with continued progress on our organic growth initiatives across all seven of our segments. Year-to-date, our organic growth rate of 2.7% is more than double last year's rate despite the fact that two of our fastest-growing segments, Auto OEM and Food Equipment, are experiencing a little bit of market softness. Based on our solid Q3 results and a fairly stable near-term end market demand environment; we are increasing our full year EPS guidance as we now expect to grow full year earnings by 14% at the midpoint, and that's excluding the 17% per share full year benefit from the legal settlement. Overall, we continue to be very pleased with the progress we are making in leveraging ITW's differentiated business model and high-quality diversified business portfolio to deliver consistent top tier performance. We look forward to updating you on our strategy and long-term performance goals at our Annual Investor Day on December 1. With that, I'll turn the call over to Michael, who will provide you with more detail regarding our Q3 performance and 2017 forecast. Michael?

Thanks, Scott. I'm on Slide 3 and I'd like to start the financial discussion today by separating the impact of the legal settlement from our underlying operating performance in the quarter. The schedule on Slide 3 lays out the key performance metrics as reported, including GAAP EPS of $1.85, the impact of the legal settlement, you can see the $0.14 benefit to EPS here and all the metrics excluding the legal settlement, with EPS of $1.71, an increase of 14% versus prior year. When I discuss our financial results for Q3 on the following slides, all of the results presented and my supporting commentary exclude the impact of the legal settlement. Okay. So, I'm on Slide 4, and as I mentioned, EPS increased 14% year-over-year to $1.71 and exceeded the midpoint of our guidance by $0.09, with $0.06 contribution from margins and $0.03 from currency translation. As you may know, we've met or exceeded the midpoint of our EPS guidance every quarter since we began executing on our enterprise strategy five years ago. Total revenue was $3.6 billion, an increase of 4% with organic growth of 2%, which was right in line with the midpoint of our guidance. Six of seven segments had positive organic growth, led by Specialty up 5% and Welding and Construction, which were both up 4%. By geography, organic growth was strong internationally, up 4% led by China, which was up 13% and Europe was up 2%. As we discussed on the last earnings call, this quarter had one less shipping day, and in addition, Product Line Simplification ran a little higher than usual and was a 70-basis point drag on our organic growth rate in the quarter. Adjusting for these two items, the underlying organic growth rate is closer to 4% on an equal day basis. Just to remind you that the calendar for Q4 also has one less shipping day which is factored into our guidance. We increased the operating margin by 130 basis points to 24.4%, a new record for the company, driven by our continued progress on enterprise strategy initiatives and positive volume leverage. Enterprise Initiatives contributed 110 basis points of margin expansion, and we continue to have strong momentum on our Strategic Sourcing and 80/20 initiatives. Operating income grew 9% to $881 million, making this quarter the most profitable quarter in the company's history. Free cash flow was solid at 108% of net income, in line with typical seasonality, and it's worth reminding everyone that we raised the annual dividend by 20% in August. Overall, another strong high-quality quarter as the ITW team continues to leverage our highly differentiated business model to consistently deliver top tier results. On slide 5, we've laid out the key drivers of our 130 basis points of operating margin expansion this quarter. Enterprise Initiatives continue to be ITW's main driver of margin expansion as they contributed 110 basis points of structural margin improvement, marking the best quarterly performance so far, this year. Volume leverage was 60 basis points and as expected, price/cost was unfavorable 40 basis points, due primarily to higher steel costs, which impacted a few segments. For comparison purposes, please keep in mind that we do not include Strategic Sourcing savings in our price/cost calculation. Those are reported separately as a part of the Enterprise Initiatives savings number. If we were to include them, price/cost would have been positive and accretive to operating margin in the quarter. As in prior quarters, we more than offset the cost side with price on a dollar-for-dollar basis. We expect that price/cost for the full year will be positive in dollar terms by $30 million to $40 million and unfavorable by approximately 40 basis points to the margin percentage. Overall, really strong operating margin performance, record operating margin performance, in fact, in the quarter. On slide 6, on the left side of the page, you can see what Scott mentioned earlier, the solid progress on organic growth versus last year as reflected by our year-to-date organic growth rate of 2.7% and positive organic growth in all seven segments. Our growth rate of 2.7% is more than double the 1.2% we did in full year 2016 despite the fact that we were expecting a little bit of softness in two of our fastest-growing segments. In terms of operating margin, you can see the results by segment with meaningful sustainable margin expansion as six of seven segments have improved margin on a year-over-year basis. Test & Measurement and Electronics is leading the way in 2017 with 320 basis points followed by Welding up 230 basis points and Specialty up 200 basis points. As expected, Automotive OEM margins are down due to the margin dilution impact from the acquisition of EF&C last year. Excluding the 160 basis points of dilution from EF&C, Automotive OEM margins are up 20 basis points to 24.3%. I will now discuss the segment results starting with Automotive OEM, which delivered organic revenue growth of 1% in Q3 and grew above market in all key geographies as we continue to increase our content per vehicle. In North America, revenue was down 7%, which was better than the decline in auto builds, which were down 10% overall and down 14% at the Detroit 3 where we have relatively higher content per vehicle. Outside North America, growth continued to be very strong, with Europe up 8% and China up 10% versus market growth of 5% and 1%, respectively. The most recent IHS forecast for Q4 auto builds calls for more moderate declines year-over-year, including down 3% in North America and down 9% at the D3. As a result, we now expect full year organic revenue growth in our global Auto OEM segment of approximately 4%, pretty solid considering a second half decline in North America of 7% overall and 12% with the D3. Turning to slide seven. Food Equipment organic revenue this quarter was flat overall as strength in international markets was offset by market softness and difficult comparisons due to the timing of new program rollouts in North America. North America was down 4% with equipment down 6%. However, international equipment was strong, up 6%. Operating margin remained solid at 27.3% despite a little bit of a slowdown in the organic growth rate. Test & Measurement and Electronics organic revenue grew 1% as Test & Measurement grew by 4%. In the Instron, where demand is tied more closely to the CapEx cycle, organic growth was up 3% as the positive trend continues from the first half of the year. Electronics was down 3% due to a tough comparison versus last year when the business was up 13% due to some one-time large equipment purchases. Operating margin performance was very strong at 24.1%, an improvement of 310 basis points driven by Enterprise Initiatives. As a reminder, the 24.1% includes 300 basis points of non-cash expense associated with amortizing acquisition-related intangible assets. Turning to slide eight. The positive momentum in Welding continued with organic growth of 4% in Q3. By geography, North America was up 8% with equipment up 10% and consumables up 5%. Our industrial equipment business, which sells primarily into manufacturing, including automotive and heavy equipment, was strong, up 11% in the quarter, while our commercial equipment business, which sells through distribution to construction, light fabrication, farm and ranch customers, was up a solid 5% year-on-year. International was down 11% due primarily to oil and gas. And keep in mind though that international only represents approximately 20% of our Welding segment. Operating margin was solid at 26.6%, but was negatively impacted by increased restructuring costs in Europe. Excluding these added restructuring expenses, operating margin Q3 would have been up 70 basis points to 27.3%. Polymers & Fluids revenue improved 1% organically with automotive aftermarket up 1%. Fluids, which primarily sells highly-engineered lubricants and cleaners into industrial and commercial end markets, was up 4%, driven by demand internationally. Polymers, which primarily sells engineered adhesives and sealants for industrial MRO and OEM applications, was down 1%. Keep in mind that the 21% operating margin number includes 400 basis points of non-cash expense associated with amortizing acquisition-related intangible assets. On Slide 9, Construction Products organic revenue was up 4%. And demand in North America was solid with organic growth up 4% as residential led the way with 7% organic growth. Commercial, which is about 20% of our North American construction business, was down 3%. Europe and Asia Pacific was solid, both up 3%. Operating margin performance was very strong at 25.4%, which represents 280 basis points improvement year-over-year, primarily due to volume leverage and Enterprise Initiatives. Finally, in Specialty Products, organic revenue was strong, up 5% led by the international side, which was up 7% and operating margin was the highest in the company at 27.7%, an increase of 160 basis points due to volume leverage and Enterprise Initiatives. Let's turn to Slide 10 and our updated guidance for the full year and fourth quarter. Starting on the left side of the page, we're showing the as-reported numbers, which include the full year impact of the legal settlement. As a result of our strong Q3 results, we're raising our full year earnings guidance by $0.25 to a new EPS range of $6.62 to $6.72. And the $0.25 increase reflects the $0.09 beat from margins and currency in Q3, $0.14 from the legal settlement and $0.02 from higher operating margins in Q4. At current levels of demand, we expect full year organic growth of 2% to 3%, more than double our 2016 organic growth rate as all seven segments are poised to deliver positive organic growth for the full year. ITW's key performance metrics for the year are expected to be all-time records for the company. Excluding the legal settlement, we expect EPS growth of 14% at the midpoint and operating margin of approximately 24%, an increase of 150 basis points, with Enterprise Initiatives contributing 100 basis points. After-tax ROIC is expected to be approximately 23.5%, and free cash flow is expected to be greater than net income. As you can see, we are projecting another strong year for ITW, a record year. Finally, turning to the fourth quarter, our EPS guidance range is $1.55 to $1.65, an increase of 10% at the midpoint. You may recall that in the fourth quarter last year, we recorded a $0.06 EPS benefit from a special dividend related to an investment. Excluding this item, our fourth quarter EPS guidance represents 15% earnings growth at the midpoint. Finally, we expect organic revenue growth of 2% to 3% and as always, we're factoring current foreign exchange rates and current levels of demand into our forecasts. So, with that, we'll now open up the call to your questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Andy Kaplowitz with Citi. Your line is now open.

Good morning, guys.

Hey Andy.

Can you give us a little more color regarding what's going on in Food Equipment? Obviously, U.S. restaurant seems to be a little weak. It's still a small portion of that business for you guys. Did institutional get a little weaker in the quarter? And you did mention the timing of shipments impacting quarter, so how are you thinking about the potential for recovery in the business at this point moving forward?

Right, Andy. So clearly, we've seen a little bit of pullback here on the demand side. If you look at it in North America, the equipment side, down 6%. If you look at it by end market, the institutional side was only down slightly, down 1%. And restaurants were actually positive for us, up 1%. And if you'll recall in the last quarter, restaurant was actually down 7%. So, restaurants were up 1%. And then the retail side is where we had the comparison challenge in terms of product rollouts last year that didn't repeat this year in the retail side, which was the scales and the weigh wrap equipment was down 13% on a year-over-year basis.

So, Mike, do you see these parts of Food Equipment recovering here, or how should we look at it over the next few quarters? I know in the last quarter, you have said sort of 2% to 3% growth moving forward, but obviously, it's been a little weaker.

Yeah, I know it's -- you're right, it's been a little bit weaker than expected, and based on what we're seeing in the business, we're not expecting anything very different in Q4, which as always, is based on current run rates. So, we're not seeing anything to suggest that these markets are coming back in the near term.

Okay. That's helpful. And then Scott or Mike, maybe you could just step back and assess the pivot to growth here in 2017. I know you talked about generating something like 130 basis points of higher organic growth this year versus last year, which is good. But as you move forward here, I mean, the global economy has clearly improved a bit. I'm not sure that you're going to generate 200 basis points above market this year but the goal was for exiting next year. So how does that look at this point, especially if a business like Food Equipment is a little bit slower?

Well, I think overall, what I would say is we certainly are getting much better balanc across the portfolio. Keep in mind that there is – and this is just repeating something you already know, but there has been an intense focus on a lot of the restructuring initiatives going on inside the company related to our Enterprise Initiatives. 85 divisions across the company all starting to make this pivot, all of them in various – in different stages in terms of making that turn. But I think the encouraging part in terms of what we see is that we're getting better balance across the portfolio. All seven of our businesses are improving in terms of their year-on-year organic growth rate. But it's not a matter of just simply flipping the switch. It is a matter of making a progress on the things that they're focused on internally and then making the shift in terms of the relative balance of effort, energy, attention and investment around growth initiatives. And those are all transitioning across again 85 different divisions across the company. So, I think as we look in terms of our progress to date, I think Michael talked about it, I think our – the fact that we've been able to get the organic growth rate up better than a full percentage point this year relative to last year with the two businesses that were generating the fastest organic growth for us being in -- experiencing some challenging near-term market conditions, I think, overall feels pretty good. And certainly, understanding what's going on inside these businesses and the kind of progress they're making in terms of this turn, I think we're set up well for another -- we'll talk about 2018 in December so we won't get ahead of ourselves, but we expect continued progress in 2018.

Scott, I don't want – I know you don't want to get ahead of yourself, but do you still feel confident about accelerating organic growth, lower POS as you go into 2018 and generally momentum from the businesses from pivot to growth?

Yes, I feel confident that our -- we'll be able to make another step change improvement in overall organic growth rate in 2018 relative to 2017.

Great. Thanks guys.

Thank you. Our next question comes from Nigel Coe with Morgan Stanley. Your line is now open.

Thanks. Good morning, guys.

Good morning.

I know you don't really guide quarter-by-quarter, but I'm just wondering it seems that you're not expecting Food to get better anytime soon. So, I'm just wondering if maybe you could just sort of broaden that out in terms of 4Q, the 2% to 3% organic, maybe just throw in a specific comment on Auto. Given the interest there, how do you see the segments relative to the 2% to 3%?

Yes. I think for Food Equipment, first, Nigel, I would expect a growth rate in Q4 on a year-over-year basis that is similar to what we just had here in Q3, maybe a little bit better than Q3 based on current run rates. I think for the Automotive business, the organic growth rate in Q4, on a year-over-year basis based on current run rates should be slightly better than Q3 and also factoring in the forecast from IHS that I just went through. So, if you look at in Q4, North America is down less than it was in Q4 and the Detroit 3 are down less in Q4 than they were in Q3. So, both those businesses should be in line with Q3, maybe a little bit better on a year-over-year basis in Q4.

Okay. And the rest of the segments will be pretty much consistent with what we saw in 3Q as well?

Exactly. As the momentum is solid in the other five, that's what I would say heading into Q4.

Yeah, I think what you'll see, Nigel, based on current run rates, most of our businesses will improve their year-over-year organic growth rate in the fourth quarter relative to the third quarter.

Okay. That's helpful. And then just my one follow-on, obviously, the margin trends in aggregates remained very, very strong. Auto margins were slightly weaker year-over-year despite comping the acquisition in 3Q. Maybe just -- maybe Michael or Scott, just discuss the impact of the mix between D3 being down mid-teens versus Europe, Asia up strong? So maybe just talk about that mix and perhaps whether or not we saw a disproportionate impact from raw materials in Auto as well?

Yeah. It's actually not that much of a mix issue, Nigel. If you look at our business and you don't see this, but if you look at the profitability by geography, it's very similar across North America, Europe and China. Really, what you're seeing in the Automotive margins is the price/cost equation being negative here in the near term.

Okay. That's very helpful. Thanks guys.

Thank you. Our next question comes from Joe Ritchie with Goldman Sachs. Your line is now open.

Thank you and good morning everyone.

Joe, good morning.

My first question is perhaps just welding margins for a second. I think, the incrementals were, I think, slightly below 30% for the quarter. I know you guys put through some pricing increases as well, so would have just expected that to be a little bit higher. And Michael, I think in your prepared comments, I think you mentioned some restructuring that was coming through in Europe. So maybe to the extent that you can talk about that restructuring, when we’re going to be through it? And anything else that may have affected the incrementals this quarter?

The bulk of it, Joe, I mean, so you're seeing a little bit of steel inflation coming through on the Welding side, and then you saw the 70 basis points of increased restructuring costs year-over-year. I think if you look at the year-to-date performance and for the full year, we expect to be in this 27% range in Q4 and for the full year. So really nothing unusual beyond those two items.

And the European restructuring is a one-quarter event.

Yeah, yeah.

Q3.

So, this is a one-time restructuring event, which will have benefits obviously in Q4 and next year.

Got it. Maybe – and maybe just a little bit more color. What specifically were you guys doing in Europe from a restructuring standpoint?

Joe, we typically don't discuss the specifics of those projects.

It's related to Enterprise Initiatives. Nothing unusual out of the ordinary.

Okay. All right. Maybe switching then to price/cost. I know that this quarter, I think you guys did 40 basis points or the 40-basis point drag on margins. I think you guys had expected price/cost to be a little bit less of a drag in the second half of the year. And so, I'm just wondering whether that expectation has now changed. And how should we be then thinking about it also for 2018? Is there an opportunity potentially for this to turn into a tailwind to your margins next year?

So, Joe, on 2018, I think we're going to have to wait until -- when we get together in New York in December. I think, we haven't rolled out the annual plan here yet, so I wouldn't be -- I really don't want to comment on 2018 yet at this point. I think what we did say on the call last time where the headwind was 50 basis points in Q2, that we expected it to get better from here on out. We just did 40 basis points in Q3. We expect it to be a little bit better than that here in Q4. And so, for the full year, it should be about 40 basis points of headwind. And I'll just -- to put it in context, I mean, we just took up our margin guidance for the full year. We expect to be at 24% operating margin, and that's after offsetting 40 basis points of price/cost headwind here in 2017. So, we -- fundamentally, nothing has changed in terms of how we look at the price/cost equation. Should get a little better in Q4 and then we'll give you an update in December when we get together in New York in terms of what it might look like for 2018.

Got it. That makes sense. Thanks guys.

Thank you. Our next question comes from David Raso with ISI Evercore. Your line is now open.

Hi. Thank you. First question, I just want to bridge the gap on the faster organic growth in the fourth quarter than third quarter. You didn't call it out but is it Test & Measurement off of an easier comp? Is that really the notable acceleration in organic fourth quarter versus third? Is the other business still…

A little better Auto.

Yeah. I mean, that's part of it. I think, in Electronics this quarter, like, I think, we said in the script here is, Electronics was up 13% last year and so a tough comp and so they will get a little bit better here in the fourth quarter. But I think as we look at it, based on current run rates, the majority of our segments will have a higher year-over-year growth rate in Q4 than they did in Q3.

Okay. And that is a set up a bit for when you made the comment earlier about in progress, I don’t know if you would used the word, significant progress on the organic sales growth for next year. I know it's a little bit harder with sales than with margins in a way, but we used to think of the margin story as 100 bps a year. This year, the organic sales growth accelerated, if you hit your number, about 120 bps. Just so we can frame the expectations going into the December meeting, when you say significant progress, can you at least give us some idea of -- I mean, people just trying to figure out if the CapEx businesses may be aren't coming back quite as quickly as we like. In Auto, maybe a slower just given the strong growth to start this year. Where are the businesses that we expect accelerated growth? Is it the business that are doing pretty well now? Or is it some of the laggers like Polymers and Food stepping it up? If you can just kind of help frame the acceleration for next year that you speak to.

Yeah. I think we’ve got to defer you to December, sorry. Our plans are still coming together. I would expect every one of our seven businesses to be better in 2018 than they were in 2017.

Okay. Yeah.

So organically every business faster growth rate in 2018?

Organic and on margins, too.

Yes.

Now what exactly that looks like, we got to get through the annual plan process here and then we'll -- we can talk about it in December.

No, that's helpful. I appreciate it. Thank you.

Sure.

Thank you. Our next question comes from Mig Dobre with Baird. Your line is now open.

Yes. Good morning everyone.

Hi, Mig.

Just maybe to follow-up a bit on David's line of questioning here. I guess I'm wondering, when you're looking at your business this year, obviously, it's done better from an organic growth standpoint. But broadly speaking, growth has been considerably better. I mean, PMI, for instance, is now at the highest level since 2004 and who knows, chances are it's probably not going to accelerate from here as we look at 2018. So, if you're thinking about accelerating organic growth, how much of it would you say is going to be within your control, things like PLS or new products or things of that nature as opposed to simply end markets being better?

Well, I'd make two comments. One is that -- one would be just to remind you that PMI was strong in 2014, 2015 and 2016 when overall organic rates in our industry were not particularly strong, so I'm not sure that, that's the best parameter necessarily. But I would say overall is we are all about what's within our control. So as Michael said, none of our forecast is ever related to anything other than current run rates and what we expect to do incremental beyond that. So, everything that we are committing to, everything that we are working on is all in the realm of the various areas within our control. So, pivot to organic growth is much more focused on, as we talked about, additional penetration opportunities with our biggest and best customers, a very healthy and productive new product pipeline and some combination thereof across all sets of our businesses.

Is it fair to expect lower drag from PLS next year?

I think it'll -- it's hard to tell. It may be in line with what we're seeing this year, maybe a little bit lower than that. I'll just -- the PLS is a drag on organic growth rate but it is really a very positive thing for what we're trying to do from an 80/20 standpoint. It really sets up the portfolio for much stronger organic growth on a go-forward basis with best-in-class margins and returns. So, we haven't talked about it much this year. We – I mentioned it today because it was a little bit higher, it can be a little bit lumpy as we go through these projects across 85 divisions. And when we rolled it out, we were a little bit higher than the average for this year. But in 2018, we're probably going to enter into more of a maintenance mode. What that number looks like, I don't know right now but it's probably a little bit lower than what we have seen this year.

Okay. Great. Lastly, on Specialty Product, there were some headlines early in the quarter here that the Zip-Pak business had three trademarks canceled. I guess, I'm wondering if there's any comment as to how this might impact either the revenue stream going forward or any impact to margin for the Zip-Pak business. Thanks.

Yeah, thanks. There's no impact from that.

All right. Thank you.

Thank you.

Thank you. Our next question comes from Ann Duignan with JPMorgan. Your line is now open.

Hi, good morning.

Hi, Ann.

Just a point of clarification. On the price/cost versus the enterprise strategic sourcing savings, is the right way to think about that price/cost being more perhaps steel inflation showing up in the gross margins versus enterprise strategic sourcing savings maybe being more indirect savings like travel, et cetera? Is that the right way to think about it conceptually?

So, I'd say that the first point of your question was correct that you do see the impact of price/cost in gross margins. But you also see the impact of the strategic sourcing efforts in the gross margins.

At this point, that's where the 80 of the benefit is, right.

So really on the indirect side is not -- it's really primarily on the direct side. And the only point we're making, Ann, is if we take those -- if we were to report those Strategic Sourcing savings in the price/cost number as some of our peers are doing, not saying it’s good or bad, I'm just saying the way we report it looks a little bit different than some of our peers, the price/cost equation would be positive this year and it would have been positive in Q3.

Okay, I appreciate that. I just wanted to make sure I was thinking about it conceptually the right way.

Yeah. That's fair.

Then on the remainder of your businesses, could you just talk, I guess, specifically construction and maybe welding? Was there any impact on your business? I think about the welding business, you can use those welders with backup power units. Any impact on either welding or construction in the back of the storms or anything anticipated going forward?

Yeah, so Ann, let me just say first, we have more than 300 employees in Houston, 400 in Florida, 20 employees in Puerto Rico, and the most important thing as we talked about the impact of the storms is that they're all safe and we're only a small number of them are personally invited. And all of our facilities, the eight facilities in the region, we didn't have a lot of significant damage and we're back up – and they were back up and running pretty quickly. So, in terms of the results here in the near term, there were certainly some puts and takes by business, which is what you're getting at. We did see a little bit of an uptick on the welding side as well as the construction side. And that was offset actually by some Food Equipment orders that were not shipped into the region where the customer elected to defer for now. So overall, probably neutral for ITW here in terms of the third quarter. I think longer term this will probably be a net positive for some of our businesses, especially on the Construction side. But we've not put anything in the forecast at this point.

Okay. I’ll take it offline and get back. Thank you. Thanks.

Thank you. Our next question comes from Jamie Cook with Credit Suisse. Your line is now open.

Hi. Good morning. A couple of questions. I guess, first question, obviously, you guys have done a phenomenal job on the margin side in terms of Enterprise Initiatives. As we think about the different business segments, are there certain segments where you feel like you that story sort of played out and there's not as much to do within your control and we should think about margins more driven by volumes versus incremental help from the Enterprise Initiatives as we think to 2018?

Yeah, thank you, Jamie. And I think we would – the way we think about it is that despite the considerable progress at the enterprise level and also by segment that we've shown you that data in the past, we believe that there's more room for improvement here. And I think that's a -- we believe that's true for all of our segments and that's based on what they're telling us. This is not what we here at corporate think. This is based on the roll up from the divisions. And we'll see what 2018 looks like, but we expect at least another 100 basis points of margin expansion just from the Enterprise Initiatives alone. And just as an aside, if you look at –

It's in 2018 over 2017.

In 2018 over 2017. And just as an aside, if you look at Q3, every one of the segments had at least 90 basis points of Enterprise Initiative impact. So, it’s broad-based, it's still going on and is having a meaningful impact on our margins. The other point, I'll just make, if you look at – if you go back to slide 6 on the deck, you can see that our seven segments are all starting to cluster around the mid to high 20s from an operating margin standpoint. And some of these businesses have improved by more than 10 percentage points since we started the enterprise strategy. And I think that the fact that they're now clustering in the mid-20s really speaks to how powerful, our differentiated business model is. And as we continue to focus on leveraging that, we expect to continue to see improved margins across the portfolio, and therefore also at the enterprise level.

Okay. Thanks. I’ll get back in queue.

Thank you. Our next question comes from Steve Fisher with UBS. Your line is now open.

Thanks. Good morning.

Good morning.

Michael, you mentioned that PLS can be lumpy, but to what extent was that PLS drag in the quarter plan going into the quarter? Or was that an adjustment that you made as the quarter progressed? Just wondering where you felt the need to do more PLS or kind of where you found the opportunity?

Yeah, so this was all planned, Steve, at the division level. So, I think I can't really point to any one segment. There's still –the 80/20 initiatives are broad-based across 85 divisions. And like I said, when you we rolled up the number for the quarter, it was 70 basis points, a little bit higher than what we had expected maybe, but that's actually a good thing, as I tried to say earlier.

Okay. And you mentioned some of the puts and takes of the hurricane in September. But more broadly, did you see any particular acceleration or deceleration as the quarter progressed?

No, I think when we looked at the monthlies they were all right in line with run rate and what we had expected. So, nothing unusual from a monthly standpoint.

Okay. And then just real quick, the commercial construction looked like it flipped to a minus 3% from positive 3% last quarter. Was that just a comps thing or is there something moderating there?

I think that business can be – commercial construction side can be a little lumpy. I think that market, I would probably say, is flat to maybe slightly negative, maybe slowing a little bit on the commercial construction side, but more than offset by the 7% growth that you saw in residential. And just if you look at commercial construction business on a year-to-date basis, it's flat, which is probably in line with where we see the market right now.

Okay. Thanks a lot.

Thank you. Our next question comes from Nathan Jones with Stifel. Your line is now open.

Good morning, everyone.

Good morning.

Good morning.

Just a question on corporate expense. You guys have had fairly low corporate expense this year, even adjusting out the legal sentiment. Can you talk about what we should expect for our quarterly run rate, say in the fourth quarter and going into 2018?

So, if you look at, Nathan, so there's a line in the income statement in the schedule on the back where we typically, on a quarterly basis, have $20 million of unallocated cost. That has flipped positive with the legal settlement. I would expect for next year that our corporate cost will be flat on a year-over-year basis. And so, as a result of that, you'll see – we will come back to that $20 million of unallocated cost in the income statement as we go through next year on a quarterly basis. So, don't expect any big changes from a corporate cost standpoint.

Okay, so about $80 million next year. Then just one question on the international Welding business. You said that was mostly dragged down by the oil and gas market. Is it possible for you to give us any information on how the international Welding business did ex the oil and gas market?

It's really the majority of what we're showing there is oil and gas, so international was down. I think oil and gas international was down 11%, which is in line with the overall number for the international side.

The vast majority of our international sales, so I don't think we have much in terms of read-through.

Okay. Fair enough. Thanks very much.

Right.

Thank you. Our last question comes from Joe O'Dea with Vertical Research Partners. Your line is now open.

Hi. Good morning.

Good morning.

Looks like another quarter of good growth out of China. And I think actually looked like some acceleration from 2Q, given a harder comp. We see the data on the Auto side, but just if you could talk about China a little bit more broadly, maybe where you're seeing some sources of acceleration there and kind of confidence that you have in those demand levels as we move forward.

Yes. I think, Joe, if you remember last year, the Auto business in China was up 40% year-over-year, so that was – so this was a tough comp, and despite that, the business was up 10%, the Automotive business in China. When we look at China, it's – the strength is really broad-based. So, Test & Measurement, Food, Polymers & Fluids, Welding all positive, Specialty Products all positive here in the third quarter, up 13%. And on a year-to-date basis, the same is true and our businesses in China are up 15% on a year-to-date basis.

That's really helpful. And then, I guess, just along that, no signs of something within the quarter that would have been a particular boost? That's more kind of stable demand that you see that's supporting that growth?

Yeah, no, I think across the board really stable overall, like I said, China up 13%.

Great. And then just on price/cost, when you talk about the split between the dollars and the margin, when you think about the typical lag, if you can kind of characterize it in any sort of typical fashion, what do you generally see as the lag time before we'd start to see margin come back so that you're at least net neutral on price/cost?

Yeah, it's about two quarters until we've offset any -- the material cost side with price, about two quarters historically so.

Perfect. Thanks very much.

All right. Thank you.

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