Illinois Tool Works reports 3% revenue growth and record operating margin, narrowing EPS guidance range amid mixed demand environment.

OPERATOR - (00:01:29)

Good day everyone and thank you for joining us for today's ITW third quarter 2025 earnings webcast. As a reminder, all phone participants have been placed in a listen only mode to cut down on background noise and later you will have the opportunity to ask questions during our question and answer session. Also, please be aware that today's session is being recorded. It is now my pleasure to turn the floor over to our host, Aaron Linehan, Vice President of Investor Relations.

Aaron Linehan - Vice President of Investor Relations - (00:01:54)

Welcome. Thank you Jim Good morning and welcome to ITW's third quarter 2025 conference call. Today I'm joined by our President and CEO Chris O' Herlihy and Senior Vice President and CFO Michael Larson. During today's call we will discuss ITW's third quarter financial results and provide an update on our outlook for full year 2025. Slide 2 is a reminder that this presentation contains forward looking statements. We refer you to the company's 2024 Form 10K and subsequent reports filed with the SEC for more detail about important risks that could cause actual results to differ materially from our expectations. This presentation uses certain non GAAP measures and a reconciliation of those measures to the most directly comparable GAAP measures is contained in the press release. Please turn to slide three and it's now my pleasure to turn the call over to our President and CEO Chris O'Herlihy.

Chris O'Herlihy - (00:02:53)

Chris, thank you, Aaron and good morning everyone. As detailed in our press release this morning, the ITW team continues to perform at a high level, successfully outpacing underlying end market demand and delivering solid operational and financial execution within a stable yet still challenging demand environment. For the third quarter, revenue increased 3% excluding a 1% reduction related to our ongoing strategic product line simplification efforts. Organic growth was 1%, a solid performance relative to end markets that we estimate declined low single digits and a 1 percentage point improvement from our second quarter growth rate. Favourable foreign currency translation contributed 2% to revenue. Focusing on the bottom line, we achieved GAAP EPS of $2.81, grew operating income by 6% to a record $1.1 billion and significantly improved our operating margin by 90 basis points to 27.4%. We maintained excellent execution in controlling the controllables and as enterprise initiatives contributed 140 basis points and effective pricing and supply chain actions more than covered tariff costs and positively impacted both EPS and margins in the quarter. Consistent with our long term commitment to increasing annual cash returns to shareholders. On August 1st we announced our 62nd consecutive dividend increase, raising our dividend by 7% additionally, year to date we have repurchased more than $1.1 billion of our outstanding shares. Furthermore, I'm encouraged by the significant progress on our next phase strategic growth priorities. We remain laser focused on making above market organic growth powered by customer backed innovation and defining ITW strength. The strategy is working and we remain firmly on track to deliver on our 2030 performance goals which include customer backed innovation yield of 3% plus. As we've stated before, ITW is built to outperform in challenging environments. As we look ahead to the balance of the year, we are narrowing our EPS guidance range, confident in our ability to continue leveraging the fundamental strength of the ATL business model, the inherent resilience of our diversified portfolio and the high quality execution demonstrated every day by our colleagues worldwide. I will now turn the call over to Michael to discuss our third quarter performance and full year 2025 outlook in more detail.

Michael Larson - Senior Vice President and CFO - (00:05:37)

Michael thank you Chris and good morning everyone. Leveraging the strength of the ITW business model and high quality business portfolio, the ITW team delivered solid operational execution financial performance in Q3 starting with the top line, total revenue increased by more than 2%, driven in part by 1% organic growth, an improvement of a percentage point from Q2 geographically. While North America organic revenue was flat and Europe was down 1%. Asia Pacific was a standout performer with a 7% increase which included 10% growth in China. Consistent with ITW's 'do what we say' execution, we continue to demonstrate strong performance on all controllable factors. Our enterprise initiatives were particularly effective this quarter, contributing 140 basis points to record operating margin of 27.4% which expanded by 90 basis points year over year. Furthermore, our pricing and supply chain actions more than covered tariff costs and positively impacted both EPS and margin. In Q3, free cash flow grew 15% to more than $900 million with a conversion rate of 110%. GAAP EPS was $2.81 with an effective tax rate in the quarter of 21.8%. As detailed in the press release, the rate was driven by a benefit related to the filing of the 2024 U.S. tax return, partially offset by the settlement of a foreign tax audit. In summary, in what continues to be a pretty challenging demand environment, ITW delivered a strong combination of above market growth with a revenue increase of 2% and solid operational execution resulting in consistent improvement across all key performance metrics as evidenced by incremental margins of 65%, operating margins of more than 27%, and GAAP EPS of 281 an increase of 6% excluding a prior year divestiture gain. Turning to Slide 4 for a closer look at our sequential performance year to date on some key financial metrics. As you can see, ITW's organic growth rate, operating income, operating margins and GAAP EPS have all continued to improve in what has remained a mixed demand environment. Turning to our segment results and beginning with Automotive OEM which led the way on both organic growth and margin improvement this quarter, revenue was up 7% and organic growth was up 5%. With growth in all three key regions, strategic PLs reduced revenue by over 1%. Regionally, North America grew 3%, Europe was up 2% and China was up 10%. The team in China continues to gain market share in the rapidly expanding EV market as customer backed innovation efforts drive higher content per vehicle. In our full year guidance we have incorporated the most recent automotive build forecasts which are projecting a modest slowdown in the fourth quarter. For the full year, we continue to project that the automotive OEM segment will outperform relevant industry builds by 2 to 300 basis points as we consistently grow our content per vehicle. On the bottom line, strong performance again this quarter with operating margin improving 240 basis points to 21.8% and we're well positioned to achieve our goal from investor day of low to mid 20s operating margin by 2026. Turning to food equipment on slide 5, revenue increased 3% with 1% organic growth while equipment sales were down 1%. Our service business grew by 3%. Regionally, North America grew by 2% driven by 1% growth in equipment and 4% growth in service demand remained solid on the institutional side. International, however was down 1%. Operating margins improved 80 basis points to 29.2% for test and measurement and electronics revenue was flat this quarter as organic revenue saw a 1% decline. The demand for capital equipment in our test and measurement businesses remained choppy as revenues declined 1%. In addition, electronics declined 2% as demand slowed in semiconductor related markets. On a positive Note, operating margin improved 260 basis points sequentially from Q2 to 25.4% excluding 50 basis points of restructuring impact in Q3, margins were 25.9% and both operating margins and revenues are projected to improve meaningfully in the fourth quarter. Moving to slide six, welding was a bright spot delivering 3% organic growth with a contribution of more than 3% from customer back innovation. Equipment sales increased 6% while consumables were down 2%. Industrial sales increased 3% in the quarter as North America was up 3% and international sales grew 4% with China up 13%. Operating margin of 32.6% was up 30 basis points. As the welding segment continued to demonstrate strong margin and profitability performance in polymers and fluids revenues declined 2%. Organic revenue declined 3% which included a percentage point of headwind from PLS. Polymers declined 5% against a difficult comparison in the year ago quarter of plus 10%. While fluids was flat in the quarter. The more consumer oriented automotive aftermarket business was down 3%. But although the top line declined, the Segment expanded margin by 60 basis points to 28.5% supported by a strong contribution from enterprise initiatives. Moving on to construction Products on slide 7, revenues were down only 1% as organic revenue declined 2% in the quarter, significantly better than last quarter's 7% organic decline. Revenue was also impacted by a 1% reduction from PLS. Regionally, revenue in North America declined 1%, Europe was down 3% and Australia New Zealand decreased 4%. Despite market headwinds, the segment improved operating margin by 140 basis points to 31.6%. For specialty products, revenue increased 3% with organic revenue up 2%. Revenue included a percentage point of headwind from PLS by region. Revenue In North America declined 1% against a difficult comparison in the year ago quarter of + 8% while International was up 7%. Driven by consistent strength in our packaging and aerospace equipment businesses. Operating margin improved 120 basis points to 32.3% supported by a strong contribution from enterprise initiatives. With that, let's move to slide 8 for an update on our full year 2025 guidance. Starting with the top line, we remain well positioned to outperform our end markets in Q4 and we continue to project organic growth of 0 to 2% for the full year. Per our usual process. Our guidance factors in current demand levels, the incremental pricing actions related to tariffs, the most recent autobuilt projections and typical seasonality. Total revenue is projected to be up 1 to 3% reflecting current foreign exchange rates. On the bottom line, we're highly confident that the ITW team will continue to execute at a high level operationally on all the profitability drivers within our control. This includes our enterprise initiatives which we now Expect will contribute 125 basis points to full year operating margins independent of volume. Additionally, we expect that tariff related pricing and supply chain actions will more than offset tariff costs and favorably impact both EPS and margins. Our operating margin guidance of 26 to 27% remains unchanged after raising GAAP EPS guidance by $0.10 last quarter we are narrowing the range of our guidance to a new range of $10.40 to $10.50. Our EPS guidance range includes the benefit of a lower projected tax rate of approximately 23% for the full year and factors in that the top line is trending towards the lower end of our revenue guidance ranges. With those two elements effectively offsetting each other, we remain firmly on track to deliver on our EPS guidance, including the 1045 midpoint, which as a reminder is 10 cents higher than our initial guidance midpoint in February. To wrap up. We remain highly confident that the inherent strength and resilience of the ITW business model, combined with our high quality diversified portfolio and most importantly, our dedicated colleagues around the world, all put us in a strong position to effectively manage our way through challenging macro environment. However, the demand picture evolves from here. We remain focused on delivering differentiated financial performance and steadfastly pursuing our long term enterprise strategy which is squarely centered around making above market organic growth a defining strength for itw. With that, Erin, I'll turn it back to you.

Aaron Linehan - Vice President of Investor Relations - (00:15:14)

Thank you, Michael. Jim, will you please open the call for Q and A?

Jim - (00:15:19)

I'd be happy to. Thank you.

OPERATOR - (00:15:20)

Ladies and gentlemen. If you would like to ask a question at this time over your phones, simply press Star and one on your telephone keypad. Pressing Star and one will place you into queue. into a queue. And I will open your lines one at a time. Once again, ladies and gentlemen, that is Star and one. If you would like to ask a question, we'll hear first from the line of Jeff Sprague at Vertical Partners. Please go ahead. Your line is open.

Jeff Sprague - Equity Analyst at Vertical Partners - (00:15:44)

Good morning, everyone.

Jen - (00:15:45)

Morning. Morning, Jen.

Jeff Sprague - Equity Analyst at Vertical Partners - (00:15:46)

Good morning. Hey, maybe just two questions from me. Discuss two different businesses if I could. First just on construction, you know, clearly you've been working the playbook. I mean, one of the things that stands out to me is this: Just jumps off the page to me is this is the 11th quarter in a row of organic revenue declines and the margins are still going up in the business. Could you elaborate on anything in particular? Beyond kind of the normal 80/20 blocking and tackling that's behind that mix changes or other things and just your confidence to be able to move those margins up further if and when the revenues do ever inflect positively.

Chris O'Herlihy - (00:16:28)

Sure, yeah. So Jeff, I think the margins in construction are squarely related to two things. Number one, I think the quality of the construction portfolio, as we often say, we tend to operate in businesses which may be a bit of cyclicality and they're both the long term are fundamentally very healthy. And our strategy is always to try and operate in the most attractive parts of those market. And that's what you're seeing in construction. We're in the most attractive parts of the market. We are executing very well from a business model perspective against those particular parts of the market. And that's ultimately what drives the margins. It's ultimately also what will drive the high quality organic growth going forward. So very confident that not only will we grow in construction when markets recover, but grow at very high quality.

Jeff Sprague - Equity Analyst at Vertical Partners - (00:17:13)

Great. And then maybe you could elaborate a little bit on what sounds like you've got a fair amount of visibility on test and measurement improving in the fourth quarter. Maybe you could speak to that. Anything in particular that you're seeing? Orders and markets. I'll leave it there, let you answer.

Chris O'Herlihy - (00:17:31)

Yeah. So I think test measurement has a normal cyclical improvement in Q4, which we expect to achieve again this year. Q3 was a little bit mixed. Obviously we saw continued slowdown on the capex side really we would believe on the basis of the tariff uncertainty in Q2 ultimately having a spillover effect in terms of capex demand into Q3. So we expect that to improve a little bit. And then the other thing we saw in Q3 which should improve is we saw a little bit of a deceleration in semi which only represents about 15% of the segment. But where we saw some real green shoots in Q2 we saw somewhat of a deceleration still growth, but a deceleration in Q3 and we expect that to. Get a little bit.

Jeff Sprague - Equity Analyst at Vertical Partners - (00:18:14)

Okay, great. Thank you.

Chris O'Herlihy - (00:18:16)

Thanks Jeff.

OPERATOR - (00:18:19)

Our next question will come from Andy Kaplowitz at Citi.

Andy Kaplowitz - Equity Analyst at Citi - (00:18:23)

Good morning everyone.

Michael Larson - Senior Vice President and CFO - (00:18:24)

Morning Andy.

Chris O'Herlihy - (00:18:25)

Hey Andy.

Andy Kaplowitz - Equity Analyst at Citi - (00:18:26)

Chris and Michael, you obviously didn't change your organic revenue growth guide for the year. I think last quarter you talked about embedded in it was 2 to 3% organic growth for the second half which means you still need a significant uptick in Q4. I don't think comps get a lot easier for you in Q4 versus Q3. So it's just more pricing that's laddering in Q4 because I think you just said you're run rating as usual. Any other businesses get better in Q4 versus Q3?

Michael Larson - Senior Vice President and CFO - (00:18:53)

Well, I think what we are to give you a little bit of color on Q4 and you have to factor in what we said in the prepared remarks that we are trending towards the lower end of the organic growth guidance for the for the full year we typically see sequential improvement from Q3 to Q4 in that plus a couple of points of growth Primarily driven by the test and measurement business, as Chris just mentioned, and offset by the typical seasonal decline that we're seeing in our construction business. So, you know, Q3 to Q4 revenue is up maybe a point or so on the margin side. What we also typically see from Q3 to Q4 is a modest decline sequentially of about 50 basis points or so. So still in that 27% range and with a nice improvement on a year over year basis. And then the key driver of Q4 is a more normal tax rate. So that's about a $0.10 headwind relative to Q3. So, you know, Q4 looks a lot like Q3 with the normal tax rate. And that's how you get to kind of the implied midpoint of our guidance here. Maybe just a comment or two on Q3. You know, I think it was a little bit unusual quarter in the sense that we came into Q3 after a strong June. We had a strong July, perhaps related to some of the tariffs announcement and related pricing actions. And then we saw a little bit of a slowdown in August, actually pretty pronounced in August and then a more normal September and really a mixed bag in the quarter with a stronger automotive performance certainly. But also some of the green shoots we talked about last quarter in the order rates in places like test and measurement and semi didn't really materialize for us. So I think at the end of the day though, we're able to offset some of this choppiness, this macro softness with strong margin performance. And as we typically do, we found a way to deliver a pretty solid quarter from a margin earnings and free cash flow standpoint.

Andy Kaplowitz - Equity Analyst at Citi - (00:21:14)

Michael, helpful color. And speaking of that, I mean you're well up already in your range in auto in terms of margin, almost 22% in the quarter. And auto markets as you know, overall don't feel that great yet. So can you actually, I know you did 5% organic growth, but can you actually push to the higher end of Your low to mid 20s over the next couple years? How should we consider this given you're already there?

Michael Larson - Senior Vice President and CFO - (00:21:40)

Yeah, I think we're pretty confident in the margin. The target we laid out kind of low to mid 20s by next year. I think there's still a lot of opportunity here from an enterprise initiative standpoint primarily. You also see a pretty healthy dose of product line simplification again this quarter, which that's all short term headwind to the top line, but really positions the remainder of the portfolio for growth and higher margin performance as we Exit some of the slower growth and less profitable typically product line. So the market builds will be what they are next in Q4, they'll be a little bit lower probably than what we saw in Q4 3. So we won't have the same amount of operating leverage, but we'll still outperform as we have historically the builds. And next year you should expect kind of our typical 2 to 3 points above builds, whatever that build number is. Obviously as we sit here today. We don't know that.

Chris O'Herlihy - (00:22:42)

Andy. Just to add to that, the other. Big driver of margin improvement in auto is customer backed innovation. We're getting a real nice healthy contribution that this year we expect that to continue and indeed accelerate over the next couple of years. And at itw, innovation always comes a higher margin.

Andy Kaplowitz - Equity Analyst at Citi - (00:22:58)

Appreciate the color, guys. Sure.

OPERATOR - (00:23:04)

Next we'll hear from Jamie Cook at Truist Securities. Please go ahead.

Jamie Cook - Equity Analyst at Truist Securities - (00:23:14)

You know, the guidance relative to earlier in the year, I think earlier in the year you assumed, you know, foreign exchange headwinds of 30 cents that went positive or neutral last quarter. What's embedded in the guide. And you also have the benefits now from the lower tax rate. So I guess, Michael, I'm just trying to understand the puts and takes because it sounds like we have at least 40 cents of tailwind. You're lowering your organic growth to the low, sorry, your sales to the lower end. But it still seems like, I don't know, the guidance should be better, I guess than what it is just based on those tailwinds. So if you can help me understand that.

Michael Larson - Senior Vice President and CFO - (00:23:46)

Yeah, I guess, yeah. I think the short answer is that just given the choppy demand environment, we're maybe taking a more measured, a more cautious approach to our guidance here as we go into Q4. We're off to a solid start in October, but things can change quickly as we saw both as an example, the auto builds, the swing in autobills semi not really panning out. So I think we're just being a little bit more measured in our guidance here with one quarter to go and as always, we have a path to do a little bit better than what we're laying out for you. You cut off initially, but I think you're talking about foreign exchange. What's embedded here is the current rates as of today. And obviously they can change a little bit there. A little bit of a headwind tailwind now relative to a headwind earlier in the year. But we're talking pennies, you know. So I think in Q3FX was favorable $0.04. But then other things like restructuring were unfavorable by, you know, a couple of pennies. So there's some puts and takes there. And we've also embedded, obviously, as we said in the prepared remarks, the lower full year tax rate of 23% and we expect a more typical, you know, 24 to 25% tax rate here for the fourth quarter. So hopefully that's helpful.

Jamie Cook - Equity Analyst at Truist Securities - (00:25:12)

Okay, thank you. I'll get back in queue.

Michael Larson - Senior Vice President and CFO - (00:25:15)

Sure.

OPERATOR - (00:25:18)

Once again, ladies and gentlemen, that is Star and One. If you would like to ask a question, we'll hear from Tammy Zakaria at JPMorgan.

Tammy Zakaria - Equity Analyst at JPMorgan - (00:25:27)

Hi, good morning to Team ITW. Hope you're doing well. A medium long term question for you. Given all the policy changes to incentivize bringing auto production back into the U.S. do you perceive this to be an opportunity down the line given your market share with the big three? Or would onshoring not be a net gain because you already supply parts to manufacturing overseas? So how to think about that on shoring opportunity autos?

Michael Larson - Senior Vice President and CFO - (00:26:01)

Yeah. So Tammy, I would say that, you know, largely as we've said before, we're a produce-where-we-sell company. And so we've already, you know, we're positioned to supply our auto customers anywhere in the world, wherever they are, based on our current manufacturing setup and that will continue. So, you know, business come back to the US would just mean more production for our US factories. But you know, they're already here, so we don't see, I mean, there wouldn't be a huge net benefit that we can see based on the fact that we're a producer, we sell a company.

Tammy Zakaria - Equity Analyst at JPMorgan - (00:26:30)

Understood. And one question on pls, I think it's about a percentage impact. Should we expect this to continue at that 1% range for the next few years or is this year more of a heavy lifting, so it might fade as we go into next year and beyond?

Michael Larson - Senior Vice President and CFO - (00:26:50)

Yeah. So we haven't the planning process completed yet, Tammy. But basically what I would say is that for us, PLS is a bottom up activity. It's driven by our businesses. It's very much an essential part of the ongoing kind of strategic review that we do in a critical part of 80/20 in our divisions. And you know, obviously, you know, deep into the company we have this very tried and trusted methodology, requires a lot of discipline, but there's a lot of benefit that our divisions get from this. But the point is that there's a, there's, it's bottom up. We don't have the numbers for 2026 yet, but whatever it is, you know, it's, it's something that makes sense in the context of. It makes sense from a long term growth perspective in terms of it provides strategic clarity around where we want to focus effective resource deployment on the back of that and also from a margin improvement standpoint, obviously there's some cost savings which are a meaningful component of enterprise initiatives and a lot of these projects have a payback of less than a year or so. So we very much see pls, whether it's 50bps or 100bps as an ongoing value creating activity in our divisions. And like I say, we've got a lot of positive experience and expertise on this but it's going to be a bottom up number basically.

Tammy Zakaria - Equity Analyst at JPMorgan - (00:28:03)

Thank you.

OPERATOR - (00:28:07)

We'll hear next from the line of Joe Ritchie at Goldman Sachs. Your line is open.

Joe Ritchie - Equity Analyst at Goldman Sachs - (00:28:14)

Thanks. Good morning guys.

Michael Larson - Senior Vice President and CFO - (00:28:15)

Good morning Joe.

Joe Ritchie - Equity Analyst at Goldman Sachs - (00:28:18)

Hey, I know that you know you'll typically like guide to trends and as I guess as we're kind of thinking about 2026 and that potential initial framework with the moving pieces that you know today any, any color that you can kind of give how you're thinking about it at least like this early on and what 2026 could look like.

Michael Larson - Senior Vice President and CFO - (00:28:41)

Yeah, I mean I think as you say joda, you know, we don't really give guidance until we've gone through our bottom up planning process here and talk to the segments about their plans for 2026 and that doesn't happen until in November here. You know, to give you a little bit of a way to think about this maybe, you know, I think you should expect that per our usual process, our top line guidance will be based on run rates exiting Q4. We'd expect some continued progress on our strategic initiatives including the contribution from customer backed innovation. We'd expect some market share gains and the combination of those things leading to above market organic growth again in 2026. And then the big question is really what will the market give us on the things within our control? We'd expect to see continued margin improvement and a healthy contribution from enterprise initiatives. You should expect to see some strong incremental margins that are probably above our historical average. And I think those are kind of the big items. Then there'd be some puts and takes around, you know, price and FX and lower share count that may skew favorably. I'd expect a similar tax rate to this year. And then as usual, like I said we'll update you in February which and we'll include our usual kind of segment detail to help everybody kind of think through what the Year might look like.

Joe Ritchie - Equity Analyst at Goldman Sachs - (00:30:27)

Okay, great, that's helpful, Michael. And then I guess just on capital deployment, I know you guys are doing the billion and a half buyback. You know, it seems like you've got probably some room on your balance sheet if you wanted to lever up a little further still stay investment grade. Like how are you guys like thinking about the right leverage for you going forward and put that into context of potential like M and A opportunities and what you guys are looking at across your different businesses?

Michael Larson - Senior Vice President and CFO - (00:30:59)

Yeah, I mean, I think we're sitting here at about two times EBITDA leverage, which is right in line with what our long term target has been. You know, the buyback specifically is really the allocation of the surplus capital that we generate, which is a big number for ITW, about 1.5 billion. And that's what is being allocated to the share buyback program and leads to a reduction in the overall share count of about 2%. But all of that only happens after we have invested in these highly profitable core businesses for both organic growth and productivity. We're fortunate that only consumes 20 to 25% of our operating cash flow. The second priority here is an attractive dividend that grows in line with earnings over time. Chris talked about this being our 62nd year of consecutive dividend increases of 7%. And then when all said and done, we still have a lot of capacity on the balance sheet for any type of M&A opportunities. You know, as you may know, we have the highest credit rating in the, in the industrial space. We have arguably the strongest balance sheet. And so there's a lot of room here if the right opportunities were to present themselves.

Joe Ritchie - Equity Analyst at Goldman Sachs - (00:32:34)

Okay, great guys, thank you.

OPERATOR - (00:32:40)

Next question today comes from Steven Volkeman. Please go ahead. Your line's open.

Steven Volkeman - (00:32:46)

Great, thank you. Good morning, guys. Good morning. So I'm curious whatever commentary you might wish to provide around what you're seeing on sort of price cost and obviously it didn't impact you in the quarter, but are you seeing suppliers raising prices and you're kind of able to offset that however you choose, or do you think maybe they're holding back and that's still to come? And then in that vein, you know, just how do you ascertain that you will cover whatever costs? Will it be dollar for dollar or also on margin? Thanks.

Michael Larson - Senior Vice President and CFO - (00:33:25)

Yeah, I think, Stephen, the biggest driver of cost increases this year has been the tariff related cost increases. And I think we've responded with both pricing actions that we've talked about and also supply chain actions. As you know, we are largely a produce-where-we-sell company. The 93% or so of the company is produced where we sell. We had a little bit of exposure that we talked about earlier in the year. We've worked hard to mitigate that and put ourselves in a really good position. We've been able to, through those actions, offset the impact from tariffs this year. And in Q3, as we said in our prepared remarks, price cost was positive, both from a dollar for dollar earnings standpoint and also from a margin standpoint. So I feel like at this point we're kind of back to a more normal environment at this point. From a price cost standpoint. We are not completely caught up yet, but we've got a quarter to go and then for next year, who knows what the tariff environment might mean for next year. But I think we feel very confident given our track record here in terms of being able to manage whatever those cost increases, whether they are typical inflationary increases or tariff increases, might be as we head into next year. So.

Steven Volkeman - (00:34:56)

Super. Okay, thanks. And then just pivoting. China was obviously really good for you guys this quarter. Wondering if you might be able to drill in there a little bit and give us a sense of what's driving that and I don't know, maybe some of the CBI initiatives or something.

Chris O'Herlihy - (00:35:13)

Yeah. Do you want to go ahead, Chris? Yeah. Yes. So basically, Steve, you know, what's driving China right now is auto in China in particular, I think our penetration on EV in China, particularly with Chinese OEMs, we continue to make great progress on CBI and market penetration in China, particularly with Chinese OEMs, we continue to increase content per vehicle. As you know, China represents mid-60s in terms of percentage of worldwide EV builds. And we're growing nicely there, particularly with a strong position with Chinese OEMs. In addition, you would mentioned CBI. I would say that China, even though it represents about 8% of our revenues, we certainly get disproportionate amount of our patent activity from China in terms of the level of innovation activity that's going on. So, yeah, innovation in China, particularly in automotive, is what's striking our progress. And we're basically penetrating at a level well above the market.

Michael Larson - Senior Vice President and CFO - (00:36:11)

Yeah. And maybe to put some quantification around it, if I just look at kind of year to date in China, as Chris said, the big driver is our automotive business, up 15%. That's our largest business in China. But also test and measurement, electronics up in the mid teens. Polymers and fluids up 10%, welding up 20% plus, I mean, I think fueled by CBI certainly in most cases here, I think the team's doing a really nice job overall, up 12% in China on a year-to-date basis and pretty confident that the things again that are within our own control will continue to have a positive contribution to the top and bottom line in Q4 and headed into next year.

Steven Volkeman - (00:37:02)

Great, thank you, guys.

OPERATOR - (00:37:07)

Next we'll hear from the line of Julian Mitchell at Barclays.

Julian Mitchell - Equity Analyst at Barclays - (00:37:13)

Hi, good morning.

Michael Larson - Senior Vice President and CFO - (00:37:14)

Morning.

Julian Mitchell - Equity Analyst at Barclays - (00:37:15)

Good morning. Maybe just wanted to start with the operating margins. So I think you'd mentioned, Michael, that next year you should be above the historical incremental. And I guess you have that sort of placeholder of 35 to 40% dating back to the investor day. So it's presumably in reference to that. But just wanted to understand. As you.

Michael Larson - Senior Vice President and CFO - (00:37:43)

Look at next year on the margin side of things, is there a big kind of payback from the restructuring efforts that happened this year coming in price cost maybe for this year as a whole is margin neutral and then that flips positive next year. Maybe just any sort of fleshing out of the thoughts on some of those margin moving parts, please. Yeah, I think, Julian, the biggest driver of margin performance for I'm going to say the last decade or so has been the enterprise initiatives. And we've consistently put up 100 basis points of margin improvement from our strategic sourcing efforts and from our 8020 front to back efforts. And so we would expect that to continue to be the case next year. Whether that exactly 100 basis points or not, we won't know until we've rolled up the plans. But that will far outweigh any contributions from price cost, for example. And then the other big element which is a function of really what end market demand will do is if you look just at our performance year to date or in the third quarter, our incremental margins are significantly above kind of our historical 35 to 40%, including 65% in the third quarter. And you look at the margin performance this quarter in the automotive OEM business where 5% organic growth translates into income growth of 20% plus. So it's just an illustration of we don't need a lot of growth to put up some really differentiated performance from a margin and profitability standpoint. So, you know, I can't tell you, as we say today, what the incrementals might be for, for next year on, on the organic growth. But I would tell you I believe that they it'll probably be above the historical range that we just referenced. That's helpful.

Julian Mitchell - Equity Analyst at Barclays - (00:39:55)

And then just maybe one for Chris more looking at, you know, Slide 8 and that CBI contribution of sort of over two points to sales and the sort of partial offset from PLS headwinds that you discussed earlier on this call somewhat. And I realize this isn't how you look at it and it's sort of really bottom up driven. But if we're thinking about that spread of say CBI vs. PLS Enterprise wide, is the assumption that that should be more and more of a net positive as those CBI efforts that you talked about at the investor day a couple of years ago increasingly get traction. Just trying to understand how to think about the delta between those two. Understanding that they are independent bottom up process.

Chris O'Herlihy - (00:40:49)

Yeah, I'm not sure there's a huge amount of correlation between the two, Julian. I mean CBI is really referencing in our efforts around improving the quality of execution on innovation. Whereas pls we typically in our businesses typically use for kind of product line pruning. I think the only correlation between the two is that they're both connected to differentiation. PLS results is as a result of where we feel maybe we're on the same level of differentiation and we're pilot lane pruning accordingly. Whereas CBI we're leaning in to basically create and develop more differentiated approach products. For sure you're going to see an improvement in CBI over time. We've already seen that the number has actually doubled since 2018 directionally in the 1% range. It was 2% last year trending 2,3 to 2,5 this year. Well on track to get to 3 plus by 2030. PLS is a circumstantial and ongoing review. Of our businesses by our businesses of. Their product lines and they react accordingly. And as I said earlier, you know, we see this as there's a lot of value creation comes from pls, but in a different way. So I'm not sure there's a huge amount of correlation between the two. I kind of think about two of them kind of differently.

Julian Mitchell - Equity Analyst at Barclays - (00:42:00)

Thank you. But the sort of net spread of them should be increasingly positive. I suppose it should be.

Michael Larson - Senior Vice President and CFO - (00:42:06)

No, absolutely. Driven by improvements in CDI. Correct. I mean PLS, as Chris said, is an outcome of process. Our 8020 front to back process we've talked about kind of in the long run, you know, maintenance PLs being in that 50 basis points range. We have a little bit more this year. We've talked about specialty and kind of strategically repositioning that segment for faster organic growth. And then as Chris said, CBI will continue to improve from here. So that Spread to your point will widen. But my fault for putting them right next to each other on slide 8, they're completely independent of each other. And so I just want to make sure that's clear, that there's no linkage between the two. But mathematically the spread will grow between the two and net net will be a more positive contributor to organic above market organic growth as we go forward.

Julian Mitchell - Equity Analyst at Barclays - (00:43:05)

That's great color. Thank you. Thank you.

OPERATOR - (00:43:13)

Our next question today will come from Joe o' Day at Wells Fargo. Please go ahead.

Joe o' Day - Equity Analyst at Wells Fargo - (00:43:20)

Hi, good morning. Thanks for taking my question. Can you talk about sort of tariff impact a little bit? There were periods of time earlier this year where the math would have suggested something up to know, 2% kind of price requirement to offset. And it seems like we're in an environment now where the pricing required is probably less than 1%. But, you know, anyway, any, any of your, any thoughts around that and then, you know, stepping back, it would seem like, you know, that's not necessarily a big hit to demand. And so the tariff kind of overhang would be more uncertainty related than magnitude of pricing required at this point. Related. But your thoughts on that?

Michael Larson - Senior Vice President and CFO - (00:44:03)

Yeah, I think price cost from a, in terms of kind of combined with supply chain actions, our ability to offset tariffs, I think is not really the main event at this point. I think we've demonstrated that we know how to do that and we've further mitigated the risk of any tariff related specifically to China. So I think that part of the equation we feel really good about. I think the impact on demand is probably something we talked about also on the last call, that it may have led to a little bit of demand orders being frozen back in the April kind of Q2 time frame. And there's probably a little bit of overhang still from that. I mean, I think we saw what's been a pretty choppy demand environment. As I said earlier, you know, we had some positive order activity in June, July, then it slowed, April, May, you know, kind of pretty choppy also. So I think the impact maybe from a demand standpoint, at least initially, was, you know, maybe more significant and who knows, kind of where we go from here into next year. But I think it's largely behind us at this point. Certainly from a cost standpoint and maybe from a demand standpoint, this is no longer. Tariffs are no longer the kind of the main event here.

Joe o' Day - Equity Analyst at Wells Fargo - (00:45:33)

And so what do you think the main event is in terms of seeing kind of an unlock of better demand? You're outgrowing markets, but that Market growth rate not kind of all that inspiring at this point. And so in sort of this protracted kind of challenge demand environment, if tariffs are kind of easing as a headwind, what do you think is the key to the unlock?

Chris O'Herlihy - (00:46:00)

Yes, I think Johor, we think we take a long term view here. We believe fundamentally we're in really good markets for the long term. We're obviously going through a period right. Now where there's quite a bit of. Contraction and uncertainty and so on and so forth in areas like construction. But you know, our fundamental thesis is that we're in markets which we believe for the long term are attractive. We want to make sure we're in the best parts of those markets and we believe that we are. We believe we can see quite clearly in areas like automotive and construction and historically in welding and food equipment that we're outgrowing the markets at the point at which the cycle turns. We'd be really well positioned and to Michael's earlier point, not just for growth, but for even higher quality of growth on the basis that our incrementals have strengthened from historical levels on the basis of portfolio pruning around sustainable differentiation coupled with very high quality execution on the business model. So we feel pretty good about the long term, or we're just going through a period where we see some short term demand issues, but we feel we've got a really good portfolio for long term growth.

Joe o' Day - Equity Analyst at Wells Fargo - (00:47:07)

Maybe just tying that into test and measurement and what you're seeing there, you know, it seemed like an environment you're investing in cbi, like we hear a number of companies talking about innovation, it would seem like they need your equipment. Are you seeing this kind of build up in terms of what would have kept them on the sidelines, but if they want to invest in innovation, it would seem like they're going to need your help.

Chris O'Herlihy - (00:47:30)

Absolutely, that's correct. Test and measurement is a really fertile space for us in terms of long term growth. There's lots of new materials being developed, there's increasing stringency in innovation standards and quality standards, all of which are requiring more and more exacting testing equipment. And that's where we play. So again, short term issues here around capex environment and so on. So a bit of compression in Q3 relating to some capex freezing in Q2, but for the long term this is a really, really healthy environment for us, will be a healthy environment for us on the basis of the quality of innovation in test and measurement and also the end markets that are lined up against biomedical and so on. All of which have very strong fundamentals going forward.

Joe o' Day - Equity Analyst at Wells Fargo - (00:48:15)

I appreciate it. Thank you.

OPERATOR - (00:48:20)

Next we'll hear a question from the line of Nigel Ko at Wolf Research.

Nigel Ko - (00:48:25)

Oh, thanks. Good morning, everyone. We covered a lot of ground here. Hi guys. Just, just want to go back to the comments around, you know, strong starts to the quarter and then it sort of petered out. Do you think there's any, you know, unusual behavior with distributors around price increases or tariffs? Obviously we have, we had the big tariff in the middle of the quarter. Anything you call out there, number one and then number two, you know, structure actions in the first half of the year. Did we see the full benefits in 3Q or was there still some benefits come through in 4Q?

Michael Larson - Senior Vice President and CFO - (00:49:00)

Yeah. So let me start with kind of the cadence as we went through the quarter and I'm not sure we have a great answer for you, Nigel. I mean, I think like we said, June and July were really some of our better months with meaningful organic growth on a year over year basis. Then a slowdown in August and a recovery in September. And if you look at NET NET for Q3, we were actually pretty close to kind of typical run rates. But so the point I think we're trying to make, it's just a pretty choppy environment and things can change pretty quickly. But we're not really making any long term forecast in terms of kind of what that may mean on a go forward basis. Some of it may be related to the tariff announcements and the associated pricing, but really hard to tell, you know, restructuring. For us, it's a little bit of a misnomer. I mean, these are, these are funds that, you know, expenses that are funding our 80, 20 front to back projects. And so there's no big restructuring initiative going on inside of itw. Our spend this year will be similar to last year in that, you know, $40 million range. We try to, you know, kind of level load things and do a similar amount every quarter, but it's really a, a function of the timing of tens of projects across the company and when the divisions want to execute on those projects. So those restructuring savings are, these are projects with paybacks of less than a year. So it happens pretty quickly and it's part of what's funding the enterprise initiative savings that we're getting next year. But these are not big kind of restructuring, traditional restructuring projects. These are all tied to 80, 20 front to back as per usual. So yeah. Okay, thanks Michael. That's helpful. Quick one on welding, you know, we've seen, you know, I think now 2/4 of nice inflection in growth on equipment. But consumables remains stuck down in that low single digit declining territory.

Nigel Ko - (00:51:24)

Is that primarily a price differentiation between.

Michael Larson - Senior Vice President and CFO - (00:51:26)

Equipment and consumables or anything else you'd call out? Yeah. So, Nigel, I think it's mainly because the consumer is more of a discretionary purchase. You mean commercial or consumables? Consumables, I think. Right. Is that right, Nigel, what were you referring to? And equipment's up nicely? Yeah, Yeah. I think it's a little bit of a head scratcher, to be honest with you. You know, equipment up 6 and consumables, you know, down 2. Within that there are some of the welding, some of the filler metals are actually showing positive growth. The other thing, what we're seeing is a pickup on the industrial side. So these are typically, you know, large heavy equipment manufacturers. And then the commercial side or the consumer side is a little bit slower where it's a little bit more of a exposed to the kind of consumer discretionary spending. So it's a little bit of a mixed picture. I think the real positive in welding is this growth is fueled by cbi. And so it's not that the markets are picking up. It's really new products primarily on the equipment side as well as both in North America and international with some really nice growth in our European than in our China business. So that's probably the best answer I can give you.

Nigel Ko - (00:52:51)

Okay, thanks. I appreciate that. Yeah.

OPERATOR - (00:52:55)

Our next question will come from Avi or excuse me, Yaroslavich at ubs.

Avi Yaroslavich - (00:53:01)

Please go ahead. Hi. Thank you. Good morning. So appreciate that you're. That you're saying that you're trending towards the lower end on sales guidance. Can you just talk about some of. The thinking for leaving that range unchanged and, and just kind of wider than you typically would for this time of year. I assume you're still thinking there could be some upside to get you to the midpoint or better for the year. And would that come from any particular segments or. It sounds like more from demand than pricing. So just. Yeah. Is that the right way to think about it?

Michael Larson - Senior Vice President and CFO - (00:53:35)

Yeah, I mean, I think typically we update guidance kind of halfway through the year. And at this point, with a quarter to go, we're well within the ranges. And so we didn't see the need to kind of update the whole thing. And we'd. And the decision was to narrow the range and to explain why we're not flowing through the benefit of the lower tax rate, which is really due to the fact that we're turning towards the lower end on the revenues. So that's our way of being as transparent as we can be around the guidance. I think the, you know, your question kind of Q3 versus Q4, I think we've kind of covered that. Again, the segment that typically shows the biggest pickup from Q3 to Q4 is our test and measurement business. And then that's partially offset by the construction being down, kind of typical seasonality. And when all is said and done, revenues from Q3 to Q4 should be up by a point or so. Certainly, you know, we've also factored in, I should say, the lower auto build forecast. There's been, you know, which is done by, you know, third party kind of industry experts and there's been some noise around some supplier, supplier issues for some of our customers. And all of that is included in our automotive projection here for the fourth quarter based on everything that we know as we sit here today. So hopefully that answers your question. Okay, appreciate it. Thank you.

OPERATOR - (00:55:15)

Our next question will come from Mig Dobre at Baird.

Mig Dobre - (00:55:21)

Hey, thank you for squeezing me in. Good morning. I also kind of want to go. Back to the PLS discussion and I guess my question is this. When you sort of look at your. Comments for delivering above normal incremental margins, how reliant are you on PLS in order to be able to do that? How important is PLS to in that algorithm? And I guess given how high your margins are, and I'm kind of looking almost across the board in your businesses, you are pretty much outperforming anyone else out there that I'm looking at. Is there a point in time here where it's rational to sort of say, hey, look, maybe we can throttle back on TLS because we can actually deliver more earnings growth and more return for shareholders by just trying to accelerate organic growth rather than improving the portfolio? Yes.

Michael Larson - Senior Vice President and CFO - (00:56:19)

So, Mig, I think there is a relationship between PLs and incrementals and so on, but it's not the only factor. I mean, pls is an element of 80 20. It's not the, you know, it's not holistic 80 20. So I think the implementation, the business model, again, the quality of the portfolio is ultimately what drives the, you know, the incrementals ultimately, you know, drives the margins. In terms of your comment on, I guess the comment on organic growth versus margin. And so from our standpoint, I mean, you know, organic growth and operating margin and margin expansion kind of go hand in hand. And you know, we talk about quality of growth and I Think we demonstrated that for instance, coming out of the pandemic, we saw very healthy growth and margin expansion while over that period we were investing in a very focused way in our businesses in innovation, strategic marketing. And that very much continues today. So really it's about the quality of the organic growth 33% incremental. Historically we're now well above that, comfortably kind of into the 40s. And that's again at a time when we are very much investing in our businesses in a very focused way around innovation, strategic marketing and so on. So for us the math is pretty simple. With margins at 26 and with growth incremental margins at 35 plus or even 40 plus right now, it's the operating leverage that is really driving the margins forward from here. And as we look at 2030 and our 30% goal, that's a goal that's not going to be achieved through structural cost reduction, that's going to be achieved through continuous improvement in organic growth at high quality and high incremental margins. So we see the two as being. As being correlated, I would say.

Mig Dobre - (00:58:03)

Understood. But you know, in terms of maybe the framework for 26, asking the question that somebody else asked earlier. Right. If CBI is contributing 2.3 to 2 and a half, maybe you can rethink product line simplification to some, to some extent and maybe the end markets get better again. You know, from my perspective, being able to get your organic growth back to that 4 or 5 plus percent range. Is really the thing that at this. Point seems to be needle moving in terms of both maybe investor sentiment as well as overall earnings growth. So I'm curious if I understand it's early for 2026. Curious though if you think that it's plausible that we could be looking at that kind of growth as we can spot next year.

Michael Larson - Senior Vice President and CFO - (00:58:48)

Thank you. I think we're probably, as we said earlier, running a little bit higher on PLs than kind of the normal maintenance run rate. We're doing that specifically in a business like specialty products where we've talked about. We're strategically repositioning that segment for growth. I will tell you that in other segments and industries that I know you follow, like food equipment and welding, that number is significantly lower, maybe even zero in some cases. So it's not an across the board and it's also not a number that we want to or even could manage from the corporate, you know, from corporate, this is such an integral part of, you know, our 8020 front to back process. It's a bottom up number. And if we were to say. And it's tempting. I know what you know. I understand how you're thinking about it. It's tempting to say, okay, no more Pls. That also would say, no more 80, 20 front to back. And that is certainly not in anybody's long term interest, I can promise you that. All right, that makes sense.

Mig Dobre - (01:00:04)

Thank you. Thank you.

OPERATOR - (01:00:08)

Ladies and gentlemen. That was the final question in our queue for today. We'd like to thank you all for your participation in today's session. And you may now disconnect. Disconnect your lines, please. Have a good day.