Operator
Good morning. My name is Connor Meek, and I will be your conference operator today. At this time, I would like to welcome everyone to ITW's third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you'd like to withdraw your question, please press the star followed by number one key again. For those participating in the Q&A, you will have the opportunity to ask one question, and if needed, one follow-up question. Thank you. Aaron Linehan, Vice President of Investor Relations, you may begin your conference.
Speaker 6
President and CFO, Michael Larson. During today's call, we will discuss ITW's third quarter, 2026 financial results, and provide guidance for full year 2026. Slide 2 is a reminder that this presentation contains forward-looking statements. Please refer to the company's 2025 Form 10 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'Hearlyhy.
Thank you, Erin, and good morning, everyone. As you saw in our press release this morning, the ITW team delivered another quarter of strong operational and financial performance. Our third quarter highlights include organic growth of 4%, or 5%, excluding the impact of a tornado event at one of our welding locations. Our top line was fueled by another meaningful increase in customer-backed innovation, and we are raising our full-year CBA projection to 3% plus. Operating margin expanded 40 basis points to 27.8%, and operating income increased 6%, marking a new quarterly record for ITW. Gap EPS exceeded our estimate and increased 7% to $3. Demand momentum this quarter continued to accelerate in our two capex-related segments, led by organic growth of 16% in test and measurement electronics and 7% in welding, or 15% excluding the tornado event. In addition, polymers and fluids grew 8% due to robust contributions from both market share gains and new products. Beyond capitalizing on favorable market conditions, we continue to make meaningful progress on our long-term organic growth agenda across all segments. On that note, I'm very encouraged by our customer-backed innovation progress, which so far this year has contributed more than 3% to revenue growth, about 2.4% in 2025. As I mentioned, we are now projecting that CBI will exceed 3% for the full year, which is the single biggest catalyst for achieving our enterprise goal of sustained high-quality organic growth of 4% or higher. Our performance year to date offers another proof point that disciplined execution on our next phase enterprise strategy priorities is yielding strong results, positioning us very well for 2027, and putting us firmly on track to achieve our 2030 performance goals. Before I transition to the bottom line, let me spend just a minute on the unfortunate tornado event that we mentioned on our call in July, which damaged two of our welding facilities and reduced our revenues by about $40 million, our one percentage point in the third quarter. I'm pleased to say that our colleagues were all safe, and the team did an outstanding job quickly and safely restoring operations and taking care of customers. Our swift recovery serves as a great demonstration of our ability to read and react, a key proof point of the value of ITW's decentralized entrepreneurial culture. With welding order growth running well ahead of revenue, we expect welding to return to strong growth again in the fourth quarter and carry good momentum into next year. On the bottom line, the ITW team continued to execute at a high level, with enterprise initiatives contributing 130 basis points to our operating margin. And in a very dynamic inflationary environment, our teams continue to respond decisively and effectively. Overall, price cost was favorable in the third quarter. But as you can see, in a few segments such as automotive OEM and construction products, we have some catching up to do. Turning to capital allocation, in the quarter, we raised our dividends 7%, marking our 63rd consecutive year of dividend increases. In the first three quarters of the year, we have returned $2.7 billion to shareholders through share repurchases and dividends. In terms of our outlook, we are raising our full-year gap EPS guidance by 5 cents to a new midpoint of $11.50, reflecting 10% year-over-year growth. This marks our third guidance increase of the year. Looking ahead to 2027, and with the caveat that we haven't developed our annual plans yet, demand momentum continues to build across several of our end markets, notably in welding and test and measurement electronics. In addition, we are exiting this year with CBI already at 3% We would expect another meaningful contribution from our enterprise initiatives and incremental margins in the 40% plus range. Our long-term performance framework, 4% plus organic growth and 30% operating margins by 2030 is very much intact and remains well within our reach. In conclusion, I want to thank our dedicated IHW colleagues around the world, and this quarter in particular, the welding folks in Appleton, Wisconsin, for their dedication to serving our customers and executing our strategy with excellence. With that, I'd hand the call over to Michael to walk you through the segment details and updated full year outlook. Michael.
Thank you, Chris, and good morning, everyone. Starting with the top line, total revenue grew 4.4%, driven by 3.8% organic growth, a 0.3% contribution from foreign currency translation and 0.3% from an acquisition. Excluding the tornado event in welding, our organic growth rate would have been approximately 4.8%. Importantly, odor growth continued to accelerate in both welding and test and measurement and electronics, and demand remained strong in polymers and fluids. Moving to the bottom line, operating margin expanded by 40 basis points year-over-year to 27.8 percent, with another solid 130 basis points contribution from enterprise initiatives. Sequentially, margins improved 110 basis points from Q2. In the quarter, price increases and other actions offset higher raw material costs in dollar and margin terms. Those favorable drivers were partially offset by inflation in other areas, such as employee-related costs. Free cash flow was $851 million, or 100% of net income. And on a year-to-date basis, free cash flow grew 9% to more than $2 billion, or 82% of net income. Finally, GAAP EPS was $3, an increase of 7%, despite a headwind of about $0.10 cents from a higher tax rate of 24.4% compared to 21.8% last year. Overall, a strong quarter operationally and financially and with significant positive momentum going forward. Turning to slide four, from a regional perspective, organic growth was up 6% in our largest region, North America. Asia Pacific was up 3%, with China down 2%, primarily due to a tough comparison of plus 10%, and Europe was flat. Moving to the segment highlights, starting with automotive OEM, organic revenue was down 2% against a tough comparison last year of plus 5%. In Q3, North America was down 1%, Europe down 7%, and China was down 1%. In the quarter, we meaningfully outperformed build rates in both North America and China, while Europe was impacted by unfavorable customer mix and product line simplification. For the full year, we expect to outperform builds and remain well positioned to continue to execute on our long-term growth opportunities such as EV growth in China. Operating margin was down 170 basis points, primarily due to resin inflation and the resulting price cost timing lag, which was partially offset by favorable enterprise initiatives. As usual, we expect to recover the price-cost impact over time, helped by new product launches, and we remain on track to achieve our longer-term margin targets for the segment. Turning to slide five, food equipment organic revenue grew 1% overall, a service strength of plus 5%, helped offset a 2% decline in equipment, which marked a notable sequential improvement from the mid-single-digit equipment declines in the first half. Regionally, North America was down 3% due to soft but sequentially improving institutional demand in areas such as K-12, which are impacted by a decline in funding levels, partially offset by high single-digit growth in areas such as retail. On a positive note, international again delivered strong growth up 5% in the quarter. Operating margin improved 60 basis points to 29.8%. Looking ahead, with North America orders up mid-single digits this quarter, we are now projecting year-by-year organic growth in the low single digits and operating margin expansion in Q4. Test and measurement and electronics had another outstanding quarter with 16% organic growth, led by a 31% surge in electronics, which represents approximately 40% of the segment. Test and measurement was up 8% driven primarily by semiconductor demand with general industrial auto activity also beginning to pick up. The two main drivers of the strong growth that we're seeing in this segment are first, our electronic assembly businesses which serve the printed circuit board industry and second, our semiconductor related businesses which serve the chip manufacturing industry. Staying invested in our strategic growth initiatives in those businesses through the cycle has positioned us to take full advantage of the significant growth opportunities that remain ahead as orders continue to outpace revenue growth by a wide margin. Operating margin expanded by 330 basis points to 28.7%, primarily as a result of strong operating leverage. Moving on to slide 6, welding was obviously impacted by the tornado event in the quarter, but still managed to deliver remarkably resilient top and bottom line results, including 7% organic growth, which would have been 15% excluding the tornado event. Equipment revenue grew 5% as orders continued to surge across most end markets, and consumables grew double digit driven by both market tailwinds and strong new product adoption. North America, which represents 85% of the welding segment, was up 8% with broad-based growth across both industrial and commercial markets as demand momentum continued to strengthen end markets such as infrastructure, energy, aerospace, defense, and semiconductors. On the bottom line, the loss of operating income associated with the tornado event was offset by business interruption insurance, which favorably impacted margins. Looking ahead, we expect welding margins to return to their typical best-in-class levels. In palmas and fluids, organic growth reached 8%, driven by strength across most end markets, with strong traction on CBI and continued market share gains. Organic growth was 6% in automotive aftermarket, while organic growth of 12% in polymers and 9% in fluids was supported by robust momentum in general industrial and biopharma markets. Operating margin expanded 280 basis points to 31.3%. Turning to slide 7, in our most interest rate sensitive segment, construction products, organic growth was down 1% compared to end markets which we estimate were down in the mid single digits north america was flat europe was down two percent and australia new zealand was up one percent while residential renovation in north america was down two percent commercial construction which represents about 15 of the region was up 19 due to strong demand in areas such as data center construction Operating margin was down 170 basis points to 29.9%, due primarily to near-term price-cost headwinds. Specialty products, organic growth, was down 1%, which included the impact of 130 basis points of product line simplification, primarily in the appliance components business. North America grew 3% on solid demand for consumer packaging, offset by an 8% decline in international markets, which had a tough comparison of 7%. Operating margin was down 90 basis points to 31.4%. With that, let's turn to our slide 8 for an update on our full year guidance. Overall we are carrying significant positive momentum forward and are well positioned to continue to deliver strong operational and financial performance in the fourth quarter and beyond. Starting with the top line and per usual process, our guidance is based on current levels of demand adjusted for typical seasonality and prevailing foreign exchange rates. As a result, our organic growth projection remains three to four percent for the full year, despite the Q3 tornado event, which implies organic growth of five percent plus in Q4. Sequentially, revenues grow one to two percent from Q3, despite two fewer shipping days in Q4. We're raising total revenue growth guidance by 50 basis points to four and a half to five and a half percent to account for current foreign exchange rates. On the bottom line, our operating margin guidance remains unchanged at 26.5% to 27.5%, and we expect Q4 margins in the mid to high 27s, similar to Q3, which would mark a significant improvement year over year. Enterprise initiatives remain the primary margin driver and are expected to contribute more than 100 basis points. For the full year, we're estimating that price costs will be favorable on an income basis and about neutral to margins in what remains a very dynamic environment. Factoring in our strong third quarter results, we're raising our GAAP EPS guidance by $0.05 to a narrow range of $11.45 to $11.55, with a new midpoint of $11.50 representing 10% year-to-year growth. The projected effective tax rate remains unchanged at 23% to 24%. Free cash flow conversion is projected to be approximately 100% of net income, with full-year share repurchases of approximately $1.5 billion. Considering some of the unique challenges we have to deal with this quarter, we're pleased with our performance and especially the strong momentum across the company. Combined with our best-in-class margins and our disciplined operational execution, we remain well positioned to deliver differentiated financial performance in 2026 and beyond. With that, I'll turn the call back over to Erin.
Speaker 6
Thank you, Michael. Connor, will you please open the queue for questions?
Operator
At this time, I would like to remind everyone to ask a question, press star, then the number one on your telephone keypad. We'll pause just for a moment to compile the Q&A roster. Your first question comes from the line of Jamie Cook with True Securities. Jamie, your line is now open. Please go ahead.
Hey, good morning. I guess two questions. First, just on the price cost in the quarter, I think originally you'd said it would have been a headwind. You expected a headwind of 30 bps, and it sounds like it was better than that. Just if you could quantify that. And then I guess my second question. It sounds like there's opportunities within automotive and construction for margins to improve. It sounds like there's a pricing lag there. Can you talk to what pricing actions that you're taking and when we should see that start to hit the bottom line?
Yeah. Let's start with price cost. If we look back to Q3, our pricing actions largely came through as planned. And like everyone else, we continue to see a lot of inflation in raw material costs, such as resin, chemicals, steel, electronic components, kind of in that 4% to 5% range. Price costs was modestly favorable in the third quarter. And given the dynamic environment, we don't really want to provide a whole lot more detail than that. What we can say is that for the full year, we also expect the margin impact to be about neutral for the full year. Just given the very kind of dynamic conditions here, we're going to refrain from providing more detail on Q3 and Q4 and quantifying specifically the basis points. Now, looking ahead to 2027, what we've talked about in the past is still the case that we expect conditions to normalize here uh in 2027 which typically uh is a 10 to 20 basis points tailwind to margins uh from price cost so that's kind of the base assumption for for 2027 so a little bit of near-term uh headwind and we expect to get through that over the next uh you know by year end and next year then would be a more kind of normal uh environment and then maybe on the automotive oem margins uh chris if you wanted to comment yeah so i would say in both auto and uh construction we are busily recovering price right now but i think in both cases you know we
think about margins in across all seven segments but particularly with auto for a second the primary drivers of auto margins are enterprise initiatives and higher margin innovation and we're making great progress on on those both in auto and construction we see those sustaining into next year.
Okay, sorry. One follow-up. Obviously, Chris, congratulations. It seems like we're getting some good traction on CBI. It's trending ahead of your expectations. Besides auto, where are you seeing the biggest benefits, and should we assume that momentum improves, continues to improve into 2027? Thank you.
Yeah, you should assume it continues to improve. What I would say is that, just to refresh in terms of how we think about this, what's captured in our CBI numbers, incremental revenue growth over a three-year period, net of cannibalization. So on that basis, you need to keep refilling the pipeline with new projects. So it can be a little lumpy from quarter to quarter, but what's evident is that the work that we've done over the past two, three years have really resulted in this step change from what was 1% five years ago to 2% two years ago to a 3% contribution level right And we would expect, you know, given the improvements in innovation practice across the company uh as you as you surmised this number to incrementally improve from here on a year over year basis going forward and as we've said you know the most actionable and sustainable way that we drive organic growth over the long term is cbi so we're pretty encouraged what this means for organic growth thank you the next question is from andy kaplowitz of city group your line
is open please go ahead hey good morning everyone and morning christian michael i know you generally of short-cycle businesses, but you obviously went in 26 with relatively strong organic revenue growth. And I would imagine you have some backlog in your CapEx-focused businesses now. So how does that position you when you think about 27? Chris, I think you sounded pretty confident regarding meeting or beating that 4% or better algorithm that you have, but maybe you can elaborate on any puts and kicks.
I know you talked about CBI to Jane, but anything else and maybe, you know, elaborate on if you do have backlog in these capex businesses so um we do have a little bit more backlog uh than usual um but we're talking about months not you know years of backlog so just as a reminder we're still very much a um a short cycle uh business part of that is because of our 80 20 operating system which allows us to take orders today ship them tomorrow and then replenish the inventory the next day. So there's no incentive for customers to place orders significantly ahead of when they need them. So as we kind of, that said, obviously with what we've seen on the CapEx side of the business, particularly in welding and test and measurement electronics, we are carrying a little bit more backlog than usual. We actually saw, to complete the picture, there's a little bit of a backlog increase also in the food equipment business here going into the fourth quarter. And so all of that bodes really well for this 5% plus organic growth number that's implied in our guidance for 2026. And maybe more importantly, as we go into 2027, not so much the backlog, but just the underlying momentum that we're seeing in these businesses, the feedback we're getting from customers, the new products that are coming through at significantly higher margins now, as Chris said, at a 3% plus plus TBI contribution, and 3% plus in the segments we just talked about, you know, welding and test of measurement is, you could surmise that it's significantly higher than three in those segments. So those really have a lot of momentum going into 2027.
Yeah, I would just add to that, Andy, that, you know, as Michael indicated, you know, strong order intake, higher than revenue growth for both test of measurement and welding in the quarter. What's also encouraging is that for welding and test and measurement that the growth is pretty broad based so think about welding you know very strong growth on not just on the industrial side in areas like energy aerospace construction fabrication and so on but also on the commercial side on small fab and similarly with that with test and measurement you know obviously semi has been strong for a little while now but we're now starting to see a real nice pickup on the industrial side of the business as well in areas like like in strong so even though we don't forecast cycles i would certainly say that the the current order activity and the feedback to Michael's point that we're getting from our customers gives us some good confidence going into 2027.
Thanks for that, guys. And then I think 8% organic growth in polymers and fluids is the strongest growth you've had in the last few years in that segment. So I know you mentioned market share gains, strength in general industrial and bioformer, but maybe give us a little more color on the sustainability of that growth for that segment. Sure.
So polymers and fluids have been building for a little while now and And, you know, certainly some gains, but also I think some real nice progress on CBI, above average contribution CBI in that segment, but broad based across all three platforms of automotive aftermarket, polymers and fluids. I would say polymers in particular are really well positioned in very high growth markets, pretty sophisticated adhesive bonding applications, things like electronics, electric vehicles. And then similarly on the fluids business, we're having some real nice success on the biopharma space. So I think what this all says, Andy, is that it really highlights the fact that this segment is really well positioned to be a 4% plus grower for the enterprise on a sustained basis going forward.
And I would just add, Andy, as you think about this from a modeling standpoint, the comparison does get quite a bit tougher here in the fourth quarter. So Q4 last year, as Chris said, this has been going on for a while, was up, you know, the segment was up 5% organic. And so the, you know, the Q4 growth rate might not be, you know, starting with an 8 is kind of what I'm trying to tell you here.
Got it. Appreciate all the color, guys.
Operator
The next question is from the line of Julian Mitchell with J.P. Morgan. Your line is open. Please go ahead.
This is Piyush on for Julian. Thanks for taking the question. Maybe first on welding. You guys noted of associated loss of operating income was largely offset by business interruption insurance. So what is the underlying margins in welding in Q3 and what should we expect in Q4?
Yeah, I think what I said in the prepared remarks was that we would expect to return to kind of our typical best-in-class margins in that, you know, 32%, 33%, 34% range.
Oh, okay. Got it. And maybe sticking one more on margins, maybe on the polymers and fluids margins, very strong. Anything one time here now into the 30s, can they stay here or maybe push up?
I think, like I just said to Andy, I think we're probably expecting a little less operating leverage here in the fourth quarter, and so maybe a little bit lower than what we put up here in the third quarter, which I believe was a record for the segment, by the way. But still very healthy. Still very healthy.
Operator
The next question is from the line of Stephen Fisher with UBS. Your line is open. Please go ahead.
You mentioned, Michael, that construction products is the market with the biggest interest rate sensitivity, which makes sense given the housing relevance there. But I'm wondering, are there any areas within your own business or products that are more affected by financing costs, thinking like large commercial dishwashers, et cetera, that might be financed? Are you seeing any impact from higher interest rates or hearing any anecdotes on that from your various businesses?
Not specific to food equipment, which I think is your question. I mean, I think if you just look at the portfolio, it's pretty easy to see that the growth is really driven by the more industrial businesses, the CapEx related businesses, as well as Palmers and Fluids. there's a fair bit of underlying industrial demand in that business. And then there's a little bit more challenge in the more consumer-oriented, kind of interest rate sensitive parts of the company, which would be construction, maybe to some extent also the automotive business. But really, I think construction and automotive are the ones we would consider the most interest rate sensitive. I think it's really encouraging when you look at the automotive business here in the third quarter that in North America we significantly outperformed bills, which is – and the same is true in China by about five basis points, five percentage points in both cases. And so there is room for opportunities for growth here with select customers and as a result of really driving CBI and new products in this segment. And then the challenge was really mostly on the European side, but that was kind of a unique situation related to PLS and customer mix. But that's really how we would think about it.
Okay, that's helpful. And then just maybe from a geographic perspective, just love to gauge your sense of momentum or relative optimism or pessimism. I mean, noticing that Europe is flat, see North America growing nicely, just kind of curious if you have any feeling of whether Europe can hold flat. And if it doesn't, are you assuming that North America will accelerate? I'm just curious for sort of any momentum and expectation commentary around geographies.
Yeah, I think, Steve, what's very clear is, you know, North America is the fastest growing region. Like I said, up 6% here in the third quarter. We do expect that momentum to continue and maybe even build a little bit here in Q4. And then when we do the plans for next year, we'll have a better feel for that. But a lot of positive momentum in North America, particularly test and measurement electronics, welding, polymers and fluids, kind of the usual suspects are driving a lot of the growth there. And we expect that to continue in the fourth quarter. Europe, it's tough to be super optimistic about Europe, about flat here in Q3. Could be a little bit better in the fourth quarter. tied to automotive, test and measurement electronics, but not expecting, you know, a lot of improvement in that geography. And then, you know, China, after years of double-digit growth, and I think last year up 9%, I think the growth there, as you would expect, has maybe slowed down a little bit. And so we're still in kind of the flat kind of China, maybe down low single digits in Q3 and Q4. But a lot of potential going forward. in that geography. So maybe that's how we would handicap it by region.
One great spot we have in Europe is food equipment.
Yeah, that's true. Yeah, I mean, I think that's a really good point. You know, food equipment up mid-single digits, like I said, in Europe, both on the equipment as well as on the service side. And so that's a real strength for the company.
Operator
The next question is from Nicole DeBlas of Deutsche Bank. Your line is open. Please go ahead.
Nicole? Sorry, guys. I was on mute. Can you hear me now?
I appreciate that. Thank you for the question. So I just wanted to hit on margins a little bit more. You guys said, you know, kind of expect flat margins sequentially in the fourth quarter, but we know that that welding insurance gain kind of goes away. You talked about polymers and fluids probably seeing a bit of sequential decline. What is then getting you back to flat? Are you expecting Q1Q margin expansion across the rest of the businesses? And were there any tariff refunds in the margins this quarter?
So I think really if you look at the Q4 margins, I think what you're hinting at is the fact that margins typically go down from Q3 to Q4. The reason that we don't think that's the case is based on current run rates. we actually expect revenues to go up sequentially from Q3 to Q4. We said between 1% and 2% growth sequentially, which gets us to that 5% plus organic revenue growth in the fourth quarter. And so beyond that operating leverage that comes with that, everything else is pretty much the same in terms of the biggest structural driver of margin improvement remains the enterprise initiatives. which could just contribute 130 basis points. We expect another 100 there. You know, volume leverage was favorable in Q3. Like I said, we expect that to be more favorable in Q4. We're being a little cautious around price costs, just given how quickly those can move around. But overall, you know, we're pretty confident that we'll be able to improve margins here in the fourth quarter on a year-over-year basis and then sequentially about the same, which box kind of the typical seasonality.
Okay. Okay. Thank you. That's really helpful. And then just as a follow-up, the 31% organic growth in electronics is pretty stunning. What is your thoughts on the sustainability of that magnitude of growth in the fourth quarter and perhaps into 27 as well?
Yeah. So, Nicole, we believe it's very, very sustainable based on the strong order activity that we're seeing from our semi-electronics customers. I mean, these customers are working very hard to increase fab capacity, produce printed circuit boards, and meet the growing needs of AI, you know. So, you know, very sustainable, very encouraging. We have – this is an area where we've invested in considerably over the last number of years, so we're now very well positioned to completely capitalize on that. It's also a great opportunity for us to innovate for us. So, given the strong competitive advantages that we have as it relates to semi-manufacturing, testing equipment particularly, we're really well positioned here to take share as the end markets continue to improve.
Thank you. I'll pass it on.
Operator
As there are no more questions at this time, we'd like to thank you for participating in today's conference call. All lines may now disconnect.
