Illinois Tool Works Inc (ITW) 2016 Q3 法說會逐字稿

Welcome and thank you all for standing by.

(Operator Instructions)

Today's call is being recorded. If you have any objections, you may disconnect at any point.

I'd like to turn the call over now to your host, Mr. Michael Larsen, Senior Vice President and Chief Financial Officer. Sir, you may begin.

Thank you, Gary. Good morning and welcome to ITW's third-quarter 2016 conference call. I am Michael Larsen, ITW's Senior Vice President and CFO, and joining me this morning is our Chairman and CEO, Scott Santi. During today's call, we will discuss our third-quarter 2016 financial results, and update you on our 2016 earnings forecast.

Before we get to the results, let me remind you that this presentation contains our financial forecast for the fourth quarter and full year 2016, as well as other forward-looking statements identified on this slide. We refer you to the Company's 2015 Form 10-K and Form 10-Q for the second quarter of 2016 for more detail about important risks that could cause actual results to differ materially from our expectation.

Also, this presentation uses certain non-GAAP measures. And while we use very few non-GAAP measures, 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.

In Q3, ITW delivered another quarter of high-quality earnings growth, with record operating income, operating margin, and return on invested capital performance. In the quarter, we generated 8% GAAP earnings-per-share growth. Operating margin of 23.1%, which if you exclude the 80 basis points of EF&C acquisition dilution was 23.9% on an apples-to-apples basis, and after-tax return on invested capital came in at 23%. The key driver of our performance continues to be the execution of our strategy. The third quarter marked the 12th quarter in a row that our enterprise strategy initiatives delivered more than 100 basis points of margin expansion. In addition, we are continuing to make good progress in executing our pivot to growth, with six of our seven segments again delivering positive organic growth in Q3, despite a macro environment that obviously remains challenging.

Through the execution of our strategy, we have grown earnings per share by an average of 15% per year over the last four years with almost no help from the market environment. But we still have a ways to go before we are operating to our full potential. We look forward to providing an update on the work that we have ahead of us to deliver on ITW's full performance potential at our annual Investor Day in December.

With that, I'll turn the call over to Michael who will provide you with more detail regarding our Q3 performance and our updated Q4 2016 forecast. Michael?

Thank you, Scott.

ITW's third quarter was another high-quality quarter, with solid earnings growth, continued margin expansion, and solid free cash flow. EPS was up 8% to $1.50, slightly ahead of the midpoint of our guidance, due to solid execution and the resulting better margin performance. Total revenue was $3.5 billion, up 4%, and organic growth was 2% in line with guidance.

Overall demand was pretty steady-state as we moved through the quarter in what continues to be a fairly challenging environment, particularly on the capital equipment side. Nevertheless, 6 or 7 segments delivered positive organic growth, and key regions such as North America, Europe, Asia Pacific, including China, were all positive.

In my opinion, the highlight this quarter was ITW's record operating margin performance of 23.1%, 23.9% when you exclude EF&C, and all seven segments performing above 21%. Operating income grew 6% to $808 million, and the after-tax return on invested capital improved 140 basis points to 23%. Both of these performance metrics were all-time highs for ITW.

We invested more than $150 million in capital equipment, new products and projects to simplify our businesses. Free cash flow of 101% of net income was a little lower than last year due to some quarterly timing. But year to date, we're on track at 94%, which compares to 96% at this point last year. We typically have a strong Q4, and we expect to finish the year above 100%. In addition, we repurchased shares for $500 million, and expect to complete this year's program with another $500 million in Q4, bringing the total to $2 billion. Finally, as you saw in August, ITW announced a dividend increase of 18%. So overall, a pretty straightforward good quarter as ITW continued to execute well and deliver strong results.

On slide 5, starting with the key drivers of our operating margin performance. The strong execution of our enterprise initiatives contributed 120 basis points; price cost was slightly favorable. Volume leverage of 30 basis points was offset by a number of other items, and EF&C diluted margin 80 basis points, resulting in 23.1% a record for the Company. And like I said, 23.9% if you're comparing to our long-term performance goal on 23%-plus.

On page 6, really good operating performance across the seven segments, with all segments at or above 21% for the first time ever. I wanted to point out that automotive OEM margins, as expected, were diluted 370 basis points by EF&C and that the core business is obviously still very strong at 25%-plus. In construction, restructuring related to the simplification of our European manufacturing footprint created a drag of 190 basis points. The other segment numbers speak for themselves, really strong performance again this quarter.

Turning to the segment discussion and starting with our automotive OEM. A really good quarter on the top line as organic revenue grew 7% due to strong penetration gains in every region. In North America, 5% organic growth compares favorably to [order bills] of 2%, and that includes a 1% decline at the so-called D3 where we have relatively higher content. Europe was up 5%, with 700 basis points of penetration gains as overall builds were down 2%. And China was up 40%, with very significant penetration gains due to new product launches this quarter. Also, you may recall that China was down 5% in this quarter last year, making for a relatively easy comparison.

Food equipment was up 1% organically, with North America equipment up 3% due to a difficult year-over-year comparison. You may recall that in the third quarter last year, equipment was up 8%. International equipment was down 3%, and service was up 1%. Based on Q3 exit run rates and backlog and a more normalized comparison, we expect the Q4 organic growth rate to be more in line with recent trends. So continued solid demand in food equipment. Also, continued strong margin performance, as 27.4% was the highest margin in the Company this quarter.

A good quarter for test & measurement and electronics, as organic revenue grew 7%, due primarily to an easy comparison. Last year in the third quarter, the segment was down 11%. Electronics was up 13%, and test & measurement was up 1% in what continues to be a fairly sluggish capital investment demand environment. However, the solid margin expansion is really encouraging, and something we talked about on this call before. Margin improved 440 basis points to 21%, with 190 basis points from enterprise initiatives and the balance primarily from volume leverage.

While the demand environment in welding is stable, it is still pretty challenging, as evidenced by the 9% decline in year-over-year revenues. The decline breaks down as 4 points from oil and gas, 3 points from industrial, which is mostly heavy equipment related to agriculture, infrastructure, and mining, and then 2 points from commercial.

The brighter story is on the margin front, as the welding team continues to do an excellent job managing the cost structure through this cycle while preserving our strong position in the marketplace. And being ready to fully participate as things eventually turn around. Despite peak-to-trough revenues being down about 20%, operating margin is 26.5% this quarter, which is only 150 basis points below peak margins. In the third quarter, benefits from enterprise initiatives and the restructuring projects we talked about last quarter contributed 240 basis points to margin expansion. As we've said before, our welding segment remains a good example of how resilient the ITW business model is across a wide range of economic scenarios.

Polymers & fluids delivered another quarter of positive organic revenue growth, up 1%. On a regional basis, international was up 3%, and North America was down 1%, mostly due to lower demand on the industrial MRO side of the business. Margin improved 200 basis points to 21%, driven by initiatives and restructuring savings.

Demand in construction products held pretty steady this quarter, as the segment grew 2% organically. Construction also had a challenging comparison to last year when North America was up 7%. This quarter, North America was up 1% as compared to down 1% in Q2. And this quarter commercial grew 5%, renovation and remodeling was up 4%, and residential was down slightly 1 point. Asia Pacific was up 2%, Europe was pretty good, up 2%, but below the Q2 growth rates of 7% and 6% respectively. And we talked about the margins, 24.5% in construction if you exclude the European simplification project this quarter.

Finally, specialty products organic revenue essentially flat, with international up 3% and North America down slightly. Our consumer packaging consumable businesses in this segment are growing solidly, offset by weaker demand on the capital equipment side. Good progress on the margin side, with an increase of 210 basis points to 26.1% driven by 180 basis points from enterprise initiatives.

Turning to page 10, our updated guidance for 2016. As you saw this morning, we are raising the midpoint of our full year EPS guidance and narrowing the range to $5.56 to $5.66, which represents 9% earnings growth at the midpoint. As usual, we are assuming current foreign exchange rates, which, given the recent strengthening of the dollar against the pound and the euro creates a few pennies of currency translation headwind in the fourth quarter. As a result, the full-year guidance increase of $0.01 is essentially the $0.03 beep from the third quarter partially offset by $0.02 of additional currency translation headwind in the fourth quarter at today's foreign exchange rates.

We expect full-year 2016 operating margin to be above 22.5%, a new full-year record for the Company, and up from 21.4% last year. Keep in mind that EF&C dilutes full-year margin by approximately 50 basis points. In other words, excluding EF&C, we would be talking about approximately 23% operating margin for the year.

For the fourth quarter, as usual, our forecast assumes Q3 exit run rates, which equates to organic growth of 0% to 2%. And embedded in that organic growth forecast is a steady-state demand assumption that we feel is pretty reasonable in light of the relatively stable demand trends across our business portfolio in Q3. We expect operating margin of approximately 21.5%, which is greater than 22% when you exclude EF&C, which compares to 20.7% in Q4 last year. So continued strong margin expansion in Q4. Finally, EPS guidance is $1.31 to $1.41, which is 11% earnings growth at the midpoint, marking a pretty strong finish to the year.

So that concludes our prepared remarks, and we'll now open up the call to your questions.

(Operator Instructions)

For our first question it's from Mr. John Inch from Deutsche Bank.

Thank you. Good morning, everyone. Guys, international food equipment softness I guess was consistent with [Lenox] comments. I'm wondering if we could get a little more color on that, what you're seeing?

I remember the call or the commentary around restaurants, which were softer. I believe it was about -- I think restaurants were about 15% of your mix. Maybe if you could just put the international softness in the restaurant issue into a context for us?

Yes, so, John, I wouldn't read too much into this quarter in food equipment. As you know, the quarter trends can bounce around a little bit. I think if you look at the year-to-date numbers, up in that 3% to 4% range, we expect to end up in the same place in Q4 and for the full year.

I'd say in food equipment more broadly, we continue to see strength on the institutional side which is the majority of our business, particularly in refrigeration. And then on the scale side in the retail business. But really nothing to be too concerned about in terms of the demand environment, pretty stable as we went through the quarter and we'll be back on trend in Q4.

Okay. So this international is -- you're describing it more as a blip versus some beginning of a trend. Is that a fair statement?

Yes, that's correct.

Okay. And then test & measurement and electronics, I think some people don't fully appreciate what's in the electronics segment. And I make the commentary in the context that 3M and others have experienced consumer electronics weakness.

In their situation, it's OLED conversion and smartphone saturation. And I guess I'm wondering, are you experiencing any kind of consumer softness within the confines of the umbrella of this electronics up 13% organically?

Our exposures there really fall into two buckets. One is -- and largely clean room MRO collection of businesses, that's a pretty steady Eddie business. And then the other piece which is where we saw some of the -- the big driver of year-on-year growth improvement was really on the equipment side.

So we're producing equipment that people use to produce printed circuit boards. And that business, again Michael talked about it, was up somewhat in the quarter but also on a very low comp on the prior year. So I think we would not describe that business as being down significantly or being under pressure, but it's -- I also wouldn't read a lot into the year-on-year growth number either.

That's fair. And then just lastly, your auto strength in China. Michael, you attributed it to product launches.

Is this a one quarter phenomenon, or are you gearing up to try and penetrate the China auto sector? Does this have more legs beyond the quarter I guess is what I'm wondering?

Yes, I think this has a lot more legs to it as we go forward and into next year and beyond. Obviously at 40%, builds were up 20% plus. But in terms of what the penetration gains can be, I think that's directionally -- that's where we would expect it to be going forward.

And that 2x number, is that what you're saying?

Yes, I think that's doable. Based on the new products and what's in the pipeline, yes.

Thanks very much, appreciate it.

Thank you. And for our next question it's from Joe Ritchie from Goldman Sachs.

Thanks, good morning, guys.

Morning.

Nice fundamental quarter. Maybe just focusing on auto since there seems to be a lot of concern out there right now, given potentially peaking auto builds and Ford's comments about idling capacity.

You mentioned in your prepared remarks that the big three was down [1%], but the out growth in North America was still really strong. And so maybe just provide a little bit more color on where you're seeing the out growth, and expectation longer term to continue to outgrow auto production?

We've talked about this over times in the past. But the auto business for us is one where we do have a reasonable amount of forward visibility, typically two to three years. So we feel very good about our pipeline of new content going on new vehicles.

Certainly, we will be impacted on a relative basis based on the overall build levels in the market. But our ability to continue to outgrow whatever the market growth rate is, if it flattens out, we would still expect to be positive by 200 to 400 basis points. And that's pretty much a three-year look. We've got some great backlogs, some great programs in place, and a lot of really compelling things we're working on. So it's an area that we are very bullish on on a long-term basis.

And I would just add, Joe, specifically to the D3 being down 1%, the expectation is for them to be down again in Q4 and that's fully embedded in our forecast. And I think similar to in food, you'll see a growth rate in line with what we've done historically on the auto side here in Q4.

Got it, that's helpful. And maybe touching base on the margins on auto. I know you guys are under consistent pricing pressure, but at the same time can really get a lot of production efficiency to help continue to grow margins in that segment.

Given that it's longer cycle and maybe you have a little bit more visibility on auto, I'm just curious, compare and contrast auto versus welding. Because you've done such a great job at continuing to expand margins in your welding segment, despite a rollover in growth. I'm just curious how resilient you think your auto margins can be if we do start to see a slowdown in auto?

Well the auto margin story is largely about the value-add content we put in the product. So we have talked I think on a number of occasions of our business being very nichey, very oriented around solving tough problems for our OEM customers. We are not playing in the bumpers on whatever model car you're talking about.

We're not an RFQ bidder, we are a problem solver. So from the standpoint of the overall margin performance in that business, it largely is a function of our discipline around the types of opportunities we are willing to engage at with our customers on and how well our skill set matches up with what they need a partner to do. So I think we're in really good shape.

These are typically longer term, 6, 7 year kinds of programs. And certainly there are some commitments often embedded in terms of annual cost take out, but those are fully baked in terms of our knowledge up front. And we will work really hard on delivering value not only in the design of the actual solution, but on an ongoing basis continue to drive benefits for our customers that also drive benefits to the Company.

Okay, fair enough. I'll get back in queue. Thanks, guys.

Thank you, sir. And for our next question, it's from Scott Davis from Barclays.

Hello, good morning, guys. I'm trying to get a sense of when welding does come back, what type of margin structure we can expect? And the question really here is that how much discretionary spend has been cut and things that you're going to have to add back pretty quickly, your investment spend or how you define it?

But just general spend that may come back that would indicate that maybe even margins don't go up when welding comes back, but more flattish. Just some color on that would be helpful.

Yes, your final comment would be very hard for me to see any scenario where that would be the case. The teams in welding have done a really nice job of adjusting cost structure to the overall current demand environment. But there's nothing -- we've also been very clear and they've worked very hard in making sure all that of our important growth investments remain fully funded throughout this down cycle.

So it is largely a matter of a lot of reapplication of 80/20, a lot of focus and prioritization. It's not about cutting muscle, it's about adjusting the cost structure. So from the standpoint of how it looks on a go-forward basis I would have a hard time seeing any scenario where the incremental margins on the recovery would be far outside of our traditional 30% to 35% bucket.

Okay, that's helpful. And then just as a follow on, if you think in terms of some normalization in welding sequentially. When do you think you'd be -- I know this is hard, but given that oil prices are back up over $50 and emerging markets are getting a bit better and such, do you get a sense of a book-to-bill in the 1.0 or a little bit better range earlier in 2017, or do you still think it might more of a mid to later?

I tell you what, I would probably not want to get into the forecasting business here. We're going up on eight quarters now, some pretty significant contraction. We got to see it flatten out first.

I would say from the standpoint of just sequential daily order rate demand trends, it's been pretty solid, pretty steady state for the last three or four quarters here. But we're certainly not seeing signs of any pick up at this point. I would really hesitate to call a turn at some point in the future, but we're well positioned to participate in it when it happens and I think we're managing the business through this down cycle pretty well.

Fair. Thank you, guys. Appreciate it.

Thank you. For our next question, it's from David Raso from Evercore ISI.

Thank you. First, a broad question. Can you set the framework for the December meeting? What we should be expecting, organic growth, enterprise initiatives for next year?

No. Dave, we haven't even been through our full planning cycle yet for 2017. So that happens in November which is always our normal routine, and then we come to December well armed with a pretty good view of what we think we ought to be able to accomplish in the upcoming year.

Is it fair to say given next year is officially the last year of the enterprise initiatives, that yes, there's a year left of that but the meeting is going to pivot more? I'm trying to focus on can you accelerate organic growth with internal initiatives? Is that the --?

Not necessarily.

Okay, that's interesting. When I think about the incremental margins you just put up, and simplistically, I think of it as when you provide that organic margin change the straight operating leverage that you provide right before any changes in variable margin overhead costs. The incremental margins were about 36%, and then obviously it went higher when you added some of the enterprise initiatives.

Whatever you do provide in organic sales growth for 2017 at that meeting, how should we be thinking about how you view your organic incremental margins? Because we're trying to pivot away from an internal, hey we can keep growing these margins 100 bps a year because at some point it just gets more challenging. What can you give us on organic, and what kind of leverage do you expect? Just to provide some framework.

Well I think, David, consistent with what we've said before and I think Scott just mentioned this and when we're talking about welding is we would expect our incremental margins to continue to be in that 30% to 35% range. That's the base rate, that does not include the enterprise initiatives. That's correct, yes.

(Multiple speakers) for the buckets, whatever you can do inorganically, and obviously the pressure is on a little bit as we pivot away from the enterprise initiatives. How much can you get the ready to grow to show itself and faster organic? But you still have another year of enterprise value.

And then again, Scott, I do assume at the meeting we'll get some further progress on the idea of pivoting to the organic story. And the capital allocation, obviously, you're still generating strong cash. I assume we'll get some clarity on how to think about the next few years?

I know it's hard to forecast, just the pivot here from margin story internally to organic was always the benefit of your strong cash flow and capital allocation. It is an interesting moment for the stocks evolution, right? We'll get more than just a hey, here is the 2017 outlook, is that fair?

Yes.

Okay, thank you very much. I appreciate it.

Thank you. For our next question, it's from Andy Kaplowitz from Citi.

Hey, good morning, guys. Scott, so with expected margin in test & measurement to improve as your enterprise initiatives continue to ramp up, were you surprised by the speed of the margin ramp up? Is it really just new leadership this year taking a fresh look at the business and making more immediate changes than anything else? And is there anything stopping test & measurement from being a mid 20% margin business like your other businesses over time?

Yes. The second answer -- the answer to the second question is no. Great fundamentals in that business, and I would say, as with all of our seven businesses, they are, in terms of the work they've done, moving through these enterprise strategy initiatives, they all started in a different place.

They all had their own level of work to be done, and in test & measurement's case they are -- we said progress in terms of outcome is not worthy. But they've been doing things inside that haven't necessarily showed up in terms of margin for the last six or eight quarters. So I'm very pleased with now what's starting to show up, but they've been on a pretty good track all the way along in terms of what they've been working on to get where they can be, and as you said, still have more room to go.

Okay, that's great, Scott. And then just shifting to construction, can you talk about what happened this quarter? You said BSS reduced margins by 190 basis points, but I would have thought that much of the simplification in that segment had already occurred,

We know you have been trying to simplify your European construction footprint for some time. But the level of BSS seems a little more out of the blue I guess than I would have thought.

Well it wasn't necessarily out of the blue, but there was -- from day one we knew that there was a lot to get done there. They've gone through a couple of cycles. And this particular project that has certainly a visible impact on margin in Q3 was one that has been in the planning cycle for a while.

But it was among our most complex structures in the Company. If you go back to 20 -- I'm talking about European construction. And so we've talked in the past about not only the work we've been doing, but the way we've been doing the work in terms of doing it in a methodical fashion, in a way that doesn't impair our ability to serve our customers, and generate some reasonable incremental progress along the way.

So while this particular activity was known, we knew we were going to have to do it almost back to the beginning. It's one where we also are now at a place from the standpoint of timing where we are in a position to do it, and do it in a way that doesn't impact our ability to serve our customers in the region. So it wasn't out of the blue from our standpoint by any stretch.

Scott, does the headwind from this quickly go away in terms of the margin difference?

Yes, look at welding from last quarter. Our restructuring when it tends to be that concentrated in the segment, we're doing it every quarter. We talked to you about the overall spend, it's typically spread pretty evenly. We don't even talk about it, it's just part of how we operate.

But in the case of welding in Q2, we talked about some fairly sizeable actions and then look at the recovery in Q3 already in terms of margin from that. So in construction, the expense side of these are front-end loaded based on the accounting rules. But the benefits ultimately start to show up, maybe not fully in Q4 but certainly over the next three quarters or so.

Okay, great. Appreciate it, guys.

Thank you. For our next question it is from Nigel Coe from Morgan Stanley.

Yes, thanks. Good morning. I know you don't provide quarterly guidance by segment, but just given the diversions that we saw this quarter I just wonder if you could maybe give us some help in terms of how you see the 0% to 2% playing out in 4Q? I'm assuming that auto tries to maintain 7%, but any commentary in terms of that spread would be helpful.

Yes, so as you know and as we said, our Q4 organic growth forecast is based on the Q3 exit run rates from a demand standpoint. And really what some of the deviations from that, as you see, are really more a comparison issue than anything else.

And I think you asked about automotive. Automotive, if you look at their year-to-date growth rate in that 4% to 5% range, that's probably what you'd expect to see given current run rates and given the comps here in the fourth quarter.

Okay. And then how does that look in 4Q?

How does it look in, sorry?

How does that look in 4Q?

In test & measurement?

Exactly, yes.

I think test & measurement, the comparison is really the driver of the big 7% increase this quarter. That normalizes a little bit here in Q4, and I think you'll see probably a year-over-year increase in Q4 that's in the low single digits in test & measurement. And it's really driven by the continued sluggish demand for capital equipment which impacts the test & measurement side of that segment.

Right. Okay, great. And then just a quick one on the impact of EFC in 4Q. You guided for 50 bps or thereabouts of dilution for the full year, suggests that the margin impact is going to be slightly greater in 4Q than 3Q. Is that correct, and if that is the case why would that be given I've expected most of the wipe downs have happened in the 3Q as opposed to 4Q?

I'm not sure how you got that, Nigel. Q4 is going to look a lot like Q3 in terms of the EF&C impact. So you saw the margin dilution, 80 basis points at the enterprise level, we would expect the same here in Q4. Revenues in Q3 of $117 million, which is in line with what we expected and we expect something very similar to that here in the fourth quarter.

And then finally on the EPS side, consistent with what we said before, EPS neutral in the first six months here in the second half of 2016. And then accretive, I would expect it to be accretive as we get into 2017 and we have to go through the planning process, as Scott said, and then we'll give you an update when we get to giving guidance for 2017.

Okay, I'll leave it there. Thank you very much.

Thank you.

Thank you. And next question is from Mig Dobre from Baird.

Yes, thank you. Good morning. If we can go back to food equipment, I'm looking at North America service and growth here over the past couple of quarters has slowed a bit after running at 4% to 5% for the last couple of years. I'm wondering if you can give us any color as to what's going on here, what's driving the slowdown?

I wouldn't say, Mig, it's necessarily a slowdown, I think again, if you go back and look service in North America was up 4% in Q3 last year, we're up 2% this year. That's pretty solid. But we've also talked about the fact that we think there is more potential here for organic growth, that's probably closer to what we're seeing at least on the equipment side.

I know, but I'm asking really about service. And it is a slowdown from the 4% to 5% that you've consistently put up since early 2014. And I guess my question is really going to this idea that we're starting to see that restaurant sales have slowed here, and I'm wondering if that's the driver or if it's something else?

No, that's not it at all. I think if you go back and look, I don't we've put up 4% to 5% in service since 2014. But I think that going forward, that's not an unrealistic expectation.

Service is stable here. We had, we talked about this last quarter also, a little bit of PLS in some parts of the business, but overall in this low single digit is a pretty good way to think about the business on a go-forward basis from a growth standpoint. And then obviously as you know, this is a very profitable part of the business, more profitable than the equipment side.

And then my follow up is back to auto, looking at the core margin this quarter which was flattish on pretty good volume growth. I'm wondering if there is a bit of a mix issue there or anything else you'd highlight?

Yes, that's exactly it. So it's really a product mix issue.

And how do we think about (multiple speakers)?

So 25.5% in automotive, pretty solid margins. And you're right to point out that the volume leverage really here is the reason why it didn't show up is a product mix issue.

Is this with us going forward into the fourth quarter?

It might be. It's hard to forecast at that level of detail, but what is going to be with us on a go-forward basis are these core margins in the mid 20%s.

Thank you.

Thank you.

(Operator Instructions)

Our next question is from Andy Casey from Wells Fargo Securities.

Thanks a lot. Good morning, everybody. Just another question on the auto margin, could you define what the purchase accounting charges were in Q3, and are there any one-offs in Q4?

Yes, I think rather than go through the individual pieces here, Andy, I'd rather wait until we can give you the complete picture also and include in that the guidance here for next year. What I will tell you is that the business is actually performing a little bit better than what we thought from an operational standpoint. The operating margins are right where we thought they were going to be, there were no surprises from a purchase accounting standpoint, and like we said there was no EPS impact here in the quarter.

Which in fact means that the charges basically ate up what the business earned for the next couple of quarters.

That's exactly right. So that's the way to think about it. And we've talked about this, Andy, when we give you guidance for 2017, we'll give you a complete picture.

Okay, thank you, Michael. And then the last one in polymers & fluids, within that, the 1% North America decline. Can you give any color on that, and update us on what's going on in the auto aftermarket?

Yes, I think automotive aftermarket was pretty stable here again, flat to slightly positive. The decline is really tied to the maintenance, the industrial MRO side of that business. So some of the industrial lubricants and consistent with what we've seen in prior quarters, that is still somewhat challenged, the industrial MRO side.

Okay, thank you very much.

Thank you. Our next question is from Ann Duignan from JPMorgan.

Hello, good morning, everyone.

Good morning.

Can you talk a little bit about the fundamentals in European construction, and by country or by region and then by application? Where are you seeing strength, are you seeing any slowdown in the UK, et cetera? If you could just give us a little bit more color on what you're seeing there, that would be great.

I think Europe was pretty good this quarter, up 2%, pretty steady and really nothing unusual as we went through the quarter or nothing really material to point out on a country level. So pretty steady state, feel pretty good about the demand levels obviously up 2% and feel good about it going into Q4.

Okay. So no big changes in the UK versus some of the other regions?

Not at this point.

No, overall UK, as you know, our UK business overall not talking construction is about 4% of sales, and it was actually positive in the quarter. Like we talked about before, the impact right now what we're seeing is on the currency side really on the translation side of things, but we haven't seen anything other than that that's worth mentioning.

And the FX, is that a net positive or a net negative? Are you exporting out of the UK or importing into the UK?

We're producing and selling in the UK.

The impact is really on the translation side, so we are -- we have run profitable businesses in the UK. And when we bring those, we translate those British pound earnings into US dollars, there's a headwind. So that's really what we are talking about.

Okay, I appreciate the color. And then just a little bit more color on the automotive, sorry to keep coming back to automotive. But your comments that mix had an impact on the quarter, can you just give us more color there? Is that regional mix or mix of builds, and just a little bit more on how we should think about that going forward?

Yes, what we are talking about is product mix I think in North America. And so depending -- our content per vehicle might be slightly different by product line, and that's really what we are talking about.

So can I take that as there isn't a huge difference in margins regionally?

Yes, that's correct, yes.

Okay, that's important. Thank you. I'll get back in line.

Thank you. Our next question is from Steven Fisher from UBS.

Thanks, good morning. I think you made indirect reference to this, David Raso, but how is your visibility changing on winding down POS activities? To what extent are you increasingly confident that 2016 is the last main year we'll see it as a headwind?

Well I think what I would prefer to do is wait till we go through this planning cycle that we just talked about. We will give you a good update on the end of December. But I think before we do any speculating, we'll let our businesses run their plans for 2017 through and then we'll have a better picture there.

Clearly at some point, it will start winding down. I would also argue on the other side that we have -- this is activity that is very healthy from the standpoint of profitability and focus. So to the extent that there's continued activity there, we're going to continue to support it until we get all the stuff out of here that we think needs to go so we can really focus on the highly profitable parts of our business that we think have long-term growth potential.

So we're not -- so we'll see what happens. I would expect that certainly things start to at least stabilize there, if not start to slow down. But until we go through the actual details of what our businesses have in mind for next year, it's hard to comment.

Okay. And then within your 35% or so incremental margin targets, how should we think about -- how much of that is driven by pricing versus volume? As we look at slide 5, it looked like we had a negative volume impact there, so just trying to break that down if we could.

Yes, pricing is not a big margin driver for us here, as really the big margin driver is and has been I think Scott mentioned 12 quarters in a row of the enterprise initiatives, and that's really what's driving the margin expansion. And the incremental margins, if you go back and look historically, that's where the Company has been for a long time in that 30% to 35% range. And really on the pricing side, all we're trying to do is to offset some material cost inflation, but it's not the key driver of our growth or of our margin expansion.

Okay, thank you.

Thank you.

(Operator Instructions)

Our next question is from Stephen Volkmann from Jefferies.

Hello, good morning. Most of my questions have been answered, but I think you said price cost was like 10 basis points or something in the quarter. I'm just curious if there's anything interesting to talk about on either the price or the cost side, and how we think that's going to look maybe in the fourth quarter? Does it actually turn negative, or whatever commentary you might have there? Thanks.

No, there's really nothing interesting to report. I think I said, all we're trying to do is offset to the extent that there is material cost inflation, we're trying to offset that with price. We've been in this 10 to 20 basis points range for a number of quarters here, actually longer than that, and we expect it to stay in that range on a go-forward basis.

Okay. I guess there's a perception that some of these material costs are starting to go up. Are you seeing that and you're just able to price for it, or is that not consistent with what you're seeing?

We're not seeing any material cost inflation at this point. And when we do, we will react, like I said, and do our best in the divisions to offset that with efficiency and with price.

I appreciate it, thanks.

Thank you. And for our last question for today, we have Jamie Cook from Credit Suisse.

Hello, good morning. I just guess just two follow-up questions.

One, in your prepared remarks you mentioned free cash flow. The free cash flow was a little light, and it sounded like there was some timing issues. Can you just talk around that, what the issues were and how much incremental that is to the fourth quarter?

And then second, I guess when I look at your construction revenues on an organic basis, it's still up but obviously the increases are declining. So just a little color on your concern whether that market is turning at all in particular with the ABI data points that we're getting out because commercial was also very strong within the construction segment? Thanks.

I think on the free cash flow, like I said, on a year-to-date basis, we're exactly where we were last year. So there is -- things can move around a little bit on a quarterly basis. For example, our CapEx number is up a little bit this quarter, but year to date it's exactly in line with last year and then maybe some larger payments that go out one quarter versus another.

We fully expect we'll be at above 100% for the year, which would imply a strong Q4 which seasonally that's what we usually do. So other than that, feel very good about the free cash flow performance.

And on the construction side, I'd just add similar to what we said earlier, demand is pretty steady state. There's some comp issues that we're dealing with, but we feel good about the using current run rates to model the fourth quarter and we're not expecting any big changes from where we are right now.

Okay, thanks. I'll get back in queue.

Okay, and that's all for the questions, sir.

Very good. Thank you very much and have a great day.

Okay. That concludes today's conference. Thank you all for joining. You may now disconnect.