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Illinois Tool Works Inc  (NYSE:ITW)
Q3 2018 Earnings Conference Call
Oct. 24, 2018, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello and welcome to ITW's 2018 Third Quarter Earnings Call. My name is Ian and I'll be your event specialist today. All lines have been placed on mute to prevent any background noise. Please note that today's conference is being recorded. At the end of today's presentation. We will conduct a question-and-answer session. (Operator Instructions)

It is now my pleasure to turn today's program over to Karen Fletcher, Vice President of Investor Relations. Karen, the floor is yours.

Karen Fletcher -- Vice President of Investor Relations

Okay. Thank you, Ian. Good morning, and welcome to ITW's third quarter 2018 conference call. I'm joined by our Chairman and CEO, Scott Santi along with Senior Vice President and CFO, Michael Larsen. During today's call we will discuss third quarter financial results and provide guidance for the fourth quarter.

Slide number two is a reminder that this presentation contains our financial forecast for the fourth quarter and full year 2018, as well as other forward-looking statements identified on this slide. We refer you to the Company's 2017 Form 10-K, and subsequently filed Form 10-Qs for more detail about important risks that could cause actual results to differ materially from our expectations. Also, this presentation uses certain non-GAAP measures and a reconciliation of those measures to the most comparable GAAP measures is contained in the press release.

Turning to slide three, today, we're announcing the date and location for ITW's Investor Day. We hope you can join us on Friday, December 7th, in New York City, at which time, we'll provide updates term strategy as well as guidance for 2019. If you plan to attend, we ask that you please register on our investor website.

Moving on to slide four, as a reminder, in the third quarter of 2017, we disclosed a $80 million favorable legal settlement. This table summarizes key financial measures on a GAAP basis and on an adjusted basis that excludes the legal settlement. Going forward in our presentation this morning, our comments and variances exclude the legal settlement.

I will now turn the call over to our Chairman and CEO, Scott Santi.

Scott Santi -- Chairman and Chief Executive Officer

Thanks, Karen, and good morning, everyone. The ITW team delivered a solid quarter, with 11% earnings growth and EPS at the high end of our guidance range. We improved operating margin by 30 basis points to 24.6%, and increased free cash flow by 17%. In the quarter, pricing actions more than offset material cost inflation on a dollar-for-dollar basis and price/cost related margin percentage dilution showed sequential improvement versus the second quarter.

In Q3, we delivered on our earnings commitment, with top-tier margins and returns despite more challenging end market conditions than we anticipated as we headed into the quarter in a few places. North America remained solid, with 4% organic growth, while demand in international markets was mixed, as auto production in Europe and China and demand levels in several international markets served by our Specialty Products and Polymers & Fluids segments softened.

Michael will walk you through the details in a few minutes, but at a high level, the pullback in auto production in Europe and China and the softening that we saw in the two segments I mentioned internationally, negatively impacted the Company's overall organic growth rate by approximately 2 percentage points in Q3 versus what it would have been had demand in those sectors stayed even with second quarter run rates.

In addition, and as expected, ongoing product line simplification activities reduced organic growth by 70 basis points in the quarter.

Our proprietary business model continues to generate strong free cash flow, with 116% conversion in the quarter, supporting our ability to raise our dividend 28% to an annualized $4 a share and repurchase $500 million of our shares in the third quarter. While we expect that near-term market challenges will continue in the fourth quarter, we are narrowing our guidance range and reaffirming the midpoint of our 2018 EPS guidance at $7.60 per share, which represents 15% growth.

Our ability to deliver consistent strong results across a wide range of economic and end market scenarios is a direct reflection of the resilience of our high-quality, diversified business portfolio, the strength of ITW's proprietary business model and our team's focused execution of ITW's long-term strategy.

Before I turn the call over to Michael to provide more detail on the quarter, I'd like to again thank our more than 50,000 ITW colleagues around the world for their efforts in executing our strategy and serving our customers with excellence each and every day.

Michael, over to you.

Michael M. Larsen -- Analyst

Thanks, Scott. Let's recap some of the highlights on slide five. Year-over-year earnings growth in the quarter was 11%, or 13% excluding $0.03 of unfavorable currency translation impact. Despite the more challenging end market conditions in a few places that Scott talked about, we delivered earnings per share of $1.90 at the high end of our guidance range.

Organic revenue growth increased a solid 4% in North America, offset by a 1% decline in Europe, and a 2% decline in Asia Pacific . China was down 2% in the quarter, but we remain on track for mid-single digit growth in 2018, after being up 13% last year. Operating margin was 24.6%, an improvement of 30 basis points year-over-year and versus the second quarter. I will go into more detail on margin on the next slide.

After-tax return on invested capital was 28%, an improvement of 400 basis points, resulting primarily from the new US tax rules and regulations. The effective tax rate in the quarter was 23.7%, due to a net discrete tax benefit of $15 million in the quarter. Free cash flow was strong at $743 million, an increase of 17% and in the quarter, we repurchased $500 million of our shares and raised our annual dividend 28%.

Moving to slide six, and operating margin -- operating margin at 24.6% was a new record when you exclude the favorable legal settlement last year. Our strong execution on enterprise initiatives continued to contribute in a meaningful way, with 100 basis points in the quarter. Our price actions are catching up to raw material cost inflation as price/cost (Technical Difficulty) improved to 60 basis points from 70 basis points in the second quarter. And in addition, price more than offset raw material costs on a dollar-for-dollar basis this quarter.

The other line includes a number of puts and takes year-over-year, including some growth investment impact and is in line with our normal (Technical Difficulty) this quarter as a 30 basis points impact to margin. All in, operating margin expanded by 30 basis points in the quarter to 24.6%.

I'm going to spend some time on the left side of slide seven to provide additional color on the organic growth performance relative to our expectations heading into the third quarter. It comes down to three key drivers, all of them related to international end markets that collectively, reduced our organic growth rate by 2 percentage points.

The first one is our international automotive OEM business, as both European and Chinese auto production came in lower than expected. European auto production declined 5% in the quarter following 4% growth in the second quarter. Based on what we're hearing this was due primarily to the new emission regulations that went into effect in the quarter and lower exports to China. Overall, this change in builds led to a 6% decline in our auto business in Europe following 3% growth in the second quarter.

Auto production in China was down 4% following 11% growth in the second quarter. This change appears to be more related to overall consumer sentiment and the availability of financing. As a result, our China business, which was up 12% in the first half was flat, was flat.

We experienced some softness in a few international end markets served by our Polymers & Fluids segment. Specifically in Europe, additives for automotive aftermarket and reagents experienced lower demand, as did our Polymers & Fluids division in Brazil. Overall, the international component of our Polymers & Fluids segment declined 5% in Q3, in contrast with our North American business, which was up a solid 3%. Finally, the international component of our Specialty Products segment was down 7% after being down 2% in Q2.

There were significant PLS activities this quarter in addition to demand declines versus Q2 levels in three divisions: Marking & Coding, Graphics primarily for sports apparel, and Appliance Components. That said, as you can see from the left of the slide, there were some bright spots too internationally. Welding accelerated to 12% growth with the solid recovery in oil and gas after 1% growth in Q2. Test & Measurement and Electronics and Food Equipment, both had sequential organic growth increases of 2 full percentage points.

Let's walk through each segment for additional color, starting with Automotive OEM on the right side of the slide. Overall, organic growth was flat with builds down about 3% for North America, Europe and China combined. North America was strong up, 7%, 5 percentage points ahead of builds, with solid penetration gains. As I mentioned, Europe was down 6%, in line with builds and China was flat versus builds down 4%.

We continue to generate solid penetration gains with European auto OEM customers. However, inventory reductions to adjust for lower forecasted build rates offset these penetration gains, resulting in our revenues essentially declining in line with European auto rates in Q3. Despite some of the price challenges in the Automotive segment that we've discussed on prior calls, Automotive was able to hold margins on a year-over-year basis. And if it wasn't for higher restructuring expense related to acquisition integration, margins would actually have improved year-over-year.

Moving onto slide eight, Food Equipment was a bright spot, with organic revenue growth of 4%, as overall demand continued to accelerate from the first half of the year. North America overall was up 4%, with Equipment up 6%, and up 10% excluding the retail sector, which remains challenging due to lower customer investment and a tough comp from a major national roll out in 2017.

We saw particular strength on the institutional side, up in the mid-teens, as healthcare was up 20% plus, and education and lodging were both up 10% plus. International was also solid, up 3% on Equipment and up 4% on service. Operating margin of 26.6% was up more than 100 basis points sequentially from Q2 and down slightly year-over-year due to unfavorable product mix.

Test & Measurement and Electronics's organic revenue was up 3%. Test & Measurement was strong, up 7%, with Instron up double digits. Electronics slowed slightly due to lower demand in end-markets related to solar and consumer electronics, while semiconductor remained fairly stable. Operating margin improved by 60 basis points to 24.7%, a new record for this segment.

On slide nine, Welding had another strong quarter, with 10% organic growth and really strong performance across the board. Global equipment grew 12%, and consumables were up 9%. By region, North America was up 10% and international growth was up 12%. The industrial business and oil and gas were both up double-digit and the commercial business grew in the high single digits. Margin expanded by 160 basis points to 28.2%.

As we discussed, Polymers & Fluids' organic growth was down 1 point, despite solid 3% growth in North America. New product launches in auto aftermarket contributed to organic growth and margin gains in North America. Operating margin improved by more than 100 basis points.

Turning to slide 10, Construction delivered 1% organic growth in the quarter, as Europe led the way with 4% organic growth. North America was essentially flat, with residential down 1 point on a tough comparison and inventory de-stocking. Recall that residential was up 7% in the third quarter last year. Underlying demand in residential remains solid, as the business is up 4% on a year-to-date basis, and the outlook for Q4 looks in line with that growth rate. Commercial was solid too, up 5% and operating margin improved 40 basis points.

As we talked about, in Specialty, organic growth slowed on the international side, but there were also some real bright spots, with 5% growth in consumer packaging, up 6% year to date, and 7% growth in packaging equipment. Overall packaging equipment is up 12% year-to-date. On a year-to-date basis, the segment is about flat, which is also our outlook for the year as the comps are challenging in Q4.

Moving onto slide 11, with an update on raw material costs and tariffs. We continue to make good progress on price/cost as our ongoing price actions are catching up to raw material cost inflation as pricing dollars are ahead of cost dollars in a meaningful way and the margin dilution impact is stabilizing. We continue to view the tariff impact as manageable and are adjusting pricing as necessary to offset the approximately $30 million impact in 2018.

As we talked about on the last call, our exposure is significantly mitigated by our produce where we sell strategy and the fact that only 2% of ITW's spend is sourced from China. For 2019, we estimate the impact of tariffs at around $60 million, which is based on all announced tariffs and tariff increases, as well as any carryover from 2018. And we continue to expect that our pricing actions will continue to offset raw material cost inflation, including tariff impact on a dollar-for-dollar basis.

Let's got to slide 12 and guidance. We remain on track to deliver our full year EPS guidance mid-point of $7.60, despite some of the challenges we've talked about today. Our mid-point represents 15% earnings growth year-over-year, and as you saw, we narrowed the EPS range to $7.55 to $7.65 per share.

In 2018, as we have for the last five plus years, we will continue to expand our already best-in-class operating margins, returns on capital and free cash flows. For the year, we expect revenue growth of 3% to 4%, with organic growth of 2% to 3%, and operating margins in the 24% to 25% range. Enterprise initiatives contribute more than 100 basis points again this year. We are planning to repurchase approximately $2 billion of our own shares in 2018, and our tax rate for the year is expected to be in the 25% range.

Our Q4 EPS guidance is $1.78 to $1.88, up 8% year-over-year, with organic growth in the 1% to 2% range based on current levels of demand. Looking forward, we remain well positioned to continue to deliver differentiated results across a wide range of macroeconomic and end market scenarios, as we leverage our diversified, high quality business portfolio, the strength of ITW's proprietary business model and our team's ability to execute.

We hope to see many of you at our Investor Day on December 7th, and at that time, we'll discuss the details of our Finish the Job agenda, as we work to get the remainder of our divisions to their full potential in terms of organic growth and continue to improve on our best-in-class operating margins, returns on capital, and free cash flow over the next two years.

Karen, back to you.'

Karen Fletcher -- Vice President of Investor Relations

Okay. Thanks, Michael. Let's go ahead and open up the lines for questions.

Questions and Answers:

Operator

Your first question comes from the line of Joe Ritchie, Goldman Sachs. Your line is open.

Joe Ritchie -- Goldman Sachs -- Analyst

Thank you. Good morning, everyone.

Scott Santi -- Chairman and Chief Executive Officer

Good morning.

Joe Ritchie -- Goldman Sachs -- Analyst

Maybe, just kind of starting out, just a clarification on the auto OEM growth. So we saw organic growth was down 5% this quarter. When I do the regional builds the plus 7% North America, minus 6% Europe, flat China, something just -- I don't know, the math isn't really working out for me. I'm a bit curious like, are you guys disproportionately greater in Europe than you are in North America? I thought North America was a larger geography.

Scott Santi -- Chairman and Chief Executive Officer

So, I don't know what data you are looking at Joe, but we are overweight in North America followed by Europe and then China.

Joe Ritchie -- Goldman Sachs -- Analyst

Okay. Yeah. And -- OK, maybe I can follow up offline, it's just that the minus 5% number versus the regional builds looks a little bit odd. I guess maybe just sticking with organic growth for a second, if you think about the fourth quarter, 1% to 2%, pretty similar to 3Q, but the comps get tougher on a two-year basis. I guess just from an underlying perspective, what do you guys expect to be, better in 4Q versus 3Q?

Michael M. Larsen -- Analyst

Yeah. So, Joe, we just hit the $1.90 EPS, the midpoint for Q4 is $1.83. The revenue is expected to be fairly similar at current levels of demand, and mix is going to be a little bit better by segment. So some of our higher margin businesses such as Food, Specialty Products, should improve and Construction, and even Polymers & Fluids, their growth rates should improve in Q4 relative to Q3, offset by Auto, which is really at this point one of the lower margin businesses inside the Company.

So we also -- so that's really on the revenue side, 1% to 2% organic. We expect to expand margins year-over-year as we've done every quarter this year. Price/cost turned positive on a dollar basis in Q3 versus neutral for the first half. Currency headwind is a little bit lower in Q4 than in Q3. The share count is a little bit lower and the tax rate is a little difficult to call. There's some new guidance expected here in Q4, but overall, we've got a solid path here to our guidance and I'd maybe just point to our track record over the last five years.

Joe Ritchie -- Goldman Sachs -- Analyst

Okay. And then just maybe specifically just on organic growth for Auto OEM in the fourth quarter, are you expecting that to improve at all in 4Q versus 3Q?

Scott Santi -- Chairman and Chief Executive Officer

If anything, we expect it to get a little bit worse than Q3.

Joe Ritchie -- Goldman Sachs -- Analyst

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

Scott Santi -- Chairman and Chief Executive Officer

Sure.

Operator

Your next question comes from the line of Ann Duignan, JPMorgan. Your line open.

Ann Duignan -- JPMorgan -- Analyst

Yeah. Hi. Just taking your comments there on revenue, Q4 versus Q3, and knowing the way that you guys guide kind of at your current run rate, that would imply that 2019 revenue would come in around $14.4 billion, if I just took Q4 and multiplied it by four, which --

Michael M. Larsen -- Analyst

You mean 2018 Ann? You said '19. You mean '18?

Ann Duignan -- JPMorgan -- Analyst

Yeah. Well, I was going to start looking at 2019 because you'll guide to that in December, but my point being that that would be well below your long-term target of 3% to 5% organic growth. I mean is that -- am I missing something, or is that the way we should be thinking about it that the fourth quarter run rate will be what you build off of organic growth for next year or is there anything new or difference?

Scott Santi -- Chairman and Chief Executive Officer

Surely, to say, we're going through our planning process right now. And so, we'll update you in December in terms of our view kind of go-forward basis. But beyond the macro, we are working on, as we have been for the last five years, repositioning of our businesses really on two levels, as we've talked about for a while now. One is that we've got a lot of work to do in terms of operational excellence, reapplying 80-20. And once we get there, positioning (ph) those businesses to leveraging their growth potential and realizing their organic growth potential, we are today at about 50% there in terms of the divisions that I would say have -- are operating sort of within the range of their potential, both from the standpoint of 80-20 and from the standpoint of their organic growth, where the combined organic growth year-to-date of those 51% of our divisions is about 7.5% year-to-date.

So part of our growth for next year -- is certainly beyond the macro, is the continued improvement in the underlying performance of those other 49% of our businesses. We're going through the planning process now, so there is a number of different things beyond just the macros that are going to affect our organic growth rate. But I think we're pretty encouraged by the progress that we've generated in the 50% of divisions that are largely there. And as I said, 7.5% year-to-date on a combined basis, that's pretty good and speaks a lot to the potential to continue to move down that path at the entire Company level.

Ann Duignan -- JPMorgan -- Analyst

Okay. That's useful color. I didn't realize there were so many still to be realized with their potential. And just to follow up on, you noted that, in Food Equipment, margin was down, mix is up because it was more equipment and less service. Is that the right way to think about that? And then what's the outlook there for the mix?

Michael M. Larsen -- Analyst

It's really more related to what's going on on the retail side of the business, being down in a pretty significant way.

Ann Duignan -- JPMorgan -- Analyst

Okay. And the outlook there for retail, continued weakness?

Michael M. Larsen -- Analyst

Ann, certainly in the near term, we don't expect any improvement in -- on the retail side here.

Scott Santi -- Chairman and Chief Executive Officer

Through Q4.

Michael M. Larsen -- Analyst

Through Q4, I think when you look at the balance of the year, the momentum going into Q4 in Food specifically looks good. We would expect a slight improvement in the growth rate in Q4 relative to Q3. And I'd just point, margins, you're right, the mix did have an impact on a year-over-year basis. Sequentially though, we are up over 100 basis points.

Ann Duignan -- JPMorgan -- Analyst

Okay. I'll leave it there, and get back in queue. I appreciate the color.

Scott Santi -- Chairman and Chief Executive Officer

Sure.

Operator

Our next question comes from the line of Andrew Kaplowitz, Citi. Your line is open.

Andrew Kaplowitz -- Citi Research -- Analyst

Hey. Good morning, guys.

Scott Santi -- Chairman and Chief Executive Officer

Good morning.

Andrew Kaplowitz -- Citi Research -- Analyst

Scott or Michael, can you give us a little more color into your margin performance in terms of the sustainability of that performance into 2019? Again, I know you will talk about this more in December, but if I look at the quarter enterprise strategy, tailwind was still solid, volume was a little less of a tailwind, but the other headwind was half of what it was last quarter. I know you didn't break out growth this time. Price versus cost is a little better, so as you open 2019, do you have decent visibility at this point that enterprise strategy could still be a 50 basis point to 100 basis point tailwind? You've already talked about price versus cost and that other doesn't creep back up so you still see good margin expansion next year.

Michael M. Larsen -- Analyst

Yeah. I think -- and it's a little early here. We haven't gone through the plans for 2019 yet. Just on other specifically, this is kind of our normal run rate, if you go back and look where -- it's in that 20 basis points to 30 basis points range, may move around a little bit, but I think that's a pretty safe assumption on a go-forward basis. At Investor Day, we'll lay out specifically the Finish the Job agenda and which -- and what we're trying to accomplish over the next two years, including continued margin expansion.

And as we've said in the past, we certainly expect an positive impact from the enterprise initiatives next year, but I can't give you the number as we sit here simply because we haven't gone through the plans and we haven't looked at the projects and activities and the carryover that will get us to a solid number for 2019.

Scott Santi -- Chairman and Chief Executive Officer

But we'll weight it out in December.

Michael M. Larsen -- Analyst

Right.

Andrew Kaplowitz -- Citi Research -- Analyst

Okay. Michael, that's helpful. And then just the comment that you just made about 50% of the businesses still have potential for pivot to growth. I guess my understanding was that 2018 for you the tone (ph) was a pivotal year for you guys in terms of this pivotal -- pivot to growth and we think about where growth is going to come in at for this year, it's probably going to be less than 2017. And again I know that some of the markets have turned down, but when you look at businesses like Construction or Specialty Products, Polymers & Fluids, how much of the weakness is maybe that these businesses aren't performing yet to the potential that they can versus just simple market weakness?

Scott Santi -- Chairman and Chief Executive Officer

Well, it's certainly some of both. I think the -- what I can tell you is, inside the Company, this is not a sector issue in terms of Polymers & Fluids versus Automotive or any of our other segments. This is 87 divisions that operate inside each of those seven segments, and we were at about 51%, as I said earlier, in terms of businesses that are both operating at the level of excellence that they're capable of from an operational standpoint, application of 80-20 and are driving organic growth at a range that is within what we believe their potential is.

And the other 50%, we've got more work to do. And this is -- and those are pretty equally spread across all seven segments, so there is no particular tilt. I certainly expect that we would have put some better overall progress on the board had we not had auto pull back like it's pulling back in the second half of the year. It has been our fastest growing segment. So, we're giving up a little bit in the near term, but our focus is on getting this Company to its full potential. We think we've got about two years left to run in terms of getting all the way there. I don't want to steal the story from December, but that's what Michael's alluding to. And we've got plenty of more room to go on both -- both from an operational margin standpoint, and certainly we've got to get the other 49% of our divisions moving faster on organic.

And it's not that they have underexecuted. It's that they started from further back, they've had more work to do to get there. And I think, our plan at this point is probably to have some pretty specific detail at the December Investor Day. So you will have a good view of what we think. (Multiple Speakers), and what process will look like over the next couple of years to do it.

Andrew Kaplowitz -- Citi Research -- Analyst

No, Scott, real simply, do you think that 2019, you could actually have more outperformance versus markets than '18, is that sort of the plan as we sit here today?

Scott Santi -- Chairman and Chief Executive Officer

I think, give me -- give us a chance to run up -- run through all the other operating plans. We are right in the middle of that process now. I don't mean to be evasive at all, but I think the December Investor Day is in December for a reason, because it gives us a chance to go through in detail. But what I would say is, we will have a plan for the 49% of our divisions that are not there yet, how many of them are we going to get there in '19 and what kind of help that's going to provide.

Andrew Kaplowitz -- Citi Research -- Analyst

Thank you.

Operator

Your next question comes from the line of Ross Gilardi, Bank of America-Merrill Lynch. Your line is open.

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

Thank you. Good morning.

Michael M. Larsen -- Analyst

Good morning.

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

Just curious, how are you going to think about the IHS forecast in the next year's initial -- into initial guide for auto? I mean, they continue to forecast 12% -- 2% global production growth in '19, I believe, I mean with China up 4% and the US kind of flattish, Europe up a little bit. So I mean you can't help but wonder obviously if there's downward bias based on all the possible (ph) warnings we're are seeing in the global auto space. So are you going to abandon pegging your outlook to IHS and take a more conservative approach or how are you going to think about that?

Scott Santi -- Chairman and Chief Executive Officer

Well, I think, certainly over the last couple of quarters, the facts are that the backward look of IHS in terms of what production actually was is pretty good. The forward looks has not been so good. So obviously, we're going to think -- we will probably take a more ITW-specific view based on our experience as we think about '19 for Auto.

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

Okay. Thanks. And then, in Test & Measurement. I think last quarter you had attributed some of the slowdown in organic to delivery timing, but the organic seemed to slow down even further. Was there an underlying slowdown that was stronger than expected in any of your businesses? And there certainly seems to be a lot of negative headlines on semis. You said your semi-related business was stable. So could you still have a softening there still ahead of you, or are you just positioned in a part of the market that's going to be immune from some of these broader pressures?

Scott Santi -- Chairman and Chief Executive Officer

No. I think semi, as we said, was fairly stable here in Q3, which means positive growth, although at a lower rate and what we've seen in the first half of the year, that was as expected. We do expect it to slow a little bit further here in Q4 and that's included in our guidance. The other thing to keep in mind for Test & Measurement is, you're running up against a difficult comp here in Q4. On a year-over-year basis, that segment was up 9% last year. And even though Test & Measurement was up 7%, with a lot of strength in Instron here in Q3, the growth rate year-over-year is probably going to slow a little bit just based on the comp. But the underlying demand trends in Test & Measurement and Electronics broadly are very solid.

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

Okay. Thanks. And just the last one on Polymers & Fluids. I mean some of the global peers in that market seem to be getting squeezed pretty hard by raw material costs, but your margins are actually surprise to the upside. I mean is there a cost pressure still on the comp in that segment or do you think you've just adjusted prices faster than everybody else?

Michael M. Larsen -- Analyst

I can't really comment on everybody else. I can tell you what we're doing. We are seeing a fair amount of cost pressure. Other than Auto, it's the second highest in terms of price/cost impact. But they've done a great job really reacting on the pricing side, and more than offsetting those cost increases on a dollar-for-dollar basis.

Scott Santi -- Chairman and Chief Executive Officer

And as we said before, we don't hedge. So we have been incurring those costs as they are happening.

Michael M. Larsen -- Analyst

Yeah. I think that's a good point. I mean, relative to others and this is true. And maybe to expand a little bit, it's not just on raw materials, but also on currency, because we do not hedge currency and raw material costs, maybe they show up faster at ITW and gives our businesses a real-time view of what's going on and then they can react maybe faster on the pricing side. So --

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

Got it. Okay. Thanks very much guys.

Operator

Your next question comes from the line of John Inch, Gordon Haskett. Your line is open.

John Inch -- Gordon Haskett -- Analyst

Going back, Michael, to the semi exposure, can you just remind us how much of Test & Measurement, Electronics is semi? And I think, to that last question, is there something about the nature of your exposure that's allowed you to outperform?

Michael M. Larsen -- Analyst

It's about $200 million. I can't really comment specifically on why we are outperforming. Like I said, we've certainly benefited from strong growth over a long period of times. The growth rate slowed a little bit here in Q3 as expected, and we expect it to slow a little bit further here in Q4. How that compares to everybody else, I'm not sure I can give you a good view.

John Inch -- Gordon Haskett -- Analyst

No. That's fine. So, autos globally, you guys continue to outperform in North America and China. Last couple of quarters, you've had slightly below build average results in Europe, and I'm wondering is that tied to this WLTP emission stuff with respect to your portfolio, are you positioned, like are you doing some PLS work there, just what maybe or may not be going on in Europe?

Scott Santi -- Chairman and Chief Executive Officer

Yeah. I think, John, it's more related to the fact that sort of inventory levels are getting adjusted to these lower build rates. We have a lot of confidence based on new programs that we've added and are continuing to add that we are still getting penetration gains in Europe and it's just a matter of those are being offset by our customers pulling inventory down. Their requirements are less because they're producing less, but you'll see it go positive -- back to positive, certainly, over the next couple of quarters depending on how -- where the overall production rates go.

John Inch -- Gordon Haskett -- Analyst

Yeah. No. That makes sense. Maybe one more. So thinking about Polymers & Fluids and then Specialty, other aspects of your portfolio over the last few years have grown more rapidly than these businesses. Pretty strong performance, relatively strong competitive positionings, and then, as Europe's obviously softened, you've got elements of these portfolios on I think the consumables side weakening. So I'm curious, Scott, does this -- it's one of those things where they -- I'm sure they're all good businesses, but they're not necessarily performing as resiliently as some of your other segments. Does this suggest that maybe there is a lot more PLS work to do or perhaps even maybe make some select divestitures on, I don't know, some of these consumable elements of both of those segments?

Scott Santi -- Chairman and Chief Executive Officer

Well, I think what I can say for sure is, in both cases, for a slightly different reasons, they are -- the starting point, it was certainly further back in the pack, in terms of just the kind of complexity. Polymers & Fluids was a complete acquisition build segment. So we just had a lot more -- we've had a lot more stuff to deal with there in terms of getting them positioned to do what we think they are capable of. That's sort of where I sit today. I think we've got another couple of years to get this whole Company where we think it can be. And those two, I'd say, parts of Specialty and a lot of Polymers & Fluids, it's just a matter of the starting point was further back if you will in terms of making the kind of transformation that we're in the process of making.

Both are highly differentiated. Look at the margin rates, they have really solid positions inside some really strong niches, so I think we like the competitive position overall, but they have to grow faster. There is no doubt. And if we determine that they can't at some point, then I think your logic is not unreasonable, but I think we've got some more room to go before we are ready to make a call on that.

John Inch -- Gordon Haskett -- Analyst

Maybe just one last one on that point. Is there any kind of -- I realize there's a lot of niche business in here, is any of this pertaining to scale? So in other words, maybe instead of looking at divestitures, maybe it might make sense to add to those portfolios in some manner to beef up scale to kind of push it further over the goal line, if you will? Again --

Scott Santi -- Chairman and Chief Executive Officer

I think all of that across the whole portfolio is stuff -- those are sort of options that are certainly both valid and really interesting. I think the -- just given the level of performance and profitability and what we think the core growth potential is, I think what we will -- our focus is, let's get what we have in full potential position, and not try to fix our problems, let's address it with the businesses by operating the business we own to their full potential and from that view, then we can look at how we might supplement or perhaps organize ourselves differently.

John Inch -- Gordon Haskett -- Analyst

Makes perfect sense. Thanks very much.

Scott Santi -- Chairman and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Steve Volkmann, Jefferies. Your line is open.

Stephen Volkmann -- Jefferies -- Analyst

Good morning. Thank you. Just a couple of clarifications, if I might, I guess we had a little bit of sequential improvement in the price/cost headwind on margins and I assume your goal is still to fully offset that over time. Is the 10 basis point sequential improvement the right way to think about the path to get there or can you do it more quickly?

Michael M. Larsen -- Analyst

Well, I think, what's encouraging is that the margin impact, specifically year-over-year, it seems to have stabilized and certainly it's encouraging to see an improvement in Q3 relative to Q2. This is not going to be a quick fix. I mean, we do expect between raw materials and tariffs, there is -- we are going to have to continue to work the price lever, which we are. And the other piece of the equation is -- were favorable, price dollars were significantly higher than the cost dollars here in Q3, relative to the first half, where we were neutral. So that's -- when we talk about things beginning to improve, that's really what we're talking about. But obviously we are in a pretty dynamic environment here in terms of raw material costs and tariffs, and I just want to be a little cautious in terms of saying that all of this is behind us. We're going to have to continue to work this really hard, but certainly encouraged with what we've seen here in the near term.

Stephen Volkmann -- Jefferies -- Analyst

Okay. All right. Thanks, Michael. And then, just a quick follow-up and I apologize to keep beating on auto, but I think you had mentioned in your comments that there was a fair amount of restructuring and integration expense, and I think you said margins would have been up without that. And I'm just curious where are we in that process? How long does that continue? As we get further down the road, when does that headwind fade, if it does?

Michael M. Larsen -- Analyst

Yeah. We're making really good progress there. We are in the year three of basically a five-year process. And we're talking specifically about EF&C that we added.

Stephen Volkmann -- Jefferies -- Analyst

Right.

Scott Santi -- Chairman and Chief Executive Officer

And so, the things are progressing, I would say, at this point ahead of plan. It's a great business, we've added some great team members and progress is really good. And I think some of the quarterly timing in terms of restructuring is also -- I don't think it's a particularly big headwind for margin in auto on an annual basis, (Multiple Speakers) jump out in a quarter based on timing of when we are actually implementing certain things, and I think that was probably more of the case.

Michael M. Larsen -- Analyst

Yeah. I think that the impact in Q3 here was 40 basis points. We laid out a plan, Steve, a five-year plan to get margins to 20% and really a steady 200 basis points improvement every year and that's what we've delivered so far. So -- but it's not a one-time, it's really more of an ongoing program. No rush to do this, but we're definitely on the right track here.

Stephen Volkmann -- Jefferies -- Analyst

Okay. Great. And then just one final knit, if I could. The de-stocking that you're seeing in European auto, I guess we had heard through the channel that that was somewhat short term in nature and I guess you're saying that's going to continue, but at some point I suppose that that headwind goes away as well.

Scott Santi -- Chairman and Chief Executive Officer

Well, we think -- from what we're hearing, the biggest factor is this new emission standard and there's been a lot of, let's call them, bottlenecks in terms of our customers getting their vehicles through that process and to the extent that's not something that we control, nor is it something that we have either direct input from our customers on or upon view in terms of where that bottleneck clears and things, let's say, normalize. So that was -- but that was big factor in Europe in terms of the decline in production in Q3. That's certainly going to continue to be there in Q4.

We will hope to have -- looking at '19 by December in terms of, at least, give you our view of how that will play out. And the other part of Europe was also the softer demand in China. A fair amount of auto production in Europe is exported to China and ultimately how demand there -- is on -- there being China on a go forward basis will also have an impact. But right now, what we're calling this Q4 and we're not expecting any change.

Stephen Volkmann -- Jefferies -- Analyst

I appreciate it. Thank you.

Operator

Your next question comes from the line of Andy Casey, Wells Fargo Securities. Your line is open.

Andrew Casey -- Wells Fargo Securities -- Analyst

Thanks a lot. Good morning, everybody.

Scott Santi -- Chairman and Chief Executive Officer

Good morning.

Andrew Casey -- Wells Fargo Securities -- Analyst

I'm trying to understand some of the patterns that seemed to be appearing in the results that seems a little sporadic by region, but industrial seems like it's reasonably strong, but some of the consumer-oriented stuff is -- seems to be softening. Is that consistent with how you're looking at the portfolio? And if so, outside of international auto, can you talk about whether you're seeing any of your channel partners de-stock?

Michael M. Larsen -- Analyst

We talked a little bit about de-stocking on the Construction side, really into the big-box retailers here in Q3. That's really more of a near-term impact. You're correct, I mean the industrial side continues to be very solid, and then, on the consumer side, we are seeing some slightly lower growth rates on a year-over-year basis. I think on a geographic basis that we talked about, I mean North America continues to be really solid, up in the mid-single digits year-to-date, and for the year. And really what changed here in Q3 versus Q2 was what we talked about in terms of the international side of the business. Now, when you look at it by geography, It's hard to say that there are any real trends.

Scott Santi -- Chairman and Chief Executive Officer

It's pretty narrow in terms of the impacts that we saw auto in a couple of spots --

Michael M. Larsen -- Analyst

Right. It's a couple of pockets of -- offset by strength in other pockets. So we're not making any regional calls here in terms of what's going on from a macro standpoint. We saw some challenges in a few end markets, but there is also strength in other markets in that same region. So we're not making a region call here.

Andrew Casey -- Wells Fargo Securities -- Analyst

Okay. Thank you. And then separately on Food Equipment, within your prepared remarks you mentioned retail was weak. Can you give a little bit more color on that?

Michael M. Larsen -- Analyst

Yeah. So, I'd rather not go into too much detail here. I'm sorry, Andy. I mean what I can tell you is, it's been pretty challenged for a year now. The comps are going to get easier, but really, last year we saw the beginnings of a slowdown in investment --

Scott Santi -- Chairman and Chief Executive Officer

This is grocery stores just --

Michael M. Larsen -- Analyst

In grocery stores, as it relates to our products around -- these are scales, way wrap equipment. We also had a major new roll out of product last year that didn't repeat this year. And we'll see when we do the plans here in a couple of weeks with the Food Equipment team what to expect for next year, but for Q4 and the near term here, we are expecting that things do not get better on the retail side. And it's really strength outside of retail, what we call food service on the equipment side, particularly on the institutional side, where our business is up in the mid teens, with a lot of strength, as we talked about, in healthcare, education, lodging, those trends certainly look really good.

Andrew Casey -- Wells Fargo Securities -- Analyst

Okay. Thanks. And if I could squeeze a clarification, in that 2019 $60 million headwind from tariff impact, does that include the anticipated 25% List 3 increase next year?

Michael M. Larsen -- Analyst

Yes, it does.

Andrew Casey -- Wells Fargo Securities -- Analyst

Okay. Thank you.

Operator

Your next question comes from the line of Scott Davis, Melius Research. Your line is open. Scott Davis, you line is open.

Scott Santi -- Chairman and Chief Executive Officer

Hello? Can we move to next call?

Karen Fletcher -- Vice President of Investor Relations

Yeah. Beth, let's take the next call.

Operator

Your next question comes from the line of Mig Dobre, Robert W. Baird. Your line is open.

Karen Fletcher -- Vice President of Investor Relations

Okay. Beth keep moving.

Operator

Your next question comes from the line of Jamie Cook, Credit Suisse. Your line is open.

Jamie Cook -- Credit Suisse -- Analyst

Hi. Can you hear me?

Scott Santi -- Chairman and Chief Executive Officer

Go ahead. Okay. Good.

Jamie Cook -- Credit Suisse -- Analyst

All right. It's working. Just a couple of quick follow-up questions. One, John asked you about portfolio optimization, either divestitures or acquisitions, whether you need scale or to help the organic growth story, but how much is the macro impacting your view of being more opportunistic on the M&A front and if multiples come down at all?

And then my second question, just clarification, I think you said in response to one of the questions, in the fourth quarter sequentially you expect Polymer & -- P&F and the Specialty division to improve sequentially, just was there anything specific driving that? Thank you.

Scott Santi -- Chairman and Chief Executive Officer

I'll take the first one. I'll let Michael take the second one. And I again don't mean to be evasive, but I think in December we'll give you a fulsome update on our thinking with regard to portfolio and how we're thinking about it and how we will go forward.

Michael M. Larsen -- Analyst

Yeah. And then specifically on Polymers & Fluids and Specialty, based on -- our guidance is based on the current level of demand, current run rates in those businesses. We factor in the comps on a year-over-year basis and based on that the year-over-year organic growth rate in Q4 is expected to be better than the equivalent in Q3. So there's nothing specific other than based on current run rates, factoring in the comps.

Jamie Cook -- Credit Suisse -- Analyst

Okay. And then just follow-up question. Some other companies or investors have been concerned that with trade war talks, et cetera, and price increases that there's been any pull forward in demand, which is why some companies might be seeing good strength in the beginning of the year and then things deteriorating in the back half. I mean, do you get a sense for any of that as you talk to your customer base?

Scott Santi -- Chairman and Chief Executive Officer

No. We're a book-and-bill. I mean you order it today, we ship it tomorrow. We've not seen any pull-forward that I could think of running my head through the portfolio here. In fact, we given our delivery performance, (inaudible) by the opposite.

Jamie Cook -- Credit Suisse -- Analyst

Okay. Great. Thank you. I'll get back in queue.

Operator

Your next question comes from the line of Joel Tiss, Bank of Montreal. Your line is open.

Joel Tiss -- Bank of Montreal -- Analyst

Hey guys. How's it going?

Scott Santi -- Chairman and Chief Executive Officer

Good Morning.

Joel Tiss -- Bank of Montreal -- Analyst

I wonder is there any -- you guys have been at this a long time, are there any signals from your earlier cycle businesses that give you any insight into what could be happening in the later cycle businesses further down the road/

Michael M. Larsen -- Analyst

I can't really -- we're looking at each other here and shaking our heads. We can't really think of anything, Joel, in terms short cycle being a leading indicator. Like we said, this was -- other than auto and a few end markets internationally in the two segments we talked about, the performance is pretty good. And we're certainly not seeing anything that underlying demand trends are beginning to slow here.

Joel Tiss -- Bank of Montreal -- Analyst

Okay. Good. And then, can we just spend a minute going through the different pieces inside the Construction business? We haven't talked about that very much. You mentioned big box retail was de-stocking a little bit, but can you just talk about some of the other trends you're seeing there, please?

Michael M. Larsen -- Analyst

Yeah. I think that was really the big one that we called out. I mean I think, overall, 1% organic growth in the quarter. Europe really good, Australia maybe slowing just a little bit, in North America the residential side was down, and that's really more of a comp issue. We had -- there is the hurricane impact in Q3.

Scott Santi -- Chairman and Chief Executive Officer

That was a factor this year versus last.

Michael M. Larsen -- Analyst

So, hurricane impact. Last year business was up 7% sequentially on a run rate basis. The underlying demand is still very good. The business is up 4% on a year-to-date basis. Q4 looks to be in line with that and the full year should be up in that 4% to mid-single digit range on the residential side.

Commercial is a smaller part of our business. It can be a little lumpy. It's been flattish for a while here. We were up 5% in the quarter. I wouldn't get too excited about that to be honest with you. I mean, I think this is more of the low single-digit type growth rate on the commercial side. And even with this slowdown, some pressure on the cost side, the fact that the business improved operating margin 40 basis points is pretty good.

Joel Tiss -- Bank of Montreal -- Analyst

All right. Great. Thank you.

Michael M. Larsen -- Analyst

Sure.

Operator

Your next question comes from the line of Steven Fisher, UBS. Your line is open.

Steven Fisher -- UBS -- Analyst

Thanks. Good morning.

Scott Santi -- Chairman and Chief Executive Officer

Good morning.

Steven Fisher -- UBS -- Analyst

Good morning. Talking about international Welding, some nice strength there. Can you just talk about where that strength internationally is coming from, which market? And what visibility you have to kind of continuation of that?

Michael M. Larsen -- Analyst

I think, really, what we saw was a pickup. So, most of our international business is -- as you remember, is oil and gas related. So we saw a pretty nice recovery. Europe up 10% -- little bit more than that, 11% in the quarter on the Welding side. China up 15%, so the majority of that is really driven by oil and gas, which overall was up double digits. You saw the pickup also in consumables, I think up 12% in the quarter here. So, those are kind of the big -- and just in terms of the sustainability, we haven't seen anything to suggest that things are slowing.

Steven Fisher -- UBS -- Analyst

Okay. That's helpful. And then, in terms of organic growth, fourth quarter, number of positive segments versus the number of negative. Obviously, we had a few -- or I guess three that turned to the negative side in Q3. And as you've talked about, some of the comps get tougher in Q4. Anyway that -- and we can also get to that 1% to 2% organic growth for the fourth quarter in a variety of different ways. So I'm just curious if you think the number of segments that are going to be negative in the fourth quarter are going to be more than what we've seen here in the third quarter?

Scott Santi -- Chairman and Chief Executive Officer

No.

Michael M. Larsen -- Analyst

It will be -- we expect it to be less. And it's really just -- the one that stands out is Auto, even though Auto was about flat this -- here in Q3, where in our guidance and based on what we're seeing, we're planning for a little bit worse in that segment. The other segments should be positive. And for the full year, even Auto is going to be very close to positive and all segments, even including Auto.

Steven Fisher -- UBS -- Analyst

Terrific. Thank you.

Michael M. Larsen -- Analyst

Sure.

Operator

Your next question comes from the line of Nicole DeBlase, Deutsche Bank. Your line is open.

Nicole DeBlase -- Deutsche Bank -- Analyst

Yeah. Thanks. Good morning.

Scott Santi -- Chairman and Chief Executive Officer

Good morning.

Nicole DeBlase -- Deutsche Bank -- Analyst

If I could just ask a little bit of a more detailed question around price/cost. So just compared to the headwind that you guys have had over the past several quarters, what's the expectation that's baked into the fourth quarter guidance?

Michael M. Larsen -- Analyst

So, we are assuming pretty similar Q4 to what we saw in Q3. It's like, we said earlier, I mean on the cost side this is a pretty dynamic environment. It's -- even though certain of raws may, looking back, have stabilized. There are others where that's not the case and so it's hard to call, but we are expecting that Q4 is similar to Q3. And I think that's a pretty -- hopefully, a pretty conservative assumption, but it's hard to tell.

Nicole DeBlase -- Deutsche Bank -- Analyst

Okay. Got it. That's helpful. And then, on Specialty Products, there was a big negative surprise for us this quarter, if you could just give us some color on what drove the pretty big swing to the organic decline, and if that continues into the fourth quarter?

Michael M. Larsen -- Analyst

Yeah. It was really -- they are the three divisions internationally that we talked about. So the Marking & Coding business, the Graphics business, and then the Appliance business, which -- so, we sell components into appliance customers, and then, a fair bit of PLS as well, particularly on the international side. So those were the key drivers. I think it masks a little bit of this really solid performance on the Consumer Packaging side, which up 5%, the Equipment side up 7% --

Scott Santi -- Chairman and Chief Executive Officer

Which is the biggest business in this segment.

Michael M. Larsen -- Analyst

Right. And so, it was really though -- it was just a couple of divisions on the international side that drove the negative organic growth rate here in Q3.

Nicole DeBlase -- Deutsche Bank -- Analyst

Got it. Thanks.

Operator

Your next question comes from the line of Seth Weber, RBC Capital Markets. Your line is open.

Karen Fletcher -- Vice President of Investor Relations

Okay. Beth, let's -- we are at the end of the hour. Why don't we take maybe one more and we'll end the call.

Operator

Your next question comes from the line of Josh Pokrzywinski, Morgan Stanley. Your line is open.

Josh Pokrzywinski -- Morgan Stanley -- Analyst

Hi. Good morning. Thanks for taking my question.

Scott Santi -- Chairman and Chief Executive Officer

Good morning.

Josh Pokrzywinski -- Morgan Stanley -- Analyst

Just to follow up quickly on the last question on price/cost and how that layers in from here. I get that 4Q maybe doesn't look a lot different, but tariffs ramp up again to start the year, is there a potential for that 60 basis points to actually get a little worse before it gets better? I'm not trying to put too finer point on or get into 2019 guidance, it's just earmark date on the calendar that I want to understand a little better?

Michael M. Larsen -- Analyst

I mean Josh the best I can give you is, we gave you what we think the impact of tariffs is going to be for 2019 and that $60 million compared to $30 million this year. That's a meaningful number, but nothing insurmountable here. It's certainly manageable as we continue to work the price side of things. Beyond that I can't really tell you until we've gone through the detailed plans here with everybody.

Just to be clear, the $60 million includes, I think we said this earlier, the List 3 increase from 10% to 25%, and so that's in all-in number based on what we know today, but it's a pretty dynamic environment.

Scott Santi -- Chairman and Chief Executive Officer

And everybody is going through it. So, one thing I would add is that the pricing reaction of this in the marketplace has been going on all year, will continue to go on. And not just by ITW, but you're hearing it from, I'm sure, all of other industrial companies that you cover, and so I think the environment is one that I think we've got a good view as to how costs are going to continue to escalate In terms of what's known. We've got contingency, and we're certainly not anticipating them to go the other way anytime soon. So I think from the standpoint of attention and focus and our ability to continue to respond as necessary and as appropriate, I think we're pretty comfortable with where we sit.

Josh Pokrzywinski -- Morgan Stanley -- Analyst

Got it. That's helpful. And then just one quick one. I know we've talked ought about de-stocking in European auto, but was there any restock that you guys saw in North America Welding? I have heard some of that comment in the channel, just curious did it impact you at all?

Scott Santi -- Chairman and Chief Executive Officer

No, we didn't see that Josh.

Josh Pokrzywinski -- Morgan Stanley -- Analyst

Okay. Appreciate the time.

Karen Fletcher -- Vice President of Investor Relations

Okay. Thanks everybody for joining us today. If you have any follow-up questions, just reach out and we're happy to help you after the call. Thank you.

Operator

Thank you. This concludes today's conference call. You may now disconnect. Have a good day.

Duration: 65 minutes

Call participants:

Karen Fletcher -- Vice President of Investor Relations

Scott Santi -- Chairman and Chief Executive Officer

Michael M. Larsen -- Analyst

Joe Ritchie -- Goldman Sachs -- Analyst

Ann Duignan -- JPMorgan -- Analyst

Andrew Kaplowitz -- Citi Research -- Analyst

Ross Gilardi -- Bank of America Merrill Lynch -- Analyst

John Inch -- Gordon Haskett -- Analyst

Stephen Volkmann -- Jefferies -- Analyst

Andrew Casey -- Wells Fargo Securities -- Analyst

Jamie Cook -- Credit Suisse -- Analyst

Joel Tiss -- Bank of Montreal -- Analyst

Steven Fisher -- UBS -- Analyst

Nicole DeBlase -- Deutsche Bank -- Analyst

Josh Pokrzywinski -- Morgan Stanley -- Analyst

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