Illinois Tool Works Inc (ITW) — Q2 2017 Earnings Call Transcript

Okay, thank you Bob. Good morning and welcome to ITW's second quarter 2017 conference call. I am Michael Larsen, ITW's Senior Vice President and CFO. Joining me this morning is our Chairman and CEO, Scott Santi. During today's call, we will discuss our second quarter financial results and update you on our 2017 earnings forecast. Before we get to the results, let me remind you that this presentation contains our financial forecasts for the third quarter and full-year 2017 as well as other forward-looking statements identified on this slide. We refer you to the Company's 2016 Form 10-K for more detail, but important risks that could cause actual results to differ materially from our expectations. 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. Overall, ITW continued to execute well in the second quarter as we delivered strong results and established several new all-time performance records for the company. Earnings per share of $1.69 was up 16% year-on-year, 14% if you exclude the $0.03 of share benefit from a legal settlement that we recognized in the quarter. Operating income of $874 million was up 10% year-on-year, the highest quarterly operating income in the company's history. Q2 operating margin of 24.3% was also an all-time record for the company and was up 120 basis points, with enterprise initiatives contributing 100 basis points of improvement. After-tax return on invested capital improved 190 basis points to 24.8%. We are continuing to make good progress in our pivotal organic growth. Year-to-date, our organic growth rate is up 3%, almost 2 full percentage points versus last year reflecting both improving demand in our industrial facing businesses, particularly Welding and Test & Measurement, and Electronics, and continued progress on organic growth framework initiatives across all seven of our segments. Based on our Q2 and a relatively stable near-term end market demand environment, we're increasing our full-year EPS guidance by $0.12 at the midpoint. Overall, we continue to make good progress on our path to ITW’s full potential and the company is well positioned to deliver continued strong performance in the second half and beyond. With that, I'll turn the call over to Michael who will provide you with more detail regarding our Q2 results and updated 2017 forecast.

Thank you, Scott. So starting with Slide 3, GAAP EPS increased 16% to $1.69. Total revenue was $3.6 billion, an increase of 4.9%, with organic growth of 2.6%. Organic growth was positive in all major geographies with North America up 1.4% and international up 4.2%, driven primarily by Europe, which was up 3.4% and China, which was up 13.3%. Six of our seven segments had positive organic growth. It was great to see welding turn positive, up 3% for the first time since 2014. Sequentially, from Q1 to Q2, organic revenues accelerated 2.8%. Ahead of our historical run rate as welding, test and measurement electronics, and specialty products all exceeded their Q1 run rate. We increased operating margin 120 basis points over last year, which was driven primarily by continued progress on our enterprise strategy initiatives and volume leverage. Enterprise initiatives contributed 100 basis points of margin expansion. And five of seven segments increased operating margin. Operating income grew 10% to $874 million, making this quarter the most profitable quarter in the company's history. As Scott mentioned, we recorded an EPS benefit of $0.03 per share related to a confidential legal settlement. Excluding this item, second quarter earnings were $1.66 per share, an increase of 14% versus the prior year. Our effective tax rate was 28.4% in the second quarter, in line with our expectations. Free cash flow of $502 million adjusted for a discretionary pension contribution of $115 million was 85% of net income, which is in line with typical seasonality. In the quarter, we made the decision to accelerate future pension contributions, with surplus cash, essentially fully funding our US plan and setting the stage for lower pension contributions in the future. On Slide 4, you can see that we achieved an all-time record for operating margin in the quarter. Once again, enterprise initiatives contributed 100 basis points of structural margin improvement. In addition, volume leverage contributed 50 basis points. As expected, price cost was unfavorable due primarily to higher steel costs in two segments; automotive OEM and construction. At current raw material costs and with our 2017 price adjustments, we expect that price cost for the full year will be positive in dollar terms, but slightly unfavorable 20 to 40 basis points to margin percentage. The legal settlement that I mentioned a minute ago contributed 40 basis points and EF&C diluted margins by 60 basis points as expected. We added a line to the margin work to point out the timing impact of lower restructuring spend in Q2 that will catch up in the second half and overhead management efficiencies that we've planned for the second half that we were able to accelerate into Q2. Combined, these two items contributed the balance 40 basis points. In total, margin improved 120 basis points in the quarter. On Slide 5, you can see our strong first half 2017 performance at the enterprise level, with 18% earnings growth and 3% organic growth. We improved our operating margin by 120 basis points to 23.8% and grew operating income by 11% to $1.7 billion. Free cash flow was $946 million adjusted for pension. Overall, strong performance in the first half of 2017 and positive momentum going into the second half. Turning to Slide 6, on the left side of the page you can see what Scott mentioned a minute ago. The solid first half progress on organic growth versus last year as reflected by our first half organic growth rate of 3% as compared to 1.2% in 2016. You can see the results by segment with meaningful improvement in end market conditions in our Welding, Test & Measurement, Electronics segments, continued strong above-market organic growth from our Automotive OEM segment and continued progress on our pivotal growth efforts across all seven of our segments. We also laid out the progress on margins with six of seven segments expanding margins on a year-over-year basis. Excluding the 270 basis points of dilution from the EF&C acquisition, automotive OEM margins would be up 190 basis points to 26% and all seven segments show margin improvement. I'll now discuss the segment results in a little more detail starting with automotive OEM, which delivered another strong quarter with organic revenue growth of 4%, more than 400 basis points above global car builds. In North America, the business was flat as auto builds declined 3% overall, with builds down 6% for the Detroit 3 where we have relatively higher content. Outside North America, growth continued to be very strong, with Europe up 7% with builds down 3% and China was up 17%, all significantly above market as we continue to increase our content per vehicle, particularly with domestic OEMs. As we have discussed since December last year, IHS is forecasting a decline in domestic auto builds in the second half of 6% in Q3 and moderating to 2% in Q4. Our full-year guidance incorporates this IHS forecast as it currently stands, which results in full-year organic growth from automotive OEM business of approximately 3%. Operating margin was 22.3%, lower than last year due to EF&C. Turning to Slide 7, Food Equipment was up 1% organically. North America was down 1% against a challenging comparison versus the prior. North America equipment was down 2% and service was up 1%. Internationally, equipment was up 3% and service was also up 1%. Operating margin improved 140 basis points to 26.4% due to enterprise initiatives. We had another solid quarter in test and measurement and electronics with organic growth of 4%. Test & Measurement grew organic revenue by 6% with continued solid demand in semiconductor related end markets. In our Instron business, where demand is tied more closely to business investment, organic growth was up 4%, which is a good sign for the second half. Electronics was up 3%. Operating margin improved 330 basis points to 21.9%, driven by enterprise initiatives and volume leverage. As a reminder, the 21.9% includes 320 basis points of non-cash expense associated with amortizing acquisition related intangible assets. Turning to Slide 8, demand in welding continues to improve as organic growth was up 3% in Q2. Excluding normal seasonality, demand improved 1.5% sequentially from Q1 to Q2, and year-over-year equipment was up 7% and consumables were down slightly 2%. By geography, North America, which is approximately 80% of our business, was up 5%, driven by solid growth in both our industrial and commercial equipment businesses. Our commercial equipment business which sells through distribution to construction, light fabrication, farm and ranch customers was up 5% year on year in Q2. And it was very encouraging to see that our industrial equipment business which sells primarily into manufacturing including automotive and heavy equipment was also up 5% in the quarter. Operating margin performance was very strong at 27.2%, driven by enterprise initiatives and lower restructuring. Polymers & fluids revenue declined 1% organically, with automotive aftermarket down 2%, while fluids, which primarily sells highly engineered lubricants and cleaners into industrial and commercial end markets was up 1%. Polymers, which primarily sells engineered adhesives and sealants for industrial MRO and OEM applications was down 1%. Operating margin improved 50 basis points to 21.4%, which includes 400 basis points of non-cash expense associated with amortizing acquisition-related intangible assets. In Slide 9, construction products organic revenue was up 2%, demand in North America was solid with organic growth of 3%, both commercial and residential were up 3%. Europe was flat and Asia Pacific was up 1%. Operating margin was 24% down slightly due to headwind on price cost driven by the price of steel. Finally, in specialty products, organic revenue was up 4% with continued strong above-market organic growth of 5% in our consumer packaging businesses. Operating margin was the highest in the company at 28.3%, an increase of 230 basis points due to volume leverage and enterprise initiatives. Turning to Slide 10 and our updated guidance for 2017. As a result of our strong Q2 results and based on current foreign exchange rates, we’re raising our full-year earnings guidance by $0.12 to a new EPS range of $6.32 to $6.52. The increase reflects the $0.09 beat from Q2 and $0.03 from favorable foreign exchange rates. Also, at current levels of demand, we expect organic growth of 2% to 4% for the year. And we're raising our margin expectation to approximately 24%. For the third quarter, EPS guidance is $1.57 to $1.67 with organic growth of 1% to 3%, which includes the impact I discussed previously of the decline in domestic auto builds. Finally, our third quarter and revised full-year EPS guidance does not include any EPS benefit from the previously disclosed legal settlement beyond the $0.03 per share recorded in the second quarter.

Can we start off this line item unallocated in the op margins? I'm trying to remember what is that because it's run rate kind of in the mid 20s down to sort of - it was sort of a source of significant income, why was it almost zero this quarter? Is there any explanation?

Yes. So that is the impact of the illegal settlement, which was booked in that line item essentially. So what we do is we allocate our corporate cost to the segments on a percentage of revenue basis and because our corporate costs went down as a result of the legal settlement, we allocated less to the segments this quarter. So that's what you're seeing in that line, John.

So was it about 20% of the run rate that it has been? There's nothing else in there, right?

No, there's nothing else of significance in there, yes.

Food equipment was a little weak and it seemed like - if I go back to my notes, I thought some projects, I realized it was a tough compare, but I thought projects were being - have been deferred from the first quarter into the second quarter. Did those not hit or was there anything else kind of going on in the segment?

Those did John, that was on the international side and you international up a solid 3% in line with expectations. I think what you saw a little bit in Q2 here was a slowdown on the restaurant side of the business, which is only about 20% of our business, but it was down in the 7% range. Our business as you know is primarily focused on the institutional side and institutional was actually up in that 2% to 3% range in the quarter. And for us, the QSR side was also positive and the retail side. So overall, the slight slowdown that you're seeing here is as a result of the restaurant side. And as we look into the second half here based on the current run rates and backlog in that business, we’ll be back in that 2% to 3% range organic growth in the second half for the business.

And then lastly Michael, your auto guidance, you’re still sticking to the 3, so that implies your core growth – ITW’s core growth is going to go negative in the second half? How would you parse that out sort of between third and fourth quarter?

So the decline in automotive OEM, if you look at in the second half is going to be in Q3. So that's when you see the bulk of the decline in North America auto builds down 6% and actually down more than that with the D3s where we have relatively higher content. And then the decline in builds moderates in Q4. And so, if you translate that, that's part of what's driving the Q3 versus Q4 organic growth rate for the company. So we’ll be you know we are guiding to 1% to 3% for Q3 and that implies a better organic growth rate than that in the fourth quarter, really primarily driven by the auto builds. That is a fair statement.

So Michael, this one might be for you. Maybe talking about price versus cost in general, I know you mentioned that you would have 20 to 40 basis points of headwind this year; I think you had talked about 10 to 30 last quarter. It doesn't look like that big a deal on the total impact of ITW, but it led to a decline as you mentioned in construction products. So as you go forward here, can you pass through more price in that segment to offset rising costs or should we set out flat margin profile for that segment going forward for a while because of price versus cost?

Andy, let me just put it in context, I mean, we just reported record operating margins at 24.3%. So price cost was a little bit more of a headwind really as a result of the primarily the price of steel. We have passed on - we’ve made the price adjustments essentially we need to make for 2017 and we're set up for the pressure on price cost to moderate here in the second half of the year and margins would continue to improve from here on the construction side.

And Scott, shifting over to welding, obviously it's continuing to improve. I know in the past we talked about, you know, welding used to be a high-single digit growth business and assuming that this is a relatively traditional recovery, is it fair to say that welding growth could get back here into at least the mid-single digits as it’s been in the past? And do you have any visibility that tells you that we're still on the upward glide? I know you mentioned the better industrial results. So, is that the way to look at it going forward?

I absolutely believe that the underlying potential is every bit as positive in welding as it has been historically on a go forward basis. We are, you know, Michael talked about it, I think the encouraging thing in Q2 is that we saw the industrial side of that business turn positive in a pretty significant way in Q2. I think it's, you know, we hate to call one quarter trend. So I think we're in the wait and see mode here a little bit, but overall I would say that we are at least hopeful that what we saw in the second quarter will continue and if it does, then we would expect welding to be back at some point here to its traditional place in our portfolio as one of the strongest organic growers in the company.

I was curious about the guidance, the organic sales growth guidance. If Q3 does come in at your guidance of positive 2%, to reach the full-year guide it implies the fourth quarter again. It clearly has to reaccelerate close to 4%. Can you explain why do you expect that much of an acceleration in the fourth quarter?

I think we’ve just talked about this a couple minutes ago. I mean the key driver here is really if you look at the IHS forecast for the second half, the decline in domestic builds is greater in Q3 than Q4. So that delta is really what's driving the bulk of what you're describing, which is a 1% to 3% organic growth rate expected for Q3 and then implied a higher growth rate than that for Q4. So it's primarily driven by the forecast for auto builds in North America.

So for the fourth quarter, are there any other businesses that we should be thoughtful about that you expect an acceleration or is it really that significantly sensitive to the auto swing in Q3 and Q4 year-over-year?

All of the other businesses, David, as we usually do is modeled based on current run rate adjusted for typical seasonality.

Industrial.

Right, I mean, that’s the other thing. I mean, we are seeing what we just talked about, you know, the industrial businesses; welding, test & measurement, electronics, there is some positive momentum in those businesses. But it is primarily driven…

Run rated out from here.

Yeah. I mean what we usually do is we take current Q2 run rate and order rate and we run rate amount adjust for seasonality, but there is no assumption of a significant acceleration beyond that built into Q4.

But that math is what it is, just taken some of those CapEx businesses, run rates run them out. They do give you a little better organic growth in Q4 then 3Q or recently right, that's the idea of…

Yeah.

Solely auto, but auto is the main issue. Second question, last question, the gross margin is down year over year; they haven't been down year over year for six years. I wish all my companies could have 42% gross margins, but still to see it down 70 bps year-over-year, was that what you were expecting and is that how we should think of the rest of the year if you can explain that in more detail?

Yeah I think price cost was a little more unfavorable than maybe we expected. We've talked about this lag in the past between when you start realizing price increases and when the material costs show up in the income statement. And I think what the timing was off maybe a little bit versus what we expected, but as I also said on price cost, we would expect that to start to moderate that pressure here as we go into the second half. We've made the price adjustments we need to make based on current material cost and if anything, some of the pressure we've seen on steel may be easing here in the second half. So we feel fairly confident that we have this one baked in our guidance for the rest of the year.

So for the full year, if you think about the growth, the operating margin is up 150 bps. Do you expect any improvement year-over-year in the gross margin or is it more of an SG&A story for this year?

It’s both; you will see both, David.

So you expect gross margins to be still higher year-over-year, okay. Thank you very much, I appreciate it.

I have a couple of quick follow-ups. Based on your comments, Mike, it seems like the second half auto is expected to be down in Q3 and then flat in Q4. Is that an accurate assessment?

I'd prefer not to provide guidance by segment based on external forecasts, as it can complicate things. However, if you model it, you should be able to get quite close on your own.

And then just thinking about welding, obviously welding is coming off the trough, so the recovery is going to be somewhat lumpy, but if you think about the sequentials from what we saw in the first half to the second half, we normally see seasonality down slightly from the first half, but obviously coming off the trough, it could be a little bit better than that. So how do you view the second half versus first half in welding?

Yeah. I mean that is correct. I mean, we've modeled the second half based on current run rates, which is the commercial side, up 5; the industrial side, which was the new news, up 5, that business was down 2 in prior quarter; and then oil and gas is still flattish, down actually 1% here in Q2. So we haven't seen a pickup on that side yet.

Okay. And just a quick follow-on on the margin bridge, you actually called out overhead efficiency and restructuring of 40 bps, but what exactly is overhead efficiency and how does that differ from the enterprise initiatives?

This is more discretionary cost management, so it's your day-to-day blocking and tackling on the cost side.

So I guess my first question is on, maybe if you can give a little bit more color on EF&C and the progress that you're making there on the margin side and I guess the reason I'm asking the question is because it seemed to have a little bit more of a negative impact in Q2 to Q1. So any color around that would be helpful.

We are very pleased with the progress we've made. I'll let Scott address the operational aspects, but on the financial side, we are surpassing our acquisition projections by a considerable amount. When they first joined us, their EBIT margins were around 7%, and now, a year later, we are already at 11%. We are excited about the positive financial outcomes we are experiencing.

I want to emphasize what we've discussed previously: this is a great match for our business. We're very satisfied with the leadership team we've brought on board. Everything is progressing well. As usual, this integration will take some time, typically about four to five years. While we are currently four quarters into this process, and as Michael mentioned, we are ahead of expectations, it's still early in the scheme of things. Overall, it has met all our expectations so far.

Got it. That's good to hear. And I guess as my follow-on question, maybe going back to a little bit of discussion here so far an organic growth, so clearly understand the auto build down in the second half of the year and then you guys take a run rate on the rest of your businesses. But to the extent you can provide any color on how business trends went throughout the quarter on the remaining businesses, that would be helpful.

Yes, actually we – typically, we don't see much anything unusual. We actually did see quite an improvement in the month of June. So we feel really good about the momentum going into the third quarter here.

Was it anywhere specifically Michael?

It was actually broad based and the international side continues to be strong. And then in North America, in the month of June, now, it's one month, so I wouldn't read too much into it, but really broad based, a meaningful organic growth rate in the mid-single digits, maybe a little higher than that.

If we could just focus on food service again, just given all the headwinds that are facing the restaurants in this environment, are you seeing any increase in competition for your institutional business? I mean, you've always had a strength in that segment, but I'm just curious if restaurant is under pressure, are the competitors refocusing their efforts on institutional, if you could just give us some color there would be great.

Ann, this is Michael. We haven't seen any change in the competitive dynamics on the institutional side. As you pointed out, we have a really strong position there that's been our focus for a long time and we were pleased to see the business up on a year-over-year basis, again in Q2 and feel very good about our competitive position.

Okay. And then as my follow up, could you just talk about share repurchase and what your ending share count was on a diluted basis at the end of quarter? Thanks.

Yeah. I think we ended up at 347 and so we are executing the program we laid out back in December, which is $1 billion for the year. $250 million per quarter is the plan and that is the plan for the back half here in Q3 and Q4. I will point out that we have a board meeting coming up where we will, as we typically do, discuss capital allocation and surplus capital deployment specifically and after that meeting, here in a couple of weeks, we’ll provide an update, not just into the dividend, but also any potential further share repurchases for the year.

Okay. And any update on acquisition pipeline.

Not much of an update here, Ann. We’re not necessarily a great proxy for what's going on in the broader M&A market. I mean, we're really focused on executing this enterprise strategy and deliver the types of results that you've seen from us over the last four years. So that's our primary focus right now.

A lot obviously has been covered already, a couple of detailed points on total revenue, you raised it a little bit. It looks like it's based primarily on currency. What sort of translation rates are you building in there specifically for the euro?

Yes. So currency was still a headwind in Q2 and what we, as we always do, Andy, we're modeling based on current rates. So I think if you look today, it’s about 1.17 for the euro. Last year, I think we were 1.12 on average. That dealt, the $0.05 just as a rule of thumb drives $0.05 of EPS for the full year. And so in the second half, that’s the $0.03 of EPS favorability versus guidance. But it's nice to see that if rates stay where they are, we're not going to be talking about headwind on currency, which it's been a while since we're able to say that.

Sure. That is good news. Second one, when you look across your businesses and including the comment you made to an earlier question about June seeing disproportionate strength relative to the rest of the quarter, did that drive any incremental backlog growth at the end of the quarter that you will realize in the second half.

Andy, most of our business involves booking and shipping. We receive the order today, ship it tomorrow, and replenish inventory the following day. Therefore, we operate on a short cycle and haven't experienced a significant change in backlog. As I mentioned, we are not primarily a backlog-driven company.

You guys have a few businesses that have margins that are notably below the rest of the company at this point and looking at test and measurement, autos, polymers and fluid, I know you have had obviously in test and measurement, a pretty good year-over-year improvement, which is impressive, but how focused are you on bringing those segments up to the company average or margin improvement results come more so from the other businesses?

The standout points can be found in the schedule included in the 8-K that accompanies the press release, which outlines the impact I mentioned on the call. I regularly discuss the amortization of intangibles related to acquisitions. Recently, due to acquisitions in test and measurement, electronics, and polymers and fluids, these areas show the most significant impact. Therefore, on a like-for-like basis, you should add back 320 basis points this quarter in test and measurement, 400 basis points in polymers and fluids, and about 150 basis points at the enterprise level. Additionally, if you look at the same schedule, you'll see that this translates to an EPS impact of approximately $0.10 per quarter, equating to $0.40 of non-cash expense, or $0.40 in annual EPS. We are committed to enhancing margins across all our businesses. Encouragingly, our operations are clustered in a tight range with mid-20s operating margins. This reflects our unique business model that ensures a high level of efficiency. Currently, we have a highly diversified, high-quality portfolio without any weak links. When comparing our operating margins to peers, we find that on average, they are 500 basis points better, and in some cases, significantly higher. I hope this addresses your question.

And then why are the consumables or welding, why is that declining, is that just lagging the equipment declines we saw over the last couple of years and if so, if the equipment is turned around, how quickly could the consumables turn around and what the underlying would drive it to become positive that’s not already driving it with the equipment sales?

It's a good question. First of all, it's a fairly small part of our business, making up 20% of our revenues. As you know, we’re primarily focused on the equipment side of our businesses. Consumables were down slightly in the current quarter, which is mainly linked to the international market, particularly oil and gas. As the oil and gas cycle starts to improve, we should also see an uptick in the consumable sector.

Can we talk a little bit about any changes, if there are any, in your view vis-à-vis longer term capital deployment, how you're thinking about M&A, any areas where you'd like to add to the portfolio, any updated thoughts here would be helpful.

Yeah. Mig, I mean, at this point, nothing has really changed. I think we've been very consistent in terms of our ability to generate strong cash flow, maintain a strong balance sheet and allocate our capital or our shareholders capital with a very high level of discipline and so our number one priority is to invest in our businesses and to drive organic growth and productivity. That's our number one priority. That only consumes, in our very asset light business model, about 25% of our operating cash flows. The second priority is the dividend. And so as you’ve seen, we've been leaning into the dividend with a meaningful increase last year, I just talked about we have a meeting coming up in August here. We allocate about 25% to 30% of our operating cash flow to a dividend that has been growing slightly faster than earnings certainly last year. And that leaves a fairly sizable portion for external investments, some combination of acquisitions and we’ve talked about the criteria that we're looking for there from a strategic and from an 80-20 improvement standpoint. We also talked about that not being really the primary focus for us right now and then any remaining surplus capital, we've returned to shareholders through the share repurchase program and so $1 billion this year that we're executing is really our estimate of surplus cash available in North America. So that's a rebound line of our capital allocation strategy and Mig, just given the performance of the company and our strong position here, we haven't changed anything.

Starting off here in test and measurement and electronics, obviously, very good margin performance there. It looks like record quarterly margins. Was there anything in terms of mix that influenced that or are we just looking at the enterprise strategy taking hold there and some leverage on volume and how should we think about those margins going forward?

It's exactly as you described, there's over 300 basis points of impact from enterprise initiatives and volume leverage. In these segments, you see a bit of organic growth contributing to volume leverage, and the earnings growth we achieve from that is quite significant. This is why we are so focused on increasing the organic growth rate. We anticipate that the test and measurement business will continue to improve from here.

Okay. And then just a question more broadly on the industrial operating businesses. I would assume over the last two or three years that you've probably seen some demand related pricing pressure in those businesses. You're now talking about those businesses improving. How are you thinking about your ability to potentially raise real pricing more than just to cover raw materials as we go forward and see the industrial, the industrial economy recovering?

Yeah. I mean Nathan, I appreciate the question. That's not really how we think about it. I mean, we price for value, as we continue to innovate and deliver value to customers, that's how we get price. We’re not, in terms of the price cost equation, we are just trying to cover our increases on the raw materials side. The margin performance by ITW continues to be driven by the enterprise initiatives primarily and then the volume leverage that you're seeing. So those are the key drivers of margin expansion at ITW, not the price cost equation.

Two questions. One on polymers and fluids, I know, the business declined organically in a quarter and I guess the comps were a little tougher, but can you talk about the main drivers, how much of that was auto and what your exposure is there? And then my second question, just broadly on China, you continue to see pretty good growth there. I know a lot of it’s driven by the auto business, but just sustainability of China growth in the second half of the year across your different segments. Thanks.

Yeah. So polymers and fluids, as you point out, is really more of a comp issue in the automotive aftermarket business. We launched, the business launched a new product last year and typically, when we do that, you see a ramp up in the quarter that didn't repeat this year. So the only other thing I can point to is really on the polymers side is in selling into the wind industry, there's a little bit of a decline in that part of the business, but overall, stable. And I would just point out that even though as you saw revenues were down slightly, margins continued to improve in that business, which is certainly encouraging. In terms of China, the growth continues to be really strong and it's not just the automotive business, it's really across the board. Excluding automotive, China was up 11% this quarter. And on a year-to-date basis, up 16% and it's really broad based. So we feel really good about our position in China and we feel good about our ability to continue to perform at a high level in the second half.

Wanted to ask about just kind of the overall margin profile for the company. It’s a great performance this quarter. I think in the past, you talked about getting to 25% overall and I think that was a 2018 number. And I just wondered if volume, the organic growth continues to come back, are we thinking about the wrong way, if we're thinking mid-20s is where the operating margin improvement ends, could you get to 28%, 30% with operating leverage coming through?

It's a good question, Walt. For the year, we expect to be at 24%. We see potential for another 100 basis points of margin expansion from enterprise initiatives, particularly for the second half of 2017 and into 2018. That alone would bring us into the 25% range. Then, we need to consider what the organic growth rate will be for the company. Historically, our incremental margins on organic growth have been around 30% to 35%, with a tendency towards the higher end of that range recently. So theoretically, that's where we could max out. I wouldn't consider the 25% as a limit in any way. We genuinely believe there is more potential for margin growth. We are continuing to see strong progress on organic growth with solid incremental margins. I believe that this year we’ll likely see some slowdown in the market. However, in the long term, we are confident that we can grow the food equipment business at a rate in the mid-single digits, which would exceed the market by 200 to 300 basis points. For this year, we expect to experience slightly below mid-single digits in organic growth for the food equipment business.

I wanted to just follow-up on one comment you made earlier that you thought steel pressure might ease some in the second half and it's widely expected the section 232 decision is going to be out fairly shortly, which arguably could have upward pressure. So I'm just curious what you're seeing in the marketplace that makes you think that steel could come off in the second half? Appreciate that. Thanks.

Yeah. I mean I think we are seeing a slight moderation on steel prices right now. The tariff really, I mean that’s anyone's guess. If that were to happen, then we will react accordingly. All right. Thank you, Bob. Thanks for dialing in and have a great day.