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Illinois Tool Works(NYSE: ITW)
Q3 2024 Earnings Call
Oct 30, 2024, 10:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning. My name is Kathleen, and I will be your conference operator today. At this time, I would like to welcome everyone to the ITW's third-quarter earnings conference call. [Operator instructions] Erin Linnihan, vice president of investor relations, you may begin your conference.
Erin Linnihan -- Vice President, Investor Relations
Thank you, Kathleen. Good morning, and welcome to ITW's third-quarter 2024 conference call. Today, I'm joined by our president and CEO, Chris O'Herlihy; and senior vice president and CFO, Michael Larsen. During today's call, we will discuss ITW's third-quarter financial results and provide an update on our outlook for full year 2024.
Slide 2 is a reminder that this presentation contains forward-looking statements. Please refer to the company's 2023 Form 10-K and subsequent reports filed with the SEC for more detail about important risks that could cause actual results to differ materially from our expectations. This presentation uses certain non-GAAP measures, and a reconciliation of those measures to the most directly comparable GAAP measures is contained in the press release. Please turn to Slide 3, and it's now my pleasure to turn the call over to our president and CEO, Chris O'Herlihy.
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Chris?
Christopher A. O'Herlihy -- President and Chief Executive Officer
Thank you, Erin, and good morning, everyone. As you saw in our press release this morning, during the third quarter, the market demand environment continued to moderate across our portfolio, with further softness in the automotive and construction markets. Overall, third quarter revenues came in approximately 0.5 percentage point or $25 million below what they would have been, had demand held at the level we were seeing exiting the second quarter. That said, the slowdown in Q3 was less than in Q2, where revenue came in approximately 1 percentage point or $50 million below run rate.
As a result, third quarter organic revenue declined 1%, with 5 segments down year-over-year, partially offset by growth in 2 segments. This 1% revenue decline compares to our end markets, which we believe were down in the low to mid-single digits. As we have all year, the ITW team continued to successfully navigate and overcome these market challenges with strong operational execution. Those efforts resulted in operating income of $1.05 billion, with operating margin of 26.5%, which included a 130 basis point contribution from enterprise initiatives.
With little operating leverage, 6 of 7 segments still increased operating margin, resulting in segment operating margin expansion of 110 basis points. EPS grew 4% to $2.65, excluding the gains from the divestiture that Michael will review in more detail. The continued contribution from enterprise initiatives regardless of volume speaks to the power and resilience of our business model. And it is notable that for the first time, 3 of our segments delivered operating margin above 30% in the quarter, and we are well on our way to achieve our goal of 30% operating margins for the company by 2030.
Our continued focused execution and typical operational excellence have enabled ITW to effectively counter persistent market headwinds and achieve increased profitability, where we continue to maximize -- to invest to maximize growth and performance over the long term. Consistent with our long-term commitment to return surplus capital to shareholders by an attractive and growing dividend, on August 2, we announced our 61st consecutive dividend increase, raising our dividend by 7%. And year-to-date, we have repurchased more than $1.1 billion of our outstanding shares. Today, we are raising our full year GAAP EPS guidance by $1.33 from a range of $10.30 to $10.40 to a new range of $11.63 to $11.73 to incorporate the impact of the divestiture gain and a lower projected tax rate for the full year.
Based on current levels of demand exiting Q3, we are maintaining our previous operational guidance for revenue and organic growth to be approximately flat for the year, and our operating margin to be between 26.5% and 27%. While the ITW team has done a commendable job managing the short-term challenges this year, perhaps more importantly, we continue to deliver solid progress on our next phase enterprise strategy priorities. As we outlined to you a year ago, the central focus of the next phase of our enterprise strategy is to elevate high-quality organic growth and customer-backed innovation as key ITW differentiators on par with our best-in-class operational capabilities and financial performance. This quarter, we made further progress in our journey to achieve this strategic goal.
We believe that customer-back innovation, or CBI, as we call it, is the most impactful driver of our ability to consistently grow revenue above market. In essence, the customer-back innovation revenue of today fuels the ability to drive market penetration and share gain in the future. Over the past few years, we've made progress on expanding our revenue from CBI from less than 1% in 2017 to approximately 2% today. And at our September Leadership conference, we launched next phase CBI framework for our 84 divisions around the world.
Just as we successfully focused the entire organization on 80/20 front-to-back over a decade ago, we are now doubling down on customer-back innovation. And I, for one, can feel the energy, excitement, and momentum from our team as they implement this strategy at each division. With our continued laser focus on our typical do what we say execution, it is with strong conviction that I know we will build above-market organic growth, fueled by customer-back innovation into a defining ITW strength. In concluding my remarks, I want to thank all of our ITW colleagues around the world for their exceptional efforts and dedication in serving our customers with excellence and driving continuous progress on our path to ITW's full potential.
I'll now turn the call over to Michael to discuss our Q3 performance and full year guidance in more detail. Michael?
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
Thank you, Chris, and good morning, everyone. Starting on Slide 3. As expected, the third quarter ended up looking a lot like the second quarter with continued strong operational execution in a moderating demand environment. Total revenue declined 1.6% with organic revenue down 1.4%.
Foreign currency translation reduced revenue by 0.4% and acquisitions increased revenue by 0.2%. On a geographic basis, organic revenue declined about 3% in North America, Europe was down 0.5%, and Asia Pacific was down 1% with China, essentially flat. In this environment, the ITW team continued to focus and execute well on the things that we can control, as evidenced by 6 of our 7 segments expanding operating margin, driven primarily by enterprise initiatives that contributed between 70 and 180 basis points to each segment and 130 basis points at the enterprise level. Third quarter operating margin was 26.5%, up 30 basis points sequentially from the second quarter and flat with the prior year due to a tough comparison.
As you may recall, last year's Q3 margin of 26.5% expanded 200 basis points compared to 2022 due in part to the favorable impact of a few corporate items that we discussed on the call last year, including a onetime insurance recovery. Excluding those onetime items last year and looking just at segment operating margin, which is included in the press release tables, our segment operating margin increased by 110 basis points compared to the prior year, which is more in line with our typical margin expansion on a quarterly basis. GAAP EPS of $3.91 was up 53% and included $1.26 gain from the divestiture of our noncontrolling equity interest in Wilsonart. Excluding this gain, EPS of $2.65 was an increase of 4% year-over-year.
I wanted to spend a minute on the previously announced Wilsonart divestiture. The proceeds from the transaction, net of transaction costs were approximately $395 million, which we used to reduce our commercial paper balance. The transaction resulted in a pre-tax gain of $363 million, and income taxes on the gain were more than offset by a discrete tax benefit of $107 million related to the utilization of capital loss carryforwards, which resulted in a favorable GAAP EPS impact of $1.26. Free cash flow was $783 million, which was 102% conversion of adjusted net income.
And as Chris mentioned, in the third quarter, we raised our dividend by 7% to an annualized payout of $6 per share, which marks our 61st consecutive year of increases. And as planned, we repurchased $375 million of our own shares during the quarter. The effective tax rate in the quarter of 14.9% was below our typical tax rate in the 24% to 25% range. As you can see from the reconciliation in the press release, the tax rate was favorably impacted by several discrete items in the quarter, including the Wilsonart transaction.
Excluding these discrete items, our core tax rate was 23.7%. So in summary, the third quarter looked a lot like the second quarter with moderating, but also stable demand and solid operating margin and profitability performance as we continue to focus and execute well on the things that we can control. Please turn to Slide 4 for a look at our year-to-date segment margin performance. And as you can see from the table on the left side, 6 of our 7 segments have expanded their already best-in-class margins year-to-date and 3 segments by more than 100 basis points.
Food Equipment is a bit of an outlier due to the growth investments in our service business and specifically the near-term inefficiencies associated with onboarding of new service technicians to support accelerated organic growth in this business. This margin headwind is now largely behind the Food Equipment segment as evidenced by 110 basis points of margin improvement in the third quarter. Total company margin is up 180 basis points, which in fairness includes 100 basis points from the onetime LIFO adjustment in the first quarter, but still solid performance in the current environment. Moving to the segments and starting with Automotive OEM.
Organic revenue declined 3% in the third quarter as industry build rates continue to come down. North America was down 6% as the D3 customer builds were down 9%. Europe was down 5%, and China was down 2%. Compared to the automobile industry build data, the segment has outperformed builds by about 200 basis points year-to-date, and we expect similar outperformance in the fourth quarter.
The segment also delivered solid operating margin performance of 19.4%, a 50 basis points increase despite lower volume, and we expect more progress in the fourth quarter and next year as we continue to work toward our long-term goal of achieving operating margins in the low to mid-20s by 2026 in this segment. Turning to Slide 5. Organic revenue and Food Equipment was about flat against a tough comp of plus 6% last year as equipment was down 4% and offset by service, which grew 7%. Regionally, North America was down 2% after being up 10% last year, with institutional sales about flat as healthcare was up mid-single digits, and restaurants were down about 10%.
International was solid, up 3% with the service business up 8% and Europe up 4%. Operating margin improved 110 basis points due to the service margin normalizing and a solid contribution from enterprise initiatives. As we mentioned last quarter, we expect margin to continue to improve as we go through the year. Test & Measurement and Electronics organic revenue was down only 1% after being down 3% last quarter, with stable demand in semiconductor, Electronics and CapEx sensitive end markets.
While Test & Measurement was down 3%, Electronics was up 1% in the quarter after being down 3% last quarter, and this marked the first quarter of positive growth in Electronics since the end of 2022, and we're beginning to see increase semiconductor customer activity, suggesting that perhaps we are near the bottom for this market. As we've discussed before, we remain very well positioned to capitalize on the growth opportunities in this space when the inevitable recovery does happen. Operating margin expanded by 190 basis points in the quarter to 25.7%. Moving on to Slide 6.
Welding's organic revenue declined 1%, a meaningful improvement from being down 5% in the second quarter as both equipment and consumables revenue declined 1%. North America revenue was down 2%, but international was up 6% with solid growth in Europe and China. As we talked about at the beginning of the year, the Welding team was planning on a solid contribution to the top line from the launch of new products, which in the third quarter resulted in a 3% plus contribution to growth. And this is just one of many examples inside the company that illustrates how continued progress on CBI, as Chris was talking about, gives our segments the ability to gain share and outgrow their end markets.
Operating margin of 32.3% was a third quarter record for the Welding segment. Polymers & Fluids organic revenue grew 1%, with Polymers up 10% due to international strength and Fluids was up 3%. Automotive aftermarket, which as you know, is tied closely to consumer discretionary spending was down 3% in the quarter. On a geographic basis, North America declined 5% and international grew 11%, with Europe again showing solid demand.
Turning to Slide 7. Organic revenue in Construction Products was down 9% as construction end markets took a sizable step back from the second quarter with new housing starts down 10% on an annualized basis as compared to down 6% in the second quarter. As a result, North America declined 10% with residential down 12% and commercial construction down 7%. Europe was down 4%, and Australia and New Zealand was down 11%.
Despite the lower volume, operating margin of 30.2% was a record for the segment, with another significant contribution from enterprise initiatives. Finally, Specialty Products had a solid quarter, with organic revenue growth of 6%, with strength across the portfolio as both equipment and consumables were up 6%. North America was up 8% and international grew 2%. The 6% growth rate for this segment included about 200 basis points of PLS or product line simplification in the quarter as we continue to make progress on repositioning some of our Specialty Products divisions for consistent above-market organic growth.
We expect about 300 basis points of PLS in the fourth quarter, and that the segment will be flat to up low single digits for the full year. Operating margin expanded 330 basis points to 31.1%, a third quarter record for the segment with strong contributions from operating leverage and enterprise initiatives. Moving to Slide 8 and our updated full year 2024 guidance. As you've seen all year, the ITW team continues to execute at a very high level and find a way to leverage our business model and high-quality diversified business portfolio to deliver solid operational and financial results in a challenging demand environment.
Looking ahead at the fourth quarter, we do not expect the near-term demand environment to improve. And as usual, our guidance is based on current levels of demand, seasonally adjusted and foreign currency exchange rates. As a result, we're maintaining our previous projection for revenue and organic growth to be approximately flat for the year. We're also maintaining our full year operating margin guidance, which is projected to be between 26.5% and 27%, an improvement of 165 basis points at the midpoint with enterprise initiatives contributing more than 100 basis points.
As you saw in the press release, we incorporated the impact of the Wilsonart divestiture gain and a lower projected effective tax rate of 21.5% for the full year into our EPS guidance as we raised GAAP EPS guidance from a range of $10.30 to $10.40 per share by $1.33 to a new range of $11.63 to $11.73 per share. Excluding the Wilsonart gain, the EPS range is $10.37 to $10.47 per share or $10.42 at the midpoint. So in summary, while the overall demand environment remains pretty uncertain and challenging in the near term, we remain laser-focused on leveraging ITW's unique strengths and capabilities to optimize our ability to deliver differentiated performance over the long term. And with that, Erin, I'll turn it back to you.
Erin Linnihan -- Vice President, Investor Relations
Thank you, Michael. Kathleen, will you please open the queue for questions.
Questions & Answers:
Operator
[Operator instructions] And your first question comes from the line of Jeff Sprague of Vertical Research Partners. Your line is now open.
Jeffrey Sprague -- Analyst
Hello. Good morning, everyone. Hey, I just wanted to sort of pick up sort of where you left off there, Michael, with kind of the trends into the fourth quarter. I don't know, unless my math is wrong, I think kind of sequentially, you're looking at revenues up maybe 4% or 5% when normally they decline slightly.
So was your exit rate in September or your early read in October, kind of better than what we saw in the quarter in aggregate? Or maybe you could just clarify if I'm missing anything there?
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
Yes. Sure, Jeff. So let me start by saying, as you know, we don't give quarterly guidance. And as you were trying to do, based on our year-to-date performance and our full year guidance, you can get pretty close in terms of figuring out Q4, but maybe let me try to help out a little bit.
So I'd say at a high level, Q4 looks a lot like Q3. Typically, what we see from a seasonality standpoint, is a sequential improvement in revenues from Q3 to Q4 about 1 point to 1.5 points, and that's going all the way back to 2017. So at current run rates, typically, we're up 1 point, 1.5 points. We do have easier comparisons in the fourth quarter.
And for what it's worth, there's also an extra shipping day in the quarter. So you add all that up, we get to about flat revenues on a year-over-year basis. We expect, again, our typical margin improvement of about 100 basis points on a year-over-year basis. So that is a slight decline from Q3 to Q4, which is kind of the typical seasonality.
And the main driver here remains another strong contribution from the enterprise initiatives. And then factoring in a more kind of normal tax rate for us in that 24%, 25% range, and you get to EPS at the midpoint. And I'm just doing the math, I'm not giving guidance, that's in that 2 51 range for the fourth quarter. So I'll just add, while we're talking about the fourth quarter, we do expect a strong quarter again from a free cash flow standpoint, and we're projecting some meaningful improvement on our inventory levels in the fourth quarter, which is not easy in the current demand environment.
So hopefully, that's helpful, Jeff.
Jeffrey Sprague -- Analyst
Yes. That's very helpful. And then just kind of secondarily, your business in China is not huge. It's very important for auto though.
And it was just kind of interesting that China Welding was solid, a lot of cross currents there. We had some pretty ugly China numbers out of Trane and Otis today. Those are different businesses, obviously. But maybe this is for Chris.
Can you just maybe give us your bigger picture view on what's going on there? And also just kind of given the importance of auto, anything in this kind of China, Europe, tariff stat around automotive influence your view or outlook at all?
Christopher A. O'Herlihy -- President and Chief Executive Officer
Yes. So I think from an auto China standpoint, Jeff, I mean China builds this year on auto are expected to be up 1%. We expect to be up 8%. So our businesses continue to penetrate very successfully in China.
EV, obviously, is a large part of the story given the fact that China is producing about 60% of the world's EVs. But we're making very strong penetration gains in EV in China as evidenced by the market growth. In auto, in general, we expect to be up a couple of percent against flat builds this year -- sorry, flat versus negative down 2%, builds are up 2%, I would say, as we have been kind of historically and would expect to be on into the future. And that strength has been pretty much across all 3 geographies: Europe, North America, but especially in China.
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
So maybe just add a little bit of color, Chris. So I think if you look at the third quarter, about flat with auto, as we said, down 2% and certainly some challenges also in Test & Measurement down single digit -- low single digits, same in Food Equipment. So strength in Welding, which is tied to oil and gas, LNG transportation and also some strength in our Specialty Products appliance business. So you all add up, you get to about flat for the quarter, up 6% year-to-date, we think in the fourth quarter.
As Chris said, we'll see a pickup on the automotive side, continued strength in Welding. And so Q4 should be kind of flat, maybe up low single digit and the full year up in that 5% range. So as we sit here today, I think we feel pretty good about China. I know there's a lot of talk about stimulus and so forth.
We haven't seen a lot of that yet. So if that's still to come, that would certainly be helpful. But as we sit here today, we feel pretty good about China.
Jeffrey Sprague -- Analyst
OK. Thank you for the color.
Operator
Your next question comes from the line of Jamie Cook of Truist Securities. Please go ahead.
Jamie Cook -- Analyst
Hi. Good morning. I got two questions. One, I was impressed with the Specialty growth in the quarter despite headwinds from PLS.
And I know Specialty's special because there's a lot of different businesses in there. But can you just sort of break down what you're seeing within that business, where -- what segments drove sort of the organic growth? That would be my first question, and then I'll give you my follow-up after that.
Christopher A. O'Herlihy -- President and Chief Executive Officer
Yes. So Jimmy, I think a good part of the specialty story is strength in the aerospace. We have one particular business that's focused on aerospace. And again, we saw about 30% growth in that business this quarter.
We saw, I'd say, pockets of strong demand, I think, throughout the segment. Areas like consumer packaging, consumer packaging equipment were also pretty strong. And we did have some favorable comps in specialty versus last year. But even with all that, we expect specialty to be up kind of low single digits for the full year.
And it's really strengthening our conviction that on the basis of the strategic portfolio positioning we've been doing in that segment, which involved some, as we said before, some product line improving throughout the segment, which is certainly choppy, and it's creating a bit of a drag, as Michael just indicated, a couple of hundred basis points this year. But what it does -- what this is all doing is really strengthening our conviction that the objective to make specialty a 4% grower in the long term is well on track here. And everything we've seen this year gives us a strong belief that we can do that.
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
And I think the only thing I'd add is just, Jamie, if you look at the margin performance, you can see what happens in -- at ITW, and this is not unique to specialty, when you get a little bit of operating leverage suddenly, you're in that 31% plus range, which is certainly very encouraging and gives us, as we said earlier, a lot of conviction in our ability to get to that 30% target at the enterprise level with 3 segments this quarter above 30%, which is -- that's the first time that's happened. And again, that's with very little operating leverage. So that's certainly really gives pretty encouraging as we look also into next year in terms of the momentum around the margin performance of the company continues.
Jamie Cook -- Analyst
That's helpful because I think it's embarrassing that the 30% plus is challenging for you guys to do. So it's nice to see that. I guess one more follow-up, Chris. You talked about market outgrowth in auto.
You talked about Welding from the new product introductions and even on Food, the increased service effort. You go through CBI, and you're now -- you've been with ITW forever, but CEO for a longer period of time. Are there any businesses that you're considering are more challenged like over the longer term that you think is going to be tough to get to the organic growth targets that you have? You don't have to say which ones, but just understanding if there's any difference in how you're thinking about the portfolio relative to when you first took over.
Christopher A. O'Herlihy -- President and Chief Executive Officer
Not at all, Jamie. I think if we go back to Investor Day last year, we were very overt in our comments that we felt that all 7 of our segments have the capability to grow 4% plus, and we certainly believe that today and even more so. With respect to CBI, the CBI opportunity, I think, is very relevant across all 7 segments. We're at different points in terms of the development around that.
But I think everything we've seen would indicate that all these segments have a pretty fertile innovation environment, have critical customer pain points that are there to be solved. We're certainly mobilizing the company around that in a very similar way to the way we mobilized the company around front to back 10, 12 years ago with the same kind of capability build and investment in resources, a much higher level of leadership, kind of time and focus on CBI. We have lots of great innovation practice across the company. And we've now codified that into a very effective innovation framework.
And this is the exact same approach that we took on 80/20 front to back, which as we know, was very successful. And we've seen this. I mean this is not something that's starting today. We've been working on this for a couple of years now in terms of focused investment and resources on CBI.
And we've seen that in terms of the improvement in yield that we've seen from CBI. So there's a lot of conviction here that the yield improvement from 1 to somewhere over 2 today will be north of 3 in due course, and we have a very clear path to doing that. And like I said, that's going to result in improvements in every one of our segments and the ultimate journey to having every one of these segments growing at 4 plus.
Jamie Cook -- Analyst
Thank you.
Operator
Your next question comes from the line of Andy Kaplowitz of Citigroup. Please go ahead.
Andrew Kaplowitz -- Analyst
Hey. Good morning, everyone. Chris or Michael, I know you've been hopeful about a turn in Test & Measurement for much of this year. And you did mention maybe more positive discussions with semiconductor customers, and you did see Electronics turn positive.
So maybe you can give us a little more color on the conversations you're having, the outlook. Obviously, you're always going to predict run rates. But as you go into '25, do you see a better outlook for the segment?
Christopher A. O'Herlihy -- President and Chief Executive Officer
Yes. I think based on the customer conversations that we're having, we're starting to see a bottoming, particularly in semi. Now just to characterize, semi is about 15% of Test & Measurement. It represents a couple of percent of ITW's revenues.
So just to put it in context. But there's no doubt that we saw a bottoming and a slight improvement in this, I think, in the third quarter. Electronics, similarly, have been down for quite a while, significantly down earlier this year, is starting to bottom there as well. And then I think an important kind of bellwether for us, the Instron business, which is a critical business within Test & Measurement, had very solid growth during the quarter.
And that's certainly encouraging as we look here for the balance of the year and on into next year.
Andrew Kaplowitz -- Analyst
That's helpful, Chris. And then, Michael, I think you mentioned, I think what you call the solid step back in construction markets in Q3, do you see any hint of stabilization as you go toward the end of the year in those markets? I mean, obviously, we started U.S. cutting -- rate cutting cycle, maybe what changed in Q3 versus Q2 in your businesses that led to the step down?
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
I think, Andy, we're talking about our most interest rate sensitive segment. So I think what we're seeing here is a market that's down in the low teens I pointed in the script to kind of the housing start numbers being down 10% on an annualized basis, which kind of mirrors our business in North America, maybe we're a little bit better than that. And then we're seeing similar type of softness in Australia and New Zealand, which is a meaningful part of our business. So I think at this point, it's really too early to point to any signs or indicators that things are getting better here.
Over the long term, certainly the fact that interest rates appear to be coming down has been a leading indicator, but we've not seen anything to suggest that things are picking up in construction at this point. So -- and I'll just say, in that context, I think it's even more remarkable that the team put up margins of 30% plus here in the third quarter in an environment that's certainly pretty challenging. So -- and about as challenging as we see across the company at this point in the cycle.
Andrew Kaplowitz -- Analyst
Appreciate it, guys.
Operator
Your next question comes from the line of Tami Zakaria of J.P. Morgan. Your line is now open.
Tami Zakaria -- JPMorgan Chase and Company -- Analyst
Hi. Good morning, team. I hope you're doing well. So my first question is on margins, very nice margin performance in the quarter.
I'm curious, what was price/cost in the quarter? And more broadly, how are you thinking about enterprise initiative and related margin improvement potential in 2025? It seems like almost like an endless well at this point, and I mean it positively. So any forward-looking comments about enterprise initiatives and what you're expecting for next year would be helpful.
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
Yes. Let me do price/cost, and then, Chris, you can add some commentary on the enterprise initiatives. But I think at this point, Tami, as we said before, price/cost has kind of normalized. This is no longer a distraction as it was back in '21, '22 and '23.
At this point, price dollars are ahead of cost on a dollar basis and modestly positive from a margin standpoint. Now that -- just to be clear, it doesn't mean that costs are coming down, particularly Electronics, energy in certain geographies, components that have labor content. We're also seeing it in our employee costs, health and welfare and other pockets, overhead costs, such as I just point out rental, expense, leases, software licenses. So we have to continue to be very diligent in this area and make sure that we get price to offset all of these pressures.
But overall, nothing significant to point to on the price/cost equation. And then maybe on the enterprise initiatives, Chris?
Christopher A. O'Herlihy -- President and Chief Executive Officer
Sure. So Tami, as you said, enterprise initiatives continue to be an important contributor to results. And how we think about both these initiatives is that these initiatives are independent of volume. And they're really an outcome of the continuous improvement mindset that's very much part of ITW's DNA, I would say.
And this is what really drives this divisional kind of quality of practice and 80/20 front to back in sourcing. And typically, very bottom-up initiatives driven by our talented people and our divisions at a very granular level. Most of these initiatives are in the couple of hundred thousand dollar range in terms of individually. But when you have 84 divisions, these add up to a very meaningful number.
So the divisions have a lot of visibility, ownership, and accountability on these and as the track record, as indicator over the last 11 years, our divisions going to do what they say when they forecast these. So our confidence on enterprise initiatives going forward that this will continue really is an outcome of the strong ownership and accountability that resides in our divisions and the strong continuous improvement mindset that I refer to, that's really hard word in our divisions at this point. And in the case of 80/20, as we know, this is the gift that keeps on giving. So with that, we certainly see an ongoing contribution from enterprise initiatives going forward, including in 2025.
And this is a fundamental part of how we drive differentiated execution in any environment.
Tami Zakaria -- JPMorgan Chase and Company -- Analyst
Got it. That is very helpful. And my second question is more strategic. So there's a lot of optimism around data centers, AI, power generation, power demand, so on and so forth.
How do you assess these opportunities internally? Do you see an opportunity for ITW to increase its exposure to some of these trends, maybe organically or through acquisitions? So how do you evaluate some of the things?
Christopher A. O'Herlihy -- President and Chief Executive Officer
So I think as it relates to data center specifically, we have standard characteristics of businesses that we would pursue for acquisition based on sustainable differentiation. So if an opportunity came along that was data center related and met our normal criteria, then we'd be all in based on the characteristics of having a business that could grow above market, that we can leverage our business model, and we could acquire at the right valuation. And that applies to everything, not just data centers. So we don't have a specific focus on data centers.
We kind of look at all these things on an equal basis in terms of their long-term attractiveness for us.
Tami Zakaria -- JPMorgan Chase and Company -- Analyst
Got it. Thank you.
Operator
Your next question comes from the line of Joe O'Dea from Wells Fargo. Please go ahead.
Joe O'Dea -- Analyst
Hi. Good morning. First, just wanted to ask on and kind of specific to North America, but interested in kind of CapEx versus OpEx trends. And I think appreciating a pretty quick book-and-ship model.
I'm not sure how much you would see this. But we do hear about inquiry activity being better than order activity out there. And so curious the degree to which you see some of that or hear some of that from your sales force and customer tone as you think about rates starting to come down, I think some folks are waiting for getting postelection and just the idea that you're getting a sense that there is some pent-up demand that hasn't moved forward with some uncertainty overhang and thoughts on that potentially moving forward nearer term?
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
Well, I think, Joe, I'd start by saying, we're not economists, we're not trying to predict the impossible here, which is where the economy is going. We are, as you said, much more short cycle. Our divisions do a great job kind of reading and reacting to what's going on in their respective end markets. I'll just make a broader comment based on what we saw in the third quarter, which is some stability in the more CapEx-sensitive businesses.
So I'll point to Welding. As I mentioned, I'll point to Test & Measurement, including our Instron business, which was up in a meaningful way on a year-over-year basis and improve kind of quoting and order activity. So maybe that squares with what you were talking about. And then the softness in Q3 was really much more tied to Construction and Automotive production, specifically with our customers with the T3 customers.
But certainly some stability in CapEx, and we'll see where it goes from here. We're modeling based on current run rates. So based on what we're seeing in our businesses today, and we'll see how it all plays out as we go into 2025 and interest rates maybe would be a little helpful if they came lower, for sure.
Joe O'Dea -- Analyst
I appreciate that color. And then just wanted to ask on CBI, and we think about -- as we think about it becoming sort of a growing initiative, just what it means on the R&D side and the degree to which you can keep R&D relative to sales at sort of similar levels or what you're doing there as we would think to drive more innovation, you might need to allocate a little bit more there?
Christopher A. O'Herlihy -- President and Chief Executive Officer
Yes. So for us, spend in R&D or innovation is largely an outcome of basically request of more divisions. Basically, we fund all the good projects. We have been making -- over the last 3 or 4 years making very focused investments in areas like innovation and strategic marketing.
We expect that to continue. But if that number was to go up, that's not a problem for us. It's really an outcome of funding all these good projects. And our teams are really focused on -- there are 80 opportunities in their market, but they're key customers.
And whatever we spend in R&D typically is an outcome of that. And we're very happy to spend it because it's typically money well spent on the degree of focus that our businesses have.
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
Yes. And just from a numerical standpoint, I'd say, our R&D spend, the way we've defined it here over the years, is about 1.8% of sales. So as sales grow, so will the R&D dollar spend. And we don't foresee any significant change in that as we go forward.
As Chris said, we really fund every project that our divisions put forward, and that's important to them. And so that's how we approach it here, really in terms of it's an outcome of this process that Chris described.
Joe O'Dea -- Analyst
I appreciate it. Thank you.
Operator
Your next question comes from the line of Sabrina Abrams of Bank of America. Please go ahead.
Sabrina Abrams -- Bank of America Merrill Lynch -- Analyst
Hi. Good morning. As a follow-up to some of the CBI commentary and question, I think back at your Investor Day, the framework for CBI for segment was about 2% to 3% contribution at its most meaningful driver to reach the long-term targets. Are you on track for that this year? And I understand it's relevant to all 7 segments.
But maybe if you could provide any color on which segments you think are more mature in this journey.
Christopher A. O'Herlihy -- President and Chief Executive Officer
Yes. So we're very much on track to do 3% plus in line with our target by 2030, if not indeed, before that, based on the progress that we are making. We're at varying levels of accomplishment currently across our 7 segments. I would point to Welding as an example, this year, as we've highlighted and Michael highlighted in his commentary, our Welding business is suffering some significant end market challenges, but we're getting north of 3% contribution of CBI in welding, as we forecasted at the beginning of the year, several new product launches.
So Welding will be one, Test & Measurement and Electronics, obviously, an area of significant attractiveness around innovation in the context of what's going on in those markets, new materials being developed, all of which required to be tested, increasing stringency in areas like R&D and in quality control, all of which requires more and more sophisticated testing equipment, which really speaks to our competitive advantages. And then the other one I'd highlight is Food Equipment. Our Food Equipment sustainability in areas of energy savings, water savings is a very fertile innovation environment, and we've managed to leverage that for several years. And the other one, of course, I'd point to is auto.
Auto, given the disruptive nature of auto right now, particularly with the increased penetration of electric vehicles, provides enormous opportunity for innovation. And we're capitalizing on that as evidenced by the fact that our electric vehicle -- penetration into electric vehicles is higher than the market average. So we feel pretty good about all 7 segments, but those are the 4 that I highlight right now.
Sabrina Abrams -- Bank of America Merrill Lynch -- Analyst
And it seems some of the above-average PLS and Specialty Products is behind us, and that business is growing nicely. You guys got rid of Wilsonart. Moving past some of this portfolio rationalization, is there more appetite to do M&A given some of these divestitures are behind us?
Christopher A. O'Herlihy -- President and Chief Executive Officer
Yes. So I would say our posture on M&A hasn't changed since we outlined this at the leadership conference. We got a pretty disciplined portfolio strategy, clear -- we believe clear and well-defined view of what fits our strategy. And so it's a case of us finding the right opportunities.
And for us, we're focused on high-quality acquisitions that extend our ability to grow at a minimum 4% over the long term. That's the first criteria. The second criteria we look at is that we're able to leverage the business model to improve margins. And then obviously acquiring the business at the right valuation to provide a decent long-term return for our shareholders.
We review opportunities on an ongoing basis, but we're very selective on the base of these criteria. And if I could point to MTS, as an example, MTS was an example of an acquisition we did 2.5 years ago, which fulfilled all of our criteria. And thanks to very strong execution, that's now turning out to be a home run on the basis of being pretty selectable, the criteria going in, strong execution when we acquire it. And now we've got a business that in the long term will be a superb ITW business.
Sabrina Abrams -- Bank of America Merrill Lynch -- Analyst
Thank you.
Operator
Your next question comes from the line of Julian Mitchell of Barclays. Please go ahead.
Julian Mitchell -- Analyst
Hi. Good morning. I was hoping this might be one call I could escape AI data centers, but I think they got dragged in.
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
We didn't bring it up just for the record.
Julian Mitchell -- Analyst
No. Totally fair. Totally fair. If we think just for a second, Michael or Chris, about sort of inventories.
Just curious about your own levels and those of your customers or distributor partners. I think your own inventories dollar-wise are pretty steady sequentially this year, but still running a little bit high as a share of revenue versus pre-COVID, maybe 11% versus something like 8% 5 years ago, 6 years ago. Is 11% sort of a good run rate from here? Or no, it should come down over time, but gradually just as the revenue picks up. And then how do you assess the sort of state of play of inventories at your distributors and customers? Are they kind of generally rightsized now after 2 years of being leaned out?
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
Yes, I think that's right, Julian. Let's start there, the channel. I think those inventory levels are -- have normalized. Our channel doesn't carry a lot of inventory because they're used to our kind of place an order today, we ship you tomorrow.
So with that level of customer service, there's no incentive for them to carry a lot of inventory. And then I'd kind of pivot into our own inventory levels. I'd say just more broadly on free cash flow. It was good to be above 100% again here in the third quarter, which is more in line with the typical levels that you expect from us.
And we expect to continue to make meaningful progress again in Q4 on inventory and free cash flow. So we've talked about our focus on reducing our months on hand, getting back to kind of pre-COVID levels of about 2.5 months on hand. We're about 3. The difference here is in that $300 million to $400 million range of additional inventory that we'll expect to come out Q4 and then into next year.
So we view that I think the same way you do as a big opportunity to drive above average free cash flow for the company here in the near term. I think we've made some progress down, I think it's 6% year-over-year. Last year, inventories came down 17%, but we can certainly -- we agree that there's some opportunity here. And we want to do that, reduce our inventory levels while maintaining those customer service levels, which is where I started, because we believe they are a real competitive advantage for us.
And the last thing I'll say is all of this, the fact that maybe we're a little bit lower this year on free cash flow than in prior years, doesn't impact our capital allocation plans. We're investing in our businesses for growth and productivity. All new products are funded. We raised the dividend 7% in August, and we're buying back 1.5 billion of our shares this year as planned.
So -- but I agree with you that there's definitely an opportunity here, and we're going after it in every one of our 84 divisions in a meaningful way here.
Julian Mitchell -- Analyst
That's a very good answer. And then just my follow-up, sort of thinking again about that question of customer-back innovation and driving up organic growth and market share. I think, as you said, sort of R&D to sales is pretty steady, so maybe flattish dollars year-to-date versus last year. CapEx was sort of flattish year-to-date down somewhat in the third quarter year-on-year.
So when we're thinking about kind of the levers of getting that market share up, and it's in the context of a sort of decentralized operating structure where you're sort of letting the businesses ask you for R&D dollars. Maybe give us 1 or 2 examples of how you're driving up that share? How does that interplay work between trying to get more dollars of spend into different businesses with a high return versus that kind of decentralized nature? Any sort of examples around that might be helpful for me, at least.
Christopher A. O'Herlihy -- President and Chief Executive Officer
Yes. So I would say, Julian, that our spend in innovation has been rising over the last 2 or 3 years. I mean, we've seen double-digit increases in spend on the basis of pretty focused investments in strategic marketing and innovation across the portfolio. But a lot of this goes beyond spend.
It really comes down to a much higher level of, I think, leadership time and focus. As I said, we're already doubling down on this in the same way we doubled down on 80/20 front-to-back last time. And we've been investing in building capability really for the last few years here. But I think you can see that in the increased yield that we've had since like '17, '18, where it was about 1% to now where it's about 2%.
So we're already seeing the investments. And this capability build is both in our divisions, but also at our segment level to really enable our businesses to be able to achieve this. A lot this comes down to the quality of the framework. We have a lot of great innovation practice across the company.
We've codified that and now we want to make sure that it resides everywhere in every division in ITW. And this is the exact same approach that we took on 80/20 front to back that was very successful in the last phase of our strategy. So we're on a great path there. We're already seeing the outcomes.
We expect to see continuous improvement in CBI contribution every year from here on out, starting in 2025.
Julian Mitchell -- Analyst
That's great. Thanks, Chris.
Operator
Your next question comes from the line of Nathan Jones of Stifel. Please go ahead.
Adam Farley -- Stifel Financial Corp. -- Analyst
Good morning. This is Adam Farley, on for Nathan. I wanted to follow up on Welding. What impact do you believe the upcoming election is having on the sentiment in the underlying industrial market? Could we potentially see an improvement in '25, maybe postelection?
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
Maybe you want to jump in?
Christopher A. O'Herlihy -- President and Chief Executive Officer
Yes. So at a high level, Nathan, I would say, look, we're a short cycle company. So we're kind of reading and reacting to what's in front of us. There's nothing overt or specific that we're hearing from our customers related to the election, I would say.
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
Yes, I would agree with that. I think there are some -- other than anecdotes, there's really nothing specific that we can point to. And I think that we'll kind of leave it at that.
Adam Farley -- Stifel Financial Corp. -- Analyst
OK. Fair enough. I know it wasn't called out in the press release, but was there any hurricane impact at your sites or maybe your customer sites?
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
No. Not in our side. I can't speak for all of our thousands of customers in those affected regions, but there was no impact on our facilities and thank God, on our people in those areas.
Erin Linnihan -- Vice President, Investor Relations
Kathleen, does that end the call for us today?
Operator
[Operator signoff]
Duration: 0 minutes
Call participants:
Erin Linnihan -- Vice President, Investor Relations
Christopher A. O'Herlihy -- President and Chief Executive Officer
Michael M. Larsen -- Senior Vice President, Chief Financial Officer
Jeffrey Sprague -- Analyst
Michael Larsen -- Senior Vice President, Chief Financial Officer
Jeff Sprague -- Analyst
Chris O'Herlihy -- President and Chief Executive Officer
Jamie Cook -- Analyst
Andrew Kaplowitz -- Analyst
Andy Kaplowitz -- Analyst
Tami Zakaria -- JPMorgan Chase and Company -- Analyst
Joe O'Dea -- Analyst
Sabrina Abrams -- Bank of America Merrill Lynch -- Analyst
Julian Mitchell -- Analyst
Adam Farley -- Stifel Financial Corp. -- Analyst
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