Earnings Call Transcript - ITW Q3 2021

Operator, Operator

Good morning. My name is Tammy, and I will be your conference operator today. At this time, I would like to welcome everyone to the conference call. Thank you. Karen Fletcher, Vice President of Investor Relations, you may begin your conference.

Karen Fletcher, Vice President of Investor Relations

Thanks, Tammy. Good morning, and welcome to ITW's Third Quarter 2021 Conference Call. I'm joined by our Chairman and CEO, Scott Santi; and Senior Vice President and CFO, Michael Larsen. During today's call, we will discuss ITW's third quarter financial results and update our guidance for full year 2021. Slide 2 is a reminder that this presentation contains forward-looking statements. We refer you to the company's 2020 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 Chairman and CEO, Scott Santi.

Scott Santi, Chairman and CEO

Thank you, Karen. Good morning, everyone. In the third quarter, we saw continued strong growth momentum in 6 of our 7 segments and delivered excellent operational execution and financial results. Revenue grew 8% with organic growth of 6% and earnings per share of $2.02 was up 10%. At the segment level, organic growth was led by welding at plus 22%; food equipment at plus 19%; Test & Measurement and Electronics at plus 12% and specialty products at plus 8%. Our automotive OE segment continued to be impacted in the near term by auto production cutbacks associated with the well-publicized supply chain challenges affecting our auto customers. In Q3, auto production cutbacks ended up being significantly larger than what was projected heading into the quarter. As a result, our auto OEM segment revenues were down 11% in Q3 versus the minus 2% we were expecting at the end of June. In a very challenging environment, our teams around the world continue to do an exceptional job of executing for our customers and for the company. In Q3, our people leveraged the combination of ITW's robust and highly flexible 80/20 front-to-back operating system, the company is close to the customer manufacturing and supply chain capabilities and systems, and our decision to stay fully staffed and invested through the pandemic to sustain world-class service levels for our customers. They also executed appropriate and timely price adjustments in response to rapidly rising raw material costs. As a result, we were able to fully offset input cost increases on a dollar-for-dollar basis in Q3, resulting in a 0 EPS impact from price cost in the quarter. Our teams also managed to continue to drive progress on our long-term strategy, execute on our Win the Recovery positioning initiative, and deliver another 100 basis points of margin improvement benefit from enterprise initiatives. Moving forward, we remain very focused on sustaining our growth momentum and on fully leveraging the competitive strength of the ITW business model and the investments we have made and continue to make in support of the execution of our enterprise strategy. Before turning it over to Michael, I want to thank all of our ITW colleagues around the world for all their efforts and for their dedication to keeping themselves and their ITW colleagues safe, serving our customers with excellence, and driving continued progress on our path to ITW's full potential. Michael, over to you.

Michael Larsen, Senior Vice President and CFO

Thank you, Scott, and good morning, everyone. As Scott said, demand remained strong in Q3 with total revenue of $3.6 billion, an increase of 8% with organic growth of 6%. Growth was positive in 6 of 7 segments, ranging from 3% to 22% and in all geographic regions, led by North America, which was up 9%; Europe was up 1%, and Asia was up 5%. China was up 2% versus prior year and up 6% sequentially. GAAP EPS of $2.02 was up 10% and included a one-time tax benefit of $0.06. Operating income increased 7% and operating margin was flat at 23.8% despite significant price cost headwinds. Enterprise Initiatives were really positive again this quarter at 100 basis points, as was volume leverage, which contributed more than 100 basis points. Thanks to a great effort by our businesses, price cost was EPS-neutral in Q3 but still dilutive to operating margin percentage by 200 basis points as raw material cost increases further escalated in the third quarter. Throughout 2021, our businesses have quickly and decisively responded to raw material and logistics cost inflation with pricing actions in alignment with our policy to fully offset these cost increases with price on a dollar-for-dollar basis. As we’ve talked about this before, we don’t hedge, so current cost inflation is always moving through our businesses in real-time. After-tax return on invested capital was 28.5%, and free cash flow was $548 million. Free cash flow conversion was 86% as our businesses have been very intentional about adding inventory to both support our growth and to mitigate supply chain risk and sustain world-class service levels for our customers. Overall, for the quarter, we saw strong growth in 6 of 7 segments and excellent operational and financial execution across the board. Let's go to Slide 4 for segment results. And before we get to the segment detail, the data on the left side of the slide illustrates our strong Q3 results with and without automotive OEM. I wanted to highlight 2 key points. The first is the benefit we derive from our high-quality diversified business portfolio in terms of the strength, resilience, and consistency of ITW's financial performance, which is enabling us, in this case, to power through significant near-term headwinds in our largest segment and still deliver top-tier overall performance. The second is the accelerating growth momentum with strong core earnings leverage we're generating across the company. Excluding our auto OEM segment, given the issues affecting that market right now, the rest of the company collectively delivered organic growth of 11% and operating income growth of 14% with an operating margin of 25% plus in Q3. The price/cost impact revealed that our core incrementals were a very strong 52% in the third quarter, which points to the quality of growth and profitability leverage that define the core focus of our business model and strategy. Now let's take a closer look at our segment performance in Q3, beginning with automotive OEM on the right side of this page. Organic revenue was down 11%, with North America down 12%, Europe down 18%, and China up 2%. As Scott mentioned, supply chain-related production cutbacks were much larger in Q3 than what we and most, if not all, external auto industry forecasters were expecting heading into the quarter. While conditions in the auto market are obviously very challenging in the near term, good news from our standpoint is that the eventual and inevitable recovery of the auto market will be a major source of growth for ITW over an extended period of time once the current supply chain issues begin to improve and ultimately get resolved. Between now and whenever that is, we will remain fully invested and strongly positioned to support our customers and seize incremental share gain opportunities as production accelerates coming out the other side of this situation. Turning to Slide 5 for Food Equipment, organic revenue growth was very strong at 19%, and the Food Equipment recovery that began in Q2 continues to gain strength. North America was up 18% with equipment up 20% and service up 14%. Institutional revenue, which is about one-third of our revenue, increased more than 20%, with strength in education, which was up over 40%, and health care and lodging growth around 20%. Restaurants were up almost 50% with strength across the board. Strong demand is evident internationally as well, with Europe up 20% and Asia Pacific up 23%. Equipment sales led the way, up 26%, with service growth of 8%. In our view, this segment is in the early stages of recovery as evidenced by revenues that are still below pre-COVID levels. Test & Measurement and Electronics organic revenue was strong with growth of 12%. Test & Measurement was up 15%, driven by continued strength in customer CapEx spend and in our businesses that serve the semiconductor space. Electronics grew 8% and operating margin was 26.8%. Moving to Slide 6. Welding demand continued to be very strong with organic revenue growth of 22%. Equipment revenue was up 25% and consumables grew 18%. Our industrial businesses increased 32%, and the commercial business, which sells to small businesses and individual users, grew 18%. North America was up 24% and international growth was 12%, with continued recovery in oil and gas, which was up 9%. Welding had an operating margin of 30% in the quarter. Polymers & Fluids organic growth was 3%, with demand holding steady at the elevated levels that began in Q3 of last year, consequently, having a tough comp of plus 6% a year ago. In Q3, growth was led by the Polymers business, up 8% with continued strength in MRO and heavy industry applications. Automotive aftermarket grew 4% with sustained strength in the retail channel, and Fluids was down 5% due mostly to a decline in pandemic-related hygiene products versus prior year. Margins were 24.2%, with more than 250 basis points of negative margin impact from price cost, driven by significantly higher costs for resins and silicone. Moving to Slide 7. A similar situation with construction, where organic growth was also up 3% on top of a strong year-ago growth rate of plus 8%. All 3 regions delivered growth, with North America up 2%, residential renovation up 1% on top of plus 14% comp a year ago, and commercial was up 10%. Europe was up 8%, and Australia and New Zealand was up 2%. Specialty organic revenue was up 8%, driven by continued recovery in North America, which was up 15%, and international was down 4%. Equipment sales were up 10% with consumables up almost 8%. Let's move on to Slide 8 for an update on our full year 2021 guidance. As you saw in the press release, we're updating our GAAP EPS guidance to a range of $8.30 to $8.50, which incorporates the impact of actual and anticipated lower automotive customer production levels in Q3 and Q4 compared to our previous guidance on July 30. We now expect the Automotive OEM segment revenue to be down about 15% in the second half, including being down 20% in Q4 versus the forecast of roughly flat second half auto OEM revenues that was embedded in our previous guidance. All other segments remain on track or better compared to our previous guidance. Our $8.40 midpoint equates to earnings growth of 27% for the full year. We now expect full year revenue to be in the range of $14.2 billion to $14.3 billion, which is up 13% at the midpoint, with organic growth in the range of 11% to 12%. Of that organic growth rate of 11% to 12%, volume growth, including share gains, are 8%, with price of 3% to 4%. For the full year, we expect operating margin of approximately 24%, which is up 100 basis points versus last year. The fact that we're expanding margins at all in this environment is pretty strong performance, considering that we now expect raw material costs to be up 9% or more than $400 million year-over-year, which is more than 4x our expectation coming into this year. Our businesses are on track to offset raw material cost increases with pricing actions on a dollar-per-dollar basis, which, as you know, is EPS neutral but margin dilutive. As raw material costs and consequently, price have gone up more than what we predicted in our previous guidance, we now estimate margin dilution percentage impact from price cost for the full year at about 150 basis points versus our previous expectation of 100 basis points. These margin headwinds, though, will be offset by strong volume leverage of about 250 basis points and another solid contribution from enterprise initiatives of more than 100 basis points. Free cash flow is expected to be approximately 90% of net income as we continue to prioritize sustaining our world-class service levels for our customers in this challenging environment, and as such, we will continue to invest in additional working capital to support our growth and mitigate supply chain risks. Our updated guidance is based on an expected tax rate for Q4 of 23% to 24% for a full year tax rate of approximately 19% to 20%. As per usual process, our guidance excludes any impact from the previously announced acquisition of the MTS Test and Simulation business. We are awaiting one final regulatory approval and expect to receive that and close the transaction in Q4. In summary, this will be a record year for ITW with double-digit organic growth, margin expansion, strong cash flow, and EPS growth of 25% plus. We expect this strong demand momentum to continue in Q4 and well into next year with an additional boost from the automotive OEM segment likely at some point in 2022 as the supply chain issues there begin to improve. ITW remains very well positioned to continue to deliver differentiated best-in-class performance as we leverage our diversified high-quality business portfolio, the competitive strength of ITW's proprietary business model, and our team's proven ability to execute at a very high level in any environment. With that, Karen, I'll turn it back to you.

Karen Fletcher, Vice President of Investor Relations

Thanks, Michael. Operator, can you please open up the lines for questions?

Operator, Operator

Your first question comes from the line of Jeffrey Sprague with Vertical Research.

Jeffrey Sprague, Analyst

And maybe just to start. Could you speak to what, if any kind of whipsaw effect that's going on as it relates to inventories? Just really trying to think about kind of how and when your sales might fully recouple with production? Or do you feel like they are fully coupled at this point? So any kind of nuances there to be aware of as we try to get out of this point.

Scott Santi, Chairman and CEO

Yes. I don't know a whole lot of nuances. I know that our customers expect us to be able to, as we've talked many times before, we work today, we ship tomorrow. In the auto space, we are certainly giving quarterly guides from our customers in terms of their production forecast. Obviously, those have been more volatile than normal lately. I would say that we’re not - there may be a little bit of inventory cushioning going on if you look at sort of build rates relative to our sales. I think our sales were actually higher than production declines in Q3 by sort of an incremental margin about 3 percentage points. I don't know the exact number. But so there may be a little bit of cushion building there just given the overall environment. Once this thing starts to turn around, we should see a pretty immediate effect.

Jeffrey Sprague, Analyst

And Scott, would you speak also just to the activity of your M&A pipeline? It looks like we’re close to getting MTS done. Are you working an active pipeline at this point?

Scott Santi, Chairman and CEO

We've talked about this many times before. We have a very clear and well-defined view of what fits our strategy and our financial criteria. There are things that are continuously being evaluated, but it’s just a matter of the right opportunity presenting itself as we go forward. That was certainly the case with MTS, and I expect that there will be others at some point, but I would not speculate as to one.

Jeffrey Sprague, Analyst

And just one quick housekeeping one for Michael. The unallocated costs have kind of been running higher all year and bumped up a little bit more? Like what's going on there? And what should we expect?

Michael Larsen, Senior Vice President and CFO

Yes, I think during the last four quarters we’re averaging about $30 million or so. There are certain costs that we don't allocate out to the segments, for example, health and wealth costs are going up year-over-year. I would assume that we'll stay somewhere in that 30% to 40% range on a go-forward basis.

Operator, Operator

Your next question comes from the line of Scott Davis with Melius Research.

Scott Davis, Analyst

I love your slide deck. 6 real slides, 15 minutes of prepared comments, that's best-in-class from what I can tell. I appreciate the brevity and the information. Just switching gears a little bit. I mean it's a little bit hard to perhaps measure, but your comment maintaining world-class service levels. When you think about your on-time deliveries today versus where they were a few quarters ago versus perhaps pre-pandemic? Are they back up to comparable levels? Did they ever slip that much? I'm sure some of your competitors probably had major problems.

Scott Santi, Chairman and CEO

Yes. It is a bit of a summation of a number of different cases, but I would say certainly there are a number of our businesses that have sustained their traditional order and ship tomorrow kinds of service levels throughout this environment. Although I have had to certainly work a lot harder with a lot more brute force given the environment to make that happen. In some other cases, I'm thinking about we've gone from ship tomorrow in order today to ship in a week. But I’m also thinking of cases where we’ve got people we compete with in certain markets that are now quoting deliveries into next year. From a standpoint of relative advantage, I think we are - again, without 84 different cases, I can't necessarily cite every exact one of them, but my bet is that we are - that the relative advantage that we have is actually increased in terms of our ability to deliver in our service level to our customers in this pandemic period.

Scott Davis, Analyst

And does that make it, Scott, easier to get price given the value promise that you have in delivery and predictability and such that your customer doesn't have to hold a lot of extra inventory because they can have some faith that you guys are going to be there for them?

Scott Santi, Chairman and CEO

I would imagine that's certainly part of it. I think the overall dimension of the value add in terms of the IP relationship as we try to outperform to give our customers the best overall value prop in terms of both the performance of the products we supply them and the service we delivered put around those. It’s not just the delivery service; it’s the service of those businesses where we have service positions like food equipment. All of this, I think, speaks to the fact that we’ve been able to recover dollar for dollar.

Operator, Operator

Next question comes from the line of Jamie Cook with Credit Suisse.

Jamie Cook, Analyst

Good job given the challenging environment. I guess just my first question on the margins on the construction business. You were up; the margins were down a little. So just trying to get some color there and when we can see sort of margin recovery. And then my second question, can you just give us an update on what the opportunities are in the M&A pipeline and could that further supplement the growth opportunity going forward?

Michael Larsen, Senior Vice President and CFO

Jamie, I think you may have missed it. We just talked about the M&A pipeline a few minutes ago with Jeff. So I'm going to skip that.

Jamie Cook, Analyst

I'm sorry, I didn't catch that.

Michael Larsen, Senior Vice President and CFO

It's okay, don't worry about it. In terms of construction, as we look at the margins on a year-over-year basis, good enterprise initiative contributions, good volume leverage. The headwind is really on the price/cost side. Specifically, steel costs are a significant headwind. Obviously, offset with price on a dollar-for-dollar basis, in line with our policy here but still margin dilutive pretty significantly at over 300 basis points here in the third quarter. I think the timing of when that impact is going to start to diminish is difficult to say. What we can say with a high degree of confidence is our ability to read and react to whatever cost increases come our way and respond appropriately and decisively with price. We’re certainly hopeful that the worst is behind us, but we’re not counting on that as we look forward.

Operator, Operator

Your next question comes from the line of Andrew Kaplowitz with Citigroup.

Andrew Kaplowitz, Analyst

So I know it's early to talk about '22, but maybe just big picture. Given the growth momentum in your businesses, Ex-auto, up 11%, and auto potentially reflecting in '22, as you said. At this point, what's your conviction level that ITW can deliver, let's say, continuing above trend levels when we think about our longer-term goal of 3% to 5% organic growth? Are any of your businesses actually snapping back faster than expected? Food equipment comes to mind that may continue to lead growth going into '22?

Michael Larsen, Senior Vice President and CFO

Well, I think, Andy, like we said, we certainly have some really good momentum in our businesses in Q3 and Q4, if you set the auto situation aside, those businesses are up 10% organically. There’s some really positive momentum, particularly in the more CapEx-oriented businesses. So welding, test and measurement, food equipment. Once the automotive production challenges get resolved, I think we're set up really well for a strong recovery down the road. We think potentially in 2022, we'll see some positive momentum as well in automotive OEM. Until we’ve rolled up the plans for 2022, I don’t really want to comment too much. We’ll give you a full update in February, like we always do when we provide guidance. But in terms of demand, the volume leverage that goes with that, the momentum still on enterprise initiatives and our ability to deal with whatever cost and supply chain issues come our way, I think we're really well set up for 2022 and beyond.

Andrew Kaplowitz, Analyst

Michael, that's helpful. And then you mentioned Q4; there are some normal seasonality. You mentioned less shipping days. Obviously, you're forecasting EPS in the middle of the range to be down a little in Q3. Is there anything else going on? Is it maybe a lag in how costs still hit the P&L in auto and maybe polymers and fluids? Would you say that Q4 maybe is the peak negative margin impact from materials and resins and that kind of stuff?

Michael Larsen, Senior Vice President and CFO

Well, I hope so. We're not counting on it. From Q2 to Q3, we saw a big step-up in our raw material cost inflation. I think it's unlikely we'll see the same thing here in Q4. We’re already through October. But beyond that, who knows, I think, it’s a typical seasonality for us. We go down from Q3 to Q4; revenues are down. Margins are down; we have 2 less shipping days. Automotive OEM, we said down 20% year-over-year. The other 6 segments will all have positive organic growth. Margin performance in those segments will be similar to Q3, if not a little bit better. You need to adjust for the tax rate, the discrete item we gave you the detail on that in Q3 versus Q4. There is a little bit of currency headwind in Q4 compared to Q3. You put all of that together, you get to what hopefully is a risk-adjusted pretty good outlook for the fourth quarter.

Operator, Operator

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

Ann Duignan, Analyst

I'm laughing because it’s like 20 years later. Perhaps just digging a little bit more. I know you've talked a lot about the momentum going into 2022, but you said in your nice brief opening comments that other than automotive, some of your other businesses were actually doing better than you had expected. If you could just expand on that a little bit. And then on the food service equipment side, particularly on institutional, is there any risk that there’s some pull forward of demand, a lot of institutions curtailed by the federal government with COVID aid. I mean, are you hearing anything about that driving demand on the institutional side?

Michael Larsen, Senior Vice President and CFO

Yes. I think your first question was what improved here relative to expectations. Food equipment and welding, certainly test and measurement. We talked about on the last call, we had some one-time equipment orders in Q2. If you take those out, the momentum is really strong as well in the test and measurement business due to strong demand in the semiconductor space. So I'd point to those 3 as the strongest. In terms of the institutional side, we really don’t think that there’s a significant impact there. Overall, in the institutional side was up, like we said 20%, education was up 40%, but healthcare was also up 20%. We don’t see anything slowing down on the institutional side or any of the other end markets within Food Equipment.

Ann Duignan, Analyst

Okay. And then just following up on the Food Equipment side, are you seeing any changes in the types of equipment being demanded coming out of COVID, thinking about changes to quick serve or any restaurant side? Are there notable secular or structural changes in the types of equipment that are being ordered?

Michael Larsen, Senior Vice President and CFO

Not really, Ann. No, I think this is very similar to our normal product mix, so there's no real impact from that.

Operator, Operator

Your next question comes from the line of Joe Ritchie with Goldman Sachs.

Joseph Ritchie, Analyst

Can we spend a minute just talking about auto OEM margins and pricing? My understanding is that historically, you guys price when you win your platforms, and it's difficult sometimes to get back and try to get price from auto OEMs? What I'm trying to understand is at what point do we start to see a positive equation for you from a price cost perspective and thinking about the potential recovery for those margins longer term?

Scott Santi, Chairman and CEO

Yes, under normal circumstances, pricing is much more contractually negotiated in the auto space relative to the rest of our businesses. The delta of inflation in raw material cost is certainly one where we're having discussions with our customers about needing to adjust that. We are not the only ones in that respect with our auto customers. So we’re working through that. I would say it remains the segment with the biggest lag regarding our ability to recover, but ultimately, our approach there is to expect full recovery on the dollar amount of inflation that we're seeing. The margin issue is somewhat short-run, but it's much more about opportunity when shipments improve, volumes start to recover, and supply chain challenges get resolved. Nothing indicates we won’t get back to prior peak terms of auto margins and potentially see them go up from there as we grow that business.

Michael Larsen, Senior Vice President and CFO

If you're a little worried about margins here in the near term in auto, we just did 17%, which in this industry is probably top-tier performance, if not best-in-class. In Q4, we expect maybe the typical step down from Q3 to Q4, but margins will still be solidly in the mid-teens. Overall for the company, what's implied in our guidance is operating margins for Q4 in that 22% to 23% range.

Joseph Ritchie, Analyst

That's really helpful. I appreciate that color from both of you. My one follow-up is just on MTS. It’s funny; I almost had forgotten that you guys had acquired the company or were in the process of acquiring it. Can you elaborate on what's taking so long? I think you got announced in the first quarter.

Scott Santi, Chairman and CEO

I don't want to go there, Joe. We're at the 2-yard line. Let's just leave things where they are, and we'll get it over the goal line here soon.

Joseph Ritchie, Analyst

Is there anything you can tell us about the accretion from the business? Because we have it kind of sized like roughly $500 million business with high 20s type gross margin. Any thoughts on potential accretion into 2022 if it closes this year?

Michael Larsen, Senior Vice President and CFO

In year one, we think EPS neutral, and there's going to be a little bit of purchase accounting upfront here. We didn't buy this business for its EPS contribution in 2022. This is really much more of a long-term play. In terms of size, your figures are about right for pre-COVID; the purchase price of $750 million is what we disposed of entry margins, 6% EBIT in a space we're familiar with. We're excited about integrating MTS and welcoming their team into the ITW family. The one benefit of having time is that we’ve organized around integration planning, confirming our due diligence assumptions on raw materials and performance over the next 3 to 5 years.

Operator, Operator

Your next question comes from the line of Julian Mitchell with Barclays.

Julian Mitchell, Analyst

Just wanted to follow up on the near-term organic growth outlook. It looks like the implied volume growth year-on-year may be down in Q4 for ITW overall year-on-year. If you've got sort of pricing up mid-single digits, I wanted to check that that's roughly the right way to think about it on volumes? Is that auto OE-related? Anything else where the volumes are soft? How confident do you feel in that overall market share recapture effort?

Michael Larsen, Senior Vice President and CFO

It's all automotive OEM here in Q4; with revenues down 20%. The other 6 of 7 businesses are performing like we said at a high level combined. If you look at the other 6 segments, organic growth is almost 10% in Q4, or projected to be 10%. Margins are 25% plus, similar to what those businesses did in Q3. It’s a near-term issue in auto OEM that makes the numbers appear different than typical.

Julian Mitchell, Analyst

Understood. Just circling back on the divestment aspect. In the recent past, you've talked about divestments maybe being on the table next year, and certainly we’ve started to see some other industrial companies divesting assets now because valuations are very elevated. Just wanted your latest thoughts on that divestment aspect, clearly multiples are high. Are you planning to wait a bit more just to let the operating profit keep growing?

Michael Larsen, Senior Vice President and CFO

This is a reminder that we pulled back on these planned divestitures right when COVID hit. That wasn't a good time to sell these businesses; we thought these businesses would be worth more coming out the other side, which they've proven to be, not just in terms of underlying performance. We expect multiples have certainly gone up. Early next year will be a good time to relaunch some of these processes. If you go back and look at this plan we announced in 2018, we’ve completed just under half of the divestitures. We still have another $300 million to $500 million worth of businesses we’re looking closely at.

Operator, Operator

Your next question comes from the line of Nigel Coe with Wolfe Research.

Nigel Coe, Analyst

Michael, good to have you back on the call. I want to ask Joe's question in a different way. I know you have multi-year contracts with OEMs. Given the extreme pressure on inflation, do you have any mechanism to pass along that through surcharges, etc.? My question is if we see volume recovering to, maybe not in 2022 but 2023, are we still going to be a bit underwater on the inflation recovery assuming you can’t adjust all the contracts?

Michael Larsen, Senior Vice President and CFO

It’s tough to predict how this will play out next year. We can reflect back on 2018, which saw inflationary pressures followed by significant recovery in 2019. Exactly when that happens is difficult to say. What’s clear though is that being a diversified company with a high-quality set of businesses has enabled us to face unprecedented levels of inflation effectively, and this will continue moving forward. The auto segment will take a little longer, but overall, we’re well-positioned to read and react in each of our segments.

Scott Santi, Chairman and CEO

These are long-term relationships that have been built over many years. In this environment, pricing is about finding a fair arrangement for both parties. I don’t think we should focus solely on contractual aspects; these are partnerships, and we will work together to reach a solution. We will be able to address price cost equation moving forward.

Michael Larsen, Senior Vice President and CFO

The price/cost equation is one of the elements of margin expansion here at ITW. The volume leverage we’re getting with organic growth and the contributions from enterprise initiatives are other factors. I wouldn't get too negative about the price cost side as you look toward next year. In February, we'll provide more comprehensive guidance.

Operator, Operator

There are no further questions at this time. I will now turn the call back over to Ms. Karen Fletcher.

Karen Fletcher, Vice President of Investor Relations

Thanks, Tammy. I just want to thank everybody for joining us this morning for our short and efficient call. Have a great day.

Operator, Operator

Thank you for participating in today's conference call. All lines may disconnect at this time.