Illinois Tool Works Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. ITW is a diversified global industrial manufacturer operating through seven segments and 85 divisions in 55 countries.
Financial performance
- Third quarter: Revenue was $3.613 billion, essentially flat year over year; organic revenue grew 1.5%, offset by unfavorable currency translation. Operating income was $889 million, down 7.4%, and operating margin was 24.6%, down 200 basis points. Net income was $638 million versus $640 million; diluted EPS was $1.90 versus $1.85.
- Nine months: Revenue rose 4.7% to $11.188 billion, including 2.6% organic growth. Operating income increased 3.2% to $2.724 billion; operating margin declined 40 basis points to 24.3%. Net income increased to $1.956 billion from $1.763 billion; diluted EPS rose to $5.77 from $5.07.
- Cash flow: Nine-month operating cash flow was $2.002 billion and capital expenditures were $282 million, producing company-defined free cash flow of $1.720 billion, versus $1.488 billion in 2017. Dividends paid were $792 million and share repurchases were $1.5 billion.
- Liquidity and debt: Cash and equivalents were $1.589 billion at September 30, down from $3.094 billion at year-end 2017. Total debt was $7.404 billion, down from $8.328 billion; total debt to trailing EBITDA was 1.8x versus 2.1x at December 2017. Short-term debt of $1.350 billion included $1.350 billion of notes due in March and April 2019; no commercial paper was outstanding. Management said liquidity sources and access to financing were sufficient for debt service and capital priorities.
- Tax and returns: The nine-month effective tax rate was 24.1% versus 28.7%. Adjusted after-tax ROIC was 28.3% for the year-to-date period, up 420 basis points, primarily due to U.S. tax changes. The quarterly dividend was increased 28.2% in Q3.
Material changes and segment trends
- The 2017 comparison included $80 million of Q3 legal settlement income ($95 million for the nine-month period). Excluding that item, operating income increased 1.0% in Q3 and 7.0% year to date; diluted EPS increased 11.4% and 17.7%, respectively. The settlement also materially affected reported margin comparisons.
- Welding was the strongest Q3 segment by organic growth, up 10.3%; Test & Measurement and Electronics grew 2.9%, and Food Equipment grew 3.8%. Specialty Products declined 3.8% organically and Polymers & Fluids declined 0.7%.
- All seven segments recorded year-to-date organic revenue growth. Q3 growth was achieved by four of seven segments. Product line simplification reduced organic growth by 70 basis points in both periods.
- Q3 margin pressure included unfavorable price/cost, higher freight and employee-related expenses, and, in some segments, product mix. Company-wide enterprise initiatives and operating leverage partly offset these pressures.
Outlook, risks, and unusual items
- The filing provides no specific consolidated revenue or earnings guidance. Management described Q3 and year-to-date results as solid despite near-term market challenges. It noted softer auto production in Europe and China and weaker demand in some international end markets served by Specialty Products and Polymers & Fluids.
- ITW said tariffs had not materially affected results to date but expected their impact, and that of global trade policies, to increase. Raw-material inflation, supply availability, and the ability to pass cost increases to customers are risks.
- Other cited risks include economic and political conditions, currency movements, financing and credit access, pension exposure, legal proceedings, cybersecurity and data privacy, and potential goodwill or intangible-asset impairment.
- Accounting changes included a $406 million reduction to deferred tax assets and retained earnings on adoption of intra-entity tax-transfer guidance, and a $9 million reduction to retained earnings from revenue guidance adoption. The revenue guidance had an immaterial effect on 2018 results. ITW expected to adopt lease accounting in 2019 and anticipated recognizing operating-lease assets and liabilities.
- ITW repatriated approximately $2.8 billion of foreign cash during the first nine months; some proceeds repaid commercial paper and funded share repurchases. An August 2018 tax-court decision favored ITW in an IRS dispute involving $70 million of asserted additional tax, plus interest and penalties; the IRS had 90 days to appeal, and no reserve was recorded.
Important facts for investors to verify
- Whether weaker international demand and auto production continue, and how tariffs and raw-material costs affect price/cost and margins.
- The timing and funding of the $1.350 billion of 2019 note maturities, and the company’s ongoing cash, debt, dividend, and repurchase plans.
- Whether the operating-income and EPS trends remain strong after adjusting for the 2017 legal settlement and the effects of tax items.
- The status of the IRS appeal and ongoing tax audits, and the ultimate effects of tax-law implementation and lease-accounting adoption.