Illinois Tool Works Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016 unless otherwise noted. ITW is a diversified global industrial manufacturer with seven reportable segments.
Financial performance
| Metric | Q1 2017 | Q1 2016 / change |
|---|---|---|
| Operating revenue | $3.471 billion | $3.274 billion; up 6.0% |
| Organic revenue growth | 3.5% | Six of seven segments grew organically |
| Operating income | $809 million | $722 million; up 12.0% |
| Operating margin | 23.3% | 22.1%; up 120 basis points |
| Net income | $536 million | $468 million |
| Diluted EPS | $1.54 | $1.29; up 19.4% |
| Operating cash flow | $463 million | $479 million |
| Free cash flow | $399 million | $422 million; defined as operating cash flow less capital expenditures |
| Cash and equivalents | $2.493 billion | $2.472 billion at December 31, 2016 |
| Total debt | $7.876 billion | $7.829 billion at December 31, 2016; debt/EBITDA was 2.2x |
| Cash dividends paid | $226 million; $0.65 per share | $200 million; $0.55 per share |
The effective tax rate was 28.3%, versus 30.0% a year earlier; it included a $12 million discrete benefit from adopting stock-based compensation guidance. Excluding that benefit, the rate would have been 30.0%. Adjusted after-tax return on average invested capital was 23.8%, up 260 basis points, with the tax benefit contributing approximately 60 basis points.
Segments and material changes
Management attributed consolidated growth to organic revenue and acquisitions, partly offset by unfavorable currency translation. Organic growth reflected penetration gains, higher end-market demand and product innovation. Enterprise initiatives contributed an estimated 100 basis points to operating margin; positive operating leverage contributed 80 basis points. These benefits were partly offset by 50 basis points of margin dilution from the EF&C acquisition and 30 basis points from unfavorable price/cost.
| Segment | Revenue | Organic growth | Operating margin |
|---|---|---|---|
| Automotive OEM | $828 million | 9.0% | 24.4%; down 200 bps, primarily due to EF&C dilution |
| Food Equipment | $497 million | 2.0% | 25.1%; up 60 bps |
| Test & Measurement and Electronics | $480 million | 5.5% | 20.0%; up 450 bps |
| Welding | $387 million | Down 0.3% | 27.7%; up 380 bps |
| Polymers & Fluids | $426 million | 1.5% | 20.6%; up 40 bps |
| Construction Products | $395 million | 2.9% | 22.5%; up 150 bps |
| Specialty Products | $463 million | 0.8% | 26.9%; up 80 bps |
EF&C, acquired in July 2016 for approximately $450 million, contributed $128 million of Q1 2017 revenue in Automotive OEM and diluted consolidated operating margin by 50 basis points. Management expected the acquisition to be slightly accretive to earnings in its first 12 months, with improved performance later through ITW’s 80/20 process. All seven segments reported operating margins of at least 20%.
Operating cash flow and free cash flow declined year over year despite higher net income. Cash flow included working-capital outflows, including increases in receivables and inventory; the prior-year comparison also included a larger deferred-tax benefit. ITW repurchased approximately 1.9 million shares for $250 million; approximately $3.2 billion remained authorized under its $6.0 billion repurchase program.
Outlook, risks and unusual items
- The filing provides no specific numerical full-year earnings or revenue guidance. Management described its focus as sustained above-market organic growth and further structural margin improvement, including a goal of reducing sourcing spend by 1% in each of 2017 and 2018. Approximately 85% of divisions were considered ready to grow as of year-end 2016.
- After quarter-end, ITW entered a confidential litigation settlement under which it expects to receive $95 million within 120 days of execution. The benefit is primarily expected in Q3 2017 and is excluded from current guidance.
- An IRS tax dispute concerns a 2006 transaction; the IRS asserted $70 million of additional tax, plus interest and penalties. A Tax Court decision was expected in 2017. ITW stated its position remained supportable and had recorded no reserve. Ongoing tax audits could also affect unrecognized tax benefits; the company said those benefits could decrease by approximately $58 million within 12 months.
- Approximately $2.5 billion of cash was held primarily by international subsidiaries and may incur U.S. income and foreign withholding taxes if repatriated. Short-term debt included $649 million of commercial paper.
- Management cited risks including market and economic weakness, foreign currency movements, raw-material costs and shortages, execution of enterprise initiatives, acquisition performance, financing and credit conditions, pension funding, tax matters, legal proceedings, and cybersecurity or service interruptions.
- ITW expected no material impact from adopting the new revenue standard in 2018; it had not completed its assessment of the 2019 lease standard and expected to recognize operating-lease right-of-use assets and liabilities.
Important facts for investors to verify
- Whether organic growth and margin gains persist across segments, particularly in North America, Welding and the acquired EF&C business.
- How much of reported EPS and return improvement reflects recurring operations versus the $12 million tax benefit and share-count reduction.
- Cash conversion and working-capital trends, including the location and potential repatriation costs of international cash.
- Debt refinancing and liquidity needs, commercial-paper exposure, and continued capital allocation among dividends, repurchases and investment.
- The timing and accounting impact of the $95 million settlement, and developments in the IRS dispute and other tax audits.
- The filing states disclosure controls were effective as of March 31, 2017, with no identified material change in internal control over financial reporting during the quarter.