Business context and reporting period
Illinois Tool Works Inc. (ITW) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2012. The diversified industrial manufacturer reports eight segments. Prior-period segment results and income statements were recast for discontinued operations and segment reclassifications.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $4.655B | $4.615B | $9.202B | $8.887B |
| Operating income | $770M | $711M | $1.475B | $1.370B |
| Operating margin | 16.5% | 15.4% | 16.0% | 15.4% |
| Continuing-operations income | $527M | $484M | $998M | $1.090B |
| Net income | $881M | $499M | $1.367B | $1.122B |
| Diluted continuing-operations EPS | $1.11 | $0.96 | $2.08 | $2.17 |
Q2 revenue rose 0.9%; first-half revenue rose 3.5%. First-half operating income increased 7.7%, with margin improving 60 basis points. In the first half, base-business revenue grew 2.7%, acquisitions contributed 3.7% to revenue growth, and currency translation reduced revenue by 3.0%. Management cited stronger North American conditions, modestly negative European conditions and slower Asian growth.
First-half net cash from operating activities was $832M, versus $457M; capital spending was $184M, producing company-defined free operating cash flow of $648M, versus $281M. Cash and equivalents were $1.692B at June 30. Current assets were $7.551B and current liabilities $3.936B; the current ratio was 1.92, down from 2.30 at year-end 2011.
Total debt was $4.906B, up from $3.990B at December 31, 2011; debt to capitalization rose to 32.7% from 28.5%, and trailing-twelve-month debt/EBITDA was 1.4x versus 1.2x at year-end. Short-term debt included $1.3B of commercial paper, compared with $192M at year-end. The company had no borrowings under its new $1.5B credit facility at June 30. All $1.7B of reported cash was held by international subsidiaries and could be subject to tax if repatriated.
Material changes and notable items
- Continuing-operations income for the first half declined 8.4%, and diluted EPS declined to $2.08 from $2.17. The 2011 comparison included a $166M favorable, non-cash discrete tax benefit related to an Australian tax case; the first-half effective tax rate was 29.0% in 2012 versus 16.3% in 2011.
- Net income included $354M of Q2 income from discontinued operations, including a $454M pretax gain on the April 2 sale of the finishing businesses for $650M cash. The first-half discontinued-operations income was $369M. The consumer packaging business remained classified as held for sale; ITW expected to complete its sale in Q3 2012.
- Operating margins increased across most segments. Construction Products was a notable exception: first-half operating income fell 12.8%, affected by restructuring costs, currency and weak international markets. Food Equipment and Industrial Packaging reported lower revenue but higher operating income.
- First-half foreign exchange reduced continuing-operations income by approximately $29M ($0.06 per diluted share). Interest expense increased to $100M from $89M.
- ITW repurchased $1.0B of shares in the first half, including approximately 9.5M shares in Q2 at an average $55.40; about $2.9B remained authorized. First-half cash dividends paid were $346M.
Outlook, commentary and risks
No specific consolidated revenue or earnings guidance is provided in the supplied filing text. Management said internally generated cash flows should be adequate for debt service, internal growth, dividends and small-to-medium acquisitions. The company expected 2012 pension contributions of approximately $165M and other postretirement contributions of $39M; $144M and $16M, respectively, had been contributed by June 30. Management expected a possible $70M–$220M reduction in unrecognized tax benefits within 12 months, predominantly from cross-border tax claims and audits.
Risks identified include market weakness and deterioration in domestic or international economic conditions, foreign exchange movements, raw-material price increases or supply shortages, acquisition-related profitability impacts, credit availability, tax changes or rulings, pension-market risks and adverse legal outcomes. The company said remaining welding-consumables toxic-tort claims were not expected to materially affect results, financial position or cash flows; it had resolved substantially all manganese-related claims for an immaterial amount.
Investor verification points
- Separate underlying continuing-operations performance from the finishing-business sale gain and discontinued-operations results.
- Assess the sustainability of margin gains, including pricing versus material costs, restructuring savings and acquisition-related amortization.
- Monitor short-term borrowing, debt levels and liquidity, noting that reported cash was held outside the United States.
- Track the expected consumer packaging divestiture and the potential timing and amount of tax-benefit changes.
- Consider the company’s stated exposure to economic, currency, input-cost, pension, tax and litigation risks.