Illinois Tool Works Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2012. Unless noted, figures are in U.S. dollars; financial statement amounts are in millions.
Business context and reporting period
Illinois Tool Works (ITW) is a diversified industrial manufacturer operating across eight reportable segments, including Transportation, Power Systems & Electronics, Industrial Packaging, Food Equipment, Construction Products, Polymers & Fluids, Decorative Surfaces, and All Other. Prior-period segment data was recast for management reporting changes. Certain divested businesses are presented as discontinued operations.
Financial performance and liquidity
- Third quarter: Revenue was $4.501 billion, down 1.7% year over year. Operating income rose 6.8% to $763 million, and operating margin increased to 16.9% from 15.6%. Continuing-operations income was $525 million versus $490 million; diluted continuing-operations EPS was $1.12 versus $1.00. Net income was $524 million versus $507 million.
- Nine months: Revenue increased 1.7% to $13.703 billion. Operating income rose 7.4% to $2.238 billion, with operating margin of 16.3% versus 15.5%. Continuing-operations income declined 3.6% to $1.523 billion, while diluted continuing-operations EPS increased to $3.20 from $3.17. Net income increased to $1.891 billion from $1.629 billion, including $368 million of discontinued-operations income.
- Cash flow: Nine-month operating cash flow was $1.467 billion, versus $1.244 billion. Capital spending was $274 million, yielding company-defined free operating cash flow of $1.193 billion, up from $985 million. Cash dividends paid were $515 million; share repurchases were $1.396 billion.
- Balance sheet and debt: Cash and equivalents were $2.054 billion at September 30, up from $1.178 billion at year-end 2011. Total debt was $4.996 billion, compared with $3.990 billion; debt-to-capitalization was 32.7% versus 28.5%, and trailing debt/EBITDA was 1.4 versus 1.2. Current assets were $7.650 billion and current liabilities $2.928 billion, for a 2.61 current ratio.
- All reported cash was held by international subsidiaries and could be subject to taxes if repatriated. The company had $357 million of commercial paper outstanding and a $1.5 billion credit facility, with no borrowings under that facility at quarter-end.
- Cash dividends declared were $0.38 per share for the quarter, compared with $0.36 a year earlier. The company repurchased 7.6 million shares in the quarter under its $4.0 billion authorization; approximately $2.5 billion remained authorized.
Material changes versus prior comparable periods
- Quarterly revenue was pressured by currency translation, which reduced revenue by 4.1%, while base-business revenue grew 0.9% and acquisitions net of divestitures contributed 1.4%. For the first nine months, currency reduced revenue by 3.4%; base-business growth and acquisitions more than offset that impact.
- Management attributed higher operating income and margins mainly to better variable margins, operating efficiencies, and positive operating leverage. Higher restructuring costs and currency effects partly offset those gains.
- North American base revenue was comparatively resilient, while international base revenue declined 2.7% in the quarter, including declines in Europe and Asia Pacific. Management described European conditions as weak and Asia Pacific as softer.
- The nine-month continuing-operations comparison was affected by a $166 million favorable Australian tax benefit recorded in 2011. The 2012 effective tax rate was 29.0%, compared with 20.7% in 2011.
- Debt increased following the August issuance of $1.1 billion of 3.9% senior unsecured notes due 2042. Proceeds were used to repay commercial paper.
Outlook, commentary, risks, and unusual items
- No specific consolidated earnings or revenue guidance is provided in the filing. Management said internally generated cash flows were expected to support debt service, internal growth, dividends, and small-to-medium acquisitions.
- Management expected to contribute approximately $180 million to pension plans and $39 million to other postretirement plans in 2012; $162 million and $23 million, respectively, had been contributed through September 30.
- ITW agreed to sell a 51% majority interest in Decorative Surfaces to funds managed by Clayton, Dubilier & Rice through a new joint venture. ITW expected to receive approximately $1.05 billion and retain an approximately 49% common-unit interest. Closing was expected in the fourth quarter, subject to financing, regulatory approvals, and other conditions. ITW expected a gain and to account for its retained interest under the equity method after closing. The joint venture was expected to incur approximately $725 million of new debt; its preferred units carry a 10% annual dividend, potentially increasing to 12% under specified conditions.
- Discontinued operations included the completed sale of the finishing businesses, which generated a $454 million pretax gain in the second quarter, and the sale of a consumer packaging business, which generated a $17 million pretax gain in the third quarter. No businesses remained classified as held for sale at September 30.
- The third-quarter annual impairment review resulted in approximately $2 million of charges: $1 million for goodwill and $1 million for an intangible asset. The filing reported no such charges in the 2011 quarter.
- Tax audits and disputes remain a risk. The company said unrecognized tax benefits could increase or decrease by approximately $150 million within the next 12 months, predominantly related to intercompany financing and global legal-structure matters.
- ITW said remaining welding-related toxic-tort claims were not expected to have a material adverse effect. The filing identifies broader risks including economic weakness, foreign exchange, raw-material costs and supply, acquisitions, credit availability, pension exposure, tax outcomes, legal proceedings, and execution of enterprise initiatives.
Most important facts for investors to verify
- Whether the Decorative Surfaces transaction closed on the expected terms and timing, including final proceeds, debt, gain, and treatment of ITW’s retained interest.
- Whether margin improvement and free operating cash flow persist amid weak international markets, restructuring activity, and currency headwinds.
- How increased debt, share repurchases, dividends, and the location of cash outside the United States affect financial flexibility and capital allocation.
- Developments in tax audits and the potential approximately $150 million change in unrecognized tax benefits.
- The cover page appears to mark “No” for filing all required reports during the preceding 12 months; investors should verify this unusual disclosure against the official filing.