Illinois Tool Works Inc. — Q3 2009 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2009; unaudited. ITW is a diversified manufacturer serving industrial, construction, automotive, food-service, electronics, and other markets.
Key financial results
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Revenue | $3.580 billion | $4.465 billion | $10.120 billion | $13.146 billion |
| Operating income | $483.6 million | $671.0 million | $909.7 million | $2.047 billion |
| Operating margin | 13.5% | 15.0% | 9.0% | 15.6% |
| Income from continuing operations | $303.0 million | $464.6 million | $473.9 million | $1.389 billion |
| Net income | $302.4 million | $453.5 million | $439.6 million | $1.285 billion |
| Diluted EPS | $0.60 | $0.87 | $0.88 | $2.45 |
Year over year, Q3 revenue declined 19.8% and operating income 27.9%; nine-month revenue fell 23.0% and operating income 55.6%. Nine-month continuing-operations income declined 65.9%. The filing attributes the deterioration chiefly to lower base demand, unfavorable currency translation, restructuring costs, and impairment charges.
Cash flow and liquidity: Nine-month operating cash flow was $1.640 billion, versus $1.633 billion a year earlier. Free operating cash flow, the company’s non-GAAP measure, was $1.466 billion versus $1.358 billion; capital expenditures were $174.4 million. Cash ended at $942.9 million. Current assets were $5.285 billion and current liabilities $2.467 billion; the current ratio was 2.14, versus 1.19 at December 31, 2008. Working-capital improvement largely reflected reduced short-term debt and lower receivables and inventories.
Debt and capital: Total debt was $2.937 billion, down from $3.682 billion at year-end 2008; debt to capitalization was 26.3%, compared with 32.4%. Short-term debt was $67.5 million and long-term debt $2.869 billion. The company had no commercial paper outstanding and no borrowings under its $2.0 billion credit facility, which terminates June 11, 2010. In March, ITW issued $800 million of 5.15% notes due 2014 and $700 million of 6.25% notes due 2019, using net proceeds to repay commercial paper.
Dividends paid were $464.4 million for the first nine months, and the quarterly dividend paid was $0.31 per share. No shares were repurchased during the period, versus $991.6 million of repurchases in the prior-year period.
Changes, segments, and unusual items
- Q3 base revenues declined 17.9%, but management said they improved compared with Q2. North American and international base revenues fell 21.6% and 13.8%, respectively. Currency translation also reduced nine-month revenue by approximately $766 million and continuing-operations diluted EPS by approximately $0.11.
- Revenue declined across every reported segment. The steepest Q3 declines included Power Systems & Electronics (34.6%), Industrial Packaging (29.5%), and Construction Products (23.3%). Transportation was down 7.0%; its automotive markets showed improvement from Q2, partly associated with the “cash for clunkers” program.
- Cost reductions and favorable price-versus-raw-material comparisons helped base margins. Management reported improving base manufacturing margins in Q3, while lower revenues, restructuring, and impairments continued to weigh on total results.
- Nine-month goodwill and intangible impairment charges were $102.0 million, versus $1.4 million a year earlier. These included $78.0 million of goodwill impairments and $12.0 million of intangible impairments in Q1, and a $12.0 million Q3 goodwill impairment in Transportation. ITW moved its annual goodwill impairment assessment from Q1 to Q3.
- The nine-month effective tax rate was 38.9%, compared with 28.9% in 2008, reflecting largely nondeductible impairment charges and $46.8 million of discrete tax adjustments, including tax-contingency reserves and valuation allowances.
- Discontinued operations generated a nine-month loss of $34.3 million, including a $29.6 million pretax loss on the sale of Click Commerce. The automotive components business was sold in Q3. In May, the board rescinded its plan to divest Decorative Surfaces, which is presented as continuing operations.
Outlook, risks, and contingencies
Management anticipated that the weak global economic environment would continue through 2009 and that key end markets would remain negatively affected; it also noted that trends were weak but improving versus Q2. The filing provides no numerical earnings or revenue guidance. Principal risks identified include further weakness in construction, industrial, automotive, and food-service markets; economic deterioration; foreign-exchange and raw-material movements; reduced credit availability; product-development challenges; acquisition conditions; and tax-law or tax-authority developments.
Tax authorities were reviewing matters in Australia, Germany, and the United States, including financing transactions, leveraged leases, and mortgage-backed securities. ITW said it could resolve matters within 12 months and that unrecognized tax benefits might decline by approximately $270 million to $580 million; this is a possible reduction, not a stated expected cash recovery. For 2009, management expected pension contributions of approximately $218 million and other postretirement contributions of $38 million; by September 30, it had contributed $209.8 million and $24.2 million, respectively.
Investor verification points
- Assess whether the reported Q3 improvement in base revenues continued after September and how exposed demand remained to the company’s end markets.
- Reconcile reported earnings and margins with the $102.0 million impairment charge, restructuring costs, and elevated tax rate; review assumptions behind goodwill valuations.
- Check the nature, timing, and possible outcomes of the $270 million–$580 million tax-contingency range.
- Monitor debt maturities, credit-facility availability and renewal, and the effect of the 2009 debt issuance on interest expense and leverage.
- Compare subsequent cash generation, dividend commitments, and pension contributions with the company’s liquidity and capital-allocation objectives.