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, 2014. The company reported seven continuing segments after completing the sale of its Industrial Packaging segment to The Carlyle Group on May 1, 2014. Prior-period results were recast to present designated businesses as discontinued operations.
Financial performance
Unless otherwise noted, amounts are in millions of dollars. Continuing-operations results exclude discontinued operations.
- Revenue and operating profit: Second-quarter revenue was $3,719, up 3.5% year over year; organic growth was 1.4%. Operating income rose 21.2% to $763, and operating margin increased to 20.5% from 17.5%. For the first half, revenue increased 3.9% to $7,288, operating income rose 18.5% to $1,430, and margin was 19.6% versus 17.2%.
- Earnings: Second-quarter income from continuing operations was $494 ($1.21 diluted EPS), compared with $416 ($0.92). First-half continuing income was $922 ($2.22 diluted EPS), versus $817 ($1.80). Net income was $1,492 for the quarter and $1,965 for the half, substantially boosted by the Industrial Packaging sale gain.
- Cash flow: First-half cash from operations was $887, down from $1,009. Free operating cash flow, a company-defined non-GAAP measure, was $741 versus $831, after $146 of capital expenditures. Cash increased to $5,297 from $3,618 at year-end.
- Liquidity and debt: Current assets were $9,791 and current liabilities $3,923; the current ratio was 2.5, compared with 1.6 at December 31, 2013. Total debt was $7,210, up from $6,344; trailing-twelve-month debt to adjusted EBITDA was 2.2 versus 2.1. No commercial paper was outstanding at quarter-end, and $2.5 billion of U.S. committed credit lines had no borrowings.
- Capital returns: First-half share repurchases were $2,905 and dividends paid were $355. ITW completed its approximately 50-million-share repurchase program intended to offset the sale’s dilution to continuing-operations EPS; $2.8 billion remained under its separate 2013 repurchase authorization. The declared dividend was $0.42 per share for the quarter, up from $0.38.
Material changes and management commentary
The Industrial Packaging sale for $3.2 billion generated a $1.7 billion pretax gain ($1.1 billion after tax). Discontinued operations contributed $998 of second-quarter net income and $1,043 for the first half. The first-half discontinued-operations tax expense included $175 related to repatriating approximately $1.3 billion of international sale proceeds.
Management attributed improved continuing operating income and margins mainly to better variable margins and overhead costs, organic growth, enterprise initiatives, and lower restructuring costs. Those initiatives contributed 120 basis points of margin improvement in both the quarter and first half. Demand was mixed: first-half organic revenue grew 6.8% in Asia Pacific, while North American growth was 1.1%. Automotive OEM was particularly strong; Welding and Polymers & Fluids had weaker revenues. The company said portfolio management was essentially complete and continued to emphasize business simplification, strategic sourcing, and organic growth.
Outlook, risks and contingencies
The filing provides no specific numerical earnings or revenue guidance. Management said cash, operating cash flow, credit facilities, and debt-market access were expected to support debt service and capital allocation. It intended to repay €750 million of 5.25% notes due October 2014 with available cash. Most cash was held by international subsidiaries and could incur U.S. and foreign taxes if repatriated.
Key risks include uneven global demand, foreign-exchange movements, raw-material cost and supply changes, execution of simplification and sourcing initiatives, access to financing, and the timing of repurchases. Divestitures may leave ITW with retained or indemnified liabilities. The IRS asserted $70 million of additional tax for 2006, plus interest and penalties, concerning a subsidiary distribution; ITW challenged the assessment in Tax Court and said it believed its position would prevail. Tax audits are ongoing. Management estimated unrecognized tax benefits could decrease by about $8 million within 12 months. Expected 2014 contributions were approximately $136 million to pension plans and $7 million to other postretirement plans.
Important facts for investors to verify
- How much of reported earnings and cash generation reflects recurring continuing operations versus the Industrial Packaging gain and other discontinued-operation effects.
- Whether modest organic growth and margin improvements persist, particularly in weaker segments and regions.
- Use of international cash, repayment of the October 2014 Euro notes, and the effect of higher debt and interest costs.
- Share-repurchase pace and funding, alongside dividends and other capital needs.
- Resolution of the IRS dispute, post-sale adjustments or retained liabilities, and the eventual impact of new accounting standards.