Business Context and Reporting Period
Illinois Tool Works Inc. (ITW) is a diversified global industrial manufacturer operating in 56 countries. This Form 10-K covers the fiscal year ended December 31, 2013; quarterly figures below are for the fourth quarter. Continuing operations were reported in seven segments following a reporting-structure change effective January 1, 2013. Comparatives were restated to align with the new presentation.
Financial Performance and Position
| Metric | FY 2013 | FY 2012 |
|---|---|---|
| Revenue | $14.135 billion | $14.791 billion |
| Operating income | $2.514 billion | $2.475 billion |
| Operating margin | 17.8% | 16.7% |
| Income from continuing operations | $1.630 billion | $2.233 billion |
| Diluted continuing-operations EPS | $3.63 | $4.72 |
| Net income | $1.679 billion | $2.870 billion |
| Operating cash flow | $2.528 billion | $2.072 billion |
| Free operating cash flow | $2.160 billion | $1.690 billion |
| Cash and equivalents at year-end | $3.618 billion | $2.779 billion |
| Total debt | $6.344 billion | $5.048 billion |
| Debt to adjusted EBITDA | 2.1x | 1.7x |
| Cash dividends declared per share | $1.60 | $1.48 |
Fourth-quarter 2013 revenue was $3.554 billion versus $3.484 billion; operating income was $628 million versus $524 million; income from continuing operations was $407 million versus $921 million; and diluted continuing-operations EPS was $0.92 versus $1.99.
Material Changes Versus Prior Period
- Full-year revenue fell 4.4%, principally because divestitures reduced revenue by 6.3%. Excluding the $921 million of Decorative Surfaces revenue included in 2012, revenue increased 1.9%; worldwide base revenue grew 0.2%.
- Operating income rose 1.6% and margin improved 1.1 percentage points. Management attributed the margin improvement mainly to lower overhead costs, enterprise initiatives, and favorable selling-price-versus-material-cost comparisons.
- Continuing-operations income and EPS declined substantially, in part because 2012 included a $933 million pretax ($632 million after-tax) gain on the sale of a majority interest in Decorative Surfaces.
- Discontinued-operations income was $49 million in 2013 versus $637 million in 2012. 2013 included $72 million of after-tax disposal losses and $42 million of goodwill impairment; 2012 included a significant gain from selling the finishing businesses.
- Segment results varied: Automotive OEM, Food Equipment, Construction Products, and Specialty Products increased operating income; Test & Measurement and Electronics and Welding declined. Food Equipment and Construction Products materially expanded margins.
- Debt increased by $1.296 billion, largely reflecting higher commercial-paper borrowing associated primarily with share repurchases. The current ratio declined to 1.63 from 3.00, partly due to debt maturities reclassified as current.
Outlook, Management Commentary, Risks, and Unusual Items
- ITW’s enterprise strategy, expected to continue through 2017, focuses on portfolio management, business-structure simplification, and strategic sourcing to support organic growth, profitability, and returns. Management cited lower overhead costs and business simplification as contributors to 2013 margin gains.
- On February 6, 2014, ITW agreed to sell Industrial Packaging to The Carlyle Group for $3.2 billion, subject to regulatory approval and customary conditions; closing was expected by mid-2014. Management planned to repurchase approximately 35 million additional shares, with the program expected to conclude no later than year-end 2014, to offset divestiture-related continuing-EPS dilution. Repurchases depend on market conditions, financing, and U.S. cash availability.
- The filing provides no clear numerical operating or EPS guidance for 2014. It notes management’s expectation that cash flows, credit facilities, and market access would support debt service and capital-allocation priorities.
- Cash of $3.618 billion was primarily held by international subsidiaries; repatriation may incur U.S. and foreign taxes. ITW also had $1.834 billion of current long-term debt maturities due in 2014 and $1.652 billion of commercial paper outstanding at year-end. A new $1.0 billion short-term credit line was entered into in January 2014.
- The effective tax rate was 30.6% versus 30.3%; 2013 included a $40 million discrete tax charge related to intercompany financing and foreign earnings. Other notable items included a $30 million pretax gain from acquiring control of an equity investment and $45 million in pension settlement charges, primarily associated with Decorative Surfaces employees leaving the U.S. primary pension plan.
- Key risks include global economic weakness, foreign-exchange movements, raw-material cost or supply changes, execution of enterprise initiatives and divestitures, share-repurchase funding, credit-market access, tax disputes, pension-market exposure, acquisition integration, impairment risk, and product-liability claims. The company said pending ordinary-course legal matters were not expected to materially affect its financial position, liquidity, or future operations.
Important Facts for Investors to Verify
- Reconcile the 2012 comparison for the Decorative Surfaces sale gain and the significant discontinued-operations gains; assess underlying earnings apart from these items.
- Track completion and proceeds from the Industrial Packaging sale, and whether the planned repurchases offset the associated EPS dilution without unduly increasing leverage.
- Review 2014 maturities, commercial-paper levels, refinancing plans, and access to liquidity; consider that much of reported cash was held internationally.
- Monitor whether base-revenue growth and margin improvements persist, particularly given weakness in electronic assembly, European markets, and selected industrial and construction end markets.
- Assess the impact of tax exposures and pension assumptions, as well as disposal-related losses and goodwill impairments.
- Note that Deloitte & Touche issued an unqualified opinion on the financial statements and internal control over financial reporting; management also reported effective controls.