Illinois Tool Works Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. ITW is a diversified global industrial manufacturer with seven reporting segments and 87 operating divisions.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Operating revenue | $3.479 billion | $3.613 billion | $10.640 billion | $11.188 billion |
| Operating income | $868 million | $889 million | $2.578 billion | $2.724 billion |
| Operating margin | 25.0% | 24.6% | 24.2% | 24.3% |
| Net income | $660 million | $638 million | $1.880 billion | $1.956 billion |
| Diluted EPS | $2.04 | $1.90 | $5.76 | $5.77 |
| Free cash flow | $830 million | $743 million | $1.977 billion | $1.720 billion |
Quarterly revenue decreased 3.7% and operating income decreased 2.3%; net income rose about 3.4% and diluted EPS rose about 7.4%. For the nine-month period, revenue decreased 4.9%, operating income decreased 5.3%, net income decreased 3.9%, and diluted EPS was nearly flat. Revenue declines reflected lower organic sales and unfavorable foreign currency translation. Q3 organic revenue declined 1.7%; on an equal-shipping-day basis, the decline was 3.2%, as 2019 had one extra shipping day.
Q3 operating margin expanded 40 basis points, primarily from enterprise initiatives and favorable price/cost, partly offset by negative operating leverage and higher employee-related costs. Nine-month margin fell 10 basis points; excluding higher restructuring costs, it increased 20 basis points. All segments reported operating margins above 21% in Q3 and year to date.
Cash, debt and liquidity
- Nine-month operating cash flow was $2.221 billion, compared with $2.002 billion; capital spending was $244 million, versus $282 million.
- At September 30, cash and equivalents were $1.825 billion, versus $1.504 billion at year-end 2018. Total debt was $7.643 billion, up from $7.380 billion; short-term debt was zero and long-term debt was $7.643 billion.
- Trailing-twelve-month total debt to EBITDA was 2.0x, compared with 1.8x at December 31, 2018. The company had a $2.5 billion credit facility, with no amount outstanding, extended to September 2024.
- In June, ITW issued €1.6 billion of euro notes with maturities in 2024, 2027 and 2031; proceeds were used to repay commercial paper and for general corporate purposes.
- Nine-month cash dividends paid were $977 million and share repurchases were $1.125 billion. ITW raised its quarterly dividend 7% in Q3. The 2018 repurchase authorization had $2.3 billion remaining at quarter-end.
Material changes and segment trends
Organic revenue fell in five segments in Q3, led by Specialty Products (down 4.7%), Test & Measurement and Electronics (down 3.3%), and Automotive OEM (down 2.3%). Polymers & Fluids grew 2.8% organically, while Food Equipment declined 0.7%. Automotive OEM was affected by weaker vehicle builds and unexpected North American customer shutdowns. Specialty Products faced lower consumables demand. Polymers & Fluids delivered 200 basis points of Q3 margin expansion; margins declined in Construction Products and Specialty Products.
Foreign currency translation reduced Q3 revenue by 1.8% and nine-month revenue by 2.7%. Higher restructuring expenses particularly affected year-to-date results, reducing operating margin by an estimated 30 basis points. Interest expense declined to $52 million in Q3 and $170 million year to date, mainly following repayment of $1.35 billion of notes that matured in March and April 2019.
Outlook, management commentary and risks
- Management said the company performed well despite demand softness across its portfolio and emphasized its 80/20 operating model, customer-focused innovation, portfolio discipline and efforts to improve organic growth. The filing provides no clear numeric full-year revenue or EPS guidance.
- ITW was exploring options, including potential divestitures, for businesses with annual revenue of up to $1 billion. It approved plans in Q2 to sell six businesses, expected to be sold within one year; these represented $378 million of revenue in the first nine months of 2019. Management said potential EPS dilution from contemplated divestitures would be offset by incremental share repurchases. A $4 million estimated divestiture loss was recorded in Q2.
- Management said tariffs had not materially affected operating results to date, but would continue assessing tariff and raw-material cost impacts and pricing responses.
- Key risks include end-market weakness and economic or political deterioration, foreign-exchange movements, raw-material cost increases or shortages, execution and growth impacts of enterprise initiatives, divestiture liabilities, financing and credit risks, pension exposures, tax matters, litigation, cyber and data-security events, and potential goodwill or intangible impairment.
- Tax authorities were conducting ongoing audits. ITW said unrecognized tax benefits could decrease by approximately $55 million within 12 months, primarily related to intercompany transactions. Q3 tax results included a $21 million discrete tax benefit; the nine-month effective tax rate was 23.5%, versus 24.1%.
Most important facts for investors to verify
- Whether organic demand stabilizes, particularly in Automotive OEM, Specialty Products, and Test & Measurement and Electronics, and how much of the decline reflects end markets versus product-line simplification.
- Whether margin gains from enterprise initiatives can continue to offset negative operating leverage, restructuring costs, employee expenses, and adverse product mix.
- Progress, timing, proceeds, and earnings effects of the six planned divestitures and any additional portfolio actions.
- Debt growth, the 2.0x debt-to-EBITDA ratio, and continued funding of dividends and repurchases from free cash flow.
- Foreign-exchange, tariff, raw-material, tax-audit, and other disclosed risks, including whether the estimated $55 million tax-benefit reduction occurs.