Illinois Tool Works Inc. — Q3 2013 Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and nine months ended September 30, 2013. ITW reported seven operating segments following a 2013 reorganization. Prior-period segment data was recast to the new structure. Decorative Surfaces was deconsolidated after ITW sold a 51% interest in October 2012; ITW retains a 49% equity-method interest in Wilsonart.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Operating revenue | $3.568B | $3.733B | $10.581B | $11.307B |
| Operating income | $678M | $667M | $1.886B | $1.951B |
| Operating margin | 19.0% | 17.9% | 17.8% | 17.3% |
| Income from continuing operations | $406M | $445M | $1.223B | $1.312B |
| Net income | $452M | $524M | $1.271B | $1.891B |
| Diluted EPS, continuing operations | $0.90 | $0.95 | $2.70 | $2.75 |
| Diluted EPS, total | $1.01 | $1.12 | $2.81 | $3.97 |
Q3 revenue fell 4.4% year over year, largely reflecting the Decorative Surfaces deconsolidation; excluding that segment’s prior-year revenue, Q3 revenue increased 2.9%. Worldwide base revenue grew 0.4% in Q3, with international growth offset by a 1.4% decline in North America. For the nine months, reported revenue declined 6.4%; excluding Decorative Surfaces, it increased 1.0%, while base revenue declined 0.5%.
Operating income rose 1.8% in Q3, helped by lower expenses and higher base revenue, but declined 3.3% year to date, primarily due to the divestiture. Management attributed higher base margins mainly to overhead reductions from business-structure simplification and favorable price-versus-material-cost effects.
Segment highlights, Q3 year over year: Automotive OEM revenue increased 13.2% and operating income 25.0%; Food Equipment revenue increased 10.4% and operating income 15.6%; Specialty Products revenue increased 11.4% and operating income 19.7%. Test & Measurement and Electronics revenue declined 10.9% and operating income 20.4%, mainly due to lower electronics assembly sales after unusually strong orders from a key customer in 2012. Welding revenue declined 1.0%; Construction Products revenue increased 1.7%.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $1.820B, versus $1.467B; capital expenditures were $257M, producing company-defined free operating cash flow of $1.563B, versus $1.193B.
- Cash and equivalents were $3.018B at September 30, 2013, up from $2.779B at year-end 2012. The company said most cash was held by international subsidiaries and may incur U.S. and withholding taxes if repatriated.
- Total debt was $5.136B, compared with $5.048B at year-end; debt to capitalization was 32.9%, versus 32.3%. Trailing-twelve-month debt to adjusted EBITDA was 1.8x, versus 1.7x at December 2012.
- Current ratio was 2.4, down from 3.0. Management said the working-capital increase primarily reflected reclassifying net assets and liabilities of businesses held for sale; $800M of notes due April 2014 was also reclassified as short-term debt.
- ITW had $446M of commercial paper outstanding and no borrowings under its $2.5B credit facilities. Management stated that internally generated cash should support debt service, dividends, internal growth and small-to-medium acquisitions.
- Nine-month cash uses included $1.034B of share repurchases, $342M of dividends paid and $367M for acquisitions and additional affiliate interests. Cash dividends declared were $1.18 per share for the period.
Material changes, outlook and risks
- The Board authorized a sale process for Industrial Packaging in September; management expected the process to continue into 2014 and anticipated a sale by mid-2014. The segment was classified as held for sale and presented in discontinued operations. Several other businesses were also classified as held for sale. At quarter-end, held-for-sale assets were $1.951B and liabilities were $394M.
- ITW intended to repurchase approximately 50 million shares by the end of 2014 to offset the expected continuing-operations EPS dilution from the Industrial Packaging sale, using sale proceeds, free cash flow and additional leverage. A new $6B repurchase authorization was approved; no shares had yet been repurchased under it at quarter-end. The filing cautions that timing and amount could change with market conditions, share price, investment opportunities and U.S. cash availability.
- Q3 included a $40M discrete tax charge related to intercompany financing and foreign earnings; the reported effective tax rate was 35.4%, versus 27.8%. The nine-month effective rate was 31.1%, versus 28.3%.
- Nine-month discontinued-operations income was $48M, versus $579M in 2012. The prior-year period included a major gain on the sale of the finishing businesses; 2013 included impairment and disposal losses. Total net income and EPS comparisons are therefore materially affected by discontinued operations.
- Other unusual items included a $30M pre-tax gain from obtaining control of an existing equity-method investment, and pension settlement charges of $42M in 2013 (including $8M in Q3). The Q3 annual impairment review produced a $2M intangible-asset charge and no goodwill impairment.
- Management identified risks from global economic weakness, execution of enterprise initiatives, divestitures and acquisitions, foreign exchange, raw-material costs and supply, taxes, pension obligations, credit availability and legal proceedings. It provided no specific consolidated earnings or revenue guidance in the supplied filing text.
Most important facts to verify
- Progress, timing, proceeds and final terms of the planned Industrial Packaging sale and other held-for-sale divestitures.
- Whether the planned 50-million-share repurchase is completed, how it is funded, and whether it offsets divestiture-related EPS dilution without materially increasing leverage.
- Underlying organic revenue and margin trends, especially in electronics assembly, North America and Europe, versus acquisition and divestiture effects.
- Cash accessibility and potential tax cost of repatriating overseas cash, alongside the April 2014 note maturity and refinancing or repayment plan.
- Resolution of tax audits and unrecognized tax benefits; management said approximately $21M could decrease within twelve months.