Illinois Tool Works Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Dollar figures are in millions unless stated otherwise. Prior-period comparisons reflect the company’s retrospective alignment of international reporting to the calendar year.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $4,580.5 | $3,941.1 | $13,467.3 | $11,501.9 |
| Operating income | $714.3 | $619.7 | $2,083.9 | $1,771.4 |
| Operating margin | 15.6% | 15.7% | 15.5% | 15.4% |
| Income from continuing operations | $490.1 | $403.1 | $1,579.9 | $1,124.1 |
| Net income | $507.6 | $422.0 | $1,629.2 | $1,167.3 |
| Diluted EPS, continuing operations | $1.00 | $0.80 | $3.17 | $2.23 |
| Diluted net EPS | $1.04 | $0.84 | $3.27 | $2.31 |
Nine-month revenue increased 17.1%, reflecting 8.0% base-business growth, acquisitions and favorable currency translation. Operating income rose 17.6%; reported operating margin improved 0.1 percentage point year over year, although Q3 margin eased 0.1 point. Management attributed base-margin improvement to operating leverage, partly offset by selling-price versus material-cost pressures. Foreign currency increased nine-month revenue by approximately $550 million and continuing-operations diluted EPS by approximately $0.13.
Nine-month operating cash flow was $1,244.3 versus $1,132.1; capital expenditures were $258.9 versus $199.6. Company-defined free operating cash flow was $985.4 versus $932.5. Cash and equivalents were $1,318.9 at quarter-end, most held internationally. Net working capital was $3,698.5 and the current ratio was 2.02, compared with 1.98 at year-end 2010.
Total debt rose to $4,562.9 from $2,868.3 at December 31, 2010; debt-to-capitalization increased to 31.7% from 23.1%, above the company’s stated 20%–30% target range. Short-term debt was $1,040.8, including $712.0 of commercial paper; long-term debt was $3,522.1. The company had no borrowings under its $1 billion revolving credit facility, which runs to June 2016. It issued $1 billion of senior unsecured notes in August, due 2021 and 2041, and said proceeds were used to pay down commercial paper.
Material changes and business mix
- Quarterly base revenues grew 6.2%; North American base revenues rose 7.8% and international base revenues 4.2%. Management said economic conditions had moderated from earlier in the year, while welding, automotive, and test-and-measurement end markets remained strong.
- Q3 segment revenue grew across the reported segments. Transportation, Power Systems & Electronics, and Polymers & Fluids posted particularly strong growth; Food Equipment operating income declined 3.6% and margin fell to 16.3% from 17.7%, amid weak institutional equipment demand and unfavorable mix. Industrial Packaging, Power Systems & Electronics, Polymers & Fluids, and Decorative Surfaces also reported lower Q3 margins.
- Nine-month acquisitions excluding cash used $1,198.7, versus $301.5 a year earlier. Acquisitions contributed to revenue growth but diluted consolidated margins, principally due in part to acquired-intangible amortization. Nine-month amortization expense increased to $186.3 from $154.7.
- Share repurchases were $950.0 during the first nine months, compared with $350.0 in 2010; cash dividends paid were $506.3 versus $467.6. The 2011 buyback authorization had approximately $3.9 billion remaining at September 30.
Outlook, unusual items, and risks
- No specific earnings or revenue guidance is provided in the filing. Management said internally generated cash flow should be adequate for debt service, dividends, internal growth, and small-to-medium acquisitions, and believed additional financing was available if needed.
- The nine-month effective tax rate was 20.7%, versus 31.8% in 2010, mainly due to a $165.9 million favorable, non-cash discrete tax benefit in Q1 following an Australian court decision. The 2010 rate included a $21.9 million tax charge related to U.S. health-care legislation. The Australian Tax Office appealed the timing of certain deductions; the company did not expect that appeal’s outcome to be material. Tax audits remain ongoing in multiple jurisdictions.
- The company agreed to sell its finishing businesses to Graco for $650 million cash; regulatory review meant completion was not expected before the end of Q4 2011. It also planned to divest consumer packaging and electronics-components businesses, with disposal expected within one year. These operations were classified as discontinued operations/held for sale. Held-for-sale assets were $411.5 and liabilities $97.1 at quarter-end.
- Other material risks identified include a slowdown or deterioration in domestic and international markets, acquisition impacts on profitability and returns, pension-plan financial-market exposure, currency and raw-material cost movements, reduced credit availability, tax-law or tax-authority changes, and execution of product-development and acquisition plans.
Important facts for investors to verify
- How much of nine-month earnings growth is sustainable excluding the $165.9 million tax benefit, currency effects, and acquisition contributions.
- Whether base-business growth and margins hold up as economic conditions moderate and input-cost and pricing pressures continue.
- Completion, proceeds, and final financial effects of the announced divestitures, especially the $650 million finishing-business sale.
- Debt reduction plans and the effect of acquisitions and repurchases on leverage, given debt-to-capitalization of 31.7% versus the stated target range.
- Working-capital conversion and cash generation, including receivables and inventory growth and the concentration of cash held internationally.