Illinois Tool Works Inc. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022. Figures are in U.S. dollars; financial statement amounts are in millions except per-share data.
Business context and results
ITW is a diversified global industrial manufacturer with seven segments. In Q3, revenue growth reflected higher organic sales and the MTS Test & Simulation acquisition, partly offset by unfavorable foreign currency translation. Six of seven segments reported worldwide organic revenue growth.
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Operating revenue | $4,011; +12.8% | $3,556 | $11,961; +11.0% | $10,776 |
| Organic revenue growth | 15.7% | — | 12.2% | — |
| Operating income | $983; +16.4% | $845 | $2,804; +6.1% | $2,643 |
| Operating margin | 24.5%; +70 bps | 23.8% | 23.4%; −110 bps | 24.5% |
| Net income | $727 | $639 | $2,127 | $2,085 |
| Diluted EPS | $2.35; +16.3% | $2.02 | $6.83; +3.8% | $6.58 |
Q3 margin expansion was driven mainly by operating leverage and enterprise initiatives, partly offset by acquisition dilution, unfavorable price/cost and higher operating expenses. Nine-month margin fell primarily from unfavorable price/cost, MTS dilution and increased operating expenses, partly offset by operating leverage and enterprise initiatives. Reported nine-month EPS growth was 3.8%; excluding specified discrete tax benefits in both years, management reported growth of 8.1%.
Segments and material changes
- Strongest Q3 sales growth: Test & Measurement and Electronics revenue rose 29.5%, including 18.3% from MTS; Food Equipment rose 16.4%; Automotive OEM rose 16.5%. Specialty Products revenue declined 4.7%, including a 0.3% organic decline.
- Margin pressures: Q3 Test & Measurement and Electronics margin declined 160 bps, mainly due to MTS dilution and unfavorable price/cost. Construction Products margin declined 210 bps, primarily due to unfavorable price/cost and higher expenses. Automotive OEM’s nine-month margin fell 360 bps.
- MTS acquisition: Completed December 1, 2021 for a purchase price of $750 million, subject to adjustments. It contributed $101 million of Q3 and $308 million of nine-month 2022 revenue. Purchase price allocation remained in progress; recorded goodwill was $435 million and intangible assets were $257 million.
- Divestiture: ITW completed the sale of a Polymers & Fluids business on October 3, 2022, after quarter-end, for $220 million subject to closing adjustments. A pre-tax gain of approximately $156 million was expected in Q4 2022. Two businesses held for sale had combined 2021 revenue of $115 million.
Cash flow, debt and liquidity
- Cash flow: Nine-month operating cash flow was $1,537 versus $1,783 in 2021; capital expenditures were $256 versus $217. Free cash flow, a company-defined non-GAAP measure, was $1,281 versus $1,566. ITW attributed the decline to working-capital investment, including higher inventory to mitigate supply-chain risk. Q3 free cash flow was $612 versus $548.
- Capital returns: Nine-month dividends paid were $1,139 and share repurchases were $1,250. The quarterly dividend declared was $1.31 per share. Approximately $2.0 billion remained authorized under the $3.0 billion 2021 repurchase program at September 30.
- Liquidity and working capital: Cash and equivalents were $774 at September 30, down from $1,527 at year-end 2021. Net working capital was $1,804, down from $2,904. ITW reported no borrowings under its $2.5 billion revolving credit facility at quarter-end.
- Debt: Total debt was $7,628 versus $7,687 at year-end 2021. Short-term debt included $1.2 billion of commercial paper, with a 2.68% weighted-average rate, and $490 million of Euro notes due in May 2023. The trailing-twelve-month debt-to-EBITDA ratio was 1.9, compared with 2.0 at year-end 2021. On October 21, 2022, ITW replaced its $2.5 billion revolver with a $3.0 billion facility due in 2027.
Outlook, risks and unusual items
The filing provides no specific numerical full-year earnings or revenue guidance. Management described results as strong despite rising costs and a challenging global supply chain, and said it believed operating cash flow, credit facilities and debt-market access were adequate to fund operations and capital priorities. Forward-looking statements remain subject to uncertainty.
- Key risks identified include inflation and interest rates, economic recession or end-market weakness, raw-material cost and availability, supply-chain disruption, foreign-exchange movements, COVID-19 impacts, geopolitical conditions and sanctions related to Russia’s invasion of Ukraine, and risks from acquisitions, divestitures, litigation, environmental matters and cybersecurity.
- ITW reported that Russian subsidiaries and sales were immaterial to consolidated results. COVID-related disruptions and China stay-at-home measures continued to affect operations and markets.
- The Q3 effective tax rate was 23.9%, versus 20.8% a year earlier; the nine-month rates were 21.8% and 17.7%. The 2022 nine-month rate included a $51 million discrete tax benefit related to resolution of a U.S. tax audit; 2021 included discrete benefits of $21 million and $112 million.
- Foreign-currency translation reduced comprehensive income by $210 million in Q3 and $394 million for the nine months. The annual impairment tests found no goodwill or indefinite-lived intangible asset impairment in 2022.
- No legal proceedings were reported in Part II, and ITW reported no material changes to the risk factors in its 2021 Form 10-K. Disclosure controls were deemed effective as of September 30, 2022.
Important facts for investors to verify
- Whether organic growth and margins persist as pricing, input costs, freight and employee expenses evolve.
- How much of reported growth and future profitability is attributable to MTS, and the completed purchase-price allocation and integration performance.
- Working-capital normalization and conversion of earnings to cash, given lower year-to-date free cash flow and higher inventory.
- Commercial-paper exposure, refinancing of the 2023 Euro notes, and liquidity under the replacement revolving facility.
- Completion and financial effects of the remaining divestiture plans, including the expected Q4 gain from the completed sale.
- Comparability of earnings and EPS across periods after discrete tax benefits, as well as the continuing effects of currency, geopolitical and supply-chain risks.