Illinois Tool Works Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. ITW is a diversified industrial company with seven reportable segments: Automotive OEM; Test & Measurement and Electronics; Food Equipment; Polymers & Fluids; Welding; Construction Products; and Specialty Products.
Financial results
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Operating revenue | $3.354bn | $3.692bn | $10.130bn | $10.980bn |
| Operating income | $761m | $772m | $2.188bn | $2.202bn |
| Operating margin | 22.7% | 20.9% | 21.6% | 20.1% |
| Continuing-operations income | $511m | $507m | $1.449bn | $1.429bn |
| Diluted continuing-operations EPS | $1.39 | $1.28 | $3.90 | $3.49 |
| Operating cash flow | $706m | $271m | $1.596bn | $1.158bn |
| Free cash flow | $644m | $145m | $1.387bn | $886m |
Free cash flow is the company’s non-GAAP measure of operating cash flow less capital expenditures. It equaled 126% of net income in Q3 and 96% year to date. Nine-month total net income was $1.449bn versus $2.496bn in 2014, when it included $1.067bn of discontinued-operations income, principally a $1.7bn pretax gain on the Industrial Packaging sale.
At September 30, cash and equivalents were $3.001bn, short-term debt $812m, long-term debt $7.000bn, and total debt $7.812bn. Total debt was $7.457bn at year-end 2014; trailing-twelve-month debt/EBITDA was 2.3x versus 2.2x at December 31, 2014. Current assets were $6.969bn and current liabilities $2.724bn. Cash was primarily held by international subsidiaries and may incur U.S. and foreign withholding taxes if repatriated.
Nine-month cash uses included $2.002bn of share repurchases and $542m of dividends. The company issued €1.0bn of notes in May 2015, with maturities in 2023 and 2030 and coupons of 1.25% and 2.125%; proceeds were used to repay commercial paper and for general corporate purposes. The quarterly dividend was increased 13.4% in Q3.
Material changes and operating drivers
- Revenue declined 9.2% in Q3 and 7.7% year to date, chiefly from unfavorable foreign-currency translation. Organic revenue declined 1.7% in Q3 and 0.3% year to date; product-line simplification reduced organic growth by about one percentage point in both periods.
- Operating income decreased 1.4% in Q3 and 0.7% year to date despite higher margins. Management attributed margin expansion mainly to strategic sourcing and business-structure simplification; lower restructuring expense also helped. Currency translation reduced diluted EPS by about $0.12 in Q3 and $0.33 year to date.
- Strength included organic growth in Automotive OEM, Food Equipment, and Construction Products. Test & Measurement and Electronics and Welding faced weak capital spending and/or lower oil-and-gas demand. Polymers & Fluids was pressured by European offshore wind and industrial MRO weakness.
- Q3 segment margin examples: Food Equipment 26.3% (up 320 basis points); Construction Products 23.1% (up 420 basis points); Test & Measurement and Electronics 16.6% (down 210 basis points); Welding 24.8% (down 140 basis points).
- Cash declined $989m from December 2014, primarily due to share repurchases and exchange-rate effects. Foreign-currency translation adjustments reduced comprehensive income by $743m year to date and contributed to the decline in equity.
Outlook, risks, and unusual items
- No specific near-term revenue or EPS guidance is provided. The company’s 2017 strategy goals are organic growth 200 basis points above global GDP, operating margin of approximately 23%, after-tax ROIC above 20%, and free cash flow equal to net income. Management reported Q3 operating margin of 22.7% and adjusted ROIC of 21.5%.
- Management expects product-line simplification’s revenue headwind to moderate beginning in 2016. The enterprise initiatives are intended to support long-term annualized total shareholder return of 12%–14%, assuming global GDP growth of 3%.
- Management cited challenging end markets and currency headwinds. Key disclosed risks include economic or market weakness, execution and timing of enterprise initiatives, currency movements, financing and credit conditions, raw-material costs and availability, pension funding, tax and legal outcomes, divestiture liabilities, impairment, and cybersecurity or IT disruptions.
- The IRS asserted a $70m tax deficiency for 2006, plus interest and penalties, regarding a subsidiary distribution. ITW is contesting the assessment, believes it will prevail, and has recorded no reserve; the outcome is uncertain. Separately, the company said unrecognized tax benefits could decrease by approximately $68m within the next 12 months, mainly related to intercompany transactions.
- Q3 included a $2m impairment charge for a Polymers & Fluids brand; the annual assessment found no goodwill impairment. Year-to-date other income included a $15m gain on a business sale.
Important facts for investors to verify
- Whether organic demand and segment performance improve, particularly in capital-spending-sensitive, oil-and-gas, and European markets.
- How much revenue headwind remains from product-line simplification and whether expected benefits from enterprise initiatives continue to offset it.
- Cash availability and repatriation constraints, debt levels, and the company’s capacity to fund dividends and its remaining $5.4bn share-repurchase authorization.
- Progress toward 2017 strategy targets and the assumptions underlying management’s long-term shareholder-return objective.
- Resolution of the IRS dispute and other tax audits, and any material developments in currency, impairment, legal, pension, or cybersecurity risks.