Illinois Tool Works Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. ITW is a diversified manufacturer operating through seven reportable segments. Financial amounts are in millions of U.S. dollars unless stated otherwise.
Financial performance
| Metric | Q1 2015 | Q1 2014 | Change / context |
|---|---|---|---|
| Operating revenues | $3,342 | $3,569 | Down 6.4%; organic revenue increased 0.7%, while currency translation reduced revenue by 6.8 percentage points (about $243). |
| Operating income | $697 | $667 | Up 4.4%. |
| Operating margin | 20.9% | 18.7% | Up 2.2 percentage points. |
| Income from continuing operations | $458 | $428 | Diluted EPS was $1.21 versus $1.01. |
| Net income | $458 | $473 | Prior-year net income included $45 from discontinued operations. |
| Diluted EPS | $1.21 | $1.11 | Prior-year EPS included $0.11 from discontinued operations. |
| Interest expense | $54 | $64 | Lower, primarily reflecting debt repayments, partly offset by 2014 debt issuances. |
| Effective tax rate | 31.0% | 30.0% | Increased 1.0 percentage point. |
Cash flow: Operating cash flow was $442, compared with $314; capital expenditures were $83 versus $68. Company-defined free operating cash flow was $359 versus $246. Dividends paid were $186 and share repurchases were $1,479, contributing to a $1,318 decline in cash during the quarter.
Balance sheet and liquidity: Cash and equivalents were $2,672 at March 31, down from $3,990 at December 31, 2014. Current assets were $6,667 and current liabilities $3,744; net working capital was $2,923, down from $4,543. Total debt was $7,553, versus $7,457 at year-end, including $1,708 of short-term debt, primarily commercial paper. Trailing-twelve-month total debt to EBITDA was 2.2x, unchanged from December 31. Management said cash, operating cash flow, credit facilities and access to debt markets were sufficient for debt service and capital priorities; most cash was held by international subsidiaries and may incur tax if repatriated to the U.S.
Comprehensive income: ITW reported a comprehensive loss of $110, principally reflecting $577 of after-tax foreign currency translation losses.
Segments and material changes
Revenue fell across all seven reported segments on a reported basis, with foreign currency translation a substantial headwind. Organic growth was strongest in Automotive OEM and Food Equipment; Welding and Specialty Products experienced organic declines. Segment operating income and reported revenue were as follows:
| Segment | Revenue | Operating income | Reported revenue change |
|---|---|---|---|
| Automotive OEM | $653 | $163 | Down 2.1%; organic growth 6.7%. |
| Test & Measurement and Electronics | $483 | $71 | Down 7.0%; organic revenue down 0.9%. |
| Food Equipment | $495 | $112 | Down 3.1%; organic growth 4.0%. |
| Polymers & Fluids | $441 | $88 | Down 7.9%; organic revenue down 0.5%. |
| Welding | $433 | $117 | Down 6.6%; organic revenue down 3.3%. |
| Construction Products | $381 | $63 | Down 8.4%; organic growth 2.4%. |
| Specialty Products | $462 | $104 | Down 11.3%; organic revenue down 5.7%. |
Consolidated margin improvement reflected enterprise initiatives and cost management, including strategic sourcing and business-structure simplification, as well as lower restructuring expense. Management attributed 100 basis points of organic margin improvement to strategic sourcing and business-structure simplification and 60 basis points to cost management and product/customer simplification. Product-line and customer-base simplification reduced organic revenue growth by about one percentage point.
Outlook, commentary, risks and unusual items
- The filing provides no specific quarterly or full-year earnings or revenue guidance. Management described its 2013–2017 Enterprise Strategy as targeting organic growth, improved profitability and returns through portfolio management, business-structure simplification and strategic sourcing. Divestitures under the portfolio initiative were described as essentially complete; future acquisitions are expected to focus on bolt-ons and new platforms.
- Currency weakness reduced continuing-operations income by approximately $37, or $0.10 per diluted share, versus Q1 2014. Management also cited weaker demand in some equipment businesses, South American weakness—particularly Brazil—and lower oil-and-gas-related demand affecting Welding.
- Unusual items included a $15 gain on the sale of a business within other income and a discrete claim recovery that contributed 90 basis points to Polymers & Fluids margin improvement. The prior-year comparison included discontinued operations income of $45; all previously discontinued businesses had been divested by Q2 2014.
- ITW paid $1,479 for share repurchases. The 2013 $6.0 billion repurchase authorization was completed in Q1; a new $6.0 billion program was authorized in February 2015, with approximately $5.8 billion remaining at quarter-end. The quarter’s repurchases were funded in part through lower cash and increased short-term commercial-paper borrowings.
- Tax matters include ongoing audits and a possible approximately $68 decrease in unrecognized tax benefits within 12 months. The IRS asserted $70 of additional tax for 2006, plus interest and penalties, relating to a disputed return of capital; ITW is challenging the assessment in Tax Court, believes it will prevail, and recorded no reserve.
- Other stated risks include foreign-exchange movements, end-market weakness, execution and timing of enterprise initiatives, financing and credit availability, raw-material costs and supply, pensions, legal and tax outcomes, divestiture liabilities, impairment risk, and cybersecurity or IT disruptions. The company added information-technology interruption, data-corruption, cyberattack and network-security risks to its risk-factor discussion.
- Management assessed disclosure controls as effective as of March 31, 2015, and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether modest organic growth can persist and offset continuing currency and end-market headwinds, especially in Welding, Specialty Products and Brazil-exposed operations.
- Whether margin gains are sustainable after accounting for restructuring reductions, the discrete Polymers & Fluids claim recovery, and ongoing simplification effects.
- Cash deployment and funding: the scale of repurchases, commercial-paper borrowing, international cash accessibility, and leverage (2.2x debt/EBITDA).
- Resolution and potential financial effects of the IRS tax dispute and other tax audits.
- Execution of the 2013–2017 Enterprise Strategy and the long-term impact of portfolio changes and product/customer simplification on growth and returns.