Illinois Tool Works Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Amounts are in millions except per-share data. The filing presents eight reportable segments following a 2013 reorganization; prior-period segment results were restated to conform.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Operating revenue | $4,219 | $4,463 | $8,228 | $8,821 |
| Operating income | $702 | $758 | $1,362 | $1,452 |
| Operating margin | 16.6% | 17.0% | 16.5% | 16.5% |
| Income from continuing operations | $464 | $519 | $923 | $983 |
| Continuing diluted EPS | $1.03 | $1.09 | $2.03 | $2.04 |
| Net income | $465 | $881 | $819 | $1,367 |
Revenue fell 5.5% in Q2 and 6.7% year to date, largely reflecting the 2012 deconsolidation of Decorative Surfaces. Excluding that former segment from the comparable periods, revenue rose 1.0% in Q2 and declined 0.4% year to date. Worldwide base revenue was flat in Q2 and down 1.3% year to date. Operating income declined 7.5% and 6.2%, respectively. Reported net income comparisons are heavily affected by discontinued operations, including a substantial 2012 divestiture gain.
- Cash flow: Six-month operating cash flow was $1,009, up from $832; capital spending was $178, yielding company-defined free operating cash flow of $831 versus $648.
- Cash and liquidity: Cash was $2,768 at June 30, compared with $2,779 at year-end. Current assets were $8,213 and current liabilities $3,711; the current ratio was 2.2, down from 3.0. The company said most cash was held by international subsidiaries and may be subject to taxes if repatriated. Its commercial-paper program is backed by $2.5 billion of long-term credit facilities.
- Debt: Total debt was $5,072, versus $5,048 at year-end; debt to capitalization was 33.1%, compared with 32.3%. Total debt to adjusted EBITDA was 1.5x. The $800 of 5.15% notes due April 2014 was reclassified as current debt.
- Capital returns: The company repurchased $677 of shares in the first half and paid $171 in dividends. Approximately $1.2 billion remained authorized under the $4.0 billion repurchase program.
Material changes and segment trends
- The company sold a 51% interest in Decorative Surfaces in October 2012, retained 49% of Wilsonart, and now accounts for that interest under the equity method. Decorative Surfaces contributed $286 of revenue and $48 of operating income in Q2 2012; it was not consolidated in 2013.
- Automotive OEM was a relative strength: Q2 revenue increased 12.3% and operating income 15.9%, supported by broad-based automotive growth and product penetration gains.
- Test & Measurement and Electronics weakened: Q2 revenue decreased 8.5% and operating income 20.0%, reflecting lower electronics assembly demand, especially capital-equipment spending.
- Food Equipment Q2 revenue rose 3.0% and operating income 17.4%; Specialty Products revenue rose 5.2% and operating income 7.2%. Industrial Packaging revenue declined 0.6% and operating income 7.0% in Q2.
- Industrial Packaging was under strategic review, with a possible sale or spin-off; management expected the review to conclude during 2013.
Outlook, commentary, risks and unusual items
- Management stated that internally generated cash flow was expected to be adequate to service debt, fund internal growth, continue dividends, and support small-to-medium acquisitions. The filing does not provide a specific earnings or revenue forecast.
- Management attributed margin support to lower overhead from simplification and sourcing initiatives and favorable selling-price-versus-material-cost comparisons. These benefits were partly offset by lower base revenue, restructuring costs, and a $34 pre-tax pension settlement charge in Q2.
- First-half discontinued operations recorded a $104 loss, including $42 of goodwill impairment and $67 of loss reserves related to planned divestitures. Certain transportation and construction distribution businesses remained held for sale at June 30; management expected to dispose of the remaining businesses within a year.
- A $30 pre-tax gain was recorded in Q1 upon obtaining control of a previously equity-accounted consumer-packaging investment. First-half interest expense rose to $119 from $100, partly reflecting notes issued in 2012.
- Risks identified include economic and end-market weakness, execution of enterprise initiatives and divestitures, acquisition returns, currency movements, raw-material costs and supply, credit availability, pension-market exposure, tax matters, and legal proceedings. Ongoing tax audits could reduce unrecognized tax benefits by approximately $57 within twelve months, according to management.
Important facts for investors to verify
- Whether the Industrial Packaging strategic review resulted in a sale, spin-off, or other action, and its effect on earnings and cash flow.
- Progress and final proceeds or losses from the businesses classified as held for sale, including the recorded impairment and reserve charges.
- Cash availability and potential tax costs associated with repatriating international cash, alongside the upcoming $800 note maturity.
- Whether base-revenue trends, particularly in electronics and industrial markets, and margin gains from cost initiatives persisted in later periods.
- The continuing effects of the pension settlement and tax audits, including any changes to estimated exposures or benefit-plan contributions.