Business context and reporting period
Illinois Tool Works Inc. (ITW) is a diversified global industrial manufacturer with seven segments, 87 divisions in 55 countries, and approximately 48,000 employees. This Form 10-K covers the fiscal year ended December 31, 2018; quarterly figures below refer to the fourth quarter.
Financial performance and liquidity
Unless noted, amounts are U.S. dollars. Annual figures are for continuing operations.
| Metric | 2018 | 2017 |
|---|---|---|
| Revenue | $14.768 billion | $14.314 billion |
| Organic revenue growth | 2.2% | 2.9% |
| Operating income | $3.584 billion | $3.485 billion |
| Operating margin | 24.3% | 24.3% |
| Net income | $2.563 billion | $1.687 billion |
| Diluted EPS | $7.60 | $4.86 |
| Operating cash flow | $2.811 billion | $2.402 billion |
| Free cash flow | $2.447 billion | $2.105 billion |
- Reported 2018 diluted EPS increased 56.4%; excluding the 2017 tax charge and legal-settlement benefit, EPS increased 15.3%.
- Fourth-quarter revenue was $3.580 billion versus $3.629 billion; operating income was $860 million versus $846 million; net income was $607 million versus a $76 million loss.
- Cash and equivalents were $1.504 billion at year-end, down from $3.094 billion. Net working capital was $2.236 billion, compared with $4.225 billion.
- Total debt declined to $7.380 billion from $8.328 billion. Debt/EBITDA was 1.8x versus 2.1x. The $1.5 billion cash balance and $2.5 billion committed credit line support liquidity; no amounts were drawn on that line at year-end.
- 2018 dividends paid were $1.124 billion; share repurchases totaled $2.0 billion. The quarterly dividend was increased 28.2% during the year.
- Five of seven segments achieved worldwide organic revenue growth; two were flat. Welding led growth, with 9.7% organic revenue growth. Specialty Products’ organic revenue declined 0.4%.
Material changes versus the prior period
- Revenue rose 3.2%, reflecting 2.2% organic growth and favorable currency translation, partly offset by divestitures. Product-line simplification reduced organic growth by 70 basis points.
- Operating income increased 2.8%; excluding the $95 million 2017 legal-settlement benefit, it increased 5.7%. Margin was flat as reported, but increased 60 basis points excluding that settlement; enterprise initiatives contributed 110 basis points, partly offset by unfavorable price/cost and higher freight and employee costs.
- The effective tax rate fell to 24.5% from 48.4%. The 2017 rate included a one-time $658 million charge related to U.S. tax reform; excluding it, the 2017 rate was 28.3%.
- Operating cash flow and free cash flow increased. Capital spending rose to $364 million from $297 million, while repurchases doubled to $2.0 billion.
- 2018 adoption of accounting guidance reduced retained earnings by $415 million in total, including a $406 million cumulative adjustment for intra-entity asset transfers and a $9 million revenue-guidance adjustment.
Outlook, management commentary, risks and unusual items
- Management described 2018 results as solid despite second-half softness in European and Chinese auto production and some Specialty Products markets. No specific 2019 revenue or EPS guidance is provided in the filing text.
- ITW’s stated priorities are organic growth, portfolio discipline, continued use of its 80/20 operating process, margin improvement, dividends, selective acquisitions and share repurchases. Strategic sourcing had reduced spend by an average of 1% annually from 2013–2018; management said it was on track to do so again in 2019.
- The company was exploring options, including possible divestitures, for businesses with revenues totaling up to $1 billion. Management expected any resulting EPS dilution to be offset by incremental share repurchases.
- Management said tariffs imposed in 2018 had not materially affected results, but warned that trade-policy changes and retaliatory tariffs could raise raw-material costs or disrupt supply. Other key exposures include global economic slowdowns, currency movements, product-line simplification’s short-term revenue drag, acquisition execution, goodwill impairment, pension markets, tax matters, litigation, cybersecurity and regulatory compliance.
- Debt maturities include $1.350 billion in 2019, including $650 million of 1.95% notes and $700 million of 6.25% notes. The company reported no significant off-balance-sheet commitments and stated that ordinary-course legal matters were not expected to have a material adverse effect.
- Unusual comparability items: the 2017 $95 million legal settlement boosted operating income; the 2017 tax-reform charge reduced earnings. The 2018 effective tax rate also benefited from discrete tax items. The company repatriated approximately $3.0 billion of foreign cash during 2018.
Important facts for investors to verify
- Underlying growth and margin trends after adjusting for the 2017 legal settlement, 2017 tax charge, currency effects and product-line simplification.
- Whether automotive and Specialty Products softness, unfavorable price/cost, freight and labor pressures persist, and how tariff exposure develops.
- Cash availability by geography, near-term debt refinancing or repayment plans, and the pace of future buybacks relative to free cash flow and dividends.
- Progress and potential earnings impact of any divestitures under consideration, as well as management’s stated repurchase-offset assumption.
- Developments in tax audits and unrecognized tax benefits, pension assumptions, and impairment-sensitive goodwill and intangible assets.