Illinois Tool Works Inc. — Q3 2010 Form 10-Q
Business context and reporting period. The filing covers the three and nine months ended September 30, 2010, compared with the same 2009 periods. ITW operates across diversified industrial and consumer markets through multiple segments. Amounts below are in millions of dollars unless stated otherwise.
Key financial results
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $4,018.5 | $3,580.4 | $11,701.1 | $10,119.6 |
| Operating income | $640.5 | $483.6 | $1,777.2 | $909.7 |
| Operating margin | 15.9% | 13.5% | 15.2% | 9.0% |
| Net income | $419.3 | $302.4 | $1,134.4 | $439.6 |
| Diluted EPS | $0.83 | $0.60 | $2.25 | $0.88 |
| Cash from operations | — | — | $1,101.8 | $1,640.3 |
| Free operating cash flow | $411.8 | $516.2 | $906.2 | $1,465.9 |
- Q3 revenue rose 12.2% and net income rose 38.7% year over year. Nine-month revenue increased 15.6%; operating income nearly doubled, while net income increased substantially from a prior-year period that included impairment charges and discontinued-operation losses.
- Management attributed revenue and margin improvement principally to higher base-business sales and operating leverage, restructuring benefits, and acquisitions. Nine-month currency translation added approximately $202 million to revenue and $0.06 per diluted share to net income.
- Cash from operations declined 32.8% year over year for the first nine months; free operating cash flow, defined by the company as operating cash flow less capital expenditures, fell 38.2%. Increased receivables and inventory were significant cash uses.
Balance sheet, liquidity, and capital allocation
- At September 30, cash and equivalents were $1,649.1, current assets $6,334.8, and current liabilities $3,221.3. Net working capital was $3,113.5 and the current ratio was 1.97, compared with 2.00 at year-end 2009.
- Total debt was $3,382.3, up from $3,128.6 at December 31, 2009; debt to capitalization increased to 27.6% from 26.2%. Short-term debt rose to $644.9, including $552.5 of commercial paper. Two revolving credit facilities totaling $2.0 billion had no amounts drawn at quarter-end. Management’s stated debt-to-capital target is 20%–30%.
- Nine-month capital expenditures were $195.5. Dividends paid were $467.6, and the company repurchased $350 million of stock, or about 8.1 million shares at an average $43.29. Approximately $871 million remained authorized under the repurchase program.
- Management said internally generated cash was expected to support debt service, dividends, internal growth, and small-to-medium acquisitions. In Q3, it revised its dividend payout guideline from 25%–35% of the prior two years’ average continuing income to 30%–45% of the prior two years’ average free operating cash flow.
Changes, outlook, and notable items
- Broad-based recovery lifted most segments, notably Transportation, Industrial Packaging, and Power Systems & Electronics. Food Equipment revenue remained soft; Decorative Surfaces revenue was flat in Q3, and its flooring business was being closed. North American construction demand remained weak, though the segment benefited year to date from a one-time licensing settlement.
- Management cited improved macroeconomic conditions across many end markets, but gave no specific consolidated revenue or earnings guidance in the provided filing text. It identified potential risks including economic or end-market deterioration, raw-material costs and foreign exchange, pension-market exposure, acquisition execution, credit availability, and tax matters.
- The Australian Tax Office dispute concerning intercompany financing was heard in September 2010. A judgment was expected by year-end; depending on the outcome, the tax provision could be affected favorably or unfavorably by approximately $173.2 million. The company said it had recorded its best estimate of the exposure.
- The nine-month 2010 effective tax rate was 32.2%, including a $21.9 million discrete charge related to U.S. health-care legislation and a $7.3 million discrete charge related to a business-sale gain. The 2009 comparison included $102.0 million of goodwill and intangible impairments and $34.3 million of discontinued-operation losses. Q3 2010 impairment charges were described as immaterial.
- Management reported effective disclosure controls as of September 30, 2010, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether operating cash flow recovers as receivables and inventories rise with sales, and how durable free cash flow is after dividends, acquisitions, and repurchases.
- The outcome and timing of the Australian tax dispute, including the potential approximately $173.2 million tax impact.
- Whether margin gains persist despite unfavorable selling-price-versus-material-cost comparisons and higher overhead in some businesses.
- Trends in weaker end markets, particularly food equipment, decorative surfaces/flooring, and North American construction.
- Debt and commercial-paper levels, capital allocation priorities, and the effects of acquisitions and ongoing share repurchases.