Illinois Tool Works Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Amounts are in millions of U.S. dollars except per-share data. ITW is a diversified global industrial manufacturer operating through seven segments.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Operating revenue | $3,609 | $3,831 | $7,161 | $7,575 |
| Operating income | $871 | $932 | $1,710 | $1,835 |
| Operating margin | 24.1% | 24.3% | 23.9% | 24.2% |
| Net income | $623 | $666 | $1,220 | $1,318 |
| Diluted EPS | $1.91 | $1.97 | $3.72 | $3.87 |
| Free cash flow | $608 | $533 | $1,147 | $977 |
Revenue fell 5.8% in Q2 and 5.5% year to date. Organic revenue declined 2.8% and 2.2%, respectively; foreign currency translation also reduced reported revenue. Operating income decreased 6.6% in Q2 and 6.8% year to date. Management attributed the declines primarily to weaker organic revenue, currency effects and higher restructuring expenses. Excluding higher restructuring costs, operating margin increased 10 basis points in Q2 and 20 basis points year to date, supported by enterprise initiatives.
Q2 operating cash flow was $685 and capital expenditures were $77; year-to-date operating cash flow was $1,301 and capital expenditures were $154. Cash and equivalents were $1,677 at June 30, versus $1,504 at year-end. Total debt was $7,809, up from $7,380; short-term debt was zero and long-term debt was $7,809. Trailing-twelve-month debt/EBITDA was 2.0, compared with 1.8 at December 31, 2018. Net working capital was $4,101, up from $2,236, primarily because current maturities of debt were repaid.
ITW issued €1.6 billion of notes in June, with maturities in 2024, 2027 and 2031 and coupons of 0.25%, 0.625% and 1.00%. Proceeds were used to repay commercial paper and for general corporate purposes. The notes were designated as hedges of net investments in euro-denominated operations. Year-to-date dividends paid were $654; share repurchases were $750, covering approximately 5.2 million shares.
Material changes and segment trends
- Automotive OEM: Q2 organic revenue declined 7.1%; year-to-date operating margin fell 190 basis points to 21.4%, reflecting weak auto production, negative operating leverage, restructuring and price/cost pressures.
- Specialty Products: Q2 organic revenue declined 6.4% and operating margin fell 200 basis points to 26.1%, with lower consumables demand, product mix and negative operating leverage among the pressures.
- Food Equipment: Organic revenue rose 1.7% in both periods; margins improved 20 basis points in Q2 and 30 basis points year to date.
- Test & Measurement and Electronics: Q2 organic revenue declined 1.3%, while margin improved 100 basis points to 24.5%.
- Welding: Q2 organic revenue declined 2.4%; year-to-date organic revenue increased 0.2%, and the year-to-date margin was flat at 28.5%.
- Polymers & Fluids: Q2 organic revenue was essentially flat; margin increased 160 basis points to 22.8%.
- Construction Products: Q2 organic revenue declined 0.7%; margin increased 50 basis points to 25.0%.
Outlook, commentary and risks
Management reported softness in certain end markets, especially customer capital-equipment purchases, amid broad uncertainty. It did not provide a quantified earnings or revenue forecast in the supplied filing text. The company is exploring portfolio options, including potential divestitures of businesses with annual revenue totaling up to $1 billion. In Q2 it approved plans to divest six businesses, classified as held for sale and expected to be sold within one year; none was considered significant. The company recorded an estimated $4 loss on two Specialty Products businesses. Management said any EPS dilution from potential divestitures is expected to be offset by incremental share repurchases.
Management stated tariffs had not materially affected results to date, but will continue assessing tariffs and related pricing actions. Key disclosed risks include economic and end-market downturns, foreign-exchange movements, raw-material cost increases or shortages, execution and timing of enterprise initiatives, divestiture-related liabilities, financing and credit conditions, tax matters, pension exposure, litigation, and cybersecurity or data-privacy events. Ongoing tax audits could reduce unrecognized tax benefits by approximately $50 within 12 months, predominantly related to intercompany transactions.
Six held-for-sale businesses generated $128 of revenue in Q2 and $255 year to date, compared with $137 and $275 in the corresponding 2018 periods. Disclosure controls were deemed effective, and no material change in internal control over financial reporting was identified during the quarter.
Investor verification points
- Track whether organic demand stabilizes, particularly in Automotive OEM and Specialty Products, and assess the effect of end-market and regional weakness.
- Separate underlying operating performance from currency translation, restructuring costs, product-line simplification and divestiture effects.
- Monitor completion, proceeds and earnings impact of the six planned divestitures and other potential portfolio actions, including the stated share-repurchase offset.
- Review debt levels, debt/EBITDA, cash generation and the sustainability of dividends and repurchases following the euro-note issuance.
- Follow tax-audit developments and the stated potential change in unrecognized tax benefits.