Illinois Tool Works Inc. — Q1 2016 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2016; comparisons are with Q1 2015 unless noted. ITW is a diversified global industrial manufacturer organized into seven reportable segments. The company attributed results to execution of its enterprise initiatives despite challenging end markets and foreign-currency headwinds.
Financial results and liquidity
Amounts are in USD millions, except per-share data and ratios.
- Revenue was $3,274, down 2.0%; organic revenue increased 0.7%. Currency translation reduced reported revenue growth by 2.6 percentage points.
- Operating income rose 3.7% to $722; operating margin expanded 120 basis points to a first-quarter record of 22.1%. Net income increased to $468 from $458. Diluted EPS was $1.29 versus $1.21.
- Interest expense increased to $58 from $54. Other income was $4 versus $21, primarily reflecting a $15 prior-year gain on a business sale and lower interest income. The effective tax rate declined to 30.0% from 31.0%.
- Operating cash flow was $479 versus $442; free cash flow, a company-defined non-GAAP measure, was $422 versus $359. Capital expenditures were $57 versus $83.
- Cash and equivalents were $2,448 at quarter-end, down from $3,090 at December 31, 2015. The company said the decline primarily reflected share repurchases. Most cash was held by international subsidiaries and may incur tax and withholding costs if repatriated.
- Total debt was $7,003, down from $7,422 at year-end; total debt to trailing-twelve-month EBITDA was 2.1x versus 2.2x. The $650 of short-term debt included $649 of notes due February 2017 reclassified from long-term debt; no commercial paper was outstanding at quarter-end.
- Net working capital decreased to $3,525 from $4,352, primarily due to lower cash. Management said cash, free cash flow, credit facilities and debt-market access were adequate for debt service and capital priorities.
- Dividends paid were $200; declared and paid dividends were $0.55 per share, up from $0.485. ITW repurchased 5.3 million shares for approximately $500, leaving about $4.9 billion authorized under its 2015 repurchase program.
Material changes and segment performance
- Consumer-facing businesses, about 60% of revenue, grew organically 3.3%; industrial-facing businesses declined 3.1%. Product-line simplification reduced organic revenue growth by about one percentage point.
- Automotive OEM, Food Equipment, Construction Products and Specialty Products delivered organic growth. Specialty Products operating income rose 16.9%, Construction Products 27.7%, and both segments expanded margins substantially.
- Test & Measurement and Electronics organic revenue declined 1.9%, amid weak capital spending and product-line simplification. Welding revenue fell 10.0% and operating income fell 20.0%, reflecting weak oil-and-gas demand and capital spending, lower-margin mix, restructuring and intangible-asset impairment. Polymers & Fluids revenue fell 5.1%, largely due to currency.
- Foreign-currency translation was a significant headwind to reported revenue and earnings, but currency translation adjustments contributed $164 to comprehensive income, compared with a $577 loss in Q1 2015.
Outlook, commentary, risks and contingencies
- The filing provides no specific consolidated revenue or EPS forecast. Management expected approximately 85% of businesses to be “ready to grow” by year-end 2016; preparing divisions for accelerated organic growth generally takes 18–24 months.
- Management said enterprise initiatives contributed 130 basis points to consolidated margin improvement, with additional benefit from price/cost and operating leverage, partly offset by business investment and overhead inflation. Strategic sourcing had delivered an average 1% annual reduction in spend during 2013–2015; ITW expected similar reductions in 2016 and 2017.
- Key risks identified include weakening end markets, economic and political changes, currency fluctuations, execution and timing of enterprise initiatives, raw-material costs or shortages, financing and credit risks, cyber incidents, impairment, tax and legal outcomes, and acquisition integration.
- ITW had agreed to acquire ZF TRW’s Engineered Fasteners and Components business. The filing highlights integration, valuation, contingent-liability and goodwill/intangible impairment risks associated with acquisitions.
- Tax authorities had ongoing audits. ITW said unrecognized tax benefits could decrease by approximately $122 within 12 months, predominantly relating to intercompany transactions. Separately, an IRS deficiency notice asserts $70 of additional tax for 2006, plus interest and penalties; trial was set for Q3 2016. ITW expected to defend its position and had recorded no reserve.
- Expected 2016 contributions were approximately $73 to pension plans and $5 to other postretirement plans; $5 and $1, respectively, had been contributed by quarter-end.
Important facts for investors to verify
- Whether organic growth and the expected readiness of divisions for growth materialize, particularly given weak industrial, oil-and-gas and capital-spending markets.
- Whether margin gains persist and how much reflects recurring operating improvement versus restructuring, impairment, mix or prior-year comparison effects.
- Cash availability and potential tax costs associated with international cash, alongside the effect of ongoing repurchases and dividends on liquidity and leverage.
- Developments in the IRS dispute and tax audits, including the timing and amount of any resolution.
- Completion and performance of the proposed ZF TRW business acquisition, including purchase price, integration costs and assumed liabilities.