Illinois Tool Works Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. ITW is a diversified global industrial manufacturer with 84 divisions organized into seven segments. Results were materially affected by COVID-19 disruptions.
Key financial results
| Metric | Q2 2020 | Q2 2019 | H1 2020 | H1 2019 |
|---|---|---|---|---|
| Operating revenue | $2.564B | $3.609B | $5.792B | $7.161B |
| Operating income | $449M | $871M | $1.210B | $1.710B |
| Operating margin | 17.5% | 24.1% | 20.9% | 23.9% |
| Net income | $319M | $623M | $885M | $1.220B |
| Diluted EPS | $1.01 | $1.91 | $2.78 | $3.72 |
| Free cash flow | $681M | $608M | $1.235B | $1.147B |
Q2 revenue fell 29.0% (organic revenue down 26.5%) and operating income fell 48.4%. For H1, revenue declined 19.1% (organic down 16.6%) and operating income declined 29.2%. Management attributed the declines mainly to pandemic-related demand and operating disruptions. Q2 margin contracted 660 basis points, primarily due to negative operating leverage; enterprise initiatives partly offset the pressure.
Segments and operating trends
All seven segments reported lower Q2 revenue year over year. Automotive OEM was most severely affected: revenue was $361M, down 54.1%, with an operating loss of $28M and a negative 7.8% margin. Food Equipment revenue declined 38.6% to $336M, with a 9.2% margin. Test & Measurement and Electronics was more resilient, with revenue down 14.7% to $455M and margin up to 25.7%. Construction Products’ U.S. residential business grew, partly offsetting weakness elsewhere. Segment declines reflected broad end-market disruption, with notable severity in automotive, food equipment and welding.
Cash, debt and liquidity
- Operating cash flow was $737M in Q2 and $1.351B in H1; capital expenditures were $56M and $116M, respectively. Free cash flow, a company-defined non-GAAP measure, was higher than the prior-year periods.
- At June 30, cash and equivalents were $1.812B; total debt was $7.769B, including $7.765B of long-term debt. The company reported no commercial paper or revolving-credit borrowings and had a $2.5B credit facility available. Debt maturities in the next 12 months were $4M.
- Total debt to trailing-12-month EBITDA was 2.3x, versus 2.0x at December 31, 2019. Cash exceeded short-term debt, but most cash was held by international subsidiaries and could be subject to withholding taxes if repatriated.
- H1 cash dividends paid were $680M. ITW repurchased approximately 4.2 million shares for $706M in Q1, then suspended repurchases starting in March; $1.2B remained authorized under its repurchase program.
Outlook, risks and other notable items
- ITW expected COVID-19 disruptions to adversely affect results across all segments in the second half of 2020, with more pronounced impacts in Automotive OEM, Food Equipment and Welding. Management expected Q3 demand to be better than Q2, but did not provide specific financial guidance and emphasized that the pandemic’s duration and effects remained highly uncertain.
- Management cited its business model and balance sheet as sources of resilience and prioritized employee safety, customer service, liquidity, cost and working-capital management, and readiness for recovery. Facilities were open at quarter-end, although many operated below capacity.
- ITW deferred $158M of U.S. income tax payments to Q3 under the CARES Act. Ongoing tax audits could reduce unrecognized tax benefits by approximately $40M within 12 months, predominantly relating to intercompany transactions.
- Only one previously designated business remained held for sale at June 30, with $221M of assets and $40M of liabilities presented as held for sale; it was expected to be sold within one year. Pandemic-related uncertainty had caused two other planned sales to no longer be considered probable within one year.
- Principal risks include prolonged or renewed pandemic disruption, reduced customer demand, operating-capacity constraints, supply-chain interruptions, customer or supplier financial distress, and possible limits on access to financing. The company stated that disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether demand recovered as management anticipated for Q3 and how second-half results compared with the expected continuing pandemic impact.
- Automotive OEM’s return to profitability and margin recovery in the most affected segments.
- Whether free cash flow remains sufficient to support dividends, debt service and strategic investment while buybacks are suspended.
- Cash accessibility, debt leverage and any changes in credit-facility use or financing conditions.
- Progress on the remaining held-for-sale business and the outcome of tax audits and other disclosed contingencies.