Illinois Tool Works Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. ITW reported seven continuing-operation segments. Prior-period results are presented on a comparable basis with divested businesses classified as discontinued operations.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Operating revenue | $3.692 billion | $3.568 billion | $10.980 billion | $10.581 billion |
| Operating income | $772 million | $678 million | $2.202 billion | $1.886 billion |
| Operating margin | 20.9% | 19.0% | 20.1% | 17.8% |
| Continuing-operations income | $507 million | $406 million | $1.429 billion | $1.223 billion |
| Net income | $531 million | $452 million | $2.496 billion | $1.271 billion |
| Diluted EPS, continuing operations | $1.28 | $0.90 | $3.49 | $2.70 |
| Diluted EPS, total | $1.34 | $1.01 | $6.09 | $2.81 |
- Q3 revenue grew 3.5%, entirely from organic growth; nine-month revenue rose 3.8%, including 2.7% organic growth. Product-line and customer simplification reduced organic growth by about one percentage point.
- Operating income increased 13.8% in Q3 and 16.8% year to date. Management attributed margin improvement to organic growth and operating leverage, cost and overhead improvements, and enterprise initiatives.
- Nine-month net income includes the $1.1 billion after-tax gain from the Industrial Packaging sale. Continuing-operations income provides a clearer view of ongoing earnings.
- Q3 segment revenue was strongest in Automotive OEM (+7.1%), Food Equipment (+6.0%) and Test & Measurement and Electronics (+5.6%). Polymers & Fluids revenue fell 2.8%; Welding and Specialty Products were nearly flat. Segment operating income generally increased, with Welding and Specialty Products showing more modest gains.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $1.158 billion, versus $1.820 billion in 2013. Capital expenditures were $272 million, producing company-defined free operating cash flow of $886 million, compared with $1.563 billion. Q3 free operating cash flow was $145 million versus $732 million.
- Cash and equivalents totaled $4.820 billion at September 30, 2014. Total debt was $7.530 billion, up from $6.344 billion at year-end 2013; short-term debt was $1.496 billion and long-term debt $6.034 billion. The company reported total debt/adjusted EBITDA of 2.2x, versus 2.1x at year-end.
- Current assets were $9.152 billion and current liabilities $3.874 billion; the reported current ratio was 2.4, compared with 1.6 at year-end. The company had $2.5 billion in U.S. committed credit lines, with none drawn, and reported compliance with its interest-coverage covenant.
- Cash rose by $1.202 billion over the first nine months, reflecting $3.191 billion in net proceeds from discontinued-operation sales, partly offset by $3.516 billion of share repurchases, dividends, debt activity and foreign-exchange effects. Management said most cash was held by international subsidiaries and could face tax or withholding costs if repatriated.
Material changes, outlook and risks
- ITW completed the sale of Industrial Packaging to Carlyle for $3.2 billion on May 1, 2014, recording a $1.7 billion pretax gain. It completed divestitures of the businesses previously classified as discontinued operations; none remained held for sale at quarter-end.
- The company completed its planned repurchase of approximately 50 million shares intended to offset dilution from the Industrial Packaging divestiture. It repurchased 5.8 million shares in Q3 and had about $2.3 billion remaining under its $6.0 billion authorization.
- Management described its 2012–2017 enterprise strategy—portfolio management, business-structure simplification and strategic sourcing—as aimed at organic growth, profitability and returns. Divestiture activity was described as essentially complete. The filing provides no specific earnings or revenue guidance for the next quarter or full year.
- Risks identified include economic and end-market weakness, foreign-currency volatility, raw-material costs and shortages, execution and timing of enterprise initiatives, financing availability, tax-law changes and rulings, pension-market exposure, litigation, and possible goodwill or intangible-asset impairments.
- The IRS asserted that a subsidiary capital return was a taxable dividend, assessing $70 million of additional tax for 2006 plus interest and penalties. ITW challenged the notice in Tax Court and said it believed it would prevail; outcome is uncertain. Ongoing tax audits may also affect unrecognized tax benefits.
- Foreign-currency translation reduced comprehensive income by $515 million in Q3 and $537 million for the first nine months. The company recorded $3 million of Q3 intangible-asset impairment and no goodwill impairment.
Important facts for investors to verify
- Underlying earnings and cash generation excluding the Industrial Packaging disposal gain, and the reasons operating cash flow and free operating cash flow declined.
- Whether organic growth and margin gains can continue, particularly in weaker businesses and markets, and the continuing effect of product/customer simplification.
- Use and location of cash, debt maturities and refinancing needs, leverage progression, and the pace and funding of future repurchases and dividends.
- Resolution and potential financial impact of the IRS dispute and other tax audits, including any repatriation-related taxes.
- Exposure to foreign exchange, pension obligations, raw-material prices, and risks to goodwill and intangible-asset valuations.