Illinois Tool Works Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011, compared with the corresponding 2010 periods. Dollar amounts are in millions unless otherwise stated. The company retrospectively aligned international reporting periods to the calendar year; prior-period figures were adjusted.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Operating revenues | $4,614.9 | $3,928.1 | $8,886.8 | $7,560.8 |
| Operating income | $711.1 | $626.0 | $1,369.6 | $1,151.7 |
| Operating margin | 15.4% | 15.9% | 15.4% | 15.2% |
| Income from continuing operations | $483.5 | $399.8 | $1,089.8 | $721.1 |
| Net income | $498.4 | $411.5 | $1,121.6 | $745.3 |
| Diluted continuing-operations EPS | $0.96 | $0.79 | $2.17 | $1.43 |
| Diluted net EPS | $0.99 | $0.81 | $2.23 | $1.47 |
Q2 revenue rose 17.5% and operating income 13.6%; first-half revenue rose 17.5% and operating income 18.9%. Management attributed growth to higher base-business revenues, favorable currency translation, and acquisitions. First-half base revenues increased 8.9%; management cited moderating economic growth in Q2. Consolidated operating margin declined 0.5 percentage point in Q2 but increased 0.2 point for the first half.
First-half net income growth was materially affected by a $165.9 million favorable, non-cash discrete tax benefit following an Australian court decision. The first-half effective tax rate was 16.3%, versus 32.6% in 2010, which included a $21.9 million discrete tax charge. The company reported first-half continuing-operations income growth of 51.1%; the tax item makes this comparison less representative of underlying operations.
Cash flow, liquidity, and debt
- First-half operating cash flow was $457.2 million, down from $608.2 million. Free operating cash flow, as defined by the company, was $281.2 million versus $484.9 million, reflecting higher investment in plant and equipment and working-capital outflows, including receivables and inventory.
- Cash and equivalents were $1,230.7 million at June 30, 2011. Current assets were $7,557.1 million and current liabilities $4,062.2 million; the current ratio was 1.86, down from 1.98 at year-end 2010.
- Total debt increased to $4,073.1 million from $2,868.3 million at December 31, 2010; debt-to-capitalization rose to 28.1% from 23.1%. Short-term debt included $1,065.9 million of commercial paper. The company had no borrowings under its $1.0 billion revolving credit facility, renewed through June 2016.
- Cash uses included $747.9 million for acquisitions, $339.3 million in dividends, and $550.0 million for share repurchases. The dividend was $0.34 per share in Q2, versus $0.31 a year earlier.
Segments and material changes
Revenue increased across all reported segments. Power Systems & Electronics had the strongest first-half operating-income growth among the segments shown, up 26.0%, with margin improving to 20.9% from 19.9%. Construction Products’ Q2 operating income fell 4.7% and margin declined to 12.4% from 14.5%, amid weak North American construction demand and pricing/material-cost pressure. Polymers & Fluids revenue grew substantially, partly from acquisitions, but margin declined to 16.8% from 20.1% in Q2. Management repeatedly cited selling-price versus material-cost comparisons and higher costs as margin pressures.
The company repurchased approximately 9.6 million shares in the first half at an average $57.01 per share. A new $4.0 billion repurchase authorization was approved in May; no shares had been bought under it by June 30. Approximately $321 million remained under the prior authorization.
Outlook, transactions, and risks
- No specific consolidated revenue or earnings guidance for the remainder of 2011 is provided in the filing. Management stated that internally generated cash flow was expected to support debt service, dividends, internal growth, and small-to-medium acquisitions.
- The company agreed to sell its finishing businesses to Graco for $650 million cash; completion was not expected before Q4 2011, subject to regulatory review. It also planned to divest consumer packaging and electronics components businesses, with disposal expected within one year. These businesses were classified as held for sale; reported assets held for sale were $423.8 million and related liabilities $102.2 million.
- Management identified risks including weaker or interrupted economic recovery, acquisition effects on profitability and returns, pension-market exposure, currency and raw-material cost changes, reduced credit availability, product-development execution, tax rulings, and regulatory or acquisition-market conditions.
- Expected 2011 pension contributions were approximately $129.1 million and other postretirement contributions $39.5 million; $44.0 million and $16.3 million, respectively, had been contributed by June 30.
- Management concluded disclosure controls were effective as of June 30, 2011, and reported no quarterly changes to internal controls that materially affected or were reasonably likely to materially affect them.
Important facts for investors to verify
- How much of reported earnings growth reflects recurring operating performance versus the $165.9 million Australian tax benefit.
- Whether operating cash flow and free operating cash flow recover as working-capital needs and capital spending evolve.
- Use of commercial paper and debt levels following acquisitions, dividends, and share repurchases, including progress toward the company’s targeted debt-to-capital range.
- Completion timing, proceeds, and final accounting for the announced divestitures, and the impact of discontinued businesses on future results.
- Whether margin pressure from raw-material costs, pricing, and operating expenses persists, particularly in Construction Products and Polymers & Fluids.