Business context and reporting period
Illinois Tool Works Inc. (ITW) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2010. The company operates across diversified industrial businesses, including transportation, industrial packaging, food equipment, power systems and electronics, construction products, polymers and fluids, decorative surfaces, and other businesses. Amounts below are in U.S. dollars; financial statements are in thousands unless stated otherwise.
Financial performance and position
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Revenue | $4.076 billion | $3.393 billion | $7.683 billion | $6.539 billion |
| Operating income | $652.7 million | $334.8 million | $1.137 billion | $426.1 million |
| Operating margin | 16.0% | 9.9% | 14.8% | 6.5% |
| Net income | $420.8 million | $176.6 million | $715.1 million | $137.2 million |
| Diluted earnings per share | $0.83 | $0.35 | $1.41 | $0.27 |
| Cash from operations | $338.4 million | $624.1 million | $617.8 million | $1.071 billion |
| Free operating cash flow, as defined by ITW | $275.8 million | $566.7 million | $494.5 million | $949.7 million |
For the six months, revenue rose 17.5%, including 11.5% growth in base business revenue. Management attributed growth to recovering end markets, favorable currency translation, and acquisitions. Operating income increased substantially, supported by revenue leverage, cost reductions and restructuring benefits, as well as the absence of $90.0 million of prior-year goodwill and intangible impairment charges. The prior-year comparison also included a $33.7 million discontinued-operations loss. The six-month 2010 effective tax rate was 32.5%, versus 47.7% in 2009; 2010 included a $21.9 million discrete charge related to health-care legislation.
At June 30, 2010, cash and equivalents were $1.265 billion; current assets were $5.766 billion and current liabilities $2.777 billion. Net working capital was $2.990 billion and the current ratio was 2.08. Total debt was $3.030 billion, down from $3.129 billion at December 31, 2009; debt to capitalization was 25.8%, compared with 26.2%. Commercial paper outstanding was $248.5 million. ITW had $2.0 billion of revolving credit facilities available, with no amounts drawn at quarter-end. Capital expenditures were $123.4 million for the six months, and dividends paid were $311.5 million; the declared dividend was $0.31 per share for Q2.
Material changes and management commentary
- Revenue and profitability improved broadly as many markets recovered. Transportation, industrial packaging, power systems and electronics, construction products, polymers and fluids, and All Other reported higher revenues and operating income. Food Equipment revenue was nearly flat; Decorative Surfaces operating income declined.
- North American and international base revenues grew 15.8% and 14.2%, respectively, in Q2. Management cited strength in transportation, polymers and fluids, industrial packaging, and PC board/electronics.
- Six-month operating cash flow and free operating cash flow fell year over year. Management’s cash-flow table shows substantial cash uses from higher trade receivables and inventories; acquisitions also increased, to $217.4 million from $113.6 million.
- Currency movements helped six-month results: management estimated they added approximately $277 million to revenue and $0.06 per diluted share to net income. Conversely, foreign-currency translation adjustments reduced first-half comprehensive income and accumulated other comprehensive income.
- Management said internally generated cash flow should be adequate for debt service, dividends, internal growth and small-to-medium acquisitions. The filing provides no specific earnings or revenue guidance for future periods.
Outlook, risks, contingencies and unusual items
- Risks identified include weaker served markets or economic conditions, raw-material and currency movements, constrained credit, pension-plan market exposure, acquisition-related execution or returns, product-development interruption, and unfavorable tax-law changes or tax rulings.
- ITW is litigating an Australian Tax Office dispute concerning intercompany financing. The company recorded its best estimate of exposure; it said unrecognized tax benefits could decrease by approximately $163 million if the matter is resolved within the next 12 months. The timing and outcome are uncertain.
- The company recorded a $21.9 million first-quarter tax charge from 2010 health-care reform. It expects 2010 contributions of $70.5 million to pension plans and $37.9 million to other postretirement plans; contributions made through June 30 were $35.8 million and $18.4 million, respectively.
- Construction Products benefited from a one-time licensing-agreement settlement in Q2. Management also noted unfavorable Q2 selling-price-versus-material-cost comparisons in some businesses. Decorative Surfaces results were affected by a Q2 fixed-asset impairment.
- Disclosure controls were concluded to be effective as of June 30, 2010; no material change in internal control over financial reporting during the quarter was identified.
Most important facts for investors to verify
- Whether the recovery in end-market demand and base-business growth continued after Q2, particularly in cyclical businesses.
- Whether operating-margin improvements are sustainable without the prior-year impairment comparison, restructuring benefits, favorable currency, or one-time items.
- Why operating cash flow fell despite higher earnings, including the trajectory of receivables and inventory, and whether cash conversion improves.
- The outcome and potential financial impact of the Australian tax dispute and other ongoing tax audits.
- Debt, commercial-paper usage, credit-facility availability, planned pension contributions, and the company’s capacity to fund dividends and acquisitions.