Illinois Tool Works - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Commission File Number: 1-4797

(Exact name of registrant as specified in its charter)

(Registrant’s telephone number, including area code) 847-724-7500

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  [X]No  [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  [X]No  [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [X]    Accelerated filer [   ]

Non-accelerated filer  [   ]     Smaller reporting company  [   ]

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  [   ]No  [X]

The number of shares of registrant’s common stock, $0.01 par value, outstanding at September 30, 2009: 500,909,909.

Item 1 – Financial Statements

(1)           FINANCIAL STATEMENTS

The unaudited financial statements included herein have been prepared by Illinois Tool Works Inc. and Subsidiaries (the “Company”). In the opinion of management, the interim financial statements reflect all adjustments of a normal recurring nature necessary for a fair statement of the results for interim periods. Events that occurred after September 30, 2009 through the time that these financial statements have been filed on October 30, 2009 with the Securities and Exchange Commission were considered in the preparation of these financial statements. These financial statements should be read in conjunction with the financial statements and notes to financial statements included in the Company’s Annual Report on Form 10-K, as updated by the Current Report on Form 8-K filed August 7, 2009. Certain reclassifications of prior year data have been made to conform to current year reporting.

(2)           COMPREHENSIVE INCOME

The Company’s components of comprehensive income in the periods presented are:

(3)           DISCONTINUED OPERATIONS

The Company periodically reviews its 895 operations for businesses which may no longer be aligned with its long-term objectives. In August 2008, the Company’s Board of Directors authorized the divestiture of the Click Commerce industrial software business which was previously reported in the All Other segment. In the second quarter of 2009, the Company completed the sale of the Click Commerce business.

In the fourth quarter of 2007, the Company classified an automotive components business and a consumer packaging business as held for sale. The consumer packaging business was sold in the second quarter of 2008. The Company sold the automotive components business in the third quarter of 2009.

In May 2009, the Company’s Board of Directors rescinded a resolution from August 2008 to divest the Decorative Surfaces segment. The consolidated financial statements and related notes for all periods have been restated to present the results related to the Decorative Surfaces segment as continuing operations.

Results of the discontinued operations were as follows:

In 2009, the Company recorded a pre-tax loss on the disposal of the Click Commerce business of $29,626,000. Loss before taxes in 2008 includes goodwill impairment charges of $132,700,000 related to the Click Commerce business and a pre-tax gain on the disposal of the consumer packaging business of $25,062,000.

(4)           INCOME TAXES

In the first nine months of 2009, the Company incurred significant charges related to the impairment of goodwill and intangible assets of $101,997,000 that were mostly non-deductible, and discrete tax items of $46,849,000 to record reserves for tax contingencies related to audits and valuation allowances on net operating loss carryforwards no longer expected to be utilized. The components of the effective tax rate for the nine month period ended September 30, 2009 were as follows:

The Company and its subsidiaries file tax returns in the U.S. and various state, local and foreign jurisdictions. These tax returns are routinely audited by the tax authorities in these jurisdictions and a number of these audits are currently ongoing.

As part of the Australia, Germany and U.S. tax audits, the tax authorities are reviewing several items, the most significant of which are related to financing transactions, leveraged leases and mortgage-backed securities. The Company believes it is reasonably possible that it will resolve the matters currently under consideration within the next 12 months, and that the amount of the Company’s unrecognized tax benefits may be reduced by a range of approximately $270 million up to $580 million. The Company has recorded its best estimate of the exposure for these issues.

(5)           INVENTORIES

Inventories at September 30, 2009 and December 31, 2008 were as follows:

(In thousands)

(6)           GOODWILL AND INTANGIBLE ASSETS

Goodwill represents the excess cost over fair value of the net assets of purchased businesses. The Company does not amortize goodwill and intangible assets that have indefinite lives. The Company performs an annual impairment assessment of goodwill and intangible assets with indefinite lives based on the fair value of the related reporting unit or intangible asset.

In September 2006, the Financial Accounting Standards Board issued new accounting guidance on fair value measurements. The Company adopted these provisions on January 1, 2009 for all nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value on a nonrecurring basis. The new accounting guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants and provides guidance for measuring fair value and the necessary disclosures.

When performing its annual goodwill impairment assessment, the Company compares the estimated fair value of each of its 62 reporting units to the carrying value. Fair values are determined primarily by discounting estimated future cash flows based either on current operating cash flows or on a detailed cash flow forecast prepared by the relevant reporting unit. The Company also considers additional valuation techniques, such as market multiples from similar transactions and quoted market prices of relevant public companies. If the fair value of a reporting unit is less than its carrying value, an impairment loss, if any, is recorded for the difference between the implied fair value and the carrying value of the reporting unit’s goodwill.

The Company’s indefinite-lived intangibles consist of trademarks and brands. The fair values of these intangibles are determined based on a relief-of-royalty income approach derived from internally forecasted revenues of the related products. If the fair value of the trademark or brand is less than its carrying value, an impairment loss is recorded for the difference between the estimated fair value and carrying value of the intangible.

In the first quarter of 2009, the Company performed its annual impairment testing of its goodwill and intangible assets with indefinite lives in compliance with the newly adopted fair value measurement provisions which resulted in goodwill impairment charges of $60,000,000 related to the pressure sensitive adhesive reporting unit in the Polymers & Fluids segment and $18,000,000 related to the PC board fabrication reporting unit in the Power Systems & Electronics segment.

Also in the first quarter of 2009, intangible asset impairments of $11,997,000 were recorded to reduce to the estimated fair value the carrying value of certain trademarks and brands with indefinite lives. Approximately $5,800,000 of this charge related to the PC board fabrication reporting unit and the remainder to various trademarks and brands of other reporting units.

In the third quarter of 2009, the Company changed the date of its annual goodwill impairment assessment from the first quarter to the third quarter. This constitutes a change in the method of applying an accounting principle that the Company believes is preferable.  The change was made to better align the timing of the Company’s goodwill impairment assessment with the Company’s annual business planning and forecasting process. The Company performed an impairment assessment of its goodwill in the third quarter which resulted in an impairment charge of $12,000,000 related to the truck remanufacturing and parts/service reporting unit in the Transportation segment.  

The goodwill impairments in the first and third quarters were related to new reporting units which were acquired over the last few years before the recent economic downturn. These charges were driven by lower current forecasts compared to the expected forecasts at the time the reporting units were acquired.

A summary of goodwill and indefinite-lived intangible assets that were adjusted to fair value and the related impairment charges included in earnings for 2009 is as follows:

(7)RETIREMENT PLANS AND POSTRETIREMENT BENEFITS

Pension and other postretirement benefit costs for the periods ended September 30, 2009 and 2008 were as follows:

The Company expects to contribute approximately $218,000,000 to its pension plans and $38,000,000 to its other postretirement plans in 2009. As of September 30, 2009, contributions of $209,800,000 to pension plans and $24,200,000 to other postretirement plans have been made.

(8)           SHORT-TERM DEBT

On June 12, 2009, the Company entered into a $2,000,000,000 Line of Credit Agreement with a termination date of June 11, 2010 which replaced the prior line of credit. No amounts were outstanding under this facility at September 30, 2009.

The Company had no commercial paper outstanding at September 30, 2009 and $1,820,423,000 outstanding at December 31, 2008.

In 1999, the Company issued $500,000,000 of 5.75% redeemable notes due March 1, 2009. These notes were repaid at maturity.

(9)           LONG-TERM DEBT

On March 23, 2009, the Company issued $800,000,000 of 5.15% redeemable notes due April 1, 2014 at 99.92% of face value and $700,000,000 of 6.25% redeemable notes due April 1, 2019 at 99.98% of face value. The effective interest rates of the notes are 5.2% and 6.3%, respectively.

Based on rates for comparable instruments the approximate fair value and related carrying value of the Company’s long-term debt, including current maturities, were as follows:

(In thousands)

(10)           STOCKHOLDERS' EQUITY

On January 1, 2009, the Company adopted new accounting guidance on noncontrolling interests. Upon adoption, the Company reclassified the December 31, 2008 balance of $11,616,000 from other noncurrent liabilities to noncontrolling interest in stockholders’ equity.

(11)           SEGMENT INFORMATION

See Management’s Discussion and Analysis for information regarding operating revenues and operating income for the Company’s segments.

In 2007, the Company classified an automotive components business and a consumer packaging business as discontinued operations. Additionally, in 2008, the Company’s Board of Directors authorized the divestiture of the Click Commerce industrial software business which was previously reported in the All Other segment. The consolidated statements of income, statements of financial position, the notes to financial statements and management’s discussion and analysis for all periods have been restated to present the results related to all of these businesses as discontinued operations. See the Discontinued Operations note for further information on the Company’s discontinued operations.

In May 2009, the Company’s Board of Directors rescinded a resolution from August 2008 to divest the Decorative Surfaces segment. The consolidated financial statements, the notes to financial statements and management’s discussion and analysis for all periods have been restated to present the results related to the Decorative Surfaces segment as continuing operations.

The Company’s consolidated results of operations for the third quarter and year-to-date periods of 2009 and 2008 were as follows:

In the third quarter and year-to-date periods of 2009, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

Revenues decreased 19.8% and 23.0% in the third quarter and year-to-date periods of 2009, respectively, primarily due to lower base revenues and the unfavorable effect of currency translation, mainly due to the strengthening of the Dollar, partially offset by revenues from acquisitions. Total base revenues declined 17.9% and 20.9% in the third quarter and year-to-date periods, respectively, but showed improvement as compared to the second quarter 2009. North American base revenue declined 21.6% and 24.8%, in the third quarter and year-to-date periods, respectively, while international base revenues declined 13.8% and 16.7% in the same periods. Both North American and international base revenues were adversely affected by weak, but improving macroeconomic and industrial production trends as compared to the second quarter 2009. The Company anticipates that the current weak global economic environment will continue through 2009 and as such, expects that key end markets will continue to be negatively impacted.

Operating income declined 27.9% and 55.6% in the third quarter and year-to-date periods of 2009, respectively, primarily due to the decline in base revenues, the negative effect of currency translation, increased restructuring charges and increased goodwill and intangible impairment charges. In the first quarter of 2009, the Company recorded impairment charges of $78 million and $12 million against goodwill and intangibles, respectively, and in the third quarter recorded a $12 million goodwill impairment charge. The goodwill and intangible impairments were primarily related to new reporting units which were acquired over the last few years. These charges were driven by lower current forecasts compared to the expected forecasts at the time the reporting units were acquired. The higher restructuring charges reflect the Company’s efforts to reduce costs in response to current economic conditions. Improvements in base variable margins and lower overhead costs increased base margins 5.8% and 3.5% in the third quarter and year-to-date periods, respectively, as the cumulative benefits of past restructuring projects began to be more fully realized and price versus raw material cost comparisons were favorable. Total margins declined by 1.5% and 6.6% in the third quarter and year-to-date periods of 2009, respectively, primarily due to the declines in base revenues, restructuring charges and the goodwill and intangible impairment charges.

The reconciliation of segment operating revenues to total operating revenues is as follows:

INDUSTRIAL PACKAGING

Businesses in this segment produce steel, plastic and paper products used for bundling, shipping and protecting goods in transit.

This segment primarily serves the primary metals, general industrial, construction, and food and beverage markets.

The results of operations for the Industrial Packaging segment for the third quarter and year-to-date periods of 2009 and 2008 were as follows:

In the third quarter and year-to-date periods of 2009, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

Revenues decreased 29.5% and 32.6% in the third quarter and year-to-date periods of 2009, respectively, primarily due to lower base revenues and the unfavorable impact of currency translation. Base revenues declined 27.0% and 29.7% for the North American industrial packaging businesses in the third quarter and year-to-date periods, respectively, largely due to declines in consumable and equipment volume in key end markets such as primary metals, construction-related materials and manufacturing. The international industrial packaging businesses declined 25.0% and 25.6%, respectively, in the third quarter and year-to-date periods, as both were adversely affected by the continued global decline in industrial production and construction industries.

Operating income decreased 52.0% and 78.9% in the third quarter and year-to-date periods of 2009, respectively, primarily due to the negative leverage effect of the decline in base revenues described above, the negative effect of currency translation and higher restructuring charges. Improvements in base variable margins and overhead costs increased margins 6.7% and 3.4% in the third quarter and year-to-date periods, respectively, as price versus raw material cost comparisons were favorable and benefits of past restructuring projects began to be realized.  Total operating margins declined by 3.6% and 8.1% in the third quarter and year-to-date periods, respectively, mainly due to the declines in base revenues.

POWER SYSTEMS & ELECTRONICS

Businesses in this segment produce equipment and consumables associated with specialty power conversion, metallurgy and electronics.

This segment primarily serves the general industrial, electronics and construction markets.

The results of operations for the Power Systems & Electronics segment for the third quarter and year-to-date periods of 2009 and 2008 were as follows:

In the thirdquarter and year-to-date periods of 2009, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

Revenues declined 34.6% and 35.2% in the third quarter and year-to-date periods of 2009, respectively, mainly due to declines in base revenues and the negative effect of currency translation. Revenues fell as end market demand continued to decline across the broad spectrum of industries that this segment serves, including key end markets such as commercial construction and manufacturing. The revenue decrease was partially offset by 2008 acquisitions, including a welding equipment business and a PC board fabrication business. Worldwide base welding revenues declined 36.2% in the third quarter and 34.9% year-to-date. North American welding businesses declined 40.0% and 39.1% while international base businesses declined 26.7% and 23.5%, in the respective periods. Base revenues for the electronics businesses fell 32.6% and 36.6% in the third quarter and year-to-date periods, respectively, while base revenues in the PC board fabrication businesses fell 42.3% and 52.1% in the same periods, both largely due to the decline in consumer demand for electronics.

Operating income decreased 41.2% and 59.4% in the third quarter and year-to-date periods of 2009, respectively, primarily due to the declines in base revenues described above, first quarter 2009 impairment charges, higher restructuring charges and the negative effect of currency translation. Goodwill and intangible asset impairment charges of $18.0 million and $6.7 million, respectively, were incurred in the PC board fabrication and welding accessories businesses in the first quarter of 2009. Total operating margins declined by 2.0% and 7.8% in the third quarter and year-to-date periods, respectively, primarily due to the declines in base revenues and higher year-to-date impairment and restructuring charges. Improvements in variable margins and overhead expenses, including favorable price versus raw material cost comparisons and benefits of prior restructuring projects, increased operating margins by 7.5% and 5.1% in the third quarter and year-to-date periods, respectively.

TRANSPORTATION

Businesses in this segment produce components, fasteners, fluids and polymers, as well as truck remanufacturing and related parts and service.

This segment primarily serves the automotive original equipment manufacturers and tiers and automotive aftermarket markets.

The results of operations for the Transportation segment for the third quarter and year-to-date periods of 2009 and 2008 were as follows:

In the third quarter and year-to-date periods of 2009, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

Revenues declined 7.0% and 18.2% in the third quarter and year-to-date periods, respectively, due to declines in base revenues and the unfavorable effect of currency translation. Acquisition revenue partially mitigated the base revenue decrease and was primarily related to the purchase of a North American truck remanufacturing and parts/service business in the third quarter of 2008. Worldwide automotive base revenues declined 9.7% and 28.9% in the third quarter and year-to-date periods, respectively, as automotive production continued to be lower than last year, but better than the first and second quarters of 2009. North American automotive base revenues declined 14.3% and 33.6% in the third quarter and year-to-date periods, respectively, on declines of 21% and 41% in North American auto builds in the same periods. Despite the year-over-year declines, the third quarter improved as compared to the second quarter 2009 due to the “cash for clunkers” program. International automotive base revenues declined 4.7% and 24.3% for the third quarter and year-to-date periods, respectively, on declines in car builds of 7% and 21%. The automotive aftermarket businesses declined 4.5% in the third quarter and 9.2% year-to-date as a result of a continued decline in discretionary consumer spending.

Operating income decreased 17.0% and 75.1% in the third quarter and year-to-date periods of 2009, respectively, primarily due to the decline in base revenues described above, higher restructuring costs and the unfavorable effect of currency translation. In addition, a $12 million goodwill impairment charge was recorded in the third quarter of 2009 related to the North American truck remanufacturing and parts/service business. The increase in restructuring charges is primarily due to continued efforts to reduce costs in response to current economic conditions and the decline in worldwide automotive production. Total operating margins declined by 1.3% and 10.0% in the third quarter and year-to-date periods, respectively, primarily due to the decline in base revenues described above. Improvements in variable margins and overhead expenses, including favorable price versus raw material cost comparisons and benefits of prior restructuring projects, increased operating margins by 5.4% and 1.5% in the same periods.

FOOD EQUIPMENT

Businesses in this segment produce commercial food equipment and related service.

This segment primarily serves the food institutional/restaurant, service and food retail markets.

The results of operations for the Food Equipment segment for the third quarter and year-to-date periods of 2009 and 2008 were as follows:

In the third quarter and year-to-date periods of 2009, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

Revenues decreased 10.2% and 13.9% in the third quarter and year-to-date periods of 2009, respectively, primarily due to the decline in base business and the unfavorable effect of currency translation, partially offset by revenues from acquisitions. The acquired revenues were attributable to the acquisition of a European food equipment business. North American food equipment base revenues declined 8.0% and 10.0%, respectively, for the third quarter and year-to-date periods, while international food equipment base revenues declined 4.9% and 6.9% in the same periods. Base revenues for the North American institutional/restaurant businesses declined 7.9% and 13.0% in the third quarter and year-to-date periods, respectively, as customers delayed equipment purchases. Base service revenues were flat in the third quarter and declined 1.4% for the year-to-date period as customers continued to maintain existing equipment.

Operating income declined 5.1% and 19.7% in the third quarter and year-to-date periods, respectively, primarily due to the decrease in base revenues described above and the unfavorable effect of currency translation and restructuring. Total operating margins increased 0.9% in the third quarter and decreased 1.0% year-to-date primarily due to the decline in base revenues offset in the third quarter by margin gains due to favorable price versus raw material cost comparisons, favorable product mix and benefits from restructuring. For the year-to-date period, lower operating costs did not fully offset the effect of lower base revenues.

CONSTRUCTION PRODUCTS

Businesses in this segment produce tools, fasteners and other products for construction applications.

This segment primarily serves the residential construction, renovation construction and commercial construction markets.

The results of operations for the Construction Products segment for the third quarter and year-to-date periods of 2009 and 2008 were as follows:

In the third quarter and year-to-date periods of 2009, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

Revenues declined 23.3% and 30.3% in the third quarter and year-to-date periods of 2009, respectively, primarily as a result of the decline in base revenues and the unfavorable effect of currency translation. Base revenues for the North American, European and Asia-Pacific regions decreased 27.3%, 22.0% and 0.1%, respectively, during the third quarter while declining 30.8%, 27.3% and 2.3% year-to-date. These declines in base revenues were the result of ongoing weakness in the residential and commercial construction markets in North America and Europe. North American housing starts declined 32% on an annualized basis in the third quarter. In addition, U.S. commercial construction activity fell 48% year-to-date. The European and Asia-Pacific regions continued to show weakening demand, primarily in the commercial construction category.

Operating income decreased 41.7% and 73.4%, respectively, in the third quarter and year-to-date periods of 2009, primarily due to the base revenue decline described above. In addition, the unfavorable effect of currency translation and higher restructuring charges contributed to the lower income and margins. Total margins declined 3.4% and 8.2% as reduced operating expenses, including favorable price versus raw material cost comparisons and benefits from past restructuring projects, were more than offset by the effect of lower base revenues.

POLYMERS & FLUIDS

Businesses in this segment produce adhesives, sealants, lubrication and cutting fluids, and hygiene products.

This segment primarily serves the general industrial, construction, maintenance, repair and operations and automotive aftermarket markets.

The results of operations for the Polymers & Fluids segment for the third quarter and year-to-date periods of 2009 and 2008 were as follows:

In the third quarter and year-to-date periods of 2009, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:

Revenues decreased 16.8% and 9.7% in the third quarter and year-to-date periods of 2009, respectively, primarily due to lower base revenues and the unfavorable effect of currency translation partially offset by revenues from acquisitions. Acquisition revenue was primarily the result of the purchase of a pressure sensitive adhesives business and two construction adhesives businesses in 2008. Total base revenues declined 13.9% and 15.1% in the third quarter and year-to-date periods, respectively, primarily due to continued weakness in worldwide industrial production and slow recovery in MRO market demand. Worldwide base revenue for the fluids businesses declined 11.9% and 15.8% in the third quarter and year-to-date periods, respectively, while base revenues for the polymers businesses declined 16.8% and 17.3% in the same periods.

Operating income decreased 9.7% and 81.3% in the third quarter  and year-to-date periods of 2009, respectively, primarily due to the decline in base revenues, the unfavorable effect of currency translation and a $60.0 million goodwill impairment charge against the pressure sensitive adhesive business in the first quarter of 2009. Base operating margins increased 1.8% in the third quarter and declined 0.9% year-to-date as the third quarter benefited from savings from prior period restructuring projects and favorable price versus raw material cost comparisons. The first quarter 2009 goodwill impairment charge reduced year-to-date margins by 7.7%. Additionally, acquisitions had no margin affect in the third quarter and diluted margins 1.2% year-to-date.

DECORATIVE SURFACES

Businesses in this segment produce decorative surfacing materials for countertops, flooring, furniture and other applications.

This segment serves the commercial construction, renovation construction, residential construction and general industrial markets.

The results of operations for the Decorative Surfaces segment for the third quarter and year-to-date periods of 2009 and 2008 were as follows:

In the third quarter and year-to-date periods of 2009, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors: