UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________________________
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2007
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
For the transition period from _______________ to _______________
Commission File Number: 1-4797
ILLINOIS TOOL WORKS INC.
(Exact name of registrant as specified in its charter)
Delaware
36-1258310
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)
3600 West Lake Avenue, Glenview, IL
60026-1215
(Address of principal executive offices)
(Zip Code)
(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 o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated file (as defined in Rule 12b-2 of the Exchange Act).
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o
No x
The number of shares of registrant’s common stock, $.01 par value, outstanding at July 31, 2007: 552,034,685.
Part I – Financial Information
Item 1 – Financial Statements
ILLINOIS TOOL WORKS INC. and SUBSIDIARIES
FINANCIAL STATEMENTS
The unaudited financial statements included herein have been prepared by Illinois Tool Works Inc. and Subsidiaries (the “Company” or “ITW”). 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. It is suggested that these financial statements be read in conjunction with the financial statements and notes to financial statements included in the Company’s Annual Report on Form 10-K/A. Certain reclassifications of prior years data have been made to conform with current year reporting.
STATEMENT OF INCOME
(UNAUDITED)
(In thousands except for per share amounts)
Three Months Ended June 30
Six Months Ended June 30
2007
2006
Operating Revenues
$
4,159,689
3,579,470
7,918,730
6,876,506
Cost of revenues
2,675,515
2,292,821
5,124,544
4,412,495
Selling, administrative, and research
and development expenses
745,718
602,221
1,446,903
1,203,642
Amortization and impairment of
goodwill and other intangible assets
39,779
24,664
79,958
60,637
Operating Income
698,677
659,764
1,267,325
1,199,732
Interest expense
(25,606
)
(19,009
(50,008
(37,906
Other income
44,135
25,699
70,724
35,858
Income Before Taxes
717,206
666,454
1,288,041
1,197,684
Income Taxes
211,600
200,600
380,000
365,300
Net Income
505,606
465,854
908,041
832,384
Net Income Per Share:
Basic
$0.91
$0.82
$1.63
$1.47
Diluted
$0.90
$0.81
$1.61
$1.46
Cash Dividends:
Paid
$0.21
$0.165
$0.42
$0.33
Declared
Shares of Common Stock Outstanding During the Period:
Average
556,793
567,446
558,022
565,462
Average assuming dilution
561,244
571,954
562,388
569,808
STATEMENT OF FINANCIAL POSITION
(In thousands)
June 30, 2007
December 31, 2006
ASSETS
Current Assets:
Cash and equivalents
481,508
590,207
Trade receivables
2,882,698
2,471,273
Inventories
1,612,380
1,482,508
Deferred income taxes
213,905
196,860
Prepaid expenses and other current assets
463,792
465,557
Total current assets
5,654,283
5,206,405
Plant and Equipment:
Land
209,374
193,328
Buildings and improvements
1,414,465
1,374,926
Machinery and equipment
3,694,081
3,594,057
Equipment leased to others
147,615
149,682
Construction in progress
115,275
96,853
5,580,810
5,408,846
Accumulated depreciation
(3,463,982
(3,355,389
Net plant and equipment
2,116,828
2,053,457
Investments
560,667
595,083
Goodwill
4,183,793
4,025,053
Intangible Assets
1,225,320
1,113,634
Deferred Income Taxes
132,978
116,245
Other Assets
762,531
770,562
14,636,400
13,880,439
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Short-term debt
528,096
462,721
Accounts payable
805,983
707,656
Accrued expenses
1,192,528
1,187,526
Cash dividends payable
115,874
117,337
Income taxes payable
177,671
161,344
Total current liabilities
2,820,152
2,636,584
Noncurrent Liabilities:
Long-term debt
956,578
955,610
285,668
259,159
Other
1,185,546
1,011,578
Total noncurrent liabilities
2,427,792
2,226,347
Stockholders’ Equity:
Common stock
5,612
6,309
Additional paid-in-capital
106,908
1,378,587
Income reinvested in the business
9,217,978
10,406,511
Common stock held in treasury
(479,873
(3,220,538
Accumulated other comprehensive income
537,831
446,639
Total stockholders’ equity
9,388,456
9,017,508
STATEMENT OF CASH FLOWS
Cash Provided by (Used for) Operating Activities:
Net income
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation
174,798
150,859
Amortization and impairment of goodwill and other intangible assets
Change in deferred income taxes
(28,723
43,646
Provision for uncollectible accounts
5,346
7,202
(Gain) loss on sale of plant and equipment
1,019
(705
Income from investments
(28,223
(36,559
(Gain) loss on sale of operations and affiliates
(35,441
3,429
Stock compensation expense
15,045
19,777
Other non-cash items, net
(7,777
3,021
Changes in assets and liabilities:
(Increase) decrease in--
(192,151
(147,236
(72,766
(90,841
Prepaid expenses and other assets
(41,260
9,861
Increase (decrease) in--
(10,118
42,406
Accrued expenses and other liabilities
(38,475
(14,743
Income taxes receivable and payable
223,385
(132,250
Other, net
1,799
2,104
Net cash provided by operating activities
954,457
752,992
Cash Provided by (Used for) Investing Activities:
Acquisition of businesses (excluding cash and equivalents)
(424,420
(281,479
Additions to plant and equipment
(174,329
(144,994
Purchase of investments
(7,538
(3,809
Proceeds from investments
24,872
18,549
Proceeds from sale of plant and equipment
8,712
7,106
Proceeds from sale of operations and affiliates
149,760
12,901
(68
9,078
Net cash used for investing activities
(423,011
(382,648
Cash Provided by (Used for) Financing Activities:
Cash dividends paid
(234,248
(186,183
Issuance of common stock
77,101
63,007
Repurchases of common stock
—
Net proceeds (repayments) from short-term debt
12,628
(157,843
Proceeds from long-term debt
22
179
Repayments of long-term debt
(9,728
(6,246
Excess tax benefits from share-based compensation
9,886
10,552
Repayment of preferred stock of subsidiary
(40,000
Net cash used for financing activities
(664,212
(276,534
Effect of Exchange Rate Changes on Cash and Equivalents
24,067
(5,041
Cash and Equivalents:
Increase (decrease) during the period
(108,699
88,769
Beginning of period
370,417
End of period
459,186
Cash Paid During the Period for Interest
81,579
37,633
Cash Paid During the Period for Income Taxes
170,413
446,983
Liabilities Assumed from Acquisitions
331,275
148,231
NOTES TO FINANCIAL STATEMENTS
(1)
COMPREHENSIVE INCOME
The Company’s components of comprehensive income in the periods presented are:
Foreign currency translation adjustments
99,114
116,726
76,244
145,144
Amortization of unrecognized pension and
postretirement expense
4,468
14,948
Total comprehensive income
609,188
582,580
999,233
977,528
(2)
INVENTORIES
Inventories at June 30, 2007 and December 31, 2006 were as follows:
Raw material
520,905
470,032
Work-in-process
169,080
166,946
Finished goods
922,395
845,530
(3)
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 or intangible assets that have indefinite lives. In the first quarter of each year, 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.
As of January 1, 2007, the Company had assigned its recorded goodwill and intangible assets to approximately 440 of its 750 reporting units. When performing its annual impairment assessment, the Company compares the fair value of each reporting unit to its carrying value. Fair values are determined by discounting estimated future cash flows at the Company’s estimated cost of capital of 10%. Estimated future cash flows are based either on current operating cash flows or on a detailed cash flow forecast prepared by the relevant operating unit. If the fair value of an operating unit is less than its carrying value, an impairment loss is recorded for the difference between the implied fair value of the unit’s goodwill and the carrying value of the goodwill.
Amortization and impairment of goodwill and other intangible assets for the periods ended June 30, 2007 and 2006 were as follows:
Goodwill:
Impairment
988
9,200
Intangible Assets:
Amortization
77,804
48,452
1,166
2,985
Total
In the first quarter of 2007, the Company performed its annual impairment testing of its goodwill and intangible assets, which resulted in total impairment charges of $2,154,000. The first quarter 2007 goodwill impairment charges of $988,000 were primarily related to a French polymers business and an Asian construction business in the Engineered Products – International segment and resulted from lower estimated future cash flows than previously expected. Also in the first quarter of 2007, intangible asset impairments of $1,166,000 were recorded to reduce to the estimated fair value the carrying value of trademarks and customer-related intangible assets primarily related to a French polymers business in the Engineered Products – International segment and a U.S. contamination control business in the Engineered Products – North America segment.
In the first quarter of 2006, the Company recorded goodwill impairment charges of $9,200,000 which were primarily related to a U.S. construction joist business in the Engineered Products – North America segment, a U.S. thermal transfer ribbon business in the Specialty Systems – North America segment, and an Asian construction business in the Engineered Products – International segment, and resulted from lower estimated future cash flows than previously expected. Also in the first quarter of 2006, intangible asset impairments of $2,985,000 were recorded to reduce to the estimated fair value the carrying value of trademarks, patents and customer-related intangible assets primarily related to a U.S. welding components business in the Specialty Systems – North America segment and a U.S. contamination control business in the Engineered Products – North America segment.
(4)
RETIREMENT PLANS AND POSTRETIREMENT BENEFITS
Pension and other postretirement benefit costs for the periods ended June 30, 2007 and 2006 were as follows:
Three Months Ended
June 30
Six Months Ended
Pension
Other Postretirement Benefits
Components of net periodic benefit cost:
Service cost
28,698
26,734
3,782
4,186
57,365
53,404
7,564
8,373
Interest cost
26,548
24,165
8,058
8,225
52,962
48,161
16,116
16,449
Expected return on plan
assets
(38,856
(34,360
(2,899
(1,997
(77,575
(68,545
(5,797
(3,992
Amortization of actuarial loss
5,086
6,319
506
1,292
9,983
12,593
1,011
22,281
Amortization of prior service
cost (income)
(586
(565
1,565
1,392
(1,174
(1,132
3,130
2,783
Amortization of net transition
amount
4
16
10
32
Curtailment/settlement loss
(gain)
262
(1,562
6,000
Net periodic benefit cost
21,156
22,309
9,450
13,098
47,571
44,513
20,462
45,894
The Company expects to contribute $82,400,000 to its pension plans in 2007. As of June 30, 2007, contributions of $62,400,000 have been made.
(5)
SHORT-TERM DEBT
In June 2006, the Company entered into a $600,000,000 Line of Credit Agreement with a termination date of June 15, 2007. This line of credit was replaced on June 15, 2007, by a $1,000,000,000 Line of Credit Agreement with a termination date of June 13, 2008. No amounts were outstanding under this facility at June 30, 2007.
The Company had outstanding commercial paper of $393,940,000 at June 30, 2007 and $200,340,000 at December 31, 2006.
(6)
LONG-TERM DEBT
In June 2006, the Company entered into a $350,000,000 revolving credit facility (“RCF”) with a termination date of June 16, 2011. This RCF was replaced on June 15, 2007 by a $500,000,000 RCF with a termination date of June 15, 2012. No amounts were outstanding under this facility at June 30, 2007.
(7)
INCOME TAXES
On January 1, 2007, the Company adopted Financial Accounting Standard Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in tax returns, and provides guidance on derecognition, classification, and interest and penalties, related to uncertain tax positions. As a result of implementation of FIN 48, the Company did not recognize any change in its liability for unrecognized tax benefits.
As of the adoption date, the Company had $688,000,000 of unrecognized tax benefits. If these unrecognized tax benefits were recognized, approximately $593,000,000 would impact the Company's effective tax rate. There has been no significant change to the amount of unrecognized tax benefits during the six months ended June 30, 2007. The Company does not expect the total amount of uncertain tax provisions as of June 30, 2007 to change significantly in the next twelve months.
The Company files numerous consolidated and separate income tax returns in the United States Federal jurisdiction and in many state and foreign jurisdictions. The following table summarizes the open tax years for the Company’s major jurisdictions:
Jurisdiction
Open Tax Years
United States – Federal
2001-2006
United Kingdom
2000-2006
Germany
France
Australia
2002-2006
The Company recognizes interest and penalties related to income tax matters in income tax expense. There were no significant accruals for interest and penalties recorded as of January 1, 2007.
(8)
LEVERAGED LEASES
On January 1, 2007, the Company adopted FASB Staff Position No. FAS 13-2, Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction (“FSP 13-2”). FSP 13-2 addresses how a change or projected change in the timing of cash flows relating to income taxes generated by a leveraged lease transaction affects the accounting by a lessor for that lease. Upon adoption of FSP 13-2, the Company recorded an after-tax charge to retained earnings of $22,600,000, resulting from a change in the timing of expected cash flows related to income tax benefits of the Company's leveraged lease transactions.
(9) STOCKHOLDERS' EQUITY
On August 4, 2006 the Company's Board of Directors authorized a stock repurchase program which provided for the buyback of up to 35,000,000 shares. In the first six months of 2007, the Company repurchased 9,464,419 shares of its common stock at an average price of $50.70 per share. On February 9, 2007, the Company retired 72,151,184 shares of Common Stock Held in Treasury. Common Stock, Additional Paid-In-Capital, Income Reinvested in the Business and Common Stock Held in Treasury activity during the first six months of 2007 are shown below:
Common Stock
Additional Paid-In-Capital
Income Reinvested in the Business
Common Stock Held in Treasury
Balance, December 31, 2006
During 2007
Retirement of treasury shares
(721
(1,378,587
(1,841,230
3,220,538
Shares issued for stock options and grants
24
77,184
Shares surrendered on exercise of stock options
(108
Tax benefits related to stock options
14,787
Cash dividends declared
(232,785
Cumulative effect of adopting FSP 13-2
(22,559
Balance, June 30, 2007
(10)
SEGMENT INFORMATION
See Management’s Discussion and Analysis for information regarding operating revenues and operating income for the Company’s segments.
Item 2 - Management’s Discussion and Analysis
CONSOLIDATED RESULTS OF OPERATIONS
The Company’s consolidated results of operations for the second quarter and year-to-date periods of 2007 and 2006 were as follows:
(Dollars in thousands)
Operating revenues
Operating income
Margin %
16.8
%
18.4
16.0
17.4
In the second quarter and year-to-date periods of 2007, the changes in revenues, operating income and operating margins over the prior year were primarily due to the following factors:
% Increase (Decrease)
% Point Increase (Decrease)
Operating Margins
Base manufacturing business:
Revenue change/Operating
leverage
2.4
5.2
0.5
1.7
4.0
0.4
Changes in variable margins and
overhead costs
(1.8
(0.3
(1.1
(0.2
3.4
0.2
2.9
Acquisitions
12.0
(1.7
11.4
0.9
(1.6
Divestitures
(1.3
(0.8
0.1
(0.9
(0.5
Restructuring costs
(1.5
(1.4
Impairment of goodwill and
intangibles
0.8
Translation
3.6
3.1
2.8
Intercompany/Other
(0.4
16.2
5.9
)%
15.2
5.6
In the second quarter and year-to-date period of 2007 revenues increased 16.2% and 15.2%, respectively, over 2006 primarily due to revenues from acquisitions and favorable currency translation. Base business revenues increased 2.4% and 1.7% in the second quarter and year-to-date periods, respectively, over the same periods of 2006 primarily related to an 8.0% and 8.4% increase in international base business revenues for the second quarter and year-to-date periods, respectively. These increases were offset by a 1.4% and 2.5 % decline in North American base revenues in the second quarter and the year-to-date periods, respectively. European economic strength and market demand continued the growth seen in last half of 2006. North American base revenues declined, although at a lower rate than first quarter 2007, due to weak industrial production and slow demand throughout the North American end markets, primarily automotive and construction.
Operating income in the second quarter and year-to-date period improved over 2006 primarily due to leverage from the growth in base business revenues, favorable currency translation versus the prior year and the effect of acquisitions, partially offset by increased restructuring expenses and the effect of divestitures. Operating margins were negatively affected by lower margins of acquired businesses, including amortization expense.
ENGINEERED PRODUCTS - NORTH AMERICA
Businesses in this segment are located in North America and manufacture a variety of short lead-time plastic and metal components and fasteners, as well as specialty products for a diverse customer base. These commercially oriented, value-added products become part of the customers’ products and typically are manufactured and delivered in a time period less than 30 days.
In the plastic and metal components and fasteners category, products include:
•
metal fasteners and fastening tools for the commercial, residential and renovation construction industries;
metal plate connecting components, machines and software for the commercial and residential construction industries;
laminate products for the commercial, residential and renovation construction industries and furniture markets;
metal fasteners for automotive, appliance and general industrial applications;
metal components for automotive, appliance and general industrial applications;
plastic components for automotive, appliance, furniture, electronics and general industrial applications; and
plastic fasteners for automotive, appliance, electronics and general industrial applications.
In the specialty products category, products include:
reclosable packaging for consumer food and storage applications;
hand wipes and cleaners for use in industrial manufacturing locations;
chemical fluids which clean or add lubrication to machines and automobiles;
adhesives for industrial, construction and consumer purposes;
epoxy and resin-based coating products for industrial applications;
components for industrial machines;
automotive aftermarket maintenance and appearance products; and
swabs, wipes and mats for clean room usage in the electronics and pharmaceutical industries.
This segment primarily serves the construction, automotive and consumer durables markets.
The results of operations for the Engineered Products – North America segment for the second quarter and year-to-date periods of 2007 and 2006 were as follows:
1,088,908
1,091,673
2,115,573
2,122,011
194,475
209,723
347,767
383,001
17.9
19.2
16.4
18.0
(3.3
(7.0
(0.7
(4.8
(11.0
(1.2
(0.6
(0.1
1.4
0.3
(7.6
(9.6
3.5
1.5
5.1
1.1
Translation/Other
(7.3
(9.2
Revenues decreased modestly in both the second quarter and year-to-date periods of 2007 versus 2006 primarily due to a decline in base business revenues and the effect of divestitures, mostly offset by revenues from acquisitions. Acquisition revenue was primarily related to the acquisition of an electronic switches business and a specialty wipes business. In the fourth quarter of 2006, a roofing components business was divested. In the second quarter and year-to-date periods, construction base revenues declined 5.4% and 7.8%, respectively, due to declines in the residential construction market. Automotive base revenues decreased 3.6% and 5.3%, respectively, primarily due to a 7% and 9% decline in automotive production at the Detroit 3 automotive manufacturers in the second quarter and year-to-date periods. Base revenues from the other industrial-based businesses in this segment declined 0.7% and 1.0% in the second quarter and year-to-date periods, respectively, primarily due to declines in the strength films, and industrial plastics and metals businesses, partially offset by revenue increases in the polymers and fluids businesses in both periods.
Operating income decreased in the second quarter of 2007 and year-to-date period primarily due to the decline in base business revenues described above and higher restructuring expenses. The decrease for the year-to-date period was partially offset by lower first quarter 2007 goodwill and intangible impairment charges. Variable margins increased 30 basis points for both the second quarter and year-to-date period mainly due to expense management in the automotive, construction, and polymers businesses and the benefits of 2006 restructuring projects. Base overhead expenses increased 40 basis points in the second quarter due to increased selling and advertising expenses in the laminate business as a result of new product launches. Year-to-date overhead expenses are flat as increased selling and advertising costs were offset by the positive 2007 effect of a first quarter 2006 charge of $9.8 million related to retiree healthcare and life insurance liabilities.
ENGINEERED PRODUCTS - INTERNATIONAL
Businesses in this segment are located outside North America and manufacture a variety of short lead-time plastic and metal components and fasteners, as well as specialty products for a diverse customer base. These commercially oriented, value-added products become part of the customers’ products and typically are manufactured and delivered in a time period less than 30 days.
metal plate connecting components and software for the commercial and residential construction markets;
plastic components for automotive, appliance, electronics and general industrial applications; and
reclosable packaging for consumer food applications;
electronic component packaging trays used for the storage, shipment and manufacturing insertion of electronic components and microchips;
The results of operations for the Engineered Products – International segment for the second quarter and year-to-date periods of 2007 and 2006 were as follows:
976,744
736,567
1,809,829
1,360,888
148,039
110,466
245,579
186,298
15.0
13.6
13.7
7.2
19.3
7.6
22.3
1.9
(5.5
(8.5
13.8
16.1
9.4
16.6
9.3
10.5
9.0
10.2
32.6
34.0
33.0
31.8
Revenues increased in the second quarter and year-to-date periods of 2007 due to revenues from acquisitions, the favorable effect of currency translation and growth in base business revenues. Base business construction revenues increased 9.9% and 11.0% in the second quarter and year-to date periods, respectively, due to strong demand across the European and Asia-Pacific markets. Automotive base business revenues increased 5.4% and 3.2% in the second quarter and year-to-date periods, respectively, due to a 3% and 4% increase in auto production, respectively. Base revenues from the other businesses in this segment increased 3.9% and 5.4% in the second quarter and year-to-date periods, respectively, as they benefited from strong demand in the broad array of industrial and commercial end markets that they serve. Acquisition revenue was primarily related to the acquisitions of a European laminate business, one Korean and one European automotive business, and two European performance polymers businesses.
Operating income increased in the second quarter and year-to-date periods of 2007 versus 2006 primarily due to the positive leverage effect from the increase in base revenues described above, the favorable effect of currency translation and income from acquisitions. Variable margins declined 70 basis points and 90 basis points in the second quarter and year-to-date periods, respectively, mainly due to increased raw material costs. Operating margins were negatively affected by the lower margins of acquired businesses.
SPECIALTY SYSTEMS - NORTH AMERICA
Businesses in this segment are located in North America and design and manufacture longer lead-time machinery and related consumables, as well as specialty equipment for a diverse customer base. These commercially oriented, value-added products become part of the customers’ processes and typically are manufactured and delivered in a time period of more than 30 days.
In the machinery and related consumables category, products include:
industrial packaging equipment and plastic and steel strapping for the bundling and shipment of a variety of products for customers in numerous end markets;
welding equipment, metal consumables and related accessories for a variety of end market users;
equipment and plastic consumables that multi-pack cans and bottles for the food and beverage industry;
plastic stretch film and related packaging equipment for various industrial purposes;
paper and plastic products used to protect shipments of goods in transit;
marking tools and inks for various end users;
foil and film and related equipment used to decorate a variety of consumer products; and
solder materials, services and equipment for the electronic and microelectronic assembly industry.
In the specialty equipment and systems category, products include:
commercial food equipment such as dishwashers, refrigerators, cooking equipment and food machines for use by
restaurants, institutions and supermarkets and related service;
paint spray equipment for a variety of general industrial applications;
materials and structural testing machinery and software;
static control equipment for electronics and industrial applications;
airport ground power generators for commercial and military applications; and
supply chain management software for the industrial, aerospace and health care markets.
This segment primarily serves the general industrial, food institutional and service, maintenance, repair and operations (“MRO”)/metals, and food and beverage markets.
The results of operations for the Specialty Systems – North America segment for the second quarter and year-to-date periods of 2007 and 2006 were as follows:
1,253,535
1,134,457
2,475,904
2,258,543
238,268
232,289
462,383
454,223
19.0
20.5
18.7
20.1
2.0
2.1
1.6
11.7
1.3
(1.9
10.8
(2.1
(1.0
2.6
9.6
1.8
Revenues increased in the second quarter and year-to-date periods of 2007 over 2006 primarily due to revenues from acquisitions. The acquired revenues were primarily related to the acquisition of two businesses supplying the electronic and microelectronic assembly industry, a supply chain management software business, two test and measurement businesses and two decorating businesses. The quality measurement business was divested during the second quarter of 2007. Base business revenues increased slightly in the second quarter of 2007 but remained negative for the year-to-date period primarily due to decreased demand for machinery and consumables in many of the end markets that this segment serves. Food equipment base revenues increased 6.9% in the second quarter and 4.9% year-to-date due to growth in the restaurant and institutional sector as well as the service business. Welding base revenues increased 3.0% and 5.1% in the second quarter and year-to-date periods, respectively, due to higher demand in energy-related end markets. Total packaging base revenues declined 4.5% and 5.7% in the second quarter and year-to-date periods, respectively, due to weakness in the metals and construction-related industrial packaging categories in North America. Base business revenue from the other businesses in this segment, including the decorating and finishing businesses, decreased 2.0% and 4.1% for the second quarter and year-to date periods, respectively.
Operating income increased in the second quarter and year-to-date periods of 2007 versus 2006 primarily due to decreased overhead costs, including the favorable first quarter 2007 impact of a $9.8 million charge related to retiree health care and life insurance liabilities incurred in the first quarter of 2006 offset by higher restructuring expenses and the effect of divestitures. Year-to-date operating income was also favorably effected by lower impairment charges. Acquisitions favorably impacted income in the second quarter and had a negative effect year-to-date.
SPECIALTY SYSTEMS - INTERNATIONAL
Businesses in this segment are located outside North America and design and manufacture longer lead-time machinery and related consumables, as well as specialty equipment for a diverse customer base. These commercially oriented, value-added products become part of the customers’ processes and typically are manufactured and delivered in a time period of more than 30 days.
welding equipment and metal consumables for a variety of end market users;
In the specialty equipment category, products include:
commercial food equipment such as dishwashers, refrigerators and cooking equipment for use by restaurants, institutions and supermarkets and related service;
static control equipment for electronics and industrial applications; and
airport ground power generators for commercial applications.
This segment primarily serves the general industrial, food institutional and retail, food and beverage, and MRO/metals markets.
The results of operations for the Specialty Systems – International segment for the second quarter and year-to-date periods of 2007 and 2006 were as follows:
960,369
719,641
1,743,800
1,335,340
117,895
107,284
211,596
176,210
12.3
14.9
12.1
13.2
8.8
23.1
9.1
27.1
2.2
(8.0
(5.1
15.1
22.0
19.6
(4.9
(2.9
15.5
(3.0
(2.0
(2.8
(2.2
(6.1
7.9
8.0
8.3
33.5
9.9
(2.6
30.6
Revenues increased in the second quarter and year-to-date periods of 2007 versus 2006 primarily due to revenues from acquired companies, base business revenue growth and the favorable effect of currency translation. The revenue contribution from acquired businesses was primarily related to the acquisition of a European food equipment business, two worldwide businesses supplying the electronic and microelectronic assembly industry, and two European test and measurement businesses. Food equipment base revenues increased 8.8% and 8.3% in the second quarter and year-to-date periods, respectively, due primarily to growth in European institutional demand. Total packaging base revenue increased 6.7% and 6.8% during the second quarter and year-to-date periods, respectively, with strong demand in the European and Asia-Pacific industrial packaging businesses. Other base business revenues, including the welding and finishing businesses, increased 11.2% and 12.0% in the second quarter and year-to-date periods, respectively, led by strong welding equipment and consumable sales in Europe and Asia.
Operating income increased in the second quarter and year-to-date periods of 2007 versus 2006 primarily due to leverage from the revenue increases described above and the favorable effect of currency translation. These increases were partially offset in both periods by increased restructuring costs, the effect of acquisitions, and the effect of the divestiture of the sleeve label business in the first quarter of 2007. Base variable margin decreased 50 basis points in the second quarter and year-to-date 2007 periods primarily due to increased raw material costs. Operating margins were negatively effected by the lower margins of acquired businesses.
OPERATING REVENUES
The reconciliation of segment operating revenues to total operating revenues is as follows:
Engineered Products - North America
Engineered Products – International
Specialty Systems - North America
Specialty Systems – International
Intersegment revenues
(119,867
(102,868
(226,376
(200,276
Total operating revenues
AMORTIZATION AND IMPAIRMENT OF GOODWILL AND INTANGIBLE ASSETS
The Company does not amortize goodwill and intangible assets that have indefinite lives. In the first quarter of each year, 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 the first quarter of 2007, the Company performed its annual impairment testing of its goodwill and intangible assets, which resulted in total impairment charges of $2.2 million. The first quarter 2007 goodwill impairment charges of $1.0 million were primarily related to a French polymers business and an Asian construction business in the Engineered Products – International segment and resulted from lower estimated future cash flows than previously expected. Also in the first quarter of 2007, intangible asset impairments of $1.2 million were recorded to reduce to the estimated fair value the carrying value of trademarks and customer-related intangible assets primarily related to a French polymers business in the Engineered Products – International segment and a U.S. contamination control business in the Engineered Products – North America segment.
In the first quarter of 2006, the Company recorded goodwill impairment charges of $9.2 million which were primarily related to a U.S. construction joist business in the Engineered Products – North America segment, a U.S. thermal transfer ribbon business in the Specialty Systems – North America segment, and an Asian construction business in the Engineered Products – International segment, and resulted from lower estimated future cash flows than previously expected. Also in the first quarter of 2006, intangible asset impairments of $3.0 million were recorded to reduce to the estimated fair value the carrying value of trademarks, patents and customer-related intangible assets primarily related to a U.S. welding components business in the Specialty Systems – North America segment and a U.S. contamination control business in the Engineered Products – North America segment.
INTEREST EXPENSE
Interest expense increased to $50.0 million in the first six months of 2007 from $37.9 million in 2006 primarily due to a higher amount of commercial paper outstanding in the first six months of 2007.
OTHER INCOME
Other income increased to $70.7 million for the first six months of 2007 versus income of $35.9 million in 2006, primarily due to gains on divestitures in 2007 versus losses in 2006. These amounts are partially offset by lower investment income in 2007, primarily due to the liquidation of the Company’s mortgage transactions in the fourth quarter of 2006.
The effective tax rate for the first six months of 2007 was 29.5%, 100 basis points lower than the effective rate for the first six months of 2006. The reduction in the effective tax rate in 2007 resulted primarily from an increase in the domestic manufacturing deduction and a higher proportionate share of income in foreign jurisdictions with lower tax rates.
NET INCOME
Net income of $908.0 million ($1.61 per diluted share) in the first six months of 2007 was 9.1% higher than the 2006 net income of $832.4 million ($1.46 per diluted share).
FOREIGN CURRENCY
The weakening of the U.S. dollar against foreign currencies in 2007 increased operating revenues for the first six months of 2007 by approximately $228.1 million and increased earnings by approximately 5 cents per diluted share. The strengthening of the U.S. dollar against foreign currencies in 2006 decreased operating revenues for the first six months of 2006 by approximately $120.0 million and decreased earnings by approximately 2 cents per diluted share.
NEW ACCOUNTING PRONOUNCEMENTS
On January 1, 2007, the Company adopted Financial Accounting Standard Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in tax returns, and provides guidance on derecognition, classification, and interest and penalties, related to uncertain tax positions. As a result of implementation of FIN 48, the Company did not recognize any change in its liability for unrecognized tax benefits. See the income taxes note for additional information.
On January 1, 2007, the Company adopted FASB Staff Position No. FAS 13-2, Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction (“FSP 13-2”). FSP 13-2 addresses how a change or projected change in the timing of cash flows relating to income taxes generated by a leveraged lease transaction affects the accounting by a lessor for that lease. Upon adoption of FSP 13-2, the Company recorded an after-tax charge to retained earnings of $22.6 million, resulting from a change in the timing of expected cash flows related to income tax benefits of the Company's leveraged lease transactions.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow
The Company’s primary source of liquidity is free operating cash flow. Management continues to believe that such internally generated cash flow will be adequate to service existing debt and to continue to pay dividends that meet its dividend payout guideline of 25% to 35% of the last two years’ average net income. In addition, free operating cash flow is expected to be adequate to finance internal growth, acquisitions and share repurchases.
The Company uses free operating cash flow to measure normal cash flow generated by its operations that is available for dividends, acquisitions, share repurchases and debt repayment. Free operating cash flow is a measurement that is not the same as net cash flow from operating activities per the statement of cash flows and may not be consistent with similarly titled measures used by other companies.
On August 4, 2006, the Company’s Board of Directors authorized a stock repurchase program which provides for the buyback of up to 35.0 million shares. In the second quarter of 2007, the Company repurchased 5,787,278 shares of its common stock at an average price of $51.84 per share. Since inception of this program, the Company has repurchased 19,145,150 shares of its common stock for $926.7 million at an average price of $48.41 per share.
Summarized cash flow information for the second quarter and year-to-date periods of 2007 and 2006 was as follows:
531,638
361,607
(89,038
(76,675
Free operating cash flow
442,600
284,932
780,128
607,998
(155,338
(82,482
(116,911
(93,563
58,021
377
26,098
21,000
(300,000
Net proceeds (repayments) of debt
(86,293
(139,940
2,922
(163,910
38,756
14,392
59,931
36,435
Net increase (decrease) in cash and equivalents
(93,067
4,716
Return on Average Invested Capital
The Company uses return on average invested capital (“ROIC”) to measure the effectiveness of its operations’ use of invested capital to generate profits. ROIC for the second quarter and year-to-date periods of 2007 and 2006 was as follows:
Operating income after taxes
492,567
461,175
893,464
833,814
Invested Capital:
2,374,172
1,370,047
1,916,032
907,515
Goodwill and intangible assets
5,409,113
3,997,555
Accounts payable and accrued expenses
(1,998,511
(1,694,839
(191,553
316,107
Total invested capital
10,391,622
9,186,589
Average invested capital
10,253,622
8,994,013
10,117,625
8,791,908
Annualized return on average invested capital
17.7
The 130 basis point decrease in ROIC in the second quarter of 2007 was due primarily to a 14.0% increase in average invested capital, mainly from acquisitions. The negative impact of acquisitions was partially offset by a 6.8% increase in after-tax operating income primarily due to an increase in base business operating income, translation, and a decrease in the effective tax rate.
The 130 basis point decrease in ROIC for year-to-date 2007 was due primarily to a 15.1% increase in average invested capital, mainly from acquisitions. The negative impact of acquisitions was partially offset by a 7.2% increase in after-tax operating income primarily due to an increase in base business operating income, translation, and a decrease in the effective tax rate.
Working Capital
Net working capital at June 30, 2007 and December 31, 2006 is summarized as follows:
Increase/(Decrease)
411,425
129,872
677,697
662,417
15,280
447,878
65,375
1,998,511
1,895,182
103,329
293,545
278,681
14,864
183,568
Net Working Capital
2,834,131
2,569,821
264,310
Current Ratio
2.00
1.97
Trade receivables and inventories increased due to increased sales, acquisitions and foreign currency translation. Accounts payable increased primarily due to acquisitions.
Debt
Total debt at June 30, 2007 and December 31, 2006 was as follows:
Total debt
1,484,674
1,418,331
Total debt to capitalization
The Company had outstanding commercial paper of $393.9 million at June 30, 2007 and $200.3 million at December 31, 2006.
In June 2006, the Company entered into a $600,000,000 Line of Credit Agreement with a termination date of June 15, 2007. This line of credit was replaced on June 15, 2007 by a $1,000,000,000 Line of Credit Agreement with a termination date of June 13, 2008. No amounts were outstanding under this facility at June 30, 2007.
Stockholders’ Equity
The changes to stockholders’ equity during 2007 were as follows:
Total stockholders’ equity, December 31, 2006
Stock option activity
106,932
Amortization of unrecognized pension and postretirement expense
Currency translation adjustments
Cumulative effect of adopting FSP13-2
Total stockholders’ equity, June 30, 2007
FORWARD-LOOKING STATEMENTS
This document contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including, without limitation, statements regarding 2007 contributions to the Company’s pension plans, the adequacy of internally generated funds, the meeting of dividend payout objectives, the impact of new accounting pronouncements and the estimated amount of unrecognized tax benefits. These statements are subject to certain risks, uncertainties, and other factors, which could cause actual results to differ materially from those anticipated. Important risks that may influence future results include (1) a downturn in the construction, general industrial, automotive, or food institutional and service markets, (2) deterioration in international and domestic business and economic conditions, particularly in North America, Europe, Asia or Australia, (3) the unfavorable impact of foreign currency fluctuations and costs of raw materials, (4) an interruption in, or reduction in, introducing new products into the Company’s product lines, (5) an unfavorable environment for making acquisitions, domestic and international, including adverse accounting or regulatory requirements and market values of candidates, and (6) unfavorable tax law changes and tax authority rulings. The risks covered here are not all inclusive and given these and other possible risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.
ITW practices fair disclosure for all interested parties. Investors should be aware that while ITW regularly communicates with securities analysts and other investment professionals, it is against ITW’s policy to disclose to them any material non-public information or other confidential commercial information. Shareholders should not assume that ITW agrees with any statement or report issued by any analyst irrespective of the content of the statement or report.
Item 4 – Controls and Procedures
The Company’s management, with the participation of the Company’s Chairman & Chief Executive Officer and Senior Vice President & Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a–15(e)) as of June 30, 2007. Based on such evaluation, the Company’s Chairman & Chief Executive Officer and Senior Vice President & Chief Financial Officer, have concluded that, as of June 30, 2007, the Company’s disclosure controls and procedures were effective in timely alerting the Company’s management to all information required to be included in this Form 10-Q and other Exchange Act filings.
In connection with the evaluation by management, including the Company’s Chairman & Chief Executive Officer and Senior Vice President & Chief Financial Officer, no changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the quarter ended June 30, 2007 were identified that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.
Part II – Other Information
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
On August 4, 2006, the Company's Board of Directors authorized a stock repurchase program, which provides for the buyback of up to 35,000,000 shares of common stock.
Share repurchase activity under this program for the second quarter was as follows:
Period
Total Number of Shares Purchased
Average Price Paid Per Share
Total Number of Shares Purchased as part of Publicly Announced Program
Maximum Number that may yet be Purchased Under Program
June 2007
5,787,278
$51.84
15,854,850
Item 4 – Submission of Matters to a Vote of Security Holders
The Company’s Annual Meeting of Stockholders was held on May 4, 2007. The following members were elected to the Company’s Board of Directors to hold office for the ensuing year:
Nominees
In Favor
Withheld
W. F. Aldinger
497,011,259
10,123,579
M. J. Birck
499,580,809
7,554,029
M. D. Brailsford
488,570,823
18,564,015
S. Crown
499,484,869
7,649,969
D. H. Davis, Jr.
501,234,376
5,900,462
R. C. McCormack
485,727,052
21,407,786
R. S. Morrison
503,031,409
4,103,429
J. A. Skinner
498,326,924
8,807,914
H. B. Smith
501,830,642
5,304,196
D. B. Speer
499,627,812
7,507,026
The appointment of Deloitte & Touche LLP as the Company’s independent public accountants was ratified with 494,919,218 votes in favor, 9,703,039 votes against, and 2,512,582 votes abstained.
Item 6 – Exhibits
Exhibit Index
Exhibit No.
Description
31
Rule 13a-14(a) Certification.
Section 1350 Certification.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: August 3, 2007
By: /s/ Ronald D. Kropp
Ronald D. Kropp
Senior Vice President & Chief Financial Officer
(Principal Accounting & Financial Officer)