How much of ITW's 2003 growth came from organic operations versus currency and acquisitions?

Revenue growth of 6% was attributed mainly to favorable foreign currency translation (about 6 points) and acquisitions (about 3 points), partly offset by a 2% decline in base business manufacturing revenues. Operating income growth of 8% reflected the net effect of currency (+5%), base business declines (-6% through operating leverage), and operational cost savings (+9%). Organic, constant-currency demand was therefore weak, and profit growth depended heavily on cost actions.

What is the nature of ITW's Leasing and Investments segment, and what risks does it carry?

The segment makes opportunistic investments in mortgage entities, equipment leases (telecommunications, aircraft, and air traffic control), property developments, affordable housing partnerships, and a venture capital fund. Operating income was $117 million in 2003. Key risks include the recoverability of the mortgage investments, which depend on a swap counterparty's performance and the disposition of underlying assets over ten-year terms; credit exposure on leased aircraft after the 2002 United Airlines bankruptcy; and future cash contributions to affordable housing and venture capital partnerships. The filing refers investors to the Annual Report for more detail on these estimates.

Why did total debt and the debt-to-capitalization ratio drop so sharply in 2003?

Total debt fell from $1.58 billion to $976 million. The main driver was the July 1, 2003 adoption of FIN 46, which led ITW to deconsolidate its mortgage entities; their nonrecourse notes payable no longer appear on the consolidated balance sheet. Cash also increased to $1.68 billion. Debt-to-total-capitalization was 11.0%, or 9.5% excluding the Leasing and Investments segment. ITW retained $750 million of unused U.S. debt capacity, plus a new $350 million revolving credit facility and a $400 million line of credit.

What is driving ITW's 2004 outlook, and how sensitive is it to the North American economy?

Management is 'cautiously optimistic' about gradual improvement in North American end markets. Its 2004 forecast of $3.66 to $3.96 per diluted share assumes 1% to 4% base business revenue growth, acquired revenues of $500 million to $700 million, restructuring costs of $55 million to $65 million, exchange rates held at year-end 2003 levels, and a 34% tax rate. The company flags a North American and European downturn in construction, automotive, general industrial, and food service markets as a key risk, so the outlook is sensitive to a weaker-than-expected industrial recovery.

Are there any notable legal, accounting, or governance concerns in this filing?

The legal exposure appears limited: the EPA's RCRA penalty claim is $255,000 at one Michigan facility, which ITW disputes. On accounting, the filing states that Arthur Andersen could not provide consent to reissue its January 28, 2002 audit report, so investors may be unable to pursue Section 11 claims against Andersen regarding those statements. Deloitte & Touche audited 2003 and 2002. The CEO and CFO concluded that disclosure controls were effective, and no material internal control changes were identified during the fourth quarter.

ITW 10-K FY2003 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 9, 2004. Cited figures are marked; the original filing is the authoritative source.

Illinois Tool Works (ITW) closed 2003 with record operating results: operating revenues rose 6% to $10.04 billion^a, operating income climbed 8% to $1.63 billion, and income from continuing operations reached $1.04 billion, or $3.37 per diluted share, up 11.6% from 2002.

Growth was driven mainly by favorable currency translation (about 6 points of revenue growth) and acquisitions (about 3 points), while base business manufacturing revenues fell 2%. The margin improvement came primarily from $64 million^b in restructuring-enabled cost savings under the company's 80/20 simplification process, which lifted operating margin 40 basis points to 16.3%. North American demand remained weak, with capacity utilization and capital spending still depressed.

Balance sheet strength improved materially. Total debt fell to $976 million^c from $1.58 billion, reducing the debt-to-capitalization ratio to 11.0% from 19.2%, largely because the mortgage investment entities were deconsolidated under FIN 46 on July 1, 2003. Cash and equivalents rose to $1.68 billion, and free operating cash flow was $1.17 billion.

Return on average invested capital improved to 16.1% from 15.0%. Management guided 2004 income from continuing operations to $3.66 to $3.96^d per diluted share, assuming 1% to 4% base business revenue growth, which signals cautious optimism about a gradual North American recovery. Investors should note several areas of ongoing exposure.

The Leasing and Investments segment, which contributed $117 million of operating income, carries complex, long-dated mortgage and equipment lease positions, including an aircraft lease impairment in 2002 tied to United Airlines' bankruptcy. The company's 2003 accounting change to the equity method for mortgage entities is expected to recognize $190 million of future income over the remaining transaction terms. Separately, the filing discloses that Arthur Andersen's consent to reincorporate its 2001 audit report was not obtainable, which may limit investors' Section 11 recourse for those statements.

02—Key points

Key Highlights

Operating revenues grew 6% to $10.04 billion in 2003, driven mostly by a 6% favorable currency translation effect and a 3% acquisition contribution, offset by a 2% decline in base business manufacturing revenues.
Income from continuing operations rose 11.6% to $1.04 billion ($3.37 per diluted share); operating margin improved 40 basis points to 16.3%, aided by about $64 million of restructuring-driven cost savings.
Total debt was reduced by $606 million to $976 million, and the debt-to-total-capitalization ratio fell to 11.0% from 19.2%, partly reflecting the FIN 46 deconsolidation of mortgage entities.
Free operating cash flow reached $1.17 billion, up 7% from 2002, supporting dividends of $0.94 per share (declared) and continued acquisitions of $204 million.
Return on average invested capital improved to 16.1% from 15.0%, and stockholders' equity increased to $7.87 billion, aided by $408 million of currency translation gains.
2004 guidance calls for income from continuing operations of $3.66 to $3.96 per diluted share, assuming base business revenue growth of 1% to 4% and a 34% effective tax rate.
A $256,000 EPA civil penalty claim relating to a 2002 inspection at a Michigan facility is disputed by management, and no other material legal proceedings are described.

03—Questions

Frequently Asked Questions

How much of ITW's 2003 growth came from organic operations versus currency and acquisitions?
Revenue growth of 6% was attributed mainly to favorable foreign currency translation (about 6 points) and acquisitions (about 3 points), partly offset by a 2% decline in base business manufacturing revenues. Operating income growth of 8% reflected the net effect of currency (+5%), base business declines (-6% through operating leverage), and operational cost savings (+9%). Organic, constant-currency demand was therefore weak, and profit growth depended heavily on cost actions.
What is the nature of ITW's Leasing and Investments segment, and what risks does it carry?
The segment makes opportunistic investments in mortgage entities, equipment leases (telecommunications, aircraft, and air traffic control), property developments, affordable housing partnerships, and a venture capital fund. Operating income was $117 million in 2003. Key risks include the recoverability of the mortgage investments, which depend on a swap counterparty's performance and the disposition of underlying assets over ten-year terms; credit exposure on leased aircraft after the 2002 United Airlines bankruptcy; and future cash contributions to affordable housing and venture capital partnerships. The filing refers investors to the Annual Report for more detail on these estimates.
Why did total debt and the debt-to-capitalization ratio drop so sharply in 2003?
Total debt fell from $1.58 billion to $976 million. The main driver was the July 1, 2003 adoption of FIN 46, which led ITW to deconsolidate its mortgage entities; their nonrecourse notes payable no longer appear on the consolidated balance sheet. Cash also increased to $1.68 billion. Debt-to-total-capitalization was 11.0%, or 9.5% excluding the Leasing and Investments segment. ITW retained $750 million of unused U.S. debt capacity, plus a new $350 million revolving credit facility and a $400 million line of credit.
What is driving ITW's 2004 outlook, and how sensitive is it to the North American economy?
Management is 'cautiously optimistic' about gradual improvement in North American end markets. Its 2004 forecast of $3.66 to $3.96 per diluted share assumes 1% to 4% base business revenue growth, acquired revenues of $500 million to $700 million, restructuring costs of $55 million to $65 million, exchange rates held at year-end 2003 levels, and a 34% tax rate. The company flags a North American and European downturn in construction, automotive, general industrial, and food service markets as a key risk, so the outlook is sensitive to a weaker-than-expected industrial recovery.
Are there any notable legal, accounting, or governance concerns in this filing?
The legal exposure appears limited: the EPA's RCRA penalty claim is $255,000 at one Michigan facility, which ITW disputes. On accounting, the filing states that Arthur Andersen could not provide consent to reissue its January 28, 2002 audit report, so investors may be unable to pursue Section 11 claims against Andersen regarding those statements. Deloitte & Touche audited 2003 and 2002. The CEO and CFO concluded that disclosure controls were effective, and no material internal control changes were identified during the fourth quarter.

04—Continue

← View all 10-K filings