QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
September 30, 2019
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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)
155 Harlem Avenue
Glenview
IL
60025
(Address of principal executive offices)
(Zip Code)
(Registrant’s telephone number, including area code)847-724-7500
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on Which Registered
Common Stock
ITW
New York Stock Exchange
1.75% Euro Notes due 2022
ITW22
New York Stock Exchange
1.25% Euro Notes due 2023
ITW23
New York Stock Exchange
0.250% Euro Notes due 2024
ITW24A
New York Stock Exchange
0.625% Euro Notes due 2027
ITW27
New York Stock Exchange
2.125% Euro Notes due 2030
ITW30
New York Stock Exchange
1.00% Euro Notes due 2031
ITW31
New York Stock Exchange
3.00% Euro Notes due 2034
ITW34
New York Stock Exchange
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.
Yesx No o
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yesx No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
☐
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
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, 2019: 321,406,096.
Selling, administrative, and research and development expenses
566
581
1,775
1,813
Amortization and impairment of intangible assets
38
47
122
143
Operating Income
868
889
2,578
2,724
Interest expense
(52
)
(64
)
(170
)
(194
)
Other income (expense)
26
10
49
48
Income Before Taxes
842
835
2,457
2,578
Income Taxes
182
197
577
622
Net Income
$
660
$
638
$
1,880
$
1,956
Net Income Per Share:
Basic
$
2.05
$
1.91
$
5.79
$
5.81
Diluted
$
2.04
$
1.90
$
5.76
$
5.77
Shares of Common Stock Outstanding During the Period:
Average
322.3
333.3
324.8
336.7
Average assuming dilution
324.0
335.3
326.6
339.0
The Notes to Financial Statements are an integral part of this statement.
3
Illinois Tool Works Inc. and Subsidiaries
Statement of Comprehensive Income (Unaudited)
Three Months Ended
Nine Months Ended
September 30,
September 30,
In millions
2019
2018
2019
2018
Net Income
$
660
$
638
$
1,880
$
1,956
Other Comprehensive Income (Loss):
Foreign currency translation adjustments, net of tax
(105
)
(67
)
(134
)
(283
)
Pension and other postretirement benefit adjustments, net of tax
4
8
13
26
Comprehensive Income
$
559
$
579
$
1,759
$
1,699
The Notes to Financial Statements are an integral part of this statement.
4
Illinois Tool Works Inc. and Subsidiaries
Statement of Financial Position (Unaudited)
In millions except per share amounts
September 30, 2019
December 31, 2018
Assets
Current Assets:
Cash and equivalents
$
1,825
$
1,504
Trade receivables
2,499
2,622
Inventories
1,209
1,318
Prepaid expenses and other current assets
292
334
Assets held for sale
420
—
Total current assets
6,245
5,778
Net plant and equipment
1,693
1,791
Goodwill
4,430
4,633
Intangible assets
890
1,084
Deferred income taxes
479
554
Other assets
1,223
1,030
$
14,960
$
14,870
Liabilities and Stockholders' Equity
Current Liabilities:
Short-term debt
$
—
$
1,351
Accounts payable
493
524
Accrued expenses
1,229
1,271
Cash dividends payable
344
328
Income taxes payable
61
68
Liabilities held for sale
96
—
Total current liabilities
2,223
3,542
Noncurrent Liabilities:
Long-term debt
7,643
6,029
Deferred income taxes
716
707
Noncurrent income taxes payable
462
495
Other liabilities
946
839
Total noncurrent liabilities
9,767
8,070
Stockholders’ Equity:
Common stock (par value of $0.01 per share):
Issued- 550.0 shares in 2019 and 2018
Outstanding- 321.4 shares in 2019 and 328.1 shares in 2018
6
6
Additional paid-in-capital
1,286
1,253
Retained earnings
22,104
21,217
Common stock held in treasury
(18,632
)
(17,545
)
Accumulated other comprehensive income (loss)
(1,798
)
(1,677
)
Noncontrolling interest
4
4
Total stockholders’ equity
2,970
3,258
$
14,960
$
14,870
The Notes to Financial Statements are an integral part of this statement.
5
Illinois Tool Works Inc. and Subsidiaries
Statement of Changes in Stockholders' Equity (Unaudited)
In millions except per share amounts
Common Stock
Additional Paid-in Capital
Retained Earnings
Common Stock Held in Treasury
Accumulated Other Comprehensive Income (Loss)
Non-controlling
Interest
Total
Three Months Ended September 30, 2019
Balance at June 30, 2019
$
6
$
1,270
$
21,788
$
(18,276
)
$
(1,697
)
$
4
$
3,095
Net income
—
—
660
—
—
—
660
Common stock issued for stock-based compensation
—
6
19
—
—
25
Stock-based compensation expense
—
10
—
—
10
Repurchases of common stock
—
—
—
(375
)
—
—
(375
)
Dividends declared ($1.07 per share)
—
—
(344
)
—
—
—
(344
)
Pension and other postretirement benefit adjustments
—
—
—
—
4
—
4
Currency translation adjustment
—
—
—
—
(105
)
—
(105
)
Balance at September 30, 2019
$
6
$
1,286
$
22,104
$
(18,632
)
$
(1,798
)
$
4
$
2,970
Three Months Ended September 30, 2018
Balance at June 30, 2018
$
6
$
1,231
$
20,633
$
(16,555
)
$
(1,530
)
$
3
$
3,788
Net income
—
—
638
—
—
—
638
Common stock issued for stock-based compensation
—
(1
)
—
1
—
—
—
Stock-based compensation expense
—
11
—
—
—
—
11
Repurchases of common stock
—
—
—
(500
)
—
—
(500
)
Dividends declared ($1.00 per share)
—
—
(333
)
—
—
—
(333
)
Pension and other postretirement benefit adjustments
—
—
—
—
8
—
8
Currency translation adjustment
—
—
—
—
(67
)
—
(67
)
Noncontrolling interest
—
—
—
—
—
1
1
Balance at September 30, 2018
$
6
$
1,241
$
20,938
$
(17,054
)
$
(1,589
)
$
4
$
3,546
Nine months ended September 30, 2019
Balance at December 31, 2018
$
6
$
1,253
$
21,217
$
(17,545
)
$
(1,677
)
$
4
$
3,258
Net income
—
—
1,880
—
—
—
1,880
Common stock issued for stock-based compensation
—
1
—
38
—
—
39
Stock-based compensation expense
—
32
—
—
—
32
Repurchases of common stock
—
—
—
(1,125
)
—
—
(1,125
)
Dividends declared ($3.07 per share)
—
—
(993
)
—
—
—
(993
)
Pension and other postretirement benefit adjustments
—
—
—
—
13
—
13
Currency translation adjustment
—
—
—
—
(134
)
—
(134
)
Balance at September 30, 2019
$
6
$
1,286
$
22,104
$
(18,632
)
$
(1,798
)
$
4
$
2,970
Nine months ended September 30, 2018
Balance at December 31, 2017
$
6
$
1,218
$
20,210
$
(15,562
)
$
(1,287
)
$
4
$
4,589
Net income
—
—
1,956
—
—
—
1,956
Adoption of new accounting guidance
—
—
(370
)
—
(45
)
—
(415
)
Common stock issued for stock-based compensation
—
(8
)
—
8
—
—
—
Stock-based compensation expense
—
31
—
—
—
31
Repurchases of common stock
—
—
—
(1,500
)
—
—
(1,500
)
Dividends declared ($2.56 per share)
—
—
(858
)
—
—
—
(858
)
Pension and other postretirement benefit adjustments
—
—
—
—
26
—
26
Currency translation adjustment
—
—
—
—
(283
)
—
(283
)
Balance at September 30, 2018
$
6
$
1,241
$
20,938
$
(17,054
)
$
(1,589
)
$
4
$
3,546
The Notes to Financial Statements are an integral part of this statement.
6
Illinois Tool Works Inc. and Subsidiaries
Statement of Cash Flows (Unaudited)
Nine Months Ended
September 30,
In millions
2019
2018
Cash Provided by (Used for) Operating Activities:
Net income
$
1,880
$
1,956
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation
199
203
Amortization and impairment of intangible assets
122
143
Change in deferred income taxes
47
(20
)
Provision for uncollectible accounts
3
4
(Income) loss from investments
(12
)
(8
)
(Gain) loss on sale of plant and equipment
(8
)
(2
)
(Gain) loss on sale of operations and affiliates
6
1
Stock-based compensation expense
32
31
Other non-cash items, net
7
6
Change in assets and liabilities, net of acquisitions and divestitures:
(Increase) decrease in-
Trade receivables
(38
)
(202
)
Inventories
31
(122
)
Prepaid expenses and other assets
21
8
Increase (decrease) in-
Accounts payable
15
3
Accrued expenses and other liabilities
(68
)
(25
)
Income taxes
(21
)
24
Other, net
5
2
Net cash provided by operating activities
2,221
2,002
Cash Provided by (Used for) Investing Activities:
Acquisition of businesses (excluding cash and equivalents) and additional interest in affiliates
(4
)
—
Additions to plant and equipment
(244
)
(282
)
Proceeds from investments
16
13
Proceeds from sale of plant and equipment
22
14
Proceeds from sales of operations and affiliates
5
1
Other, net
(15
)
(4
)
Net cash provided by (used for) investing activities
(220
)
(258
)
Cash Provided by (Used for) Financing Activities:
Cash dividends paid
(977
)
(792
)
Issuance of common stock
50
11
Repurchases of common stock
(1,125
)
(1,500
)
Net proceeds from (repayments of) debt with original maturities of three months or less
(1
)
(850
)
Proceeds from debt with original maturities of more than three months
1,774
—
Repayments of debt with original maturities of more than three months
(1,350
)
(1
)
Other, net
(12
)
(11
)
Net cash provided by (used for) financing activities
(1,641
)
(3,143
)
Effect of Exchange Rate Changes on Cash and Equivalents
(39
)
(106
)
Cash and Equivalents:
Increase (decrease) during the period
321
(1,505
)
Beginning of period
1,504
3,094
End of period
$
1,825
$
1,589
Supplementary Cash Flow Information:
Cash Paid During the Period for Interest
$
207
$
211
Cash Paid During the Period for Income Taxes, Net of Refunds
$
553
$
618
Cash Paid During the Period for Lease Liabilities
$
53
Right-of-Use Assets Obtained in Exchange for Lease Liabilities
$
43
The Notes to Financial Statements are an integral part of this statement.
7
Illinois Tool Works Inc. and Subsidiaries
Notes to Financial Statements (Unaudited)
(1) Significant Accounting Policies
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. 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 2018 Annual Report on Form 10-K. Certain reclassifications of prior year data have been made to conform with current year reporting.
New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (the "FASB") issued authoritative guidance to change the criteria for revenue recognition. The core principle of the new guidance is that revenue should be recognized to depict the transfer of control of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, expanded revenue disclosures are required. The Company's sales arrangements with customers are predominantly short-term in nature and generally provide for transfer of control and risks and rewards of ownership at the time of product shipment or delivery of service. As such, the timing of revenue recognition under both the prior and new guidance is the same for the majority of the Company’s transactions. Effective January 1, 2018, the Company adopted the new revenue recognition guidance under the modified retrospective method and recorded a cumulative-effect adjustment reducing retained earnings by $9 million as of January 1, 2018.
In February 2016, the FASB issued authoritative guidance to change the criteria for recognizing leasing transactions. The primary change under the new guidance is that a lessee is required to recognize a lease liability and corresponding right-of-use asset for its operating leases. The new guidance also requires additional disclosures. Effective January 1, 2019, the Company adopted the new guidance prospectively for all operating lease transactions as of and after the effective date with a noncancellable lease term greater than one year. Upon adoption, the Company recorded a lease liability of $205 million and a corresponding right-of-use asset. The new guidance did not have a material impact on the results of operations or cash flows for the three and nine month periods ended September 30, 2019. Refer to Note 7. Leases for additional information regarding the Company’s lease transactions.
In October 2016, the FASB issued authoritative guidance requiring the recognition of the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs rather than when transferred to a third party as required under the prior guidance. The provisions of the new guidance are being applied prospectively to intra-entity asset transfers on or after January 1, 2018 and may result in future tax rate volatility. Upon adoption of the new guidance on January 1, 2018, the Company recorded a cumulative-effect adjustment reducing deferred tax assets and retained earnings by $406 million.
In August 2017, the FASB issued authoritative guidance which included targeted improvements to simplify the application of hedge accounting and improve financial reporting of hedging activities. Effective January 1, 2019, the Company adopted the new guidance which did not have a material impact on the results of operations, financial position or cash flows.
In February 2018, the FASB issued authoritative guidance which allows for an optional one-time reclassification of the stranded tax effects resulting from the change in the U.S. federal corporate income tax rate under the "Tax Cuts and Jobs Act" (the "Act") from accumulated other comprehensive income ("AOCI") to retained earnings. The guidance was effective January 1, 2019, with early adoption permitted. The Company elected to early adopt this guidance as of January 1, 2018 and to reclassify the stranded tax effects related to the Act, which resulted in an increase of $45 million to both retained earnings and accumulated other comprehensive loss.
8
(2) Divestitures
The Company consistently reviews its portfolio, assesses businesses that are long-term growth-challenged and evaluates if further portfolio refinements may be needed. The Company is currently exploring options, including potential divestitures, for certain businesses with annual revenues totaling up to $1 billion. As such, the Company may commit to a plan to exit or dispose of certain businesses and present them as businesses held for sale.
In the second quarter of 2019, the Company approved plans to divest six of the Company's businesses, including two businesses in the Test & Measurement and Electronics segment, one business in the Automotive OEM segment, one business in the Welding segment, and two businesses in the Specialty Products segment. These businesses were classified as held for sale beginning in the second quarter of 2019 and are expected to be sold within one year. None of the six held for sale businesses are considered significant to the Company.
As a result of being classified as held for sale, the Company recorded estimated losses of $4 million in the second quarter of 2019 related to the two businesses in the Specialty Products segment, which were included in Other income (expense) in the Statement of Income. Operating revenue of the businesses held for sale for the three and nine months ended September 30, 2019 and 2018 were as follows:
Three Months Ended
Nine Months Ended
September 30,
September 30,
In millions
2019
2018
2019
2018
Operating revenue
$
123
$
124
$
378
$
399
As of September 30, 2019, the assets and liabilities related to the six businesses discussed above that were included in assets and liabilities held for sale in the Statement of Financial Position were as follows:
In millions
September 30, 2019
Trade receivables
$
95
Inventories
46
Net plant and equipment
55
Goodwill and intangible assets
192
Other
32
Total assets held for sale
$
420
Accounts payable
$
25
Accrued expenses
22
Other
49
Total liabilities held for sale
$
96
9
(3) Operating Revenue
The Company's 87 diversified operating divisions are organized and managed based on similar product categories and end markets, and are reported to senior management as the following seven segments: Automotive OEM; Food Equipment; Test & Measurement and Electronics; Welding; Polymers & Fluids; Construction Products; and Specialty Products. Operating revenue by product category, which is consistent with the Company's segment presentation, for the three and nine months ended September 30, 2019 and 2018 was as follows:
Three Months Ended
Nine Months Ended
September 30,
September 30,
In millions
2019
2018
2019
2018
Automotive OEM
$
744
$
781
$
2,338
$
2,561
Food Equipment
551
567
1,617
1,647
Test & Measurement and Electronics
512
536
1,569
1,633
Welding
402
414
1,251
1,277
Polymers & Fluids
418
415
1,261
1,302
Construction Products
416
431
1,241
1,303
Specialty Products
441
475
1,379
1,482
Intersegment revenue
(5
)
(6
)
(16
)
(17
)
Total
$
3,479
$
3,613
$
10,640
$
11,188
The following is a description of the product offerings, end markets and typical revenue transactions for each of the Company's seven segments:
Automotive OEM—This segment is a global, niche supplier to top tier OEMs, providing unique innovation to address pain points for sophisticated customers with complex problems. Businesses in this segment produce components and fasteners for automotive-related applications. This segment primarily serves the automotive original equipment manufacturers and tiers market. Products in this segment include:
•
plastic and metal components, fasteners and assemblies for automobiles, light trucks and other industrial uses.
Products sold in this segment are primarily manufactured to the customer's specifications and are sold under long-term supply agreements with OEM auto manufacturers and other top tier auto parts suppliers. The Company typically recognizes revenue for products in this segment at the time of shipment. Certain products may be produced utilizing tooling that is owned by the customer that the Company developed and is reimbursed by the customer for the associated cost. In these arrangements, the Company typically retains a contractual right to use the customer-owned tooling for the purpose of fulfilling its obligations under the supply agreement. The Company records reimbursements for the cost of customer-owned tooling as a cost offset rather than operating revenue as tooling is not considered a product offering central to the Company's operations.
Food Equipment—This segment is a highly focused and branded industry-leader in commercial food equipment differentiated by innovation and integrated service offerings. This segment primarily serves the food service, food institutional/restaurant and food retail markets. Products in this segment include:
•
warewashing equipment;
•
cooking equipment, including ovens, ranges and broilers;
•
refrigeration equipment, including refrigerators, freezers and prep tables;
•
food processing equipment, including slicers, mixers and scales;
•
kitchen exhaust, ventilation and pollution control systems; and
•
food equipment service, maintenance and repair.
Revenue for equipment sold in this segment is typically recognized at the time of product shipment. In limited circumstances involving installation of equipment and customer acceptance, the Company may recognize revenue upon completion of installation and acceptance by the customer. Annual service contracts are typically sold separate from equipment and the related revenue is recognized on a straight-line basis over the annual service period. Operating revenue for on-demand service repairs and parts is recorded upon completion and customer acceptance of the work performed.
10
Test & Measurement and Electronics—This segment is a branded and innovative producer of test and measurement and electronic manufacturing and maintenance, repair, and operations, or "MRO" solutions that improve efficiency and quality for customers in diverse end markets. Businesses in this segment produce equipment, consumables, and related software for testing and measuring of materials and structures, as well as equipment and consumables used in the production of electronic subassemblies and microelectronics. This segment primarily serves the electronics, general industrial, industrial capital goods, automotive original equipment manufacturers and tiers, and consumer durables markets. Products in this segment include:
•
equipment, consumables, and related software for testing and measuring of materials, structures, gases and fluids;
•
electronic assembly equipment and related consumable solder materials;
•
electronic components and component packaging;
•
static control equipment and consumables used for contamination control in clean room environments; and
•
pressure sensitive adhesives and components for electronics, medical, transportation and telecommunications applications.
Revenue for products sold in this segment is typically recognized at the time of shipment. In limited circumstances where significant obligations to the customer are unfulfilled at the time of shipment, typically involving installation of equipment and customer acceptance, revenue recognition is deferred until such obligations have been completed.
Welding—This segment is a branded value-added equipment and specialty consumable manufacturer with innovative and leading technology. Businesses in this segment produce arc welding equipment, consumables and accessories for a wide array of industrial and commercial applications. This segment primarily serves the general industrial market, which includes fabrication, shipbuilding and other general industrial markets, and energy, construction, MRO, automotive original equipment manufacturers and tiers, and industrial capital goods markets. Products in this segment include:
•
arc welding equipment;
•
metal arc welding consumables and related accessories; and
•
metal jacketing and other insulation products.
Products in this segment are primarily manufactured to meet anticipated customer demand. The Company typically recognizes revenue for these products at the time of product shipment.
Polymers & Fluids—This segment is a branded supplier to niche markets that require value-added, differentiated products. Businesses in this segment produce engineered adhesives, sealants, lubrication and cutting fluids, and fluids and polymers for auto aftermarket maintenance and appearance. This segment primarily serves the automotive aftermarket, general industrial, MRO and construction markets. Products in this segment include:
•
adhesives for industrial, construction and consumer purposes;
•
chemical fluids which clean or add lubrication to machines;
•
epoxy and resin-based coating products for industrial applications;
•
hand wipes and cleaners for industrial applications;
•
fluids, polymers and other supplies for auto aftermarket maintenance and appearance;
•
fillers and putties for auto body repair; and
•
polyester coatings and patch and repair products for the marine industry.
Products in this segment are primarily manufactured to meet anticipated customer demand. The Company typically recognizes revenue for these products at the time of product shipment.
Construction Products—This segment is a branded supplier of innovative engineered fastening systems and solutions. This segment primarily serves the residential construction, renovation/remodel and commercial construction markets. Products in this segment include:
•
fasteners and related fastening tools for wood and metal applications;
•
anchors, fasteners and related tools for concrete applications;
•
metal plate truss components and related equipment and software; and
•
packaged hardware, fasteners, anchors and other products for retail.
Products in this segment are primarily manufactured to meet anticipated customer demand. The Company typically recognizes revenue for these products at the time of product shipment.
11
Specialty Products—This segment is focused on diversified niche market opportunities with substantial patent protection producing beverage packaging equipment and consumables, product coding and marking equipment and consumables, and appliance components and fasteners. This segment primarily serves the food and beverage, consumer durables, general industrial, printing and publishing and industrial capital goods markets. Products in this segment include:
•
line integration, conveyor systems and line automation for the food and beverage industries;
•
plastic consumables that multi-pack cans and bottles and related equipment;
•
foil, film and related equipment used to decorate consumer products;
•
product coding and marking equipment and related consumables;
•
plastic and metal closures and components for appliances;
•
airport ground support equipment; and
•
components for medical devices.
Products in this segment are primarily manufactured to meet anticipated customer demand. The Company typically recognizes revenue for these products at the time of product shipment. In limited circumstances where significant obligations to the customer are unfulfilled at the time of shipment, typically involving installation of equipment and customer acceptance, revenue is recognized when such obligations have been completed.
(4) Income Taxes
The Company's effective tax rate for the three months ended September 30, 2019 and 2018 was 21.6% and 23.7%, respectively. The third quarter 2019 effective tax rate benefited from a discrete tax benefit of $21 million for the U.S. federal provision to return adjustment resulting primarily from changes in estimates related to the "Tax Cuts and Jobs Act." The third quarter 2018 effective tax rate benefited from a discrete tax benefit of $37 million related to the release of a valuation allowance against the deferred tax assets of a non-U.S. subsidiary, which was partially offset by a discrete tax charge of $22 million related to foreign tax credits. The Company's effective tax rate for the nine months ended September 30, 2019 and 2018 was 23.5% and 24.1%, respectively, which benefited from the discrete tax items discussed above. Additionally, the third quarter of 2019 and year-to-date periods of 2019 and 2018 benefited from discrete tax benefits of $7 million in the third quarter of 2019 and $16 million and $6 million in the year-to-date periods of 2019 and 2018, respectively, related to excess tax benefits from stock-based compensation.
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, including the Internal Revenue Service ("IRS"), Her Majesty's Revenue and Customs, German Fiscal Authority, French Fiscal Authority, and Australian Tax Office, and a number of these audits are currently ongoing, which may increase the amount of the unrecognized tax benefits in future periods. Due to the ongoing audits, the Company believes it is reasonably possible that within the next twelve months the amount of the Company's unrecognized tax benefits may be decreased by approximately $55 million related predominantly to various intercompany transactions. The Company has recorded its best estimate of the potential exposure for these issues.
(5) Goodwill and Intangible Assets
The Company performed its annual impairment assessment of goodwill and indefinite-lived intangible assets in the third quarters of 2019 and 2018. The assessments resulted in no impairment charges in either 2019 or 2018.
(6) Inventories
Inventories as of September 30, 2019 and December 31, 2018 were as follows:
In millions
September 30, 2019
December 31, 2018
Raw material
$
455
$
523
Work-in-process
151
161
Finished goods
691
731
LIFO reserve
(88
)
(97
)
Total inventories
$
1,209
$
1,318
12
(7) Leases
Effective January 1, 2019, the Company adopted new lease accounting guidance which requires the recognition of a lease liability and corresponding right-of-use asset for all operating leases with a noncancellable lease term of greater than one year. The new guidance did not change the recognition of rental expense for operating leases which is recognized on a straightline basis over the noncancellable lease term based on the minimum lease payments at lease inception. Changes in rent subsequent to commencement that were not included in minimum lease payments at inception are recognized as variable rent in the period incurred.
The Company’s lease transactions are primarily for the use of facilities, vehicles and equipment under operating lease arrangements. Total rental expense for operating leases for the three months ended September 30, 2019 was $25 million, which included $17 million related to capitalized operating leases and $8 million related to short-term operating leases and variable lease payments. Total rental expense for operating leases for the nine months ended September 30, 2019 was $81 million, which included $53 million related to capitalized operating leases and $28 million related to short-term operating leases and variable lease payments. Short-term operating leases have original terms of one year or less, or can be terminated at the Company's option with a short notice period and without significant penalty, and are not capitalized. The right-of-use asset related to operating leases was $210 million as of September 30, 2019 and was included in Other assets. As of September 30, 2019, the current portion of the lease liability for operating leases was $50 million and was included in Accrued expenses, and the long-term portion was $133 million and was included in Other liabilities. Future maturities of operating lease liabilities for the years ended December 31 are as follows:
In millions
October 1, 2019 through December 31, 2019
$
12
2020
55
2021
40
2022
30
2023
22
2024 and future years
37
Total future minimum lease payments
196
Less: Imputed interest
(13
)
Operating lease liability
183
Less: Current portion of operating lease liability
(50
)
Long-term portion of operating lease liability
$
133
As of September 30, 2019, operating leases included in the lease liability had a weighted average remaining lease term of 4.7 years and a weighted average discount rate of 2.61% based on the incremental borrowing rate of the Company and its subsidiaries.
As of December 31, 2018, minimum lease payments under operating leases with noncancellable terms in excess of one year for the years ending December 31 were as follows:
In millions
2019
$
67
2020
48
2021
32
2022
24
2023
18
2024 and future years
34
Total future minimum lease payments
$
223
13
(8) Pension and Other Postretirement Benefits
Pension and other postretirement benefit costs for the three and nine months ended September 30, 2019 and 2018 were as follows:
Three Months Ended
Nine Months Ended
September 30,
September 30,
Pension
Other Postretirement Benefits
Pension
Other Postretirement Benefits
In millions
2019
2018
2019
2018
2019
2018
2019
2018
Components of net periodic benefit cost:
Service cost
$
13
$
15
$
1
$
2
$
39
$
45
$
5
$
6
Interest cost
20
18
5
4
59
54
15
13
Expected return on plan assets
(30
)
(31
)
(5
)
(6
)
(91
)
(95
)
(16
)
(18
)
Amortization of actuarial loss (gain)
5
11
—
(1
)
16
33
(1
)
(2
)
Amortization of prior service cost
—
—
—
—
1
—
—
—
Total net periodic benefit cost
$
8
$
13
$
1
$
(1
)
$
24
$
37
$
3
$
(1
)
The service cost component of net periodic benefit cost is presented within Cost of revenue and Selling, administrative, and research and development expenses in the statement of income while the other components of net periodic benefit cost are presented within Other income (expense).
The Company expects to contribute approximately $30 million to its pension plans and $5 million to its other postretirement benefit plans in 2019. As of September 30, 2019, contributions of $22 million to pension plans and $3 million to other postretirement benefit plans have been made.
(9) Debt
There was no commercial paper outstanding as of September 30, 2019 and December 31, 2018. As of December 31, 2018, short-term debt included $650 million related to the 1.95% notes due March 1, 2019 and $700 million related to the 6.25% notes due April 1, 2019, both of which were repaid on their due date.
During the third quarter of 2019, the Company entered into a $2.5 billion, five-year line of credit agreement with a termination date of September 27, 2024. This agreement replaced the existing $2.5 billion line of credit agreement with a termination date of May 9, 2021. No amount was outstanding under the line of credit agreement as of September 30, 2019.
In June 2019, the Company issued €600 million of 0.25% Euro notes due December 5, 2024 at 99.662% of face value, €500 million of 0.625% Euro notes due December 5, 2027 at 99.343% of face value and €500 million of 1.00% Euro notes due June 5, 2031 at 98.982% of face value. Net proceeds from the issuances were used to repay commercial paper and for general corporate purposes.
The Company designated the €1.6 billion of Euro notes issued in June 2019 as a hedge of a portion of its net investment in Euro-denominated foreign operations to reduce foreign currency risk associated with the investment in these operations. Refer to Note 10. Accumulated Other Comprehensive Income (Loss) for additional information regarding the net investment hedge.
The approximate fair value and related carrying value of the Company's total long-term debt, including current maturities of long-term debt presented as short-term debt, as of September 30, 2019 and December 31, 2018 were as follows:
In millions
September 30, 2019
December 31, 2018
Fair value
$
8,582
$
7,665
Carrying value
7,643
7,379
14
The approximate fair values of the Company's long-term debt, including current maturities, were based on a valuation model using Level 2 observable inputs which included market rates for comparable instruments for the respective periods.
(10) Accumulated Other Comprehensive Income (Loss)
The following table summarizes changes in Accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2019 and 2018:
Three Months Ended
Nine Months Ended
September 30,
September 30,
In millions
2019
2018
2019
2018
Beginning balance
$
(1,697
)
$
(1,530
)
$
(1,677
)
$
(1,287
)
Adoption of new accounting guidance related to reclassification of certain tax effects
—
—
—
(45
)
Foreign currency translation adjustments during the period
(65
)
(69
)
(98
)
(270
)
Foreign currency translation adjustments reclassified to income
—
5
—
5
Income taxes
(40
)
(3
)
(36
)
(18
)
Total foreign currency translation adjustments, net of tax
(105
)
(67
)
(134
)
(283
)
Pension and other postretirement benefit adjustments during the period
—
—
—
1
Pension and other postretirement benefit adjustments reclassified to income
5
10
16
31
Income taxes
(1
)
(2
)
(3
)
(6
)
Total pension and other postretirement benefit adjustments, net of tax
4
8
13
26
Ending balance
$
(1,798
)
$
(1,589
)
$
(1,798
)
$
(1,589
)
Effective January 1, 2018, the Company elected to early adopt new accounting guidance related to the stranded tax effects resulting from the change in the U.S. federal corporate income tax rate under the "Tax Cuts and Jobs Act" (the "Act") and reclassified $45 million of stranded income tax effects from Accumulated other comprehensive income (loss) to Retained earnings. Refer to Note 1. Significant Accounting Policies for additional information.
Pension and other postretirement benefit adjustments reclassified to income related to the amortization of actuarial gains and losses and prior service cost. Refer to Note 8. Pension and Other Postretirement Benefits for additional information.
The Company designated the €1.0 billion of Euro notes issued in May 2014, the €1.0 billion of Euro notes issued in May 2015 and the €1.6 billion of Euro notes issued in June 2019 as hedges of a portion of its net investment in Euro-denominated foreign operations to reduce foreign currency risk associated with the investment in these operations. Changes in the value of this debt resulting from fluctuations in the Euro to U.S. dollar exchange rate have been recorded as foreign currency translation adjustments within Accumulated other comprehensive income (loss). The carrying values of the 2019, 2015 and 2014 Euro notes were $1.7 billion, $1.1 billion and $1.1 billion, respectively, as of September 30, 2019. The unrealized pre-tax gain recorded in Accumulated other comprehensive income (loss) related to the net investment hedge was $351 million and $187 million as of September 30, 2019 and December 31, 2018, respectively.
The ending balance of Accumulated other comprehensive income (loss) as of September 30, 2019 and 2018 consisted of cumulative translation adjustment losses, net of tax, of $1.4 billion and $1.3 billion, respectively, and unrecognized pension and other postretirement benefits costs, net of tax, of $351 million and $321 million, respectively.
(11) Segment Information
The Company's operations are organized and managed based on similar product offerings and end markets, and are reported to senior management as the following seven segments: Automotive OEM; Food Equipment; Test & Measurement and
15
Electronics; Welding; Polymers & Fluids; Construction Products; and Specialty Products. Refer to Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations for information regarding operating revenue and operating income for the Company's segments.
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTION
Illinois Tool Works Inc. (the "Company" or "ITW") is a global manufacturer of a diversified range of industrial products and equipment with 87 divisions in 55 countries. As of December 31, 2018, the Company employed approximately 48,000 people.
The Company's operations are organized and managed based on similar product offerings and end markets, and are reported to senior management as the following seven segments: Automotive OEM; Food Equipment; Test & Measurement and Electronics; Welding; Polymers & Fluids; Construction Products; and Specialty Products.
Due to the large number of diverse businesses and the Company's decentralized operating structure, the Company does not require its businesses to provide detailed information on operating results. Instead, the Company's corporate management collects data on several key measurements: operating revenue, operating income, operating margin, overhead costs, number of months on hand in inventory, days sales outstanding in accounts receivable, past due receivables and return on invested capital. These key measures are monitored by management and significant changes in operating results versus curr