10-Q 1 itw-20140630x10q.htm 10-Q ITW-2014.06.30-10Q


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, 2014
 
 
 
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)
 
 
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 [ ]

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).
Yes [X]                        No [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer X                                                                                                Accelerated filer  ___
Non-accelerated filer  ___ (Do not check if a smaller reporting company)                                                                                                                     Smaller reporting company  ___

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [   ]                        No [X]

The number of shares of registrant’s common stock, $0.01 par value, outstanding at June 30, 2014: 396,513,007.




Part I – Financial Information
Item 1 – Financial Statements
Illinois Tool Works Inc. and Subsidiaries
Statement of Income (Unaudited)


 
Three Months Ended
 
Six Months Ended
(In millions except per share amounts)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Operating Revenues
$
3,719

 
$
3,593

 
$
7,288

 
$
7,013

Cost of revenues
2,219

 
2,155

 
4,377

 
4,233

Selling, administrative, and research and development expenses
677

 
747

 
1,359

 
1,450

Amortization of intangible assets
60

 
61

 
122

 
122

Operating Income
763

 
630

 
1,430

 
1,208

Interest expense
(64
)
 
(59
)
 
(128
)
 
(119
)
Other income (expense)
7

 
10

 
16

 
57

Income from Continuing Operations Before Income Taxes
706

 
581

 
1,318

 
1,146

Income Taxes
212

 
165

 
396

 
329

Income from Continuing Operations
494

 
416

 
922

 
817

Income from Discontinued Operations
998

 
49

 
1,043

 
2

Net Income
$
1,492

 
$
465

 
$
1,965

 
$
819

 
 
 
 
 
 
 
 
Income Per Share from Continuing Operations:
 
 
 
 
 
 
 
Basic
$
1.22

 
$
0.93

 
$
2.23

 
$
1.81

Diluted
$
1.21

 
$
0.92

 
$
2.22

 
$
1.80

Income Per Share from Discontinued Operations:
 
 
 
 
 
 
 
Basic
$
2.47

 
$
0.11

 
$
2.52

 
$

Diluted
$
2.45

 
$
0.11

 
$
2.50

 
$

Net Income Per Share:
 
 
 
 
 
 
 
Basic
$
3.69

 
$
1.04

 
$
4.76

 
$
1.82

Diluted
$
3.66

 
$
1.03

 
$
4.72

 
$
1.81

Cash Dividends Per Share:
 
 
 
 
 
 
 
Paid
$
0.42

 
$
0.38

 
$
0.84

 
$
0.38

Declared
$
0.42

 
$
0.38

 
$
0.84

 
$
0.76

 
 
 
 
 
 
 
 
Shares of Common Stock Outstanding During the Period:
 
 
 
 
 
 
 
Average
404.7

 
449.6

 
413.3

 
450.7

Average assuming dilution
407.6

 
452.5

 
416.3

 
453.7


The Notes to Financial Statements are an integral part of these statements.

2




Illinois Tool Works Inc. and Subsidiaries
Statement of Comprehensive Income (Unaudited)

 
Three Months Ended
 
Six Months Ended
(In millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Net Income
$
1,492

 
$
465

 
$
1,965

 
$
819

Other Comprehensive Income:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(50
)
 
(251
)
 
(22
)
 
(401
)
Pension and other postretirement benefit adjustments, net of tax
(11
)
 
108

 
(3
)
 
120

Comprehensive Income
$
1,431

 
$
322

 
$
1,940

 
$
538


The Notes to Financial Statements are an integral part of these statements.


3



Illinois Tool Works Inc. and Subsidiaries
Statement of Financial Position (Unaudited)

(In millions)
 
June 30, 2014
 
December 31, 2013
Assets
 
 
 
Current Assets:
 
 
 
Cash and equivalents
$
5,297

 
$
3,618

Trade receivables
2,598

 
2,365

Inventories
1,305

 
1,247

Deferred income taxes
307

 
384

Prepaid expenses and other current assets
284

 
366

Assets held for sale

 
1,836

Total current assets
9,791

 
9,816

 
 
 
 
Net plant and equipment
1,700

 
1,709

Goodwill
4,904

 
4,886

Intangible assets
1,876

 
1,999

Deferred income taxes
368

 
359

Other assets
1,297

 
1,197

 
$
19,936

 
$
19,966

 
 
 
 
Liabilities and Stockholders' Equity
 

 
 

Current Liabilities:
 

 
 

Short-term debt
$
1,070

 
$
3,551

Accounts payable
683

 
634

Accrued expenses
1,278

 
1,272

Cash dividends payable
167

 
181

Income taxes payable
715

 
69

Deferred income taxes
10

 
10

Liabilities held for sale

 
317

Total current liabilities
3,923

 
6,034

 
 
 
 
Noncurrent Liabilities:
 

 
 

Long-term debt
6,140

 
2,793

Deferred income taxes
515

 
507

Other liabilities
918

 
923

Total noncurrent liabilities
7,573

 
4,223

 
 
 
 
Stockholders’ Equity:
 

 
 

Common stock
6

 
6

Additional paid-in-capital
1,064

 
1,046

Income reinvested in the business
16,568

 
14,943

Common stock held in treasury
(9,562
)
 
(6,676
)
Accumulated other comprehensive income
359

 
384

Noncontrolling interest
5

 
6

Total stockholders’ equity
8,440

 
9,709

 
$
19,936

 
$
19,966


The Notes to Financial Statements are an integral part of these statements.

4



Illinois Tool Works Inc. and Subsidiaries
Statement of Cash Flows (Unaudited)

 
Six Months Ended
(In millions)
June 30,
 
2014
 
2013
Cash Provided by (Used for) Operating Activities:
 
 
 
Net income
$
1,965

 
$
819

Adjustments to reconcile net income to cash provided by operating activities:
 

 
 

Depreciation
137

 
154

Amortization and impairment of goodwill and other intangible assets
122

 
178

Change in deferred income taxes
51

 
49

Provision for uncollectible accounts
5

 
5

(Income) loss from investments
(6
)
 
(5
)
(Gain) loss on sale of plant and equipment

 
(1
)
(Gain) loss on discontinued operations
(1,709
)
 
76

(Gain) loss on sale of operations and affiliates
5

 
6

Stock-based compensation expense
21

 
18

Gain on acquisition of controlling interest in an equity investment

 
(30
)
Other non-cash items, net
4

 
4

Change in assets and liabilities:
 

 
 

(Increase) decrease in-
 

 
 

Trade receivables
(232
)
 
(315
)
Inventories
(55
)
 
(33
)
Prepaid expenses and other assets
(71
)
 
5

Increase (decrease) in-
 

 
 

Accounts payable
(22
)
 
75

Accrued expenses and other liabilities
(1
)
 
30

Income taxes
746

 
(7
)
Other, net
(73
)
 
(19
)
Net cash provided by operating activities
887

 
1,009

Cash Provided by (Used for) Investing Activities:
 

 
 

Acquisition of businesses (excluding cash and equivalents) and additional interest in affiliates
(6
)
 
(77
)
Additions to plant and equipment
(146
)
 
(178
)
Proceeds from investments
11

 
14

Proceeds from sale of plant and equipment
15

 
11

Net proceeds from sale of discontinued operations
3,177

 
59

Proceeds from sales of operations and affiliates
9

 
1

Other, net
14

 
(6
)
Net cash provided by (used for) investing activities
3,074

 
(176
)
Cash Provided by (Used for) Financing Activities:
 

 
 

Cash dividends paid
(355
)
 
(171
)
Issuance of common stock
81

 
128

Repurchases of common stock
(2,905
)
 
(677
)
Net proceeds from (repayments of) debt with original maturities of three months or less
(1,680
)
 
42

Proceeds from debt with original maturities of more than three months
3,329

 
1

Repayments of debt with original maturities of more than three months
(801
)
 
(1
)
Other, net
7

 
14

Net cash provided by (used for) financing activities
(2,324
)
 
(664
)
Effect of Exchange Rate Changes on Cash and Equivalents
42

 
(180
)
Cash and Equivalents:
 

 
 

Increase (decrease) during the period
1,679

 
(11
)
Beginning of period
3,618

 
2,779

End of period
$
5,297

 
$
2,768

Supplementary Cash and Non-Cash Information:
 
 
 
Cash Paid During the Period for Interest
$
93

 
$
95

Cash Paid During the Period for Income Taxes, Net of Refunds
$
343

 
$
232

Liabilities Assumed from Acquisitions
$
4

 
$
72


The Notes to Financial Statements are an integral part of these statements.

5



Illinois Tool Works Inc. and Subsidiaries
Notes to Financial Statements (Unaudited)

(1)    Financial Statements

The unaudited financial statements included herein have been prepared by Illinois Tool Works Inc. and Subsidiaries (the “Company”). In the opinion of management, the interim financial statements reflect all adjustments of a normal recurring nature necessary for a fair statement of the results for interim periods. 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 2013 Annual Report on Form 10-K. Certain reclassifications of prior year data have been made to conform with current year reporting.

(2)    Discontinued Operations

The Company periodically reviews its operations for businesses which may no longer be aligned with its enterprise initiatives and long-term objectives. As such, the Company may commit to a plan to exit or dispose of certain businesses and present them as discontinued operations. The following summarizes the Company's discontinued operations.
The Company has restated the statement of income and the notes to financial statements to present the operating results of the held for sale and previously divested businesses discussed below as discontinued operations.
Third Quarter 2013 Discontinued Operations - In February 2013, the Company announced that it was initiating a review process to explore strategic alternatives for its Industrial Packaging segment. In September 2013, the Company’s Board of Directors authorized a plan to commence a sale process for the Industrial Packaging segment. The Company classified the Industrial Packaging segment as held for sale beginning in the third quarter of 2013.
On February 6, 2014, the Company announced that it had signed a definitive agreement to sell its Industrial Packaging segment to The Carlyle Group for $3.2 billion. The transaction was completed on May 1, 2014, resulting in a pre-tax gain of $1.7 billion ($1.1 billion after tax) in the second quarter of 2014, and is subject to customary post-close adjustments.
In the third quarter of 2013, the Company also committed to plans for the divestiture of a construction distribution business previously included in the Construction Products segment and a specialty coatings business previously included in the Polymers & Fluids segment. These businesses were classified as held for sale beginning in the third quarter of 2013. The specialty coatings business was sold in the fourth quarter of 2013. The construction distribution business was sold in the second quarter of 2014.
First Quarter 2013 Discontinued Operations - In the first quarter of 2013, the Company committed to plans for the divestiture of two transportation related businesses and a machine components business previously included in the Specialty Products segment, two construction distribution businesses previously included in the Construction Products segment, and a chemical manufacturing business previously included in the Polymers & Fluids segment. These businesses were classified as held for sale beginning in the first quarter of 2013.
The Company also reclassified certain previously divested businesses as discontinued operations in the first quarter of 2013. These included a consumer packaging business that was previously included in the Specialty Products segment, a packaging distribution business which was previously included in the former Industrial Packaging segment, and a welding manufacturing business previously included in the Welding segment.
In the second quarter of 2013, the Company divested one of the held for sale transportation related businesses, the machine components business, and the chemical manufacturing business. In the third quarter of 2013, the Company divested the second held for sale transportation related business. In the fourth quarter of 2013, the Company divested one construction distribution business and the remaining construction distribution business was sold in the second quarter of 2014.


6



Results of the discontinued operations for the three and six months ended June 30, 2014 and 2013 were as follows:
 
Three Months Ended
 
Six Months Ended
(In millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Operating revenues
$
212

 
$
759

 
$
798

 
$
1,496

 
 
 
 
 
 
 
 
Income before income taxes
$
1,724

 
$
69

 
$
1,796

 
$
50

Income tax expense
(726
)
 
(20
)
 
(753
)
 
(48
)
Income from discontinued operations
$
998

 
$
49

 
$
1,043

 
$
2


Income before income taxes from discontinued operations was income of $1.8 billion and $50 million for the six months ended June 30, 2014 and 2013, respectively. The income in the first six months of 2014 included the pre-tax gain of $1.7 billion ($1.1 billion after tax) on the sale of the Industrial Packaging segment recorded in the second quarter of 2014. Income tax expense in the first six months of 2014 includes $175 million of U.S. income tax expense related to the repatriation of approximately $1.3 billion of international proceeds from the sale of the Industrial Packaging segment. The income in the first six months of 2013 included a $42 million goodwill impairment charge recorded in connection with the anticipated sale of one of the transportation related businesses discussed above and loss reserves on assets held for sale of $67 million.

There were no businesses classified as held for sale as of June 30, 2014. As of December 31, 2013, the assets and liabilities of the Industrial Packaging business and the two construction distribution businesses discussed above were included in assets and liabilities held for sale in the statement of financial position, as follows:
(In millions)
 
December 31, 2013
Trade receivables
$
352

Inventories
244

Net plant and equipment
305

Goodwill and intangible assets
844

Other
91

Total assets held for sale
$
1,836

 
 
Accounts payable
$
87

Accrued expenses
139

Other
91

Total liabilities held for sale
$
317


(3)    Gain on Acquisition of Controlling Interest in Equity Investment

On January 31, 2013, the Company acquired the controlling interest of an existing consumer packaging business in the Specialty Products segment previously accounted for under the equity method. The Company recorded a pre-tax gain of $30 million in Other income (expense) in the first quarter of 2013 as a result of remeasuring the Company's existing equity interest to fair value by determining the implied equity value using a Level 3 valuation method.

(4)    Income Taxes

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 $8 million related predominantly to various intercompany transactions. The Company has recorded its best estimate of the potential exposure for these issues.


7



On February 18, 2014, the Company received a Notice of Deficiency (“NOD”) from the IRS asserting that a non-taxable return of capital received from a subsidiary was a taxable dividend distribution. The NOD assesses additional taxes of $70 million for the 2006 tax year, plus interest and penalties. In May 2014, the Company petitioned the United States Tax Court to challenge the NOD. The Company's petition was subsequently denied and the case will proceed to court. Although the outcome of this process cannot be predicted with certainty, the Company believes it will be successful in defending its position.

(5)    Inventories

Inventories as of June 30, 2014 and December 31, 2013 were as follows:
(In millions) 
June 30, 2014
 
December 31, 2013
Raw material
$
456

 
$
445

Work-in-process
153

 
145

Finished goods
696

 
657

Total inventories
$
1,305

 
$
1,247


(6)    Retirement Plans and Postretirement Benefits

Pension and other postretirement benefit costs related to both continuing and discontinued operations for the three and six months ended June 30, 2014 and 2013, were as follows:
 
Three Months Ended
 
Six Months Ended
(In millions)
June 30,
 
June 30,
 
Pension
 
Other Postretirement Benefits
 
Pension
 
Other Postretirement Benefits
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Components of net periodic benefit cost:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
20

 
$
23

 
$
2

 
$
3

 
$
40

 
$
46

 
$
5

 
$
6

Interest cost
26

 
24

 
6

 
6

 
52

 
48

 
12

 
12

Expected return on plan assets
(39
)
 
(39
)
 
(6
)
 
(6
)
 
(79
)
 
(78
)
 
(12
)
 
(11
)
Amortization of actuarial (gain)/loss
12

 
19

 
(1
)
 

 
24

 
38

 
(3
)
 

Amortization of prior service cost

 

 

 
1

 

 

 

 
1

Settlement loss/curtailment (gain)
2

 
34

 
(9
)
 

 
2

 
34

 
(9
)
 

Net periodic benefit (income)/cost
$
21

 
$
61

 
$
(8
)
 
$
4

 
$
39

 
$
88

 
$
(7
)
 
$
8

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Amounts were included in the statement of income as follows:
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
Continuing operations
$
18

 
$
59

 
$
1

 
$
4

 
$
34

 
$
83

 
$
2

 
$
8

Discontinued operations
3

 
2

 
(9
)
 

 
5

 
5

 
(9
)
 

Net periodic benefit (income)/cost
$
21

 
$
61

 
$
(8
)
 
$
4

 
$
39

 
$
88

 
$
(7
)
 
$
8


In the second quarter of 2013, the Company recognized a $34 million pre-tax settlement charge tied primarily to higher lump sum pension payments related to the exit of Decorative Services employees from the Company's U.S. primary pension plan. The Company expects to contribute approximately $136 million to its pension plans and $7 million to its other postretirement plans in 2014. As of June 30, 2014, contributions of $111 million to pension plans and $3 million to other postretirement plans have been made.

(7)    Debt

Short-term debt represents obligations with a maturity date of one year or less and are stated at cost which approximates fair value. Short-term debt also includes current maturities of long-term debt. Short-term debt as of June 30, 2014 and December 31, 2013 included €750 million of 5.25% Euro notes which mature on October 1, 2014. In addition, at December 31, 2013, short-term debt included $800 million of 5.15% redeemable notes due April 1, 2014, which were repaid on the due date, and commercial paper of $1.7 billion. No commercial paper was outstanding as of June 30, 2014.

8



On January 22, 2014, the Company entered into a $1.0 billion short-term line of credit agreement with a term of up to 364 days to provide additional liquidity under the Company's commercial paper program in order to fund short-term capital allocation needs. This short-term line of credit agreement was terminated on May 15, 2014.

Long-term debt represents obligations with a maturity date greater than one year, and excludes current maturities that have been reclassified to short-term debt. In February 2014, the Company issued $650 million of 0.9% notes due February 25, 2017 at 99.861% of face value, $650 million of 1.95% notes due March 1, 2019 at 99.871% of face value, and $700 million of 3.5% notes due March 1, 2024 at 99.648% of face value. Net proceeds from the February 2014 debt issuance were used to repay commercial paper.
 
In May 2014, the Company issued €500 million of 1.75% Euro notes due May 20, 2022 at 99.16% of face value and €500 million of 3.0% Euro notes due May 19, 2034 at 98.089% of face value. The carrying values of the Euro notes were $679 million and $672 million, respectively, as of June 30, 2014. Net proceeds from the May 2014 debt issuances were used for general corporate purposes. The Company designated the €1.0 billion of Euro notes 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. 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. The unrealized gain recorded in Accumulated other comprehensive income related to the net investment hedge was $1 million as of June 30, 2014.

The Company has committed lines of credit of $2.5 billion in the U.S. to support its commercial paper program. In May 2014, the Company amended its financial covenants within these agreements. The previous financial covenant, limiting total debt to total capitalization, was replaced with a minimum interest coverage ratio. As of June 30, 2014, the Company was in compliance with this covenant and there were no amounts outstanding under these credit agreements.

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 June 30, 2014 and December 31, 2013 were as follows:

(In millions)
 
June 30, 2014
 
December 31, 2013
Fair value
$
7,425

 
$
4,670

Carrying value
7,170

 
4,627

 
The approximate fair values of the Company's long-term debt, including current maturities, were based on a Level 2 valuation model, using observable inputs which included market rates for comparable instruments for the respective periods.

(8)    Accumulated Other Comprehensive Income

The following table summarizes changes in Accumulated other comprehensive income for the three and six months ended June 30, 2014 and 2013:

9



 
Three Months Ended
 
Six Months Ended
(In millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Beginning balance
$
420

 
$
155

 
$
384

 
$
293

 
 
 
 
 
 
 
 
Foreign currency translation adjustments during the period
82

 
(253
)
 
110

 
(407
)
Foreign currency translation adjustments reclassified to income
(132
)
 
2

 
(132
)
 
6

Total foreign currency translation adjustments
(50
)
 
(251
)
 
(22
)
 
(401
)
 
 
 
 
 
 
 
 
Pension and other postretirement benefit adjustments during the period
(41
)
 
111

 
(41
)
 
111

Pension and other postretirement benefit adjustments reclassified to income
19

 
58

 
29

 
77

Income taxes
11

 
(61
)
 
9

 
(68
)
Total pension and other postretirement benefit adjustments
(11
)
 
108

 
(3
)
 
120

 
 
 
 
 
 
 
 
Ending balance
$
359

 
$
12

 
$
359

 
$
12


Foreign currency translation adjustments reclassified to income are primarily related to the disposal of certain discontinued operations. Refer to the Discontinued Operations note for additional information. Pension and other postretirement benefit adjustments reclassified to income represent the amortization of actuarial losses and prior service cost, and settlement loss/curtailment gain recognized in net periodic benefit cost. Refer to the Retirement Plans and Postretirement Benefits note for the amounts included in net periodic benefit cost.

The ending balance of accumulated other comprehensive income as of June 30, 2014 and 2013 consisted of cumulative translation adjustment income of $652 million and $466 million, respectively, and unrecognized pension and other postretirement benefits costs, net of tax, of $293 million and $454 million, respectively.

(9)    Segment Information

The Company has seven reportable segments: Automotive OEM; Test & Measurement and Electronics; Food Equipment; Polymers & Fluids; Welding; Construction Products; and Specialty Products. See Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations for information regarding operating revenues and operating income for the Company's segments.



10



Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction

Management analyzes the Company’s consolidated results of operations and the results of each segment by identifying the effects of changes in the results of the base businesses, newly acquired and recently divested companies, restructuring costs, goodwill and intangible asset impairment charges, and currency translation on the operating revenues and operating income of each segment. Base businesses are those businesses that have been included in the Company’s results of operations for more than 12 months. The changes to base business operating income include the estimated effects of both operating leverage and changes in variable margins and overhead costs. Operating leverage is the estimated effect of the base business revenue volume changes on operating income, assuming variable margins remain the same as the prior period. As manufacturing and administrative overhead costs usually do not significantly change as a result of revenues increasing or decreasing, the percentage change in operating income due to operating leverage is usually more than the percentage change in the base business revenues. Changes in variable margins and overhead costs represent the estimated effect of non-volume related changes in base business operating income and may be driven by a number of factors, including changes in product mix, the cost of raw materials, labor and overhead, and pricing to customers. Selling price versus material cost comparisons represent the estimated net impact of increases or decreases in the cost of materials used in the Company’s products versus changes in the selling price to the Company’s customers. Management reviews these price versus cost comparisons by analyzing the net impact of changes to each segment’s operating margin.

The discussion of operating results should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Enterprise Strategy

During 2012, the Company embarked on an Enterprise Strategy that includes three key initiatives - portfolio management, business structure simplification, and strategic sourcing. These enterprise initiatives are expected to enhance the business through 2017 and are targeted at expanding organic revenue growth and improving profitability and returns.

Portfolio Management - The Company's portfolio management initiative aims to construct a business portfolio that leverages the Company’s differentiated business model and growth potential. As part of this initiative, the Company reviews its operations for businesses that may no longer be aligned with its long-term objectives. As a result, the Company's divestiture activity increased in 2012, 2013 and 2014. With the sale of the Company's former Industrial Packaging segment on May 1, 2014, the Company's portfolio management initiative is essentially complete. The Company has historically acquired businesses with complementary products and services as well as larger acquisitions that represent potential new platforms. Going forward, the Company will emphasize organic growth and focus on acquisitions with sustainable differentiation and growth potential. Refer to the Discontinued Operations note in Item 1 - Financial Statements for discussion of the Company’s discontinued operations.

Business Structure Simplification - The business structure simplification initiative simplifies the Company's organizational model and adds scale to the Company's operating divisions in order to increase organic revenue growth, enhance global competitiveness and drive operational efficiencies. This initiative focuses on reducing the number of the Company's operating divisions and increasing the average revenue size of each division, while retaining the positive attributes of a decentralized operating model. The Company expects to enhance its profitability and returns through a combination of applying its 80/20 business process to the new divisions, more focused growth investments and reduced infrastructure.

Strategic Sourcing - The Company's strategic sourcing initiative focuses on building sourcing capability in order to leverage purchasing scale to enhance profitability and global competitiveness. It incorporates both enterprise-level and segment-level purchasing that cross the Company's many businesses. This initiative is expected to transform sourcing into a core strategic function in the Company.

An integral part of the Company's 80/20 business process and enterprise strategy is the focus on product line and customer base simplification, or "PLS." PLS focuses on eliminating the complexity and overhead costs associated with smaller product lines and customers, and focuses businesses on supporting and growing their largest customers and product lines. PLS is a core element of the Company's 80/20 business process and is key to improving the Company's long-term operating and financial performance.


11



Discontinued Operations

The Company periodically reviews its operations for businesses which may no longer be aligned with its enterprise initiatives and long-term objectives. As such, the Company may commit to a plan to exit or dispose of certain businesses and present them as discontinued operations.

In February 2013, the Company announced that it was initiating a review process to explore strategic alternatives for the Industrial Packaging segment. In September 2013, the Company’s Board of Directors authorized a plan to commence a sale process for the Industrial Packaging segment. The Company classified the Industrial Packaging segment as held for sale beginning in the third quarter of 2013.
On February 6, 2014, the Company announced that it had signed a definitive agreement to sell the Industrial Packaging segment to The Carlyle Group for $3.2 billion. The transaction was completed on May 1, 2014, resulting in a pre-tax gain of $1.7 billion ($1.1 billion after tax) in the second quarter of 2014, and is subject to customary post-close adjustments.

In the third quarter of 2013, the Company also committed to plans for the divestiture of a construction distribution business previously included in the Construction Products segment and a specialty coatings business previously included in the Polymers & Fluids segment. The construction distribution and specialty coatings businesses were classified as held for sale beginning in the third quarter of 2013.
In the first quarter of 2013, the Company committed to plans for the divestiture of two transportation related businesses and a machine components business previously included in the Specialty Products segment, two construction distribution businesses previously included in the Construction Products segment, and a chemical manufacturing business previously included in the Polymers & Fluids segment. These businesses were classified as held for sale beginning in the first quarter of 2013.

These held for sale businesses discussed above, as well as certain previously divested businesses, are reported as discontinued operations in the statement of income. All related prior period income statement information has been restated to conform to the current year reporting of these businesses. The Company has completed the divestiture of all of the businesses previously classified as discontinued operations. Refer to the Discontinued Operations note in Item 1 - Financial Statements for discussion of the Company’s discontinued operations.

Consolidated Results of Operations

The Company’s consolidated results of operations for the second quarter and year-to-date periods of 2014 and 2013 were as follows:
 
Three Months Ended
 
Six Months Ended
(Dollars in millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Operating revenues
$
3,719

 
$
3,593

 
$
7,288

 
$
7,013

Operating income
763

 
630

 
1,430

 
1,208

Operating margin %
20.5
%
 
17.5
%
 
19.6
%
 
17.2
%


12



In the second quarter and year-to-date periods of 2014, the changes in operating revenues, operating income and operating margins over the prior year were primarily due to the following factors:
 
Three Months Ended
 
Six Months Ended
 
June 30
 
June 30
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
Operating Revenues
 
Operating Income
 
Operating Margins
 
Operating Revenues
 
Operating Income
 
Operating Margins
Base business (organic):
 
 
 
 
 
 
 
 
 
 
 
Revenue change/Operating leverage
1.4
%
 
3.4
%
 
0.4
 %
 
2.3
%
 
5.9
%
 
0.6
 %
Changes in variable margins & overhead costs
%
 
13.7
%
 
2.3
 %
 
%
 
10.2
%
 
1.7
 %
 
1.4
%
 
17.1
%
 
2.7
 %
 
2.3
%
 
16.1
%
 
2.3
 %
Acquisitions and divestitures
1.2
%
 
0.7
%
 
(0.1
)%
 
1.3
%
 
0.6
%
 
(0.2
)%
Restructuring costs
%
 
2.3
%
 
0.4
 %
 
%
 
1.4
%
 
0.2
 %
Translation
0.9
%
 
1.1
%
 
 %
 
0.3
%
 
0.4
%
 
0.1
 %
Total
3.5
%
 
21.2
%
 
3.0
 %
 
3.9
%
 
18.5
%
 
2.4
 %

Operating Revenues

Operating revenues increased 3.5% and 3.9% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 primarily due to an increase in organic revenues, revenues from acquisitions and the favorable impact of currency translation. Total organic revenues increased 1.4% and 2.3% in the second quarter and year-to-date periods, respectively, as worldwide demand was mixed. International organic revenues grew 1.8% and 4.0% in the second quarter and year-to-date periods. Asia Pacific organic revenues increased 6.5% and 6.8% in the respective periods, primarily due to growth in Automotive OEM in China and Construction Products in Australia. European organic revenues increased 0.6% and 2.6% in the second quarter and year-to-date periods, respectively, primarily driven by the Automotive OEM and Test & Measurement and Electronics segments, partially offset by Welding. North American organic revenues increased 1.2% and 1.1% in the second quarter and year-to-date periods, respectively, as growth in the Automotive OEM, Food Equipment and Welding segments was partially offset by a decline in revenues in Polymers & Fluids due to ongoing product line and customer base simplification ("PLS") for each of the respective periods. The acquisitions of a European consumer packaging equipment business and a Chinese food equipment business completed in 2013 contributed 1.3% and 1.4% to revenues in the second quarter and year-to-date periods, respectively.

Operating Income

Operating income increased 21.2% and 18.5% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 primarily due to changes in variable margins and overhead costs, higher organic revenues and lower restructuring expenses. In the second quarter of 2013, the Company recognized a $34 million pre-tax pension settlement charge tied primarily to higher lump-sum pension payments related to the exit of Decorative Surfaces employees. Total base operating margins increased 270 and 230 basis points in the second quarter and year-to-date periods, respectively, due to changes in variable margins and overhead costs and the positive operating leverage effect of the increase in organic revenues. The changes in variable margins and overhead costs increased base margins by 230 and 170 basis points in the second quarter and year-to-date periods, respectively. The benefits of the Company's enterprise initiatives, business structure simplification and strategic sourcing, contributed 120 basis points of improvement in each respective period, and base margins were favorably impacted by 90 and 50 basis points in the respective periods due to the prior year pension settlement charge mentioned above. Lower restructuring expenses in the second quarter and year-to-date periods favorably impacted total operating margins by 40 and 20 basis points, respectively.

13




Results of Operations by Segment

Total operating revenues are as follows:
 
Three Months Ended
 
Six Months Ended
(In millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Automotive OEM
$
671

 
$
614

 
$
1,339

 
$
1,203

Test & Measurement and Electronics
558

 
542

 
1,077

 
1,062

Food Equipment
537

 
491

 
1,048

 
958

Polymers & Fluids
506

 
525

 
985

 
1,017

Welding
470

 
480

 
933

 
952

Construction Products
444

 
446

 
860

 
855

Specialty Products
540

 
506

 
1,060

 
987

Intersegment revenues
(7
)
 
(11
)
 
(14
)
 
(21
)
Total Operating Revenues
$
3,719

 
$
3,593

 
$
7,288

 
$
7,013


Total operating income is as follows:
 
Three Months Ended
 
Six Months Ended
(In millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Automotive OEM
$
158

 
$
126

 
$
314

 
$
243

Test & Measurement and Electronics
85

 
74

 
148

 
142

Food Equipment
105

 
92

 
200

 
170

Polymers & Fluids
99

 
96

 
179

 
168

Welding
124

 
128

 
243

 
250

Construction Products
81

 
61

 
142

 
109

Specialty Products
130

 
113

 
239

 
209

Unallocated
(19
)
 
(60
)
 
(35
)
 
(83
)
Total Operating Income
$
763

 
$
630

 
$
1,430

 
$
1,208


AUTOMOTIVE OEM

Businesses in this segment produce components and fasteners for automotive-related applications.

In the Automotive OEM segment, products and services include:

plastic and metal components, fasteners and assemblies for automobiles, light trucks, and other industrial uses.

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

The results of operations for the Automotive OEM segment for the second quarter and year-to-date periods of 2014 and 2013 were as follows:


14



 
Three Months Ended
 
Six Months Ended
(Dollars in millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Operating revenues
$
671

 
$
614

 
$
1,339

 
$
1,203

Operating income
158

 
126

 
314

 
243

Operating margin %
23.7
%
 
20.6
%
 
23.5
%
 
20.2
%

In the second quarter and year-to-date periods of 2014, the changes in operating revenues, operating income and operating margins over the prior year were primarily due to the following factors:
 
Three Months Ended
 
Six Months Ended
 
June 30
 
June 30
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
Operating Revenues
 
Operating Income
 
Operating Margins
 
Operating Revenues
 
Operating Income
 
Operating Margins
Base business (organic):
 
 
 
 
 
 
 
 
 
 
 
Revenue change/Operating leverage
7.8
%
 
14.2
%
 
1.2
%
 
10.3
%
 
19.0
%
 
1.6
%
Changes in variable margins & overhead costs
%
 
6.9
%
 
1.3
%
 
%
 
6.2
%
 
1.1
%
 
7.8
%
 
21.1
%
 
2.5
%
 
10.3
%
 
25.2
%
 
2.7
%
Acquisitions and divestitures
%
 
%
 
%
 
%
 
%
 
%
Restructuring costs
%
 
2.7
%
 
0.5
%
 
%
 
2.7
%
 
0.5
%
Translation
1.4
%
 
1.9
%
 
0.1
%
 
1.0
%
 
1.5
%
 
0.1
%
Total
9.2
%
 
25.7
%
 
3.1
%
 
11.3
%
 
29.4
%
 
3.3
%

Operating Revenues

Operating revenues increased 9.2% and 11.3% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 due to the increase in organic revenues and the favorable effect of currency translation. As a result of product penetration gains, worldwide automotive organic revenue grew 7.8% and 10.3% for the second quarter and year-to-date periods, respectively, exceeding worldwide auto builds, which grew 2% and 4% over the respective periods. North American automotive organic revenues grew 7.7% and 9.2% for the second quarter and year-to-date periods, respectively, as North American auto builds increased 4% versus each of the respective prior year periods. European organic revenue growth of 8.6% and 11.4% for the second quarter and year-to-date periods, respectively, exceeded auto build growth of 2% in the second quarter and 5% in the year-to-date period. Organic revenues for Asia Pacific increased 16.0% and 16.6% in the second quarter and year-to-date periods, respectively, primarily due to organic revenue increases in China of 22.2% and 24.9%, respectively, which exceeded Chinese auto build growth of 11% and 10% versus the respective prior year periods.

Operating Income

Operating income increased 25.7% and 29.4% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 due to higher organic revenues, changes in variable margins and overhead costs, lower restructuring expenses and the favorable impact of currency translation. Total base operating margins increased 250 and 270 basis points for the second quarter and year-to-date periods, respectively, due to the positive operating leverage effect of the increase in organic revenues of 120 and 160 basis points in the respective periods and changes in variable margins and overhead costs. The changes in variable margins and overhead costs increased base margins by 130 and 110 basis points in the second quarter and year-to-date periods, respectively, primarily driven by the benefits of the Company's enterprise initiatives, partially offset by unfavorable selling price versus material cost comparisons of 40 and 30 basis points in each respective period. Lower restructuring expenses increased total operating margins by 50 basis points in each respective period.


15



TEST & MEASUREMENT AND ELECTRONICS

Businesses in this segment produce equipment, consumables, and related software for testing and measuring of materials and structures, and equipment and consumables used in the production of electronic subassemblies and microelectronics.

In the Test & Measurement and Electronics segment, products 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 telecommunications, electronics, medical and transportation applications.

This segment primarily serves the general industrial market, which includes industrial capital goods, energy, and other general industrial markets, electronics, automotive original equipment manufacturers and tiers, and consumer durables markets.

The results of operations for the Test & Measurement and Electronics segment for the second quarter and year-to-date periods of 2014 and 2013 were as follows:

 
Three Months Ended
 
Six Months Ended
(Dollars in millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Operating revenues
$
558

 
$
542

 
$
1,077

 
$
1,062

Operating income
85

 
74

 
148

 
142

Operating margin %
15.2
%
 
13.7
%
 
13.8
%
 
13.4
%

In the second quarter and year-to-date periods of 2014, the changes in operating revenues, operating income and operating margins over the prior year were primarily due to the following factors:
 
Three Months Ended
 
Six Months Ended
 
June 30
 
June 30
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
Operating Revenues
 
Operating Income
 
Operating Margins
 
Operating Revenues
 
Operating Income
 
Operating Margins
Base business (organic):
 
 
 
 
 
 
 
 
 
 
 
Revenue change/Operating leverage
1.4
 %
 
4.7
 %
 
0.4
 %
 
0.5
 %
 
1.8
 %
 
0.2
 %
Changes in variable margins & overhead costs
 %
 
8.7
 %
 
1.2
 %
 
 %
 
4.5
 %
 
0.6
 %
 
1.4
 %
 
13.4
 %
 
1.6
 %
 
0.5
 %
 
6.3
 %
 
0.8
 %
Acquisitions and divestitures
(0.1
)%
 
0.2
 %
 
 %
 
(0.1
)%
 
0.3
 %
 
 %
Restructuring costs
 %
 
(2.0
)%
 
(0.3
)%
 
 %
 
(4.0
)%
 
(0.5
)%
Translation
1.4
 %
 
2.1
 %
 
0.2
 %
 
0.9
 %
 
1.4
 %
 
0.1
 %
Total
2.7
 %
 
13.7
 %
 
1.5
 %
 
1.3
 %
 
4.0
 %
 
0.4
 %

Operating Revenues
 
Operating revenues increased 2.7% and 1.3% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 primarily due to the increase in organic revenues and the favorable effect of currency translation. Organic revenues for the worldwide test and measurement businesses increased 5.5% and 2.2% in the second quarter and year-to-date periods, respectively, primarily due to improved North American demand in the second quarter. Worldwide electronics organic revenues decreased 2.8% and 1.2% in the second quarter and year-to-date periods, respectively, primarily due to 10.9% and 9.2%

16



declines in the electronic assembly businesses in the second quarter and year-to-date periods, respectively, resulting primarily from electronic assembly orders in 2013 that did not recur in the second quarter of 2014. Organic revenues for the other electronics businesses increased 1.2% and 2.5% in the second quarter and year-to-date periods, respectively.

Operating Income

Operating income increased 13.7% and 4.0% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 primarily due to changes in variable margins and overhead costs, higher organic revenues and the favorable effect of currency translation, partially offset by higher restructuring expenses. Total base operating margins increased 160 and 80 basis points in the second quarter and year-to-date periods, respectively, due to changes in variable margins and overhead costs and higher organic revenues. The changes in variable margins and overhead costs increased base margins by 120 and 60 basis points in the respective periods, primarily due to benefits resulting from the Company's enterprise initiatives, and favorable selling price versus material cost comparisons of 30 and 20 basis points, respectively. Higher restructuring expenses diluted total operating margins by 30 and 50 basis points in the second quarter and year-to-date periods, respectively.

FOOD EQUIPMENT

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

In the Food Equipment segment, products and services 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.

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

The results of operations for the Food Equipment segment for the second quarter and year-to-date periods of 2014 and 2013 were as follows:

 
Three Months Ended
 
Six Months Ended
(Dollars in millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Operating revenues
$
537

 
$
491

 
$
1,048

 
$
958

Operating income
105

 
92

 
200

 
170

Operating margin %
19.5
%
 
18.7
%
 
19.1
%
 
17.7
%


17



In the second quarter and year-to-date periods of 2014, the changes in operating revenues, operating income and operating margins over the prior year were primarily due to the following factors:
 
Three Months Ended
 
Six Months Ended
 
June 30
 
June 30
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
Operating Revenues
 
Operating Income
 
Operating Margins
 
Operating Revenues
 
Operating Income
 
Operating Margins
Base business (organic):
 
 
 
 
 
 
 
 
 
 
 
Revenue change/Operating leverage
3.4
%
 
8.4
 %
 
0.9
 %
 
4.3
%
 
11.1
%
 
1.2
 %
Changes in variable margins & overhead costs
%
 
(2.3
)%
 
(0.4
)%
 
%
 
2.8
%
 
0.4
 %
 
3.4
%
 
6.1
 %
 
0.5
 %
 
4.3
%
 
13.9
%
 
1.6
 %
Acquisitions and divestitures
4.1
%
 
3.1
 %
 
(0.2
)%
 
3.7
%
 
2.2
%
 
(0.3
)%
Restructuring costs
%
 
3.0
 %
 
0.5
 %
 
%
 
%
 
 %
Translation
2.0
%
 
2.2
 %
 
 %
 
1.4
%
 
1.7
%
 
0.1
 %
Total
9.5
%
 
14.4
 %
 
0.8
 %
 
9.4
%
 
17.8
%
 
1.4
 %

Operating Revenues

Operating revenues increased 9.5% and 9.4% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 primarily due to the increase in organic revenues, revenues from an acquisition and the favorable effect of currency translation. North American organic revenues increased 4.3% and 4.9% in the second quarter and year-to-date periods, respectively, as equipment revenues increased 3.6% and 4.9%, respectively, primarily due to growth associated with new product innovation in the refrigeration and cooking businesses. North American service revenues increased 4.8% and 4.9%, respectively. International organic revenues increased 2.6% and 3.9% in the second quarter and year-to-date periods, respectively, as equipment revenues increased 5.3% and 6.2%, respectively, primarily due to growth in warewash and refrigeration businesses from new product innovation. International service organic revenues declined 2.2% and 0.3% in the second quarter and year-to-date periods, respectively, primarily due to lower sales activity in France. The increase in revenues from acquisitions was due to the purchase of a Chinese food equipment business in the third quarter of 2013.

Operating Income

Operating income increased 14.4% in the second quarter of 2014 primarily due to higher organic revenues, income from an acquisition, lower restructuring expenses, and the favorable effect of currency translation, partially offset by changes in variable margins and overhead costs. Total base operating margins increased 50 basis points in the second quarter due to the positive operating leverage effect of the increase in organic revenues, partially offset by changes in variable margins and overhead costs. The changes in variable margins and overhead costs decreased base margins by 40 basis points in the second quarter primarily due to higher overhead expenses driven by higher research and development expenses, partially offset by the benefits of the Company's enterprise initiatives and favorable selling price versus material cost comparisons of 20 basis points. In the year-to-date period, operating income increased 17.8% due to higher organic revenues, changes in variable margins and overhead costs, income from an acquisition, and the favorable effect of currency translation. Total base operating margins increased 160 basis points in the year-to-date period due to the positive operating leverage effect of the increase in organic revenues and the changes in variable margins and overhead costs. In the year-to-date period, the changes in variable margins and overhead costs increased base margins by 40 basis points primarily driven by the benefits of the Company's enterprise initiatives and favorable selling price versus material cost comparisons of 20 basis points, partially offset by higher research and development expenses. Acquisitions diluted total operating margins by 20 and 30 basis points in the second quarter and year-to-date periods, respectively, primarily due to amortization expense related to intangible assets.

POLYMERS & FLUIDS

Businesses in this segment produce adhesives, sealants, lubrication and cutting fluids, janitorial and hygiene products, and fluids and polymers for auto aftermarket maintenance and appearance.


18



In the Polymers & Fluids segment, products 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.

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

The results of operations for the Polymers & Fluids segment for the second quarter and year-to-date periods of 2014 and 2013 were as follows:
 
Three Months Ended
 
Six Months Ended
(Dollars in millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Operating revenues
$
506

 
$
525

 
$
985

 
$
1,017

Operating income
99

 
96

 
179

 
168

Operating margin %
19.6
%
 
18.3
%
 
18.1
%
 
16.5
%

In the second quarter and year-to-date periods of 2014, the changes in operating revenues, operating income and operating margins over the prior year were primarily due to the following factors:
 
Three Months Ended
 
Six Months Ended
 
June 30
 
June 30
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
Operating Revenues
 
Operating Income
 
Operating Margins
 
Operating Revenues
 
Operating Income
 
Operating Margins
Base business (organic):
 
 
 
 
 
 
 
 
 
 
 
Revenue change/Operating leverage
(3.0
)%
 
(7.1
)%
 
(0.8
)%
 
(1.7
)%
 
(4.5
)%
 
(0.5
)%
Changes in variable margins & overhead costs
 %
 
10.3
 %
 
1.9
 %
 
 %
 
10.3
 %
 
1.6
 %
 
(3.0
)%
 
3.2
 %
 
1.1
 %
 
(1.7
)%
 
5.8
 %
 
1.1
 %
Acquisitions and divestitures
 %
 
(0.1
)%
 
 %
 
 %
 
(0.1
)%
 
 %
Restructuring costs
 %
 
0.1
 %
 
 %
 
 %
 
1.4
 %
 
0.2
 %
Translation
(0.5
)%
 
 %
 
0.2
 %
 
(1.4
)%
 
(1.0
)%
 
0.3
 %
Total
(3.5
)%
 
3.2
 %
 
1.3
 %
 
(3.1
)%
 
6.1
 %
 
1.6
 %

Operating Revenues

Operating revenues decreased 3.5% and 3.1% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 due to a decrease in organic revenues and the unfavorable effect of currency translation. Organic revenues declined 3.0% and 1.7% in the second quarter and year-to-date periods, respectively, primarily due to ongoing PLS activity. Organic revenues for the polymers businesses declined 6.2% and 7.1% for the respective periods. Organic revenues for the fluids and hygiene businesses decreased 3.3% in the second quarter, primarily due to weakness in Europe, and increased 0.3% in the year-to-date period. Organic revenues for the automotive aftermarket businesses declined 0.8% in the second quarter due to lower U.S. end market demand and increased 0.5% in the year-to-date period.


19



Operating Income

Operating income increased 3.2% and 6.1% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 primarily due to changes in variable margins and overhead costs and lower restructuring expenses, partially offset by declines in organic revenues. Total base operating margins increased 110 basis points in each respective period, primarily due to changes in variable margins and overhead costs, partially offset by the decline in organic revenues. The changes in variable margins and overhead costs increased base margins by 190 and 160 basis points in the second quarter and year-to-date periods, respectively, primarily due to lower overhead expenses resulting primarily from the benefits of the Company's enterprise initiatives. Lower restructuring expenses increased total operating margins by 20 basis points in the year-to-date period.
WELDING

Businesses in this segment produce arc welding equipment, consumables and accessories for a wide array of industrial and commercial applications.

In the Welding segment, products include:

arc welding equipment;
metal arc welding consumables and related accessories; and
metal jacketing and other insulation products.

This segment primarily serves the general industrial market, which includes the energy, fabrication, industrial capital goods and other general industrial markets, maintenance, repair and operations or “MRO”, and construction markets.

The results of operations for the Welding segment for the second quarter and year-to-date periods of 2014 and 2013 were as follows:
 
Three Months Ended
 
Six Months Ended
(Dollars in millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Operating revenues
$
470

 
$
480

 
$
933

 
$
952

Operating income
124

 
128

 
243

 
250

Operating margin %
26.3
%
 
26.5
%
 
26.0
%
 
26.2
%

In the second quarter and year-to-date periods of 2014, the changes in operating revenues, operating income and operating margins over the prior year were primarily due to the following factors:
 
Three Months Ended
 
Six Months Ended
 
June 30
 
June 30
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
Operating Revenues
 
Operating Income
 
Operating Margins
 
Operating Revenues
 
Operating Income
 
Operating Margins
Base business (organic):
 
 
 
 
 
 
 
 
 
 
 
Revenue change/Operating leverage
(1.8
)%
 
(2.8
)%
 
(0.3
)%
 
(1.9
)%
 
(3.0
)%
 
(0.3
)%
Changes in variable margins & overhead costs
 %
 
0.4
 %
 
0.1
 %
 
 %
 
1.8
 %
 
0.5
 %
 
(1.8
)%
 
(2.4
)%
 
(0.2
)%
 
(1.9
)%
 
(1.2
)%
 
0.2
 %
Acquisitions and divestitures
 %
 
 %
 
 %
 
0.6
 %
 
0.1
 %
 
(0.1
)%
Restructuring costs
 %
 
(0.1
)%
 
 %
 
 %
 
(1.1
)%
 
(0.3
)%
Translation
(0.2
)%
 
(0.3
)%
 
 %
 
(0.6
)%
 
(0.6
)%
 
 %
Total
(2.0
)%
 
(2.8
)%
 
(0.2
)%
 
(1.9
)%
 
(2.8
)%
 
(0.2
)%


20



Operating Revenues

Operating revenues decreased 2.0% and 1.9% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 due to a decline in organic revenues and the unfavorable effect of currency translation, partially offset by revenues from an acquisition in the year-to-date period. Organic revenues declined 1.8% and 1.9% in the second quarter and year-to-date periods, respectively. International organic revenues decreased 14.5% and 12.1% in the second quarter and year-to-date periods, respectively, primarily due to a delay in China oil and gas pipeline projects and continued PLS activity in Europe. North American welding organic revenues increased 3.7% and 2.4% in the second quarter and year-to-date periods, respectively, primarily due to strength in equipment sales to industrial and commercial customers. The increase from acquisition revenues in the year-to-date period was due to the purchase of a European supplier of welding consumables in the first quarter of 2013.

Operating Income

Operating income decreased 2.8% in the second quarter and year-to-date periods of 2014 versus 2013 primarily due to lower organic revenues, higher restructuring expenses and the unfavorable effect of currency translation, partially offset by changes in variable margins and overhead costs. Total base operating margins decreased 20 basis points in the second quarter and increased 20 basis points in the year-to-date period. Changes in variable margins and overhead costs increased base margins by 10 and 50 basis points in the second quarter and year-to-date periods, respectively, primarily due to favorable selling price versus material cost comparisons of 60 and 70 basis points, respectively, and the benefits of the Company's enterprise initiatives, partially offset by lower variable margins. Higher restructuring expenses diluted total operating margins by 30 basis points in the year-to-date period.

CONSTRUCTION PRODUCTS

Businesses in this segment produce construction fastening systems and truss products.

In the Construction Products segment, products 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.

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

The results of operations for the Construction Products segment for the second quarter and year-to-date periods of 2014 and 2013 were as follows:
 
Three Months Ended
 
Six Months Ended
(Dollars in millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Operating revenues
$
444

 
$
446

 
$
860

 
$
855

Operating income
81

 
61

 
142

 
109

Operating margin %
18.2
%
 
13.7
%
 
16.5
%
 
12.7
%


21



In the second quarter and year-to-date periods of 2014, the changes in operating revenues, operating income and operating margins over the prior year were primarily due to the following factors:
 
Three Months Ended
 
Six Months Ended
 
June 30
 
June 30
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
Operating Revenues
 
Operating Income
 
Operating Margins
 
Operating Revenues
 
Operating Income
 
Operating Margins
Base business (organic):
 
 
 
 
 
 
 
 
 
 
 
Revenue change/Operating leverage
0.4
 %
 
1.1
 %
 
0.1
%
 
2.4
 %
 
8.3
 %
 
0.7
 %
Changes in variable margins & overhead costs
 %
 
16.2
 %
 
2.2
%
 
 %
 
15.8
 %
 
2.0
 %
 
0.4
 %
 
17.3
 %
 
2.3
%
 
2.4
 %
 
24.1
 %
 
2.7
 %
Acquisitions and divestitures
(0.8
)%
 
(0.7
)%
 
%
 
(0.4
)%
 
(0.4
)%
 
 %
Restructuring costs
 %
 
15.7
 %
 
2.2
%
 
 %
 
9.4
 %
 
1.2
 %
Translation
 %
 
(0.8
)%
 
%
 
(1.4
)%
 
(2.8
)%
 
(0.1
)%
Total
(0.4
)%
 
31.5
 %
 
4.5
%
 
0.6
 %
 
30.3
 %
 
3.8
 %

Operating Revenues

Operating revenues were flat in the second quarter of 2014 versus 2013 due to divestitures, partially offset by a modest increase in organic revenues. Operating revenues increased 0.6% in the year-to-date period of 2014 versus 2013 due to a 2.4% increase in organic revenues, partially offset by the unfavorable effect of currency translation and divestitures. International organic revenues increased 1.4% and 4.2% in the second quarter and year-to-date periods, respectively. Asia Pacific organic revenues increased 7.9% and 10.7% in the respective periods, primarily due to stronger residential and commercial end market growth in Australia and New Zealand. European organic revenues decreased 4.1% and 1.5% in the respective periods, primarily due to weak commercial construction activity. North American organic revenues decreased 1.6% and 0.8% in the second quarter and year-to-date periods, respectively, as U.S. residential organic revenues declined 4.4% in the second quarter and increased 0.8% in the year-to-date period. U.S. renovation organic revenues grew 3.0% and 1.7%, respectively. U.S. commercial organic revenues increased 1.4% in the second quarter and decreased 2.9% in the year-to-date period.

Operating Income

Operating income increased 31.5% and 30.3% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 primarily due to changes in variable margins and overhead costs, lower restructuring expenses and higher organic revenues, partially offset by the unfavorable effect of currency translation. Total base operating margins increased 230 and 270 basis points in the second quarter and year-to-date periods, respectively, due to changes in variable margins and overhead costs and the positive operating leverage effect of the increase in organic revenues. The changes in variable margins and overhead costs increased base margins by 220 and 200 basis points in the second quarter and year-to-date periods, respectively, primarily due to lower overhead costs resulting from the benefits of the Company's enterprise initiatives, partially offset by unfavorable selling price versus material cost comparisons of 10 basis points in the year-to-date period. Lower restructuring expenses increased total operating margins by 220 and 120 basis points in the second quarter and year-to-date periods, respectively.

SPECIALTY PRODUCTS

Diversified businesses in this segment produce beverage packaging equipment and consumables, product coding and marking equipment and consumables, and appliance components and fasteners.

In the Specialty Products segment, products 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;

22



plastic and metal fasteners and components for appliances;
airport ground support equipment; and
components for medical devices.

This segment primarily serves the food and beverage, general industrial market, which includes industrial capital goods and other general industrial markets, consumer durables, and printing and publishing markets.

The results of operations for the Specialty Products segment for the second quarter and year-to-date periods of 2014 and 2013 were as follows:
 
Three Months Ended
 
Six Months Ended
(Dollars in millions)
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Operating revenues
$
540

 
$
506

 
$
1,060

 
$
987

Operating income
130

 
113

 
239

 
209

Operating margin %
24.2
%
 
22.4
%
 
22.6
%
 
21.2
%

In the second quarter and year-to-date periods of 2014, the changes in operating revenues, operating income and operating margins over the prior year were primarily due to the following factors:
 
Three Months Ended
 
Six Months Ended
 
June 30
 
June 30
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
% Increase (Decrease)
 
% Increase (Decrease)
 
% Point Increase (Decrease)
 
Operating Revenues
 
Operating Income
 
Operating Margins
 
Operating Revenues
 
Operating Income
 
Operating Margins
Base business (organic):
 
 
 
 
 
 
 
 
 
 
 
Revenue change/Operating leverage
%
 
%
 
 %
 
0.7
%
 
1.5
%
 
0.2
 %
Changes in variable margins & overhead costs
%
 
11.6
%
 
2.6
 %
 
%
 
7.7
%
 
1.6
 %
 
%
 
11.6
%
 
2.6
 %
 
0.7
%
 
9.2
%
 
1.8
 %
Acquisitions and divestitures
5.5
%
 
1.7
%
 
(0.9
)%
 
5.7
%
 
1.5
%
 
(1.0
)%
Restructuring costs
%
 
0.2
%
 
 %
 
%
 
2.7
%
 
0.6
 %
Translation
1.3
%
 
1.7
%
 
0.1
 %
 
1.0
%
 
1.4
%
 
 %
Total
6.8
%
 
15.2
%
 
1.8
 %
 
7.4
%
 
14.8
%
 
1.4
 %

Operating Revenues

Operating revenues increased 6.8% and 7.4% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 primarily due to an increase in acquisition revenues and the favorable effect of currency translation. Worldwide consumer packaging organic revenues were flat in the second quarter and increased 0.6% in the year-to-date period. Worldwide appliance organic revenues increased 1.3% and 0.4% in the second quarter and year-to-date periods, respectively. Worldwide ground support organic revenues increased 0.4% and 5.4% in the second quarter and year-to-date periods, respectively. Acquisition revenue was primarily due to the third quarter 2013 purchase of a European consumer packaging equipment business.

Operating Income

Operating income increased 15.2% and 14.8% in the second quarter and year-to-date periods of 2014, respectively, versus 2013 primarily due to changes in variable margins and overhead costs, and lower restructuring expenses in the year-to-date period. Total base operating margins increased 260 and 180 basis points in the second quarter and year-to-date periods, respectively, due to changes in variable margins and overhead costs in each of the respective periods and the positive operating leverage effect of the increase in organic revenues in the year-to-date period. The changes in variable margins and overhead costs increased base margins by 260 and 160 basis points in the second quarter and year-to-date periods, respectively, driven by the benefits of the Company's enterprise initiatives, partially offset by unfavorable selling price versus material cost comparisons of

23



30 and 40 basis points, respectively. Acquisitions diluted total operating margins by 90 and 100 basis points in the second quarter and year-to-date periods, respectively, primarily due to amortization expense related to intangible assets. Lower restructuring expenses increased total operating margins by 60 basis points in the year-to-date period.

AMORTIZATION OF INTANGIBLE ASSETS

Amortization expense for the year-to-date period ended June 30, 2014 remained flat at $122 million versus the year-to-date period ended