Eaton Corporation plc — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Eaton is a global power-management company. Amounts are in U.S. dollars; financial figures are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $5,533 | $5,487 | $10,838 | $10,738 |
| Gross profit margin | 33.2% | 33.1% | 32.9% | 32.5% |
| Net income attributable to Eaton shareholders | $636 | $610 | $1,158 | $1,098 |
| Diluted EPS | $1.50 | $1.39 | $2.73 | $2.50 |
| Adjusted earnings per share | $1.53 | $1.39 | $2.79 | $2.50 |
Q2 sales rose 1%, reflecting 2.5% organic growth offset by 1.5% unfavorable currency translation. First-half sales also rose 1%, with 3% organic growth offset by 2% currency impact. Gross margin gains were attributed mainly to volume and operating improvements in Electrical Products and Electrical Systems and Services, and favorable Aerospace mix. The effective tax rate rose to 13.9% in Q2 and 13.7% for the first half, from 12.0% and 12.8%, respectively, due to a greater share of income in higher-tax jurisdictions.
Adjusted earnings and adjusted EPS are non-GAAP measures. They exclude acquisition integration and divestiture charges, primarily related to the planned Lighting spin-off and Ulusoy Elektrik acquisition: $14 million after tax, or $0.03 per diluted share, in Q2; $25 million, or $0.06 per share, for the first half.
Segment developments
- Electrical Products: Q2 sales +2%; operating margin 19.5%, up from 18.5%.
- Electrical Systems and Services: Q2 sales +5%; margin 17.4%, up from 15.0%, supported by industrial projects and commercial construction.
- Aerospace: Q2 sales +12%; margin 24.6%, up from 19.4%, reflecting commercial-market growth, volume and favorable mix.
- Hydraulics: Q2 sales -3%; margin 11.5%, down from 14.0%, with unfavorable mix and operating inefficiencies cited.
- Vehicle: Q2 sales -11%; margin 16.9%, down from 18.5%, amid global light-vehicle weakness and revenue transfers to the Eaton Cummins joint venture.
- eMobility: Q2 sales +1%; margin 8.3%, down from 16.9%, primarily due to increased R&D costs.
Cash flow, liquidity and debt
- First-half operating cash flow was $1,431, up from $838 a year earlier, attributed to higher net income and lower working-capital use.
- Investing cash outflow was $710, including $298 of capital expenditures, $243 paid for an acquisition and $221 of net purchases of short-term investments.
- Financing cash outflow was $599; the company paid $609 in dividends and repurchased $440 of shares.
- At June 30, cash was $412 and short-term investments were $385. Current assets were $8,126 versus current liabilities of $4,450.
- Total debt was approximately $8,086, comprising $2 short-term debt, $5 current long-term debt and $8,079 long-term debt; long-term debt was $6,768 at year-end 2018. The increase followed a May euro-note issuance of €1.1 billion, with maturities in 2021 and 2025 and coupon rates of 0.02% and 0.70%.
- No borrowings were outstanding under the $2 billion revolving credit facilities at quarter-end. Eaton reported covenant compliance and said it believed liquidity and capital-market access were sufficient for operating needs and scheduled debt payments.
Business changes, outlook and risks
- Eaton completed the acquisition of an 82.275% controlling interest in Turkey-based Ulusoy Elektrik on April 15 for approximately $214 million. Ownership rose to 93.7% after additional tender-offer purchases through July.
- After quarter-end, Eaton acquired Innovative Switchgear Solutions on July 19. On July 22, it committed to acquire Souriau-Sunbank for $920 million, subject to approvals and other closing conditions; closing was expected by year-end 2019.
- Eaton planned a tax-free spin-off of its Lighting business, expected by year-end 2019, and announced plans to sell its Automotive Fluid Conveyance business.
- Backlog was approximately $5.5 billion at June 30, versus $5.3 billion at year-end 2018; Eaton expected to recognize about 87% within the next twelve months. The filing provides no clear full-year earnings or sales guidance.
- In a long-running tax dispute, the Tax Court granted the IRS partial summary judgment on a controlled-foreign-corporation income issue. Eaton intended to appeal and said it believed it would succeed; it recorded no additional financial-statement impact. A separate transfer-pricing issue remained unresolved, and the potential impact was not estimable.
- Eaton paid $297 million in November 2018 in connection with an arbitration award in the Pepsi/Cooper dispute; its appeal was dismissed in April 2019. The company said its broader legal matters were not expected to have a material adverse effect, while noting outcomes cannot be predicted with certainty.
- The filing identified market demand, customer purchasing, competition and pricing, input costs, acquisitions and divestitures, regulation, taxes, currencies, litigation and economic conditions among forward-looking risks. It reported no material change in risk factors from the 2018 Form 10-K or in market-risk exposures since year-end.
Important facts for investors to verify
- Whether sales, backlog conversion and operating cash flow remain resilient, especially if working-capital patterns change.
- Whether weakness and margin pressure in Hydraulics, Vehicle and eMobility persist, and whether stronger Electrical and Aerospace results continue.
- Execution, financing and closing conditions for the Souriau-Sunbank acquisition, as well as the planned Lighting spin-off and Automotive Fluid Conveyance sale.
- Developments in the IRS tax litigation and the unresolved transfer-pricing matter, including any eventual financial exposure.
- Debt levels, cash deployment, and the pace of share repurchases under the $5 billion authorization; first-half repurchases totaled $440 million.