Eaton Corporation plc — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Eaton is a global power-management company. Financial amounts below are in U.S. dollars; millions unless stated otherwise.
Financial performance
| Metric | Q3 2017 | Q3 2016 | First 9 months 2017 | First 9 months 2016 |
|---|---|---|---|---|
| Net sales | $5,211 | $4,987 | $15,191 | $14,880 |
| Gross profit | $1,742 | $1,616 | $4,962 | $4,799 |
| Gross margin | 33.4% | 32.4% | 32.7% | 32.3% |
| Income before tax | $1,691 | $573 | $2,725 | $1,568 |
| Net income attributable to Eaton shareholders | $1,399 | $523 | $2,346 | $1,418 |
| Diluted EPS | $3.14 | $1.15 | $5.23 | $3.09 |
- Sales rose 4.5% in Q3, reflecting 3.5% organic growth and 1% favorable currency; nine-month sales grew 2%, all organic.
- Q3 and nine-month shareholder earnings included an after-tax $843 gain on the sale and fair-value remeasurement of the automated-transmission venture. The gain contributed $1.89 and $1.88 per diluted share, respectively; reported earnings growth therefore substantially reflects this unusual item.
- Excluding the transaction’s gain, the filing reports effective tax rates of 9.5% for Q3 and 8.8% for nine months, versus reported rates of 17.3% and 13.9%. Higher income in higher-tax jurisdictions increased the Q3 rate.
Segments and material comparisons
- Electrical Products: Q3 sales +5%; operating margin 18.6% versus 18.7%. Nine-month sales +3%; margin 17.8% versus 17.7%.
- Electrical Systems and Services: Q3 sales −1%; margin 13.8% versus 13.7%. Nine-month sales −1%; margin 13.1% versus 12.7%. Management cited softness in North American assembly markets.
- Hydraulics: Q3 sales +13%; margin 12.6% versus 10.9%. Nine-month sales +9%; margin 11.5% versus 9.5%, supported by stronger OEM and distribution demand.
- Aerospace: Q3 sales flat and margin declined to 19.2% from 20.2%. Nine-month sales −2% and margin 18.7% versus 18.9%, reflecting lower sales in several markets and unfavorable mix.
- Vehicle: Q3 sales +10%; margin 17.4% versus 15.5%. Nine-month sales +3%; margin 15.9% versus 15.6%. Q3 growth included strength in North American Class 8 trucks; reported sales also reflected the business sale.
Gross-margin improvement reflected volume, restructuring savings and lower restructuring charges, partly offset by commodity inflation and disruption from three hurricanes and the Mexico City earthquake.
Cash flow, balance sheet and capital
- Nine-month operating cash flow was $1,787, down from $1,932 in 2016, chiefly due to higher pension contributions. Capital expenditures were $351. Investing cash outflow was $435, including $621 of net short-term investment purchases and $600 sale proceeds.
- Financing cash outflow was $1,115. Eaton paid $803 in dividends and repurchased $789 of shares (10.7 million shares); Q3 repurchases were 4.4 million shares for $324.
- At September 30, cash was $791 and short-term investments $843, versus $543 and $203 at year-end 2016. Current assets were $8,449 and current liabilities $5,900.
- Total debt was approximately $8,772, comprising $5 short-term debt, $1,494 current maturities and $7,273 long-term debt, up from $8,277 at year-end. A subsidiary issued $1,000 of senior notes in September, in 2027 and 2047 tranches bearing 3.1% and 3.9% interest. Eaton reported compliance with debt covenants and no outstanding borrowings under its $2,000 revolving credit facilities.
- U.S. pension contributions were $370 through September; the company expected $375 for full-year 2017.
Outlook, commentary and risks
- No specific consolidated sales or EPS guidance is stated in the supplied filing text. Eaton expected 2017 restructuring charges of $100 and incremental savings of $155 from its multi-year restructuring program.
- Management said it believed cash, short-term investments, operating flexibility and capital-market access were sufficient for operating needs and scheduled debt payments.
- The company sold a 50% interest in its heavy- and medium-duty automated-transmission business to Cummins for $600 cash on July 31, 2017. Eaton retained a 50% interest, to be accounted for under the equity method. The $1,077 pretax gain included $544 from remeasuring the retained investment.
- Risks identified include market and customer demand changes, competition and pricing, material-cost inflation, natural disasters, litigation, tax exposure, interest rates, currency fluctuations and economic conditions. Eaton said market-risk exposures had not materially changed since year-end 2016.
- Pepsi-related arbitration commenced in October 2017; Eaton stated it believed the claims were without merit and expected no material financial impact. The company also disclosed Iran sales by non-U.S. subsidiaries under General License H: approximately €1.02 million revenue and €0.28 million net profit for the quarter.
- Eaton planned to adopt the new revenue standard in Q1 2018 using the modified retrospective approach and expected little difference in revenue recorded, though some revenue streams would shift to recognition over time. The impact of the new lease standard had not yet been estimated.
Important facts for investors to verify
- How much of earnings and EPS growth is attributable to the one-time Cummins venture gain versus recurring operating performance.
- Whether organic growth, segment margins and restructuring savings continue, particularly given softness in Electrical Systems and Services and Aerospace pressures.
- Cash conversion and pension funding: operating cash flow declined year over year as pension contributions increased.
- Debt maturities, interest costs, liquidity and the use of cash for dividends and share repurchases.
- Progress and accounting effects of revenue-standard adoption, and developments in the Pepsi arbitration and other disclosed legal and tax matters.