Eaton Corporation plc — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Amounts are in millions of U.S. dollars, except per-share data. Eaton is a global power-management company. It reorganized certain businesses and added eMobility as a reportable segment; historical segment data was recast, with no effect on consolidated results.
Financial performance and position
- Revenue and profitability: Net sales were $5,251, up 8% year over year, reflecting 6% organic growth and 3% favorable currency translation, partly offset by a 1% decline from divestitures. Gross profit was $1,678; gross margin improved to 32.0% from 31.8%. Income before taxes was $565 versus $467. Net income attributable to Eaton shareholders was $488 versus $434, and diluted EPS was $1.10 versus $0.96. Adjusted earnings, a non-GAAP measure, were also $488 versus $435; adjusted diluted EPS was $1.10 versus $0.96.
- Segments: Sales increased across all segments. Hydraulics grew 21% and Vehicle 14%; their operating margins rose to 12.7% and 14.8%, respectively. eMobility sales rose 22%, but operating margin declined to 14.3% from 17.5%, primarily due to higher R&D costs. Electrical Products, Electrical Systems and Services, and Aerospace margins also improved.
- Cash flow: Operating cash flow was $339, down from $463, primarily because of higher working capital balances. Investing cash outflow was $137 versus $229; financing cash outflow was $443 versus $563. Capital expenditures were $131. Cash declined by $244 during the quarter to $317.
- Liquidity and debt: Cash and short-term investments totaled $827 at quarter-end, versus $1,095 at December 31, 2017. Total debt, including short-term debt and current maturities, was $7,877, compared with $7,751 at year-end. Eaton reported no borrowings under its $2,000 revolving credit facilities and said it was in compliance with debt covenants and had adequate liquidity for operating needs and scheduled debt payments.
- Capital returns: Eaton paid $284 in dividends and repurchased 3.7 million shares for $300. The declared dividend was $0.66 per share, up from $0.60 in Q1 2017.
Changes, outlook, and notable matters
- Management attributed earnings growth mainly to higher sales volumes and restructuring savings, partly offset by a higher tax rate. The effective tax rate was 13.8%, compared with 7.0%; the change reflected the U.S. Tax Cuts and Jobs Act and a foreign deferred tax asset realization in Q1 2017.
- Management provided no specific full-year financial guidance in the supplied filing text. Backlog was approximately $5.2 billion, with about 88% expected to be recognized within 12 months; orders are not necessarily firm unless customers are committed.
- Revenue standard ASC 606 was adopted using the modified retrospective approach and had no material overall impact. For Q1, the filing’s comparison indicates adoption increased reported net sales by $7 and net income by $2 relative to amounts without adoption. Adoption of ASU 2016-16 reduced retained earnings by $199. Eaton was evaluating the impact of the new lease standard and planned adoption in Q1 2019; an impact estimate was not yet available.
- A Pepsi-related arbitration concerning a historical settlement was awaiting a decision. Pepsi’s experts alleged approximately $440 of value shortfall; Eaton disputed the claims and said resolution was not expected to materially affect its financial statements. Eaton also disclosed asbestos and other legal matters, which management did not expect to have a material adverse effect.
- Risk factors were unchanged from the 2017 Form 10-K, and the company reported no material change in market-risk exposures. Forward-looking results remain subject to demand, pricing, input costs, competition, currency and interest-rate changes, taxes, litigation, and other risks.
- Under its Section 13(r) disclosure, non-U.S. subsidiaries reported Q1 sales to customers in Iran of approximately €877,115 and net profits of approximately €336,919. Eaton stated it had no assets or employees in Iran and that subsidiaries intended to continue permitted activity under General License H in compliance with applicable sanctions and export-control laws.
Key facts for investors to verify
- Whether working-capital use and weaker operating cash flow persisted beyond Q1.
- Whether sales growth, segment margin improvement, and the eMobility margin trend continued.
- The effect of tax-law adjustments and the finalization of provisional TCJA amounts.
- Debt maturities, liquidity availability, and the company’s continued compliance with covenants.
- The outcome of the Pepsi arbitration and developments in other legal contingencies.
- Whether backlog converts as expected, and the potential balance-sheet effect of lease-standard adoption.