Eaton Corporation plc — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Financial amounts are in millions of dollars except per-share data. Eaton is a global power-management company. Results are substantially affected by the November 2012 acquisition of Cooper Industries, so year-over-year revenue comparisons include a significant acquisition impact.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $5,607 | $3,950 | $16,519 | $11,978 |
| Gross profit | $1,724 | $1,203 | $5,031 | $3,662 |
| Gross margin | 30.7% | 30.5% | 30.5% | 30.6% |
| Income before taxes | $521 | $376 | $1,455 | $1,163 |
| Net income attributable to Eaton shareholders | $510 | $345 | $1,382 | $1,038 |
| Diluted earnings per share | $1.07 | $1.02 | $2.90 | $3.05 |
| Operating cash flow | — | — | $1,413 | $977 |
- Q3 sales rose 42%; management attributed 40 percentage points to acquisitions, with core sales up 3% and currency reducing sales 1%. Nine-month sales rose 38%, reflecting acquisitions (+40 percentage points), lower core sales (−1%) and currency (−1%).
- Q3 net income attributable to Eaton shareholders increased 48%; nine-month net income increased 33%. Diluted EPS rose 5% in Q3 but fell 5% for the nine-month period, reflecting Cooper-related share issuance and purchase-accounting charges, among other factors.
- Management’s non-GAAP operating earnings were $536 million, or $1.12 per diluted share, in Q3 and $1,455 million, or $3.05 per diluted share, for nine months. These exclude after-tax acquisition integration charges and transaction costs; GAAP results are shown above.
- Operating cash flow increased $436 million year over year for the first nine months, primarily from higher earnings and lower pension contributions, partly offset by higher working-capital needs, including those associated with Cooper. Investing activities provided $143 million, including $761 million from the Apex Tool Group sale. Financing activities used $1,485 million, mainly for debt repayments and dividends.
Liquidity, debt and balance sheet
- At September 30, cash was $642 million and short-term investments were $698 million. Current assets were $8,766 million and current liabilities $5,054 million (a calculated current ratio of approximately 1.73).
- Total debt was approximately $9,693 million: $88 million short-term, $576 million current maturities and $9,029 million long-term. Debt declined from $10,833 million at December 31, 2012. Cash plus short-term investments exceeded $1.3 billion.
- Working-capital changes used $813 million of cash during the first nine months. Capital expenditures were $372 million. Cash dividends paid were $597 million.
- The company reported no borrowings under its $2.0 billion revolving credit facilities and stated it was in compliance with debt covenants. Approximately 65% of cash and short-term investments were held outside the U.S. and considered permanently reinvested; Eaton said it did not expect significant repatriations in the foreseeable future.
Segment results and outlook
- Electrical Products: Q3 sales were $1,817 million, up 98%, primarily due to acquisitions; pre-integration operating margin was 17.1%, down from 18.8%, largely due to product mix. 2013 market growth forecast: 1%.
- Electrical Systems and Services: Q3 sales were $1,639 million, up 80%; pre-integration margin rose to 14.7% from 12.3%. 2013 market growth forecast: 1.5%.
- Hydraulics: Q3 sales were $739 million, down 3%; pre-integration margin was 13.1%, versus 12.8%. Management forecast 2013 market decline of 6%.
- Aerospace: Q3 sales were $448 million, up 7%, and operating margin rose to 14.3% from 11.7%; management forecast 2013 market growth of 3%.
- Vehicle: Q3 sales were $964 million, up 3%, and operating margin rose to 16.7% from 15.3%; management forecast flat markets for 2013.
- Management expected overall 2013 end markets to be flat, citing subdued global economic conditions. Productivity helped keep consolidated gross margin broadly stable.
Notable items, risks and contingencies
- The effective tax rate was 1.4% in Q3 and 4.4% for nine months, compared with 7.7% and 10.6%, respectively, in 2012. Eaton attributed the lower rates to Cooper-related tax effects, research-credit treatment and increased use of foreign tax credits.
- Cooper acquisition integration charges and transaction costs totaled $38 million before tax in Q3 and $108 million for nine months. The Cooper purchase-price allocation remained under evaluation; further adjustments could materially affect results or financial position. Acquired Cooper goodwill was not tax-deductible.
- Goodwill was $14,276 million at quarter-end. Eaton’s 2013 quantitative impairment test found reporting-unit fair values substantially above carrying amounts, but the valuation depends on estimates and assumptions.
- Legal exposures include a Brazilian judgment-related matter with a recorded liability of $33 million; Eaton said any payment was not expected to exceed the accrual. Potential loss in the Meritor antitrust case and claims by the Frisby parties could not be estimated. The company said other proceedings were not expected to have a material adverse effect.
- An IRS dispute concerns proposed assessments of $75 million in taxes plus $52 million in penalties for 2005–2006 transfer pricing. The Tax Court ruled the IRS could unilaterally cancel the relevant advance pricing agreements and placed the burden on Eaton to prove abuse of discretion. Eaton disagreed and stated it did not expect a material financial-statement impact.
- Management identified risks including market and economic weakness, customer demand, pricing and input costs, acquisition integration, litigation, tax exposure, interest rates and currency movements. It reported no material change in market-risk exposures and no material change in internal control over financial reporting.
Important facts for investors to verify
- How much reported growth and future earnings are attributable to Cooper versus organic demand, and whether segment margins improve as integration proceeds.
- Whether the flat overall 2013 market outlook and segment forecasts were achieved, especially the projected Hydraulics contraction.
- Cash conversion and working-capital trends, along with debt maturities, repayment capacity and the location and availability of cash held outside the U.S.
- Final Cooper purchase accounting, integration costs and any effects on goodwill, amortization or reported earnings.
- Developments in the IRS transfer-pricing dispute, Meritor and Frisby litigation, and the adequacy of related recorded liabilities.