Eaton Corporation plc — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. The filing also provides unaudited quarterly data, including fourth-quarter results; it is an annual report, not a standalone Q4 filing.
Business context
Eaton is a global power-management company operating in electrical products and systems, hydraulics, aerospace, and vehicle markets. It reported approximately 102,000 employees and operations in more than 60 countries. The year-over-year comparison is substantially affected by the Cooper Industries acquisition, completed November 30, 2012: Cooper was included for only December in 2012 but for all of 2013.
Key financial results
Amounts are in millions of U.S. dollars except per-share data and percentages.
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Net sales | $22,046 | $16,311 | +35% |
| Gross profit | $6,677 | $4,863 | +37% |
| Gross margin | 30.3% | 29.8% | +0.5 percentage points |
| Income before taxes | $1,884 | $1,251 | +51% |
| Net income attributable to Eaton shareholders | $1,861 | $1,217 | +53% |
| Diluted earnings per share | $3.90 | $3.46 | +13% |
| Operating cash flow | $2,285 | $1,664 | +$621 |
| Capital expenditures | $614 | $593 | +$21 |
- Management reported flat core sales growth in 2013; acquisitions added 36% to sales, while currency translation reduced sales by 1%. Thus, headline revenue growth primarily reflects the acquisition rather than underlying market expansion.
- Management-defined operating earnings were $1,971, or $4.13 per diluted share, excluding after-tax acquisition integration charges and transaction costs of $110, or $0.23 per share. These are non-GAAP measures; GAAP net income attributable to shareholders was $1,861.
- Cash flow less capital expenditures was approximately $1,671 in 2013, compared with $1,071 in 2012. This is a simple calculation from reported operating cash flow and capital expenditures, not a company-reported measure.
- Cash was $915 and short-term investments were $794 at year-end. Total debt was $9,549, including current debt; the reported net-debt-to-capital ratio fell to 31.8% from 39.2%.
- Current assets were $8,731 and current liabilities were $4,914. Eaton reported no borrowings under its $2.0 billion revolving credit facilities at year-end and said it was in compliance with debt covenants.
- Cash dividends declared were $1.68 per share, up from $1.52 in 2012. Cash dividends paid totaled $796.
Segments and changes versus prior periods
| Segment | 2013 sales | 2013 operating profit | 2013 reported margin | Notable comparison |
|---|---|---|---|---|
| Electrical Products | $7,026 | $1,090 | 15.5% | Sales +83%, largely reflecting Cooper; margin was affected by product mix. |
| Electrical Systems and Services | $6,430 | $889 | 13.8% | Sales +66%, largely acquisition-related; segment margin improved. |
| Hydraulics | $2,981 | $355 | 11.9% | Sales +1%; lower core demand contributed to lower reported profit. |
| Aerospace | $1,774 | $252 | 14.2% | Sales +3%; commercial-market strength partly offset weaker military demand. |
| Vehicle | $3,835 | $592 | 15.4% | Sales −2%; flat core sales were offset by currency effects. |
- 2013 net income growth also benefited from a 0.6% effective tax rate, versus 2.5% in 2012 and 12.9% in 2011. Eaton cited acquisition-related effects, earnings mix in lower-tax jurisdictions, foreign tax credits, and U.S. research credits. The unusually low rate is not a measure of the underlying pretax growth alone.
- Acquisition integration charges were $154 in 2013, versus $44 in 2012; transaction costs were $9, versus $178. The 2013 integration charges related primarily to Cooper and SEL, and integration and restructuring initiatives were expected to continue through 2015.
- Total debt declined from $10,836 at year-end 2012 to $9,549 at year-end 2013. Eaton repaid the remaining $669 Cooper bridge-facility borrowing in February 2013.
Outlook, risks and unusual items
- As of early February 2014, management expected 2014 end-market growth of 3% overall: 3% for each electrical segment, Hydraulics, and Aerospace, and 4% for Vehicle. These are market-growth expectations, not explicit company revenue or EPS guidance. Capital expenditures of approximately $700 were expected in 2014.
- On January 20, 2014, Eaton agreed to sell its Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses to Safran for $270, subject to approvals and customary closing conditions; closing was expected early in Q2 2014.
- Key business risks include cyclical end markets, competition and pricing, raw-material availability and costs, customer concentration in certain segments, acquisition integration and realization of Cooper synergies, currency and interest-rate exposure, cybersecurity and operational disruptions, and tax or regulatory changes. Although no customer exceeded 10% of consolidated sales, several large customers or distributors account for notable shares of individual segment sales.
- Material litigation remains unresolved. In the Meritor antitrust case, plaintiffs’ expert estimated damages of $475–$800, while Eaton’s expert estimated zero; the court permitted the plaintiffs’ expert to testify, and a damages trial was expected in 2014. Eaton said potential loss could not be estimated. The Frisby parties claimed damages of at least $376, which Eaton disputes; potential loss also could not be estimated.
- Environmental remediation liabilities were accrued at $149. Eaton stated that environmental costs were not reasonably expected to exceed the accrual by an amount material to its financial position, results, or cash flows.
- Gross unrecognized tax benefits were $479, with approximately $114 accrued for interest and penalties. The IRS transfer-pricing dispute concerning 2005–2006 proposed $75 of additional tax and $52 of penalties; litigation was ongoing. Management said it believed ultimate resolution would not materially affect the consolidated financial statements.
- Management and Ernst & Young reported effective internal control over financial reporting, and the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Separate acquisition-driven growth from organic performance: confirm Cooper’s full-year contribution and evaluate flat consolidated core sales alongside segment trends.
- Assess the quality and durability of earnings, particularly the 0.6% effective tax rate, acquisition-related costs, integration progress, and the reported margin changes.
- Review debt maturities, interest costs, pension funding needs, and liquidity; scheduled 2014 long-term debt maturities were $567, and management expected pension contributions of $362 in 2014.
- Monitor outcomes and any updated loss estimates for the Meritor and Frisby litigation, as well as the IRS tax dispute and other tax examinations.
- Confirm the Safran divestiture’s completion, proceeds, and effects on continuing operations, and track whether management’s 2014 market-growth expectations translate into Eaton sales and earnings.