Eaton Corporation plc — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Amounts are in millions of dollars except per-share data. Eaton is a diversified power-management company. Results include the acquired Cooper businesses beginning November 30, 2012, making year-over-year comparisons materially affected by acquisition timing.
Financial results
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $5,602 | $4,068 | $10,912 | $8,028 |
| Gross profit / margin | $1,732 / 30.9% | $1,253 / 30.8% | $3,307 / 30.3% | $2,459 / 30.6% |
| Income before taxes | $534 | $419 | $934 | $787 |
| Net income attributable to Eaton shareholders | $494 | $382 | $872 | $693 |
| Diluted EPS | $1.04 | $1.12 | $1.83 | $2.04 |
| Management-defined operating earnings and diluted EPS, excluding acquisition integration charges and transaction costs | $519 / $1.09 | $392 / $1.15 | $919 / $1.93 | $705 / $2.08 |
Sales rose 38% in Q2 and 36% year to date, primarily from acquisitions; core sales declined 2% and 3%, respectively. Shareholder net income increased 29% in Q2 and 26% year to date, while diluted EPS fell 7% and 10%. Eaton attributed the per-share decline principally to shares issued for Cooper and acquisition-related purchase-accounting charges. The diluted weighted-average share count increased to 476.3 million in Q2 from 339.5 million.
Net cash from operations was $709 for the first six months, versus $371 in 2012. Working-capital changes used $647, compared with $444 used in the prior-year period. Investing activities provided $606, including $761 of proceeds from the Apex Tool Group sale; capital expenditures were $251. Financing activities used $1,250, including $977 of debt repayments and $397 of dividends paid. Cash ended the period at $628, with short-term investments of $368.
At June 30, short-term debt was $115, current long-term debt $575, and long-term debt $9,069; total debt was $9,759. The company had $2,000 of revolving credit facilities with no borrowings outstanding and reported compliance with debt covenants. Approximately 87% of cash and short-term investments were held outside the U.S. and considered permanently reinvested.
Business segments and material changes
| Segment | Q2 sales | Q2 operating profit / margin | Management’s 2013 market outlook |
|---|---|---|---|
| Electrical Products | $1,758, up 95% | $272 / 15.5%; before integration charges, $284 / 16.2% | Growth of 1.5% |
| Electrical Systems and Services | $1,624, up 78% | $227 / 14.0%; before integration charges, $238 / 14.7% | Growth of 1% |
| Hydraulics | $772, approximately flat | $104 / 13.5%; before integration charges, $112 / 14.5% | Decline of 5% |
| Aerospace | $446, up 2% | $67 / 15.0% | Growth of 3% |
| Vehicle | $1,002, down 4% | $172 / 17.2% | Growth of 1% |
Electrical segment growth mainly reflects Cooper and other acquired businesses. Electrical Products margins before integration charges declined year over year, while Electrical Systems and Services margins improved, largely reflecting acquired-business mix. Hydraulics profitability weakened with lower core demand; Vehicle sales were affected by lower NAFTA Class 8 truck volumes. Eaton forecast overall 2013 end-market growth of 1%, citing subdued global economic conditions. It did not provide a full-year earnings or EPS forecast in the supplied filing text.
Outlook, risks, and unusual items
- Q2 acquisition integration charges and transaction costs totaled $39 pretax ($25 after tax); the six-month totals were $70 pretax ($47 after tax). Integration charges included $17 of 2013 restructuring costs; restructuring liabilities were $36 at June 30. Integration initiatives were expected to continue in the second half of 2013.
- Cooper purchase-price allocation remained under evaluation. Further valuation changes could materially affect results and financial position. Q2 adjustments primarily affected intangible assets, goodwill, property values, and deferred taxes.
- Effective tax rates were 7.0% for Q2 and 6.1% for the first six months, versus 8.7% and 11.9%. Eaton cited research-credit reinstatement, Cooper-related effects, and foreign tax-credit utilization.
- Legal matters include a Brazilian judgment with a recorded $32 liability; Eaton said any payment was not expected to exceed that accrual. In the Meritor antitrust case, potential loss could not be estimated. The IRS proposed $75 in additional tax and $52 in penalties for 2005–2006; the company contests the assessment, and the Tax Court ruled that the IRS could unilaterally cancel the relevant advance pricing agreements. Eaton said it believed ultimate resolution would not materially affect its financial statements.
- The company reported no material changes in market-risk exposures or risk factors from its 2012 Form 10-K. Management concluded disclosure controls were effective at June 30, 2013.
Important facts for investors to verify
- How much reported sales and earnings growth reflects Cooper and other acquisitions versus underlying core demand, and whether integration delivers expected efficiencies.
- Whether the 2013 end-market forecasts are consistent with subsequent demand, particularly in Hydraulics, Vehicle, and weaker European and Asia-Pacific markets.
- How acquisition accounting, intangible amortization, integration costs, and the larger share count affect sustainable margins and per-share earnings.
- Developments in the IRS transfer-pricing dispute and the Meritor and Brazilian legal matters, including any change to recorded liabilities or loss estimates.
- Cash availability and debt-service capacity, considering the concentration of cash outside the U.S., debt maturities, working-capital needs, and continued dividend payments.