Eaton Corporation plc — 2018 Form 10-K
Business context and reporting period
Annual report for the year ended December 31, 2018; figures below are in U.S. dollars unless noted. Eaton is a global power-management company with approximately 99,000 employees, operations in 59 countries, and 2018 sales of $21.6 billion. Its six reportable segments are Electrical Products, Electrical Systems and Services, Hydraulics, Aerospace, Vehicle, and eMobility. The audited financial statements received an unqualified opinion; the auditor also concluded internal control over financial reporting was effective.
Financial performance
| Metric | 2018 | 2017 |
|---|---|---|
| Net sales | $21.609 billion | $20.404 billion |
| Gross profit / margin | $7.098 billion / 32.8% | $6.648 billion / 32.6% |
| Income before taxes | $2.424 billion | $3.368 billion |
| Net income attributable to Eaton shareholders | $2.145 billion | $2.985 billion |
| Diluted EPS | $4.91 | $6.68 |
| Operating cash flow | $2.658 billion | $2.666 billion |
| Capital expenditures | $565 million | $520 million |
| Cash dividends declared per share | $2.64 | $2.40 |
Operating cash flow less capital expenditures was approximately $2.093 billion in 2018 (calculated). Cash and short-term investments totaled $440 million at year-end, compared with $1.095 billion in 2017. Total debt was $7.521 billion, down from $7.751 billion; this includes $414 million of short-term debt, $339 million of current long-term debt, and $6.768 billion of long-term debt. Current assets were $7.590 billion and current liabilities $5.154 billion. Eaton had $2.0 billion of revolving credit facilities with no borrowings outstanding.
Segment sales increased year over year across all six segments. Hydraulics grew 12%, Aerospace 9%, Electrical Systems and Services 6%, Vehicle 5%, Electrical Products 3%, and eMobility 13%. Segment operating margins rose in five segments; eMobility’s margin declined to 13.8% from 17.7%, primarily due to higher research and development costs. Consolidated segment operating profit was $3.630 billion, versus $3.214 billion.
Material changes versus 2017 and fourth-quarter results
- Sales rose 6%, reflecting 6% organic growth, with higher volumes in all segments. Gross margin improved to 32.8% from 32.6%, supported by volume and restructuring savings, partly offset by commodity inflation and higher freight costs.
- Reported shareholder net income fell 28% and diluted EPS fell 26%. 2018 included a $275 million pretax arbitration expense ($206 million after tax; $0.48 per share). 2017 included an $843 million after-tax gain on the sale of a 50% interest in the automated-transmission business and a $62 million tax benefit from U.S. tax reform; these items make reported year-over-year earnings less comparable.
- Fourth-quarter 2018 sales were $5.459 billion, versus $5.213 billion in fourth-quarter 2017. Shareholder net income was $631 million versus $634 million, and diluted EPS was $1.46 versus $1.43.
- Cash from operations was broadly flat. Financing cash use increased to $2.581 billion, including $1.271 billion of share repurchases and $1.149 billion of dividends. Shares outstanding declined to 423.6 million from 439.9 million.
Outlook, risks, contingencies, and unusual items
- No earnings or sales guidance is provided in the supplied filing text. Eaton expected approximately $600 million of 2019 capital expenditures and $116 million of 2019 pension contributions. Backlog was approximately $5.3 billion at year-end, with about 87% expected to be recognized within 12 months; management cautions backlog is not necessarily indicative of future results.
- On February 27, 2019, the Board declared a quarterly dividend of $0.71 per share, an 8% increase from the fourth-quarter 2018 dividend. On January 31, 2019, Eaton agreed to acquire an 82.275% interest in Ulusoy Elektrik for approximately $214 million, subject to customary closing conditions and approvals.
- The $293 million arbitration award was paid, together with accrued interest, in November 2018; Eaton appealed and the appeal remained pending. The award reduced 2018 earnings by $0.48 per share. The filing also discloses that the IRS received a favorable partial-summary-judgment ruling in February 2019 on a contested tax issue; Eaton intended to appeal and was assessing the financial-statement impact. Gross unrecognized tax benefits were $913 million, plus $74 million of accrued interest and penalties.
- Environmental remediation accruals were $116 million at year-end; Eaton reported involvement at 113 sites and did not expect environmental matters to exceed the recorded liability by a material amount. Other legal claims, including asbestos-related claims, are described in the filing; management did not expect them to have a material adverse effect, while noting outcomes cannot be predicted with certainty.
- Key disclosed risks include end-market volatility, customer and pricing pressures, raw-material cost or supply changes, tariffs and currency movements, cyber and IT security incidents, global operational disruptions, technology and product transitions, tax exposures, and litigation. The company reported approximately $933,000 of fourth-quarter revenue and $305,000 of net profit from sales by non-U.S. subsidiaries to Iran and said it would take no future orders from Iran.
- Adoption of the new lease standard in first-quarter 2019 was expected to add approximately $400–$500 million of operating lease assets and liabilities, with no material effect on income or cash flows. Eaton reported no off-balance-sheet arrangements with unconsolidated entities.
Important facts for investors to verify
- Separate recurring operating performance from the 2018 arbitration charge and the 2017 business-sale gain and tax items when comparing earnings and EPS.
- Monitor the pending arbitration appeal and the IRS tax litigation, including any subsequent changes to reserves or reported tax expense.
- Assess cash and short-term investment balances alongside debt maturities, planned capital spending, dividends, and share repurchases.
- Track eMobility profitability and whether its sales growth can offset continued investment costs; also monitor end-market conditions and margin effects from commodities and freight.
- Confirm the status, purchase price, and expected impact of the Ulusoy acquisition and the expected balance-sheet effects of lease-standard adoption.