Eaton Corporation plc — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Eaton is a global power-management company. Financial amounts are in millions of U.S. dollars unless noted.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $4,848 | $4,813 | Up 1% |
| Gross profit | $1,538 | $1,522 | Up 1% |
| Gross margin | 31.7% | 31.6% | Up 0.1 percentage point |
| Income before taxes | $464 | $442 | Up 5% |
| Net income attributable to Eaton shareholders | $432 | $404 | Up 7% |
| Diluted earnings per share | $0.96 | $0.88 | Up 9% |
| Operating cash flow | $463 | $388 | Up $75 |
Organic sales rose 2%, partly offset by a 1% negative currency effect. The effective tax rate was 7%, versus 9%, primarily reflecting excess employee share-based compensation tax benefits under a newly adopted accounting standard. Share repurchases also contributed to higher per-share earnings; diluted weighted-average shares declined to 451.0 million from 459.8 million.
Segments
| Segment | Sales | Sales change | Operating profit | Operating margin |
|---|---|---|---|---|
| Electrical Products | $1,712 | Up 2% | $297 | 17.3% |
| Electrical Systems and Services | $1,333 | Down 1% | $155 | 11.6% |
| Hydraulics | $587 | Up 7% | $60 | 10.2% |
| Aerospace | $428 | Down 4% | $79 | 18.5% |
| Vehicle | $788 | Down 1% | $108 | 13.7% |
Hydraulics had the strongest sales growth and a substantial margin improvement. Electrical Products also improved. Electrical Systems and Services faced continued oil and gas and large-project weakness; Aerospace sales fell on lower military and business-jet activity; Vehicle results were pressured by the North American Class 8 truck market, product mix, commodity inflation and higher warranty costs.
Cash flow, liquidity and debt
- Operating cash flow was $463; investing activities used $229, including $116 of capital expenditures and $93 of net purchases of short-term investments. Financing activities used $563, including $263 of dividends and $255 of share repurchases.
- Cash declined to $222 from $543 at year-end; short-term investments increased to $301 from $203. Cash plus short-term investments totaled $523 at quarter-end.
- Total debt, including short-term debt and current maturities, was $8,213, compared with $8,277 at December 31, 2016. Long-term debt carrying value, including current maturities, was $8,005; its disclosed fair value was $8,261.
- Current assets were $6,975 and current liabilities were $5,557. Eaton reported no borrowings under its $2 billion revolving credit facilities, access to a $2 billion commercial-paper program, and compliance with debt covenants.
Operating cash flow improved year over year mainly because the working-capital cash outflow was lower and insurance proceeds had been received in late 2016; higher pension contributions partly offset the increase. Pension-plan contributions were $128, versus $42 in Q1 2016.
Outlook, material items and risks
- Eaton anticipated $100 of restructuring charges in 2017 and expected annualized savings of $518 when actions are fully realized in 2018. Q1 restructuring charges were $20, down from $63 a year earlier.
- The filing provides no clear company-wide revenue or earnings guidance for 2017. Management cited higher volumes and restructuring savings as favorable, with commodity inflation, unfavorable mix and selected end-market weakness as offsets.
- After quarter-end, Eaton announced a proposed 50/50 automated-transmissions joint venture with Cummins. Eaton expects $600 in cash for its interest; closing was expected in Q3 2017, subject to regulatory approvals and customary conditions.
- Eaton adopted share-based payment accounting guidance and recorded a $48 deferred tax asset through retained earnings. It planned to adopt the new revenue-recognition standard in Q1 2018 using the modified retrospective approach; the financial impact was still being evaluated. The company also continued evaluating the impact of the new lease standard.
- Management said ordinary-course legal claims, including asbestos claims, were not expected to have a material adverse effect, while noting outcomes cannot be predicted with certainty. No material changes to previously disclosed risk factors or market-risk exposures were reported.
- A non-U.S. subsidiary reported Q1 sales to an Iranian distributor for a customer ultimately owned by the Iranian government: approximately $546,000 in revenue and $79,000 in net profit. Eaton stated that non-U.S. subsidiaries intended to continue permitted activity under General License H and that the company had no assets or employees in Iran.
Important facts for investors to verify
- How much of the lower tax rate and earnings growth is repeatable, given the share-based payment tax benefit?
- Whether restructuring delivers the stated $518 annualized savings by 2018 and what further charges are incurred.
- Whether the Cummins joint venture receives approvals, closes as expected, and delivers the stated cash proceeds.
- Trends in Hydraulics and Electrical Products against continued weakness in oil and gas, aerospace submarkets and heavy trucks.
- Cash conversion, pension funding needs, debt maturities and the effect of capital returns on liquidity.
- The eventual effects of revenue-recognition and lease-accounting changes, and the regulatory and reputational exposure associated with disclosed Iran business.