Eaton Corporation plc — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Eaton is a global power-management company serving electrical, hydraulic, and mechanical power markets. Figures are in U.S. dollars and millions, except per-share data.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $5,203 | $5,728 | $15,798 | $16,987 |
| Gross profit | $1,606 | $1,812 | $4,933 | $5,188 |
| Gross margin | 30.9% | 31.6% | 31.2% | 30.5% |
| Income attributable to Eaton shareholders | $446 | $602 | $1,447 | $1,212 |
| Diluted EPS | $0.96 | $1.26 | $3.09 | $2.53 |
| Operating cash flow | Not stated for the quarter | $1,629 | $934 |
Q3 sales fell 9% year over year, reflecting a 6% currency headwind and 3% lower organic sales. Nine-month sales declined 7%, with a 6% currency headwind and 1% lower organic sales. Q3 GAAP net income fell 26%; nine-month income rose 19%, but the comparison was affected by 2014 litigation costs and an aerospace-business divestiture gain. Eaton’s non-GAAP operating earnings were $453 million in Q3, down 26%, and $1,469 million for nine months, up 14%; nine-month operating earnings excluding the unusual 2014 items declined, according to management.
Q3 gross margin declined 0.7 percentage points, mainly due to restructuring charges; nine-month gross margin increased 0.7 points, reflecting efficiencies and new products, partly offset by Q3 restructuring.
Segments and material changes
- Electrical Products: Q3 sales $1,771 million, down 6%; operating margin 18.2%, up from 17.6%. Nine-month sales fell 3%.
- Electrical Systems and Services: Q3 sales $1,487 million, down 10%; margin fell to 11.0% from 14.4%. Weak oil and gas and industrial demand contributed.
- Hydraulics: Q3 sales $599 million, down 18%; margin fell to 7.3% from 11.5%, reflecting broad market weakness and lower volume.
- Aerospace: Q3 sales $449 million, down 1%; margin improved to 17.6% from 15.9%, supported by mix and cost controls.
- Vehicle: Q3 sales $897 million, down 11%; margin fell to 15.2% from 17.4%. Nine-month margin increased to 17.2% from 15.9%.
Currency translation affected sales across most segments. Management cited weakness in global hydraulics, oil and gas, industrial, and some international vehicle markets. Aerospace benefited from aftermarket and commercial OEM demand, partly offset by military OEM weakness.
Cash, debt, and liquidity
- Operating cash flow for the first nine months was $1,629 million, versus $934 million a year earlier; management attributed much of the increase to $654 million of litigation payments made in 2014.
- Capital expenditures were $368 million. Cash and cash equivalents were $418 million at September 30, down from $781 million at year-end; short-term investments were $150 million, for combined cash and investments of $568 million.
- Total debt was $8,671 million ($841 million current and $7,830 million long-term), down from $9,032 million at December 31, 2014. Net debt, calculated as debt less cash and short-term investments, was approximately $8,103 million.
- Current assets were $7,579 million and current liabilities $5,100 million. No borrowings were outstanding under the $2 billion revolving credit facilities; Eaton reported compliance with debt covenants.
- Nine-month cash dividends paid were $771 million and share repurchases were $454 million. Eaton repurchased 4.8 million shares in Q3 for $284 million.
Outlook, commentary, risks, and unusual items
- Q3 restructuring charges were $113 million, primarily severance, and restructuring savings were $15 million in the quarter. Management anticipated a further $10 million of charges in Q4 2015 and $30 million in 2016, with annualized savings of $160 million. These are management estimates, not a full-year earnings forecast; the filing provides no clear consolidated full-year revenue or EPS guidance.
- 2014 comparisons include $644 million of litigation settlements and a $154 million gain on the sale of aerospace businesses. The filing describes the net pre-tax effect with differing amounts; investors should consult the detailed statements and notes for the reconciliation.
- Proposed IRS assessments concern transfer pricing and other tax issues: $75 million of additional taxes plus $52 million in penalties for 2005–2006, and $190 million plus $72 million in penalties for 2007–2010. Eaton disputes the assessments. The 2005–2006 case had been tried, with post-trial briefing due by February 29, 2016; the filing says a decision could take several months to a year.
- Eaton recorded a $23 million accrual for the Brazilian Raysul matter and expected any payment not to exceed the recorded liability. Management said other legal matters were not expected to have a material adverse effect, while noting outcomes cannot be predicted with certainty.
- Other risks include market and customer demand, competition and pricing, input costs, currency and interest-rate movements, tax exposure, acquisitions and integration, regulation, and pending litigation. Management reported no material change in market-risk exposures or risk factors from the prior annual filing.
- After quarter-end, on October 28, 2015, Eaton acquired Ephesus Lighting; its reported trailing 12-month sales were $22 million. Eaton had acquired Oxalis in January 2015.
Key facts for investors to verify
- How much of the sales decline and margin pressure persists, especially in Hydraulics and Electrical Systems and Services, versus reflects currency or temporary restructuring costs.
- Whether the restructuring program achieves the stated $160 million annualized savings and what additional charges are incurred.
- The outcome and potential financial exposure from the IRS transfer-pricing cases and other disclosed legal contingencies.
- Cash generation, debt repayment, and liquidity needs relative to dividends and share repurchases.
- The reconciliation of 2014 litigation settlements and aerospace-divestiture gains when assessing year-over-year earnings comparisons.