Eaton Corporation plc — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Amounts are in millions of dollars except per-share data. Eaton is a global power-management company operating across Electrical Products, Electrical Systems and Services, Hydraulics, Aerospace and Vehicle.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $5,767 | $5,602 | $11,259 | $10,912 |
| Gross profit margin | 30.2% | 30.9% | 30.0% | 30.3% |
| Net income attributable to Eaton shareholders | $171 | $494 | $610 | $872 |
| Diluted earnings per share | $0.36 | $1.04 | $1.27 | $1.83 |
| Operating earnings, non-GAAP | $194 | $519 | $677 | $919 |
| Operating earnings per share, non-GAAP | $0.41 | $1.09 | $1.41 | $1.93 |
Sales increased 3% in both comparison periods, primarily from core growth. Gross margin edged down, which Eaton attributed in part to restructuring activities. Reported earnings fell sharply, primarily because of $644 in litigation settlements, partly offset by a $156 pretax gain on the sale of aerospace businesses. Eaton reported a Q2 income-tax benefit of $115; the effective tax rate was unusually affected by these items. Excluding the litigation settlements and related legal costs and the divestiture gain, management cited an 8% Q2 effective tax expense rate.
Segments and material changes
- Electrical Products: Q2 sales rose 4%; operating margin before acquisition-integration charges increased to 17.0% from 16.2%, supported by North American demand and Cooper synergies.
- Electrical Systems and Services: Q2 sales were essentially flat; pre-integration operating margin declined to 12.7% from 14.7%, reflecting logistics costs, unfavorable mix and pricing pressure.
- Hydraulics: Q2 sales rose 2%, but pre-integration margin declined to 12.6% from 14.5%. Eaton cited restructuring, agricultural-equipment weakness and softer China construction-equipment markets.
- Aerospace: Q2 sales rose 9%, including core growth, while margin declined to 14.2% from 15.0%, partly due to restructuring and the divestiture’s effect on sales.
- Vehicle: Q2 sales rose 3%; margin declined to 15.0% from 17.2%, primarily due to restructuring.
Acquisition-integration charges were $103 pretax for the first half. Eaton also recorded $55 of Cooper-related restructuring charges in the first half and $39 of additional restructuring charges in Q2 across Vehicle, Hydraulics and Aerospace. Restructuring liabilities increased to $99 at June 30 from $32 at year-end.
Cash flow, debt and liquidity
- First-half operating cash flow was $645, down from $709, primarily because of higher defined-benefit plan contributions. Capital expenditures were $236; operating cash flow less capital expenditures was $409.
- Investing activities provided $148, including $273 of proceeds from the aerospace-business sale. Prior-year investing cash flow included $761 from the Apex Tool Group sale.
- Financing activities used $1,078, including $576 of debt repayments, $467 of dividends and $99 of share repurchases.
- Cash was $631 and short-term investments were $634 at June 30. Total debt, including current maturities, was $9,033; cash and short-term investments together were $1,265.
- Current assets were $8,838 and current liabilities $5,543 (about 1.6 current ratio). Eaton reported no borrowings under its $2,000 revolving credit facilities and said it complied with debt covenants.
Outlook, risks and contingencies
Management continued to anticipate 3% overall end-market growth for 2014. Segment market expectations were 3% for Electrical Products, 3% for Electrical Systems and Services, 1% for Hydraulics (revised), 3% for Aerospace and 5% for Vehicle. The filing provides no clear full-year earnings-per-share guidance.
Eaton settled the Meritor lawsuit for $500 and the Triumph claims for $147.5; both amounts were paid in July 2014, after quarter-end. The filing states that other legal matters, including asbestos claims and a Brazilian dispute with a recorded liability of $36, are not expected to have a material adverse effect; the company expects any payment in the Brazilian matter not to exceed the accrued amount. Management reported no material changes to previously disclosed risk factors or market-risk exposures. Forward-looking results remain subject to demand, pricing and cost pressures, integration and divestiture execution, litigation, regulatory, tax, currency and economic risks.
The Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions sale closed May 9 for $270 and generated the $156 pretax gain. Disclosure controls were judged effective as of June 30.
Investor verification priorities
- Confirm the settlement charges, related legal costs, divestiture gain and July cash payments, including their effects on reported earnings and cash flow.
- Track segment margins—especially Electrical Systems and Services, Hydraulics and Vehicle—and whether restructuring produces the expected efficiencies.
- Assess cash conversion, pension contributions, working-capital movements, debt repayment and the company’s liquidity after settlement payments.
- Monitor the $99 restructuring liability, the Brazilian litigation accrual and the expected resolution of the $43 uncertain-tax-position item.
- Compare actual end-market demand with management’s 2014 segment growth expectations, particularly the revised 1% Hydraulics forecast.