Eaton Corporation plc — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013. Amounts are in millions of dollars unless stated otherwise. Eaton is a diversified power-management company. Results include Cooper Industries, acquired November 30, 2012; therefore, year-over-year comparisons are materially affected by the acquisition. Eaton reorganized and re-segmented its businesses in Q1; prior-period segment figures were recast, without changing consolidated results.
Financial performance
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net sales | $5,310 | $3,960 | +34% |
| Gross profit | $1,575 | $1,206 | +31% |
| Gross margin | 29.7% | 30.5% | Down 0.8 percentage points |
| Income before taxes | $400 | $368 | +9% |
| Net income attributable to Eaton shareholders | $378 | $311 | +22% |
| Diluted EPS | $0.79 | $0.91 | Down 13% |
| Operating cash flow | $100 | $(98) | Improved $198 |
Acquisitions added 40% to sales growth; core sales declined 5% and currency translation reduced sales 1%. Management attributed the core-sales decline primarily to subdued European growth and weaker demand in certain Vehicle markets in the U.S. Reported diluted EPS declined despite higher net income, reflecting shares issued for Cooper and purchase-accounting charges. Non-GAAP operating earnings were $400, up 28%; operating earnings per diluted share were $0.84, down 9%. These measures exclude after-tax acquisition integration charges and transaction costs of $22, or $0.05 per share.
Interest expense, net, rose to $75 from $28, primarily due to Cooper-related financing. The effective tax rate fell to 5.0% from 15.6%, reflecting the 2012 U.S. research credit recorded in Q1, Cooper-related effects, and increased use of U.S. foreign tax credits.
Business segments
- Electrical Products: Sales $1,660, up 87%; operating margin 14.5% versus 15.7%. Growth was acquisition-led; core sales fell 4%.
- Electrical Systems and Services: Sales $1,521, up 79%; operating margin 13.8% versus 8.9%. Core sales were flat; acquisition-related mix contributed to margin improvement.
- Hydraulics: Sales $756, up 3%; operating margin 10.3% versus 14.8%. Core sales fell 9%, with lower mining and construction-equipment demand.
- Aerospace: Sales $434, up 1%; operating margin 14.3% versus 14.0%.
- Vehicle: Sales $939, down 11%; operating margin 14.1% versus 15.1%. Core sales fell 8%, including weaker North American Class 8 and European light-vehicle markets.
Cash, debt and liquidity
At March 31, cash was $639 and short-term investments were $397, totaling $1,036, compared with $1,104 at year-end. Total debt was approximately $10,126, down from $10,833 at December 31. Eaton repaid the remaining $1,669 Cooper bridge-facility balance on February 1; Q1 cash-flow financing activities included $687 of borrowing repayments. The company had no borrowings under revolving credit facilities and reported compliance with debt covenants.
Investing cash flow was $773, including $761 proceeds from the February sale of Apex Tool Group. Financing cash flow was $(810), including debt repayments and $194 of dividends paid. Capital expenditures were $122. Approximately 86% of cash and short-term investments were held outside the U.S. and considered permanently reinvested; management said U.S. operations generate cash sufficient for domestic needs and debt service.
Outlook, risks and unusual items
- The filing provides no specific earnings or sales guidance. Management cites subdued European growth, mixed conditions in Asia-Pacific, weaker demand in mining and construction equipment, and softness in certain vehicle markets; regional and market conditions were mixed.
- Cooper purchase-price allocation remained preliminary. Further valuation adjustments during 2013 could materially affect results or financial position. Q1 included $33 of inventory step-up expense and $107 of intangible-asset amortization.
- Q1 acquisition integration charges and transaction costs totaled $31 before tax ($22 after tax). A $32 restructuring liability from 2012 actions was expected to be paid in Q2 2013.
- Legal matters include the Raysul dispute in Brazil: the company had accrued $45, and an April 2013 ruling favored Raysul; Eaton expected any payment not to exceed the recorded liability. In the Meritor antitrust case, potential damages could not be estimated; a damages report may be reconsidered, while injunctive relief had been vacated.
- The IRS proposed $75 in additional taxes plus $52 in penalties for 2005–2006 transfer-pricing matters. Eaton contested the proposed assessments and said resolution was not expected to have a material adverse impact. The filing also identifies acquisition-integration, market, pricing, input-cost, litigation, tax, currency, interest-rate, and broader economic risks.
Currency translation and related hedging produced a $206 other-comprehensive-income loss, contributing to a $160 total other comprehensive loss attributable to Eaton shareholders. Management reported no material change in market-risk exposures, risk factors, or internal controls from the prior annual filing; disclosure controls were effective at quarter-end.
Investor verification points
- Separate Cooper’s acquired sales and purchase-accounting impacts from organic growth and recurring profitability.
- Track margins and demand in Hydraulics and Vehicle, and whether Electrical Systems and Services’ margin improvement is sustained.
- Assess cash conversion and working-capital needs, including the timing and nonrecurring nature of Apex sale proceeds and pension contributions.
- Monitor debt reduction, interest expense, and the availability of cash held outside the U.S.
- Review final Cooper purchase accounting and the resolution or potential exposure from the Meritor, Raysul, and IRS matters.
- Evaluate whether the unusually low Q1 tax rate is repeatable; the filing attributes it in part to specific credits and transaction-related effects.