Eaton Corporation plc — Q2 2016 Form 10-Q
Business context and period: Eaton is a global power-management company serving electrical, hydraulic, aerospace, vehicle and related markets. This unaudited report covers the quarter and six months ended June 30, 2016; financial amounts are in millions of dollars except per-share data.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $5,080 | $5,372 | $9,893 | $10,595 |
| Gross profit margin | 32.7% | 31.6% | 32.2% | 31.4% |
| Net income attributable to Eaton shareholders | $491 | $535 | $895 | $1,001 |
| Diluted earnings per share | $1.07 | $1.14 | $1.95 | $2.13 |
| Operating cash flow | Not stated separately | Not stated separately | $1,116 | $656 |
Q2 sales declined 5% year over year, reflecting a 4% organic decline and 1% negative currency impact. First-half sales fell 7% (5% organic decline and 2% currency impact). Gross margin improved despite lower volume, primarily from restructuring and other cost savings. GAAP net income fell 8% in Q2 and 11% in the first half. Management’s non-GAAP operating earnings were $492 in Q2 and $896 for the first half, down 9% and 12%, respectively; these exclude after-tax acquisition integration charges.
First-half operating cash flow increased by $460 to $1,116, mainly because pension contributions and working-capital outflows were lower. Capital expenditures were $246, implying cash flow after capital expenditures of $870. Investing activities used $204 and financing activities used $865. Cash was $323 and short-term investments were $146 at June 30, 2016.
Total debt was $8,414 ($557 short-term, $252 current long-term and $7,605 long-term), approximately unchanged from December 31, 2015. Cash and short-term investments totaled $469. Current assets were $6,826 and current liabilities $4,816. Eaton reported no borrowings under its $2,000 revolving credit facilities and compliance with debt covenants.
Segments and material changes
- Electrical Products: Q2 sales were flat at $1,784; operating margin rose to 18.0% from 15.5%, supported by cost savings.
- Electrical Systems and Services: Q2 sales fell 5% to $1,429 and margin declined to 12.5% from 14.8%. Weak industrial-project and oil-and-gas demand, lower volumes, mix, restructuring charges and a litigation charge pressured results.
- Hydraulics: Q2 sales fell 8% to $589 and margin declined to 10.0% from 11.5%, amid weakness in mobile and industrial markets.
- Aerospace: Q2 sales fell 2% to $447, while margin improved to 18.6% from 17.0%, reflecting restructuring savings and lower program-development spending.
- Vehicle: Q2 sales fell 16% to $831 and margin declined to 16.5% from 19.2%, principally due to weaker truck markets in the Americas and lower volumes.
First-half restructuring charges were $98, compared with $14 a year earlier. Pension and other postretirement expense fell to $27 from $61 for the first half, contributing to lower corporate expense. Q2 other comprehensive loss attributable to Eaton shareholders was $255, including a $296 currency-translation and related-hedging loss; total comprehensive income was $236.
Outlook, risks and unusual items
Eaton forecast restructuring charges of $145 in 2016 and $130 in 2017, with projected annualized savings of $423 when actions are fully realized in 2018. The filing provides no specific consolidated revenue or earnings guidance. Management cited weakening demand across several end markets as a cause of lower organic sales.
Risks identified include market and customer demand changes, competitive and pricing pressure, input costs, acquisition integration, litigation, labor disruption, regulation, interest rates, taxes, currency and broader economic conditions. Eaton said there were no material changes in market-risk exposures or previously disclosed risk factors. It stated that current legal matters were not expected to have a material adverse effect; a Brazilian Raysul-related matter was settled in June 2016 without material financial impact. Management reported effective disclosure controls as of June 30, 2016.
Key facts for investors to verify
- Whether demand weakness in Vehicle, Hydraulics and Electrical Systems and Services persisted after quarter-end.
- Progress against restructuring charges and the stated $423 annualized savings target, including timing and execution costs.
- Cash conversion and working-capital trends, given the improvement in first-half operating cash flow.
- Debt maturities, interest-rate exposure and liquidity availability; reported debt fair value exceeded carrying value at June 30, 2016.
- The amount and nature of the Electrical Systems and Services litigation charge, which is not clearly quantified in the filing text.
- Impact of currency translation and the company’s share-repurchase program on future results and shareholder returns.