Eaton Corporation plc — Q2 2015 Form 10-Q
Business context and reporting period
Eaton is a global power-management company serving electrical, hydraulic and mechanical markets. This unaudited quarterly filing covers the three and six months ended June 30, 2015; balance-sheet comparisons are with December 31, 2014. Amounts are in millions of dollars except per-share data.
Key financial metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $5,372 | $5,767 | $10,595 | $11,259 |
| Gross profit margin | 31.6% | 30.2% | 31.4% | 30.0% |
| Net income attributable to Eaton shareholders | $535 | $171 | $1,001 | $610 |
| Diluted EPS | $1.14 | $0.36 | $2.13 | $1.27 |
| Operating earnings, non-GAAP | $543 | $194 | $1,016 | $677 |
| Operating earnings per diluted share, non-GAAP | $1.16 | $0.41 | $2.16 | $1.41 |
For the first six months, operating cash flow was $656, capital expenditures were $246, and free cash flow before other investing activity was $410. Investing activities used $207 and financing activities used $912. Cash fell by $478 to $303; short-term investments were $127. At June 30, total debt was $8,751, including short-term debt, versus $9,034 at year-end. Current assets were $7,644 and current liabilities $5,056.
Material changes versus prior period
- Sales fell 7% in Q2 and 6% for the half. Management attributed the six-month decline primarily to a 6% currency-translation effect; Q2 organic sales declined 1%, reflecting weaker demand in several end markets.
- Gross margin improved year over year, which management attributed mainly to efficiency actions and new products. Six-month segment operating profit rose to $1,593 from $1,552.
- Comparisons of net income and operating earnings are heavily affected by Q2 2014 litigation-settlement charges and the gain on the Aerospace business divestiture. In 2014, Eaton recorded $644 of litigation settlements and a $156 pretax divestiture gain. Excluding those items, management said operating earnings improved on higher segment margins and lower corporate costs, partly offset by currency and a higher tax rate.
- Six-month other comprehensive loss attributable to ordinary shareholders was $404, principally reflecting currency translation and related hedging.
Segments and management commentary
- Electrical Products: Q2 sales decreased 3%; organic sales grew 3%, but operating margin before integration charges fell to 15.8% from 17.0%, with unfavorable mix and Canadian exchange effects.
- Electrical Systems and Services: Q2 sales decreased 8%, including a 4% organic decline, amid oil-and-gas and industrial weakness. Pre-integration margin improved to 15.1% from 12.7% on efficiency gains.
- Hydraulics: Q2 sales decreased 18%, including an 11% organic decline, due mainly to weak agricultural and China construction-equipment markets. Pre-integration margin declined to 11.7% from 12.6% as lower volume pressured results.
- Aerospace: Q2 sales decreased 7%, partly due to currency and the 2014 divestiture; margin increased to 17.0% from 14.2%, primarily due to favorable mix. Six-month organic sales rose 3%.
- Vehicle: Q2 sales decreased 4% as currency offset 4% organic growth. Margin increased to 19.2% from 15.0%, supported by organic sales, mix and prior restructuring efficiencies.
Outlook, risks and unusual items
- The filing provides no specific earnings or sales guidance. Eaton planned approximately $145 of restructuring activities, primarily severance: $120 in the second half of 2015 and $25 in 2016. Cooper integration work was expected to continue through 2015.
- Management said available operating flexibility, cash, investments and capital-market access were sufficient for expected operating needs and scheduled debt payments; Eaton was in compliance with debt covenants and had no borrowings outstanding under its $2,000 revolving credit facilities.
- Identified business risks include market and customer demand changes, competitive pricing, input costs, acquisition integration, litigation, regulation, interest and tax changes, currency movements, and economic deterioration. Management reported no material change in market-risk exposures or risk factors from year-end.
- Eaton accrued $28 for the Raysul matter in Brazil and expected any payment not to exceed that recorded liability. Management stated that legal matters were not expected to have a material adverse effect overall.
- The company acquired UK hazardous-area communications manufacturer Oxalis in January 2015. It is evaluating the impact of the new revenue-recognition standard; the filing states that an estimate of the impact was not yet available.
Important facts for investors to verify
- How much of future sales and earnings performance reflects currency movements versus underlying demand, particularly in Hydraulics and Electrical Systems and Services.
- Whether planned restructuring spending produces durable savings and whether the stated timing and amount change.
- Cash conversion and working-capital trends: working capital changes used $506 of cash during the first half, compared with a $116 source in 2014.
- Debt maturities, refinancing needs and liquidity as cash and short-term investments declined from $1,026 at year-end to $430.
- Developments in the Raysul proceedings and any other material legal or contingent liabilities.