Eaton Corporation plc — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Eaton is a global power-management company operating in electrical, hydraulic, aerospace and vehicle markets. Amounts are in U.S. dollars, millions except per-share data.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $5,132 | $5,080 | $9,980 | $9,893 |
| Gross profit | $1,682 | $1,661 | $3,220 | $3,183 |
| Gross margin | 32.8% | 32.7% | 32.3% | 32.2% |
| Income before taxes | $570 | $553 | $1,034 | $995 |
| Net income attributable to Eaton shareholders | $515 | $491 | $947 | $895 |
| Diluted EPS | $1.15 | $1.07 | $2.10 | $1.95 |
| Operating cash flow | Not separately presented for Q2 | $1,037 | $1,133 |
For both Q2 and the first half, sales rose 1% year over year; management attributed growth to 2% organic growth, partly offset by 1% unfavorable currency translation. Eaton cited higher volume, restructuring savings, lower restructuring charges and lower taxes as contributors to earnings growth. Commodity inflation and unfavorable product mix were offsets. Share repurchases also supported per-share growth.
Cash, debt and liquidity
- At June 30, cash was $312 and short-term investments were $525, compared with $543 and $203, respectively, at year-end 2016.
- Total reported debt was $8,605: $846 short-term debt, $1,495 current long-term debt and $6,264 long-term debt. This compares with $8,277 at December 31, 2016. Cash and short-term investments totaled $837 at quarter-end.
- Current assets were $7,487 and current liabilities $6,309. Shareholders’ equity was $15,552.
- First-half operating cash flow of $1,037 was down $96 year over year, mainly due to pension contributions of $160 versus $74. Capital expenditures were $246; net cash used in investing was $586, including $309 of net short-term-investment purchases.
- Net cash used in financing was $689, including $537 of dividends and $465 of share repurchases. Cash declined $231 during the first half to $312.
- Management said liquidity, operating flexibility and access to capital markets were adequate for operating needs and scheduled debt payments. No borrowings were outstanding under the $2 billion revolving credit facilities, and Eaton reported compliance with debt covenants.
Business segments and notable changes
- Electrical Products: Q2 sales +1%; operating margin fell to 17.4% from 18.0%, reflecting commodity inflation and higher R&D investment, partly offset by restructuring savings.
- Electrical Systems and Services: Q2 sales −1%; margin improved to 13.7% from 12.5%, with savings and cost controls outweighing mix and commodity pressures. The comparison also benefited from a prior-year litigation charge.
- Hydraulics: Q2 sales +7% and margin increased to 11.7% from 10.0%, supported by stronger mobile OEM and distribution markets, higher volume and restructuring savings.
- Aerospace: Q2 sales −2% and margin was 18.5% versus 18.6%. First-half sales declined 3%, with lower military aftermarket, business and regional jet sales and lower engineering-program cost reimbursements cited.
- Vehicle: Q2 sales +2%; margin was 16.4% versus 16.5%. First-half sales were flat and margin declined to 15.1% from 15.7%, with commodity inflation, mix and higher warranty costs among the pressures.
Outlook, risks and unusual items
- Eaton expected 2017 restructuring charges of approximately $100 and projected annualized savings of $518 once actions are fully realized in 2018. The filing does not provide a clear full-year revenue or EPS guidance figure.
- On July 31, 2017, after quarter-end, Eaton and Cummins formed a 50/50 automated-transmissions joint venture. Eaton received $600 in cash for its interest and plans to account for the venture using the equity method; the financial-statement impact was still being assessed.
- A July 26, 2017 U.S. Tax Court ruling upheld the IRS’s obligation to honor advance pricing agreements for disputed 2005–2006 transfer pricing, with the ruling also applicable to the 2007–2010 issue. Eaton said it did not expect a material financial-statement impact.
- General legal matters, including asbestos claims, were not expected by management to have a material adverse effect. The filing reports no material change in risk factors or market-risk exposures since year-end.
- Non-U.S. subsidiaries reported second-quarter sales to distributors whose ultimate customers were owned by the Iranian government: approximately $121,262 revenue and $25,993 net profit. Eaton said subsidiaries intended to continue permitted business under General License H and that the company had no assets or employees in Iran.
- The effective tax rate declined to 10% for Q2 and 8% for the first half, attributed to resolutions of tax contingencies in lower-tax jurisdictions and tax benefits related to employee share-based payments. Eaton adopted ASU 2016-09, recording a $48 deferred-tax asset and retained-earnings adjustment.
- Management reported effective disclosure controls as of June 30, 2017, with no material second-quarter change in internal control over financial reporting.
Investor verification priorities
- Verify whether organic sales growth, especially in Hydraulics and Electrical Products, persists and how currency movements affect reported growth.
- Track segment margins against commodity inflation, product mix, warranty costs and restructuring savings.
- Assess the conversion of operating earnings into cash, including working-capital use and elevated pension contributions.
- Monitor debt maturities, borrowing levels, shareholder returns and liquidity after the quarter-end joint-venture cash receipt.
- Confirm realization and timing of the expected $518 annualized restructuring savings and the remaining associated charges.
- Follow the joint venture’s financial contribution, the tax dispute’s subsequent developments and compliance-related disclosures concerning Iran.