01—Abstract
Summary
Summary of the 10-K filed February 27, 2019. Cited figures are marked; the original filing is the authoritative source.
Eaton Corporation plc (NYSE: ETN) closed 2018 with net sales of $21.6 billiona, up 6% from $20.4 billion in 2017, driven by organic growth of 6% and higher volumes across all six segments.
Net income attributable to Eaton shareholders fell 28% to $2.145 billion, and diluted EPS dropped to $4.91b from $6.68. The decline reflects a $275 million pre-tax ($206 million after-tax, or $0.48 per share) arbitration award tied to the Pepsi-Cola/Cooper Industries litigation, and the absence of 2017's $843 million after-tax gain on the sale of a 50% stake in the commercial vehicle automated transmission business to Cummins. Excluding these items, operating momentum was solid: segment operating profit rose about 13% to $3.63 billion, and gross margin improved to 32.8%.
Cash generation remained strong, with operating cash flow of $2.66 billionc, roughly flat year over year, and capital expenditures of $565 million. Eaton returned substantial capital to shareholders, paying $1.15 billion in dividends and repurchasing $1.27 billion of stock, while total debt was reduced to $7.5 billion from $7.8 billion. The company ended the year with $3.9 billion in combined cash and short-term investments-related liquidity supported by $2 billion in revolving credit facilities.
Backlog rose to $5.3 billiond from $4.8 billion, and the board raised the quarterly dividend 8% to $0.71 per share in February 2019. Key risks investors should monitor include the pending appeal of the Pepsi arbitration award, an adverse Tax Court ruling on February 25, 2019 regarding controlled foreign corporation income that Eaton plans to appeal, and ongoing IRS transfer-pricing disputes.
Pension underfunding of about $1.3 billion and goodwill and intangible assets totaling $18 billion (about 58% of total assets) also warrant attention. Eaton's effective tax rate was 11.5% (12.8% excluding one-time items), and the company disclosed a small Iran-related sale in 2018 that it has since ceased pursuing.
02—Key points
Key Highlights
- Net sales rose 6% to $21.6 billion in 2018, with organic growth of 6% led by Electrical Systems and Services (+6%), Hydraulics (+12%), and eMobility (+13%) segments.
- Reported net income attributable to shareholders fell 28% to $2.145 billion, or $4.91 diluted EPS, due to a $275 million arbitration expense and the lapse of 2017's one-time $843 million after-tax divestiture gain.
- Segment operating profit grew to $3.63 billion from $3.21 billion, and gross margin expanded to 32.8% from 32.6%, supported by volume leverage and restructuring savings.
- Operating cash flow was $2.66 billion, with capital expenditures of $565 million and expected 2019 capex of about $600 million.
- Shareholder returns totaled roughly $2.4 billion in 2018, including $1.15 billion in dividends and $1.27 billion in share repurchases; the quarterly dividend was raised 8% to $0.71 for 2019.
- Backlog increased to $5.3 billion from $4.8 billion, with about 87% expected to convert within twelve months.
- Pending legal and tax exposures include the appeal of the $293 million Pepsi arbitration award (paid in November 2018) and a February 2019 Tax Court ruling against Eaton on controlled foreign corporation income, which management plans to appeal.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2018, Eaton Corp plc kept $0.10.
- Revenue$21.61B100.0%
- Cost of revenue−$14.51B67.2%
- Gross profit$7.10B32.8%
- Operating costs−$3.47B16.0%
- Operating income$3.63B16.8%
- Interest, other & tax−$1.48B6.9%
- Net income$2.15B9.9%
04—Financials
Financial Highlights
Figures from 10-KFY2018filed February 27, 2019Financial Statements
FY2018 against FY2017
| Line item | FY2018FY2017 | Change |
|---|---|---|
| Revenue | $21.61B$20.40B | +5.9% |
| Cost of Revenue | $14.51B$13.76B | +5.5% |
| Gross Profit | $7.10B$6.65B | +6.8% |
| R&D Expenses | $584.00M$584.00M | 0.0% |
| SG&A Expenses | $3.55B$3.53B | +0.6% |
| Operating Income | $3.63B$3.21B | +12.9% |
| Net Income | $2.15B$2.99B | −28.1% |
| EPS (Basic) | $4.93$6.71 | −26.5% |
| EPS (Diluted) | $4.91$6.68 | −26.5% |
| Shares Outstanding (Basic) | 434.30M444.50M | −2.3% |
| Shares Outstanding (Diluted) | 436.90M447.00M | −2.3% |
05—Questions
Frequently Asked Questions
Why did Eaton's net income decline in 2018 even though sales grew?
Net income attributable to Eaton shareholders fell 28% to $2.145 billion, mainly because 2018 included a $275 million pre-tax ($206 million after-tax, $0.48 per share) arbitration expense related to the Pepsi-Cola litigation. 2017 results also included an $843 million after-tax gain on the sale of a 50% stake in the commercial vehicle automated transmission business. Excluding these items, earnings would have risen on higher volumes, restructuring savings, and lower restructuring charges, partially offset by commodity inflation and freight costs.
What is the status of the Pepsi arbitration award and could it affect future results?
The arbitration panel ordered Cooper (an Eaton subsidiary) to pay $293 million to Pneumo Abex in August 2018. A Texas state court confirmed the award, and Eaton paid the full $297 million judgment with post-judgment interest in November 2018 while preserving its right to appeal. The appeal is pending. A successful appeal could result in a recovery, but the outcome is uncertain, and the 2018 charge has already been recognized.
How strong is Eaton's balance sheet and liquidity position?
At year-end 2018, Eaton had $283 million in cash and $157 million in short-term investments, total debt of $7.5 billion, and shareholders' equity of $16.1 billion. It maintained $2 billion in long-term revolving credit facilities with no borrowings outstanding, and its credit ratings were A- (S&P), Baa1 (Moody's), and BBB+ (Fitch, positive outlook). Management stated that the company has sufficient liquidity to meet operating needs and scheduled debt payments. Pension plans had a net unfunded position of about $1.3 billion.
What are the main tax-related risks Eaton faces?
Eaton's effective tax rate was 11.5% in 2018 (12.8% excluding one-time items). The company is contesting several IRS matters, including transfer-pricing adjustments for 2005-2010 and 2011-2013 and a controlled foreign corporation income issue. On February 25, 2019, the Tax Court granted the IRS partial summary judgment on the latter, and Eaton plans to appeal and is still assessing the impact on 2019 financial statements. Management believes final resolution of the other IRS proposed adjustments will not have a material impact. The company also has $25.5 billion of undistributed foreign earnings that it intends to reinvest indefinitely.
06—Continue