ETN 06.30.2014 10-Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2014
Commission file number 000-54863
EATON CORPORATION plc
(Exact name of registrant as specified in its charter)
Ireland
 
98-1059235
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification Number)
 
 
 
Fitzwilliam Hall, Fitzwilliam Place, Dublin 2, Ireland
 
-
(Address of principal executive offices)
 
(Zip Code)
 
 
 
+1 (440) 523-5000
 
 
 
 
 
 
(Registrant's telephone number, including area code)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not applicable
 
 
 
 
 
 
(Former name, former address and former fiscal year if changed since last report)
 
 
 
 
 
 
 
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
There were 475.9 million Ordinary Shares outstanding as of June 30, 2014.
 


Table of Contents

TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

PART I — FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS.

EATON CORPORATION plc
CONSOLIDATED STATEMENTS OF INCOME

 
Three months ended
June 30
 
Six months ended
June 30
(In millions except for per share data)
2014
 
2013
 
2014
 
2013
Net sales
$
5,767

 
$
5,602

 
$
11,259

 
$
10,912

 
 
 
 
 
 
 
 
Cost of products sold
4,025

 
3,870

 
7,883

 
7,605

Selling and administrative expense
984

 
960

 
1,946

 
1,918

Litigation settlements
644

 
—

 
644

 
—

Research and development expense
168

 
161

 
330

 
313

Interest expense - net
55

 
71

 
117

 
146

Other (income) expense - net
(166
)
 
6

 
(171
)
 
(4
)
Income before income taxes
57

 
534

 
510

 
934

Income tax (benefit) expense
(115
)
 
37

 
(103
)
 
57

Net income
172

 
497

 
613

 
877

Less net income for noncontrolling interests
(1
)
 
(3
)
 
(3
)
 
(5
)
Net income attributable to Eaton ordinary shareholders
$
171

 
$
494

 
$
610

 
$
872

 
 
 
 
 
 
 
 
Net income per ordinary share
 
 
 
 
 
 
 
Diluted
$
0.36

 
$
1.04

 
$
1.27

 
$
1.83

Basic
0.36

 
1.04

 
1.28

 
1.84

 
 
 
 
 
 
 
 
Weighted-average number of ordinary shares outstanding
 
 
 
 
 
 
 
Diluted
478.5

 
476.3

 
478.7

 
475.7

Basic
475.9

 
473.4

 
475.9

 
472.6

 
 
 
 
 
 
 
 
Cash dividends declared per ordinary share
$
0.49

 
$
0.42

 
$
0.98

 
$
0.84


The accompanying notes are an integral part of these condensed consolidated financial statements.

2
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EATON CORPORATION plc
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 
Three months ended
June 30
 
Six months ended
June 30
(In millions)
2014
 
2013
 
2014
 
2013
Net income
$
172

 
$
497

 
$
613

 
$
877

Less net income for noncontrolling interests
(1
)
 
(3
)
 
(3
)
 
(5
)
Net income attributable to Eaton ordinary shareholders
171

 
494

 
610

 
872

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
Currency translation and related hedging instruments
58

 
(109
)
 
11

 
(390
)
Pensions and other postretirement benefits
23

 
36

 
73

 
89

Cash flow hedges
2

 
1

 
2

 
(5
)
Other comprehensive income (loss) attributable to Eaton
   ordinary shareholders
83

 
(72
)
 
86

 
(306
)
 


 


 


 


Total comprehensive income attributable to Eaton
  ordinary shareholders
$
254

 
$
422

 
$
696

 
$
566


The accompanying notes are an integral part of these condensed consolidated financial statements.


3
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EATON CORPORATION plc
CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions)
June 30,
2014
 
December 31,
2013
Assets
 
 
 
Current assets
 
 
 
Cash
$
631

 
$
915

Short-term investments
634

 
794

Accounts receivable - net
4,010

 
3,648

Inventory
2,534

 
2,382

Deferred income taxes
552

 
577

Prepaid expenses and other current assets
477

 
415

Total current assets
8,838

 
8,731

 
 
 
 
Property, plant and equipment - net
3,793

 
3,833

 
 
 
 
Other noncurrent assets

 

Goodwill
14,377

 
14,495

Other intangible assets
6,976

 
7,186

Deferred income taxes
242

 
240

Other assets
1,032

 
1,006

Total assets
$
35,258

 
$
35,491

 
 
 
 
Liabilities and shareholders’ equity
 
 
 
Current liabilities
 
 
 
Short-term debt
$
2

 
$
13

Current portion of long-term debt
416

 
567

Accounts payable
2,044

 
1,960

Accrued compensation
373

 
461

Other current liabilities
2,708

 
1,913

Total current liabilities
5,543

 
4,914

 
 
 
 
Noncurrent liabilities
 
 
 
Long-term debt
8,615

 
8,969

Pension liabilities
1,222

 
1,465

Other postretirement benefits liabilities
668

 
668

Deferred income taxes
1,047

 
1,313

Other noncurrent liabilities
1,121

 
1,299

Total noncurrent liabilities
12,673

 
13,714

 
 
 
 
Shareholders’ equity
 
 
 
Eaton shareholders’ equity
16,982

 
16,791

Noncontrolling interests
60

 
72

Total equity
17,042

 
16,863

Total liabilities and equity
$
35,258

 
$
35,491


The accompanying notes are an integral part of these condensed consolidated financial statements.

4
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EATON CORPORATION plc
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 
Six months ended
June 30
(In millions)
2014
 
2013
Operating activities
 
 
 
Net income
$
613

 
$
877

Adjustments to reconcile to net cash provided by operating activities
 
 
 
Depreciation and amortization
499

 
490

Deferred income taxes
(256
)
 
30

Pension and other postretirement benefits expense
180

 
179

Contributions to pension plans
(304
)
 
(244
)
Contributions to other postretirement benefits plans
(24
)
 
(29
)
Excess tax benefit from equity-based compensation
(20
)
 
(22
)
Gain on sale of businesses
(69
)
 
(2
)
Changes in working capital
116

 
(647
)
Other - net
(90
)
 
77

Net cash provided by operating activities
645

 
709

 
 
 
 
Investing activities
 
 
 
Capital expenditures for property, plant and equipment
(236
)
 
(251
)
Sales of short-term investments - net
162

 
148

Proceeds from sale of businesses
273

 
761

Other - net
(51
)
 
(52
)
Net cash provided by investing activities
148

 
606

 
 
 
 
Financing activities
 
 
 
Proceeds from borrowings
—

 
28

Payments on borrowings
(576
)
 
(977
)
Cash dividends paid
(467
)
 
(397
)
Exercise of employee stock options
44

 
78

Repurchase of shares
(99
)
 
—

Excess tax benefit from equity-based compensation
20

 
22

Other - net
—

 
(4
)
Net cash used in financing activities
(1,078
)
 
(1,250
)
 
 
 
 
Effect of currency on cash
1

 
(14
)
Total (decrease) increase in cash
(284
)
 
51

Cash at the beginning of the period
915

 
577

Cash at the end of the period
$
631

 
$
628


The accompanying notes are an integral part of these condensed consolidated financial statements.

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EATON CORPORATION plc
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Amounts are in millions unless indicated otherwise (per share data assume dilution).
Note 1.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Eaton Corporation plc (Eaton or the Company) have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles (US GAAP) for complete financial statements. However, in the opinion of management, all adjustments (consisting of normal recurring accruals) have been made that are necessary for a fair presentation of the condensed consolidated financial statements for the interim periods.
This Form 10-Q should be read in conjunction with the consolidated financial statements and related notes included in Eaton’s 2013 Form 10-K. The interim period results are not necessarily indicative of the results to be expected for the full year. Management has evaluated subsequent events through the date this Form 10-Q was filed with the Securities Exchange Commission.
Certain prior year amounts have been reclassified to conform to the current year presentation.
Recently Issued Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (ASU 2014-09). This accounting standard supersedes all existing US GAAP revenue recognition guidance. Under ASU 2014-09, a company will recognize revenue when it transfers the control of promised goods or services to customers in an amount that reflects the consideration which the company expects to collect in exchange for those goods or services. ASU 2014-09 will require additional disclosures in the notes to the consolidated financial statements and is effective for annual and interim reporting periods beginning after December 15, 2016. Eaton is evaluating the impact of ASU 2014-09 and an estimate of the impact to the consolidated financial statements cannot be made at this time.

Note 2.
ACQUISITIONS AND SALE OF BUSINESSES
Eaton's most recently acquired businesses, and the related annual sales prior to acquisition, are summarized below:
Acquired businesses
 
Date of
transaction
 
Business
segment
 
Annual
sales
 
 
Cooper Industries plc (Cooper)
 
November 30,
2012
 
Electrical Products;
Electrical Systems and Services
 
$5,409
for 2011
A diversified global manufacturer of electrical products and systems, with brands including Bussmann electrical and electronic fuses; Crouse-Hinds and CEAG explosion-proof electrical equipment; Halo and Metalux lighting fixtures; and Kyle and McGraw-Edison power systems products.
 
 
 
 
 
 
 
 
 
 
Rolec Comercial e Industrial S.A.
 
September 28,
2012
 
Electrical Systems and Services
 
$85 for the
12 months
ended
September 30,
2012
A Chilean manufacturer of integrated power assemblies and low- and medium-voltage switchgear, and a provider of engineering services serving mining and other heavy industrial applications in Chile and Peru.
 
 
 
 
 
 
 
 
 
 
Jeil Hydraulics Co., Ltd.
 
July 6,
2012
 
Hydraulics
 
$189
for 2011
A Korean manufacturer of track drive motors, swing drive motors, main control valves and remote control valves for the construction equipment market.
 
 
 
Polimer Kaucuk Sanayi ve Pazarlama A.S.
 
June 1,
2012
 
Hydraulics
 
$335
for 2011
A Turkish manufacturer of hydraulic and industrial hose for construction, mining, agriculture, oil and gas, manufacturing, food and beverage, and chemicals markets. This business sells its products under the SEL brand name.
 
 
 
 
 
 
 
 
 
 
Gycom Electrical Low-Voltage Power Distribution, Control and Automation
 
June 1,
2012
 
Electrical Systems and Services
 
$24
for 2011
A Swedish electrical low-voltage power distribution, control and automation components business.
 
 
 
See Note 3 for information about acquisition integration charges and transaction costs related to these acquisitions.

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Sale of Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions
On January 20, 2014, Eaton announced it entered into an agreement to sell the Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses to Safran for $270. The sale closed on May 9, 2014 and resulted in a pre-tax gain of $156.

Note 3.
ACQUISITION INTEGRATION AND RESTRUCTURING CHARGES
Eaton incurs integration charges and transaction costs related to acquired businesses. A summary of these charges follows:
 
Three months ended
June 30
 
Six months ended
June 30
 
2014
 
2013
 
2014
 
2013
Acquisition integration charges
 
 
 
 
 
 
 
Electrical Products
$
12

 
$
12

 
$
41

 
$
15

Electrical Systems and Services
13

 
11

 
39

 
16

Hydraulics
5

 
8

 
9

 
20

Total business segments
30

 
31

 
89

 
51

Corporate
7

 
6

 
14

 
12

Total acquisition integration charges
37

 
37

 
103

 
63

 
 
 
 
 
 
 
 
Transaction costs
 
 
 
 
 
 
 
Corporate
—

 
2

 
—

 
7

Total transaction costs
—

 
2

 
—

 
7

 
 
 
 
 
 
 
 
Total acquisition integration charges and transaction costs before income taxes
$
37

 
$
39

 
$
103

 
$
70

Total after income taxes
$
23

 
$
25

 
$
67

 
$
47

Per ordinary share - diluted
$
0.05

 
$
0.05

 
$
0.14

 
$
0.10

Business segment integration charges in 2014 were related primarily to the integration of Cooper. Business segment integration charges in 2013 were related primarily to the integrations of Cooper, Polimer Kaucuk Sanayi ve Pazarlama, Jeil Hydraulics and Rolec Comercial e Industrial. These charges were included in Cost of products sold or Selling and administrative expense, as appropriate. In Business Segment Information the charges reduced Operating profit of the related business segment.
Corporate integration charges in 2014 and 2013 were related to the acquisition of Cooper. These charges were included in Selling and administrative expense. In Business Segment Information the charges were included in Other corporate income (expense) - net.
Acquisition-related transaction costs, such as investment banking, legal, other professional fees, and costs associated with change in control agreements, are not included as a component of consideration transferred in an acquisition but are expensed as incurred. Acquisition-related transaction costs in 2013 were related to the acquisition of Cooper. These charges were included in Selling and administrative expense, Interest expense - net and Other (income) expense - net. In Business Segment Information the charges were included in Interest expense - net and Other corporate income (expense) - net.
See Note 2 for additional information about business acquisitions.
Restructuring Charges
During 2013, Eaton undertook restructuring activities related to the acquisition and integration of Cooper in an effort to gain efficiencies in selling, marketing, traditional back-office functions and manufacturing and distribution. These actions, comprised primarily of severance costs, resulted in charges totaling $55 and $17 during the first six months of 2014 and 2013, respectively. These restructuring initiatives are expected to continue through 2015.
During April 2014, Eaton undertook certain restructuring activities in an effort to gain efficiencies in the Vehicle, Hydraulics and Aerospace business segments. These actions, comprised primarily of severance costs, resulted in charges totaling $39 in the second quarter of 2014.

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Restructuring charges were included in Cost of products sold or Selling and administrative expense, as appropriate. In Business Segment Information, the charges reduced Operating profit of the related business segment. See Note 12 for additional information about business segments. As of June 30, 2014 and December 31, 2013, liabilities related to restructuring actions totaled $99 and $32, respectively.

Note 4.
GOODWILL
A summary of goodwill follows:
 
June 30,
2014
 
December 31,
2013
Electrical Products
$
7,191

 
$
7,189

Electrical Systems and Services
4,467

 
4,517

Hydraulics
1,389

 
1,385

Aerospace
973

 
1,048

Vehicle
357

 
356

Total goodwill
$
14,377

 
$
14,495

The decrease in goodwill was primarily attributable to the sale of Eaton's Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses. For additional information on the sale of businesses, see Note 2.

Note 5.
RETIREMENT BENEFITS PLANS
The components of retirement benefits expense follow:
 
United States
pension benefit expense
 
Non-United States
pension benefit expense
 
Other postretirement
benefits expense
 
Three months ended June 30
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Service cost
$
29

 
$
32

 
$
17

 
$
15

 
$
5

 
$
5

Interest cost
41

 
37

 
22

 
19

 
10

 
8

Expected return on plan assets
(62
)
 
(56
)
 
(25
)
 
(21
)
 
(2
)
 
(1
)
Amortization
23

 
33

 
7

 
7

 
2

 
4

 
31

 
46

 
21

 
20

 
15

 
16

Settlement loss
14

 
10

 
—

 
—

 
—

 
—

Total expense
$
45

 
$
56

 
$
21

 
$
20

 
$
15

 
$
16


 
United States
pension benefit expense
 
Non-United States
pension benefit expense
 
Other postretirement
benefits expense
 
Six months ended June 30
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Service cost
$
58

 
$
64

 
$
33

 
$
30

 
$
9

 
$
10

Interest cost
81

 
74

 
44

 
39

 
19

 
17

Expected return on plan assets
(123
)
 
(113
)
 
(50
)
 
(42
)
 
(3
)
 
(3
)
Amortization
46

 
66

 
14

 
14

 
4

 
7

 
62

 
91

 
41

 
41

 
29

 
31

Settlement loss
48

 
16

 
—

 
—

 
—

 
—

Total expense
$
110

 
$
107

 
$
41

 
$
41

 
$
29

 
$
31



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Note 6.
LEGAL CONTINGENCIES
Eaton is subject to a broad range of claims, administrative and legal proceedings such as lawsuits that relate to contractual allegations, tax audits, patent infringement, personal injuries, antitrust matters and employment-related matters. Eaton is also subject to asbestos claims from historic products which may have contained asbestos. Historically, significant insurance coverage has been available to cover costs associated with these claims. Although it is not possible to predict with certainty the outcome or cost of these matters, the Company believes they will not have a material adverse effect on the consolidated financial statements.
In December 2010, a Brazilian court held that a judgment obtained by a Brazilian company, Raysul, against another Brazilian company, Saturnia, which was sold by Eaton in 2006, could be enforced against Eaton Ltda. This judgment is based on an alleged violation of an agency agreement between Raysul and Saturnia. At June 30, 2014, the Company has a total accrual of 80 Brazilian Reais related to this matter ($36 based on current exchange rates), comprised of 60 Brazilian Reais recognized in the fourth quarter of 2010 ($27 based on current exchange rates) with an additional 20 Brazilian Reais recognized through June 30, 2014 ($9 based on current exchange rates). In 2010, Eaton filed motions for clarification with the Brazilian court of appeals which were denied on April 6, 2011. Eaton Holding and Eaton Ltda. filed appeals on various issues to the Superior Court of Justice in Brasilia. In April 2013, the Superior Court of Justice ruled in favor of Raysul. Additional motions for clarification have been filed with the Superior Court of Justice in Brasilia and an additional appeal is being considered. The Company expects that any sum it may be required to pay in connection with this matter will not exceed the amount of the recorded liability.
On October 5, 2006, ZF Meritor LLC and Meritor Transmission Corporation (collectively, Meritor) filed an action against Eaton in the United States District Court for Delaware. The action sought damages, which would be trebled under United States antitrust laws, as well as injunctive relief and costs. The suit alleged that Eaton engaged in anti-competitive conduct against Meritor in the sale of heavy-duty truck transmissions in North America. On June 23, 2014, Eaton announced it signed a settlement agreement with Meritor in the amount of $500 that resolved the lawsuit and removed the uncertainty of a trial and appeal process. On July 16, 2014, Eaton paid Meritor the $500.
Frisby Corporation, now known as Triumph Actuation Systems, LLC, and other claimants (collectively, Triumph) asserted claims alleging, among other things, unfair competition, defamation, malicious prosecution, deprivation of civil rights, and antitrust in the Hinds County Circuit Court of Mississippi in 2004 and in the Federal District Court of North Carolina in 2011. Eaton had asserted claims against Triumph regarding improper use of trade secrets and these claims were dismissed by the Hinds County Circuit Court. On June 18, 2014, Eaton announced it signed a settlement agreement with Triumph in the amount of $147.5 that resolved all claims and lawsuits and removed the uncertainty of a trial and appeal process. On July 8, 2014, Eaton paid Triumph the $147.5.

Note 7.
INCOME TAXES
The effective income tax rate for the second quarter and first six months of 2014 was a benefit of 203% and 20%, respectively, compared to expense of 7% and 6% for the second quarter and first six months of 2013, respectively. Excluding the litigation settlements and related legal costs, as well as the gain on the sale of Eaton's Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses, which represents a total pre-tax expense of $494 and occurred in the second quarter of 2014, the effective income tax rate was expense of 8% for the second quarter of 2014 compared to 7% for the second quarter of 2013 and 6% for the first six months of 2014 and 2013. See Note 6 and Note 2 for additional information about legal contingencies and the sale of businesses, respectively.
During the next 12 months, the Company expects to reduce its uncertain tax position related to an international tax settlement by $43 as the result of negotiations with a government outside of Ireland and the United States. Resolution of this issue is not expected to have a material impact on the Company’s consolidated financial statements.

Note 8.
EQUITY
Eaton has an ordinary share repurchase program (2013 Program) that authorizes the repurchase of 40 million ordinary shares. During the second quarter of 2014, 1.4 million ordinary shares were repurchased under the 2013 Program in the open market at a total cost of $99.

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The changes in Shareholders’ equity follow:
 
Eaton
shareholders’
equity
 
Noncontrolling
interests
 
Total
equity
Balance at December 31, 2013
$
16,791

 
$
72

 
$
16,863

Net income
610

 
3

 
613

Other comprehensive income
86

 
—

 
86

Cash dividends paid
(467
)
 
—

 
(467
)
Issuance of shares under equity-based compensation plans - net
78

 
—

 
78

Repurchase of shares
(99
)
 
—

 
(99
)
Change in capital
(17
)
 
(15
)
 
(32
)
Balance at June 30, 2014
$
16,982

 
$
60

 
$
17,042

The changes in Accumulated other comprehensive (loss) income follow:
 
Currency translation and related hedging instruments
 
Pensions and other postretirement benefits
 
Cash flow
hedges
 
Total
Balance at December 31, 2013
$
(395
)
 
$
(1,170
)
 
$
5

 
$
(1,560
)
Other comprehensive (loss) income
    before reclassifications
11

 
3

 
4

 
18

Amounts reclassified from Accumulated other
   comprehensive (loss) income
—

 
70

 
(2
)
 
68

Net current-period other comprehensive
   (loss) income
11

 
73

 
2

 
86

Balance at June 30, 2014
$
(384
)
 
$
(1,097
)
 
$
7

 
$
(1,474
)
The reclassifications out of Accumulated other comprehensive loss follow:
 
 
Six months ended
June 30, 2014
 
Consolidated Statements of
Income classification
Amortization of defined benefit pension items
 
 
 
 
Actuarial loss
 
$
(112
)
 
1 
Tax benefit
 
42

 
 
Total, net of tax
 
(70
)
 
 
 
 
 
 
 
Gains (loss) on cash flow hedges
 
 
 
 
Floating-to-fixed interest rate swaps
 
(1
)
 
Interest expense - net
Currency exchange contracts
 
4

 
Cost of products sold
 
 
3

 
 
Tax expense
 
(1
)
 
 
Total, net of tax
 
2

 
 
 
 
 
 
 
Total reclassifications for the period
 
$
(68
)
 
 
1 These components of Accumulated other comprehensive loss are included in the computation of net periodic pension cost. See Note 5 for additional information about defined benefit pension items.

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Net Income per Ordinary Share
A summary of the calculation of net income per ordinary share attributable to shareholders follows:
 
Three months ended
June 30
 
Six months ended
June 30
(Shares in millions)
2014
 
2013
 
2014
 
2013
Net income attributable to Eaton ordinary shareholders
$
171

 
$
494

 
$
610

 
$
872

 
 
 
 
 
 
 
 
Weighted-average number of ordinary shares outstanding - diluted
478.5

 
476.3

 
478.7

 
475.7

Less dilutive effect of equity-based compensation
2.6

 
2.9

 
2.8

 
3.1

Weighted-average number of ordinary shares outstanding - basic
475.9

 
473.4

 
475.9

 
472.6

 
 
 
 
 
 
 
 
Net income per ordinary share
 
 
 
 
 
 
 
Diluted
$
0.36

 
$
1.04

 
$
1.27

 
$
1.83

Basic
0.36

 
1.04

 
1.28

 
1.84

For the second quarter and first six months of 2014, 0.5 million and 0.3 million stock options, respectively, were excluded from the calculation of diluted net income per ordinary share because the exercise price of the options exceeded the average market price of the ordinary shares during the period and their effect, accordingly, would have been antidilutive. For the second quarter and first six months 2013, 0.2 million and 0.1 million stock options, respectively, were excluded from the calculation of diluted net income per ordinary share because the exercise price of the options exceeded the average market price of the ordinary shares during the period and their effect, accordingly, would have been antidilutive.

Note 9.
FAIR VALUE MEASUREMENTS
Fair value is measured based on an exit price, representing the amount that would be received to sell an asset or paid to satisfy a liability in an orderly transaction between market participants. Fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, a fair value hierarchy is established, which categorizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
A summary of financial instruments recognized at fair value, and the fair value measurements used, follows:
 
Total
 
Quoted prices
in active
markets for
identical assets
(Level 1)
 
Other
observable
inputs
(Level 2)
 
Unobservable
inputs
(Level 3)
June 30, 2014
 
 
 
 
 
 
 
Cash
$
631

 
$
631

 
$
—

 
$
—

Short-term investments
634

 
634

 
—

 
—

Net derivative contracts
43

 
—

 
43

 
—

Long-term debt converted to floating interest rates by
   interest rate swaps - net
34

 
—

 
34

 
—

 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Cash
$
915

 
$
915

 
$
—

 
$
—

Short-term investments
794

 
794

 
—

 
—

Net derivative contracts
(35
)
 
—

 
(35
)
 
—

Long-term debt converted to floating interest rates by
   interest rate swaps - net
(39
)
 
—

 
(39
)
 
—


11
Table of Contents

Eaton values its financial instruments using an industry standard market approach, in which prices and other relevant information is generated by market transactions involving identical or comparable assets or liabilities. No financial instruments were recognized using unobservable inputs.
Other Fair Value Measurements
Long-term debt and the current portion of long-term debt had a carrying value of $9,031 and fair value of $9,444 at June 30, 2014 compared to $9,536 and $9,665, respectively, at December 31, 2013. The fair value of Eaton's debt instruments were estimated using prevailing market interest rates on debt with similar creditworthiness, terms and maturities and are considered a Level 2 fair value measurement.

Note 10.
DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
In the normal course of business, Eaton is exposed to certain risks related to fluctuations in interest rates, currency exchange rates and commodity prices. The Company uses various derivative and non-derivative financial instruments, primarily interest rate swaps, currency forward exchange contracts, currency swaps and, to a lesser extent, commodity contracts, to manage risks from these market fluctuations. The instruments used by Eaton are straightforward, non-leveraged instruments. The counterparties to these instruments are financial institutions with strong credit ratings. Eaton maintains control over the size of positions entered into with any one counterparty and regularly monitors the credit rating of these institutions. Such instruments are not purchased and sold for trading purposes.
Derivative financial instruments are accounted for at fair value and recognized as assets or liabilities in the Condensed Consolidated Balance Sheets. Accounting for the gain or loss resulting from the change in the fair value of the derivative financial instrument depends on whether it has been designated, and is effective, as part of a hedging relationship and, if so, as to the nature of the hedging activity. Eaton formally documents all relationships between derivative financial instruments accounted for as designated hedges and the hedged item, as well as its risk-management objective and strategy for undertaking the hedge transaction. This process includes linking derivative financial instruments to a recognized asset or liability, specific firm commitment, forecasted transaction, or net investment in a foreign operation. These financial instruments can be designated as:
•
Hedges of the change in the fair value of a recognized fixed-rate asset or liability, or the firm commitment to acquire such an asset or liability (a fair value hedge); for these hedges, the gain or loss from the derivative financial instrument, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in income during the period of change in fair value.
•
Hedges of the variable cash flows of a recognized variable-rate asset or liability, or the forecasted acquisition of such an asset or liability (a cash flow hedge); for these hedges, the effective portion of the gain or loss from the derivative financial instrument is recognized in Accumulated other comprehensive loss and reclassified to income in the same period when the gain or loss on the hedged item is included in income.
•
Hedges of the currency exposure related to a net investment in a foreign operation (a net investment hedge); for these hedges, the effective portion of the gain or loss from the derivative financial instrument is recognized in Accumulated other comprehensive loss and reclassified to income in the same period when the gain or loss related to the net investment in the foreign operation is included in income.
The gain or loss from a derivative financial instrument designated as a hedge that is effective is classified in the same line of the Consolidated Statements of Income as the offsetting loss or gain on the hedged item. The change in fair value of a derivative financial instrument that is not effective as a hedge is immediately recognized in income.
For derivatives that are not designated as a hedge, any gain or loss is immediately recognized in income. The majority of derivatives used in this manner relate to risks resulting from assets or liabilities denominated in a foreign currency and certain commodity contracts that arise in the normal course of business. Gains and losses associated with commodity hedge contracts are classified in Cost of products sold.
Eaton uses certain of its debt denominated in foreign currency to hedge portions of its net investments in foreign operations against foreign currency exposure (net investment hedges). Foreign currency denominated debt designated on an after-tax basis as non-derivative net investment hedging instruments was $99 and $95 at June 30, 2014 and December 31, 2013, respectively.

12
Table of Contents

Derivative Financial Statement Impacts
The fair value of derivative financial instruments recognized in the Condensed Consolidated Balance Sheets follows:
 
Notional
amount
 
Other
 current
assets
 
Other
long-term
assets
 
Other
current
liabilities
 
Other
long-term
liabilities
 
Type of
hedge
 
Term
June 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
3,440

 
$
—

 
$
60

 
$
—

 
$
26

 
Fair value
 
3 to 20 years
Currency exchange contracts
490

 
14

 
—

 
4

 
—

 
Cash flow
 
1 to 36 months
Commodity contracts
1

 
—

 
—

 
—

 
—

 
Cash flow
 
1 to 12 months
Total
 
 
$
14

 
$
60

 
$
4

 
$
26

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Currency exchange contracts
$
4,894

 
$
18

 
 
 
$
19

 
 
 
 
 
1 to 12 months
Commodity contracts
14

 
—

 
 
 
—

 
 
 
 
 
1 to 12 months
Total
 
 
$
18

 
 
 
$
19

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
3,090

 
$
1

 
$
36

 
$
—

 
$
76

 
Fair value
 
3 months to 20 years
Floating-to-fixed interest rate swaps
300

 
—

 
—

 
1

 
—

 
Cash flow
 
6 months
Currency exchange contracts
393

 
12

 
—

 
3

 
—

 
Cash flow
 
12 to 36 months
Commodity contracts
1

 
—

 
—

 
—

 
—

 
Cash flow
 
1 to 12 months
Total
 
 
$
13

 
$
36

 
$
4

 
$
76

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Currency exchange contracts
$
4,277

 
$
22

 
 
 
$
26

 
 
 
 
 
1 to 12 months
Total
 
 
$
22

 
 
 
$
26

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The currency exchange contracts shown in the table above as derivatives not designated as hedges are primarily contracts entered into to manage currency volatility or exposure on intercompany sales and loans. While Eaton does not elect hedge accounting treatment for these derivatives, Eaton targets managing 100% of the intercompany balance sheet exposure to minimize the effect of currency volatility related to the movement of goods and services in the normal course of its operations. This activity represents the great majority of these currency exchange contracts.
Amounts recognized in Accumulated other comprehensive income (loss) follow:
 
Three months ended June 30
 
2014
 
2013
 
Gain (loss)
recognized in
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
reclassified
from
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
recognized in
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
reclassified
from
Accumulated
other
comprehensive
income (loss)
Derivatives designated as cash flow hedges
 
 
 
 
 
 
 
Floating-to-fixed interest rate swaps
$
—

 
$
(1
)
 
$
—

 
$
(1
)
Currency exchange contracts
3

 
2

 
1

 
—

Commodity contracts
—

 
—

 
(1
)
 
(1
)
Total
$
3

 
$
1

 
$
—

 
$
(2
)


13
Table of Contents

 
Six months ended June 30
 
2014
 
2013
 
Gain (loss)
recognized in
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
reclassified
from
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
recognized in
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
reclassified
from
Accumulated
other
comprehensive
income (loss)
Derivatives designated as cash flow hedges
 
 
 
 
 
 
 
Floating-to-fixed interest rate swaps
$
—

 
$
(1
)
 
$
—

 
$
(1
)
Currency exchange contracts
5

 
4

 
(8
)
 
1

Commodity contracts
—

 
—

 
(1
)
 
(1
)
Total
$
5

 
$
3

 
$
(9
)
 
$
(1
)
Gains and losses reclassified from Accumulated other comprehensive income (loss) to the Consolidated Statements of Income were recognized in Cost of products sold and Interest expense - net.
Amounts recognized in net income follow:
 
Three months ended
June 30
 
Six months ended
June 30
 
2014
 
2013
 
2014
 
2013
Derivatives designated as fair value hedges
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
44

 
$
(80
)
 
$
73

 
$
(88
)
Related long-term debt converted to floating interest
   rates by interest rate swaps
(44
)
 
80

 
(73
)
 
88

 
$
—

 
$
—

 
$
—

 
$
—

Gains and losses described above were recognized in Interest expense - net.

Note 11.
INVENTORY
The components of inventory follow:
 
June 30,
2014
 
December 31,
2013
Raw materials
$
1,082

 
$
955

Work-in-process
343

 
428

Finished goods
1,229

 
1,115

Inventory at FIFO
2,654

 
2,498

Excess of FIFO over LIFO cost
(120
)
 
(116
)
Total inventory
$
2,534

 
$
2,382


Note 12.
BUSINESS SEGMENT INFORMATION
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision maker, or decision making group, in deciding how to allocate resources to an individual segment and in assessing performance. Eaton’s operating segments are Electrical Products, Electrical Systems and Services, Hydraulics, Aerospace and Vehicle. Operating profit includes the operating profit from intersegment sales. For additional information regarding Eaton’s business segments, see Note 14 to the Consolidated Financial Statements contained in the 2013 Form 10-K.

14
Table of Contents

 
Three months ended
June 30
 
Six months ended
June 30
 
2014
 
2013
 
2014
 
2013
Net sales
 
 
 
 
 
 
 
Electrical Products
$
1,832

 
$
1,758

 
$
3,558

 
$
3,418

Electrical Systems and Services
1,628

 
1,624

 
3,152

 
3,145

Hydraulics
787

 
772

 
1,569

 
1,528

Aerospace
486

 
446

 
950

 
880

Vehicle
1,034

 
1,002

 
2,030

 
1,941

Total net sales
$
5,767

 
$
5,602

 
$
11,259

 
$
10,912

 
 
 
 
 
 
 
 
Segment operating profit
 
 
 
 
 
 
 
Electrical Products
$
300

 
$
272

 
$
550

 
$
513

Electrical Systems and Services
194

 
227

 
363

 
437

Hydraulics
94

 
104

 
202

 
182

Aerospace
69

 
67

 
131

 
129

Vehicle
155

 
172

 
306

 
304

Total segment operating profit
812

 
842

 
1,552

 
1,565

 
 
 
 
 
 
 
 
Corporate
 
 
 
 
 
 
 
Litigation settlements
(644
)
 
—

 
(644
)
 
—

Amortization of intangible assets
(109
)
 
(108
)
 
(219
)
 
(215
)
Interest expense - net
(55
)
 
(71
)
 
(117
)
 
(146
)
Pension and other postretirement benefits expense
(32
)
 
(43
)
 
(83
)
 
(81
)
Inventory step-up adjustment
—

 
(1
)
 
—

 
(34
)
Other corporate income (expense) - net
85

 
(85
)
 
21

 
(155
)
Income before income taxes
57

 
534

 
510

 
934

Income tax (benefit) expense
(115
)
 
37

 
(103
)
 
57

Net income
172

 
497

 
613

 
877

Less net income for noncontrolling interests
(1
)
 
(3
)
 
(3
)
 
(5
)
Net income attributable to Eaton ordinary shareholders
$
171

 
$
494

 
$
610

 
$
872


Note 13.
CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
On November 20, 2012, Eaton Corporation issued senior notes (the Senior Notes) totaling $4,900 to finance part of the cash portion of the acquisition of Cooper. Eaton and certain other of Eaton's principal 100% owned subsidiaries (the Guarantors) fully and unconditionally guaranteed (subject, in the case of the Guarantors, other than Eaton, to customary release provisions as described below), on a joint and several basis, the Senior Notes. The following condensed consolidating financial statements are included so that separate financial statements of Eaton, Eaton Corporation and each of the Guarantors are not required to be filed with the Securities and Exchange Commission. The consolidating adjustments primarily relate to eliminations of investments in subsidiaries and intercompany balances and transactions. The condensed consolidating financial statements present investments in subsidiaries using the equity method of accounting.
The guarantee of a Guarantor that is not a parent of the issuer will be automatically and unconditionally released and discharged in the event of any sale of the Guarantor or of all or substantially all of its assets, or in connection with the release or termination of the Guarantor as a guarantor under all other U.S. debt securities or U.S. syndicated credit facilities, subject to limitations set forth in the indenture. The guarantee of a Guarantor that is a direct or indirect parent of the issuer will only be automatically and unconditionally released and discharged in connection with the release or termination of such Guarantor as a guarantor under all other debt securities or syndicated credit facilities (in both cases, U.S. or otherwise), subject to limitations set forth in the indenture.

15
Table of Contents

CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED JUNE 30, 2014
 
Eaton
Corporation
plc
 
Eaton
Corporation
 
Guarantors
 
Other
subsidiaries
 
Consolidating
adjustments
 
Total
Net sales
$
—

 
$
1,750

 
$
1,779

 
$
3,354

 
$
(1,116
)
 
$
5,767

 
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold
—

 
1,378

 
1,288

 
2,473

 
(1,114
)
 
4,025

Selling and administrative expense
(2
)
 
370

 
193

 
423

 
—

 
984

Litigation settlements
—

 
644

 
—

 
—

 
—

 
644

Research and development expense
—

 
62

 
52

 
54

 
—

 
168

Interest expense (income) - net
—

 
55

 
6

 
(8
)
 
2

 
55

Other income - net
—

 
(50
)
 
(95
)
 
(21
)
 
—

 
(166
)
Equity in (earnings) loss of
   subsidiaries, net of tax
(231
)
 
(258
)
 
(269
)
 
167

 
591

 
—

Intercompany expense (income) - net
62

 
(46
)
 
147

 
(163
)
 
—

 
—

Income (loss) before income taxes
171

 
(405
)

457


429


(595
)

57

Income tax (benefit) expense
—

 
(229
)
 
78

 
37

 
(1
)
 
(115
)
Net income (loss)
171

 
(176
)

379


392


(594
)

172

Less net income for
   noncontrolling interests
—

 
—

 
—

 
(1
)
 
—

 
(1
)
Net income (loss) attributable to
   Eaton ordinary shareholders
$
171

 
$
(176
)

$
379


$
391


$
(594
)

$
171

 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income
$
83

 
$
36

 
$
88

 
$
126

 
$
(250
)
 
$
83

Total comprehensive income
   (loss) attributable to
   Eaton ordinary shareholders
$
254

 
$
(140
)
 
$
467

 
$
517

 
$
(844
)
 
$
254

CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED JUNE 30, 2013
 
Eaton
Corporation
plc
 
Eaton
Corporation
 
Guarantors
 
Other
subsidiaries
 
Consolidating
adjustments
 
Total
Net sales
$
—

 
$
1,743

 
$
1,626

 
$
3,420

 
$
(1,187
)
 
$
5,602

 
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold
—

 
1,353

 
1,179

 
2,525

 
(1,187
)
 
3,870

Selling and administrative expense
2

 
360

 
183

 
415

 
—

 
960

Research and development expense
—

 
64

 
51

 
46

 
—

 
161

Interest expense (income) - net
—

 
69

 
7

 
(5
)
 
—

 
71

Other expense (income) - net
—

 
19

 
14

 
(27
)
 
—

 
6

Equity in (earnings) loss of
   subsidiaries, net of tax
(569
)
 
(299
)
 
395

 
(239
)
 
712

 
—

Intercompany expense (income) - net
61

 
(112
)
 
(860
)
 
911

 
—

 
—

Income (loss) before income taxes
506

 
289


657


(206
)

(712
)

534

Income tax expense (benefit)
12

 
(43
)
 
20

 
48

 
—

 
37

Net income (loss)
494

 
332


637


(254
)

(712
)

497

Less net income for
   noncontrolling interests
—

 
—

 
—

 
(3
)
 
—

 
(3
)
Net income (loss) attributable to
   Eaton ordinary shareholders
$
494

 
$
332


$
637


$
(257
)

$
(712
)

$
494

 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive loss
$
(72
)
 
$
(42
)
 
$
(70
)
 
$
(180
)
 
$
292

 
$
(72
)
Total comprehensive income
   (loss) attributable to
   Eaton ordinary shareholders
$
422

 
$
290

 
$
567

 
$
(437
)
 
$
(420
)
 
$
422


16
Table of Contents

CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 2014
 
Eaton
Corporation
plc
 
Eaton
Corporation
 
Guarantors
 
Other
subsidiaries
 
Consolidating
adjustments
 
Total
Net sales
$
—

 
$
3,417

 
$
3,420

 
$
6,645

 
$
(2,223
)
 
$
11,259

 
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold
—

 
2,720

 
2,506

 
4,865

 
(2,208
)
 
7,883

Selling and administrative expense
—

 
731

 
393

 
822

 
—

 
1,946

Litigation settlements
—

 
644

 
—

 
—

 
—

 
644

Research and development expense
—

 
122

 
102

 
106

 
—

 
330

Interest expense (income) - net
—

 
114

 
13

 
(14
)
 
4

 
117

Other income - net
—

 
(45
)
 
(92
)
 
(34
)
 
—

 
(171
)
Equity in (earnings) loss of
   subsidiaries, net of tax
(700
)
 
(465
)
 
(754
)
 
(34
)
 
1,953

 
—

Intercompany expense (income) - net
90

 
(117
)
 
267

 
(240
)
 
—

 
—

Income (loss) before income taxes
610

 
(287
)

985


1,174


(1,972
)

510

Income tax (benefit) expense