Edgar Filing: Eaton Corp plc

Large accelerated filer þ

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

(Do not check if a smaller reporting company)

ETN 06.30.2015 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, 2015

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)

Eaton House, 30 Pembroke Road, Dublin 4, Ireland		-
(Address of principal executive offices)		(Zip Code)



			+1 353 1637 2900
			(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):

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 467.5 million Ordinary Shares outstanding as of June 30, 2015.

Table of Contents



TABLE OF CONTENTS
PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS	2
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	27
ITEM 4. CONTROLS AND PROCEDURES	27
PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS	28
ITEM 1A. RISK FACTORS	28
ITEM 6. EXHIBITS	28
SIGNATURES	29
EXHIBIT INDEX	30
EX-12
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-99.1 FRS 102 NOTIFICATION
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT

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)	2015			2014			2015			2014
Net sales	$	5,372		$	5,767		$	10,595		$	11,259

Cost of products sold	3,675			4,025			7,268			7,883
Selling and administrative expense	901			984			1,816			1,946
Litigation settlements	—			644			—			644
Research and development expense	158			168			316			330
Interest expense - net	59			55			116			117
Other income - net	(19		)	(166		)	(24		)	(171		)
Income before income taxes	598			57			1,103			510
Income tax expense (benefit)	63			(115		)	101			(103		)
Net income	535			172			1,002			613
Less net income for noncontrolling interests	—			(1		)	(1		)	(3		)
Net income attributable to Eaton ordinary shareholders	$	535		$	171		$	1,001		$	610

Net income per ordinary share
Diluted	$	1.14		$	0.36		$	2.13		$	1.27
Basic	1.14			0.36			2.14			1.28

Weighted-average number of ordinary shares outstanding
Diluted	469.2			478.5			469.6			478.7
Basic	467.6			475.9			467.7			475.9

Cash dividends declared per ordinary share	$	0.55		$	0.49		$	1.10		$	0.98

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

Table of Contents

EATON CORPORATION plc

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME



	Three months ended June 30					Six months ended June 30
(In millions)	2015		2014			2015			2014
Net income	$	535	$	172		$	1,002		$	613
Less net income for noncontrolling interests	—		(1		)	(1		)	(3		)
Net income attributable to Eaton ordinary shareholders	535		171			1,001			610

Other comprehensive income (loss), net of tax
Currency translation and related hedging instruments	209		58			(511		)	11
Pensions and other postretirement benefits	18		23			104			73
Cash flow hedges	3		2			3			2
Other comprehensive income (loss) attributable to Eaton ordinary shareholders	230		83			(404		)	86

Total comprehensive income attributable to Eaton ordinary shareholders	$	765	$	254		$	597		$	696

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

Table of Contents

EATON CORPORATION plc

CONDENSED CONSOLIDATED BALANCE SHEETS



(In millions)	June 30, 2015		December 31, 2014
Assets
Current assets
Cash	$	303	$	781
Short-term investments	127		245
Accounts receivable - net	3,840		3,667
Inventory	2,439		2,428
Deferred income taxes	553		593
Prepaid expenses and other current assets	382		386
Total current assets	7,644		8,100

Property, plant and equipment - net	3,680		3,750

Other noncurrent assets
Goodwill	13,698		13,893
Other intangible assets	6,282		6,556
Deferred income taxes	250		228
Other assets	1,025		1,002
Total assets	$	32,579	$	33,529

Liabilities and shareholders’ equity
Current liabilities
Short-term debt	$	139	$	2
Current portion of long-term debt	842		1,008
Accounts payable	1,931		1,940
Accrued compensation	327		420
Other current liabilities	1,817		1,985
Total current liabilities	5,056		5,355

Noncurrent liabilities
Long-term debt	7,770		8,024
Pension liabilities	1,552		1,812
Other postretirement benefits liabilities	507		513
Deferred income taxes	876		901
Other noncurrent liabilities	1,015		1,085
Total noncurrent liabilities	11,720		12,335

Shareholders’ equity
Eaton shareholders’ equity	15,753		15,786
Noncontrolling interests	50		53
Total equity	15,803		15,839
Total liabilities and equity	$	32,579	$	33,529

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

Table of Contents

EATON CORPORATION plc

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



	Six months ended June 30
(In millions)	2015			2014
Operating activities
Net income	$	1,002		$	613
Adjustments to reconcile to net cash provided by operating activities
Depreciation and amortization	460			499
Deferred income taxes	(29		)	(256		)
Pension and other postretirement benefits expense	158			180
Contributions to pension plans	(258		)	(304		)
Contributions to other postretirement benefits plans	(16		)	(24		)
Excess tax benefit from equity-based compensation	—			(20		)
Gain on sale of businesses	—			(69		)
Changes in working capital	(506		)	116
Other - net	(155		)	(90		)
Net cash provided by operating activities	656			645

Investing activities
Cash paid for acquisitions of businesses, net of cash acquired	(38		)	—
Capital expenditures for property, plant and equipment	(246		)	(236		)
Sales of short-term investments - net	109			162
Proceeds from sale of businesses	1			273
Other - net	(33		)	(51		)
Net cash (used in) provided by investing activities	(207		)	148

Financing activities
Proceeds from borrowings	137			—
Payments on borrowings	(404		)	(576		)
Cash dividends paid	(514		)	(467		)
Exercise of employee stock options	46			44
Repurchase of shares	(170		)	(99		)
Excess tax benefit from equity-based compensation	—			20
Other - net	(7		)	—
Net cash used in financing activities	(912		)	(1,078		)

Effect of currency on cash	(15		)	1
Total decrease in cash	(478		)	(284		)
Cash at the beginning of the period	781			915
Cash at the end of the period	$	303		$	631

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

Table of Contents

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 2014 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 and 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 (FASB) 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. In July 2015, the FASB made a decision to defer the effective date of the new standard for one year and permit early adoption as of the original effective date. 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.	ACQUISITION AND SALE OF BUSINESSES

Acquisition of UK Safety Technology Manufacturer Oxalis Group Ltd.

On January 12, 2015, Eaton acquired Oxalis Group Ltd. (Oxalis). Oxalis is a manufacturer of closed-circuit television camera stations, public address and general alarm systems and other electrical products for the hazardous area, marine and industrial communications markets. Oxalis is reported within the Electrical Systems and Services business segment.

Sale of Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions

On May 9, 2014, Eaton sold the Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses to Safran for $270, which resulted in a pre-tax gain of $156 as of June 30, 2014.

Table of Contents


Note 3.	ACQUISITION INTEGRATION CHARGES

Eaton incurs integration charges related to acquired businesses. A summary of these charges follows:



	Three months ended June 30				Six months ended June 30
	2015		2014		2015		2014
Business segment
Electrical Products	$	6	$	12	$	12	$	41
Electrical Systems and Services	4		13		7		39
Hydraulics	1		5		2		9
Total business segments	11		30		21		89
Corporate	1		7		2		14
Total acquisition integration charges before income taxes	$	12	$	37	$	23	$	103
Total after income taxes	$	8	$	23	$	15	$	67
Per ordinary share - diluted	$	0.02	$	0.05	$	0.03	$	0.14

Business segment acquisition integration charges for the three and six months ended June 30, 2015 and 2014 were related primarily to the integration of Cooper Industries plc (Cooper) to gain efficiencies in selling, marketing, traditional back-office functions, manufacturing, and distribution. 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. See Note 13 for additional information about business segments.

Corporate acquisition integration charges in 2015 and 2014 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 expense - net.

The Cooper integration initiatives are expected to continue throughout 2015.

Note 4. RESTRUCTURING CHARGES

The Company plans to implement certain restructuring activities in an effort to gain efficiencies in all business segments. These restructuring activities are anticipated to be $145, comprised primarily of severance costs, with $120 to occur in the second half of 2015 and $25 in 2016.

Note 5. GOODWILL

A summary of goodwill follows:



	Electrical Products			Electrical Systems and Services			Hydraulics			Aerospace		Vehicle			Total
December 31, 2014	$	6,940		$	4,314		$	1,327		$	962	$	350		$	13,893
Additions	—			22			—			—		—			22
Reclassifications	(106		)	106			—			—		—			—
Translation	(106		)	(66		)	(42		)	1		(4		)	(217		)
June 30, 2015	$	6,728		$	4,376		$	1,285		$	963	$	346		$	13,698

Table of Contents

Note 6. 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
	2015			2014			2015			2014			2015			2014
Service cost	$	30		$	29		$	19		$	17		$	1		$	5
Interest cost	39			41			18			22			6			10
Expected return on plan assets	(65		)	(62		)	(25		)	(25		)	(1		)	(2		)
Amortization	30			23			10			7			1			2
	34			31			22			21			7			15
Settlements	19			14			—			—			—			—
Total expense	$	53		$	45		$	22		$	21		$	7		$	15



	United States pension benefit expense						Non-United States pension benefit expense						Other postretirement benefits expense
	Six months ended June 30
	2015			2014			2015			2014			2015			2014
Service cost	$	61		$	58		$	37		$	33		$	3		$	9
Interest cost	78			81			36			44			12			19
Expected return on plan assets	(131		)	(123		)	(50		)	(50		)	(2		)	(3		)
Amortization	60			46			20			14			1			4
	68			62			43			41			14			29
Settlements	33			48			—			—			—			—
Total expense	$	101		$	110		$	43		$	41		$	14		$	29

Note 7. 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 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. and Eaton Holding S.à.r.l. This judgment is based on an alleged violation of an agency agreement between Raysul and Saturnia. At June 30, 2015, the Company has a total accrual of 88 Brazilian Reais related to this matter ($28 based on current exchange rates), comprised of 60 Brazilian Reais recognized in the fourth quarter of 2010 ($19 based on current exchange rates) with an additional 28 Brazilian Reais recognized through June 30, 2015 ($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 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 were denied. On February 2, 2015, a final appeal was filed with the Superior Court of Justice in Brasilia. 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 of Delaware. The action sought damages, which would have been 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.

Table of Contents

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 8. INCOME TAXES

The effective income tax rate for the second quarter and first six months of 2015 was expense of 11% and 9%, respectively, compared to a benefit of 203% and 20% for the second quarter and first six months of 2014, respectively. Excluding the litigation settlements and related legal costs, as well as the gain on the sale of Eaton's Aerospace 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% and 6% for the second quarter and first six months of 2014, respectively. See Note 7 and Note 2 for additional information about legal contingencies and the sale of businesses, respectively.

The increase in the effective tax rate in the second quarter and first six months of 2015 is primarily due to more income earned in higher tax jurisdictions, including the United States.

Note 9. EQUITY

Eaton has an ordinary share repurchase program (2013 Program) that authorizes the repurchase of 40 million ordinary shares. During the first quarter of 2015, 2.4 million ordinary shares were repurchased under the 2013 Program in the open market at a total cost of $170. No ordinary shares were repurchased during the second quarter of 2015. During the first six months and 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.

The changes in Shareholders’ equity follow:



	Eaton shareholders’ equity			Noncontrolling interests			Total equity
Balance at December 31, 2014	$	15,786		$	53		$	15,839
Net income	1,001			1			1,002
Other comprehensive loss	(404		)	—			(404		)
Cash dividends paid and accrued	(514		)	(4		)	(518		)
Issuance of shares under equity-based compensation plans - net	54			—			54
Repurchase of shares	(170		)	—			(170		)
Balance at June 30, 2015	$	15,753		$	50		$	15,803

The changes in Accumulated other comprehensive loss follow:



	Currency translation and related hedging instruments			Pensions and other postretirement benefits			Cash flow hedges			Total
Balance at December 31, 2014	$	(1,414	)	$	(1,485	)	$	—		$	(2,899	)
Other comprehensive (loss) income before reclassifications	(511		)	30			7			(474		)
Amounts reclassified from Accumulated other comprehensive loss	—			74			(4		)	70
Net current-period Other comprehensive (loss) income	(511		)	104			3			(404		)
Balance at June 30, 2015	$	(1,925	)	$	(1,381	)	$	3		$	(3,303	)

The reclassifications out of Accumulated other comprehensive loss follow:

Table of Contents



	Six months ended June 30, 2015				Consolidated statements of income classification
Amortization of pensions and other postretirement benefits items
Actuarial loss and prior service cost	$	(114	)	¹
Tax benefit	40
Total, net of tax	(74		)

Gains and (losses) on cash flow hedges
Currency exchange contracts	6				Cost of products sold
Tax expense	(2		)
Total, net of tax	4

Total reclassifications for the period	$	(70	)

¹ These components of Accumulated other comprehensive loss are included in the computation of net periodic benefit cost. See Note 6 for additional information about pension and other post retirement benefits items.

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)	2015		2014		2015		2014
Net income attributable to Eaton ordinary shareholders	$	535	$	171	$	1,001	$	610

Weighted-average number of ordinary shares outstanding - diluted	469.2		478.5		469.6		478.7
Less dilutive effect of equity-based compensation	1.6		2.6		1.9		2.8
Weighted-average number of ordinary shares outstanding - basic	467.6		475.9		467.7		475.9

Net income per ordinary share
Diluted	$	1.14	$	0.36	$	2.13	$	1.27
Basic	1.14		0.36		2.14		1.28

For the second quarter and first six months of 2015, 1.3 million and 1.1 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. 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.

Note 10. 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:

Table of Contents



	Total			Level 1		Level 2			Level 3
June 30, 2015
Cash	$	303		$	303	$	—		$	—
Short-term investments	127			127		—			—
Net derivative contracts	73			—		73			—
Long-term debt converted to floating interest rates by interest rate swaps - net	(71		)	—		(71		)	—

December 31, 2014
Cash	$	781		$	781	$	—		$	—
Short-term investments	245			245		—			—
Net derivative contracts	70			—		70			—
Long-term debt converted to floating interest rates by interest rate swaps - net	(74		)	—		(74		)	—

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 measured using unobservable inputs.

Other Fair Value Measurements

Long-term debt and the current portion of long-term debt had a carrying value of $8,612 and fair value of $8,879 at June 30, 2015 compared to $9,032 and $9,509, respectively, at December 31, 2014. 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 11. 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.

Table of Contents

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 $82 at June 30, 2015 and $84 at December 31, 2014.

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 noncurrent assets		Other current liabilities		Other noncurrent liabilities		Type of hedge	Term
June 30, 2015
Derivatives designated as hedges
Fixed-to-floating interest rate swaps	$	3,440	$	—	$	81	$	—	$	10	Fair value	2 to 19 years
Currency exchange contracts	533		10		1		4		2		Cash flow	1 to 36 months
Commodity contracts	1		—		—		—		—		Cash flow	1 to 12 months
Total			$	10	$	82	$	4	$	12

Derivatives not designated as hedges
Currency exchange contracts	$	3,975	$	25			$	28				1 to 12 months
Total			$	25			$	28

December 31, 2014
Derivatives designated as hedges
Fixed-to-floating interest rate swaps	$	3,440	$	—	$	84	$	—	$	10	Fair value	2 to 19 years
Currency exchange contracts	432		8		1		5		3		Cash flow	1 to 36 months
Commodity contracts	1		—		—		—		—		Cash flow	1 to 12 months
Total			$	8	$	85	$	5	$	13

Derivatives not designated as hedges
Currency exchange contracts	$	4,447	$	47			$	52				1 to 12 months
Total			$	47			$	52

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.

Table of Contents

Amounts recognized in Accumulated other comprehensive loss follow:



	Gain (loss) recognized in other comprehensive (loss) income				Location of gain reclassified from Accumulated other comprehensive loss	Gain (loss) reclassified from Accumulated other comprehensive loss
	Three months ended June 30					Three months ended June 30
	2015		2014			2015		2014
Derivatives designated as cash flow hedges
Floating-to-fixed interest rate swaps	$	—	$	—	Interest expense - net	$	—	$	(1	)
Currency exchange contracts	8		3		Cost of products sold	4		2
Total	$	8	$	3		$	4	$	1



	Gain (loss) recognized in other comprehensive (loss) income				Location of gain reclassified from Accumulated other comprehensive loss	Gain (loss) reclassified from Accumulated other comprehensive loss
	Six months ended June 30					Six months ended June 30
	2015		2014			2015		2014
Derivatives designated as cash flow hedges
Floating-to-fixed interest rate swaps	$	—	$	—	Interest expense - net	$	—	$	(1	)
Currency exchange contracts	10		5		Cost of products sold	6		4
Total	$	10	$	5		$	6	$	3

Amounts recognized in net income follow:



	Three months ended June 30						Six months ended June 30
	2015			2014			2015			2014
Derivatives designated as fair value hedges
Fixed-to-floating interest rate swaps	$	(51	)	$	44		$	(3	)	$	73
Related long-term debt converted to floating interest rates by interest rate swaps	51			(44		)	3			(73		)
	$	—		$	—		$	—		$	—

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

Note 12. INVENTORY

The components of inventory follow:



	June 30, 2015			December 31, 2014
Raw materials	$	1,130		$	924
Work-in-process	279			422
Finished goods	1,152			1,201
Inventory at FIFO	2,561			2,547
Excess of FIFO over LIFO cost	(122		)	(119		)
Total inventory	$	2,439		$	2,428

Table of Contents

Note 13. 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 2014 Form 10-K.



	Three months ended June 30						Six months ended June 30
	2015			2014			2015			2014
Net sales
Electrical Products	$	1,784		$	1,832		$	3,475		$	3,558
Electrical Systems and Services	1,502			1,628			2,950			3,152
Hydraulics	643			787			1,308			1,569
Aerospace	454			486			918			950
Vehicle	989			1,034			1,944			2,030
Total net sales	$	5,372		$	5,767		$	10,595		$	11,259

Segment operating profit
Electrical Products	$	276		$	300		$	536		$	550
Electrical Systems and Services	223			194			409			363
Hydraulics	74			94			140			202
Aerospace	77			69			154			131
Vehicle	190			155			354			306
Total segment operating profit	840			812			1,593			1,552

Corporate
Litigation settlements	—			(644		)	—			(644		)
Amortization of intangible assets	(102		)	(109		)	(204		)	(219		)
Interest expense - net	(59		)	(55		)	(116		)	(117		)
Pension and other postretirement benefits expense	(33		)	(32		)	(61		)	(83		)
Other corporate (expense) benefit - net	(48		)	85			(109		)	21
Income before income taxes	598			57			1,103			510
Income tax expense (benefit)	63			(115		)	101			(103		)
Net income	535			172			1,002			613
Less net income for noncontrolling interests	—			(1		)	(1		)	(3		)
Net income attributable to Eaton ordinary shareholders	$	535		$	171		$	1,001		$	610

Note 14. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS

On November 20, 2012, Eaton Corporation issued senior notes totaling $4,900 to finance part of the cash portion of the acquisition of Cooper. On November 14, 2013, the senior notes were exchanged for senior notes registered under the Securities Act of 1933 (the Senior Notes). Eaton and certain other of Eaton's 100% owned direct and indirect 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.

During the third quarter of 2014, the Company undertook certain steps to restructure ownership of various subsidiaries. The transactions were entirely among wholly-owned subsidiaries under the common control of Eaton. This restructuring has been reflected as of the beginning of the earliest period presented below.



CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE MONTHS ENDED JUNE 30, 2015
	Eaton Corporation plc			Eaton Corporation			Guarantors			Other subsidiaries			Consolidating adjustments			Total
Net sales	$	—		$	1,806		$	1,705		$	3,248		$	(1,387	)	$	5,372

Cost of products sold	—			1,433			1,273			2,322			(1,353		)	3,675
Selling and administrative expense	2			368			172			359			—			901
Research and development expense	—			66			49			43			—			158
Interest expense (income) - net	—			58			5			(2		)	(2		)	59
Other expense (income) - net	—			11			(7		)	(23		)	—			(19		)
Equity in earnings of subsidiaries, net of tax	(619		)	(62		)	(805		)	(129		)	1,615			—
Intercompany expense (income) - net	82			(267		)	481			(296		)	—			—
Income before income taxes	535			199			537			974			(1,647		)	598
Income tax expense (benefit)	—			41			(38		)	75			(15		)	63
Net income	535			158			575			899			(1,632		)	535
Less net income for noncontrolling interests	—			—			—			(1		)	1			—
Net income attributable to Eaton ordinary shareholders	$	535		$	158		$	575		$	898		$	(1,631	)	$	535

Other comprehensive income	$	230		$	16		$	234		$	282		$	(532	)	$	230
Total comprehensive income attributable to Eaton ordinary shareholders	$	765		$	174		$	809		$	1,180		$	(2,163	)	$	765



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		)	(194		)	(256		)	214			467			—
Intercompany expense (income) - net	62			(47		)	146			(161		)	—			—
Income (loss) before income taxes	171			(468		)	445			380			(471		)	57
Income tax (benefit) expense	—			(255		)	78			63			(1		)	(115		)
Net income (loss)	171			(213		)	367			317			(470		)	172
Less net income for noncontrolling interests	—			—			—			(1		)	—			(1		)
Net income (loss) attributable to Eaton ordinary shareholders	$	171		$	(213	)	$	367		$	316		$	(470	)	$	171

Other comprehensive income	$	83		$	37		$	90		$	116		$	(243	)	$	83
Total comprehensive income (loss) attributable to Eaton ordinary shareholders	$	254		$	(176	)	$	457		$	432		$	(713	)	$	254

CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME FOR THE SIX MONTHS ENDED JUNE 30, 2015

	Eaton Corporation plc			Eaton Corporation			Guarantors			Other subsidiaries			Consolidating adjustments			Total
Net sales	$	—		$	3,508		$	3,401		$	6,364		$	(2,678	)	$	10,595

Cost of products sold	—			2,743			2,568			4,599			(2,642		)	7,268
Selling and administrative expense	4			745			348			719			—			1,816
Research and development expense	—			137			94			85			—			316
Interest expense (income) - net	—			112			11			(7		)	—			116
Other expense (income) - net	—			6			(8		)	(22		)	—			(24		)
Equity in earnings of subsidiaries, net of tax	(1,164		)	(273		)	(1,518		)	(258		)	3,213			—
Intercompany expense (income) - net	159			(308		)	752			(603		)	—			—
Income before income taxes	1,001			346			1,154			1,851			(3,249		)	1,103
Income tax expense (benefit)	—			19			(17		)	116			(17		)	101
Net income	1,001			327			1,171			1,735			(3,232		)	1,002
Less net income for noncontrolling interests	—			—			—			(2		)	1			(1		)
Net income attributable to Eaton ordinary shareholders	$	1,001		$	327		$	1,171		$	1,733		$	(3,231	)	$	1,001

Other comprehensive (loss) income	$	(404	)	$	62		$	(386	)	$	(464	)	$	788		$	(404	)
Total comprehensive income attributable to Eaton ordinary shareholders	$	597		$	389		$	785		$	1,269		$	(2,443	)	$	597

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		—