Document
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 September 30, 2018
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
 
D04 Y0C2
(Address of principal executive offices)
 
(Zip Code)
 
 
 
+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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer," “smaller reporting company,” and "emerging growth 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
 
Emerging growth company o
 
(Do not check if a smaller reporting company)
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange
Act. o
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 433.4 million Ordinary Shares outstanding as of September 30, 2018.
 


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
September 30
 
Nine months ended
September 30
(In millions except for per share data)
2018
 
2017
 
2018
 
2017
Net sales
$
5,412

 
$
5,211

 
$
16,150

 
$
15,191

 
 
 
 
 
 
 
 
Cost of products sold
3,597

 
3,466

 
10,841

 
10,221

Selling and administrative expense
889

 
902

 
2,679

 
2,669

Research and development expense
138

 
147

 
439

 
440

Interest expense - net
67

 
60

 
205

 
181

Gain on sale of business

 
1,077

 

 
1,077

Arbitration decision expense
275

 

 
275

 

Other expense - net
7

 
19

 
13

 
24

Income before income taxes
439

 
1,694

 
1,698

 
2,733

Income tax expense
23

 
293

 
184

 
381

Net income
416

 
1,401

 
1,514

 
2,352

Less net income for noncontrolling interests

 

 

 
(1
)
Net income attributable to Eaton ordinary shareholders
$
416

 
$
1,401

 
$
1,514

 
$
2,351

 
 
 
 
 
 
 
 
Net income per share attributable to Eaton ordinary shareholders
 
 
 
 
 
 
 
Diluted
$
0.95

 
$
3.14

 
$
3.45

 
$
5.24

Basic
0.96

 
3.16

 
3.47

 
5.27

 
 
 
 
 
 
 
 
Weighted-average number of ordinary shares outstanding
 
 
 
 
 
 
 
Diluted
436.3

 
445.2

 
438.4

 
448.3

Basic
433.5

 
442.6

 
435.8

 
445.9

 
 
 
 
 
 
 
 
Cash dividends declared per ordinary share
$
0.66

 
$
0.60

 
$
1.98

 
$
1.80


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

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EATON CORPORATION plc
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 
Three months ended
September 30
 
Nine months ended
September 30
(In millions)
2018
 
2017
 
2018
 
2017
Net income
$
416

 
$
1,401

 
$
1,514

 
$
2,352

Less net income for noncontrolling interests

 

 

 
(1
)
Net income attributable to Eaton ordinary shareholders
416

 
1,401

 
1,514

 
2,351

 
 
 
 
 
 
 
 
Other comprehensive (loss) income, net of tax
 
 
 
 
 
 
 
Currency translation and related hedging instruments
(132
)
 
195

 
(546
)
 
743

Pensions and other postretirement benefits
40

 
16

 
122

 
53

Cash flow hedges
(6
)
 
(12
)
 
(2
)
 
(11
)
Other comprehensive (loss) income attributable to Eaton
   ordinary shareholders
(98
)
 
199

 
(426
)
 
785

 
 
 
 
 
 
 
 
Total comprehensive income attributable to Eaton
  ordinary shareholders
$
318

 
$
1,600

 
$
1,088

 
$
3,136


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


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EATON CORPORATION plc
CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions)
September 30,
2018
 
December 31,
2017
Assets
 
 
 
Current assets
 
 
 
Cash
$
327

 
$
561

Short-term investments
178

 
534

Accounts receivable - net
4,027

 
3,943

Inventory
2,835

 
2,620

Prepaid expenses and other current assets
500

 
679

Total current assets
7,867

 
8,337

 
 
 
 
Property, plant and equipment
 
 
 
Land and buildings
2,470

 
2,491

Machinery and equipment
6,030

 
6,014

Gross property, plant and equipment
8,500

 
8,505

Accumulated depreciation
(5,054
)
 
(5,003
)
Net property, plant and equipment
3,446

 
3,502

 
 
 
 
Other noncurrent assets
 
 
 
Goodwill
13,385

 
13,568

Other intangible assets
4,949

 
5,265

Deferred income taxes
241

 
253

Other assets
1,740

 
1,698

Total assets
$
31,628

 
$
32,623

 
 
 
 
Liabilities and shareholders’ equity
 
 
 
Current liabilities
 
 
 
Short-term debt
$
82

 
$
6

Current portion of long-term debt
426

 
578

Accounts payable
2,165

 
2,166

Accrued compensation
427

 
453

Other current liabilities
2,167

 
1,872

Total current liabilities
5,267

 
5,075

 
 
 
 
Noncurrent liabilities
 
 
 
Long-term debt
6,737

 
7,167

Pension liabilities
1,160

 
1,226

Other postretirement benefits liabilities
344

 
362

Deferred income taxes
347

 
538

Other noncurrent liabilities
984

 
965

Total noncurrent liabilities
9,572

 
10,258

 
 
 
 
Shareholders’ equity
 
 
 
Eaton shareholders’ equity
16,754

 
17,253

Noncontrolling interests
35

 
37

Total equity
16,789

 
17,290

Total liabilities and equity
$
31,628

 
$
32,623

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

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Table of Contents

EATON CORPORATION plc
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 
Nine months ended
September 30
(In millions)
2018
 
2017
Operating activities
 
 
 
Net income
$
1,514

 
$
2,352

Adjustments to reconcile to net cash provided by operating activities
 
 
 
Depreciation and amortization
680

 
685

Deferred income taxes
(211
)
 
(178
)
Pension and other postretirement benefits expense
123

 
161

Contributions to pension plans
(99
)
 
(447
)
Contributions to other postretirement benefits plans
(26
)
 
(14
)
Gain on sale of business

 
(843
)
Changes in working capital
62

 
(152
)
Other - net
(205
)
 
223

Net cash provided by operating activities
1,838

 
1,787

 
 
 
 
Investing activities
 

 
 
Capital expenditures for property, plant and equipment
(411
)
 
(351
)
Proceeds from sale of business

 
600

Sales (purchases) of short-term investments - net
329

 
(621
)
Payments for settlement of currency exchange contracts not designated as hedges - net
(122
)
 

Other - net
(52
)
 
(63
)
Net cash used in investing activities
(256
)
 
(435
)
 
 
 
 
Financing activities
 
 
 
Proceeds from borrowings
80

 
1,000

Payments on borrowings
(486
)
 
(553
)
Cash dividends paid
(864
)
 
(803
)
Exercise of employee stock options
28

 
59

Repurchase of shares
(600
)
 
(789
)
Employee taxes paid from shares withheld
(24
)
 
(21
)
Other - net
(2
)
 
(8
)
Net cash used in financing activities
(1,868
)
 
(1,115
)
 
 
 
 
Effect of currency on cash
52

 
11

Total increase (decrease) in cash
(234
)
 
248

Cash at the beginning of the period
561

 
543

Cash at the end of the period
$
327

 
$
791


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 2017 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.
During the first quarter of 2018, Eaton re-segmented certain reportable operating segments due to a reorganization of the Company's businesses. The new reportable business segment is eMobility (which includes certain legacy Electrical Products and Vehicle product lines). See Note 14 for additional information related to these segments.
Certain prior year amounts have been reclassified to conform to the current year presentation.
Revenue Recognition
Sales are recognized when control of promised goods or services are transferred to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. Control is transferred when the customer has the ability to direct the use of and obtain benefits from the goods or services. The majority of the Company’s sales agreements contain performance obligations satisfied at a point in time when control is transferred to the customer. Sales recognized over time are generally accounted for using an input measure to determine progress completed at the end of the period. Sales for service contracts generally are recognized as the services are provided. For agreements with multiple performance obligations, judgment is required to determine whether performance obligations specified in these agreements are distinct and should be accounted for as separate revenue transactions for recognition purposes. In these types of agreements, we generally allocate sales price to each distinct obligation based on the price of each item sold in separate transactions.
Payment terms vary by the type and location of the customer and the products or services offered. Generally, the time between when revenue is recognized and payment is due is not significant. Eaton does not evaluate whether the selling price includes a financing interest component for contracts that are less than a year. Sales, value added, and other taxes collected concurrent with revenue are excluded from sales. Shipping and handling costs are treated as fulfillment costs and are included in Cost of products sold.
Eaton records reductions to sales for returns, and customer and distributor incentives, primarily comprised of rebates, at the time of the initial sale. Rebates are estimated based on sales terms, historical experience, trend analysis, and projected market conditions in the various markets served. The rebate programs offered vary across businesses due to the numerous markets Eaton serves, but the most common incentives relate to amounts paid or credited to customers for achieving defined volume levels. Returns are estimated at the time of the sale primarily based on historical experience and recorded gross on the Consolidated Balance Sheet. See Note 4 for additional information.
Adoption of New Accounting Standards
Eaton adopted Accounting Standard Update 2014-09, Revenue from Contracts with Customers, at the start of the first quarter of 2018 using the modified retrospective approach and recorded a cumulative effect adjustment to retained earnings based on the current terms and conditions for open contracts as of January 1, 2018. The adoption of the standard did not have a material impact on the Company’s Consolidated financial statements. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.

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Consolidated Balance Sheet
Balance at December 31, 2017
 
Adjustments due to ASU 2014-09
 
Balance at January 1, 2018
Assets
 
 
 
 
 
 
Accounts receivable - net
$
3,943

 
$
(99
)
 
$
3,844

 
Prepaid expenses and other current assets
679

 
129

 
808

 
Deferred income taxes
253

 
1

 
254

 
 
 
 
 
 


Liabilities and shareholders' equity
 
 
 
 
 
 
Other current liabilities
$
1,872

 
$
33

 
$
1,905

 
Eaton shareholders' equity
17,253

 
(2
)
 
17,251

Eaton adopted Accounting Standards Update 2016-16, Intra-Entity Transfers of Assets Other Than Inventory (ASU 2016-16), at the start of the first quarter of 2018. This accounting standard requires companies to recognize the income tax effects of intercompany sales and transfers of assets other than inventory in the period in which the transfer occurs. The previous accounting standard required companies to defer the income tax effects of intercompany transfers of assets by recording a prepaid tax, until such assets were sold to an outside party or otherwise recognized. ASU 2016-16 requires companies to write off any income tax amounts that had been deferred as prepaid taxes from past intercompany transactions, and record deferred tax balances for amounts that have not been recognized, through a cumulative-effect adjustment to retained earnings. Upon adoption, the Company recorded a cumulative-effect adjustment of $199 to reduce retained earnings.
Eaton adopted Accounting Standards Update 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (ASU 2017-07), at the start of the first quarter of 2018. The new standard requires companies to present service costs consistent with other employee compensation costs on the income statement and separate from all other elements of pension costs. The retrospective adoption of this standard resulted in an increase in selling and administrative expense with a corresponding decrease in Other expense - net of $2 for the nine months ended September 30, 2018, and a reduction in selling and administrative expense with a corresponding increase in Other expense - net of $34 for the nine months ended September 30, 2017.
Recently Issued Accounting Pronouncement
In February 2016, the FASB issued Accounting Standards Update 2016-02, Leases (Topic 842), (ASU 2016-02). This accounting standard requires that a lessee recognize a lease asset and a lease liability on its balance sheet for all leases, including operating leases, with a term greater than 12 months. ASU 2016-02 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, 2018. The Company plans to adopt the standard, and related amendments, as of the first quarter of 2019 using the optional transition method that allows for a cumulative-effect adjustment to be recorded at adoption, and will not restate prior periods. A project team has been formed to evaluate and implement the new standard. The project team has been collecting and validating the data required to account for leases under the new standard, and continues to test the functionality of a new lease accounting system being developed by a third-party. In addition, the Company is in the process of identifying and implementing the appropriate changes to business processes and controls to support recognition and disclosure under the new standard. Eaton is evaluating the impact of ASU 2016-02 and expects to recognize a significant lease asset and lease liability for operating leases on the Consolidated Balance Sheet, but does not expect a material impact to the Consolidated Statements of Income or Cash Flows.

Note 2.
SALE OF A BUSINESS
Sale of heavy-duty and medium-duty commercial vehicle automated transmission business
On July 31, 2017, Eaton sold a 50% interest in its heavy-duty and medium-duty commercial vehicle automated transmission business for $600 in cash to Cummins, Inc. The new joint venture is named Eaton Cummins Automated Transmission Technologies (ECATT). In 2017, the Company recognized a pre-tax gain of $1,077, of which $533 related to the pre-tax gain from the $600 proceeds from the sale and $544 related to the Company’s remaining 50% investment in the joint venture being remeasured to fair value. The after-tax gain was $843. The fair value is based on the price paid to Eaton for the 50% interest sold to Cummins, Inc. and further supported by a discounted cash flow model. Eaton accounts for its investment on the equity method of accounting.


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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
September 30
 
Nine months ended
September 30
 
2018
 
2017
 
2018
 
2017
Electrical Products
$

 
$
1

 
$

 
$
3

Total acquisition integration charges before income tax

 
1

 

 
3

Income taxes

 

 

 
1

Total after income taxes
$

 
$
1

 
$

 
$
2

Per ordinary share - diluted
$

 
$

 
$

 
$

Business segment acquisition integration charges in 2017 related to the integration of Ephesus Lighting, Inc. (Ephesus), which was acquired in 2015. The charges associated with Ephesus were included in Selling and administrative expense. In Business Segment Information, the charges reduced Operating profit of the related business segment. See Note 14 for additional information about business segments.

Note 4.
REVENUE RECOGNITION
Sales are recognized when obligations under the terms of the contract are satisfied and control of promised goods or services have transferred to our customers. Sales are measured at the amount of consideration the Company expects to be paid in exchange for these products or services.
The majority of the Company’s sales agreements contain performance obligations satisfied at a point in time when title and risk and rewards of ownership have transferred to the customer. Sales recognized over time are less than 5% of Eaton’s Consolidated Net Sales. Sales recognized over time are generally accounted for using an input measure to determine progress completed at the end of the period. Sales for service contracts generally are recognized as the services are provided. For agreements with multiple performance obligations, judgment is required to determine whether performance obligations specified in these agreements are distinct and should be accounted for as separate revenue transactions for recognition purposes. In these types of agreements, we generally allocate sales price to each distinct obligation based on the price of each item sold in separate transactions.
Due to the nature of the work required to be performed for obligations recognized over time, Eaton estimates total costs by contract. The estimate of total costs are subject to judgment. Estimated amounts are included in the recognized sales price to the extent it is not probable that a significant reversal of cumulative sales will occur. Additionally, contracts can be modified to account for changes in contract specifications, requirements or sale price. The effect of a contract modification on the sales price or adjustments to the measure of completion under the input method are recognized as adjustments to revenue on a cumulative catch-up basis.
Payment terms vary by the type and location of the customer and the products or services offered. Generally, the time between when revenue is recognized and when payment is due is not significant. Eaton does not evaluate whether the selling price includes a financing interest component for contracts that are less than a year. Sales, value added, and other taxes collected concurrent with revenue are excluded from sales. Shipping and handling costs are treated as fulfillment costs and are included in Cost of products sold.
Eaton records reductions to sales for returns, and customer and distributor incentives, primarily comprised of rebates, at the time of the initial sale. Rebates are estimated based on sales terms, historical experience, trend analysis, and projected market conditions in the various markets served. The rebate programs offered vary across businesses due to the numerous markets Eaton serves, but the most common incentives relate to amounts paid or credited to customers for achieving defined volume levels. Returns are estimated at the time of the sale primarily based on historical experience and are recorded gross on the Condensed Consolidated Balance Sheet.
Sales commissions are expensed when the amortization period is less than a year and are generally not capitalized as they are typically earned at the completion of the contract when the customer is invoiced or when the customer pays Eaton.
Sales of products and services varies by segment and are discussed in Note 15 of Eaton’s 2017 Form 10-K and in Note 14.

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Table of Contents

In the Electrical Products segment, sales contracts are primarily for electrical components, industrial components, residential products, single phase power quality, emergency lighting, fire detection, wiring devices, structural support systems, circuit protection, and lighting products. These sales contracts are primarily based on a customer’s purchase order followed by our order acknowledgement, and may also include a master supply or distributor agreement. In this segment, performance obligations are generally satisfied at a point in time either when we ship the product from our facility, or when it arrives at the customer’s facility.
In the Electrical Systems and Services segment, sales contracts are primarily for power distribution and assemblies, three phase power quality, hazardous duty electrical equipment, intrinsically safe explosion-proof instrumentation, utility power distribution, power reliability equipment, and services. The majority of the sales contracts in this segment contain performance obligations satisfied at a point in time either when we ship the product from our facility, or when it arrives at the customer’s facility; however, certain power distribution and power quality services are recognized over time.
Many of the products and services in power distribution and power quality services meet the definition of continuous transfer of control to customers and are recognized over time. These products are engineered to a customer’s design specifications, have no alternative use to Eaton, and are controlled by the customer as evidenced by the customer’s contractual ownership of the work in process or our right to payment for work performed to date plus a reasonable margin. As control is transferring over time, sales are recognized based on the extent of progress towards completion of the obligation. Eaton generally uses an input method to determine the progress completed and sales are recorded proportionally as costs are incurred. Incurred cost represent work performed, which corresponds with, and thereby best depicts, the transfer of control to the customer.
In the Hydraulics segment, sales contracts are primarily for hydraulic components and systems for industrial and mobile equipment. These sales contracts are primarily based on a customer’s purchase order. In this segment, performance obligations are generally satisfied at a point in time when we ship the product from our facility.
In the Aerospace segment, sales contracts are primarily for aerospace fuel, hydraulics, and pneumatic systems for commercial and military use. These sales contracts are primarily based on a customer’s purchase order, and frequently covered by terms and conditions included in a long-term agreement. In this segment, performance obligations are generally satisfied at a point in time either when we ship the product from our facility, or when it arrives at the customer’s facility. Our military contracts are primarily fixed-price contracts that are not subject to performance-based payments or progress payments from the customer.
In the Vehicle segment, sales contracts are primarily for drivetrains, powertrain systems and critical components that reduce emissions and improve fuel economy, stability, performance, and safety of cars, light trucks and commercial vehicles. These sales contracts are primarily based on a customer’s purchase order or a blanket purchase order subject to firm releases, frequently covered by terms and conditions included in a master supply agreement. In this segment, performance obligations are generally satisfied at a point in time either when we ship the product from our facility, or when it arrives at the customer’s facility.
In the eMobility segment, sales contracts are primarily for electronic and mechanical components and systems that improves the power management and performance of both on-road and off-road vehicles. These sales contracts are primarily based on a customer’s purchase order. In this segment, performance obligations are generally satisfied at a point in time either when we ship the product from our facility, or when it arrives at the customer’s facility.
In limited circumstances, primarily in the Electrical and Vehicle segments, Eaton sells separately-priced warranties that extend the warranty coverage beyond the standard coverage offered on specific products. Sales for these separately-priced warranties are recorded based on their stand-alone selling price and are recognized as revenue over the length of the warranty period.

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The Company’s six operating segments and the following tables disaggregate sales by lines of businesses, geographic destination, market channel or end market.
 
Three months ended September 30, 2018
Net sales
United States
 
Rest of World
 
Total
Electrical Products
$
1,055

 
$
734

 
$
1,789

Electrical Systems and Services
1,000

 
519

 
1,519

Hydraulics
301

 
369

 
670

 
 
 
 
 
 
 
Original Equipment Manufacturers
 
Aftermarket, Distribution and End User
 
 
Aerospace
$
269

 
$
209

 
478

 
 
 
 
 
 
 
Commercial
 
 Passenger and Light Duty
 
 
Vehicle
$
451

 
$
425

 
876

 
 
 
 
 
 
eMobility
 
 
 
 
80

 
 
 
 
 
 
Total
 
 
 
 
$
5,412

 
Nine months ended September 30, 2018
Net sales
United States
 
Rest of World
 
Total
Electrical Products
$
3,048

 
$
2,279

 
$
5,327

Electrical Systems and Services
2,877

 
1,536

 
4,413

Hydraulics
907

 
1,196

 
2,103

 
 
 
 
 
 
 
Original Equipment Manufacturers
 
Aftermarket, Distribution and End User
 

Aerospace
$
799

 
$
600

 
1,399

 
 
 
 
 

 
Commercial
 
 Passenger and Light Duty
 

Vehicle
$
1,333

 
$
1,335

 
2,668

 
 
 
 
 
 
eMobility
 
 
 
 
240

 

 

 

Total
 
 
 
 
$
16,150

The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (revenue recognized exceeds amount billed to the customer), and deferred revenue (advance payments and billings in excess of revenue recognized). Accounts receivables from customers were $3,566 and $3,399 at September 30, 2018 and December 31, 2017, respectively. Amounts are billed as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals or upon achievement of contractual milestones. These assets and liabilities are reported on the Condensed Consolidated Balance Sheets on a contract-by-contract basis at the end of each reporting period. Unbilled receivables were $91 and $117 at September 30, 2018 and January 1, 2018, respectively, and are recorded in Prepaid expenses and other current assets. The decrease in unbilled receivables was primarily due to billings to customers for amounts previously recognized as revenue, partially offset by revenue recognized and not yet billed.

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Changes in the deferred revenue liabilities are as follows:
 
Deferred Revenue
Balance at January 1, 2018
$
227

Customer deposits and billings
696

Revenue recognized in the period
(676
)
Translation
(6
)
Balance at September 30, 2018
$
241

A significant portion of open orders placed with Eaton are by original equipment manufacturers or distributors. These open orders are not considered firm as they have been historically subject to releases by customers. In measuring backlog of unsatisfied or partially satisfied obligations, only the amount of orders to which customers are firmly committed are included. Using this criterion, total backlog at September 30, 2018 was approximately $5.4 billion. Eaton expects to recognize approximately 88% of this backlog in the next twelve months and the rest thereafter.
Impact of new accounting standard
In accordance with the new revenue accounting requirements, the impact of the adoption on the financial statement line items within the accompanying financial statements was as follows:
 
Three months ended September 30, 2018
Consolidated Statements of Income
As Reported
 
Adjustment
 
Balances without Adoption of ASC 606
Net sales
$
5,412

 
$
(5
)
 
$
5,407

Cost of products sold
3,597

 
(4
)
 
3,593

Income before income taxes
439

 
(1
)
 
438

Income tax expense
23

 

 
23

Net income
416

 
(1
)
 
415

Net income attributable to Eaton ordinary shareholders
$
416

 
$
(1
)
 
$
415

 
Nine months ended September 30, 2018
Consolidated Statements of Income
As Reported
 
Adjustment
 
Balances without Adoption of ASC 606
Net sales
$
16,150

 
$
(23
)
 
$
16,127

Cost of products sold
10,841

 
(14
)
 
10,827

Income before income taxes
1,698

 
(9
)
 
1,689

Income tax expense
184

 
(2
)
 
182

Net income
1,514

 
(7
)
 
1,507

Net income attributable to Eaton ordinary shareholders
$
1,514

 
$
(7
)
 
$
1,507


11

Table of Contents

 
September 30, 2018
Condensed Consolidated Balance Sheets
As Reported
 
Adjustment
 
Balances without Adoption of ASC 606
Assets
 
 
 
 

Accounts receivable - net
$
4,027

 
$
58

 
$
4,085

Inventory
2,835

 
13

 
2,848

Prepaid expenses and other current assets
500

 
(105
)
 
395

Deferred income taxes
241

 
(1
)
 
240

 
 
 
 
 

Liabilities and shareholders’ equity
 
 
 
 

Other current liabilities
$
2,167

 
$
(30
)
 
$
2,137

Eaton shareholders' equity
$
16,789

 
$
(5
)
 
$
16,784


Note 5.
RESTRUCTURING CHARGES
During 2015, Eaton announced its commitment to undertake actions to reduce its cost structure in all business segments and at corporate. The multi-year initiative concluded at the end of 2017.
A summary of liabilities related to workforce reductions, plant closings and other associated costs announced as part of this program follows:
 
Workforce reductions
 
Plant closings and other
 
Total
Balance at December 31, 2016
$
113

 
$
1

 
$
114

  Liability recognized
57

 
59

 
116

  Payments
(102
)
 
(39
)
 
(141
)
  Other adjustments
(1
)
 
(16
)
 
(17
)
Balance at December 31, 2017
67

 
5

 
72

Payments
(29
)
 
(4
)
 
(33
)
Other adjustments
(14
)
 

 
(14
)
Balance at September 30, 2018
$
24

 
$
1

 
$
25



12

Table of Contents

Note 6.
GOODWILL
Change in the carrying amount of goodwill by segment follows:
 
December 31,
2017
 
Translation
 
September 30,
2018
Electrical Products
$
6,678

 
$
(87
)
 
$
6,591

Electrical Systems and Services
4,311

 
(40
)
 
4,271

Hydraulics
1,257

 
(50
)
 
1,207

Aerospace
947

 
(4
)
 
943

Vehicle
294

 
(2
)
 
292

eMobility
81

 

 
81

Total
$
13,568

 
$
(183
)
 
$
13,385


Eaton re-segmented certain reportable operating segments due to a reorganization of the Company's businesses. The new reportable business segment is eMobility (which includes certain legacy Electrical Products and Vehicle product lines). The Company used the relative fair value method to reallocate goodwill to the associated reporting units.

Note 7.    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 September 30
 
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
Service cost
$
25

 
$
24

 
$
16

 
$
18

 
$
1

 
$
1

 
Interest cost
30

 
30

 
13

 
14

 
3

 
4

 
Expected return on plan assets
(63
)
 
(61
)
 
(27
)
 
(24
)
 

 
(1
)
 
Amortization
24

 
21

 
9

 
13

 
(4
)
 
(3
)
 
 
16

 
14

 
11

 
21

 

 
1

 
Settlements
13

 
17

 
1

 
4

 

 

 
Total expense
$
29

 
$
31

 
$
12

 
$
25

 
$

 
$
1

 
 
 
 
 
United States
pension benefit expense
 
Non-United States
pension benefit expense
 
Other postretirement
benefits expense
 
 
Nine months ended September 30
 
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
Service cost
$
75

 
$
72

 
$
48

 
$
53

 
$
2

 
$
2

 
Interest cost
91

 
92

 
40

 
41

 
10

 
11

 
Expected return on plan assets
(190
)
 
(183
)
 
(80
)
 
(70
)
 
(2
)
 
(3
)
 
Amortization
71

 
62

 
29

 
38

 
(10
)
 
(9
)
 
 
47

 
43

 
37

 
62

 

 
1

 
Settlements
38

 
51

 
1

 
4

 

 

 
Total expense
$
85

 
$
94

 
$
38

 
$
66

 
$

 
$
1


The components of retirement benefits expense other than service costs are included in Other expense - net.



13

Table of Contents

Note 8.
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. Insurance may cover some of the costs associated with these claims and proceedings. 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 2011, Pepsi-Cola Metropolitan Bottling Company, Inc. (“Pepsi”) filed an action against (a) Cooper Industries, LLC, Cooper Industries, Ltd., Cooper Holdings, Ltd., Cooper US, Inc., and Cooper Industries plc (collectively, “Cooper”), (b) M&F Worldwide Corp., Mafco Worldwide Corp., Mafco Consolidated Group LLC, and PCT International Holdings, Inc. (collectively, “Mafco”), and (c) the Pneumo Abex Asbestos Claims Settlement Trust (the “Trust”) in Texas state court. Pepsi alleged that it was harmed by a 2011 settlement agreement (“2011 Settlement”) among Cooper, Mafco, and Pneumo Abex, LLC (“Pneumo,” which prior to the 2011 Settlement was a Mafco subsidiary), which settlement resolved litigation that Pneumo had previously brought against Cooper involving, among other things, a guaranty related to Pneumo’s friction products business. In November 2015, after a Texas court ruled that Pepsi's claims should be heard in arbitration, Pepsi filed a demand for arbitration against Cooper, Mafco, the Trust, and Pneumo. Pepsi subsequently dropped claims against all parties except Cooper. An arbitration under the auspices of the American Arbitration Association commenced in October 2017. Pepsi’s experts opined, among other things, that the value contributed to the Trust for a release of the guaranty was below reasonably equivalent value, and that an inability of Pneumo to satisfy future liabilities could result in plaintiffs suing Pepsi under various theories. Cooper submitted various expert reports and, among other things, Cooper’s experts opined that Pepsi had no basis to seek any damages and that Cooper paid reasonably equivalent value for the release of its indemnity obligations under the guaranty. The arbitration proceedings closed in December 2017. On July 11, 2018, the arbitration panel made certain findings and concluded that the value contributed to the Trust did not constitute reasonably equivalent value, but ordered the parties to recalculate the amount that should have been contributed to the Trust as of the date of the 2011 transaction. Based on the findings made by the panel and the recalculation ordered by the panel, Cooper believed that no additional amount should be contributed. Pepsi argued that an additional $347 should be contributed. Cooper and its expert disagreed with Pepsi’s argument and believed that Pepsi’s recalculation was flawed and failed to comply with the instructions of the panel. On August 23, 2018, the panel issued its final award and ordered Cooper to pay $293 to Pneumo Abex. On August 30, 2018, Pepsi sought to confirm the award in Texas state court, which Cooper opposed on October 9, 2018. Cooper further requested that the court vacate the award on various grounds, including that Cooper was prejudiced by the conduct of the proceedings, the panel exceeded its powers, and because the panel denied Cooper a full and fair opportunity to present certain evidence. The court confirmed the award at the confirmation hearing, which was held on October 12, 2018. The Company is considering its options, including an appeal.

Note 9.
INCOME TAXES

The effective income tax rate for the third quarter and the first nine months of 2018 was expense of 5.2% and 10.8% compared to expense of 17.3% and 13.9% for the third quarter and first nine months of 2017. The tax rate for the third quarter and first nine months of 2018 includes $69 of tax benefit on the arbitration decision expense which was recorded during the third quarter and is discussed in Note 8. The tax rate for the third quarter and first nine months of 2017 includes $234 of tax expense on the gain related to the sale of a business discussed in Note 2, which closed during the third quarter of 2017. Excluding the one-time impacts of the 2018 arbitration decision and the 2017 sale of a business, the effective income tax rate for both the third quarter and first nine months of 2018 was expense of 12.8% compared to expense of 9.6% and 8.9% for the third quarter and first nine months of 2017. The increase in the effective tax rate in the third quarter and first nine months of 2018 was due to greater levels of income in higher tax jurisdictions.

The U.S. Tax Cuts and Jobs Act (“TCJA”) was enacted on December 22, 2017 and the Company recorded a provisional tax benefit amount of $62 in the fourth quarter of 2017 for the remeasurement of deferred tax balances, including valuation allowances related to the realization of deferred tax assets, and the one-time transition tax. The Company continues to analyze aspects of the TCJA, including additional regulations and guidance which may impact the provisional amounts recorded for the remeasurement of deferred tax balances and related valuation allowances, and the one-time transition tax. The Company recorded a $17 tax expense adjustment to the 2017 provisional tax amounts in the third quarter of 2018, primarily related to the one-time transition tax, resulting in a cumulative provisional tax benefit amount of $45 related to the enactment of the TCJA. The Company will finalize its accounting for the 2017 tax impact of the TCJA in the fourth quarter of 2018.


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Table of Contents

During the third quarter of 2018, the United States Internal Revenue Service (“IRS”) completed its examination of the consolidated income tax returns of the Company’s United States subsidiaries for tax years 2011 through 2013 and has proposed adjustments to certain transfer pricing tax positions, including adjustments similar to those proposed and previously disclosed for prior audit periods for products manufactured in the Company’s facilities in Puerto Rico and the Dominican Republic and sold to affiliated companies located in the U.S. The IRS also proposed adjustments involving the recognition of income for several of the Company’s controlled foreign corporations, which is the same issue that has been previously disclosed and is currently in litigation for tax years 2007-2010. The Company intends to pursue its administrative appeals alternatives with respect to each of the IRS adjustments and believes that final resolution of the proposed adjustments will not have a material impact on its consolidated financial statements.

During 2010, the Company received a tax assessment of $42 (translated at the September 30, 2018 exchange rate), plus interest and penalties, in Brazil for the tax years 2005 through 2008 that relates to the amortization of certain goodwill generated from the acquisition of third-party businesses and corporate reorganizations. On August 31, 2018, the Company received an unfavorable result at the final tax administrative appeals level, resulting in an alleged tax deficiency of $42 plus $128 of interest and penalties (translated at the September 30, 2018 exchange rate). The Company plans to challenge the assessment in the judicial system, which is expected to take up to 10 years to resolve. During 2014, the Company received a tax assessment of $32 (translated at the September 30, 2018 exchange rate), plus interest and penalties, for the 2009 through 2012 tax years (primarily relating to the same issues concerning the 2005 through 2008 tax years), which the Company is also contesting and remains under review at the final tax administrative appeals level. The Company continues to believe that final resolution of both of the assessments will not have a material impact on its consolidated financial statements.


15

Table of Contents

Note 10. EQUITY
During the nine months ended September 30, 2018, 7.7 million ordinary shares were repurchased under the 2016 Program in the open market at a total cost of $600. No ordinary shares were repurchased during the three months ended September 30, 2018. During the three and nine months ended September 30, 2017, 4.4 million and 10.7 million ordinary shares, respectively, were repurchased under the 2016 Program in the open market at a total cost of $324 and $789, respectively.
The changes in Shareholders’ equity follow:
 
Eaton
shareholders’
equity
 
Noncontrolling
interests
 
Total
equity
Balance at December 31, 2017
$
17,253

 
$
37

 
$
17,290

Cumulative-effect adjustment upon adoption of ASU 2014-09
(2
)
 

 
(2
)
Cumulative-effect adjustment upon adoption of ASU 2016-16
(199
)
 

 
(199
)
Net income
1,514

 

 
1,514

Other comprehensive loss
(426
)
 

 
(426
)
Cash dividends paid
(864
)
 
(1
)
 
(865
)
Issuance of shares under equity-based compensation plans - net
78

 

 
78

Repurchase of shares
(600
)
 

 
(600
)
Changes in noncontrolling interest - net

 
(1
)
 
(1
)
Balance at September 30, 2018
$
16,754

 
$
35

 
$
16,789

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, 2017
$
(2,255
)
 
$
(1,139
)
 
$
(10
)
 
$
(3,404
)
Other comprehensive (loss) income
   before reclassifications
(546
)
 
20

 
(11
)
 
(537
)
Amounts reclassified from Accumulated other
   comprehensive loss

 
102

 
9

 
111

Net current-period Other comprehensive
   (loss) income
(546
)
 
122

 
(2
)
 
(426
)
Balance at September 30, 2018
$
(2,801
)
 
$
(1,017
)
 
$
(12
)
 
$
(3,830
)
The reclassifications out of Accumulated other comprehensive loss follow:
 
Nine months ended September 30, 2018
 
Consolidated statements
of income classification
Amortization of defined benefit pensions and other postretirement benefits items
 
 
 
Actuarial loss and prior service cost
$
(129
)
1 
 
Tax benefit
27

 
 
Total, net of tax
(102
)
 
 
 
 
 
 
Gains and (losses) on cash flow hedges
 
 
 
Currency exchange contracts
(12
)
 
Cost of products sold
Tax benefit
3

 
 
Total, net of tax
(9
)
 
 
 
 
 
 
Total reclassifications for the period
$
(111
)
 
 
1 These components of Accumulated other comprehensive loss are included in the computation of net periodic benefit cost. See Note 7 for additional information about pension and other postretirement benefits items.


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Table of Contents

Net Income Per Share Attributable to Eaton Ordinary Shareholders
A summary of the calculation of net income per share attributable to Eaton ordinary shareholders follows:
 
Three months ended
September 30
 
Nine months ended
September 30
(Shares in millions)
2018
 
2017
 
2018
 
2017
Net income attributable to Eaton ordinary shareholders
$
416

 
$
1,401

 
$
1,514

 
$
2,351

 
 
 
 
 
 
 
 
Weighted-average number of ordinary shares outstanding - diluted
436.3

 
445.2

 
438.4

 
448.3

Less dilutive effect of equity-based compensation
2.8

 
2.6

 
2.6

 
2.4

Weighted-average number of ordinary shares outstanding - basic
433.5

 
442.6

 
435.8

 
445.9

 
 
 
 
 
 
 
 
Net income per share attributable to Eaton ordinary shareholders
 
 
 
 
 
 
 
Diluted
$
0.95

 
$
3.14

 
$
3.45

 
$
5.24

Basic
0.96

 
3.16

 
3.47

 
5.27

For the third quarter and first nine months of 2018, 0.5 million and 0.4 million stock options, respectively, were excluded from the calculation of diluted net income per share attributable to Eaton ordinary shareholders 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 third quarter and first nine months of 2017, 0.2 million and 0.6 million stock options, respectively, were excluded from the calculation of diluted net income per share attributable to Eaton ordinary shareholders 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 11.
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
 
Level 1
 
Level 2
 
Level 3
September 30, 2018
 
 
 
 
 
 
 
Cash
$
327

 
$
327

 
$

 
$

Short-term investments
178

 
178

 

 

Net derivative contracts
(59
)
 

 
(59
)
 

 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
Cash
$
561

 
$
561

 
$

 
$

Short-term investments
534

 
534

 

 

Net derivative contracts
36

 

 
36

 

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 $7,163 and fair value of $7,137 at September 30, 2018 compared to $7,745 and $8,048, respectively, at December 31, 2017. 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.

17

Table of Contents


Note 12.
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. The cash flows resulting from these financial instruments are classified in operating activities on the Condensed Consolidated Statements of Cash Flows.
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 as non-derivative net investment hedging instruments on an after-tax basis was $88 at September 30, 2018 and $88 at December 31, 2017, and designated on a pre-tax basis was $631 at September 30, 2018 and $652 at December 31, 2017.

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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
noncurrent
assets
 
Other
current
liabilities
 
Other
noncurrent
liabilities
 
Type of
hedge
 
Term
September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed-to-floating interest rate
 swaps
$
2,550

 
$
1

 
$
16

 
$
1

 
$
62

 
Fair value
 
9 months to 16 years
Currency exchange contracts
954

 
12

 
2

 
21

 
5

 
Cash flow
 
1 to 36 months
Total
 
 
$
13

 
$
18

 
$
22

 
$
67

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as
 hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Currency exchange contracts
$
7,616

 
$
33

 
 
 
$
33

 
 
 
 
 
1 to 12 months
Commodity contracts
13

 

 
 
 
1

 
 
 
 
 
1 to 12 months
Total
 
 
$
33

 


 
$
34

 


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed-to-floating interest rate
 swaps
$
2,965

 
$
1

 
$
41

 
$

 
$
17

 
Fair value
 
6 months to 17 years
Currency exchange contracts
924

 
7

 
7

 
22

 
2

 
Cash flow
 
1 to 36 months
Total
 
 
$
8

 
$
48

 
$
22

 
$
19

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as
 hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Currency exchange contracts
$
3,719

 
$
39

 
 
 
$
19

 
 
 
 
 
1 to 12 months
Commodity contracts
13

 
1

 
 
 

 
 
 
 
 
1 to 12 months
Total
 
 
$
40

 


 
$
19

 


 
 
 
 
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 receivables, payables 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. For the nine months ended September 30,  2018, $122 of cash outflow resulting from the settlement of these derivatives has been classified in investing activities on the Condensed Consolidated Statement of Cash Flows. The cash flow from the settlement of these derivatives has been presented in operating activities in prior periods and have not been restated as such amounts are not material. 


19

Table of Contents

The impact of derivative instruments to the Consolidated Statement of Income and Comprehensive Income follow:
 
Gain (loss) recognized in
other comprehensive
(loss) income
 
Location of gain (loss)
reclassified from
Accumulated other
comprehensive loss
 
Gain (loss) reclassified
from Accumulated other
comprehensive loss
 
Three months ended
September 30
 
 
 
Three months ended
September 30
 
2018
 
2017
 
 
 
2018
 
2017
Derivatives designated as
   cash flow hedges
 
 
 
 
 
 
 
 
 
Forward starting floating-to-fixed
 interest rate swaps
$

 
$
(10
)
 
Interest expense - net
 
$

 
$

Interest rate locks

 
(9
)
 
Interest expense - net
 

 

Currency exchange contracts
(12
)
 
(6
)
 
Cost of products sold
 
(4
)
 
(7
)
Total
$
(12
)
 
$
(25
)
 
 
 
$
(4
)
 
$
(7
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gain (loss) recognized in
other comprehensive
(loss) income
 
Location of gain (loss)
reclassified from
Accumulated other
comprehensive loss
 
Gain (loss) reclassified
from Accumulated other
comprehensive loss
 
Nine months ended
September 30
 
 
 
Nine months ended
September 30
 
2018
 
2017
 
 
 
2018
 
2017
Derivatives designated as cash
flow hedges
 
 
 
 
 
 
 
 
 
Forward starting floating-to-fixed
interest rate swaps
$

 
$
(15
)
 
Interest expense - net
 
$

 
$

Interest rate locks

 
(9
)
 
Interest expense - net
 

 

Currency exchange contracts
(14
)
 
(5
)
 
Cost of products sold
 
(12
)
 
(12
)
Total
$
(14
)

$
(29
)



$
(12
)

$
(12
)

Amounts recognized in net income follow:
 
Three months ended
September 30
 
Nine months ended
September 30
 
2018

2017
 
2018
 
2017
Derivatives designated as fair value hedges
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
(12
)
 
$
(4
)
 
$
(71
)
 
$
(7
)
Related long-term debt converted to floating interest
   rates by interest rate swaps
12

 
4

 
71

 
7

 
$

 
$

 
$

 
$

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


20

Table of Contents


Note 13.    INVENTORY
Inventory is carried at lower of cost or net realizable value. The components of inventory follow:
 
September 30,
2018
 
December 31,
2017
Raw materials
$
1,094

 
$
953

Work-in-process
531

 
471

Finished goods
1,210

 
1,196

Total inventory
$
2,835

 
$
2,620


Note 14.
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.
During the first quarter of 2018, Eaton re-segmented certain reportable operating segments due to a reorganization of the Company's businesses. The new reportable business segment is eMobility (which includes certain legacy Electrical Products and Vehicle product lines). 
The eMobility segment designs, manufactures, markets, and supplies electrical and electronic components and systems that improve the power management and performance of both on-road and off-road vehicles. Products include high voltage inverters, converters, fuses, onboard chargers, circuit protection units, vehicle controls, power distribution, fuel tank isolation valves, and commercial vehicle hybrid systems. The principal markets for the eMobility segment are original equipment manufacturers and aftermarket customers of passenger cars, commercial vehicles, and construction, agriculture, and mining equipment.
Eaton’s operating segments are Electrical Products, Electrical Systems and Services, Hydraulics, Aerospace, Vehicle, and eMobility. Operating profit includes the operating profit from intersegment sales. For additional information regarding Eaton’s business segments, see Note 15 to the Consolidated Financial Statements contained in the 2017 Form 10-K.

21

Table of Contents

 
Three months ended
September 30
 
Nine months ended
September 30
 
2018
 
2017
 
2018
 
2017
Net sales
 
 
 
 
 
 
 
Electrical Products
$
1,789

 
$
1,785

 
$
5,327

 
$
5,167

Electrical Systems and Services
1,519

 
1,421

 
4,413

 
4,168

Hydraulics
670

 
634

 
2,103

 
1,854

Aerospace
478

 
438

 
1,399

 
1,303

Vehicle
876

 
858

 
2,668

 
2,489

eMobility
80

 
75

 
240

 
210

Total net sales
$
5,412

 
$
5,211

 
$
16,150

 
$
15,191

 
 
 
 
 
 
 
 
Segment operating profit
 
 
 
 
 
 
 
Electrical Products
$
343

 
$
330

 
$
984

 
$
915

Electrical Systems and Services
234

 
196

 
628

 
545

Hydraulics
94

 
80

 
285

 
214

Aerospace
105

 
84

 
284

 
244

Vehicle
166

 
150

 
464

 
399

eMobility
10

 
16

 
35

 
40

Total segment operating profit
952

 
856

 
2,680

 
2,357

 
 
 
 
 
 
 
 
Corporate
 
 
 
 
 
 
 
Amortization of intangible assets
(95
)
 
(98
)
 
(289
)
 
(288
)
Interest expense - net
(67
)
 
(60
)
 
(205
)
 
(181
)
Pension and other postretirement benefits expense
(3
)
 
(16
)
 
(4
)
 
(38
)
Gain on sale of business

 
1,077

 

 
1,077

Arbitration decision expense
(275
)
 

 
(275
)
 

Other corporate expense - net
(73
)
 
(65
)
 
(209
)
 
(194
)
Income before income taxes
439

 
1,694

 
1,698

 
2,733

Income tax expense
23

 
293

 
184

 
381

Net income
416

 
1,401

 
1,514

 
2,352

Less net income for noncontrolling interests

 

 

 
(1
)
Net income attributable to Eaton ordinary shareholders
$
416

 
$
1,401

 
$
1,514

 
$
2,351


22


Note 15.
CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
The Registered Senior Notes issued by Eaton Corporation are registered under the Securities Act of 1933. Eaton and certain 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 Registered 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. See Note 6 of Eaton's 2017 Form 10-K for additional information related to the Registered Senior Notes.
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 2018 and 2017, 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. These restructurings have been reflected as of the beginning of the earliest period presented below.


23


 
 
 
 
 
 
 
 
 
 
 
 
CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2018
 
Eaton
Corporation
plc
 
Eaton
Corporation
 
Guarantors
 
Other
subsidiaries
 
Consolidating
adjustments
 
Total
Net sales
$

 
$
1,808

 
$
1,814

 
$
3,134

 
$
(1,344
)
 
$
5,412

 
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold

 
1,417

 
1,322

 
2,202

 
(1,344
)
 
3,597

Selling and administrative expense
2

 
355

 
197

 
335

 

 
889

Research and development expense

 
33

 
37

 
68

 

 
138

Interest expense (income) - net

 
68

 
3

 
(4
)
 

 
67

Arbitration decision expense

 

 
275

 

 

 
275

Other expense (income) - net
(3
)
 
11

 
4

 
(5
)
 

 
7

Equity in loss (earnings) of
   subsidiaries, net of tax
(430
)
 
(212
)
 
(915
)
 
(446
)
 
2,003

 

Intercompany expense (income) - net
15

 
33

 
579

 
(627
)
 

 

Income (loss) before income taxes
416

 
103


312


1,611


(2,003
)

439

Income tax expense (benefit)

 
(10
)
 
(91
)
 
124

 

 
23

Net income (loss)
416

 
113


403


1,487


(2,003
)

416

Less net loss (income) for
   noncontrolling interests

 

 

 

 

 

Net income (loss) attributable to
   Eaton ordinary shareholders
$
416

 
$
113


$
403


$
1,487


$
(2,003
)

$
416