ETN 03.31.2014 10-Q
Table of Contents

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

FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2014
Commission file number 000-54863
EATON CORPORATION plc
(Exact name of registrant as specified in its charter)
Ireland
 
98-1059235
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification Number)
 
 
 
Fitzwilliam Hall, Fitzwilliam Place, Dublin 2, Ireland
 
-
(Address of principal executive offices)
 
(Zip Code)
 
 
 
+1 (440) 523-5000
 
 
 
 
 
 
(Registrant's telephone number, including area code)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not applicable
 
 
 
 
 
 
(Former name, former address and former fiscal year if changed since last report)
 
 
 
 
 
 
 
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
There were 476.7 million Ordinary Shares outstanding as of March 31, 2014.
 



Table of Contents

TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Table of Contents

PART I — FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS.

EATON CORPORATION plc
CONSOLIDATED STATEMENTS OF INCOME

 
Three months ended
March 31
(In millions except for per share data)
2014
 
2013
Net sales
$
5,492

 
$
5,310

 
 
 
 
Cost of products sold
3,858

 
3,735

Selling and administrative expense
962

 
958

Research and development expense
162

 
152

Interest expense - net
62

 
75

Other income - net
(5
)
 
(10
)
Income before income taxes
453

 
400

Income tax expense
12

 
20

Net income
441

 
380

Less net income for noncontrolling interests
(2
)
 
(2
)
Net income attributable to Eaton ordinary shareholders
$
439

 
$
378

 
 
 
 
Net income per ordinary share
 
 
 
Diluted
$
0.92

 
$
0.79

Basic
0.92

 
0.80

 
 
 
 
Weighted-average number of ordinary shares outstanding
 
 
 
Diluted
478.8

 
475.1

Basic
475.8

 
471.9

 
 
 
 
Cash dividends declared per ordinary share
$
0.49

 
$
0.42


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
March 31
(In millions)
2014
 
2013
Net income
$
441

 
$
380

Less net income for noncontrolling interests
(2
)
 
(2
)
Net income attributable to Eaton ordinary shareholders
439

 
378

 
 
 
 
Other comprehensive income, net of tax


 


Currency translation and related hedging instruments
(47
)
 
(281
)
Pensions and other postretirement benefits
50

 
53

Cash flow hedges

 
(7
)
Other comprehensive income (loss) attributable to Eaton
   ordinary shareholders
3

 
(235
)
 


 


Total comprehensive income attributable to Eaton
  ordinary shareholders
$
442

 
$
143


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)
March 31,
2014
 
December 31,
2013
Assets
 
 
 
Current assets
 
 
 
Cash
$
784

 
$
915

Short-term investments
360

 
794

Accounts receivable - net
3,889

 
3,648

Inventory
2,532

 
2,382

Deferred income taxes
554

 
577

Prepaid expenses and other current assets
564

 
415

Total current assets
8,683

 
8,731

 
 
 
 
Property, plant and equipment - net
3,806

 
3,833

 
 
 
 
Other noncurrent assets

 

Goodwill
14,450

 
14,495

Other intangible assets
7,078

 
7,186

Deferred income taxes
257

 
240

Other assets
988

 
1,006

Total assets
$
35,262

 
$
35,491

 
 
 
 
Liabilities and shareholders’ equity
 
 
 
Current liabilities
 
 
 
Short-term debt
$
8

 
$
13

Current portion of long-term debt
316

 
567

Accounts payable
2,076

 
1,960

Accrued compensation
334

 
461

Other current liabilities
2,071

 
1,913

Total current liabilities
4,805

 
4,914

 
 
 
 
Noncurrent liabilities
 
 
 
Long-term debt
8,991

 
8,969

Pension liabilities
1,228

 
1,465

Other postretirement benefits liabilities
666

 
668

Deferred income taxes
1,296

 
1,313

Other noncurrent liabilities
1,165

 
1,299

Total noncurrent liabilities
13,346

 
13,714

 
 
 
 
Shareholders’ equity
 
 
 
Eaton shareholders’ equity
17,037

 
16,791

Noncontrolling interests
74

 
72

Total equity
17,111

 
16,863

Total liabilities and equity
$
35,262

 
$
35,491


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

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EATON CORPORATION plc
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 
Three months ended
March 31
(In millions)
2014
 
2013
Operating activities
 
 
 
Net income
$
441

 
$
380

Adjustments to reconcile to net cash provided by operating activities
 
 
 
Depreciation and amortization
249

 
245

Deferred income taxes
(24
)
 
104

Pension and other postretirement benefits expense
99

 
87

Contributions to pension plans
(272
)
 
(208
)
Excess tax benefit from equity-based compensation
(20
)
 
(16
)
Changes in working capital
(370
)
 
(546
)
Other - net
(91
)
 
54

Net cash provided by operating activities
12

 
100

 
 
 
 
Investing activities
 
 
 
Capital expenditures for property, plant and equipment
(110
)
 
(122
)
Sales of short-term investments - net
431

 
132

Proceeds from sale of business
3

 
761

Other - net
(20
)
 
2

Net cash provided by investing activities
304

 
773

 
 
 
 
Financing activities
 
 
 
Payments on borrowings
(257
)
 
(687
)
Cash dividends paid
(229
)
 
(194
)
Exercise of employee stock options
23

 
56

Excess tax benefit from equity-based compensation
20

 
16

Other - net

 
(1
)
Net cash used in financing activities
(443
)
 
(810
)
 
 
 
 
Effect of currency on cash
(4
)
 
(1
)
Total (decrease) increase in cash
(131
)
 
62

Cash at the beginning of the period
915

 
577

Cash at the end of the period
$
784

 
$
639


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 generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting of normal recurring accruals) have been made that are necessary for a fair presentation of the condensed consolidated financial statements for the interim periods.
This Form 10-Q should be read in conjunction with the consolidated financial statements and related notes included in Eaton’s 2013 Form 10-K. The interim period results are not necessarily indicative of the results to be expected for the full year. Management has evaluated subsequent events through the date this Form 10-Q was filed with the Securities Exchange Commission.
Certain prior year amounts have been reclassified to conform to the current year presentation.

Note 2.
ACQUISITIONS AND SALE OF BUSINESSES
Eaton's most recently acquired businesses, and the related annual sales prior to acquisition, are summarized below:
Acquired businesses
 
Date of
transaction
 
Business
segment
 
Annual
sales
 
 
Cooper Industries plc (Cooper)
 
November 30,
2012
 
Electrical Products;
Electrical Systems and Services
 
$5,409
for 2011
A diversified global manufacturer of electrical products and systems, with brands including Bussmann electrical and electronic fuses; Crouse-Hinds and CEAG explosion-proof electrical equipment; Halo and Metalux lighting fixtures; and Kyle and McGraw-Edison power systems products.
 
 
 
 
 
 
 
 
 
 
Rolec Comercial e Industrial S.A.
 
September 28,
2012
 
Electrical Systems and Services
 
$85 for the
12 months
ended
September 30,
2012
A Chilean manufacturer of integrated power assemblies and low- and medium-voltage switchgear, and a provider of engineering services serving mining and other heavy industrial applications in Chile and Peru.
 
 
 
 
 
 
 
 
 
 
Jeil Hydraulics Co., Ltd.
 
July 6,
2012
 
Hydraulics
 
$189
for 2011
A Korean manufacturer of track drive motors, swing drive motors, main control valves and remote control valves for the construction equipment market.
 
 
 
 
 
 
 
 
 
 
Polimer Kaucuk Sanayi ve Pazarlama A.S.
 
June 1,
2012
 
Hydraulics
 
$335
for 2011
A Turkish manufacturer of hydraulic and industrial hose for construction, mining, agriculture, oil and gas, manufacturing, food and beverage, and chemicals markets. This business sells its products under the SEL brand name.
 
 
 
 
 
 
 
 
 
 
Gycom Electrical Low-Voltage Power Distribution, Control and Automation
 
June 1,
2012
 
Electrical Systems and Services
 
$24
for 2011
A Swedish electrical low-voltage power distribution, control and automation components business.
 
 
 
See Note 3 for information about acquisition integration charges and transaction costs related to these acquisitions.
Sale of Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions
On January 20, 2014, Eaton announced it entered into an agreement to sell the Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses to Safran for $270. The sale, which was approved by Eaton's Board of Directors, is subject to regulatory approvals and other customary closing conditions. The transaction is expected to close in the second quarter of 2014.



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Note 3.
ACQUISITION INTEGRATION AND RESTRUCTURING CHARGES
Eaton incurs integration charges and transaction costs related to acquired businesses. A summary of these charges follows:
 
Three months ended
March 31
 
2014
 
2013
Acquisition integration charges
 
 
 
Electrical Products
$
29

 
$
3

Electrical Systems and Services
26

 
5

Hydraulics
4

 
12

Total business segments
59

 
20

Corporate
7

 
6

Total acquisition integration charges
66

 
26

 
 
 
 
Transaction costs
 
 
 
Corporate

 
5

Total transaction costs

 
5

 
 
 
 
Total acquisition integration charges and transaction costs before income taxes
$
66

 
$
31

Total after income taxes
$
44

 
$
22

Per ordinary share - diluted
$
0.09

 
$
0.05

Business segment integration charges in the first quarter of 2014 were related primarily to the integration of Cooper. Business segment integration charges in the first quarter of 2013 were related primarily to the integrations of Cooper, Polimer Kaucuk Sanayi ve Pazarlama, Jeil Hydraulics, and Rolec Comercial e Industrial S.A. These charges were included in Cost of products sold or Selling and administrative expense, as appropriate. In Business Segment Information the charges reduced Operating profit of the related business segment.
Corporate integration charges in 2014 and 2013 were related primarily 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.
Acquisition-related transaction costs, such as investment banking, legal, other professional fees, and costs associated with change in control agreements, are not included as a component of consideration transferred in an acquisition but are expensed as incurred. Acquisition-related transaction costs in 2013 were related to the acquisition of Cooper. These charges were included in Selling and administrative expense, Interest expense - net and Other income - net. In Business Segment Information the charges were included in Interest expense - net and Other corporate expense - net.
See Note 2 for additional information about business acquisitions.
Restructuring Charges
During 2013, Eaton undertook restructuring activities related to the acquisition and integration of Cooper in an effort to gain efficiencies in selling, marketing, traditional back-office functions and manufacturing and distribution. These actions resulted in charges totaling $36 in 2013 and $41 in the first quarter of 2014, comprised primarily of severance costs. These restructuring initiatives are expected to continue through 2015.
Restructuring charges were included in Cost of products sold or Selling and administrative expense, as appropriate. In Business Segment Information, the charges reduced Operating profit of the related business segment. See Note 12 for additional information about business segments. As of March 31, 2014 and December 31, 2013, liabilities related to restructuring actions totaled $63 and $32, respectively.
During April 2014, the Company implemented certain restructuring activities in an effort to gain efficiencies in the Vehicle, Hydraulics and Aerospace business segments. These restructuring activities resulted in a charge of $40, comprised primarily of severance costs.



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Note 4.
GOODWILL
A summary of goodwill follows:
 
March 31,
2014
 
December 31,
2013
Electrical Products
$
7,153

 
$
7,189

Electrical Systems and Services
4,508

 
4,517

Hydraulics
1,384

 
1,385

Aerospace
1,048

 
1,048

Vehicle
357

 
356

Total goodwill
$
14,450

 
$
14,495

The decrease in goodwill in 2014 was due to currency translation.

Note 5.
RETIREMENT BENEFITS PLANS
The components of retirement benefits expense follow:
 
United States
pension benefit expense
 
Non-United States
pension benefit expense
 
Other postretirement
benefits expense
 
Three months ended March 31
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Service cost
$
29

 
$
32

 
$
16

 
$
15

 
$
4

 
$
5

Interest cost
40

 
37

 
22

 
20

 
9

 
9

Expected return on plan assets
(61
)
 
(57
)
 
(25
)
 
(21
)
 
(1
)
 
(2
)
Amortization
23

 
33

 
7

 
7

 
2

 
3

 
31

 
45

 
20

 
21

 
14

 
15

Settlement loss
34

 
6

 

 

 

 

Total expense
$
65

 
$
51

 
$
20

 
$
21

 
$
14

 
$
15

 
 
 
 
 
 
 
 
 
 
 
 
Note 6.
LEGAL CONTINGENCIES
Eaton is subject to a broad range of claims, administrative and legal proceedings such as lawsuits that relate to contractual allegations, tax audits, patent infringement, personal injuries (including asbestos claims), antitrust matters and employment-related matters. Although it is not possible to predict with certainty the outcome or cost of these matters, the Company believes they will not have a material adverse effect on the consolidated financial statements.
In December 2010, a Brazilian court held that a judgment obtained by a Brazilian company, Raysul, against another Brazilian company, Saturnia, which was sold by Eaton in 2006, could be enforced against Eaton Ltda. This judgment is based on an alleged violation of an agency agreement between Raysul and Saturnia. At March 31, 2014, the Company has a total accrual of 79 Brazilian Reais related to this matter ($35 based on current exchange rates), comprised of 60 Brazilian Reais recognized in the fourth quarter of 2010 ($27 based on current exchange rates) with an additional 19 Brazilian Reais recognized through March 31, 2014 ($8 based on current exchange rates). In 2010, Eaton filed motions for clarification with the Brazilian court of appeals which were denied on April 6, 2011. Eaton Holding and Eaton Ltda. filed appeals on various issues to the Superior Court of Justice in Brasilia. In April 2013, the Superior Court of Justice ruled in favor of Raysul. Additional motions for clarification have been filed with the Superior Court of Justice in Brasilia and an additional appeal is being considered. The Company expects that any sum it may be required to pay in connection with this matter will not exceed the amount of the recorded liability.

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On October 5, 2006, ZF Meritor LLC and Meritor Transmission Corporation (collectively, Meritor) filed an action against Eaton in the United States District Court for Delaware. The action sought damages, which would be trebled under United States antitrust laws, as well as injunctive relief and costs. The suit alleged that Eaton engaged in anti-competitive conduct against Meritor in the sale of heavy-duty truck transmissions in North America. Following a four week trial on liability only, on October 8, 2009, the jury returned a verdict in favor of Meritor. Eaton firmly believes that it competes fairly and honestly for business in the marketplace, and that at no time did it act in an anti-competitive manner. During an earlier stage in the case, the judge concluded that damage estimates contained in a report filed by Meritor were not based on reliable data and the report was specifically excluded from the case. On November 3, 2009, Eaton filed a motion for judgment as a matter of law and to set aside the verdict. That motion was denied on March 10, 2011. On March 14, 2011, Eaton filed a motion for entry of final judgment of liability, zero damages and no injunctive relief. That motion was denied on June 9, 2011. On August 19, 2011, the Court entered final judgment of liability but awarded zero damages to plaintiffs. The Court also entered an injunction prohibiting Eaton from offering rebates or other incentives based on purchasing targets but stayed the injunction pending appeal. Eaton appealed the liability finding and the injunction to the Third Circuit Court of Appeals. Meritor cross-appealed the finding of zero damages. On September 28, 2012, the Third Circuit Court of Appeals affirmed the District Court's denial of Eaton's motion for judgment as a matter of law, and let stand the jury verdict in favor of Meritor. The Third Circuit Court of Appeals also ruled that the plaintiffs' damages report was properly excluded, but reversed the judgment of zero damages and ordered that the District Court must allow plaintiffs a limited opportunity to amend the damages report, which may be re-considered for reliability and admissibility. Injunctive relief also was vacated. On remand to the District Court, plaintiffs submitted an amended damages report in which their expert opined that damages range between $475 and $800. On December 20, 2013, the District court ruled that the plaintiffs' damages expert could testify at trial and be subjected to cross-examination. The District Court has scheduled a jury trial for the second quarter of 2014. Eaton's damages expert opined that damages are zero. An estimate of any potential loss related to this action cannot be made at this time.
Frisby Corporation, now known as Triumph Actuation Systems, LLC, and other claimants (collectively, the Frisby Parties) 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 the Frisby Parties regarding improper use of trade secrets and these claims were dismissed by the Hinds County Circuit Court. On September 25, 2013, the Mississippi Supreme Court issued an order that stayed all proceedings in the Hinds County Circuit Court pending further order of the Mississippi Supreme Court. On November 21, 2013, the Mississippi Supreme Court upheld the dismissal of Eaton's claims but did not lift the stay on all proceedings in the Hinds County Circuit Court. Prior to the stay, the Frisby Parties submitted various expert damage designations related to their claims to the Hinds County Circuit Court, claiming damages of at least $376. Eaton disputes liability to the Frisby Parties and Eaton's experts dispute the amount of damages claimed by the experts for the Frisby Parties. An estimate of any potential loss related to this action cannot be made at this time.

Note 7.
INCOME TAXES
The effective income tax rate for the first quarter of 2014 was 3% compared to 5% for the first quarter of 2013. The lower effective tax rate in the first quarter of 2014 was primarily attributable to a more favorable geographic mix of income.

Note 8.
EQUITY
The changes in Shareholders’ equity follow:
 
Eaton
shareholders’
equity
 
Noncontrolling
interests
 
Total
equity
Balance at December 31, 2013
$
16,791

 
$
72

 
$
16,863

Net income
439

 
2

 
441

Other comprehensive income
3

 

 
3

Cash dividends paid and accrued
(234
)
 

 
(234
)
Issuance of shares under equity-based compensation plans - net
38

 

 
38

Balance at March 31, 2014
$
17,037

 
$
74

 
$
17,111


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

 
$
(1,560
)
Other comprehensive (loss) income
    before reclassifications
(47
)
 
9

 
1

 
(37
)
Amounts reclassified from Accumulated other
   comprehensive (loss) income

 
41

 
(1
)
 
40

Net current-period other comprehensive
   (loss) income
(47
)
 
50

 

 
3

Balance at March 31, 2014
$
(442
)
 
$
(1,120
)
 
$
5

 
$
(1,557
)
The reclassifications out of Accumulated other comprehensive loss follow:
 
 
Three months ended
March 31, 2014
 
Consolidated Statements of
Income classification
Amortization of defined benefit pension items
 
 
 
 
Actuarial loss
 
$
(66
)
 
1 
Tax benefit
 
25

 
 
Total, net of tax
 
(41
)
 
 
 
 
 
 
 
Loss on cash flow hedges
 
 
 
 
Currency exchange contracts
 
2

 
Cost of products sold
Tax expense
 
(1
)
 
 
Total, net of tax
 
1

 
 
 
 
 
 
 
Total reclassifications for the period
 
$
(40
)
 
 
1 These components of Accumulated other comprehensive loss are included in the computation of net periodic pension cost. See Note 5 for additional information about defined benefit pension items.
Net Income per Ordinary Share
A summary of the calculation of net income per ordinary share attributable to shareholders follows:
 
Three months ended
March 31
(Shares in millions)
2014
 
2013
Net income attributable to Eaton ordinary shareholders
$
439

 
$
378

 
 
 
 
Weighted-average number of ordinary shares outstanding - diluted
478.8

 
475.1

Less dilutive effect of equity-based compensation
3.0

 
3.2

Weighted-average number of ordinary shares outstanding - basic
475.8

 
471.9

 
 
 
 
Net income per ordinary share
 
 
 
Diluted
$
0.92

 
$
0.79

Basic
0.92

 
0.80

For the first quarter 2014 and 2013, 0.1 million stock options 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.

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Note 9.
FAIR VALUE MEASUREMENTS
Fair value is measured based on an exit price, representing the amount that would be received to sell an asset or paid to satisfy a liability in an orderly transaction between market participants. Fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, a fair value hierarchy is established, which categorizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
A summary of financial instruments recognized at fair value, and the fair value measurements used, follows:
 
Total
 
Quoted prices
in active
markets for
identical assets
(Level 1)
 
Other
observable
inputs
(Level 2)
 
Unobservable
inputs
(Level 3)
March 31, 2014
 
 
 
 
 
 
 
Cash
$
784

 
$
784

 
$

 
$

Short-term investments
360

 
360

 

 

Net derivative contracts
1

 

 
1

 

Long-term debt converted to floating interest rates by
   interest rate swaps - net
(10
)
 

 
(10
)
 

 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Cash
$
915

 
$
915

 
$

 
$

Short-term investments
794

 
794

 

 

Net derivative contracts
(35
)
 

 
(35
)
 

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

 
(39
)
 

Eaton values its financial instruments using an industry standard market approach, in which prices and other relevant information is generated by market transactions involving identical or comparable assets or liabilities. No financial instruments were recognized using unobservable inputs.
Other Fair Value Measurements
Long-term debt and the current portion of long-term debt had a carrying value of $9,307 and fair value of $9,683 at March 31, 2014 compared to $9,536 and $9,665, respectively, at December 31, 2013. The fair value of Eaton's debt instruments was estimated using prevailing market interest rates on debt with similar creditworthiness, terms and maturities and is considered a Level 2 fair value measurement.

Note 10.
DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
In the normal course of business, Eaton is exposed to certain risks related to fluctuations in interest rates, currency exchange rates and commodity prices. The Company uses various derivative and non-derivative financial instruments, primarily interest rate swaps, currency forward exchange contracts, currency swaps and, to a lesser extent, commodity contracts, to manage risks from these market fluctuations. The instruments used by Eaton are straightforward, non-leveraged instruments. The counterparties to these instruments are financial institutions with strong credit ratings. Eaton maintains control over the size of positions entered into with any one counterparty and regularly monitors the credit rating of these institutions. Such instruments are not purchased and sold for trading purposes.

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Derivative financial instruments are accounted for at fair value and recognized as assets or liabilities in the Condensed Consolidated Balance Sheets. Accounting for the gain or loss resulting from the change in the fair value of the derivative financial instrument depends on whether it has been designated, and is effective, as part of a hedging relationship and, if so, as to the nature of the hedging activity. Eaton formally documents all relationships between derivative financial instruments accounted for as designated hedges and the hedged item, as well as its risk-management objective and strategy for undertaking the hedge transaction. This process includes linking derivative financial instruments to a recognized asset or liability, specific firm commitment, forecasted transaction, or net investment in a foreign operation. These financial instruments can be designated as:
Hedges of the change in the fair value of a recognized fixed-rate asset or liability, or the firm commitment to acquire such an asset or liability (a fair value hedge); for these hedges, the gain or loss from the derivative financial instrument, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in income during the period of change in fair value.
Hedges of the variable cash flows of a recognized variable-rate asset or liability, or the forecasted acquisition of such an asset or liability (a cash flow hedge); for these hedges, the effective portion of the gain or loss from the derivative financial instrument is recognized in Accumulated other comprehensive loss and reclassified to income in the same period when the gain or loss on the hedged item is included in income.
Hedges of the currency exposure related to a net investment in a foreign operation (a net investment hedge); for these hedges, the effective portion of the gain or loss from the derivative financial instrument is recognized in Accumulated other comprehensive loss and reclassified to income in the same period when the gain or loss related to the net investment in the foreign operation is included in income.
The gain or loss from a derivative financial instrument designated as a hedge that is effective is classified in the same line of the Consolidated Statements of Income as the offsetting loss or gain on the hedged item. The change in fair value of a derivative financial instrument that is not effective as a hedge is immediately recognized in income.
For derivatives that are not designated as a hedge, any gain or loss is immediately recognized in income. The majority of derivatives used in this manner relate to risks resulting from assets or liabilities denominated in a foreign currency and certain commodity contracts that arise in the normal course of business. Gains and losses associated with commodity hedge contracts are classified in Cost of products sold.
Eaton uses certain of its debt denominated in foreign currency to hedge portions of its net investments in foreign operations against foreign currency exposure (net investment hedges). Foreign currency denominated debt designated as non-derivative net investment hedging instruments was $97 and $95, net of tax, at March 31, 2014 and December 31, 2013, respectively.
Derivative Financial Statement Impacts
The fair value of derivative financial instruments recognized in the Condensed Consolidated Balance Sheets follows:
 
Notional
amount
 
Other
 current
assets
 
Other
long-term
assets
 
Other
current
liabilities
 
Other
long-term
liabilities
 
Type of
hedge
 
Term
March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
3,290

 
$

 
$
39

 
$

 
$
49

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

 

 

 

 

 
Cash flow
 
3 months
Currency exchange contracts
495

 
12

 

 
3

 

 
Cash flow
 
12 to 36 months
Commodity contracts
1

 

 

 

 

 
Cash flow
 
1 to 12 months
Total
 
 
$
12

 
$
39

 
$
3

 
$
49

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Currency exchange contracts
$
4,160

 
$
23

 
 
 
$
21

 
 
 
 
 
1 to 12 months

12

Table of Contents

 
Notional
amount
 
Other
 current
assets
 
Other
long-term
assets
 
Other
current
liabilities
 
Other
long-term
liabilities
 
Type of
hedge
 
Term
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
3,090

 
$
1

 
$
36

 
$

 
$
76

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

 

 

 
1

 

 
Cash flow
 
6 months
Currency exchange contracts
393

 
12

 

 
3

 

 
Cash flow
 
12 to 36 months
Commodity contracts
1

 

 

 

 

 
Cash flow
 
1 to 12 months
Total
 
 
$
13

 
$
36

 
$
4

 
$
76

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

 
$
22

 
 
 
$
26

 
 
 
 
 
1 to 12 months
The currency exchange contracts shown in the table above as derivatives not designated as hedges are primarily contracts entered into to manage currency volatility or exposure on intercompany sales and loans. While Eaton does not elect hedge accounting treatment for these derivatives, Eaton targets managing 100% of the intercompany balance sheet exposure to minimize the effect of currency volatility related to the movement of goods and services in the normal course of its operations. This activity represents the great majority of these currency exchange contracts.
Amounts recognized in Accumulated other comprehensive income (loss) follow:
 
Three months ended March 31
 
2014
 
2013
 
Gain (loss)
recognized in
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
reclassified
from
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
recognized in
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
reclassified
from
Accumulated
other
comprehensive
income (loss)
Derivatives designated as cash flow hedges
 
 
 
 
 
 
 
Currency exchange contracts
$
2

 
$
2

 
$
(9
)
 
$
1

 
 
 
 
 
 
 
 
Gains and losses reclassified from Accumulated other comprehensive income to the Consolidated Statements of Income were recognized in Cost of products sold.
Amounts recognized in net income follow:
 
Three months ended
March 31
 
2014
 
2013
Derivatives designated as fair value hedges
 
 
 
Fixed-to-floating interest rate swaps
$
29

 
$
(8
)
Related long-term debt converted to floating interest rates by interest rate swaps
(29
)
 
8

 
$

 
$

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


13

Table of Contents

Note 11.
INVENTORY
The components of inventory follow:
 
March 31,
2014
 
December 31,
2013
Raw materials
$
1,103

 
$
955

Work-in-process
323

 
428

Finished goods
1,226

 
1,115

Inventory at FIFO
2,652

 
2,498

Excess of FIFO over LIFO cost
(120
)
 
(116
)
Total inventory
$
2,532

 
$
2,382


Note 12.
BUSINESS SEGMENT INFORMATION
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision maker, or decision making group, in deciding how to allocate resources to an individual segment and in assessing performance. Eaton’s operating segments are Electrical Products, Electrical Systems and Services, Hydraulics, Aerospace and Vehicle. For additional information regarding Eaton’s business segments, see Note 14 to the Consolidated Financial Statements contained in the 2013 Form 10-K.
 
Three months ended
March 31
 
2014
 
2013
Net sales
 
 
 
Electrical Products
$
1,726

 
$
1,660

Electrical Systems and Services
1,524

 
1,521

Hydraulics
782

 
756

Aerospace
464

 
434

Vehicle
996

 
939

Total net sales
$
5,492

 
$
5,310

 
 
 
 
Segment operating profit
 
 
 
Electrical Products
$
250

 
$
241

Electrical Systems and Services
169

 
210

Hydraulics
108

 
78

Aerospace
62

 
62

Vehicle
151

 
132

Total segment operating profit
740

 
723

 
 
 
 
Corporate
 
 
 
Amortization of intangible assets
(110
)
 
(107
)
Interest expense - net
(62
)
 
(75
)
Pension and other postretirement benefits expense
(51
)
 
(38
)
Inventory step-up adjustment

 
(33
)
Other corporate expense - net
(64
)
 
(70
)
Income before income taxes
453

 
400

Income tax expense
12

 
20

Net income
441

 
380

Less net income for noncontrolling interests
(2
)
 
(2
)
Net income attributable to Eaton ordinary shareholders
$
439

 
$
378



14

Table of Contents

Note 13.
CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
On November 20, 2012, Eaton Corporation issued senior notes (the Senior Notes) totaling $4,900 to finance part of the cash portion of the acquisition of Cooper. Eaton and certain other of Eaton's principal 100% owned subsidiaries (the Guarantors) fully and unconditionally guaranteed (subject, in the case of the Guarantors, other than Eaton, to customary release provisions as described below), on a joint and several basis, the Senior Notes. The following condensed consolidating financial statements are included so that separate financial statements of Eaton, Eaton Corporation and each of the Guarantors are not required to be filed with the Securities and Exchange Commission. The consolidating adjustments primarily relate to eliminations of investments in subsidiaries and intercompany balances and transactions. The condensed consolidating financial statements present investments in subsidiaries using the equity method of accounting.
The guarantee of a Guarantor that is not a parent of the issuer will be automatically and unconditionally released and discharged in the event of any sale of the Guarantor or of all or substantially all of its assets, or in connection with the release or termination of the Guarantor as a guarantor under all other U.S. debt securities or U.S. syndicated credit facilities, subject to limitations set forth in the indenture. The guarantee of a Guarantor that is a direct or indirect parent of the issuer will only be automatically and unconditionally released and discharged in connection with the release or termination of such Guarantor as a guarantor under all other debt securities or syndicated credit facilities (in both cases, U.S. or otherwise), subject to limitations set forth in the indenture.
CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2014
 
Eaton
Corporation
plc
 
Eaton
Corporation
 
Guarantors
 
Other
subsidiaries
 
Consolidating
adjustments
 
Total
Net sales
$

 
$
1,667

 
$
1,641

 
$
3,291

 
$
(1,107
)
 
$
5,492

 
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold

 
1,342

 
1,218

 
2,392

 
(1,094
)
 
3,858

Selling and administrative expense
2

 
361

 
200

 
399

 

 
962

Research and development expense

 
60

 
50

 
52

 

 
162

Interest expense (income) - net

 
59

 
7

 
(6
)
 
2

 
62

Other expense (income) - net

 
5

 
3

 
(13
)
 

 
(5
)
Equity in (earnings) loss of
   subsidiaries, net of tax
(469
)
 
(207
)
 
(485
)
 
(201
)
 
1,362

 

Intercompany expense (income) - net
28

 
(71
)
 
120

 
(77
)
 

 

Income before income taxes
439

 
118


528


745


(1,377
)

453

Income tax (benefit) expense

 
(25
)
 
(7
)
 
49

 
(5
)
 
12

Net income
439

 
143


535


696


(1,372
)

441

Less net income for
   noncontrolling interests

 

 

 
(2
)
 

 
(2
)
Net income attributable to
   Eaton ordinary shareholders
$
439

 
$
143


$
535


$
694


$
(1,372
)

$
439

 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
$
3

 
$
28

 
$
23

 
$
(15
)
 
$
(36
)
 
$
3

Total comprehensive income
   attributable to Eaton
   ordinary shareholders
$
442

 
$
171

 
$
558

 
$
679

 
$
(1,408
)
 
$
442


15

Table of Contents

CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2013
 
Eaton
Corporation
plc
 
Eaton
Corporation
 
Guarantors
 
Other
subsidiaries
 
Consolidating
adjustments
 
Total
Net sales
$

 
$
1,588

 
$
1,573

 
$
3,273

 
$
(1,124
)
 
$
5,310

 
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold

 
1,239

 
1,195

 
2,425

 
(1,124
)
 
3,735

Selling and administrative expense
2

 
341

 
198

 
417

 

 
958

Research and development expense

 
58

 
47

 
47

 

 
152

Interest expense (income) - net

 
74

 
7

 
(6
)
 

 
75

Other (income) expense - net

 
(5
)
 
8

 
(13
)
 

 
(10
)
Equity in (earnings) loss of
   subsidiaries, net of tax
(444
)
 
(309
)
 
(567
)
 
(166
)
 
1,486

 

Intercompany expense (income) - net
64

 
(102
)
 
176

 
(138
)
 

 

Income before income taxes
378

 
292


509


707


(1,486
)

400

Income tax (benefit) expense

 
(2
)
 
(37
)
 
59

 

 
20

Net income
378

 
294


546


648


(1,486
)

380

Less net income for
   noncontrolling interests

 

 

 
(2
)
 

 
(2
)
Net income attributable to
   Eaton ordinary shareholders
$
378

 
$
294


$
546


$
646


$
(1,486
)

$
378

 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive loss
$
(235
)
 
$
(22
)
 
$
(233
)
 
$
(391
)
 
$
646

 
$
(235
)
Total comprehensive income
   attributable to Eaton
   ordinary shareholders
$
143

 
$
272

 
$
313

 
$
255

 
$
(840
)
 
$
143

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


16

Table of Contents

CONDENSED CONSOLIDATING BALANCE SHEETS
MARCH 31, 2014
 
Eaton
Corporation
plc
 
Eaton
Corporation
 
Guarantors
 
Other
subsidiaries
 
Consolidating
adjustments
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
 
Current assets
 
 
 
 
 
 
 
 
 
 
 
Cash
$
8

 
$
46

 
$
12

 
$
718

 
$

 
$
784

Short-term investments

 

 
35

 
325

 

 
360

Accounts receivable - net

 
506

 
986

 
2,397

 

 
3,889

Intercompany accounts
   receivable
10

 
682

 
3,508

 
4,900

 
(9,100
)
 

Inventory

 
368

 
656

 
1,558

 
(50
)
 
2,532

Prepaid expenses and
   other current assets

 
473

 
156

 
476

 
13

 
1,118

Total current assets
18

 
2,075


5,353


10,374

 
(9,137
)
 
8,683

 
 
 
 
 
 
 
 
 
 
 
 
Property, plant and
   equipment - net

 
966

 
765

 
2,075

 

 
3,806

 
 
 
 
 
 
 
 
 
 
 
 
Other noncurrent assets
 
 
 
 
 
 
 
 
 
 
 
Goodwill

 
1,382

 
6,301

 
6,767

 

 
14,450

Other intangible assets

 
207

 
3,949

 
2,922

 

 
7,078

Deferred income taxes

 
826

 
12

 
153

 
(734
)
 
257

Investment in subsidiaries
25,427

 
9,057

 
41,344

 
8,701

 
(84,529
)
 

Intercompany loans receivable

 
7,872

 
2,643

 
19,840

 
(30,355
)
 

Other assets

 
417

 
183

 
388

 

 
988

Total assets
$
25,445

 
$
22,802

 
$
60,550

 
$
51,220

 
$
(124,755
)
 
$
35,262

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

 
$

 
$

 
$
8

 
$

 
$
8

Current portion of
   long-term debt

 
301

 
1

 
14

 

 
316

Accounts payable

 
475

 
391

 
1,210

 

 
2,076

Intercompany accounts payable
10

 
3,609

 
3,626

 
1,855

 
(9,100
)
 

Accrued compensation

 
48

 
42

 
244

 

 
334

Other current liabilities
10

 
667

 
381

 
1,017

 
(4
)
 
2,071

Total current liabilities
20

 
5,100

 
4,441

 
4,348

 
(9,104
)
 
4,805

 
 
 
 
 
 
 
 
 
 
 
 
Noncurrent liabilities
 
 
 
 
 
 
 
 
 
 
 
Long-term debt

 
7,720

 
1,259

 
17

 
(5
)
 
8,991

Pension liabilities

 
375

 
79

 
774

 

 
1,228

Other postretirement
   benefits liabilities

 
402

 
171

 
93

 

 
666

Deferred income taxes

 

 
1,287

 
743

 
(734
)
 
1,296

Intercompany loans payable
8,388

 
2,669

 
18,084

 
1,214

 
(30,355
)
 

Other noncurrent liabilities

 
545

 
155

 
465

 

 
1,165

Total noncurrent liabilities
8,388

 
11,711


21,035


3,306


(31,094
)

13,346

 
 
 
 
 
 
 
 
 
 
 
 
Shareholders’ equity
 
 
 
 
 
 
 
 
 
 
 
Eaton shareholders' equity
17,037

 
5,991

 
35,074

 
43,499

 
(84,564
)
 
17,037

Noncontrolling interests

 

 

 
67

 
7

 
74

Total equity
17,037

 
5,991

 
35,074

 
43,566

 
(84,557
)
 
17,111

Total liabilities and equity
$
25,445

 
$
22,802


$
60,550


$
51,220


$
(124,755
)

$
35,262


17

Table of Contents

CONDENSED CONSOLIDATING BALANCE SHEETS
DECEMBER 31, 2013
 
Eaton
Corporation
plc
 
Eaton
Corporation
 
Guarantors
 
Other
subsidiaries
 
Consolidating
adjustments
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
 
Current assets
 
 
 
 
 
 
 
 
 
 
 
Cash
$
3

 
$
51

 
$
10

 
$
851

 
$

 
$
915

Short-term investments

 

 
134

 
660

 

 
794

Accounts receivable - net

 
473

 
922

 
2,253

 

 
3,648

Intercompany accounts
   receivable
5

 
471

 
3,368

 
4,470

 
(8,314
)
 

Inventory

 
344

 
609

 
1,466

 
(37
)
 
2,382

Prepaid expenses and
   other current assets

 
458

 
175

 
350

 
9

 
992

Total current assets
8

 
1,797

 
5,218

 
10,050

 
(8,342
)
 
8,731

 
 
 
 
 
 
 
 
 
 
 
 
Property, plant and
   equipment - net

 
982

 
761

 
2,090

 

 
3,833

 
 
 
 
 
 
 
 
 
 
 
 
Other noncurrent assets
 
 
 
 
 
 
 
 
 
 
 
Goodwill

 
1,382

 
6,350

 
6,763

 

 
14,495

Other intangible assets

 
211

 
3,996

 
2,979

 

 
7,186

Deferred income taxes

 
839

 
3

 
145

 
(747
)
 
240

Investment in subsidiaries
24,940

 
8,853

 
40,776

 
8,473

 
(83,042
)
 

Intercompany loans receivable

 
8,019

 
2,518

 
18,776

 
(29,313
)
 

Other assets

 
450

 
186

 
370

 

 
1,006

Total assets
$
24,948

 
$
22,533

 
$
59,808

 
$
49,646

 
$
(121,444
)
 
$
35,491

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and
   shareholders’ equity
 
 
 
 
 
 
 
 
 
 
 
Current liabilities
 
 
 
 
 
 
 
 
 <