0001551182-15-000023.txt : 20151030 0001551182-15-000023.hdr.sgml : 20151030 20151030111112 ACCESSION NUMBER: 0001551182-15-000023 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20150930 FILED AS OF DATE: 20151030 DATE AS OF CHANGE: 20151030 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Eaton Corp plc CENTRAL INDEX KEY: 0001551182 STANDARD INDUSTRIAL CLASSIFICATION: MISC INDUSTRIAL & COMMERCIAL MACHINERY & EQUIPMENT [3590] IRS NUMBER: 981059235 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-54863 FILM NUMBER: 151185950 BUSINESS ADDRESS: STREET 1: FITZWILLIAM HALL, FITZWILLIAM PLACE CITY: DUBLIN STATE: L2 ZIP: DUBLIN 2 BUSINESS PHONE: 353 1 669 4672 MAIL ADDRESS: STREET 1: FITZWILLIAM HALL, FITZWILLIAM PLACE CITY: DUBLIN STATE: L2 ZIP: DUBLIN 2 FORMER COMPANY: FORMER CONFORMED NAME: Eaton Corp Ltd DATE OF NAME CHANGE: 20120530 10-Q 1 etn0930201510-q.htm 10-Q 10-Q
 
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, 2015
Commission file number 000-54863
EATON CORPORATION plc
(Exact name of registrant as specified in its charter)
Ireland
 
98-1059235
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification Number)
 
 
 
Eaton House, 30 Pembroke Road, Dublin 4, Ireland
 
-
(Address of principal executive offices)
 
(Zip Code)
 
 
 
+1 353 1637 2900
 
 
 
 
 
 
(Registrant's telephone number, including area code)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not applicable
 
 
 
 
 
 
(Former name, former address and former fiscal year if changed since last report)
 
 
 
 
 
 
 
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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 462.8 million Ordinary Shares outstanding as of September 30, 2015.
 








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)
2015
 
2014
 
2015
 
2014
Net sales
$
5,203

 
$
5,728

 
$
15,798

 
$
16,987

 
 
 
 
 
 
 
 
Cost of products sold
3,597

 
3,916

 
10,865

 
11,799

Selling and administrative expense
907

 
961

 
2,723

 
2,907

Litigation settlements

 

 

 
644

Research and development expense
156

 
163

 
472

 
493

Interest expense - net
59

 
56

 
175

 
173

Other income - net
(3
)
 
(10
)
 
(27
)
 
(181
)
Income before income taxes
487

 
642

 
1,590

 
1,152

Income tax expense (benefit)
42

 
37

 
143

 
(66
)
Net income
445

 
605

 
1,447

 
1,218

Less net loss (income) for noncontrolling interests
1

 
(3
)
 

 
(6
)
Net income attributable to Eaton ordinary shareholders
$
446

 
$
602

 
$
1,447

 
$
1,212

 
 
 
 
 
 
 
 
Net income per ordinary share
 
 
 
 
 
 
 
Diluted
$
0.96

 
$
1.26

 
$
3.09

 
$
2.53

Basic
0.96

 
1.27

 
3.10

 
2.55

 
 
 
 
 
 
 
 
Weighted-average number of ordinary shares outstanding
 
 
 
 
 
 
 
Diluted
466.4

 
477.2

 
468.5

 
478.2

Basic
465.1

 
474.8

 
466.8

 
475.5

 
 
 
 
 
 
 
 
Cash dividends declared per ordinary share
$
0.55

 
$
0.49

 
$
1.65

 
$
1.47


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

2


EATON CORPORATION plc
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 
Three months ended
September 30
 
Nine months ended
September 30
(In millions)
2015
 
2014
 
2015
 
2014
Net income
$
445

 
$
605

 
$
1,447

 
$
1,218

Less net loss (income) for noncontrolling interests
1

 
(3
)
 

 
(6
)
Net income attributable to Eaton ordinary shareholders
446

 
602

 
1,447

 
1,212

 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
Currency translation and related hedging instruments
(372
)
 
(609
)
 
(883
)
 
(598
)
Pensions and other postretirement benefits
60

 
45

 
164

 
118

Cash flow hedges

 
(3
)
 
3

 
(1
)
Other comprehensive loss attributable to Eaton
   ordinary shareholders
(312
)
 
(567
)
 
(716
)
 
(481
)
 


 


 


 


Total comprehensive income attributable to Eaton
  ordinary shareholders
$
134

 
$
35

 
$
731

 
$
731


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


3


EATON CORPORATION plc
CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions)
September 30,
2015
 
December 31,
2014
Assets
 
 
 
Current assets
 
 
 
Cash
$
418

 
$
781

Short-term investments
150

 
245

Accounts receivable - net
3,656

 
3,667

Inventory
2,395

 
2,428

Deferred income taxes
550

 
593

Prepaid expenses and other current assets
410

 
386

Total current assets
7,579

 
8,100

 
 
 
 
Property, plant and equipment - net
3,590

 
3,750

 
 
 
 
Other noncurrent assets
 
 
 
Goodwill
13,540

 
13,893

Other intangible assets
6,139

 
6,556

Deferred income taxes
246

 
228

Other assets
1,107

 
1,002

Total assets
$
32,201

 
$
33,529

 
 
 
 
Liabilities and shareholders’ equity
 
 
 
Current liabilities
 
 
 
Short-term debt
$
1

 
$
2

Current portion of long-term debt
841

 
1,008

Accounts payable
1,997

 
1,940

Accrued compensation
373

 
420

Other current liabilities
1,888

 
1,985

Total current liabilities
5,100

 
5,355

 
 
 
 
Noncurrent liabilities
 
 
 
Long-term debt
7,830

 
8,024

Pension liabilities
1,539

 
1,812

Other postretirement benefits liabilities
502

 
513

Deferred income taxes
820

 
901

Other noncurrent liabilities
997

 
1,085

Total noncurrent liabilities
11,688

 
12,335

 
 
 
 
Shareholders’ equity
 
 
 
Eaton shareholders’ equity
15,366

 
15,786

Noncontrolling interests
47

 
53

Total equity
15,413

 
15,839

Total liabilities and equity
$
32,201

 
$
33,529


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

4


EATON CORPORATION plc
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 
Nine months ended
September 30
(In millions)
2015
 
2014
Operating activities
 
 
 
Net income
$
1,447

 
$
1,218

Adjustments to reconcile to net cash provided by operating activities
 
 
 
Depreciation and amortization
692

 
743

Deferred income taxes
(101
)
 
(286
)
Pension and other postretirement benefits expense
244

 
260

Contributions to pension plans
(290
)
 
(333
)
Contributions to other postretirement benefits plans
(24
)
 
(38
)
Excess tax benefit from equity-based compensation

 
(20
)
Gain on sale of businesses

 
(68
)
Changes in working capital
(184
)
 
(391
)
Other - net
(155
)
 
(151
)
Net cash provided by operating activities
1,629

 
934

 
 
 
 
Investing activities
 

 
 
Cash paid for acquisitions of businesses, net of cash acquired
(38
)
 

Capital expenditures for property, plant and equipment
(368
)
 
(378
)
Sales of short-term investments - net
76

 
445

Proceeds from sale of businesses
1

 
282

Other - net
(44
)
 
(56
)
Net cash (used in) provided by investing activities
(373
)
 
293

 
 
 
 
Financing activities
 
 
 
Proceeds from borrowings
1

 

Payments on borrowings
(405
)
 
(580
)
Cash dividends paid
(771
)
 
(700
)
Exercise of employee stock options
48

 
50

Repurchase of shares
(454
)
 
(267
)
Excess tax benefit from equity-based compensation

 
20

Other - net
(8
)
 
(3
)
Net cash used in financing activities
(1,589
)
 
(1,480
)
 
 
 
 
Effect of currency on cash
(30
)
 
(7
)
Total decrease in cash
(363
)
 
(260
)
Cash at the beginning of the period
781

 
915

Cash at the end of the period
$
418

 
$
655


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

5


EATON CORPORATION plc
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Amounts are in millions unless indicated otherwise (per share data assume dilution).
Note 1.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Eaton Corporation plc (Eaton or the Company) have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles (US GAAP) for complete financial statements. However, in the opinion of management, all adjustments (consisting of normal recurring accruals) have been made that are necessary for a fair presentation of the condensed consolidated financial statements for the interim periods.
This Form 10-Q should be read in conjunction with the consolidated financial statements and related notes included in Eaton’s 2014 Form 10-K. The interim period results are not necessarily indicative of the results to be expected for the full year. Management has evaluated subsequent events through the date this Form 10-Q was filed with the Securities and Exchange Commission.
Certain prior year amounts have been reclassified to conform to the current year presentation.
Recently Issued Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (ASU 2014-09). This accounting standard supersedes all existing US GAAP revenue recognition guidance. Under ASU 2014-09, a company will recognize revenue when it transfers the control of promised goods or services to customers in an amount that reflects the consideration which the company expects to collect in exchange for those goods or services. ASU 2014-09 will require additional disclosures in the notes to the consolidated financial statements and is effective for annual and interim reporting periods beginning after December 15, 2016. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date (ASU 2015-14). This accounting standard defers the effective date of ASU 2014-09 for one year and permit early adoption as of the original effective date. Eaton is evaluating the impact of ASU 2014-09 and an estimate of the impact to the consolidated financial statements cannot be made at this time.

Note 2.
ACQUISITION AND SALE OF BUSINESSES
Acquisition of Ephesus Lighting, Inc.
On October 28, 2015, Eaton acquired Ephesus Lighting, Inc. (Ephesus). Ephesus is a leader in LED lighting for stadiums and other high lumen outdoor and industrial applications. Its sales over the last twelve months were $22. Ephesus will be reported within the Electrical Products business segment.
Acquisition of UK Safety Technology Manufacturer Oxalis Group Ltd.
On January 12, 2015, Eaton acquired Oxalis Group Ltd. (Oxalis). Oxalis is a manufacturer of closed-circuit television camera stations, public address and general alarm systems and other electrical products for the hazardous area, marine and industrial communications markets. Oxalis is reported within the Electrical Systems and Services business segment.
Sale of Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions
On May 9, 2014, Eaton sold the Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses to Safran for $270, which resulted in a pre-tax gain of $154.


6


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
 
2015
 
2014
 
2015
 
2014
Business segment
 
 
 
 
 
 
 
Electrical Products
$
5

 
$
8

 
$
17

 
$
49

Electrical Systems and Services
3

 
4

 
10

 
43

Hydraulics

 
2

 
2

 
11

Total business segments
8

 
14

 
29

 
103

Corporate
2

 
5

 
4

 
19

Total acquisition integration charges before income taxes
$
10

 
$
19

 
$
33

 
$
122

Total after income taxes
$
7

 
$
14

 
$
22

 
$
81

Per ordinary share - diluted
$
0.01

 
$
0.03

 
$
0.05

 
$
0.17

Business segment acquisition integration charges for the three and nine months ended September 30, 2015 and 2014 were related primarily to the integration of Cooper Industries plc (Cooper) to gain efficiencies in selling, marketing, traditional back-office functions, manufacturing, and distribution. These charges were included in Cost of products sold or Selling and administrative expense, as appropriate. In Business Segment Information the charges reduced Operating profit of the related business segment. See Note 13 for additional information about business segments.
Corporate acquisition integration charges in 2015 and 2014 were related to the acquisition of Cooper. These charges were included in Selling and administrative expense. In Business Segment Information the charges were included in Other corporate expense - net.
The Cooper integration initiatives are expected to continue throughout 2015.

Note 4. RESTRUCTURING CHARGES
During the third quarter of 2015, Eaton took actions to reduce its cost structure in all business segments and at corporate. The restructuring charges were $113 in the third quarter of 2015. These restructuring activities are anticipated to be $10 in the fourth quarter of 2015 and $30 in 2016.
A summary of restructuring charges by segment follows:
 
 
Three months ended September 30, 2015
Electrical Products
 
11

Electrical Systems & Services
 
26

Hydraulics
 
25

Aerospace
 
5

Vehicle
 
29

Corporate
 
17

Total
 
113


7


A summary of liabilities related to workforce reductions, plant closings and other associated costs follows:
 
 
Workforce reductions
 
Plant closing and other
 
Total
Balance at December 31, 2014
 

 

 

Liability recognized
 
99

 
14

 
113

Payments
 
(29
)
 
(1
)
 
(30
)
Other adjustments
 

 
(12
)
 
(12
)
Balance at September 30, 2015
 
70

 
1

 
71

These charges were included in Cost of products sold, Selling and administrative expenses or Other income-net, as appropriate. In Business Segment Information, the charges reduced Operating profit of the related business segment. See Note 13 for additional information about business segments.

Note 5. GOODWILL
A summary of goodwill follows:
 
 
Electrical
Products
 
Electrical
Systems and
Services
 
Hydraulics
 
Aerospace
 
Vehicle
 
Total
December 31, 2014
 
$
6,940

 
$
4,314

 
$
1,327

 
$
962

 
$
350

 
$
13,893

Additions
 

 
21

 

 

 

 
21

Reclassifications
 
(106
)
 
106

 

 

 

 

Translation
 
(170
)
 
(129
)
 
(65
)
 
(3
)
 
(7
)
 
(374
)
September 30, 2015
 
$
6,664

 
$
4,312

 
$
1,262

 
$
959

 
$
343

 
$
13,540


Note 6. RETIREMENT BENEFITS PLANS
The components of retirement benefits expense follow:
 
United States
pension benefit expense
 
Non-United States
pension benefit expense
 
Other postretirement
benefits expense
 
Three months ended September 30
 
2015
 
2014
 
2015
 
2014
 
2015
 
2014
Service cost
$
31

 
$
30

 
$
18

 
$
17

 
$
2

 
$
4

Interest cost
39

 
41

 
18

 
21

 
6

 
9

Expected return on plan assets
(65
)
 
(61
)
 
(25
)
 
(25
)
 
(2
)
 
(1
)
Amortization
29

 
23

 
10

 
7

 

 
1

 
34

 
33

 
21

 
20

 
6

 
13

Settlements
25

 
14

 

 

 

 

Total expense
$
59

 
$
47

 
$
21

 
$
20

 
$
6

 
$
13

 
United States
pension benefit expense
 
Non-United States
pension benefit expense
 
Other postretirement
benefits expense
 
Nine months ended September 30
 
2015
 
2014
 
2015
 
2014
 
2015
 
2014
Service cost
$
92

 
$
88

 
$
55

 
$
50

 
$
5

 
$
13

Interest cost
117

 
122

 
54

 
65

 
18

 
28

Expected return on plan assets
(196
)
 
(184
)
 
(75
)
 
(75
)
 
(4
)
 
(4
)
Amortization
89

 
69

 
30

 
21

 
1

 
5

 
102

 
95

 
64

 
61

 
20

 
42

Settlements
58

 
62

 

 

 

 

Total expense
$
160

 
$
157

 
$
64

 
$
61

 
$
20

 
$
42


8



Note 7. LEGAL CONTINGENCIES
Eaton is subject to a broad range of claims, administrative and legal proceedings such as lawsuits that relate to contractual allegations, tax audits, patent infringement, personal injuries, antitrust matters and employment-related matters. Eaton is also subject to asbestos claims from historic products which may have contained asbestos. Historically, significant insurance coverage has been available to cover costs associated with these claims. Although it is not possible to predict with certainty the outcome or cost of these matters, the Company believes they will not have a material adverse effect on the consolidated financial statements.
In 2010, a Brazilian court held that a judgment obtained by a Brazilian company, Raysul, against another Brazilian company, Saturnia, which was sold by Eaton in 2006, could be enforced against Eaton Ltda. and Eaton Holding S.à.r.l. This judgment is based on an alleged violation of an agency agreement between Raysul and Saturnia. At September 30, 2015, the Company has a total accrual of 91 Brazilian Reais related to this matter ($23 based on current exchange rates), comprised of 60 Brazilian Reais recognized in the fourth quarter of 2010 ($15 based on current exchange rates) with an additional 31 Brazilian Reais recognized through September 30, 2015 ($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 filed appeals on various issues to the Superior Court of Justice in Brasilia. In April 2013, the Superior Court of Justice ruled in favor of Raysul. Additional motions for clarification have been filed with the Superior Court of Justice in Brasilia and were denied. On February 2, 2015, a final appeal was filed with the Superior Court of Justice in Brasilia. The Company expects that any sum it may be required to pay in connection with this matter will not exceed the amount of the recorded liability.
On October 5, 2006, ZF Meritor LLC and Meritor Transmission Corporation (collectively, Meritor) filed an action against Eaton in the United States District Court of Delaware. The action sought damages, which would have been trebled under United States antitrust laws, as well as injunctive relief and costs. The suit alleged that Eaton engaged in anti-competitive conduct against Meritor in the sale of heavy-duty truck transmissions in North America. On June 23, 2014, Eaton announced it signed a settlement agreement with Meritor in the amount of $500 that resolved the lawsuit and removed the uncertainty of a trial and appeal process. On July 16, 2014, Eaton paid Meritor the $500.
Frisby Corporation, now known as Triumph Actuation Systems, LLC, and other claimants (collectively, Triumph) asserted claims alleging, among other things, unfair competition, defamation, malicious prosecution, deprivation of civil rights, and antitrust in the Hinds County Circuit Court of Mississippi in 2004 and in the Federal District Court of North Carolina in 2011. Eaton had asserted claims against Triumph regarding improper use of trade secrets and these claims were dismissed by the Hinds County Circuit Court. On June 18, 2014, Eaton announced it signed a settlement agreement with Triumph in the amount of $147.5 that resolved all claims and lawsuits and removed the uncertainty of a trial and appeal process. On July 8, 2014, Eaton paid Triumph the $147.5.

Note 8. INCOME TAXES
The effective income tax rate for the third quarter and first nine months of 2015 was an expense of 9%, compared to an expense of 6% and a benefit of 6% for the third quarter and first nine months of 2014, respectively. Excluding the litigation settlements and related legal costs as well as the gain on the sale of Eaton's Aerospace businesses, all of which represents a total pre-tax expense of $494 in the second quarter of 2014, the effective income tax rate for the first nine months of 2014 was an expense of 6%. See Note 7 and Note 2 for additional information about legal contingencies and the sale of businesses, respectively.
The increase in the effective tax rate in the third quarter and first nine months of 2015 is primarily due to more income earned in higher tax jurisdictions, including the United States.
At the end of the fourth quarter of 2011, the IRS issued a Notice for Eaton Corporation and Includible Subsidiaries 2005 and 2006 tax years (the 2011 Notice). The 2011 Notice proposed assessments of $75 in additional taxes plus $52 in penalties related primarily to transfer pricing adjustments 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., net of agreed credits and deductions. The Company has set its transfer prices for products sold between these affiliates at the same prices that the Company sells such products to third parties as required by two successive Advance Pricing Agreements (APAs) the Company entered into with the IRS. For the years 2001 through 2004, the IRS had previously accepted the transfer pricing methodology related to these APAs after a comprehensive review conducted in two separate audit cycles. On December 16, 2011, immediately prior to the 2011 Notice being issued, the IRS sent a letter stating that it was retrospectively canceling the APAs, even though their respective APA terms had already expired.

9


The Company is contesting the proposed assessments. The Company believes that it was in full compliance with the terms of the two APAs, and that the IRS's cancellation of these two APAs is without merit. On February 29, 2012, the Company filed a Petition with the U.S. Tax Court in which it asserted that the transfer pricing established in the APAs meets the arms-length standard set by the U.S. income tax laws, and accordingly, that the APAs should be enforced in accordance with their terms. The case involves both whether the APAs should be enforced and, if not, the appropriate transfer pricing methodology. The case was tried before the U.S. Tax Court in August and September 2015. The case will be fully submitted to the Court after the parties complete post-trial briefing on February 29, 2016, and it will likely be several months to a year before the Court renders a decision in the case.
During the third quarter of 2014, the Company received a Notice from the IRS for the 2007 through 2010 tax years (the 2014 Notice) proposing assessments of $190 in additional taxes plus $72 in penalties, net of agreed credits and deductions. The proposed assessments pertain primarily to the same transfer pricing issues that are currently in litigation for the 2011 Notice, as noted above. During 2007 through 2010, the Company set its transfer prices for products sold between these affiliates consistent with the terms of a written APA between it and the IRS that covered the years at issue. To establish the relevant transfer prices, the APA relied on prices at which the Company sells the products to third parties. The 2014 Notice includes a separate proposed assessment involving the recognition of income for several of the Company’s controlled foreign corporations. The Company believes that these proposed assessments are without merit. On November 25, 2014, the Company filed a Petition with the U.S. Tax Court in which it challenged the IRS's adjustments. The Company expects the outcome of the 2014 Notice on the transfer pricing matter to be determined by the judicial decision related to the 2011 Notice. The Company has continued to apply the arms-length transfer pricing methodology for 2011 through the current reporting period.

Note 9. EQUITY
Eaton has an ordinary share repurchase program (2013 Program) that authorizes the repurchase of 40 million ordinary shares. During the third quarter of 2015 and 2014, 4.8 million and 3.4 million ordinary shares were repurchased under the 2013 Program in the open market at a total cost of $284 and $225, respectively. During the first nine months of 2015 and 2014, 7.2 million and 4.8 million ordinary shares were repurchased under the 2013 Program in the open market at a total cost of $454 and $324, respectively.
The changes in Shareholders’ equity follow:
 
Eaton
shareholders’
equity
 
Noncontrolling
interests
 
Total
equity
Balance at December 31, 2014
$
15,786

 
$
53

 
$
15,839

Net income
1,447

 

 
1,447

Other comprehensive loss
(716
)
 

 
(716
)
Cash dividends paid
(771
)
 
(6
)
 
(777
)
Issuance of shares under equity-based compensation plans - net
77

 

 
77

Repurchase of shares
(454
)
 

 
(454
)
Change in Capital
(3
)
 

 
(3
)
Balance at September 30, 2015
$
15,366

 
$
47

 
$
15,413

The changes in Accumulated other comprehensive loss follow:
 
Currency translation and related hedging instruments
 
Pensions and other postretirement benefits
 
Cash flow
hedges
 
Total
Balance at December 31, 2014
$
(1,414
)
 
$
(1,485
)
 
$

 
$
(2,899
)
Other comprehensive (loss) income
    before reclassifications
(883
)
 
48

 
10

 
(825
)
Amounts reclassified from Accumulated other
   comprehensive loss

 
116

 
(7
)
 
109

Net current-period Other comprehensive
   (loss) income
(883
)
 
164

 
3

 
(716
)
Balance at September 30, 2015
$
(2,297
)
 
$
(1,321
)
 
$
3

 
$
(3,615
)

10


The reclassifications out of Accumulated other comprehensive loss follow:
 
Nine months ended September 30, 2015
 
Consolidated statements
of income classification
Amortization of pensions and other postretirement benefits items
 
 
 
Actuarial loss and prior service cost
$
(178
)
1 
 
Tax benefit
62

 
 
Total, net of tax
(116
)
 
 
 
 
 
 
Gains and (losses) on cash flow hedges
 
 
 
Currency exchange contracts
11

 
Cost of products sold
Tax expense
(4
)
 
 
Total, net of tax
7

 
 
 
 
 
 
Total reclassifications for the period
$
(109
)
 
 
1 These components of Accumulated other comprehensive loss are included in the computation of net periodic benefit cost. See Note 6 for additional information about pension and other post retirement benefits items.

Net Income per Ordinary Share
A summary of the calculation of net income per ordinary share attributable to shareholders follows:
 
Three months ended
September 30
 
Nine months ended
September 30
(Shares in millions)
2015
 
2014
 
2015
 
2014
Net income attributable to Eaton ordinary shareholders
$
446

 
$
602

 
$
1,447

 
$
1,212

 
 
 
 
 
 
 
 
Weighted-average number of ordinary shares outstanding - diluted
466.4

 
477.2

 
468.5

 
478.2

Less dilutive effect of equity-based compensation
1.3

 
2.4

 
1.7

 
2.7

Weighted-average number of ordinary shares outstanding - basic
465.1

 
474.8

 
466.8

 
475.5

 
 
 
 
 
 
 
 
Net income per ordinary share
 
 
 
 
 
 
 
Diluted
$
0.96

 
$
1.26

 
$
3.09

 
$
2.53

Basic
0.96

 
1.27

 
3.10

 
2.55

For the third quarter and first nine months of 2015, 1.8 million and 1.3 million stock options, respectively, were excluded from the calculation of diluted net income per ordinary share because the exercise price of the options exceeded the average market price of the ordinary shares during the period and their effect, accordingly, would have been antidilutive. For the third quarter and first nine months of 2014, 0.5 million and 0.3 million stock options, respectively, were excluded from the calculation of diluted net income per ordinary share because the exercise price of the options exceeded the average market price of the ordinary shares during the period and their effect, accordingly, would have been antidilutive.

Note 10. FAIR VALUE MEASUREMENTS
Fair value is measured based on an exit price, representing the amount that would be received to sell an asset or paid to satisfy a liability in an orderly transaction between market participants. Fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, a fair value hierarchy is established, which categorizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

11


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, 2015
 
 
 
 
 
 
 
Cash
$
418

 
$
418

 
$

 
$

Short-term investments
150

 
150

 

 

Net derivative contracts
161

 

 
161

 

Long-term debt converted to floating interest rates by
   interest rate swaps - net
(136
)
 

 
(136
)
 

 
 
 
 
 
 
 
 
December 31, 2014
 
 
 
 
 
 
 
Cash
$
781

 
$
781

 
$

 
$

Short-term investments
245

 
245

 

 

Net derivative contracts
70

 

 
70

 

Long-term debt converted to floating interest rates by
   interest rate swaps - net
(74
)
 

 
(74
)
 

Eaton values its financial instruments using an industry standard market approach, in which prices and other relevant information is generated by market transactions involving identical or comparable assets or liabilities. No financial instruments were measured using unobservable inputs.
Other Fair Value Measurements
Long-term debt and the current portion of long-term debt had a carrying value of $8,671 and fair value of $8,900 at September 30, 2015 compared to $9,032 and $9,509, respectively, at December 31, 2014. The fair value of Eaton's debt instruments were estimated using prevailing market interest rates on debt with similar creditworthiness, terms and maturities and are considered a Level 2 fair value measurement.

Note 11. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
In the normal course of business, Eaton is exposed to certain risks related to fluctuations in interest rates, currency exchange rates and commodity prices. The Company uses various derivative and non-derivative financial instruments, primarily interest rate swaps, currency forward exchange contracts, currency swaps and, to a lesser extent, commodity contracts, to manage risks from these market fluctuations. The instruments used by Eaton are straightforward, non-leveraged instruments. The counterparties to these instruments are financial institutions with strong credit ratings. Eaton maintains control over the size of positions entered into with any one counterparty and regularly monitors the credit rating of these institutions. Such instruments are not purchased and sold for trading purposes.
Derivative financial instruments are accounted for at fair value and recognized as assets or liabilities in the Condensed Consolidated Balance Sheets. Accounting for the gain or loss resulting from the change in the fair value of the derivative financial instrument depends on whether it has been designated, and is effective, as part of a hedging relationship and, if so, as to the nature of the hedging activity. Eaton formally documents all relationships between derivative financial instruments accounted for as designated hedges and the hedged item, as well as its risk-management objective and strategy for undertaking the hedge transaction. This process includes linking derivative financial instruments to a recognized asset or liability, specific firm commitment, forecasted transaction, or net investment in a foreign operation. These financial instruments can be designated as:
Hedges of the change in the fair value of a recognized fixed-rate asset or liability, or the firm commitment to acquire such an asset or liability (a fair value hedge); for these hedges, the gain or loss from the derivative financial instrument, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in income during the period of change in fair value.
Hedges of the variable cash flows of a recognized variable-rate asset or liability, or the forecasted acquisition of such an asset or liability (a cash flow hedge); for these hedges, the effective portion of the gain or loss from the derivative financial instrument is recognized in Accumulated other comprehensive loss and reclassified to income in the same period when the gain or loss on the hedged item is included in income.
Hedges of the currency exposure related to a net investment in a foreign operation (a net investment hedge); for these hedges, the effective portion of the gain or loss from the derivative financial instrument is recognized in Accumulated other comprehensive loss and reclassified to income in the same period when the gain or loss related to the net investment in the foreign operation is included in income.

12


The gain or loss from a derivative financial instrument designated as a hedge that is effective is classified in the same line of the Consolidated Statements of Income as the offsetting loss or gain on the hedged item. The change in fair value of a derivative financial instrument that is not effective as a hedge is immediately recognized in income.
For derivatives that are not designated as a hedge, any gain or loss is immediately recognized in income. The majority of derivatives used in this manner relate to risks resulting from assets or liabilities denominated in a foreign currency and certain commodity contracts that arise in the normal course of business. Gains and losses associated with commodity hedge contracts are classified in Cost of products sold.
Eaton uses certain of its debt denominated in foreign currency to hedge portions of its net investments in foreign operations against foreign currency exposure (net investment hedges). Foreign currency denominated debt designated on an after-tax basis as non-derivative net investment hedging instruments was $83 at September 30, 2015 and $84 at December 31, 2014.
Derivative Financial Statement Impacts
The fair value of derivative financial instruments recognized in the Condensed Consolidated Balance Sheets follows:
 
Notional
amount
 
Other
 current
assets
 
Other
noncurrent
assets
 
Other
current
liabilities
 
Other
noncurrent
liabilities
 
Type of
hedge
 
Term
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
3,440

 
$

 
$
136

 
$

 
$

 
Fair value
 
18 months to 19 years
Currency exchange contracts
749

 
16

 
1

 
6

 
5

 
Cash flow
 
1 to 36 months
Commodity contracts
1

 

 

 

 

 
Cash flow
 
1 to 12 months
Total
 
 
$
16

 
$
137

 
$
6

 
$
5

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as
 hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Currency exchange contracts
$
3,465

 
$
43

 
 
 
$
24

 
 
 
 
 
1 to 12 months
Total
 
 
$
43

 
 
 
$
24

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
3,440

 
$

 
$
84

 
$

 
$
10

 
Fair value
 
2 to 19 years
Currency exchange contracts
432

 
8

 
1

 
5

 
3

 
Cash flow
 
1 to 36 months
Commodity contracts
1

 

 

 

 

 
Cash flow
 
1 to 12 months
Total
 
 
$
8

 
$
85

 
$
5

 
$
13

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as
 hedges
 
 
 
 
 
 
 
 
 
 
 
 
 
Currency exchange contracts
$
4,447

 
$
47

 
 
 
$
52

 
 
 
 
 
1 to 12 months
Total
 
 
$
47

 
 
 
$
52

 
 
 
 
 
 
The currency exchange contracts shown in the table above as derivatives not designated as hedges are primarily contracts entered into to manage currency volatility or exposure on intercompany sales and loans. While Eaton does not elect hedge accounting treatment for these derivatives, Eaton targets managing 100% of the intercompany balance sheet exposure to minimize the effect of currency volatility related to the movement of goods and services in the normal course of its operations. This activity represents the great majority of these currency exchange contracts.

13


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
reclassified from
Accumulated other
comprehensive loss
 
Gain (loss) reclassified
from Accumulated other
comprehensive loss
 
Three months ended
September 30
 
 
 
Three months ended
September 30
 
2015
 
2014
 
 
 
2015
 
2014
Derivatives designated as
   cash flow hedges
 
 
 
 
 
 
 
 
 
Currency exchange contracts
6

 
(3
)
 
Cost of products sold
 
5

 
1

Total
$
6

 
$
(3
)
 
 
 
$
5

 
$
1

 
Gain (loss) recognized in
other comprehensive
(loss) income
 
Location of gain
reclassified from
Accumulated other
comprehensive loss
 
Gain (loss) reclassified
from Accumulated other
comprehensive loss
 
Nine months ended
September 30
 
 
 
Nine months ended
September 30
 
2015

2014
 
 
 
2015
 
2014
Derivatives designated as cash
   flow hedges
 
 
 
 
 
 
 
 
 
Floating-to-fixed interest rate swaps
$

 
$

 
Interest expense - net
 
$

 
$
(1
)
Currency exchange contracts
16

 
2

 
Cost of products sold
 
11

 
5

Total
$
16

 
$
2

 
 
 
$
11

 
$
4

Amounts recognized in net income follow:
 
Three months ended
September 30
 
Nine months ended
September 30
 
2015

2014
 
2015
 
2014
Derivatives designated as fair value hedges
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
65

 
$
(12
)
 
$
62

 
$
61

Related long-term debt converted to floating interest
   rates by interest rate swaps
(65
)
 
12

 
(62
)
 
(61
)
 
$

 
$

 
$

 
$

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

Note 12. INVENTORY
The components of inventory follow:
 
September 30,
2015
 
December 31,
2014
Raw materials
$
1,140

 
$
924

Work-in-process
242

 
422

Finished goods
1,136

 
1,201

Inventory at FIFO
2,518

 
2,547

Excess of FIFO over LIFO cost
(123
)
 
(119
)
Total inventory
$
2,395

 
$
2,428



14


Note 13. BUSINESS SEGMENT INFORMATION
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision maker, or decision making group, in deciding how to allocate resources to an individual segment and in assessing performance. Eaton’s operating segments are Electrical Products, Electrical Systems and Services, Hydraulics, Aerospace and Vehicle. Operating profit includes the operating profit from intersegment sales. For additional information regarding Eaton’s business segments, see Note 14 to the Consolidated Financial Statements contained in the 2014 Form 10-K.
 
Three months ended
September 30
 
Nine months ended
September 30
 
2015
 
2014
 
2015
 
2014
Net sales
 
 
 
 
 
 
 
Electrical Products
$
1,771

 
$
1,875

 
$
5,246

 
$
5,433

Electrical Systems and Services
1,487

 
1,655

 
4,437

 
4,807

Hydraulics
599

 
733

 
1,907

 
2,302

Aerospace
449

 
454

 
1,367

 
1,404

Vehicle
897

 
1,011

 
2,841

 
3,041

Total net sales
$
5,203

 
$
5,728

 
$
15,798

 
$
16,987

 
 
 
 
 
 
 
 
Segment operating profit
 
 
 
 
 
 
 
Electrical Products
$
322

 
$
330

 
$
858

 
$
880

Electrical Systems and Services
164

 
238

 
573

 
601

Hydraulics
44

 
84

 
184

 
286

Aerospace
79

 
72

 
233

 
203

Vehicle
136

 
176

 
490

 
482

Total segment operating profit
745

 
900

 
2,338

 
2,452

 
 
 
 
 
 
 
 
Corporate
 
 
 
 
 
 
 
Litigation settlements

 

 

 
(644
)
Amortization of intangible assets
(102
)
 
(107
)
 
(306
)
 
(326
)
Interest expense - net
(59
)
 
(56
)
 
(175
)
 
(173
)
Pension and other postretirement benefits expense
(38
)
 
(31
)
 
(99
)
 
(114
)
Other corporate expense - net
(59
)
 
(64
)
 
(168
)
 
(43
)
Income before income taxes
487

 
642

 
1,590

 
1,152

Income tax expense (benefit)
42

 
37

 
143

 
(66
)
Net income
445

 
605

 
1,447

 
1,218

Less net loss (income) for noncontrolling interests
1

 
(3
)
 

 
(6
)
Net income attributable to Eaton ordinary shareholders
$
446

 
$
602

 
$
1,447

 
$
1,212


Note 14. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
On November 20, 2012, Eaton Corporation issued senior notes totaling $4,900 to finance part of the cash portion of the acquisition of Cooper. On November 14, 2013, the senior notes were exchanged for senior notes registered under the Securities Act of 1933 (the Senior Notes). Eaton and certain other of Eaton's 100% owned direct and indirect subsidiaries (the Guarantors) fully and unconditionally guaranteed (subject, in the case of the Guarantors, other than Eaton, to customary release provisions as described below), on a joint and several basis, the Senior Notes. The following condensed consolidating financial statements are included so that separate financial statements of Eaton, Eaton Corporation and each of the Guarantors are not required to be filed with the Securities and Exchange Commission. The consolidating adjustments primarily relate to eliminations of investments in subsidiaries and intercompany balances and transactions. The condensed consolidating financial statements present investments in subsidiaries using the equity method of accounting.

15


The guarantee of a Guarantor that is not a parent of the issuer will be automatically and unconditionally released and discharged in the event of any sale of the Guarantor or of all or substantially all of its assets, or in connection with the release or termination of the Guarantor as a guarantor under all other U.S. debt securities or U.S. syndicated credit facilities, subject to limitations set forth in the indenture. The guarantee of a Guarantor that is a direct or indirect parent of the issuer will only be automatically and unconditionally released and discharged in connection with the release or termination of such Guarantor as a guarantor under all other debt securities or syndicated credit facilities (in both cases, U.S. or otherwise), subject to limitations set forth in the indenture.
During the third quarter of 2015, the Company undertook certain steps to restructure ownership of various subsidiaries. The transactions were entirely among wholly-owned subsidiaries under the common control of Eaton. This restructuring has been reflected as of the beginning of the earliest period presented below.
CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2015
 
Eaton
Corporation
plc
 
Eaton
Corporation
 
Guarantors
 
Other
subsidiaries
 
Consolidating
adjustments
 
Total
Net sales
$

 
$
1,755

 
$
1,664

 
$
3,105

 
$
(1,321
)
 
$
5,203

 
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold

 
1,380

 
1,269

 
2,265

 
(1,317
)
 
3,597

Selling and administrative expense
2

 
375

 
191

 
339

 

 
907

Research and development expense

 
65

 
51

 
40

 

 
156

Interest expense (income) - net

 
54

 
5

 
(3
)
 
3

 
59

Other expense (income) - net

 
11

 
3

 
(17
)
 

 
(3
)
Equity in loss (earnings) of
   subsidiaries, net of tax
(534
)
 
(266
)
 
(888
)
 
(66
)
 
1,754

 

Intercompany expense (income) - net
86

 
(54
)
 
258

 
(290
)
 

 

Income (loss) before income taxes
446

 
190


775


837


(1,761
)

487

Income tax expense (benefit)

 
17

 
(15
)
 
38

 
2

 
42

Net income (loss)
446

 
173


790


799


(1,763
)

445

Less net loss (income) for
   noncontrolling interests

 

 

 
1

 

 
1

Net income (loss) attributable to
   Eaton ordinary shareholders
$
446

 
$
173


$
790


$
800


$
(1,763
)

$
446

 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
$
(312
)
 
$
(28
)
 
$
(305
)
 
$
(415
)
 
$
748

 
$
(312
)
Total comprehensive income
  (loss) attributable to Eaton
  ordinary shareholders
$
134

 
$
145

 
$
485

 
$
385

 
$
(1,015
)
 
$
134


16


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

 
$
1,814

 
$
1,738

 
$
3,416

 
$
(1,240
)
 
$
5,728

 
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold

 
1,402

 
1,266

 
2,489

 
(1,241
)
 
3,916

Selling and administrative expense
2

 
354

 
209

 
396

 

 
961

Research and development expense

 
63

 
49

 
51

 

 
163

Interest expense (income) - net

 
58

 
7

 
(8
)
 
(1
)
 
56

Other expense (income) - net

 
3

 
11

 
(24
)
 

 
(10
)
Equity in loss (earnings) of
   subsidiaries, net of tax
(670
)
 
(251
)
 
(820
)
 
(232
)
 
1,973

 

Intercompany expense (income) - net
66

 
(59
)
 
293

 
(300
)
 

 

Income (loss) before income taxes
602

 
244


723


1,044


(1,971
)

642

Income tax expense (benefit)

 
12

 

 
25

 

 
37

Net income (loss)
602

 
232


723


1,019


(1,971
)

605

Less net loss (income) for
   noncontrolling interests

 

 

 
(3
)
 

 
(3
)
Net income (loss) attributable to
   Eaton ordinary shareholders
$
602

 
$
232


$
723


$
1,016


$
(1,971
)

$
602

 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
$
(567
)
 
$
8

 
$
(560
)
 
$
(696
)
 
$
1,248

 
$
(567
)
Total comprehensive income
   (loss) attributable to Eaton
   ordinary shareholders
$
35

 
$
240

 
$
163

 
$
320

 
$
(723
)
 
$
35

CONSOLIDATING STATEMENTS OF COMPREHENSIVE INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2015
 
Eaton
Corporation
plc
 
Eaton
Corporation
 
Guarantors
 
Other
subsidiaries
 
Consolidating
adjustments
 
Total
Net sales
$

 
$
5,263

 
$
5,065

 
$
9,469

 
$
(3,999
)
 
$
15,798

 
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold

 
4,123

 
3,837

 
6,864

 
(3,959
)
 
10,865

Selling and administrative expense
6

 
1,120

 
539

 
1,058

 

 
2,723

Research and development expense

 
202

 
145

 
125

 

 
472

Interest expense (income) - net

 
166

 
16

 
(10
)
 
3

 
175

Other expense (income) - net

 
17

 
(5
)
 
(39
)
 

 
(27
)
Equity in loss (earnings) of
   subsidiaries, net of tax
(1,698
)
 
(536
)
 
(2,405
)
 
(323
)
 
4,962

 

Intercompany expense (income) - net
245

 
(362
)
 
1,010

 
(893
)
 

 

Income (loss) before income taxes
1,447

 
533


1,928


2,687


(5,005
)

1,590

Income tax expense (benefit)

 
36

 
(32
)
 
154

 
(15
)
 
143

Net income (loss)
1,447

 
497


1,960


2,533


(4,990
)

1,447

Less net loss (income) for
   noncontrolling interests

 

 

 
(1
)
 
1

 

Net income (loss) attributable to
   Eaton ordinary shareholders
$
1,447

 
$
497


$
1,960


$
2,532


$
(4,989
)

$
1,447

 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
$
(716
)
 
$
35

 
$
(691
)
 
$
(879
)
 
$
1,535

 
$
(716
)
Total comprehensive income
   (loss) attributable to Eaton
   ordinary shareholders
$
731

 
$