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<SEC-DOCUMENT>0000950152-04-001889.txt : 20040312
<SEC-HEADER>0000950152-04-001889.hdr.sgml : 20040312
<ACCEPTANCE-DATETIME>20040312164133
ACCESSION NUMBER: 0000950152-04-001889
CONFORMED SUBMISSION TYPE: 10-K
PUBLIC DOCUMENT COUNT: 11
CONFORMED PERIOD OF REPORT: 20031231
FILED AS OF DATE: 20040312
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: EATON CORP
CENTRAL INDEX KEY: 0000031277
STANDARD INDUSTRIAL CLASSIFICATION: MOTOR VEHICLE PARTS & ACCESSORIES [3714]
IRS NUMBER: 340196300
STATE OF INCORPORATION: OH
FISCAL YEAR END: 1231
FILING VALUES:
FORM TYPE: 10-K
SEC ACT: 1934 Act
SEC FILE NUMBER: 333-56644
FILM NUMBER: 04666577
BUSINESS ADDRESS:
STREET 1: EATON CTR
STREET 2: 1111 SUPERIOR AVE
CITY: CLEVELAND
STATE: OH
ZIP: 44114-2584
BUSINESS PHONE: 2165235000
MAIL ADDRESS:
STREET 1: 1111 SUPERIOR AVENUE
CITY: CLEVELAND
STATE: OH
ZIP: 44114
FORMER COMPANY:
FORMER CONFORMED NAME: EATON YALE & TOWNE INC
DATE OF NAME CHANGE: 19710822
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>l06255ae10vk.txt
<DESCRIPTION>EATON CORPORATION
<TEXT>
<PAGE>
United States Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
---------
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the year ended December 31, 2003
Commission file number 1-1396
Eaton Corporation
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Ohio 34-0196300
------------------------ ------------------------------------
(State of incorporation) (I.R.S. Employer Identification No.)
Eaton Center, Cleveland, Ohio 44114-2584
---------------------------------------- ----------
(Address of principal executive offices) (Zip code)
(216) 523-5000
---------------------------------------------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
- ------------------------------ ---------------------------
Common Shares ($.50 par value) The New York Stock Exchange
The Chicago Stock Exchange
The Pacific Exchange
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 twelve months and (2) has been subject to such filing requirements
for the past ninety days. Yes X
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes X
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X
The aggregate market value of Common Stock held by non-affiliates of the
registrant as of June 30, 2003 was $5.9 billion.
As of January 31, 2004, there were 153,956,284 Common Shares outstanding
(restated to give effect to the two-for-one stock split effective February 23,
2004).
<PAGE>
Documents Incorporated By Reference
Portions of the Proxy Statement for the 2004 annual shareholders' meeting are
incorporated by reference into Part III.
<PAGE>
Part I
Item 1. Business
- -----------------
Eaton Corporation (Eaton or Company) is a global diversified industrial
manufacturer with 2003 sales of $8.1 billion. Eaton was incorporated in Ohio in
1916, as a successor to a New Jersey company incorporated in 1911. The Company
is a leader in the design and manufacture of fluid power systems; electrical
power quality, distribution and control; automotive engine air management and
powertrain controls for fuel economy; and intelligent drivetrain systems for
fuel economy and safety in trucks. Headquartered in Cleveland, Ohio, Eaton had
51,000 employees at year-end 2003 and sells products in more than 100 countries.
More information regarding the Company is available at http://www.eaton.com.
Eaton electronically files or furnishes reports pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 (Exchange Act) to the United States
Securities and Exchange Commission (Commission), including annual reports on
Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, as
well as any amendments to those reports. As soon as reasonably practicable,
these reports are available free of charge through the Company's Internet web
site at http://www.eaton.com. These filings are also accessible on the
Commission's Internet web site at www.sec.gov.
In light of strong results for 2003 and growing momentum in many of its markets,
Eaton took the following actions on January 21, 2004:
- - The Company's Common Shares were split two-for-one effective February 23,
2004. Accordingly, all per share amounts, average shares outstanding, shares
outstanding and stock option information have been adjusted retroactively to
reflect the stock split.
- - The quarterly dividend on the Common Shares was increased by 12.5%, from $.24
per share to $.27 per share (after adjustment for the stock split)
- - Cash of $75 million was contributed to the Company's qualified pension plans
in the United States
- - A plan was initiated to repurchase 4.2 million Common Shares to offset the
shares issued during 2003 from the exercise of stock options. In addition, the
Company now intends, depending upon circumstances, to purchase additional shares
to help offset dilution resulting from shares issued as a result of stock
options exercised over the course of 2004.
On January 31, 2003, the electrical business of Delta plc was acquired for
approximately $215. The Delta business has operations in Europe and in the
Asia/Pacific area and had sales of $326 in 2002. The business' major electrical
brands include MEM(R), Holec(TM), Bill(TM), Home Automation(TM), Elek(TM) and
Tabula(TM). Also in January 2003, the power systems business of Commonwealth
Sprague Capacitor Inc. was purchased for $6, which was equal to its annual
sales.
In August 2003, a joint venture was formed with Caterpillar Inc. to provide
switchgear products under the Cat(R) brand name. The joint venture operates
under the name Intelligent Switchgear Organization LLC and is 51% owned by
Eaton. Eaton's investment in the joint venture was approximately $30.
In third quarter 2003, Eaton announced that it, together with Shaanxi Fast
Gear Co., Ltd. and Xiang Torch Investment Co., Ltd., signed an agreement to
form a joint venture in Xi'an, China to produce heavy-duty truck
transmissions for the growing Chinese market. Eaton will have 55% ownership
of the venture, which will be called Eaton Fast Gear (Xi'an) Co., Ltd.
<PAGE>
Regulatory approval was obtained on January 4, 2004 and production is
expected to begin in fourth quarter 2004.
Business Segment Information
- ----------------------------
Information regarding principal products, net sales, operating profit and assets
by business segment and geographic region is presented in "Business Segment &
Geographic Region Information" on pages F-33 through F-37 of this report.
Additional information regarding Eaton's segments and business in general is
presented below.
Fluid Power
- -----------
Competition - Principal methods of competition in this segment are price,
geographic coverage, service and product performance. Eaton occupies a strong
competitive position in relation to the many competitors in this segment and,
with respect to many products, is considered among the market leaders.
Significant Customers - Approximately 13% of this segment's net sales in 2003
were made to three manufacturers of vehicles in the United States and Europe.
Two of these customers are also significant customers of the Automotive segment.
Electrical
- ----------
Competition - Principal methods of competition in this segment are price,
geographic coverage, service and product performance. Eaton occupies a strong
competitive position in relation to the many competitors in this segment and,
with respect to many products, is considered among the market leaders.
Significant Customers - Approximately 14% of this segment's net sales in 2003
were made to one customer located in the United States, which is not a
significant customer of any other segment.
Automotive
- ----------
Seasonal Fluctuations - Sales of the Automotive segment historically are lower
in the third quarter than in other quarters during the year as a result of the
normal seasonal pattern of automotive industry production.
Competition - Principal methods of competition in this segment are price,
service and product performance. Eaton occupies a strong competitive position in
relation to the many competitors in this segment and, with respect to many
products, is considered among the market leaders.
Significant Customers - Approximately 56% of this segment's net sales in 2003
were made to divisions and subsidiaries of five large original equipment
manufacturers of vehicles and one automotive component supplier. All of these
customers are concentrated in North America and Europe. Eaton has been
conducting business with each of these companies for many years. Sales to these
companies include a number of different products and different models or types
of the same product. With respect to many of the products sold, various
divisions and subsidiaries of each of the companies are in the nature of
separate customers, and sales to one division or subsidiary are not dependent
upon sales to other divisions or subsidiaries. Two of these customers are also
significant customers of the Truck segment, while two other customers are also
significant customers of the Fluid Power Segment.
<PAGE>
Truck
- -----
Competition - Principal methods of competition in this segment are price,
service and product performance. Eaton occupies a strong competitive position in
relation to the many competitors in this segment and, with respect to many
products, is considered among the market leaders.
Significant Customers - Approximately 67% of this segment's net sales in 2003
were made to divisions and subsidiaries of five original equipment manufacturers
of heavy-, medium-, and light-duty trucks and off-highway vehicles, concentrated
in North America, Europe and Latin America. Two of these customers are also
significant customers of the Automotive segment.
Information Concerning Eaton's Business in General
- --------------------------------------------------
Raw Materials - Principal raw materials used are iron, steel, copper, nickel,
aluminum, brass, silver, rubber, plastic and insulating materials. Materials are
purchased in various forms, such as pig iron, metal sheets and strips, forging
billets, bar stock and plastic pellets. Raw materials, as well as parts and
other components, are purchased from many suppliers and, under normal
circumstances, the Company has no difficulty obtaining them.
Patents and Trademarks - Eaton views its name and mark as significant to its
business as a whole.
Eaton's products are marketed with a portfolio of patents, trademarks, licenses
or other forms of intellectual property that expire at various dates. Eaton
develops and acquires new intellectual property on an ongoing basis and
considers all of its intellectual property to be valuable. However, based on the
broad scope of Eaton's product lines, management believes that the loss or
expiration of any single intellectual property right would not have a material
effect on the results of operation or financial position of Eaton or its
business segments. Eaton's policy is to file applications and obtain patents for
its new products including product modifications and improvements. While U.S.
patents generally expire 20 years after the patent application filing date, new
patents are issued to Eaton on a regular basis.
Order Backlog - Since a significant portion of open orders placed with Eaton by
original equipment manufacturers of cars, trucks and off-highway vehicles are
historically subject to month-to-month releases by customers during each model
year, such orders are not considered firm. In measuring backlog of orders, the
Company includes only the amount of such orders released by such customers as of
the dates listed. Using this criterion, total backlog at December 31, 2003 and
2002 was approximately $1.3 billion and $1.2 billion, respectively. Backlog
should not be relied upon as being indicative of results of operations for
future periods.
Research and Development - Research and development expenses for new products
and improvement of existing products in 2003, 2002 and 2001 (in millions) were
$223, $203 and $228, respectively. Over the past five years, the Company has
invested approximately $1.2 billion in research and development.
Protection of the Environment - Operations of the Company involve the use and
disposal of certain substances regulated under environmental protection laws.
Eaton continues to modify certain processes on an ongoing, regular basis in
order to reduce the impact on the environment, including the reduction or
elimination of certain chemicals used in, and wastes generated from, operations.
Compliance with Federal, State and local provisions which have been enacted or
adopted regulating the discharge of materials into the environment, or otherwise
relating to the protection of the environment, are not expected to have a
material adverse effect upon earnings or the competitive position of the
Company. Eaton's estimated capital expenditures for environmental control
facilities are not expected to be material for 2004 and 2005. Information
regarding the Company's liabilities related to environmental matters is
<PAGE>
presented in "Protection of the Environment" on pages F-24 and F-25 of this
report.
Foreign Operations - Eaton's foreign operations are subject to a variety of
risks that may affect such operations, including, among other things:
- - Currency fluctuations and devaluations,
- - Changes in local economic conditions, and
- - Exchange controls and currency restrictions.
While the impact of these risks is difficult to predict, any one or more of them
could adversely affect the Company's operations in the future.
Item 2. Properties
- -------------------
Eaton's world headquarters is located in Cleveland, Ohio. The Company maintains
manufacturing facilities at 178 locations in 27 countries, including 28
light-manufacturing and fabrication facilities. The Company is a lessee under a
number of operating leases for certain real properties and equipment, none of
which is material to its operations. Management believes that the manufacturing
facilities are adequate for operations, and such facilities are maintained in
good condition.
Item 3. Legal Proceedings
- --------------------------
Information regarding the Company's legal proceedings is presented in
"Protection of the Environment" and "Contingencies" on pages F-24 and F-25 of
this report.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
None.
Executive Officers of the Registrant - Information regarding executive officers
of the Company is presented in Item 10 of this Form 10-K.
Part II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
- ------------------------------------------------------------------------------
The Company's Common Shares are listed for trading on the New York, Chicago and
Pacific stock exchanges. Information regarding cash dividends paid and the high
and low market price per Common Share for each quarter in 2003 and 2002 is
presented in "Quarterly Data" on page F-57 of this report. At December 31, 2003,
there were 10,107 holders of record of the Company's Common Shares.
Additionally, 22,347 current and former employees were shareholders through
participation in the Eaton Savings Plan (ESP) and Eaton Personal Investment Plan
(EPIP).
Information regarding equity compensation plans required by Regulation S-K Item
201(d) is provided in Item 12 of this Form 10-K.
<PAGE>
Item 6. Selected Financial Data
- --------------------------------
Information regarding selected financial data is presented in the "Eight-Year
Consolidated Financial Summary" on pages F-58 and F-59 of this report.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- ------------------------------------------------------------------------
"Management's Discussion & Analysis of Financial Condition and Results of
Operations" is presented on pages F-38 through F-56 of this report.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
- ------------------------------------------------------------------
Information regarding market risk is presented in "Market Risk Disclosure &
Contractual Obligations" on pages F-50 and F-51 of this report.
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
The report of independent auditors, consolidated financial statements, and notes
to consolidated financial statements are presented on pages F-1 through F-37 of
this report.
Item 9. Change in and Disagreements with Accountants on Accounting and
Financial Disclosure
- -----------------------------------------------------------------------
None.
Item 9A. Controls and Procedures
- ---------------------------------
Pursuant to SEC Rule 13a-15, an evaluation was performed, under the supervision
and with the participation of Eaton's management, including Alexander M. Cutler
- - Chairman and Chief Executive Officer and Richard H. Fearon - Executive Vice
President - Chief Financial and Planning Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
on that evaluation, Eaton's management concluded that the Company's disclosure
controls and procedures were effective as of December 31, 2003.
Disclosure controls and procedures are designed to ensure that information
required to be disclosed in Company reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Commission's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed in Company reports filed under
the Exchange Act is accumulated and communicated to management, including the
Company's Chief Executive Officer and Chief Financial Officer, to allow timely
decisions regarding required disclosure.
<PAGE>
Part III
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
A listing of Eaton's officers, their ages, positions and offices held over the
past five years, as of January 31, 2004, follows:
<TABLE>
<CAPTION>
Name Age Position (Date elected to position)
- ---- --- -----------------------------------
<S> <C> <C>
Alexander M. Cutler 52 Chairman and Chief Executive Officer; President
(August 1, 2000 - present)
President and Chief Operating Officer
(September 1, 1995 - July 31, 2000)
Director (1993 - present)
Richard H. Fearon 47 Executive Vice President - Chief Financial and
Planning Officer (April 24, 2002 - Present)
Partner, Willow Place Partners LLC (2001 - 2002)
Senior Vice President - Corporate Development,
Transamerica Corporation (1997 - 2000)
Craig Arnold 43 Senior Vice President and Group Executive - Fluid
Power (October 25, 2000 - present)
Corporate Vice President of General Electric and
President of GE Lighting Services Ltd.
(1999 - 2000)
Corporate Vice President and President of GE
Plastics, Greater China (1998 - 1999)
Stephen M. Buente 53 Senior Vice President and Group Executive -
Automotive (August 21, 2000 - present)
Operations Vice President - Automotive Controls
(1999 - 2000)
Operations Vice President - Engine Components
(1995 - 1999)
Randy W. Carson 53 Senior Vice President and Group Executive -
Electrical (January 1, 2000 - present)
Vice President - Growth Initiatives (1999)
James E. Sweetnam 51 Senior Vice President and Group Executive -
Truck (July 1, 2001 - present)
Vice President - Heavy-Duty Transmission, Clutch
and Aftermarket (2000 - 2001)
Vice President and General Manager - Heavy-Duty
Transmission Division (1997 - 1999)
Kristen M. Bihary 50 Vice President - Communications
(July 28, 1999 - present)
Vice President - External Affairs, Internal and
Marketing Communications at Shell Chemical
Company (1998 - 1999)
Susan J. Cook 56 Vice President - Human Resources
(January 16, 1995 - present)
Earl R. Franklin 60 Vice President and Secretary
(April 24, 2002 - present)
Secretary and Associate General Counsel
(September 1, 1991 - April 23, 2002)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Thomas S. Gross 49 Vice President -- Eaton Business System
(July 23, 2003 - present)
Group Executive, Motion Control, Danaher Corp.
(2000 - 2002)
Group Executive, Electronic Test and Measurement,
Danaher Corp.
(1999 - 2000)
President and CEO, Xycom Inc.
(1997 - 1999)
J.Robert Horst 60 Vice President and General Counsel
(January 1, 2000 - present)
Deputy General Counsel (1998 - 1999)
John S. Mitchell 47 Vice President - Taxes
(November 22, 1999 - present)
Vice President - Taxes at The Limited, Inc.
(1997 - 1999)
Robert E. Parmenter 51 Vice President and Treasurer
(January 1, 1997 - present)
Billie K. Rawot 52 Vice President and Controller
(March 1, 1991 - present)
Robert L. Sell 53 Vice President - Chief Information Officer
(August 11, 2003 - present)
Senior Vice President, Chief Information Officer,
Moore Wallace Incorporated
(2002 - 2003)
Vice President, Chief Information Officer,
Brunswick Corporation
(1999 - 2001)
Ken D. Semelsberger 42 Vice President - Strategic Planning
(April 28, 1999 - present)
Director - Corporate Development and Planning
(1998 - 1999)
</TABLE>
There are no family relationships among the officers listed, and there are no
arrangements or understandings pursuant to which any of them were elected as
officers. All officers hold office for one year and until their successors are
elected and qualified, unless otherwise specified by the Board of Directors;
provided, however, that any officer is subject to removal with or without cause,
at any time, by a vote of a majority of the Board of Directors.
Information required with respect to the Directors of the Company is set forth
under the caption "Election of Directors" in the Company's definitive Proxy
Statement to be filed on or about March 15, 2004, and is incorporated by
reference.
Eaton has a separately designated standing audit committee established in
accordance with Section 3(a)(58)(A) of the Exchange Act. The current members of
the Audit Committee are Victor A. Pelson (chairman), Deborah L. McCoy, John R.
Miller and Kiran M. Patel. The Board of Directors of Eaton has determined that
John R. Miller and Kiran M. Patel are audit committee financial experts as
defined by Item 401(h) of Regulation S-K of the Exchange Act and are independent
within the meaning of Item 7(d)(3)(iv) of Schedule 14A of the Exchange Act.
The Company has adopted a Code of Ethics, which applies to the Directors,
officers (including its Chairman and Chief Executive Officer, Executive Vice
President--Chief Financial and Planning Officer and Vice President and
Controller) and employees worldwide. The Code of Ethics is included as an
<PAGE>
exhibit in the Company's definitive Proxy Statement to be filed on or about
March 15, 2004, and is incorporated by reference. The Board of Directors has
also approved charters for the Board's Audit Committee, Compensation and
Organization Committee, Finance Committee and Governance Committee, as well as
the Board of Directors Governance Policies. These documents are available on the
Company's website at http://www.eaton.com. Printed copies are also available
free of charge upon request. Requests for printed copies should be directed to
the Company's Investor Relations Office, Eaton Corporation, 1111 Superior
Avenue, Cleveland 44114-2584.
Information required with respect to compliance with Section 16(a) of the
Exchange Act is set forth under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's definitive Proxy Statement to be filed on
or about March 15, 2004, and is incorporated by reference.
Item 11. Executive Compensation
- --------------------------------
Information required with respect to executive compensation is set forth under
the caption "Executive Compensation" in the Company's definitive Proxy Statement
to be filed on or about March 15, 2004, and is incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholders Matters
- ----------------------------------------------------------------------------
Information required with respect to security ownership of certain beneficial
owners is set forth under the caption "Ownership of Outstanding Voting Shares"
in the Company's definitive Proxy Statement to be filed on or about March 15,
2004, and is incorporated by reference.
Information required with respect to management and equity compensation plans is
set forth under the caption "Equity Compensation Plans" in the Company's
definitive Proxy Statement to be filed on or about March 15, 2004, and is
incorporated by reference.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
None required to be reported.
Item 14. Principal Accountant Fees and Services
- ------------------------------------------------
Information required with respect to principal accountant fees and services is
set forth under the caption "Audit Committee Report" in the Company's definitive
Proxy Statement to be filed on or about March 15, 2004, and is incorporated by
reference.
<PAGE>
Part IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- --------------------------------------------------------------------------
(a) (1) The report of independent auditors, consolidated financial
statements and notes to consolidated financial statements, included in
Item 8 above, are filed as a separate section of this report:
Report of Independent Auditors - Page F-1
Statements of Consolidated Income - Years ended December 31, 2003, 2002
and 2001 - Page F-2
Consolidated Balance Sheets - December 31, 2003 and 2002 - Pages F-3 and
F-4
Statements of Consolidated Cash Flows - Years ended December 31, 2003
2002 and 2001 - Pages F-5 and F-6
Statements of Consolidated Shareholders' Equity - Years ended December
31, 2003, 2002 and 2001 -Pages F-7 and F-8
Notes to Consolidated Financial Statements - Pages F-9 through F-37
(2) All schedules for which provision is made in Regulation S-X of the
Securities and Exchange Commission are not required under the related
instructions or are inapplicable and, therefore, have been omitted.
(3) Exhibits
3(a) Amended Articles of Incorporation (amended and restated as of
April 27, 1994) - Incorporated by reference to the Form 10-K
for the year ended December 31, 2002
3(b) Amended Regulations (amended and restated as of April 26,
2000) - Incorporated by reference to the Form 10-Q for the six
months ended June 30, 2000
4(a) Instruments defining rights of security holders, including
indentures (Pursuant to Regulation S-K Item 601(b)(4), the
Company agrees to furnish to the Commission, upon request, a
copy of the instruments defining the rights of holders of
long-term debt)
4(b) Rights Agreement (Dated as of June 28, 1995) - Incorporated by
reference to Registration Statement 333-74355 filed on March
12, 1999
10 Material contracts - Each of the following is either a
management contract or a compensatory plan or arrangement:
(a) Deferred Incentive Compensation Plan (amended and
restated as of March 31, 2000) - Incorporated by
reference to the Form 10-K for the year ended
December 31, 2000
(b) Executive Strategic Incentive Plan I (Amended and
Restated as of January 1, 2001) - Incorporated by
reference to the Form 10-K for the year ended
December 31, 2002
(c) Group Replacement Insurance Plan (GRIP), effective as
of June 1, 1992 - Incorporated by reference to the
Form 10-K for the year ended December 31, 1992
<PAGE>
(d) 1991 Stock Option Plan - Incorporated by reference to
the Form 10-K for the year ended December 31, 2002
(e) 1995 Stock Plan - Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(f) Incentive Compensation Deferral Plan (amended and
restated as of October 1, 1997) - Incorporated by
reference to the Form 10-K for the year ended
December 31, 2000
(g) Form of Change of Control Agreement entered into with
officers of Eaton Corporation - Incorporated by
reference to the Form 10-K for the year ended
December 31, 2002
(h) Form of Indemnification Agreement entered into with
officers of Eaton Corporation - Incorporated by
reference to the Form 10-K for the year ended
December 31, 2002
(i) Limited Eaton Service Supplemental Retirement Income
Plan(amended and restated as of January 1, 2003) -
Incorporated by reference to the Form 10-K for the
year ended December 31, 2002
(j) Supplemental Benefits Plan (amended and restated as
of January 1, 1989) (which provides supplemental
retirement benefits) - Incorporated by reference to
the Form 10-K for the year ended December 31, 2002
(k) Excess Benefits Plan (Amended and Restated Effective
January 1, 1989) (with respect to Section 415
limitations of the Internal Revenue Code) -
Incorporated by reference to the Form 10-K for the
year ended December 31, 2002
(l) Executive Incentive Compensation Plan (Effective as
of January 1, 2003) - Filed in conjunction with this
Form 10-K
(m) Plan for the Deferred Payment of Directors' Fees
(Originally adopted in 1985 and amended effective as
of September 24, 1996 and January 28, 1998) -
Incorporated by reference to the Form 10-K for the
year ended December 31, 2002
(n) Plan for the Deferred Payment of Directors' Fees
(Originally adopted in 1980 and amended and restated
in 1989 and 1996) - Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(o) 1996 Non-Employee Director Fee Deferral Plan (amended
and restated as of October 22, 2002) - Incorporated
by reference to the Form 10-K for the year ended
December 31, 2002
(p) Trust Agreement - Outside Directors (dated December
6, 1996) - Incorporated by reference to the Form 10-K
for the year ended December 31, 2002
(q) Trust Agreement - Officers and Employees (dated
December 6,1996) - Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(r) 1998 Stock Plan - Incorporated by reference to the
definitive Proxy Statement dated March 13, 1998
<PAGE>
(s) 2002 Stock Plan - Incorporated by reference to the
definitive Proxy Statement dated March 15, 2002
(t) Executive Strategic Incentive Plan II (Effective as
of January 1, 2001) - Incorporated by reference to
the Form 10-K for the year ended December 31, 2002
(u) Vehicle Allowance Program (Effective as of January 1,
2003) - Filed in conjunction with this Form 10-K
12 Ratio of Earnings to Fixed Charges - Filed in conjunction with
this Form 10-K
14 Code of Ethics - Incorporated by reference to the definitive
Proxy Statement to be filed on or about March 15, 2004
21 Subsidiaries of Eaton Corporation - Filed in conjunction with
this Form 10-K
23 Consent of Independent Auditors - Filed in conjunction with
this Form 10-K
24 Power of Attorney - Filed in conjunction with this Form 10-K
31.1 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act
of 2002, Section 302) - Filed in conjunction with this Form
10-K
31.2 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act
of 2002, Section 302) - Filed in conjunction with this Form
10-K
32.1 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act
of 2002, Section 906) - Filed in conjunction with this Form
10-K
32.2 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act
of 2002, Section 906) - Filed in conjunction with this Form
10-K
(b) Reports on Form 8-K
On October 14, 2003, the Company filed a Current Report on Form 8-K regarding
the third quarter 2003 earnings release.
On January 21, 2004, the Company filed a Current Report on Form 8-K regarding
the fourth quarter 2003 earnings release.
(c) Exhibits
Certain exhibits required by this portion of Item 15 are filed as a separate
section of this report.
(d) Financial Statement Schedules
None required to be filed.
<PAGE>
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Eaton Corporation
-----------------
Registrant
Date: March 12, 2004 /s/ Richard H. Fearon
------------------------------------
Richard H. Fearon
Executive Vice President -
Chief Financial and Planning Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.
Date: March 12, 2004
<TABLE>
<CAPTION>
Signature Title
- --------- -----
<S> <C>
*
- -------------------
Alexander M. Cutler Chairman and Chief Executive Officer;
President Director
*
- ---------------
Billie K. Rawot Vice President and Controller;
Principal Accounting Officer
*
- -------------------
Michael J. Critelli Director
*
- -----------------
Ned C. Lautenbach Director
*
- --------------
John R. Miller Director
*
- --------------
Kiran M. Patel Director
*
- --------------
Gary L. Tooker Director
- -----------
Ernie Green Director
*
- ----------------
Deborah L. McCoy Director
*
- ---------------
Gregory R. Page Director
*
- ----------------
Victor A. Pelson Director
</TABLE>
*By /s/ Richard H. Fearon
--------------------------------------
Richard H. Fearon, Attorney-in-Fact
for the officers and directors signing
in the capacities indicated
<PAGE>
Report Of Independent Auditors
- ------------------------------
To the Board of Directors & Shareholders
Eaton Corporation
We have audited the accompanying consolidated balance sheets of Eaton
Corporation as of December 31, 2003 and 2002, and the related statements of
consolidated income, shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 2003. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Eaton Corporation
at December 31, 2003 and 2002, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December 31,
2003, in conformity with accounting principles generally accepted in the United
States.
As discussed in "Goodwill & Other Intangible Assets" in the Notes to
Consolidated Financial Statements, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets", effective January 1, 2002.
/s/ Ernst & Young LLP
---------------------
Cleveland, Ohio
January 20, 2004, except for the note titled
"Two-For-One Stock Split", as to
which the date is February 23, 2004
F-1
<PAGE>
Eaton Corporation
Statements of Consolidated Income
<TABLE>
<CAPTION>
Year ended December 31
------------------------
(Millions except for per share data) 2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Net sales $8,061 $7,209 $7,299
Cost of products sold 5,897 5,272 5,503
Selling & administrative expense 1,351 1,217 1,220
Research & development expense 223 203 228
Interest expense-net 87 104 142
Gains on sales of businesses (18) (61)
Other (income) expense-net (5) 32 (11)
------ ------ ------
Income before income taxes 508 399 278
Income taxes 122 118 109
------ ------ ------
Net income $ 386 $ 281 $ 169
====== ====== ======
Net income per Common Share assuming dilution $ 2.56 $ 1.96 $ 1.20
Average number of Common Shares outstanding 150.5 143.4 141.0
Net income per Common Share basic $ 2.61 $ 1.99 $ 1.22
Average number of Common Shares outstanding 147.9 141.2 138.8
Cash dividends paid per Common Share $ .92 $ .88 $ .88
</TABLE>
Net income per Common Share, average number of Common Shares outstanding and
cash dividends paid per Common Share have been restated to give effect to the
two-for-one stock split effective February 23, 2004.
The notes on pages F-9 to F-37 are an integral part of the consolidated
financial statements.
F-2
<PAGE>
Eaton Corporation
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31
-------------
(Millions of dollars) 2003 2002
---- ----
<S> <C> <C>
ASSETS
Current assets
- --------------
Cash $ 61 $ 75
Short-term investments 804 353
Accounts receivable 1,190 1,032
Inventories 721 698
Deferred income taxes 192 181
Other current assets 125 118
------ ------
3,093 2,457
------ ------
Property, plant & equipment
Land & buildings 897 790
Machinery & equipment 3,326 3,044
------ ------
4,223 3,834
Accumulated depreciation (2,147) (1,879)
------ ------
2,076 1,955
Goodwill 2,095 1,910
Other intangible assets 541 510
Deferred income taxes & other assets 418 306
------ ------
$8,223 $7,138
====== ======
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities
- -------------------
Short-term debt $ 45 $ 47
Current portion of long-term debt 257 154
Accounts payable 526 488
Accrued compensation 204 199
Accrued income & other taxes 298 225
Other current liabilities 796 621
------ ------
2,126 1,734
------ ------
Long-term debt 1,651 1,887
Postretirement benefits other than pensions 636 652
Pensions & other liabilities 693 563
Shareholders' equity
Common Shares (153.0 million outstanding
in 2003 and 141.2 million in 2002) 76 70
Capital in excess of par value 1,856 1,413
Retained earnings 1,816 1,568
Accumulated other comprehensive income (loss) (585) (699)
Deferred compensation plans (46) (50)
------ ------
3,117 2,302
------ ------
$8,223 $7,138
====== ======
</TABLE>
F-3
<PAGE>
The number of Common Shares outstanding have been restated to give effect to the
two-for-one stock split effective February 23, 2004.
The notes on pages F-9 to F-37 are an integral part of the consolidated
financial statements.
F-4
<PAGE>
Eaton Corporation
Statements of Consolidated Cash Flows
<TABLE>
<CAPTION>
Year ended December 31
----------------------
(Millions) 2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Net cash provided by operating activities
- -----------------------------------------
Net income $ 386 $ 281 $ 169
Adjustments to reconcile to net cash
provided by operating activities
Depreciation & amortization 373 353 355
Amortization of goodwill & other
intangible assets 21 23 94
Deferred income taxes (54) (51) 58
Pensions 34 (4) (84)
Other long-term liabilities 42 (1) 30
Gains on sales of businesses (18) (61)
Other non-cash items in income (4) 22 2
Changes in working capital, excluding
acquisitions & sales of businesses
Accounts receivable (51) 59 98
Inventories 79 13 149
Accounts payable (41) 41 64
Accrued income & other taxes 35 101 75
Other current liabilities 32 (14) (129)
Other working capital accounts (12) 47 (53)
Other-net 34 48 (2)
----- ----- -----
874 900 765
----- ----- -----
Net cash used in investing activities
- -------------------------------------
Expenditures for property, plant & equipment (273) (228) (295)
Acquisitions of businesses, less cash acquired (252) (153) (35)
Sales of businesses 7 96 403
Purchases of short-term investments (436) (135) (154)
Other-net (15) 5 22
----- ---- -----
(969) (415) (59)
----- ----- -----
Net cash provided by (used in) financing activities
- ---------------------------------------------------
Borrowings with original maturities
of more than three months
Proceeds 11 419 1,481
Payments (166) (635) (1,419)
Borrowings with original maturities
of less than three months-net (39) (228) (643)
Cash dividends paid (134) (123) (120)
Proceeds from exercise of employee stock options 113 45 37
Sale (purchase) of Common Shares 296 (12)
----- ----- -----
81 (522) (676)
----- ----- -----
Total (decrease) increase in cash (14) (37) 30
Cash at beginning of year 75 112 82
----- ----- -----
Cash at end of year $ 61 $ 75 $ 112
===== ===== =====
</TABLE>
F-5
<PAGE>
The notes on pages F-9 to F-37 are an integral part of the consolidated
financial statements.
F-6
<PAGE>
Eaton Corporation
Statements of Consolidated Shareholders' Equity
<TABLE>
<CAPTION>
Accumulated Total
Common Shares Capital in other Deferred share-
--------------- excess of Retained comprehensive compensa- holders'
(Millions) Shares Dollars par value earnings income (loss) tion plans equity
------ ------- --------- -------- ------------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 2001 136.6 $68 $1,266 $1,376 $(267) $(33) $2,410
Net income 169 169
Other comprehensive income (loss) (32) (32)
------
Total comprehensive income 137
Cash dividends paid (120) (120)
Issuance of shares under
employee benefit plans,
including tax benefit 2.2 2 64 (3) (1) 62
Issuance of shares to trust .6 22 (22) 0
Purchase of shares (.4) (4) (8) (12)
Other-net (2) (2)
----- --- ------ ------ ----- ---- ------
Balance at December 31, 2001 139.0 70 1,348 1,412 (299) (56) 2,475
Net income 281 281
Other comprehensive income (loss) (400) (400)
------
Total comprehensive loss (119)
Cash dividends paid (123) (123)
Issuance of shares under
employee benefit plans,
including tax benefit 2.0 (a) 61 (2) 8 67
Issuance of shares to trust .2 5 (5) 0
Other-net (1) 3 2
----- --- ------ ------ ----- ---- ------
Balance at December 31, 2002 141.2 70 1,413 1,568 (699) (50) 2,302
Net income 386 386
Other comprehensive income (loss) 114 114
------
Total comprehensive income 500
Cash dividends paid (134) (134)
Issuance of shares under
employee benefit plans,
including tax benefit 4.2 2 141 (2) 5 146
Issuance of shares to trust .1 3 (3) 0
Sale of Common Shares 7.4 4 294 (2) 296
Other-net .1 5 2 7
----- --- ------ ------ ----- ---- ------
Balance at December 31, 2003 153.0 $76 $1,856 $1,816 $(585) $(46) $3,117
===== === ====== ====== ===== ==== ======
</TABLE>
F-7
<PAGE>
(a) Balance less than $1.
The number of Common Shares outstanding have been restated to give effect to the
two-for-one stock split effective February 23, 2004.
The notes on pages F-9 to F-37 are an integral part of the consolidated
financial statements.
F-8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------
Dollars in millions, except per share data (per share data assume dilution)
TWO-FOR-ONE STOCK SPLIT
- -----------------------
On January 21, 2004, the Board of Directors of Eaton announced a two-for-one
split of the Company's Common Shares effective in the form of a 100% stock
dividend. The date of record for the stock split was February 9, 2004, and it
was distributed on February 23, 2004. Accordingly, all per share amounts,
average shares outstanding, shares outstanding and stock option information have
been adjusted retroactively to reflect the stock split.
ACCOUNTING POLICIES
- -------------------
Consolidation & Basis of Presentation
- -------------------------------------
The consolidated financial statements include accounts of Eaton and all
subsidiaries and other controlled entities. The equity method of accounting is
used for investments in associate companies where the Company has a 20% to 50%
ownership interest. These associate companies are not material either
individually, or in the aggregate, to Eaton's financial position, results of
operations or cash flows.
In fourth quarter 2003, Eaton adopted Financial Accounting Standards Board
Interpretation (FIN) No. 46, "Consolidation of Variable Interest Entities". The
adoption of FIN No. 46 had no effect on the Company's financial statements.
Eaton does not have off-balance sheet arrangements, financings or other
relationships with unconsolidated entities or other persons known as "special
purpose entities" (SPEs). In the ordinary course of business, the Company leases
certain real properties and equipment, as described in "Lease Commitments"
below. Transactions with related parties are in the ordinary course of business,
are conducted on an arm's-length basis, and are not material to Eaton's
financial position, results of operations or cash flows.
Foreign Currency Translation
- ----------------------------
The functional currency for substantially all subsidiaries outside the United
States is the local currency. Financial statements for these subsidiaries are
translated into United States dollars at year-end exchange rates as to assets
and liabilities and weighted-average exchange rates as to revenues and expenses.
The resulting translation adjustments are recorded in Accumulated other
comprehensive income (loss) in Shareholders' equity.
Inventories
- -----------
Inventories are carried at lower of cost or market. Inventories in the United
States are generally accounted for using the last-in, first-out (LIFO) method.
Remaining United States and all other inventories are accounted for using the
first-in, first-out (FIFO) method.
F-9
<PAGE>
Depreciation & Amortization
- ---------------------------
Depreciation and amortization are computed by the straight-line method for
financial statement purposes. Cost of buildings is depreciated over 40 years and
machinery and equipment over principally three to 10 years. Intangible assets
subject to amortization, primarily consisting of patents, tradenames and
distribution networks, are amortized over a range of five to 30 years. Software
is amortized over a range of three to five years.
Long-lived assets, except goodwill and indefinite life intangible assets as
described below, are reviewed for impairment whenever events or changes in
circumstances indicate the carrying amount may not be recoverable. Events or
circumstances that would result in an impairment review primarily include
operations reporting losses, a significant change in the use of an asset, or the
planned disposal or sale of the asset. The asset would be considered impaired
when the future net undiscounted cash flows generated by the asset are less than
its carrying value. An impairment loss would be recognized based on the amount
by which the carrying value of the asset exceeds its fair value.
Goodwill & Indefinite Life Intangible Assets
- --------------------------------------------
Eaton adopted Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets", effective January 1, 2002. Upon
adoption, the Company ceased the amortization of goodwill and indefinite life
intangible assets recorded in connection with current and previous business
acquisitions. Indefinite life intangible assets primarily consist of trademarks.
The Company completed the annual impairment tests for goodwill and indefinite
life intangible assets in 2003 and 2002. These tests confirmed that the fair
value of the Company's reporting units and indefinite life intangible assets
exceed their respective carrying values and that no impairment loss was required
to be recognized upon adoption of SFAS No. 142 or for the years ended December
31, 2002 and 2003.
Financial Instruments
- ---------------------
In the normal course of business, Eaton is exposed to fluctuations in interest
rates, foreign currency exchange rates, and commodity prices. The Company uses
various financial instruments, primarily foreign currency forward exchange
contracts, interest rate swaps and commodity futures contracts, to manage
exposure to price fluctuations.
Financial instruments used by Eaton are straightforward, non-leveraged
instruments for which quoted market prices are readily available from a number
of independent sources. Such financial instruments are not bought and sold
solely for trading purposes, except for nominal amounts authorized under
limited, controlled circumstances, which resulted in immaterial net gains in
2002 and 2001 and an immaterial net loss in 2003. The risk of credit loss is
deemed to be remote, because the counterparties to these instruments are major
international financial institutions with strong credit ratings and because of
the Company's control over the size of positions entered into with any one
counterparty.
All derivative financial instruments are recognized as either assets or
liabilities on the balance sheet and are measured at fair value. Accounting for
the gain or loss resulting from the change in the financial instrument's fair
value depends on whether it has been designated, and is effective, as a hedge
and, if so, on the nature of the hedging activity. Financial
F-10
<PAGE>
instruments can be designated 1) as hedges of changes in the fair value of a
recognized fixed-rate asset or liability, or the firm commitment to acquire such
an asset or liability, 2) as hedges of variable cash flows of a recognized
variable-rate asset or liability, or the forecasted acquisition of such an asset
or liability, or 3) as hedges of foreign currency exposure from a net investment
in one of the Company's foreign operations. Gains and losses related to a hedge
are either 1) recognized in income immediately to offset the gain or loss on the
hedged item or 2) deferred and reported as a component of Other comprehensive
income (loss) in Shareholders' equity and subsequently recognized in net income
when the hedged item affects net income. The ineffective portion of the change
in fair value of a financial instrument is recognized in income immediately.
The gain or loss related to financial instruments that are not designated as
hedges are recognized immediately in net income.
Warranty Expenses
- -----------------
Estimated product warranty expenses are accrued in Cost of products sold at the
time the related sale is recognized. Estimates of warranty expenses are based
primarily on historical warranty claim experience and specific customer
contracts. Warranty expenses include accruals for basic warranties for products
sold, as well as accruals for product recalls and other related events when they
are known and estimable.
Stock Options Granted to Employees & Directors
- ----------------------------------------------
Stock options granted to employees and directors to purchase Common Shares are
accounted for using the intrinsic-value-based method. Under this method, no
compensation expense is recognized on the grant date, since on that date the
option price equals the market price of the underlying shares.
In December 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure". SFAS No. 148 amended SFAS No. 123,
"Accounting for Stock-Based Compensation", to provide alternative methods of
transition when a company voluntarily changes to the fair-value-based method of
recognizing expense in the income statement for stock-based employee
compensation, including stock options granted to employees and directors. As
allowed by SFAS No. 123, Eaton has adopted the Statement's disclosure-only
provisions and does not recognize expense for stock options granted to employees
and directors. If the Company accounted for stock options under the
fair-value-based method of expense recognition in SFAS No. 123, net income per
Common Share would have been reduced by $.08 in 2003, $.10 in 2002 and $.11 in
2001, as described further in "Shareholders' Equity" below.
Revenue Recognition
- -------------------
Revenues are recognized when products are shipped to unaffiliated customers and
title has transferred. Shipping and handling costs billed to customers are
included in net sales and the related costs in cost of products sold.
Estimates
- ---------
Preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions in certain circumstances that affect amounts reported in the
F-11
<PAGE>
accompanying consolidated financial statements and notes. Actual results could
differ from these estimates.
ACQUISITIONS OF BUSINESSES
- --------------------------
Eaton acquired businesses and formed joint ventures for a combined net cash
purchase price of $252 in 2003, $153 in 2002 and $35 in 2001. All acquisitions
were accounted for by the purchase method of accounting and, accordingly, the
Statements of Consolidated Income include the results of the acquired businesses
from the effective dates of acquisition.
On January 31, 2003, the electrical business of Delta plc was acquired for
approximately $215. The Delta business has operations in Europe and in the
Asia/Pacific area and had sales of $326 in 2002. The business' major electrical
brands include MEM(R), Holec(TM), Bill(TM), Home Automation(TM), Elek(TM) and
Tabula(TM). The allocation of the purchase price for this acquisition was
substantially complete as of the end of 2003. Also in January 2003, the power
systems business of Commonwealth Sprague Capacitor Inc. was purchased for $6,
which was equal to its annual sales. In August 2003, a joint venture was formed
with Caterpillar Inc. to provide switchgear products under the Cat(R) brand
name. The joint venture operates under the name Intelligent Switchgear
Organization LLC and is 51% owned by Eaton. Eaton's investment in the joint
venture was approximately $30. These businesses are included in the Electrical
segment.
In November 2002, the Boston Weatherhead business of Dana Corporation was
purchased for $130. This business, which had sales of $211 in 2002, manufactures
hose, tubing, and fluid connectors for fluid power systems primarily for
industrial distribution, mobile off-highway and heavy-duty truck markets. Also
in November 2002, the aerospace circuit breaker business of Mechanical Products
Inc., which had sales of $12 in 2001, was purchased for $10. In June 2002, the
remaining 40% interest in Jining Eaton Hydraulics Company, Ltd., a hydraulics
systems manufacturer located in Jining, China, was acquired. This business
manufactures hydraulic pumps and motors for mobile and industrial markets. These
businesses are included in the Fluid Power segment.
In March 2001, the remaining 50% interest of Sumitomo Eaton Hydraulics Company
(now named Eaton Fluid Power Ltd.), the former joint venture with Sumitomo Heavy
Industries Ltd., was acquired. This business manufactures a complete line of
hydraulic motors under the Orbit(TM) and Orbitol(TM) brand names, primarily
for the Japanese mobile equipment market. This business is included in Fluid
Power.
During July 2001, the commercial truck clutch manufacturing assets of
Transmisiones TSP, S.A. de C.V. in Mexico were acquired and is included in the
Truck segment. In October 2001, the European portion of the vehicle mirror
actuator business of Donnelly Corporation, located in Manorhamilton, Ireland,
was acquired and is included in the Automotive segment.
SALES OF BUSINESSES
- -------------------
Eaton sold businesses, product lines and certain corporate assets for aggregate
cash proceeds of $7 in 2003, $96 in 2002 and $403 in 2001.
F-12
<PAGE>
In July 2002, the Navy Controls business was sold resulting in a pretax gain of
$18 ($13 after-tax, or $.09 per Common Share).
Sales of businesses in 2001 included the Vehicle Switch/Electronics Division
(VS/ED), the Air Conditioning and Refrigeration business, and certain assets of
the Automotive and Truck segments. The sales of these businesses resulted in a
net pretax gain of $61 ($22 after-tax, or $.15 per Common Share).
The net gains on the sales of businesses in 2002 and 2001 are reported as a
separate line item in the Statements of Consolidated Income and Business Segment
Information. The operating results of VS/ED are reported in Business Segment
Information as Divested operations.
RESTRUCTURING & OTHER CHARGES
- -----------------------------
2003 Charges
- ------------
In 2003, Eaton incurred restructuring charges related primarily to the
integration of the Boston Weatherhead fluid power business acquired in November
2002 and the electrical business of Delta plc acquired in January 2003. In
accordance with generally accepted accounting principles, these charges were
recorded as restructuring expense as incurred.
Restructuring charges in the Fluid Power segment consisted of $13 for plant
consolidations and other expenses and $1 for workforce reductions of 82
employees. The charges recorded primarily related to the closure of facilities
in Norwood, North Carolina and Mooresville, North Carolina.
Restructuring charges in the Electrical segment consisted of $20 for plant
consolidations, primarily the Ottery St. Mary, United Kingdom plant, and other
expenses and $2 of workforce reductions for 145 employees.
2002 Charges
- ------------
In 2002, Eaton incurred restructuring charges to reduce operating costs across
its business segments and certain corporate functions. The charges in 2002 were
primarily a continuation of restructuring programs initiated in 2001.
Additional restructuring charges related to past acquisitions were incurred in
Fluid Power. The additional acquisition-related charges consisted of $22 of
workforce reductions for 841 employees and $4 of asset write-downs and plant
consolidation and other expenses. The charges recorded primarily related to the
closure of facilities in Glenrothes, Scotland and Livorno, Italy, and for the
closure of the Mooresville, North Carolina facility, which was announced in
third quarter 2002 and was completed in first quarter 2003.
Restructuring charges of $13 in Electrical consisted primarily of workforce
reductions of 449 employees. The workforce reductions, primarily in the sales
force, resulted in payments for severance and other employee benefits. Asset
write-downs and plant consolidation and other expenses of $3 were also recorded
as a result of restructuring actions.
Restructuring charges in the Truck segment consisted of $6 for workforce
reductions of 251 employees and $10 for asset write-downs and plant
consolidation and other expenses. The charges primarily related to the
F-13
<PAGE>
closure of the heavy-duty transmission plant in Shelbyville, Tennessee due to
depressed conditions in the truck industry during 2002 and 2001 and Eaton's
efforts to rationalize manufacturing capacity to better manage the cyclical
nature of the truck industry.
Restructuring charges related to corporate staff consisted of $3 of workforce
reductions for 133 employees. The Company also recorded a corporate charge of
$10 representing a contribution to the Eaton Charitable Fund.
2001 Charges
- ------------
In connection with the acquisitions of businesses in Fluid Power, Eaton incurred
acquisition integration costs of $15 for plant consolidation and other expenses
and $7 for workforce reductions of 239 personnel.
Restructuring charges in Electrical consisted of $21 for workforce separation
costs for the termination of 887 personnel, primarily manufacturing, and $9 for
plant consolidation and other expenses.
Restructuring charges in Truck consisted of $35 of workforce reductions for
1,038 employees and $20 of asset write-downs and plant consolidation and other
expenses. The workforce reductions consisted of severance and other employee
benefits for the elimination of salary positions within the organization and
manufacturing personnel at the closed facilities. The Company completed the
closure of manufacturing facilities in Hillsville, Virginia, and in Tipton,
Gloucester and Aycliffe, United Kingdom, consolidating production to a facility
in Gdansk, Poland, as well as completing the closure of the heavy-duty
transmission plant in St. Nazaire, France.
Restructuring charges related to corporate staff consisted of $8 for workforce
reductions as well as $4 for asset writedowns and other expenses. A corporate
charge of $10 related to an arbitration was recorded in second quarter 2001. The
arbitration award related to a contractual dispute over supply arrangements
initiated in February 1999 against Vickers, Inc. (now named Eaton Hydraulics
Inc.), a subsidiary of Aeroquip-Vickers, Inc., which was acquired by Eaton in
April 1999.
Summary of Restructuring & Other Charges
- ----------------------------------------
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Fluid Power $ 14 $ 26 $ 22
Electrical 22 16 30
Automotive 1
Truck 16 55
----- ----- -----
36 59 107
Corporate restructuring charges 1 3 12
Other corporate charges 10 10
----- ----- -----
Pretax charges $ 37 $ 72 $ 129
===== ===== =====
After-tax charges $ 24 $ 47 $ 86
Per Common Share $ .16 $ .33 $ .60
</TABLE>
F-14
<PAGE>
The restructuring charges were included in the Statements of Consolidated Income
in Cost of products sold or Selling & administrative expense, as appropriate. In
Business Segment Information, the restructuring charges reduced Operating profit
of the related business segment or were included in Corporate expense-net, as
appropriate. The other corporate charges were included in the Statements of
Consolidated Income in Other (income) expense-net and in Business Segment
Information the charges were included in Corporate expense-net.
A comparison of restructuring charges and utilization of the various components
for 2003, 2002 and 2001 follows:
<TABLE>
<CAPTION>
Workforce reductions Inventory Plant
-------------------- & other asset consolidation
Employees Dollars writedowns & other Total
--------- ------- ------------- ------------- -----
<S> <C> <C> <C> <C> <C>
2001 charges 2,310 $ 71 $ 20 $ 28 $ 119
Utilized in 2001 (1,966) (50) (20) (26) (96)
------ ----- ----- ---- -----
Balance remaining at
December 31, 2001 344 21 0 2 23
2002 charges 1,994 45 8 9 62
Utilized in 2002 (1,844) (55) (8) (6) (69)
------ ----- ----- ---- -----
Balance remaining at
December 31, 2002 494 11 0 5 16
2003 charges 227 3 3 31 37
Utilized in 2003 (700) (12) (3) (28) (43)
------ ----- ----- ---- -----
Balance remaining at
December 31, 2003 21 $ 2 $ 0 $ 8 $ 10
====== ===== ===== ==== =====
</TABLE>
Eaton adopted Statement of Financial Accounting Standards (SFAS) No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities", effective
January 1, 2003. SFAS No. 146 addresses the reporting of expenses related to
exit and disposal activities, including business restructurings. This Statement
does not alter the accounting for exit or disposal activities associated with
acquired businesses. Facts and circumstances are evaluated to determine the
proper accounting treatment of expenses related to each exit or disposal
activity.
F-15
<PAGE>
GOODWILL & OTHER INTANGIBLE ASSETS
- ----------------------------------
As discussed in "Accounting Policies" above, Eaton adopted Statement of
Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible
Assets", effective January 1, 2002. Upon adoption, the Company ceased the
amortization of goodwill and indefinite life intangible assets recorded in
connection with previous business acquisitions. A reconciliation of net income
and net income per Common Share for 2001, as if SFAS No. 142 had been adopted as
of the beginning of that year, follows:
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Reported net income $ 386 $ 281 $ 169
Add back amortization of goodwill
& indefinite life intangible
assets, net of income taxes 63
----- ----- -----
Adjusted net income $ 386 $ 281 $ 232
===== ===== =====
Reported net income per
Common Share assuming dilution $2.56 $1.96 $1.20
Add back amortization of goodwill
& indefinite life intangible
assets, net of income taxes .44
----- ----- -----
Adjusted net income per Common Share $2.56 $1.96 $1.64
===== ===== =====
</TABLE>
A summary of other intangible assets follows:
<TABLE>
<CAPTION>
2003 2002
------------------------ ------------------------
Historical Accumulated Historical Accumulated
cost amortization cost amortization
---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Intangible assets not
subject to amortization
(primarily trademarks) $373 $ 24 $333 $ 24
==== ==== ==== ====
Intangible assets subject
to amortization
Patents $205 $ 96 $192 $ 78
Other 135 52 153 66
---- ---- ---- ----
$340 $148 $345 $144
==== ==== ==== ====
</TABLE>
Expense related to intangible assets subject to amortization for 2003 was $21.
Estimated annual pretax expense for intangible assets subject to amortization
recorded at December 31, 2003 for each of the next five years follows: 2004,
$19; 2005, $17; 2006, $16; 2007, $16 and 2008, $15.
F-16
<PAGE>
DEBT & OTHER FINANCIAL INSTRUMENTS
- ----------------------------------
Short-term debt of $45 at December 31, 2003 related to lines of credit of
subsidiaries outside the United States and was almost exclusively denominated in
foreign currencies. These subsidiaries have available short-term lines of credit
aggregating $182 from various banks worldwide. The weighted-average interest
rate on short-term debt, including commercial paper classified as long-term
debt, was 6.3% at December 31, 2003 and 3.9% at December 31, 2002.
A summary of long-term debt, including the current portion, follows:
<TABLE>
<CAPTION>
2003 2002
---- ----
<S> <C> <C>
Variable rate notes due 2003 $ 150
6.95% notes due 2004
(converted to floating rate by
interest rate swap) $ 250 250
1.62% Yen notes due 2006 47 42
8% debentures due 2006
($25 converted to floating rate by
interest rate swap) 86 86
8.9% debentures due 2006
(converted to floating rate by
interest rate swap) 100 100
6% Euro 200 million notes due 2007
(converted to floating rate by
interest rate swap) 252 209
5.75% notes due 2012
($225 converted to floating rate by
interest rate swap) 300 300
8.875% debentures due 2019
(due 2004 at option of debenture holders) 38 38
8.1% debentures due 2022
($50 converted to floating rate by
interest rate swap) 100 100
7-5/8% debentures due 2024
($55 converted to floating rate by
interest rate swap) 66 66
6-1/2% debentures due 2025
(due 2005 at option of debenture holders) 145 145
7.875% debentures due 2026 81 81
7.65% debentures due 2029
($100 converted to floating rate by
interest rate swap) 200 200
6.4% to 7.6% medium-term notes due at
various dates through 2018
($97 converted to floating rate by
interest rate swap) 137 138
Commercial paper 30
Other 106 106
------ ------
Total long-term debt 1,908 2,041
Less current portion of long-term debt (257) (154)
------ ------
Long-term debt, excluding current portion $1,651 $1,887
====== ======
</TABLE>
F-17
<PAGE>
Eaton has long-term credit facilities of $650, of which $400 expire in April
2005 and $250 in May 2008.
Aggregate mandatory annual maturities of long-term debt for each of the next
five years follows: 2004, $257; 2005, $21; 2006, $238; 2007, $305; and 2008, $1.
Interest paid was $105 in 2003, $116 in 2002, and $175 in 2001.
Eaton has entered into interest rate swaps to manage interest rate risk. A
summary of these instruments outstanding at December 31, 2003, excluding certain
immaterial instruments, follows (currency in millions):
<TABLE>
<CAPTION>
Interest rates(b)
-----------------
Interest Hedge Notional Floating interest
rate swaps (a) type amount Receive Pay rate basis
- ----------------- ---------- -------- ------- --- -------------------
<S> <C> <C> <C> <C> <C>
Fixed to floating Fair value $250 6.95% 4.9% 6 month LIBOR+3.7%
Fixed to floating Fair value $ 25 8.0% 5.8% 6 month LIBOR+4.6%
Fixed to floating Fair value $100 8.9% 5.1% 6 month LIBOR+3.9%
Fixed to floating Fair value (euro)200 6.0% 2.7% 6 month EURIBOR+.54%
Fixed to floating Fair value $225 5.75% 1.8% 6 month LIBOR+.71%
Fixed to floating Fair value $ 50 8.1% 3.6% 6 month LIBOR+2.4%
Fixed to floating Fair value $ 55 7.625% 3.3% 6 month LIBOR+2.2%
Fixed to floating Fair value $100 7.65% 3.8% 6 month LIBOR+2.5%
Fixed to floating Fair value $ 97 7.2% 3.7% 6 month LIBOR+2.5%
</TABLE>
a The maturity of the swaps correspond with the maturity of the hedged item as
noted in the long-term debt table.
b Interest rates are as of year-end 2003.
F-18
<PAGE>
The carrying values of cash, short-term investments and short-term debt in the
consolidated balance sheet approximate their estimated fair values. The
estimated fair values of other financial instruments outstanding follow:
<TABLE>
<CAPTION>
2003 2002
-------------------------- ---------------------------
Notional Carrying Fair Notional Carrying Fair
amount value value amount value value
-------- -------- ----- -------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Long-term debt &
current portion of
long-term debt (a) $(1,908) $(2,132) $(2,041) $(2,202)
Foreign currency
principal swaps $ 13 (4) (4) $ 13 (3) (3)
Commodity contracts (b) (b) (b) 10 (b) (b)
Foreign currency
forward exchange
contracts 288 3 3 275 (7) (6)
Interest rate swaps
Fixed to floating 1,154 42 42 811 59 59
Floating to fixed 13 (3) (3)
</TABLE>
(a) Includes foreign currency denominated debt.
(b) Balance less than $1.
The estimated fair values of financial instruments were principally based on
quoted market prices if such prices are available, and where unavailable, fair
values were estimated based on comparable contracts, utilizing systems obtained
from established, independent providers. The fair value of foreign currency
forward exchange contracts, which are primarily related to the Euro, Japanese
Yen and Swiss Franc, and foreign currency principal and interest rate swaps
which mature during 2004 through 2007, were estimated based on quoted market
prices of comparable contracts, adjusted through interpolation where necessary
for maturity differences.
F-19
<PAGE>
RETIREMENT BENEFIT PLANS
- ------------------------
Eaton has defined benefit pension plans and other postretirement benefit plans.
Components of plan obligations and assets, and Eaton's recorded assets
(liabilities), follow:
<TABLE>
<CAPTION>
Other
postretirement
Pension benefits benefits
------------------ --------------
2003 2002 2003 2002
---- ---- ---- ----
<S> <C> <C> <C> <C>
Changes in projected
benefit obligation
- --------------------
Benefit obligation
at beginning of year $(1,996) $(1,856) $(878) $(894)
Service cost (93) (76) (15) (15)
Interest cost (129) (126) (56) (60)
Actuarial loss (119) (118) (73) (3)
Benefits paid 189 205 97 91
Effect of foreign
currency translation (76) (43)
Effect of business acquisitions (66) (2)
Other (14) 18 (10) 3
------- ------- ----- -----
Benefit obligation at end of year (2,304) (1,996) (937) (878)
------- ------- ----- -----
Change in plan assets
- ---------------------
Fair value of plan assets
at beginning of year 1,480 1,836
Actual return on plan assets 234 (196)
Employer contributions 45 30 97 92
Benefits paid (189) (205) (97) (91)
Effect of foreign
currency translation 47 25
Effect of business acquisitions 48
Other 5 (10) (1)
------ ------ ----- -----
Fair value of plan assets at
end of year 1,670 1,480 0 0
------ ------ ----- -----
Benefit obligation in excess
of plan assets (634) (516) (937) (878)
Unrecognized net actuarial loss 894 846 250 186
Unrecognized prior service cost 21 12 13 3
Other 11 2 9 9
------ ------ ----- -----
Net amount recognized $ 292 $ 344 $(665) $(680)
====== ====== ===== =====
</TABLE>
F-20
<PAGE>
Amounts recognized in the balance sheet consist of:
<TABLE>
<CAPTION>
Other
postretirement
Pension benefits benefits
----------------- --------------
2003 2002 2003 2002
---- ---- ---- ----
<S> <C> <C> <C> <C>
Prepaid asset $ 28 $ 23
Accrued liability (402) (310) $(665) $(680)
Intangible asset 22 14
Accumulated other
comprehensive income (loss) 644 617
------ ------ ----- -----
Net amount recognized $ 292 $ 344 $(665) $(680)
====== ====== ===== =====
</TABLE>
Statement of Financial Accounting Standards No. 87 requires recognition of a
minimum liability for those pension plans with accumulated benefit obligations
in excess of the fair values of plan assets at the end of the year. Accordingly,
in fourth quarter 2002, Eaton recorded a non-cash charge of $586 ($386
after-tax) related to the additional minimum liability for certain underfunded
pension plans which reduced Accumulated other comprehensive income (loss) in
Shareholders' equity. A similar non-cash charge of $27 ($17 after-tax) was
recorded in fourth quarter 2003. Pension funding requirements are not currently
affected by the recording of these charges. These charges did not impact net
income and will be reversible should the fair value of the pension plans' assets
again exceed the accumulated benefit obligation. The total accumulated benefit
obligation for all pension plans at December 31, 2003 was $2,052 and at year-end
2002 was $1,777.
Pension plans with an accumulated benefit obligation in excess of plan assets at
December 31 follow:
<TABLE>
<CAPTION>
2003 2002
---- ----
<S> <C> <C>
Projected benefit obligation $2,242 $1,946
Accumulated benefit obligation 1,996 1,731
Fair value of plan assets 1,600 1,427
</TABLE>
The measurement date for United States pension plans and other postretirement
benefit plans, and the majority of non-United States pension plans, is November
30. Assumptions used to determine pension benefit obligations at year-end
follow:
<TABLE>
<CAPTION>
United States &
non-United States
United States plans
plans (weighted-average)
------------- -----------------
2003 2002 2003 2002
---- ---- ---- ----
<S> <C> <C> <C> <C>
Discount rate 6.25% 6.75% 6.11% 6.53%
Rate of compensation increase 3.50% 3.75% 3.60% 3.73%
</TABLE>
F-21
<PAGE>
United States pension plans represent 72% and 76% of the benefit obligation in
2003 and 2002, respectively.
The components of pension benefit income (cost) follow:
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Service cost $ (93) $ (76) $ (61)
Interest cost (129) (126) (124)
Expected return on plan assets 181 213 213
Other (7) (8) 6
----- ----- -----
(48) 3 34
Curtailment loss (1) (4) (3)
Settlement (loss) gain (34) (21) 21
----- ----- -----
$ (83) $ (22) $ 52
===== ===== =====
</TABLE>
Assumptions used to determine net periodic pension cost for the years ended
December 31 follow:
<TABLE>
<CAPTION>
United States &
non-United States
United States plans
plans (weighted-average)
--------------------- ---------------------
2003 2002 2001 2003 2002 2001
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Discount rate 6.75% 7.25% 7.75% 6.53% 6.56% 7.42%
Expected long-term
return on plan assets 8.75% 10.00% 10.00% 8.71% 9.85% 9.91%
Rate of compensation
increase 3.75% 4.00% 4.75% 3.73% 3.74% 4.65%
</TABLE>
The expected long-term rate of return on pension plan assets is determined
separately for each country and reflects long-term historical data with greater
weight given to recent years. Target asset categories are comprised of equity
securities, debt securities, and cash equivalents. A building block approach is
used to develop the expected return for each plan, taking into account the
target allocations. Under this approach separate analyses are performed to
determine (a) the expected long-term rate of inflation, (b) expected real rates
of return, and (c) the expected equity risk premium.
The weighted-average pension plan asset allocation at December 31, 2003 and
2002, by asset category are as follows:
<TABLE>
<CAPTION>
2003 2002
---- ----
<S> <C> <C>
Equity securities 81% 81%
Debt securities 18 18
Other 1 1
---- ----
100% 100%
==== ====
</TABLE>
F-22
<PAGE>
Investment policies and strategies are developed on a country specific basis.
The United States plan represents 74% of worldwide pension assets and its target
allocation is: 85% diversified equity, 12% United States Treasury
Inflation-Indexed Securities, and 3% cash equivalents. The United Kingdom plan
represents 19% of worldwide pension assets and its target allocation is: 70%
diversified equity securities and 30% United Kingdom Government Bonds.
Eaton expects to contribute $101 to pension plans in 2004 primarily consisting
of a voluntary contribution of $75 in the United States, which was made in
January, and an $18 voluntary contribution in the United Kingdom.
The components of other postretirement benefits cost follow:
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Service cost $(15) $(15) $(14)
Interest cost (56) (60) (62)
Other (9) (4) 3
---- ---- ----
(80) (79) (73)
Settlement loss (2)
---- ---- ----
$(80) $(81) $(73)
==== ==== ====
</TABLE>
Assumptions used to determine other postretirement benefit obligations and costs
follow:
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Discount rate used to determine
benefit obligation at year-end 6.25% 6.75% 7.25%
Assumptions used to determine expense
- -------------------------------------
Discount rate 6.75% 7.25% 7.75%
Health care cost trend rate
assumed for next year 9.00% 10.00% 8.00%
Ultimate health care cost trend rate 5.00% 5.00% 5.00%
Year ultimate health care cost trend
rate is achieved 2007 2007 2007
</TABLE>
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. A one-percentage point change in the assumed
health care cost trend rates would have the following effects:
<TABLE>
<CAPTION>
1% Increase 1% Decrease
----------- -----------
<S> <C> <C>
Effect on total of service
and interest cost $ 2 $ (2)
Effect on other postretirement
benefit obligation 27 (24)
</TABLE>
F-23
<PAGE>
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the
Act) was passed on December 8, 2003 subsequent to the November 30 measurement of
the Company's other postretirement benefits plan. The Act provides for
prescription drug benefits under Medicare Part D and contains a subsidy to plan
sponsors who provide actuarially equivalent prescription plans. The effects of
the Act are not reflected in the obligations or net periodic other
postretirement benefit costs presented in Eaton's financial statements for the
year ended December 31, 2003.
Financial Accounting Standards Board Staff Position FAS 106-1 requires Eaton to
make a one-time election to either defer or recognize the accounting effects of
the Act before the end of the first quarter of 2004. If recognized, the Act
would reduce the accumulated projected benefit obligation by an estimated $40 to
$50 and reduce ongoing net periodic other postretirement costs by an estimated
$5 annually. These reductions in the accumulated projected benefit obligation
and ongoing net periodic other postretirement costs would not require a
modification or amendment of the Company's benefit plans. However, if certain
plans were amended, the Act could further reduce the accumulated projected
benefit obligation and ongoing net periodic other postretirement costs.
The Company also has various defined-contribution benefit plans, primarily
consisting of the Eaton Savings Plan in the United States. Total contributions
related to these plans charged to expense were $36 in 2003, $34 in 2002, and $43
in 2001.
PROTECTION OF THE ENVIRONMENT
- -----------------------------
Eaton has established policies to ensure that its operations are conducted in
keeping with good corporate citizenship and with a positive commitment to the
protection of the natural and workplace environments. For example, each
manufacturing facility has a person responsible for environmental, health and
safety (EHS) matters. All of the Company's manufacturing facilities are required
to be certified to ISO 14001, an international standard for environmental
management systems. The Company routinely reviews EHS performance at each of its
facilities and continuously strives to improve pollution prevention at its
facilities.
As a result of past operations, Eaton is involved in remedial response and
voluntary environmental remediation at a number of sites, including certain of
its currently-owned or formerly-owned plants. The Company has also been named a
potentially responsible party (PRP) under the Federal Superfund law at a number
of waste disposal sites.
A number of factors affect the cost of environmental remediation, including the
number of parties involved at a particular site, the determination of the extent
of contamination, the length of time the remediation may require, the complexity
of environmental regulations, and the continuing advancement of remediation
technology. Taking these factors into account, Eaton has estimated (without
discounting) the costs of remediation, which will be incurred over a period of
several years. The Company accrues an amount consistent with the estimates of
these costs when it is probable that a liability has been incurred. At December
31, 2003 and 2002, the balance sheet included a liability for these costs of $65
and $64, respectively. With regard to some of the matters included in the
liability, the Company has rights of recovery from non-affiliated parties for a
portion of these estimated costs.
F-24
<PAGE>
Based upon Eaton's analysis and subject to the difficulty in estimating these
future costs, the Company expects that any sum it may be required to pay in
connection with environmental matters is not reasonably likely to exceed the
liability by an amount that would have a material adverse effect on its
financial position, results of operations or cash flows. All of these estimates
are forward-looking statements and, given the inherent uncertainties in
evaluating environmental exposures, actual results can differ from these
estimates.
CONTINGENCIES
- -------------
Eaton is subject to a broad range of claims, administrative proceedings,
and legal proceedings, such as lawsuits that relate to contractual
allegations, patent infringement, personal injuries (including asbes-
tos claims) and employment-related matters. Although it is not pos-
sible to predict with certainty the outcome or cost of these matters,
the Company believes that these matters will not have a material ad-
verse effect on its financial position, results of operations or cash flows.
SHAREHOLDERS' EQUITY
- --------------------
On January 21, 2004, the Board of Directors of Eaton announced a two-for-one
split of the Company's Common Shares effective in the form of a 100% stock
dividend. The date of record for the stock split was February 9, 2004, and it
was distributed on February 23, 2004. Accordingly, Common Shares outstanding and
stock option information have been adjusted retroactively to reflect the stock
split.
There are 300 million Common Shares authorized ($.50 par value per share), 153.0
million of which are issued and outstanding at year-end 2003. At December 31,
2003, there were 10,107 holders of record of Common Shares. Additionally, 22,347
current and former employees were shareholders through participation in the
Eaton Savings Plan (ESP) and Eaton Personal Investment Plan (EPIP).
In June 2003, Eaton sold 3.7 million Common Shares (7.4 million shares adjusted
for the February 2004 stock split) for net proceeds of $296, which were used to
pay down commercial paper and for general corporate purposes.
Eaton has plans that permit certain employees and directors to defer a portion
of their compensation. The Company has deposited $40 of Common Shares and
marketable securities into a trust to fund a portion of these liabilities. The
marketable securities are included in Other assets and the Common Shares are
included in Shareholders' equity at historical cost.
Stock Options
- -------------
Stock options have been granted to certain employees and directors, under
various plans, to purchase Common Shares at prices equal to fair market value as
of the date of grant. Historically, the majority of these options vest ratably
during the three-year period following the date of grant and expire 10 years
from the date of grant.
F-25
<PAGE>
During 1997 and 1998, Eaton granted special performance-vested stock options
with a 10-year vesting term in lieu of more standard employee stock options.
These options have a provision for accelerated vesting if and when the Company
achieves certain net income and Common Share price targets. If the targets are
not achieved, these options become exercisable 10 days before the expiration of
their 10-year term. As of December 31, 2003, 3.8 million special
performance-vested stock options were outstanding of which 1.4 million were
exercisable.
A summary of stock option activity, which has been restated to give effect to
the February 2004 stock split, follows (shares in millions):
<TABLE>
<CAPTION>
2003 2002 2001
--------------- --------------- ----------------
Average Average Average
price price price
per per per
option Options option Options option Options
------ ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Outstanding January 1 $31.70 19.2 $29.98 19.8 $28.65 20.4
Granted 35.46 2.6 40.42 2.2 36.34 2.2
Exercised 27.43 (4.2) 23.34 (2.0) 21.00 (1.8)
Canceled 35.28 (.4) 35.28 (.8) 33.52 (1.0)
---- ---- ----
Outstanding December 31 $33.22 17.2 $31.70 19.2 $29.98 19.8
==== ==== ====
Exercisable December 31 $31.50 10.5 $29.44 12.6 $27.97 12.2
Reserved for future
grants December 31 4.0 6.2 2.8
</TABLE>
The following table summarizes information about stock options outstanding and
exercisable at December 31, 2003 (shares in millions):
<TABLE>
<CAPTION>
Weighted- Weighted-
Weighted- average average
average exercise exercise
Options remaining price per Options price per
Range of exercise out- contractual outstanding exerci- exercisable
prices per option standing life (years) option sable option
- ----------------- -------- ----------- ----------- ------- -----------
<C> <C> <C> <C> <C> <C>
$20.90 - $24.91 1.6 1.5 $22.46 1.6 $22.46
$25.90 - $29.80 .1 6.2 29.10 .1 29.09
$30.74 - $34.72 9.6 5.5 31.70 6.0 30.85
$35.18 - $39.68 3.6 6.0 37.28 2.0 36.95
$40.06 - $44.81 2.3 7.9 41.03 .8 41.49
---- ----
17.2 10.5
==== ====
</TABLE>
F-26
<PAGE>
Eaton has adopted the disclosure-only provisions of Statement of Financial
Accounting Standard (SFAS) No. 123, "Accounting for Stock-Based Compensation".
If the Company accounted for its stock options under the fair-value-based method
of SFAS No. 123, net income and net income per Common Share would have been as
follows:
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Net income
- ----------
As reported $ 386 $ 281 $ 169
Stock-based compensation
expense, net of income taxes (11) (14) (16)
----- ----- -----
Assuming fair value method $ 375 $ 267 $ 153
===== ===== =====
Net income per Common Share
assuming dilution
- ---------------------------
As reported $2.56 $1.96 $1.20
Stock-based compensation
expense, net of income taxes (.08) (.10) (.11)
----- ----- -----
Assuming fair value method $2.48 $1.86 $1.09
===== ===== =====
Net income per Common Share basic
- ---------------------------------
As reported $2.61 $1.99 $1.22
Stock-based compensation
expense, net of income taxes (.08) (.10) (.11)
----- ----- -----
Assuming fair value method $2.53 $1.89 $1.11
===== ===== =====
</TABLE>
The fair value of each option grant was estimated using the Black-Scholes option
pricing model with the following assumptions:
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Dividend yield 2.5% 2.5% 2.5%
Expected volatility 28% 29% 26%
Risk-free interest rate 2.2% to 3.5% 2.6% to 4.3% 3.7% to 5%
Expected option life in years 5 4 4
Weighted-average per
share fair value of options
granted during the year $7.84 $9.17 $7.86
</TABLE>
Preferred Share Purchase Rights
- -------------------------------
In 1995, Eaton declared a dividend of one Preferred Share Purchase Right for
each outstanding Common Share. The Rights become exercisable only if a person
F-27
<PAGE>
or group acquires, or offers to acquire, 20% or more of the Company's Common
Shares. The Company is authorized to reduce that threshold for triggering the
Rights to not less than 10%. The Rights expire on July 12, 2005, unless redeemed
earlier at $.005 per Right.
When the Rights become exercisable, the holder of each Right, other than the
acquiring person, is entitled 1) to purchase for $125, one two-hundredth of a
Series C Preferred Share, 2) to purchase for $125, that number of Eaton's Common
Shares or common stock of the acquiring person having a market value of twice
that price, or 3) at the option of the Company, to exchange each Right for one
Common Share or one two-hundredth of a Preferred Share.
Comprehensive Income (Loss)
- --------------------------
The components of Accumulated other comprehensive income (loss) as reported in
the Statement of Consolidated Shareholders' Equity follow:
<TABLE>
<CAPTION>
Unrealized Deferred Minimum
Foreign gain (loss) gain pension
currency on available (loss)on liability
translation for sale cash flow adjust-
adjustments investments hedges ment Total
----------- ------------ --------- --------- -----
<S> <C> <C> <C> <C> <C>
Balance at
January 1, 2001 $(263) $(4) $(267)
2001 activity,
net of income taxes (20) 5 $(5) $(21) (41)
Recognition in income
of adjustment related
to divested businesses 9 9
----- --- --- ---- ----
Balance at
December 31, 2001 (274) 1 (5) (21) (299)
2002 activity,
net of income taxes (15) 1 (386) (400)
----- --- --- ---- ----
Balance at
December 31, 2002 (289) 1 (4) (407) (699)
2003 activity,
net of income taxes 126 1 4 (17) 114
----- --- --- ----- ----
Balance at
December 31, 2003 $(163) $ 2 $ 0 $(424) $(585)
===== === === ===== ====
</TABLE>
A discussion of the minimum pension liability adjustments recorded in 2003 and
2002 is included in "Retirement Benefit Plans" above.
F-28
<PAGE>
INCOME TAXES
- ------------
For financial statement reporting purposes, income before income taxes, based on
the geographic location of the operation to which such earnings are
attributable, is summarized below. Certain foreign operations are branches of
Eaton and are, therefore, subject to United States as well as foreign income tax
regulations. As a result, pretax income by location and the components of income
tax expense by taxing jurisdiction are not directly related. For purposes of
this note to the consolidated financial statements, non-United States operations
include Puerto Rico.
<TABLE>
<CAPTION>
Income
before income taxes
-------------------
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
United States $ 78 $ 56 $ 60
Non-United States 430 343 227
Write-off of foreign currency translation
adjustments related to divested businesses (9)
---- ---- ----
$508 $399 $278
==== ==== ====
</TABLE>
<TABLE>
<CAPTION>
Income tax expense
------------------
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Current
- -------
United States
Federal $ 97 $123 $ (8)
State & local 17 6 (5)
Non-United States 70 42 65
---- ---- ----
184 171 52
---- ---- ----
Deferred
- --------
United States Federal (67) (71) 64
Non-United States 5 18 (7)
---- ---- ----
(62) (53) 57
---- ---- ----
$122 $118 $109
==== ==== ====
</TABLE>
F-29
<PAGE>
Reconciliations of income taxes from the United States Federal statutory rate to
the effective income tax rate follow:
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Income taxes at the United States
statutory rate 35.0% 35.0% 35.0%
United States state & local income taxes 3.2 1.4 (1.7)
Other United States-net (1.4) 1.4 (9.3)
Non-United States operations (earnings
taxed at other than United States tax
rate) (12.8) (8.3) 4.2
Amortization of goodwill 4.8
Sales of businesses 6.4
---- ---- ----
24.0% 29.5% 39.4%
==== ==== ====
</TABLE>
Eaton has manufacturing operations in Puerto Rico, which operate under certain
United States tax law incentives related to the repatriation of earnings that,
at this point, are not expected to be available after 2005. Income tax credits
claimed under these incentives were $32 in 2003, $33 in 2002 and $41 in 2001.
Management believes the elimination of these repatriation laws will not have an
adverse impact on the Company's effective income tax rate.
Significant components of current and long-term deferred income taxes follow:
<TABLE>
<CAPTION>
2003 2002
---------------------------- ----------------
Long- Long- Long-
Current term term Current term
assets assets liabilities assets assets
------- ------ ----------- ------- ------
<S> <C> <C> <C> <C> <C>
Accruals & other adjustments
Employee benefits $ 63 $388 $ (6) $ 53 $ 346
Depreciation & amortization (4) (402) (10) (405)
Other 130 58 1 117 36
Other items 3 3 (4) 11 8
United States income
tax credit carryforwards 77 46
United States foreign tax
credit carryforwards 32 33
Tax loss carryforwards 51 54
Valuation allowance (74) (78)
---- ---- ---- ----- -----
$192 $133 $(19) $ 181 $ 40
==== ==== ==== ===== =====
</TABLE>
At the end of 2003, United States income tax credit carryforwards of $77 are
available to reduce future Federal income tax liabilities, including $38 which
expire at the end of 20 years and $39 of which are not subject to expiration.
Foreign tax credit carryforwards of $32 are also available to reduce United
States Federal income tax liabilities during the next five years. A full
F-30
<PAGE>
valuation allowance has been recorded for the foreign tax credit carryforwards.
At December 31, 2003, certain non-United States subsidiaries had tax loss
carryforwards aggregating $153 that are available to offset future taxable
income. Carryforwards of $111 expire at various dates from 2004 through 2013 and
the balance have no expiration date. A valuation allowance of $42 has been
recorded for the tax effect of these tax loss carryforwards.
No provision has been made for income taxes on undistributed earnings of
consolidated non-United States subsidiaries of $1,071 at December 31, 2003,
since the earnings retained have been reinvested by the subsidiaries. It is not
practicable to estimate the additional income taxes and applicable foreign
withholding taxes that would be payable on the remittance of such undistributed
earnings.
Worldwide income tax cash flows were payments of $137 in 2003 and $61 in 2002,
and a refund of $11 in 2001.
OTHER INFORMATION
- -----------------
Accounts Receivable
- -------------------
Accounts receivable are net of an allowance for doubtful accounts of $23 at the
end of 2003 and $26 at the end of 2002.
Inventories
- -----------
The components of inventories follow:
<TABLE>
<CAPTION>
2003 2002
---- ----
<S> <C> <C>
Raw materials $ 301 $ 283
Work-in-process 173 160
Finished goods 279 289
----- -----
Inventories at FIFO 753 732
Excess of FIFO over LIFO cost (32) (34)
----- -----
$ 721 $ 698
===== =====
</TABLE>
Gross inventories accounted for using the LIFO method were $432 at the end of
2003 and $478 at the end of 2002.
F-31
<PAGE>
Warranty Liabilities
- --------------------
A summary of the current and long-term liabilities for warranties follows:
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Balance at the beginning of the year $ 127 $ 128 $ 157
Current year accruals 81 129 92
Claims paid/satisfied (82) (119) (108)
Other (1) (11) (13)
----- ----- ----
Balance at the end of the year $ 125 $ 127 $ 128
===== ===== =====
</TABLE>
Lease Commitments
- -----------------
Eaton leases certain real properties and equipment. Minimum rental commitments
for 2004 under noncancelable operating leases, which expire at various dates and
in most cases contain renewal options, are $89 and decline substantially
thereafter.
Rental expense was $115 in 2003, $102 in 2002, and $113 in 2001.
Net Income per Common Share
- ---------------------------
A summary of the calculation of net income per Common Share assuming dilution
and basic follows (shares in millions):
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Net income $ 386 $ 281 $ 169
===== ===== =====
Average number of Common Shares
outstanding assuming dilution 150.5 143.4 141.0
Less dilutive effect of stock options 2.6 2.2 2.2
----- ----- -----
Average number of Common Shares
outstanding basic 147.9 141.2 138.8
===== ===== =====
Net income per Common Share
assuming dilution $2.56 $1.96 $1.20
Net income per Common Share
basic $2.61 $1.99 $1.22
</TABLE>
Employee and director stock options to purchase Common Shares of 6.0 million in
2002 and 4.4 million in 2001 were outstanding but were not included in the
computation of net income per Common Share assuming dilution, since they would
have had an antidilutive effect on earnings per share.
F-32
<PAGE>
BUSINESS SEGMENT & GEOGRAPHIC REGION INFORMATION
- ------------------------------------------------
Eaton is a global diversified industrial manufacturer with 2003 sales of $8.1
billion. The Company is a leader in the design and manufacture of fluid power
systems; electrical power quality, distribution and control; automotive engine
air management and powertrain controls for fuel economy; and intelligent
drivetrain systems for fuel economy and safety in trucks. The Company had 51,000
employees at the end of 2003 and sells products to customers in more than 100
countries. Major products included in each business segment and other
information follows.
Fluid Power
- -----------
All pressure ranges of hose, fittings, adapters, couplings and other fluid power
connectors; hydraulic pumps, motors, valves, cylinders, power steering units,
transaxles and transmissions; electronic and hydraulic controls; electric motors
and drives; filtration products and fluid-evaluation products and services;
aerospace products and systems -- hydraulic and electrohydraulic pumps, motors,
electric motor pumps, hydraulic motor driven generators and integrated system
packages, hydraulic and electromechanical actuators, flap and slat systems, nose
wheel steering systems, cockpit controls, power and load management systems,
sensors, fluid debris monitoring products, illuminated displays, integrated
displays and panels, relays and valves; clutches and brakes for industrial
machines; golf grips and precision molded and extruded plastic products
Electrical
- ----------
Low and medium voltage power distribution and control products that meet
ANSI/NEMA and IEC standards; a wide range of circuit breakers, and a variety of
assemblies and components used in managing distribution of electricity to
industrial, utility, light commercial, residential and OEM markets; engineering
services and systems to support customer power and control systems; drives,
contactors, starters, power factor and harmonic correction; a wide range of
sensors used for position sensing; a full range of operator interface hardware
and software for interfacing with machines, and other motor control products
used in the control and protection of electrical power distribution systems
Automotive
- ----------
Valvetrain systems, intake and exhaust valves, lash compensation lifters and
lash adjusters, roller rocker arms, cylinder heads, superchargers, limited slip
and locking differentials, transmission dampers, precision gear forgings, air
control valves, engine sensors and controls, mirror actuators, transmission
controls, on-board vapor recovery systems, fuel level senders and pressure
control valves
Truck
- -----
Heavy-, medium-, and light-duty mechanical transmissions; heavy- and medium-duty
automated transmissions; heavy- and medium-duty clutches; and a variety of other
products including gears and shafts, traction control systems, transfer boxes,
power take-off units, splitter boxes, gearshift mechanisms, transmissions for
off-highway construction equipment, and collision warning systems
F-33
<PAGE>
Other Information
- -----------------
The principal markets for Fluid Power, Automotive and Truck are original
equipment manufacturers and after-market customers of aerospace products and
systems, off-highway agricultural and construction vehicles, industrial
equipment, passenger cars and heavy-, medium-, and light-duty trucks. These
manufacturers are located globally and most sales of these products are made
directly to such manufacturers.
The principal markets for Electrical are industrial, construction, commercial,
automotive and government customers. These customers are generally concentrated
in North America, Europe and Asia/Pacific; however, sales are made globally.
Sales are made directly by Eaton and indirectly through distributors and
manufacturers' representatives to such customers.
No single customer represented more than 10% of net sales in 2003, 2002 or 2001.
Sales from ongoing United States and Canadian operations to customers in foreign
countries were $437 in 2003, $503 in 2002 and $520 in 2001 (5% of sales in 2003
and 7% in 2002 and 2001).
The accounting policies of the segments are generally the same as the policies
described under "Accounting Policies" above, except that inventories and related
cost of products sold of the segments are accounted for using the FIFO method
and operating profit only reflects the service cost component related to
pensions and other postretirement benefits. Intersegment sales and transfers are
accounted for at the same prices as if the sales and transfers were made to
third parties.
Identifiable assets exclude general corporate assets, which principally consist
of cash, short-term investments, deferred income taxes, certain accounts
receivable, certain property, plant and equipment, and certain other assets.
F-34
<PAGE>
Geographic Region Information
- -----------------------------
<TABLE>
<CAPTION>
Net Operating Long-lived
sales profit assets
----- --------- ----------
<S> <C> <C> <C>
2003
- ----
United States $5,758 $ 546 $1,264
Canada 209 28 16
Europe 1,581 94 491
Latin America 516 65 205
Asia/Pacific Region 504 64 100
Eliminations (507)
------ ------ ------
$8,061 $ 797 $2,076
====== ====== ======
2002
- ----
United States $5,605 $ 483 $1,338
Canada 185 15 13
Europe 1,110 65 351
Latin America 403 45 160
Asia/Pacific Region 358 43 93
Eliminations (452)
------ ------ ------
$7,209 $ 651 $1,955
====== ====== ======
2001
- ----
United States $5,677 $ 414 $1,419
Canada 177 11 15
Europe 1,108 (5) 322
Latin America 406 37 203
Asia/Pacific Region 310 19 91
Eliminations (464)
------ ------ ------
$7,214 $ 476 $2,050
====== ====== ======
</TABLE>
Net sales and operating profit are attributed to geographical regions based upon
the location of the selling unit.
Long-lived assets consist of property, plant and equipment-net.
Operating profit was reduced by restructuring and other charges as follows:
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
United States $ 22 $ 49 $ 67
Europe 11 10 37
Latin America 2
Asia/Pacific Region 3 1
---- ---- ----
$ 36 $ 59 $107
==== ==== ====
</TABLE>
F-35
<PAGE>
Business Segment Information
- ----------------------------
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Net sales
- ---------
Fluid Power $2,786 $2,456 $2,507
Electrical 2,313 1,993 2,199
Automotive 1,690 1,594 1,479
Truck 1,272 1,166 1,029
------ ------ ------
8,061 7,209 7,214
Divested operations 85
------ ------ ------
$8,061 $7,209 $7,299
====== ====== ======
Operating profit (loss)
- -----------------------
Fluid Power $ 247 $ 187 $ 183
Electrical 158 149 163
Automotive 224 225 194
Truck 168 90 (64)
------ ------ ------
797 651 476
Corporate
- ---------
Divested operations 6
Amortization of goodwill (60)
Amortization of
intangible assets (21) (23) (34)
Interest expense-net (87) (104) (142)
Gains on sales of businesses 18 61
Corporate expense-net (181) (143) (29)
------ ------ ------
Income before income taxes 508 399 278
Income taxes 122 118 109
------ ------ ------
Net income $ 386 $ 281 $ 169
====== ====== ======
</TABLE>
Income before income taxes was reduced by restructuring and other charges as
follows:
<TABLE>
<S> <C> <C> <C>
Fluid Power $ 14 $ 26 $ 22
Electrical 22 16 30
Automotive 1
Truck 16 55
Corporate 1 3 12
Other charges 10 10
------ ------ ------
$ 37 $ 72 $ 129
====== ====== ======
</TABLE>
F-36
<PAGE>
<TABLE>
<CAPTION>
2003 2002 2001
---- ---- ----
<S> <C> <C> <C>
Identifiable assets
- -------------------
Fluid Power $1,422 $1,439 $1,345
Electrical 1,072 847 1,016
Automotive 872 819 781
Truck 690 605 651
------ ------ ------
4,056 3,710 3,793
Goodwill 2,095 1,910 1,902
Other intangible assets 541 510 533
Corporate 1,531 1,008 1,418
------ ------ ------
Total assets $8,223 $7,138 $7,646
====== ====== ======
Expenditures for
property, plant & equipment
- ---------------------------
Fluid Power $ 60 $ 53 $ 61
Electrical 37 34 54
Automotive 86 75 96
Truck 71 56 64
------ ------ ------
254 218 275
Corporate 19 10 17
Divested operations 3
------ ------ ------
$ 273 $ 228 $ 295
====== ====== ======
Depreciation of
property, plant & equipment
- ---------------------------
Fluid Power $ 92 $ 91 $ 96
Electrical 80 70 72
Automotive 77 69 66
Truck 54 54 56
------ ------ ------
303 284 290
Corporate 19 22 23
------ ------ ------
$ 322 $ 306 $ 313
====== ====== ======
</TABLE>
F-37
<PAGE>
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
- ------------------------------------------------------------------------
Dollars in millions, except for per share data (per share data assume dilution)
TWO-FOR-ONE STOCK SPLIT
- -----------------------
On January 21, 2004, the Board of Directors of Eaton announced a two-for-one
split of the Company's Common Shares effective in the form of a 100% stock
dividend. The record date for the stock split was February 9, 2004, and it was
distributed on February 23, 2004. Accordingly, all per share amounts, average
shares outstanding, shares outstanding and stock option information have been
adjusted retroactively to reflect the stock split.
OVERVIEW OF THE COMPANY
- -----------------------
Eaton is a global leader in the design and manufacture of fluid power systems;
electrical power quality, distribution and control; automotive engine air
management and powertrain controls for fuel economy; and intelligent drivetrain
systems for fuel economy and safety in trucks. The principal markets for the
Fluid Power, Automotive and Truck segments are original equipment manufacturers
and after-market customers of aerospace products and systems, off-highway
agricultural and construction vehicles, industrial equipment, passenger cars and
heavy-, medium-, and light-duty trucks. The principal markets for the Electrical
segment are industrial, construction, commercial, automotive and government
customers. The Company had 51,000 employees at the end of 2003 and sells
products to customers in more than 100 countries.
HIGHLIGHTS OF RESULTS FOR 2003
- ------------------------------
While global economic conditions continued to represent a challenge in 2003,
presenting a difficult operating environment, Eaton posted significantly
improved results, with each business segment reporting solid performance during
the year. During 2003, Eaton continued to make significant progress towards key
corporate goals of 1) outgrowing end markets, 2) resizing the Company to compete
effectively and profitably in a depressed marketplace and 3) improving the
strength of the balance sheet.
<TABLE>
<CAPTION>
2003 2002 Increase
---- ---- --------
<S> <C> <C> <C>
Net sales $8,061 $7,209 12%
Net income 386 281 37%
Net income per Common
Share assuming dilution $ 2.56 $ 1.96 31%
</TABLE>
The growth in sales was a reflection of a number of Eaton's businesses
outperforming their end markets, which are estimated to have declined 2% in
2003. The growth also reflected increased sales resulting from acquisitions of
businesses and new joint ventures, which added approximately $500 of sales in
2003, and also from higher foreign exchange rates. The increase in net income
was primarily due to higher sales in 2003 and the benefits of restructuring
F-38
<PAGE>
actions taken in 2003 and prior years. Business segment operating profit of
$797 in 2003 was 9.9% of sales, compared to 9.0% in 2002.
As a result of actions taken in 2003 and earlier years to restructure operations
and integrate acquired businesses, Eaton incurred restructuring charges in 2003
of $.16 per Common Share, compared to similar charges in 2002 of $.33 per share.
The Company's results in 2003 were aided by the results of these actions, which
delivered an additional $26 of savings in 2003 that were over and above $130 of
savings delivered in 2002. Additionally, $15 in synergies were achieved through
integration of acquired businesses. These savings, coupled with higher sales in
2003, lower net interest expense and a reduction in the effective income tax
rate, helped the Company to post significantly higher net income. These
increases in net income were partially offset by additional pension expense and
other postretirement benefit expense in 2003, which reduced net income by $.28
per share compared to 2002. The Company reported no gains on the sales of
businesses in 2003 compared to a gain of $.09 per share in 2002. The sale of 3.7
million Common Shares in June 2003 (7.4 million shares adjusted for the February
2004 stock split), reduced net income per share by approximately $.06 in 2003.
Throughout 2003, Eaton maintained a strong focus on strengthening the balance
sheet. Shareholders' equity at the end of 2003 exceeded $3 billion for the first
time in Eaton's history. Cash and short-term investments rose to $865 during
2003, an increase of $437 from the end of 2002. Cash generated from operating
activities continued to be strong, with $874 generated in 2003 compared to $900
in 2002. Operating cash flow less capital expenditures (free cash flow) was $601
in 2003 compared to $672 in 2002. Total debt paid down was $190 in 2003,
partially offset by an increase of $55 in the value of debt denominated in
currencies other than the U.S. Dollar due to movement of foreign exchange rates
in 2003. In June 2003, Eaton sold 3.7 million Common Shares (7.4 million shares
adjusted for the February 2004 stock split) for net proceeds of $296, which were
used to pay down commercial paper and for general corporate purposes. The
reduction in debt during 2003, coupled with the higher amount of cash and
short-term investments at the end of 2003 and higher Shareholders' equity,
resulted in a significant reduction in the net-debt-to-total-capital ratio to
25.9% at the end of 2003 from 41.9% at year-end 2002. This ratio would have
dropped to 23.5% but for the recognition of a minimum pension liability at the
end of 2003 and the prior two year-ends, which in total reduced Shareholders'
equity by $424 at the end of 2003.
In light of strong results for 2003 and growing momentum in many of its markets,
Eaton took the following actions on January 21, 2004:
- - The Company's Common Shares were split two-for-one effective February 23, 2004
- - The quarterly dividend on the Common Shares was increased by 12.5%, from $.24
per share to $.27 per share (after adjustment for the stock split)
- - Cash of $75 was contributed to the Company's qualified pension
plans in the United States
- - A plan was initiated to repurchase 4.2 million Common Shares to offset the
shares issued during 2003 from the exercise of stock options. In addition, the
Company now intends, depending upon circumstances, to purchase additional shares
to help offset dilution resulting from shares issued as a result of stock
options exercised over the course of 2004.
F-39
<PAGE>
RESULTS OF OPERATIONS - 2003 COMPARED TO 2002
- ---------------------------------------------
Sales for 2003 rose to $8,061, 12% higher than $7,209 in 2002, and were the
highest sales since 2000. Sales growth of 12% in 2003 consisted of 6% from
recent business acquisitions and a new joint venture, net of the effect of the
sale of Navy Controls in July 2002, 3% from higher foreign exchange rates, and
3% from organic growth. Eaton continued to outperform its end markets, as the
Company estimates that its overall end markets declined 2% in 2003 compared to
2002.
Net Sales by Business Segment
- -----------------------------
<TABLE>
<CAPTION>
2003 2002 Increase
---- ---- --------
<S> <C> <C> <C>
Fluid Power $2,786 $2,456 13%
Electrical 2,313 1,993 16%
Automotive 1,690 1,594 6%
Truck 1,272 1,166 9%
------ ------
$8,061 $7,209 12%
====== ======
</TABLE>
The growth in sales of Fluid Power was due in part to the acquisition of the
Boston Weatherhead fluid power business in fourth quarter 2002. The increase in
Electrical sales was substantially the result of the acquisition of the
electrical business of Delta plc in January 2003 and a new joint venture with
Caterpillar Inc., offset by the effect of the sale of Navy Controls in July
2002. Sales of Automotive rose due to several new program launches and the
continued strong performance of the North American and European automobile
markets. The growth in Truck sales was the result of strong growth in sales of
medium-duty trucks, particularly in Latin America. The operating results of each
business segment are further discussed below.
Results by Geographic Region
- ----------------------------
<TABLE>
<CAPTION>
Net sales Operating profit
-------------------------- -----------------------
2003 2002 Increase 2003 2002 Increase
---- ---- -------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
United States $5,758 $5,605 3% $546 $483 13%
Canada 209 185 13% 28 15 87%
Europe 1,581 1,110 42% 94 65 45%
Latin America 516 403 28% 65 45 44%
Asia/Pacific region 504 358 41% 64 43 49%
Eliminations (507) (452)
------ ------ ---- ----
$8,061 $7,209 12% $797* $651* 22%
====== ====== ==== ====
</TABLE>
*A reconciliation of operating profit to net income is included in "Business
Segment Information" in the Notes to the Consolidated Financial Statements.
F-40
<PAGE>
Sales in the United States rose primarily due to the acquisition of the Boston
Weatherhead fluid power business in fourth quarter 2002, partially offset by the
sale of the Navy Controls business in second half 2002. Higher operating profit
in the United States primarily resulted from increased sales, the benefits of
restructuring actions taken in recent years, lower restructuring charges in
2003, and modest profits from the Boston Weatherhead fluid power business
acquired in late 2002. In Canada, the growth in sales and operating profit were
substantially related to foreign exchange rates and the strong performance of
Electrical. Sales in Europe rose primarily due to acquisition of the Delta
electrical business, the improved performance of Eaton's other business
segments, and foreign exchange rates. Higher operating profit in Europe
primarily resulted from increased sales and the benefits of restructuring
actions taken in recent years. The growth in sales and operating profit in Latin
America was primarily due to recent wins by Fluid Power of new
automotive-related production contracts and the strong performance of Truck.
Sales and operating profit rose in the Asia/Pacific region due to the
acquisition of the Delta electrical business and the strong performance of all
of the Company's business segments.
In 2003, Eaton incurred restructuring charges related to the integration of the
Boston Weatherhead fluid power business acquired in November 2002 and the
electrical business of Delta plc acquired in January 2003. These charges
included $14 in Fluid Power, $22 in Electrical and $1 in Corporate. In 2002, the
Company incurred restructuring charges to reduce operating costs across its
business segments and certain corporate functions. The charges in 2002 were
primarily a continuation of restructuring programs initiated in 2001. These
charges included $26 in Fluid Power, $16 in Electrical, $1 in Automotive, $16 in
Truck, and $3 in Corporate. On an after-tax basis, these restructuring charges
reduced net income for 2003 by $24 ($.16 per Common Share) and for 2002 by $41
($.29 per share). Restructuring charges in 2003 and 2002 reduced Operating
profit of the related business segment or were included in Corporate
expense-net, as appropriate. In the Statements of Consolidated Income, the
restructuring charges were included in Cost of products sold or Selling &
administrative expense, as appropriate.
Pretax income for 2003 was reduced by $66 ($43 after-tax, or $.28 per Common
Share) compared to 2002 due to increased pension and other postretirement
benefit expense in 2003 resulting from the decline over the last several years
in the market value of equity investments held by Eaton's pension plans, coupled
with the effect of the lowering of discount rates associated with pension and
other postretirement benefit liabilities at year-end 2002.
In July 2002, the Navy Controls business was sold resulting in a pretax gain of
$18 ($13 after-tax, or $.09 per Common Share). The gain was reported as a
separate line item in the Statements of Consolidated Income and Business Segment
Information.
The change of $37 in Other (income) expense-net for 2003 compared to 2002 was
primarily due to a gain of $3 in foreign exchange in 2003 versus a loss of $8 in
2002, a charge of $10 in 2002 for the contribution to the Eaton Charitable Fund,
and various other items including $11 of reduced legal expenses and favorable
legal settlements in 2003. The charge of $10 for the contribution to the Eaton
Charitable Fund ($6 after-tax, or $.04 per Common Share) was recorded in the
third quarter of 2002. In Business Segment Information, this charge was included
in Corporate expense-net.
F-41
<PAGE>
The effective income tax rate for 2003 was 24.0% compared to 29.5% for 2002. The
lower rate in 2003 reflects many factors, including higher operating earnings in
international tax jurisdictions with lower income tax rates and increased use of
international tax credit carryforwards. The change in the effective income tax
rates in 2003 compared to 2002 is further explained in "Income Taxes" in the
Notes to the Consolidated Financial Statements.
Fluid Power
- -----------
<TABLE>
<CAPTION>
2003 2002 Increase
---- ---- --------
<S> <C> <C> <C>
Net sales $2,786 $2,456 13%
Operating profit 247 187 32%
</TABLE>
Sales for Fluid Power, Eaton's largest business segment, were a new record.
Sales increased by 13% with 6% from business acquisitions, 4% from foreign
exchange rates and 3% from existing product lines. This compares to a decline of
2% in Fluid Power's markets, with North American fluid power industry shipments
down 3%, commercial aerospace markets off 12%, and defense aerospace markets up
by 13%. The traditional mobile and industrial hydraulics markets began to
recover in fourth quarter 2003, reflecting the pickup in capital goods
expenditures.
In 2003, Fluid Power's results were positively impacted by the full year results
of two businesses acquired late in 2002. The Boston Weatherhead fluid power
business was purchased in the fourth quarter of 2002. This business, which had
2002 sales of $211, manufactures hose, tubing, and fluid connectors for fluid
power systems primarily for the industrial distribution, mobile off-highway and
heavy-duty truck markets. In addition, the aerospace circuit breaker business of
Mechanical Products was purchased during that same quarter. This business had
annual sales of $12 in 2001.
Operating profit in 2003 was a new record and increased primarily due to higher
sales in 2003, the benefits of restructuring actions taken in recent years to
resize this business, and reduced restructuring charges in 2003. Restructuring
charges in 2003 were $14, and were related primarily to the acquisition of the
Boston Weatherhead business, compared to $26 in 2002. Operating profit of Fluid
Power in 2003 represented a return on sales of 8.9%, which was reduced by .5%
due to restructuring charges, compared to 7.6% in 2002, which was reduced by
1.1% due to restructuring charges.
In January 2004, Eaton announced the following actions related to Fluid Power:
- - The acquisition of Ultronics Limited and its advanced electro-hydraulic valve
system technology. The Cheltenham, United Kingdom-based company's sophisticated
electro-hydraulic control valves, systems and software technology are utilized
in mobile applications in construction, forestry, agriculture and other markets.
- - The agreement to form a joint venture with Changzhou Senstar Automobile Air
Conditioner Co. Ltd. in China to produce automotive air conditioning hose and
tube assemblies and power steering hose and tube assemblies in Shanghai for
Volkswagen's China operations. The joint venture will be called Eaton Senstar
Automotive Fluid Connector (Shanghai) Co., Ltd. Eaton will have 55% ownership
F-42
<PAGE>
of the joint venture. The joint venture is expected to be established early in
2004 following regulatory approval.
In December 2003, Eaton announced that its aerospace business has been selected
by Lockheed Martin to supply Aeroquip(R) brand fluid conveyance products on the
new F-35 Joint Strike Fighter supersonic multi-role aircraft. The award is for
the System Development and Demonstration (SDD) phase of the program, which
includes 14 aircraft over the next two years. Lockheed Martin has selected
Eaton's Aeroquip(R) brand Ultra-Mate couplings as one of the standard products
throughout the F-35 platform for primary fluid conveyance applications.
Additionally, in February 2003, the Aerospace business was selected by Goodrich
Corporation to provide the nose landing gear steering motor assembly on the F-35
platform. The potential value of the contract award is $75 over the life of the
program. Pre-production of the F-35 is scheduled to begin in 2006 with full
production beginning in 2012 for an estimated 2,600 aircraft for United States
and United Kingdom over a 35-year period. Eaton was named the Tier One fluid
power systems provider for the Joint Strike Fighter in November 2001 and in
August 2002 was awarded the wing fluid distribution package. Taken together, the
awards represent $1.7 billion in potential Eaton revenue over the life of the
program.
Electrical
- ----------
<TABLE>
<CAPTION>
2003 2002 Increase
---- ---- --------
<S> <C> <C> <C>
Net sales $2,313 $1,993 16%
Operating profit 158 149 6%
</TABLE>
In Electrical, sales growth in 2003 was primarily the result of business
acquisitions. Sales increased by 15% due to the acquisitions in January 2003 of
the electrical business of Delta plc and the power systems business of
Commonwealth Sprague Capacitor, as well as the new joint venture formed with
Caterpillar Inc. in August 2003, net of the effect of the sale of the Navy
Controls business in July 2002. Sales in 2003 were up 1% from organic growth.
End markets for the electrical business remained weak during 2003, with an
estimated 2% decline in the markets for this business compared to 2002.
In 2003, Electrical added three key businesses. On January 31st, the electrical
business of Delta plc was acquired. This business, which had sales of $326 in
2002, includes major electrical brands such as MEM(R), Holec(TM), Bill(TM), Home
Automation(TM), Elek(TM) and Tabula(TM). The Delta business represents a
significant addition to the capabilities and geographic footprint of Electrical.
Also, in January the power systems business of Commonwealth Sprague Capacitor,
which had annual sales of $6 in 2002, was acquired. In August a new joint
venture was formed with Caterpillar Inc. to provide switchgear products under
the Cat(R) brand name. The joint venture operates under the name Intelligent
Switchgear Organization LLC and is 51%-owned by Eaton.
Increased operating profit in 2003 was primarily due to the benefits of
restructuring actions taken in recent years to resize this business, partially
offset by increased restructuring charges in 2003. Restructuring charges
recorded in 2003 were $22, and were related to the acquisition of the Delta
electrical business, compared to $16 of charges in 2002. The profitability of
the base electrical business improved significantly, as operating margins for
F-43
<PAGE>
this business in the second half of 2003 were 7.6%, after reflecting a 1.3%
reduction due to the acquisition of the Delta electrical business and the new
joint venture with Caterpillar Inc. and 1.2% due to restructuring charges. The
integration of the Delta electrical business continues on track and the business
posted modest operating profit in fourth quarter 2003. Operating profit of
Electrical in 2003 represented a return on sales of 6.8%, which was reduced by
1.0% due to restructuring charges, compared to 7.5% in 2002, which was reduced
by .8% due to restructuring charges.
In January 2004, Eaton announced that its contract to provide project management
services and electrical distribution equipment for Heathrow Airport's Terminal 5
(T5) Expansion Project is worth an estimated $14 (GBP 8 million). The T5
expansion is one of the largest construction projects in Europe. Construction is
scheduled for completion in March 2008.
Automotive
- ----------
<TABLE>
<CAPTION>
2003 2002 Increase
---- ---- --------
<S> <C> <C> <C>
Net sales $1,690 $1,594 6%
Operating profit 224 225 -
</TABLE>
Sales in Automotive were a new record and considerably outpaced its end markets.
The increase in sales reflected several new program launches, the continued
strong performance of the North American and European automobile markets and
higher foreign exchange rates. NAFTA light vehicle production declined 3% to
15.9 million units in 2003 and European production declined 1% to 16.3 million
units, compared to 2002.
Operating profit of Automotive in 2003 represented a return on sales of 13.3%
compared to 14.1% in 2002. The return on sales in 2003 was lower than 2002
primarily due to increased costs related to new product launches and several
facility relocations.
Truck
- -----
<TABLE>
<CAPTION>
2003 2002 Increase
---- ---- --------
<S> <C> <C> <C>
Net sales $1,272 $1,166 9%
Operating profit 168 90 87%
</TABLE>
Sales growth of Truck was primarily due to higher sales in Latin America,
Asia/Pacific and in the aftermarket in North America. NAFTA heavy-duty
production was down 2% in 2003 to 177,000 units compared to 2002, and NAFTA
medium-duty production was flat. European medium-duty production was down 7% and
Brazilian vehicle production was flat.
Increased operating profit in 2003 was primarily due to increased sales in 2003
and the benefits of restructuring actions taken in recent years to resize this
business. No restructuring charges were incurred in 2003 compared to $16 in
2002. Operating profit of Truck in 2003 represented a return on sales of 13.2%,
F-44
<PAGE>
compared to 7.7% in 2002, which was reduced by 1.4% due to restructuring
charges.
In third quarter 2003, Eaton announced that it, together with Shaanxi Fast Gear
Co., Ltd. and Xiang Torch Investment Co., Ltd., signed an agreement to form a
joint venture in Xi'an, China to produce heavy-duty truck transmissions for the
growing Chinese market. Eaton will have 55% ownership of the venture, which will
be called Eaton Fast Gear (Xi'an) Co., Ltd. Regulatory approval was obtained on
January 4, 2004 and production is expected to begin in fourth quarter 2004.
Corporate
- ---------
Net interest expense of $87 in 2003 fell by $17 from $104 in 2002. The decrease
was primarily related to the reduction in debt of $487 from the end of 2001 to
the end of 2003, the conversion of fixed rate debt to floating rate debt through
interest rate swaps, and a slight reduction of floating interest rates in 2003.
Corporate expense-net in 2003 was $181 compared to $143 for 2002. The increase
was primarily the result of increased pension and other postretirement benefit
expense of $51 in 2003, and various other items including $11 of reduced legal
expenses and favorable legal settlements in 2003.
CHANGES IN FINANCIAL CONDITION DURING 2003
- ------------------------------------------
Throughout 2003, Eaton maintained a focus on strengthening the balance sheet.
Eaton had success in keeping tight control over working capital as year-end 2003
inventory on hand fell by 3 days compared to 2002 and accounts receivable, in
terms of days sales outstanding, declined slightly compared to 2002. Net working
capital of $967 at December 31, 2003 increased from $723 at year-end 2002. The
increase in net working capital was primarily due to increased accounts
receivable due to higher sales in 2003 compared to 2002, increased working
capital resulting from the acquisition of the Delta electrical business in
January 2003 and increased cash and short-term investments which rose $437
during 2003. The current ratio was 1.4 at year-end 2003 and 2002. In June 2003,
Eaton sold 3.7 million Common Shares (7.4 million shares adjusted for the
February 2004 stock split) for net proceeds of $296, which were used to pay down
commercial paper and for general corporate purposes. Shareholders' equity at
year-end 2003 exceeded $3 billion for the first time in Eaton's history.
As a result of the significant increase in income during 2003, cash generated
from operating activities continued to be strong with $874 generated in 2003
compared to $900 in 2002. Operating cash flow less capital expenditures (free
cash flow) was $601 in 2003 compared to $672 in 2002. The lower amount of cash
generated from operating activities in 2003 was primarily due to increased cash
used for working capital to support growth in sales. Expenditures for property,
plant and equipment were $273 in 2003, compared to $228 in 2002. Capital
expenditures for 2004 are forecasted to be $350.
Total debt of $1,953 at December 31, 2003 decreased $135 from $2,088 at year-end
2002. The decrease in debt was due to payments of $190 offset by a $55 increase
in the value of debt denominated in currencies other than the U.S. Dollar due
F-45
<PAGE>
to movement of foreign exchange rates in 2003. The reduction in debt during
2003, coupled with the $437 increase in cash and short-term investments during
2003 and the $815 increase in Shareholders' equity, resulted in a significant
reduction in the net-debt-to-total-capital ratio to 25.9% at year-end 2003 from
41.9% at the end of 2002. This ratio would have dropped to 23.5% but for the
recognition of a minimum pension liability at the end of 2003 and the prior two
year-ends, which in total reduced Shareholders' equity by $424 at the end of
2003.
Eaton has credit facilities of $650, of which $400 expire in April 2005 and the
remaining $250 in May 2008. On October 22, 2003, Fitch Ratings Services raised
the Company's long-term debt rating from 'A-' to 'A' and its short-term debt
rating from 'F2' to 'F1' or prime. Fitch also changed its outlook of the Company
from 'positive' to 'stable'. On February 9, 2004, Standard & Poor's (S&P)
Ratings Services revised its outlook on Eaton from negative to positive. At the
same time, all ratings on the Company were affirmed. S&P rates the Company's
long-term debt 'A-'and its short-term debt 'A1'. S&P indicated the action was
taken because of the better-than-expected operating performance and cash flow
generation in 2003, particularly in the second half, which has resulted in a
dramatic improvement in credit measures. S&P stated that sustained improvement
may lead to higher ratings.
In July 2003, the Company increased the quarterly cash dividend per Common Share
from $.22 to $.24 per Common Share, a 9% increase. On January 21, 2004, in light
of strong results for 2003 and growing momentum in many of its markets, Eaton
took the following actions: 1) the Company's Common Shares were split
two-for-one effective February 23, 2004; 2) the quarterly dividend on the shares
was increased by 12.5%, from $.24 per share to $.27 per share (after adjustment
for the stock split); 3) cash of $75 was contributed to the Company's qualified
pension plans in the United States; 4) a plan was initiated to repurchase 4.2
million Common Shares to offset the shares issued during 2003 from the exercise
of stock options. In addition, the Company now intends, depending upon
circumstances, to purchase additional shares to help offset dilution resulting
from shares issued as a result of stock options exercised over the course of
2004. In 2004, the increase in the cash dividend is expected to require cash of
approximately $25 compared to 2003. The cash required to repurchase shares is
dependent on the market price for the shares purchased. Assuming the market
price of the shares purchased is the same as the market price of the shares at
year-end 2003 of $54 per share, the repurchase of 4.2 million shares is expected
to required cash of $227.
OUTLOOK FOR 2004
- ----------------
As Eaton surveyed its end markets in January 2004, it anticipated growth of
approximately 4% for full year 2004. The Company also expects to outgrow its end
markets by 2 to 3%. Additional growth of 1% is expected from the full year
impact of the Delta electrical acquisition, the joint venture established during
2003 with Caterpillar Inc., and the new joint ventures with Shaanxi Fast Gear
and Senstar in China. The Company's guidance for net income per share for 2004
is $3.15 to $3.30 after restructuring charges of $.10 per share, with the first
quarter in the range of $.72 to $.77 after restructuring charges of $.03 per
share.
Eaton expects the recovery in Fluid Power's traditional mobile and industrial
hydraulics markets that began in late 2003 will gather steam during 2004,
F-46
<PAGE>
resulting in the first year of growth in these markets since 2000. However, the
Company foresees no growth in commercial aerospace during 2004, with modest
growth occurring in defense aerospace.
The growth in end markets for Electrical in fourth quarter 2003 is anticipated
to accelerate over the course of 2004, with modest growth anticipated for the
year as a whole.
For 2004, Automotive's markets are expected to be flat for both NAFTA and
European automotive production. Based on new product wins already awarded, the
Company believes it will outgrow these end markets as it did during 2003.
In Truck, Eaton believes that production in the first quarter of 2004 will be
about 55,000 units, with growth accelerating as the year progresses. For all of
2004, the Company believes that the NAFTA heavy-duty market is likely to total
240,000 units.
FORWARD-LOOKING STATEMENTS
- --------------------------
This Annual Report to Shareholders contains forward-looking statements
concerning the first quarter 2004 and full year 2004 net income per share,
Eaton's worldwide markets, growth in relation to end markets, growth from
acquisitions and joint ventures, volumes from new business awards, capital
expenditures and the repurchase of shares. These statements should be used with
caution and are subject to various risks and uncertainties, many of which are
outside the Company's control. The following factors could cause actual results
to differ materially from those in the forward-looking statements: unanticipated
changes in the markets for Eaton's business segments; unanticipated downturns in
business relationships with customers or their purchases from the Company;
competitive pressures on sales and pricing; increases in the cost of material
and other production costs, or unexpected costs that cannot be recouped in
product pricing; the introduction of competing technologies; unexpected
technical or marketing difficulties; unexpected claims, charges, litigation or
dispute resolutions; acquisitions and divestitures; new laws and governmental
regulations; interest rate changes; stock market fluctuations; and unanticipated
deterioration of economic and financial conditions in the United States and
around the world. Eaton does not assume any obligation to update these
forward-looking statements.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires Eaton's management to make
estimates and use assumptions in certain circumstances that affect amounts
reported in the accompanying consolidated financial statements. In preparing
these financial statements, management has made their best estimates and
judgments of certain amounts included in the financial statements, giving due
consideration to materiality. For any estimate or assumption there may be other
reasonable estimates or assumptions that could have been used. However, the
Company believes that given the current facts and circumstances, it is unlikely
that applying such other estimates and assumptions would have caused materially
different amounts to have been reported, except for pension and other
postretirement benefit plans for which several different reasonable assumptions
could be used for the valuation of the plans, as described below. Application
F-47
<PAGE>
of these accounting policies involves the exercise of judgment and use of
assumptions as to future uncertainties and, as a result, actual results could
differ from estimates used.
Revenue Recognition
- -------------------
Revenues are recognized when products are shipped to unaffiliated customers and
title has transferred.
Impairment of Long-Lived Assets
- -------------------------------
As a result of the adoption of Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangible Assets" in 2002, goodwill and
indefinite life intangible assets must be reviewed for impairment, in accordance
with the specified methodology. Further, goodwill, intangible and other
long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate the carrying amount may not be recoverable. Goodwill and
other intangible assets totaled $2.6 billion at the end of 2003 and represented
32% of total assets. These assets resulted primarily from the $1.1 billion
acquisition of the electrical distribution and controls business unit of
Westinghouse in 1994, and the $1.6 billion acquisition of Aeroquip-Vickers in
1999. As required by SFAS No. 142, Eaton completed the annual impairment tests
for goodwill and indefinite life intangible assets in 2003 and 2002. These tests
confirmed that the fair value of the Company's reporting units and indefinite
life intangible assets exceed their respective carrying values and that no
impairment loss was required to be recognized upon adoption of SFAS No. 142 or
for the years ended December 31, 2002 and 2003. These businesses have a long
history of operating success and profitability and hold leading market positions
in the majority of their product lines. Their products are not subject to rapid
technological or functional obsolescence, which should result in continuous
strong demand for products for many years and, accordingly, support the book
values of the goodwill and intangible assets related to these businesses.
Deferred Income Tax Assets & Liabilities
- ----------------------------------------
Deferred income tax assets and liabilities have been recorded for the
differences between the financial accounting and income tax basis of assets and
liabilities, and for certain United States income tax credit carryforwards.
Recorded deferred income tax assets and liabilities are described in detail in
"Income Taxes" in the Notes to the Consolidated Financial Statements.
Significant factors considered by management in the determination of the
probability of the realization of deferred tax assets include historical
operating results, expectations of future earnings and taxable income, and the
extended period of time over which other postretirement health care liabilities
will be paid. Management believes there is a low probability of the realization
of deferred tax assets related to tax loss carryforwards at certain
international operations and certain foreign tax credit carryforwards.
Therefore, a valuation allowance of $74 has been recognized for the full value
of these deferred tax assets.
Pension & Other Postretirement Benefit Plans
- --------------------------------------------
The measurement of liabilities related to pension plans and other postretirement
benefit plans is based on management's assumptions related to future events
including interest rates, return on pension plan assets, rate of compensation
F-48
<PAGE>
increases, and health care cost trend rates. Actual pension plan asset
performance will either reduce or increase unamortized pension losses, which
ultimately affects net income.
At the end of 2002, certain key assumptions used to calculate pension and other
postretirement benefit expense were adjusted, including the lowering of the
assumed return on pension plan assets from 10.00% to 8.75% and the discount rate
from 7.25% to 6.75%. The changes in these assumptions, coupled with the effect
of the decline over the last several years in the market value of equity
investments held by Eaton's pension plans, resulted in increased pretax expense
of $66 in 2003 compared to 2002. At the end of 2003, the discount rate was
lowered to 6.25%. This change, again coupled with the effect of the decline over
the last several years in the market value of equity investments held by Eaton's
pension plans, are expected to result in increased pension and other
postretirement benefit expense of approximately $31 in 2004 over 2003. A
one-percentage point change in the assumed rate of return on pension plan assets
from 8.75% is estimated to have approximately a $20 effect on pension expense.
Likewise, a one-percentage point change in the discount rate from 6.25% is
estimated to have approximately a $32 effect on pension expense. Information
related to changes in key assumptions used to recognize expense for other
postretirement benefit plans is found in "Retirement Benefit Plans" in the Notes
to the Consolidated Financial Statements.
Protection of the Environment
- -----------------------------
Eaton's operations involve the use and disposal of certain substances regulated
under environmental protection laws. On an ongoing, regular basis, certain
processes continue to be modified in order to reduce the impact on the
environment, including the reduction or elimination of certain chemicals used
in, and wastes generated from, operations. Liabilities related to environmental
matters are further discussed in "Protection of the Environment" in the Notes to
the Consolidated Financial Statements.
Contingencies
- -------------
Eaton is subject to a broad range of claims, administrative proceedings,
and legal proceedings, such as lawsuits that relate to contractual
allegations, patent infringement, personal injuries (including asbes-
tos claims) and employment-related matters. Although it is not pos-
sible to predict with certainty the outcome or cost of these matters,
the Company believes that these matters will not have a material ad-
verse effect on its financial position, results of operations or cash flows.
Stock Options Granted to Employees & Directors
- ----------------------------------------------
In December 2002, Statement of Financial Accounting Standards (SFAS) No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure", was
issued by the Financial Accounting Standards Board. SFAS No. 148 amends SFAS No.
123, "Accounting for Stock-Based Compensation", to provide alternative methods
of transition when a company voluntarily changes to the fair-value-based method
of recognizing expense in the income statement for stock-based employee
compensation, including stock options granted to employees and directors. As
allowed by SFAS No. 123, Eaton has adopted the disclosure-only provisions of the
Standard and does not recognize expense for stock options granted to employees.
F-49
<PAGE>
OFF-BALANCE SHEET ARRANGEMENTS
- ------------------------------
In fourth quarter 2003, Eaton adopted Financial Accounting Standards Board
Interpretation (FIN) No. 46, "Consolidation of Variable Interest Entities". The
adoption of FIN No. 46 had no effect on the Company's financial statements.
Eaton does not have off-balance sheet arrangements, financings or other
relationships with unconsolidated entities or other persons known as "special
purpose entities" (SPEs). In the ordinary course of business, the Company leases
certain real properties and equipment, as described in "Lease Commitments" in
the Notes to the Consolidated Financial Statements. Transactions with related
parties are in the ordinary course of business, are conducted on an arm's-length
basis, and are not material to Eaton's financial position, results of operations
or cash flows.
MARKET RISK DISCLOSURE & CONTRACTUAL OBLIGATIONS
- ------------------------------------------------
To manage exposure to fluctuations in foreign currencies, interest rates and
commodity prices, Eaton uses straightforward, non-leveraged, financial
instruments for which quoted market prices are readily available from a number
of independent services.
The Company is exposed to various changes in financial market conditions,
including fluctuations in interest rates, foreign currency exchange rates, and
commodity prices. Eaton manages exposure to such risks through normal operating
and financing activities.
Interest rate risk can be measured by calculating the near-term earnings impact
that would result from adverse changes in interest rates. This exposure results
from short-term debt, long-term debt that has been swapped to floating rates,
and money market investments that have not been swapped to fixed rates. A 100
basis point increase in short-term interest rates would increase the Company's
net, pretax interest expense by approximately $4.
Eaton also measures interest rate risk by estimating the net amount by which the
fair value of the Company's financial liabilities would change as a result of
movements in interest rates. Based on a hypothetical, immediate 100 basis point
decrease in interest rates at December 31, 2003, the market value of the
Company's debt and interest rate swap portfolio, in aggregate, would increase by
$79.
Foreign currency risk is the risk that Eaton will incur economic losses due to
adverse changes in foreign currency exchange rates. The Company mitigates
foreign currency risk by funding some investments in foreign markets through
local currency financings. Such non-U.S. Dollar debt was $310 at December 31,
2003. To augment Eaton's non-U.S. Dollar debt portfolio, the Company also enters
into forward foreign exchange contracts from time to time to mitigate the risk
of economic loss in its foreign investments due to adverse changes in exchange
rates. At December 31, 2003, the aggregate balance of such contracts was $138.
Eaton also monitors exposure to transactions denominated in currencies other
than the functional currency of each country in which the Company operates, and
periodically enters into forward contracts to mitigate that exposure. In the
aggregate, Eaton's portfolio of forward contracts related to such transactions
was not material to its financial position, results of operations or cash flows
during 2003.
F-50
<PAGE>
The Company does not hedge commodity prices via the derivatives markets to any
significant extent.
Other than the above noted debt and financial derivative arrangements, there
were no material derivative instrument transactions in place or undertaken
during 2003.
A summary of contractual obligations as of December 31, 2003 follows:
<TABLE>
<CAPTION>
Payments due by period
------------------------------------------
2005 2007
to to
2004 2006 2008 After Total
---- ---- ---- ----- -----
<S> <C> <C> <C> <C> <C>
Long-term debt $ 257 $ 259 $ 306 $1,086 $1,908
Operating leases 89 123 60 13 285
Purchase obligations 272 70 26 34 402
Other long-term liabilities 114 26 27 23 190
------ ------ ------ ------ ------
$ 732 $ 478 $ 419 $1,156 $2,785
====== ====== ====== ====== ======
</TABLE>
Long-term debt includes obligations under capital leases that are not material.
Purchase obligations are entered into with various vendors in the normal course
of business. These amounts include commitments for purchases of raw materials,
outstanding non-cancelable purchase orders, releases under blanket purchase
orders and commitments under ongoing service arrangements. Other long-term
liabilities include $101 of voluntary contributions to pension plans in 2004 and
$89 of deferred compensation earned under various plans for which the
participants have elected to receive disbursement at a later date.
RESULTS OF OPERATIONS - 2002 COMPARED TO 2001
- ---------------------------------------------
<TABLE>
<CAPTION>
(Decrease)
2002 2001 Increase
----- ----- ----------
<S> <C> <C> <C>
Net sales $7,209 $7,299 (1)%
Net income 281 169 66%
Net income per Common
Share assuming dilution $ 1.96 $ 1.20 63%
</TABLE>
Sales in 2002 were slightly below 2001, a reflection of difficult global
economic conditions. Despite the market conditions, sales increased by 1%, after
excluding the impact of the divestitures of the Navy Controls business in third
quarter 2002 and the Vehicle Switch/ Electronics Division (VS/ED) in first
quarter 2001.
Net income in 2002 included restructuring charges of $.33 per Common Share
compared to $.60 per share in 2001. The increase in net income in 2002 was
primarily the result of the benefits of restructuring actions taken in 2002 and
prior years, which generated $130 of savings in 2002. The increase also
reflected lower restructuring charges in 2002; reduced amortization expense
F-51
<PAGE>
in 2002 of $.44 per share related to the adoption of Statement of Financial
Accounting Standards (SFAS) No. 142, which ceased the amortization of goodwill
and indefinite life intangible assets recorded in connection with current and
previous business acquisitions; and a lower effective income tax rate in 2002.
Offsetting these positive effects on income was increased pension expense and
other postretirement benefit expense in 2002 of $.26 per share and reduced gains
on the sales of businesses of $.06 per share in 2002.
Net Sales by Business Segment
- -----------------------------
<TABLE>
<CAPTION>
(Decrease)
2002 2001 Increase
---- ---- --------
<S> <C> <C> <C>
Fluid Power $2,456 $2,507 (2)%
Electrical 1,993 2,199 (9)%
Automotive 1,594 1,479 8%
Truck 1,166 1,029 13%
------ ------
$7,209 $7,214 -
====== ======
</TABLE>
Sales of Fluid Power and Electrical were down due to weakness in end markets
served by these segments. Automotive's sales reflected the continued strength of
the North American and European automobile market. Truck's sales grew due to
purchases of heavy-trucks in North America in advance of new engine emission
requirements effective in fourth quarter 2002. The operating results of each
business segment are further discussed below.
Results by Geographic Region
- ----------------------------
<TABLE>
<CAPTION>
Net sales Operating profit
-------------------------- -----------------------
(Decrease)
2002 2001 Increase 2002 2001 Increase
---- ---- -------- ---- ---- --------
<S> <C> <C> <C> <C> <C> <C>
United States $5,605 $5,677 (1)% $483 $414 17%
Canada 185 177 4% 15 11 36%
Europe 1,110 1,108 - 65 (5) -
Latin America 403 406 (1)% 45 37 22%
Asia/Pacific region 358 310 15% 43 19 126%
Eliminations (452) (464)
------ ------ ---- ----
$7,209 $7,214 - $651* $476* 36%
====== ====== ==== ====
</TABLE>
*A reconciliation of operating profit to net income is included in "Business
Segment Information" in the Notes to the Consolidated Financial Statements.
F-52
<PAGE>
After excluding the impact of the divestitures of businesses in 2002 and 2001,
sales in the United States increased primarily as a result of continued strong
performance in Automotive and the growth in sales of Truck. Higher operating
profit in the United States primarily resulted from the benefits of
restructuring actions taken in recent years and lower related charges in 2002.
Sales in Canada, Europe, and Latin America were all flat compared to 2001, as
these economies remained weak. Profits in Europe were higher due to lower
restructuring charges in Truck in 2002 and the benefits of restructuring actions
taken in prior years. Sales and operating profit in the Asia/Pacific region rose
primarily due to improved performance of Fluid Power, Automotive and Truck
operations in this region.
As the weak economic conditions of 2001 continued into 2002, Eaton undertook
additional restructuring actions to further reduce fixed operating costs across
business segments and certain corporate functions. During 2002, $62 of
restructuring charges were recorded, including $26 for Fluid Power, $16 for
Electrical, $1 for Automotive, $16 for Truck and $3 for Corporate. These
compared to similar restructuring charges of $119 in 2001 including $22 for
Fluid Power, $30 for Electrical, $55 for Truck and $12 for Corporate. In
addition, corporate charges of $10 in each of 2002 and 2001 were recorded which
related to non-operating activities. On an after-tax basis, these restructuring
and other charges reduced net income for 2002 by $47 ($.33 per Common Share) and
for 2001 by $86 ($.60 per share). Restructuring charges in 2002 and 2001 reduced
Operating profit of the related business segment or were included in Corporate
expense-net, as appropriate. In the Statements of Consolidated Income, the
restructuring charges were included in Cost of products sold or Selling &
administrative expense, as appropriate. The other corporate charges were
included in the Statements of Consolidated Income in Other (income) expense-net.
In Business Segment Information, the charges were included in Corporate
expense-net.
Results for 2002 were favorably impacted by the adoption of SFAS No. 142, which
ceased the amortization of goodwill and indefinite life intangible assets
recorded in connection with current and previous business acquisitions. This
accounting change increased pretax income for 2002 by $73 ($63 after-tax, or
$.44 per Common Share) compared to 2001. Income for 2002 was reduced by $57 ($37
after-tax, or $.26 per share) compared to 2001 due to increased pension expense
and other postretirement benefit expense due to the effect of the decline over
the last several years in the market value of equity investments held by Eaton's
pension plans and lower discount rates associated with determining pension and
other postretirement benefit liabilities.
In third quarter 2002, the Navy Controls business was sold, which resulted in a
pretax gain of $18 ($13 after-tax, or $.09 per Common Share). During 2001,
VS/ED, the Air Conditioning and Refrigeration business and certain assets of
Automotive and Truck businesses were sold. The sales of businesses in 2001
resulted in a net pretax gain of $61 ($22 after-tax, or $.15 per share). The
gains for both years are reported as a separate line item in the Statements of
Consolidated Income and Business Segment Information. In Business Segment
Information, the operating results of VS/ED are included in divested operations.
The effective income tax rate for 2002 was 29.5% compared to 39.4% for 2001. The
higher rate in 2001 was primarily the result of the tax effect of book/tax basis
differences related to businesses sold in first quarter 2001 and the
amortization of non-deductible goodwill in 2001. Excluding the negative tax
F-53
<PAGE>
consequences related to the sales of businesses and non-deductible goodwill in
2001, the effective tax rate for 2001 was 28.2% compared to 29.5% in 2002. The
change in the effective income tax rates in 2002 compared to 2001 is further
explained in "Income Taxes" in the Notes to the Consolidated Financial
Statements.
Fluid Power
- -----------
<TABLE>
<CAPTION>
(Decrease)
2002 2001 Increase
---- ---- --------
<S> <C> <C> <C>
Net sales $2,456 $2,507 (2%)
Operating profit 187 183 2%
</TABLE>
Fluid Power's end markets showed no growth in 2002 compared to 2001, with North
American fluid power industry shipments down about 2%, commercial aerospace
markets off about 17%, and defense aerospace markets up by 27%.
In spite of general weakness in end markets, operating profit in 2002 was higher
than 2001, primarily the result of the benefits of aggressive restructuring
actions taken to resize this business in prior periods. Restructuring charges
recognized in 2002 were $26 compared to $22 in 2001. Operating profit of Fluid
Power in 2002 represented a return on sales of 7.6%, which was reduced by 1.1%
due to restructuring charges, compared to 7.3% in 2001, which was reduced by .9%
due to restructuring charges.
During second quarter 2002, Eaton purchased the remaining 40% interest in its
hydraulics systems joint venture company, Jining Eaton Hydraulics Company, Ltd.,
located in Jining, China.
In 2002, the Company announced it had been selected to receive $84 in business
as a result of the U.S. Air Force's decision to purchase an additional 60 C-17
cargo aircraft in 2004 through 2007. During 2002, Eaton also announced a
multi-year contract with Airbus to provide products for hydraulic fluid
conveyance in the new Airbus 380, the world's largest commercial aircraft. The
contract has potential revenue of $70 over the next 20 years. This was the
second contract awarded to the Company for the A380, with the combined contracts
expected to generate revenues of approximately $270 over the next 20 years.
Additionally, during 2002, the Company was awarded a multi-year contract by BMW
to provide fluid hose assemblies for two major automobile production models.
This contract is expected to have revenues in excess of $150 over the next six
years.
Electrical
- ----------
<TABLE>
<CAPTION>
2002 2001 Decrease
---- ---- --------
<S> <C> <C> <C>
Net sales $1,993 $2,199 (9%)
Operating profit 149 163 (9%)
</TABLE>
Sales for Electrical in 2002 were down 9%, but only down 7% after adjusting for
the impact of selling the Navy Controls business at the start of third quarter
2002. End markets for the electrical business weakened during the year, with an
F-54
<PAGE>
estimated 9% decline in the North American markets for this business compared to
2001. The long-cycle, large-project portion of this business, which is tied to
commercial construction, continued to soften during the year.
The decline in operating profit was primarily the result of declining sales
volume due to weak market conditions in most of the sectors this segment serves
and the effects of product mix. Restructuring charges recorded in 2002 were $16
compared to $30 in 2001. Operating profit of Electrical in 2002 represented a
return on sales of 7.5%, which was reduced by .8% due to restructuring charges,
compared to 7.4% in 2001, which was reduced by 1.4% due to restructuring
charges.
During second quarter 2002, Electrical announced the formation of its new
Performance Power Solutions organization, created to expand the Company's
position in the power quality and assurance market.
Automotive
- ----------
<TABLE>
<CAPTION>
2002 2001 Increase
---- ---- --------
<S> <C> <C> <C>
Net sales $1,594 $1,479 8%
Operating profit 225 194 16%
</TABLE>
Automotive's continued strong performance was due to sales growth that
considerably outpaced its end markets. Compared to 2001, NAFTA automotive
production was up 6% to 16.7 million units, while European production decreased
2% to 18.0 million units. The heavy investments Eaton has made in new product
development over the last several years delivered strong results, as this
segment has been able to accelerate the pace of new product introductions and
gain market share.
The increase in operating profit was primarily the result of the increase in
sales during 2002. The segment recorded $1 of restructuring charges in 2002
while none were recorded in 2001. Operating profit of Automotive in 2002
represented a return on sales of 14.1%, which was reduced by .1% due to
restructuring charges, compared to 13.1% in 2001.
In 2002, Eaton announced the acquisition, from McLaren Performance Technologies,
of the technology, trademarks, and engineering assets related to the
Gerodisc(TM) product line. The addition of this product line to the Company's
existing products broadens the product range sold to the light-duty automotive
differential market. During the year, the Company also increased its investment
to 49% in Cyltec, an associate company that manufactures cylinder heads for the
light vehicle market in North America. In late 2002, Eaton won a contract from
the Chrysler Group to provide electronic differentials for the front and rear
axles of a future vehicle platform.
Progress was made in growing Eaton's supercharger business in 2002. Delivery
began in 2002 of a high-efficiency supercharger for use with the new M-271
engine program of Mercedes. The Company is providing superchargers, intake and
exhaust valves, roller rocker arms and lash adjusters for the M-271 program.
F-55
<PAGE>
Truck
- -----
<TABLE>
<CAPTION>
2002 2001 Increase
---- ---- --------
<S> <C> <C> <C>
Net sales $1,166 $1,029 13%
Operating profit (loss) 90 (64) -
</TABLE>
In Truck, sales in the North American heavy-duty truck market were higher in the
second and third quarters of 2002 than 2001, spurred by purchases of heavy-duty
trucks in North America in advance of new engine emission requirements effective
in fourth quarter 2002. NAFTA heavy-duty truck production was up 24% in 2002 to
181,000 units, NAFTA medium-duty truck production was flat, European truck
production was down 6%, and South American production decreased by 12%.
The positive impact of the extensive restructuring actions in this segment over
the last two years can be seen in the $115 of increased profit before
restructuring costs in 2002 on increased sales of $137. Restructuring charges
recorded in 2002 were $16 compared to $55 in 2001. Operating profit of Truck in
2002 represented a return on sales of 7.7%, which was reduced by 1.4% due to
restructuring charges.
During 2002, Eaton announced two new contracts in South America with Volvo and
AGCO to supply transmissions for heavy-duty trucks and farm tractors. These
contracts are expected to generate more than $190 of sales over the next eight
years.
Corporate
- ---------
Results for 2002 were impacted favorably by the adoption of SFAS No. 142, which
ceased the amortization of goodwill and indefinite life intangible assets
recorded in connection with current and previous business acquisitions. This
accounting change resulted in a $73 reduction in amortization expense in 2002
compared to 2001.
Net interest expense of $104 in 2002 decreased by $38 compared to 2001. The
decrease was primarily related to the reduction in debt of $352 from the end of
2001 to the end of 2002, as well as a reduction of interest rates in 2002.
Corporate expense-net was $143 in 2002 compared to $29 in 2001. The increase was
primarily the result of increased pension expense and other postretirement
benefit expense of $57 in 2002 compared to 2001. This increase was due to the
effect of the decline over the last several years in the market value of equity
investments held by Eaton's pension plan, coupled with lower discount rates
associated with determining pension and other postretirement benefit
liabilities. The increase also reflected other corporate expenses including
profits owed to minority interests in subsidiaries, foreign currency costs,
environmental and legal costs, as well as other accruals.
F-56
<PAGE>
QUARTERLY DATA
- --------------
(Unaudited)
<TABLE>
<CAPTION>
Quarter ended in 2003 Quarter ended in 2002
-------------------------------------- --------------------------------------
(Millions except for per share data) Dec. 31 Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31
------- -------- ------- ------- ------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales $2,083 $2,026 $2,027 $1,925 $1,775 $1,830 $1,881 $1,723
Gross margin 578 547 529 510 469 514 517 437
Percent of sales 28% 27% 26% 26% 26% 28% 27% 25%
Income before income taxes 145 142 122 99 92 132 127 48
Net income 114 107 93 72 67 93 88 33
Net income per Common Share
- ---------------------------
Assuming dilution $ .72 $ .69 $ .64 $ .50 $ .47 $ .65 $ .61 $ .23
Basic .74 .70 .64 .51 .48 .66 .62 .24
Cash dividends paid per Common Share $ .24 $ .24 $ .22 $ .22 $ .22 $ .22 $ .22 $ .22
Market price per Common Share
- -----------------------------
High $54.70 $47.72 $42.60 $40.50 $40.15 $36.97 $43.56 $41.99
Low 44.58 38.74 34.70 33.01 29.55 29.92 34.53 32.95
</TABLE>
Net income per Common Share, average number of shares outstanding, cash
dividends paid per share and market price per share have been restated to give
effect to the two-for-one stock split effective February 23,2004.
F-57
<PAGE>
EIGHT-YEAR CONSOLIDATED FINANCIAL SUMMARY
- -----------------------------------------
<TABLE>
<CAPTION>
(Millions except for per share data) 2003 2002 2001 2000 1999 1998 1997 1996
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Continuing operations
- ---------------------
Net sales $8,061 $7,209 $7,299 $8,309 $8,005 $6,358 $7,104 $6,515
Income before income taxes 508 399 278 552 943 616 730 428
Income after income taxes 386 281 169 363 603 430 526 305
Percent of net sales 4.8% 3.9% 2.3% 4.4% 7.5% 6.7% 7.4% 4.7%
Extraordinary item - redemption of debentures (54)
Income (loss) from discontinued operations 90 14 (81) (62) 44
------ ------ ------ ------ ------ ------ ------ ------
Net income $ 386 $ 281 $ 169 $ 453 $ 617 $ 349 $ 410 $ 349
====== ====== ====== ====== ====== ====== ====== ======
Net income per Common Share assuming dilution
- ---------------------------------------------
Continuing operations $ 2.56 $ 1.96 $ 1.20 $ 2.50 $ 4.08 $ 2.96 $ 3.36 $ 1.94
Extraordinary item (.35)
Discontinued operations .62 .10 (.56) (.39) .29
------ ------ ------ ------ ------ ------ ------ ------
$ 2.56 $ 1.96 $ 1.20 $ 3.12 $ 4.18 $ 2.40 $ 2.62 $ 2.23
====== ====== ====== ====== ====== ====== ====== ======
Average number of Common Shares outstanding 150.5 143.4 141.0 145.2 147.4 145.4 156.4 156.4
Net income per Common Share basic
- ---------------------------------
Continuing operations $ 2.61 $ 1.99 $ 1.22 $ 2.53 $ 4.16 $ 3.01 $ 3.42 $ 1.96
Extraordinary item (.35)
Discontinued operations .63 .10 (.56) (.40) .29
------ ------ ------ ------ ------ ------ ------ ------
$ 2.61 $ 1.99 $ 1.22 $ 3.16 $ 4.26 $ 2.45 $ 2.67 $ 2.25
====== ====== ====== ====== ====== ====== ====== ======
Average number of Common Shares outstanding 147.9 141.2 138.8 143.6 145.0 142.8 153.6 154.8
Cash dividends paid per Common Share $ .92 $ .88 $ .88 $ .88 $ .88 $ .88 $ .86 $ .80
- ----------------------------------------------------------------------------------------------------------------------
Total assets $8,223 $7,138 $7,646 $8,180 $8,342 $5,570 $5,497 $5,290
Long-term debt 1,651 1,887 2,252 2,447 1,915 1,191 1,272 1,062
Total debt 1,953 2,088 2,440 3,004 2,885 1,524 1,376 1,092
Shareholders' equity 3,117 2,302 2,475 2,410 2,624 2,057 2,071 2,160
Shareholders' equity per Common Share $20.37 $16.30 $17.80 $17.64 $17.72 $14.34 $13.86 $14.00
Common Shares outstanding 153.0 141.2 139.0 136.6 148.0 143.4 149.4 154.2
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
F-58
<PAGE>
Net income per Common Share, average number of shares outstanding, cash
dividends paid per share and shares outstanding have been restated to give
effect to the two-for-one stock split effective February 23, 2004.
F-59
<PAGE>
Eaton Corporation
2003 Annual Report on Form 10-K
Exhibit Index
Exhibits
3(a) Amended Articles of Incorporation (amended and restated as of
April 27, 1994) - Incorporated by reference to the Form 10-K
for the year ended December 31, 2002
3(b) Amended Regulations (amended and restated as of April 26,
2000) - Incorporated by reference to the Form 10-Q for the six
months ended June 30, 2000
4(a) Instruments defining rights of security holders, including
indentures (Pursuant to Regulation S-K Item 601(b)(4), the
Company agrees to furnish to the Commission, upon request, a
copy of the instruments defining the rights of holders of
long- term debt)
4(b) Rights Agreement (Dated as of June 28, 1995) - Incorporated by
reference to Registration Statement 333-74355 filed on March
12, 1999
10 Material contracts - Each of the following is either a
management contract or a compensatory plan or arrangement:
(a) Deferred Incentive Compensation Plan (amended and
restated as of March 31, 2000) - Incorporated by
reference to the Form 10-K for the year ended
December 31, 2000
(b) Executive Strategic Incentive Plan I (Amended and
Restated as of January 1, 2001) - Incorporated by
reference to the Form 10-K for the year ended
December 31, 2002
(c) Group Replacement Insurance Plan (GRIP), effective as
of June 1, 1992 - Incorporated by reference to the
Form 10-K for the year ended December 31, 1992
(d) 1991 Stock Option Plan - Incorporated by reference to
the Form 10-K for the year ended December 31, 2002
(e) 1995 Stock Plan - Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(f) Incentive Compensation Deferral Plan (amended and
restated as of October 1, 1997) - Incorporated by
reference to the Form 10-K for the year ended
December 31, 2000
(g) Form of Change of Control Agreement entered into with
officers of Eaton Corporation - Incorporated by
reference to the Form 10-K for the year ended
December 31, 2002
(h) Form of Indemnification Agreement entered into with
officers of Eaton Corporation - Incorporated by
reference to the Form 10-K for the year ended
December 31, 2002
<PAGE>
(i) Limited Eaton Service Supplemental Retirement Income
Plan (amended and restated as of January 1, 2003) -
Incorporated by reference to the Form 10-K for the
year ended December 31, 2002
(j) Supplemental Benefits Plan (amended and restated as
of January 1, 1989) (which provides supplemental
retirement benefits) - Incorporated by reference to
the Form 10-K for the year ended December 31, 2002
(k) Excess Benefits Plan (Amended and Restated Effective
January 1, 1989) (with respect to Section 415
limitations of the Internal Revenue Code) -
Incorporated by reference to the Form 10-K for the
year ended December 31, 2002
(l) Executive Incentive Compensation Plan (Effective as
of January 1, 2003) - Filed in conjunction with this
Form 10-K
(m) Plan for the Deferred Payment of Directors' Fees
(Originally adopted in 1985 and amended effective as
of September 24, 1996 and January 28, 1998) -
Incorporated by reference to the Form 10-K for the
year ended December 31, 2002
(n) Plan for the Deferred Payment of Directors' Fees
(Originally adopted in 1980 and amended and restated
in 1989 and 1996) - Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(o) 1996 Non-Employee Director Fee Deferral Plan (amended
and restated as of October 22, 2002) - Incorporated
by reference to the Form 10-K for the year ended
December 31, 2002
(p) Trust Agreement - Outside Directors (dated December
6, 1996) - Incorporated by reference to the Form 10-K
for the year ended December 31, 2002
(q) Trust Agreement - Officers and Employees (dated
December 6, 1996) - Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(r) 1998 Stock Plan - Incorporated by reference to the
definitive Proxy Statement dated March 13, 1998
(s) 2002 Stock Plan - Incorporated by reference to the
definitive Proxy Statement dated March 15, 2002
(t) Executive Strategic Incentive Plan II (Effective as
of January 1, 2001) - Incorporated by reference to
the Form 10-K for the year ended December 31, 2002
(u) Vehicle Allowance Program (Effective as of January 1,
2003) - Filed in conjunction with this Form 10-K
12 Ratio of Earnings to Fixed Charges - Filed in conjunction with
this Form 10-K
14 Code of Ethics - Incorporated by reference to the definitive
Proxy Statement to be filed on or about March 15, 2004
21 Subsidiaries of Eaton Corporation - Filed in conjunction with
this Form 10-K
<PAGE>
23 Consent of Independent Auditors - Filed in conjunction with
this Form 10-K
24 Power of Attorney - Filed in conjunction with this Form 10-K
31.1 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act
of 2002, Section 302) - Filed in conjunction with this Form
10-K
31.2 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act
of 2002, Section 302) - Filed in conjunction with this Form
10-K
32.1 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act
of 2002, Section 906) - Filed in conjunction with this Form
10-K
32.2 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act
of 2002, Section 906) - Filed in conjunction with this Form
10-K
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-10.L
<SEQUENCE>3
<FILENAME>l06255aexv10wl.txt
<DESCRIPTION>EX-10(L) EXECUTIVE INCENTIVE COMPENSATION PLAN
<TEXT>
<PAGE>
Eaton Corporation
2003 Annual Report on Form 10-K
Item 15 (c)
Exhibit 10 (l)
EATON CORPORATION
EXECUTIVE INCENTIVE COMPENSATION PLAN
I. Purpose
The purpose of the Plan is to provide an annual incentive compensation
opportunity for eligible employees in executive, administrative, professional,
technical, or advisory positions whose actions are considered to have a
significant impact on corporate performance.
II. Effective Date
This restatement of the Plan is effective beginning with the 2003 Executive
Incentive Compensation Plan year and shall remain in effect until its terms are
changed by the Board of Directors of Eaton Corporation.
III. Administration
The Plan is adopted by the Board of Directors of the Company and may be amended,
modified or discontinued, as the Board, in its sole discretion, may deem
necessary.
The Plan is administered by the Management Compensation Committee (the
"Committee"), which shall consist of the Chief Executive Officer and up to four
officers designated by the Chief Executive Officer. The Committee shall have
complete authority to interpret all provisions of the Plan consistent with the
law.
IV. Concept
The Plan is intended to support the Company's Pay-for-Performance culture. It is
based on the concept that those individuals in positions that have an
opportunity to significantly affect company results should have a significant
portion of their total compensation at risk and linked to business and
individual results.
V. Eligibility
Any salaried employee of the Company or any of its subsidiaries (including any
subsidiary acquired after adoption of this Plan) who in the judgment of the
Committee meets the criteria described in Article I may be selected for
participation in the Plan. The Committee will have final authority for
designating participants in the Plan, but may delegate this authority, as it
deems advisable.
An employee may be designated as a participant on the first of any month
following the approval of the Committee or its designee.
VI. Calculation of Incentive Compensation Payments
Plan participants will be placed into one of three (3) Incentive Compensation
Programs within the overall Plan. These three Programs are:
- Operations Program - which will include participants who are assigned to
operating units.
<PAGE>
- Corporate Staff Program - which will include participants who are members of
corporate staff functional departments.
- Executive Management Program - which will include senior elected officers.
Beginning with the 2003 plan year, the total Corporate Incentive pool will be
created by multiplying the participants' base salaries (as in effect as of March
1 of each year) by Target Percentage Incentive Factors which are either (a) the
standard percentage Incentive Factor appropriate to their level of
responsibility or (b) an alternative individual Percentage Incentive Factor
approved by the Company's Chief Executive Officer or designee. The aggregate
pool amount will then be multiplied by the Corporate Performance Factor to
determine the Initial Adjusted Corporate Incentive Pool.
The Corporate Performance Factor raises or lowers the Initial Corporate
Incentive Pool based on Eaton's performance as measured by a matrix of Cash Flow
Return on Gross Capital (CFR) and Earnings per Share (EPS). A philosophical
cornerstone of the Plan is the belief that consistently high performance against
this Matrix will result in increases in shareholder value. The Compensation and
Organization Committee of the Board will establish the Corporate Performance
Factor Schedule. This schedule will define the threshold, target, and maximum
CFR/EPS matrix goals and pool adjustment levels for the designated year. This
process determines the maximum amount of the Initial Adjusted Corporate
Incentive Pool but is not linked to the incentive distribution process.
The Compensation and Organization Committee of the Board of Directors, in its
sole discretion, will determine the Final Adjusted Corporate Incentive Pool by
multiplying the Initial Adjusted Corporate Incentive Pool by a Corporate
Performance Incentive Pool Modifier which can affect the initial pool by as much
as plus or minus twenty (20%) percent. In applying the Corporate Performance
Incentive Pool Modifier, the Compensation and Organization Committee of the
Board of Directors will take into consideration such other performance factors
as it deems appropriate which may include, but are not limited to: performance
versus Profit Plan goals; performance versus that reported for Eaton's peer
companies and progress toward the execution of the corporation's growth
strategies.
The process of allocating the incentive funds is based upon performance ratings.
In the Operations Program, each appropriate operating unit will be given a
rating on a scale from zero (0) to 150 percent. Participants in each program
will be given individual ratings based on the same scale. These ratings will be
established by a senior officer, subject to final review and approval by the
Chief Executive Officer, and will be based primarily upon the success of the
unit and/or individual in meeting pre-established objectives. Individual Ratings
for elected officers will be recommended by the Chief Executive Officer and must
be approved by the Compensation and Organization Committee of the Board of
Directors. It is intended that the ratings process should allow maximum
flexibility for the recognition of unanticipated challenges and opportunities,
which may not have been contemplated at the time the original objectives were
established.
While it is not necessary that the entire Final Adjusted Corporate Incentive
Pool be allocated to participants, the total of all awards made to participants
throughout the Corporation cannot be greater than the sum of the pools of all
three programs. Excepted from this provision are the awards made to designated
employees by the Compensation and Organization Committee of the Board of
Directors, which shall be calculated in a manner consistent with the Plan, but
which shall be paid from the Corporation's General Funds rather than the
Corporate Incentive Pool. At the sole discretion of the
<PAGE>
Chief Executive Officer, money not distributed from one program may be
reallocated to another program.
VII. Other Provisions
The Plan provides for a Special Award Fund which will allow the Compensation and
Organization Committee of the Board of Directors, on an exception basis, to
award special payments to individual participants who, in that Committee's
judgment, have made extraordinary contributions to the Corporation in a year
when there would normally be no incentive compensation payment due to below
threshold corporate performance. The maximum amount of such awards is defined in
Article X of this Plan.
Note: When assigning individual ratings, a specific effort is made to
differentiate in order to reward extraordinary job performance. To accomplish
this, senior officers are expected to allocate ratings above 100 based on
clearly demonstrated and exceptional job performance, leadership and initiative.
The remainder of that business unit and/or department incentive pool will be
allocated, again by job performance, to the remaining participants. As a natural
consequence of this process the individual rating will generally average 100.
However, because the Plan is designed to reward exceptional performance with
ratings well above 100, fully competent performers can expect individual ratings
that may average below 100. To insure that incentive pool funds are made
available to support effective Pay-for-Performance objective, the Compensation
and Organization Committee may, as it deems necessary for selected organizations
or groups of incentive participants, require an alternative process for applying
the Corporate Performance Factor and (if applicable) the Unit Rating in the
individual award calculations. In this alternative award calculation process,
the Lowest Ten Percent (10%) of Plan participants, as determined by final
Individual Ratings Percentages, will receive the application of eighty percent
(80%) of the final approved Corporate performance Factor and, if appropriate,
the Unit Rating approved for their organization. The Next Lowest Ten Percent
(10%) will receive the application of ninety percent (90%) of the Corporate
Performance Factor and, if appropriate, the Unit Ratings approved for their
organization. Incentive dollars made available by the application of these rules
may be allocated to those Plan participants who are deemed to have made the
greatest value contributions during the Plan award period.
In the sole discretion of the Compensation and Organization Committee: (a) the
percentages cited in the above paragraphs may be adjusted from time to time to
insure effective Plan processes and (b) a process will be established for
determining the organization levels at which the Lowest and Next Lowest Ten
Percent of Individual Ratings will be identified.
VIII. Payment
Incentive compensation will be paid in the year subsequent to the year in which
it is earned at the earliest feasible date following the determination of final
corporate performance and the calculation of individual incentive payments.
IX. Service for Part of Year
A participant must be employed by the Company or one of its subsidiaries at the
end of an Award Period; provided, however, that a payment, prorated for the
participant's months of participation during the Award Period, may be authorized
by the Committee, in its sole discretion, in the event the employment of a
participant terminates before the end of an Award Period due to death, permanent
disability, normal or early retirement, closure or divestiture of an Eaton
facility or any other reason. Notwithstanding the
<PAGE>
foregoing, upon any termination of the Plan during any Award Period, payments to
all participants will be made, prorated for each participant's length of service
during the Award Period prior to the date of Plan termination.
X. Accounting Provisions and Defined Terms
Awards paid out under the provisions of the Plan to participants in the
Operations Program will be accrued for and charged to the appropriate units.
Awards to participants in the Executive management and Corporate Staff Programs
will be accrued for and charged as a corporate administrative expense.
Initial Adjusted Corporate Incentive Pool - The sum of the Incentive Potential
for all participants in each of the three programs multiplied by the Corporate
Performance Factor.
Final Adjusted Corporate Incentive Pool - The result obtained by multiplying the
Initial Adjusted Corporate Incentive Pool by the Corporate Performance Factor as
described in Section VI.
Corporate Performance Factor - Adjustment percentages, which raise or lower the
Corporate Incentive Pool, based on Eaton's performance. The following schedule
will be applied to the 2003 incentive pool adjustment and subsequent Plan years
unless adjusted by the Compensation and Organization Committee of the Board of
Directors in its sole discretion. Performance that falls between the points on
the matrix will be interpolated to arrive at the appropriate Corporate
Performance Factor to the closest 1%.
CFROGC/Earnings Per Share Matrix -
Corporate Performance Factor
<TABLE>
<CAPTION>
CFR EPS
Cash Flow Return Threshold Threshold Target Maximum
- ---------------- --------- --------- ----- ------ ----- -------
<S> <C> <C> <C> <C> <C> <C>
13.0% 40% 40%
14.3% 75%
16.4% 100%
17.0% 150%
17.6% 200%
Earnings per less
Share (EPS) than $2.70 $2.70 $3.68 $5.00 $5.40 $5.80
</TABLE>
Cash Flow Return on Gross Capital (CFR) - Net income plus depreciation, and
after-tax net interest divided by capital plus accumulated depreciation minus
goodwill and short-term investments.
Earnings per Share - Fully diluted Earnings per Share excluding Unusual Items
as reported externally (also reported as "Operating Earnings Per Share")
Special Award Fund - An amount not greater than twenty (20%) percent of the
sum of the Corporate Incentive Pool. The Compensation and Organization
Committee of the Board of Directors will have sole authority to grant up to
the maximum of this Fund to recognize extraordinary contributions to the
Corporation in a year when the CFR/EPS Matrix threshold was not met and the
Plan did not generate payments for participants.
Percentage Incentive Factor Schedule - A schedule outlining the percentage to be
applied against the base salary of each level of participant in order to
determine the participant's Incentive Potential. The target incentive factor
<PAGE>
will vary according to level of responsibility, and may be changed from time to
time to reflect the competitive practices for companies comparable to Eaton. The
target incentive factor can be further adjusted at the beginning of the Plan
year to reflect the participant's level of performance and other factors. The
individual adjusted target incentive factors will be set at the beginning of the
Plan year. The schedule of standard incentive percentages will be established by
the Compensation Department subject to review and approval of the Compensation
and Organization Committee of the Board of Directors.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-10.U
<SEQUENCE>4
<FILENAME>l06255aexv10wu.txt
<DESCRIPTION>EX-10(U) VEHICLE ALLOWANCE PROGRAM POLICY
<TEXT>
<PAGE>
Eaton Corporation
2003 Annual Report on Form 10-K
Item 15(c)
Exhibit 10(u)
EATON CORPORATION
VEHICLE ALLOWANCE PROGRAM POLICY
TIER I and TIER II
Program Overview
Eaton Corporation's Vehicle Allowance Program (Program) is designed to provide
eligible senior executives with a taxable monthly allowance to assist with the
purchase or lease of a vehicle. However, participants, in their sole discretion,
may utilize the allowance for any pur-pose they deem appropriate. No
confirmation or documentation of any kind is required with respect to the
purchase or lease of a vehicle. The Program is effective January 1, 2003 and is
subject to termination or amendment at any time at the sole discretion of Eaton
Corporation.
Program Administration
The Vehicle Allowance Program will be administered by the Fleet Administration
Department at World Headquarters.
Program Structure
The Program is comprised of Tiers I, II, and III. A specified monthly allowance,
established by the Company and subject to change from time to time, shall be
provided to participants according to their designated tier.
Eligibility
The Vice President - Human Resources and the Chief Executive Officer will
determine participant eligibility and will also determine when such eligibility
ceases.
Calculation of Allowance
The amount of the monthly allowance generally will be equal to: (1) an amount
equivalent to the cost of purchasing a vehicle once every 36 months (adjusted by
tier); (2) average interest for a 36-month loan on that amount; and (3) a fixed
monthly maintenance allowance and will vary depending on the participant's
designated tier. The actual amount of the monthly allowances will be calculated
by the Vice President of Compensation & Benefits and approved by the Chief
Executive Officer for non-executive officer participants and by the Compensation
and Organization Committee for executive officer participants.
The Vice President of Compensation & Benefits will periodically review the
allowance to determine whether it is market competitive and is consistent with
similar programs offered by other premier diversified companies. If vehicle
M.S.R.P. prices have increased sufficiently in each tier to warrant an increase
in the allowance amounts, such adjustments may be recommended. It is anticipated
that adjustments shall not be made more frequently than once every three years.
<PAGE>
In the event that it is determined that there will be an adjustment to the
amounts of the allowances, then it is anticipated that it will be implemented at
the same time for each of the participants.
The monthly allowance is comprehensive. Therefore, participants shall assume all
costs related to the purchase or lease of a vehicle, including acquisition cost,
sales tax, luxury tax, interest charges, aftermarket-installed equipment,
maintenance and repair expenses, car washes, gasoline, and all other incidental
costs. The Company will, however, reimburse participating executives for the
cost of annual vehicle titling and registration in excess of a certain limit.
Since participants will be provided with an allowance to cover the above costs,
no other vehicle-related charges, with the exception of business-related mileage
and tolls, and vehicle titling and registration fees in excess of a certain
limit, should be submitted on an expense report for reimbursement by the
Company.
Mileage for business use of a personal vehicle, tolls, and annual titling and
registration fees in excess of a certain limit should be submitted on an expense
report and shall be reimbursed based on current Company policy for reimbursement
of business use of a personal vehicle. If the Company reimburses a participant
for annual license and titling fees, the participant must provide the Program
Administrator with documentation of the expense because it qualifies for imputed
income tax.
Transition and Enrollment Procedures
Tier I and Tier II participants in the former Executive Car Purchase Program
will be transitioned to the Vehicle Allowance Program in the month following the
final imputed charge of their current 36-month test car loan. If participants
elect to retain ownership of vehicles under the previous Program, the vehicles
will immediately be transferred from the previous Program to the Executive
Vehicle Program. Insurance coverage under the latter will continue as usual.
Vehicles under the previous Program will be eligible for maintenance
reimbursement through the last day of the month prior to the month in which the
monthly allowance begins.
Tier I and Tier II participants in the Company-Provided Leased Vehicle Program
will be transitioned to the Vehicle Allowance Program in the month following the
month in which their current company cars are disposed of, either through
purchase, resale, or reassignment. Such disposition is indicated through
completion of a "Turn-In Vehicle Final Disposition" form. If participants elect
to purchase vehicles and want to enroll them in the Executive Vehicle Program
for insurance coverage, a "Procedure for Including a Personally Owned/Leased
Vehicle on the Executive Vehicle Program" form must be completed and forwarded
to the Program Administrator (see Exhibit B of the Executive Vehicle Program
Guidelines).
The World Headquarters Compensation Department shall inform the Fleet
Administration Department when a participant becomes eligible; his or her
designated tier; and the amount of his or her monthly vehicle allowance.
Termination
The World Headquarters Compensation Department shall inform the Fleet
Administration Department if a participant's eligibility ceases and will provide
the date upon which the monthly allowance should be discontinued.
<PAGE>
Retirement
Participants will continue to receive the monthly allowance as long as they are
actively employed by Eaton Corporation. As is the case with other Terminations,
upon retirement, the monthly allowance shall cease. However, participants may
continue to replace executive vehicles, at their discretion, subject to the
following restrictions:
- - The primary user of the replacement vehicles shall be the participant or his
or her spouse;
- - The total number of replacement vehicles assigned to both the participant and
his or her spouse shall not exceed three during the life of both the participant
and his or her spouse, and two during the life of the surviving spouse;
- - Eligible replacement vehicles include any vehicle (i.e., any automobile,
light-duty truck, and van) available for sale in North America; and
- - Participants will have the right to retain all executive vehicles under the
Executive Vehicle Program on the date of termination of employment for as long
as they choose.
Fees; Insurance Coverage
Any vehicle purchased or leased by a participating executive will be eligible to
participate in the Company's Executive Vehicle Program insurance arrangements
and shall be subject to the program fees and insurance coverage limitations as
they may change from time to time (see Sections VII.G. and VIII. of the
Executive Vehicle Program Guidelines for details).
Responsibility
Responsibility for periodically reviewing this policy for potential changes from
time to time resides with the Vice President - Compensation & Benefits. The
Manager, Corporate Travel & Fleet will be responsible for implementing the
provisions of this policy and for providing participants with any necessary
support and explanations.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-12
<SEQUENCE>5
<FILENAME>l06255aexv12.txt
<DESCRIPTION>EX-12 RATIO OF EARNINGS
<TEXT>
<PAGE>
Eaton Corporation
2003 Annual Report on Form 10-K
Item 15(c)
Exhibit 12
Ratio of Earnings to Fixed Charges
<TABLE>
<CAPTION>
Year ended December 31
---------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Income from continuing operations before
income taxes $ 508 $ 399 $278 $ 552 $ 943
Adjustments
- -----------
Minority interests in
consolidated subsidiaries 12 14 8 8 2
Income of equity investees (3) (1) 0 (1) (1)
Interest expensed 93 110 149 182 159
Amortization of debt issue costs 2 2 1 1 0
Estimated portion of rent expense
representing interest 38 34 38 39 36
Amortization of capitalized interest 13 13 13 10 8
Distributed income of equity
investees 0 0 0 1 0
----- ----- ---- ----- ------
Adjusted income from continuing
operations before income taxes $ 663 $ 571 $487 $ 792 $1,147
===== ===== ==== ===== ======
Fixed charges
- -------------
Interest expensed $ 93 $ 110 $149 $ 182 $ 159
Interest capitalized 7 8 12 22 21
Amortization of debt issue costs 2 2 1 1 0
Estimated portion of rent
representing interest 38 34 38 39 36
----- ----- ---- ----- ------
Total fixed charges $ 140 $ 154 $ 200 $ 244 $ 216
===== ===== ==== ===== ======
Ratio of earnings to fixed charges 4.73 3.71 2.44 3.25 5.31
</TABLE>
Income from continuing operations before income taxes for years before 2002
includes amortization expense related to goodwill and other intangible assets.
Upon adoption of Statement of Financial Accounting Standard No. 142 on January
1, 2002 the Company ceased amortization of goodwill and indefinite life
intangible assets.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-21
<SEQUENCE>6
<FILENAME>l06255aexv21.txt
<DESCRIPTION>EX-21 SUBSIDIARIES
<TEXT>
<PAGE>
Eaton Corporation
2003 Annual Report on Form 10-K
Item 15(c)
Exhibit 21
Subsidiaries of Eaton Corporation
Eaton is publicly held and has no parent corporation. Eaton's subsidiaries as of
December 31, 2003 and the state or country in which each was organized are as
follows:
<TABLE>
<CAPTION>
Consolidated subsidiaries (A) Where Organized
- ----------------------------- ---------------
<S> <C>
Eaton MDH Co. Inc. California
Aeroquip International Inc. Delaware
Eaton Administration Corporation Delaware
Eaton Aerospace LLC Delaware
Eaton Asia Investments Corporation Delaware
Eaton Electrical de Puerto Rico Inc. Delaware
Eaton Electrical Inc. Delaware
Eaton Hydraulics Inc. Delaware
Eaton International Corporation Delaware
Eaton MDH Limited Partnership Delaware
Eaton USEV Holding Company Delaware
ERC Corporation Delaware
ERC II Corporation Delaware
Integrated Partial Discharge Diagnostics, Inc. Delaware
Modern Molded Products, Inc. Delaware
Vickers International Inc. Delaware
CAPCO Automotive Products Corporation Michigan
Eaton Aeroquip Inc. Michigan
Eaton Inoac Company Michigan
G.T. Products, Inc. Michigan
Aeroquip-Vickers, Inc. Ohio
Eaton Electrical IDT Inc. Ohio
Eaton Leasing Corporation Ohio
U.S. Engine Valve Ohio
Eaton Electric Systems Pty. Ltd. Australia
Eaton Finance Pty. Ltd. Australia
Eaton Finance G.P. Australia
Eaton Industries Pty. Ltd. Australia
Eaton Pty. Ltd. Australia
Vickers Systems Pty. Ltd. Australia
Eaton Holding G.m.b.H. Austria
Aeroquip Ltd. Barbados
Aeroquip-Vickers Assurance Ltd. Barbados
Eaton Holding Limited Barbados
Eaton Services Limited Barbados
Eaton Holec Componenten N.V. Belgium
SA Schreder Hazemeyer Belgium
Saturn Insurance Company Ltd. Bermuda Islands
Aeroquip do Brasil S.A. Brazil
Eaton Ltda. Brazil
Eaton Industrias Ltda. Brazil
Vicco Participacoes Ltda. Brazil
Aeroquip-Vickers Canada Inc. Canada
Eaton ETN Offshore Ltd. Canada
Eaton Yale Ltd. Canada
Cutler-Hammer Company Cayman Islands
Cutler-Hammer Industries Ltd. Cayman Islands
Eaton Holding III Limited Cayman Islands
Cutler-Hammer (Suzhou) Electric Co., Ltd. China
Eaton China Investments Co., Ltd. China
</TABLE>
<PAGE>
<TABLE>
<S> <C>
Eaton Truck & Bus Components Company
(Shanghai) Co. Ltd. China
Eaton Fluid Power (Jining) Co. Ltd. China
Eaton Fluid Power (Shanghai) Co. Ltd. China
Shanghai Eaton Engine Components Company, Ltd. China
Zhenjiang Holec Electrical Systems Company Limited China
Eaton Controles Industriales S.A. Costa Rica
Eaton Industries s.r.o. Czech Republic
Eaton Holec, AS Denmark
Cutler-Hammer, S.A. Dominican Republic
Eaton Holec, OY Finland
Eaton S.A. France
Eaton Technologies S.A. France
Eaton Automotive G.m.b.H. Germany
Eaton G.m.b.H. & Co. K.G. Germany
Eaton Fluid Power G.m.b.H. Germany
Eaton Holding G.m.b.H. Germany
Eaton Electric & Engineering Services, Limited Hong Kong
Eaton Limited Hong Kong
Vickers Systems Limited Hong Kong
Eaton Industries Private Ltd. India
Vickers Systems International Ltd. India
Eaton Automotive Ltd. Ireland
Eaton Automotive Srl Italy
Eaton Srl Italy
Eaton Fluid Power Srl Italy
Eaton Fluid Power Limited Japan
Eaton Japan Co., Ltd. Japan
Eaton Holding S.a r.l. Luxembourg
NOCADOLI - SGPS Lda Madeira
Eaton Electric Switchgear Sdn. Bhd. Malaysia
Midland Electrical Manufacturing Holdings Sdn. Bhd. Malaysia
Aeroquip de Mexico S.A. de C.V. Mexico
Aeroquip Servicios S.A. de C.V. Mexico
Controladora Aeroquip-Vickers de Mexico S.A. de C.V. Mexico
Eaton Electrical Mexicana, S.A. Mexico
Eaton Controls, S. de R.L. de C.V. Mexico
Eaton Finance, S. de R.L. de C.V. Mexico
Eaton Industries S. de R.L. de C.V. Mexico
Eaton Molded Products S. de R.L. de C.V. Mexico
Eaton Truck Components, S. de R.L. de C.V. Mexico
Operaciones de Maquila de Juarez S. de R.L. de C.V. Mexico
Eaton s.a.m. Monaco
Eaton Automotive B.V. Netherlands
Eaton B.V. Netherlands
Eaton C.V. Netherlands
Eaton Electric N.V. Netherlands
Eaton Finance B.V. Netherlands
Eaton Holding B.V. Netherlands
Eaton Holding I B.V. Netherlands
Eaton Holding II B.V. Netherlands
Eaton Holding International I B.V. Netherlands
Eaton International B.V. Netherlands
IKU Holding Montfoort B.V. Netherlands
Holec Holland International B.V. Netherlands
Hydrowa B.V. Netherlands
Eaton Finance N.V. Netherlands Antilles
Vickers Systems Limited New Zealand
Aeroquip-Vickers International Inc. Panama
Eaton Automotive Spolka z o.o. Poland
Eaton Truck Components S.A. Poland
Aeroquip Singapore Pte. Limited Singapore
Eaton Electric Switchgear (Asia Pacific) Pte. Ltd. Singapore
</TABLE>
<PAGE>
<TABLE>
<S> <C>
Vickers Systems Asia Pacific Pte. Ltd. Singapore
Aeroquip (South Africa) Pty. Ltd. South Africa
Eaton Truck Components (Pty.) Limited South Africa
Eaton Automotive Controls Limited South Korea
Eaton Limited South Korea
Aeroquip Iberica S.A. Spain
Eaton S.L. Spain
Productos Eaton Livia S.A. Spain
Eaton Holec, AB Sweden
Eaton Global Sourcing G.m.b.H. Switzerland
Eaton Industries G.m.b.H. Switzerland
Eaton SA Switzerland
Modern Molded Products Limited Taiwan
Rubberon Technology Corporation Limited Thailand
Eaton Electric Limited United Kingdom
Eaton Electric Overseas Holding, Limited United Kingdom
Eaton Holding Limited United Kingdom
Eaton Limited United Kingdom
Cutler-Hammer de Venezuela S.A. Venezuela
</TABLE>
(A) Other Eaton subsidiaries, many inactive, are not listed above. If considered
in the aggregate, they would not be material.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-23
<SEQUENCE>7
<FILENAME>l06255aexv23.txt
<DESCRIPTION>EX-23 CONSENT OF INDEPENDENT AUDITORS
<TEXT>
<PAGE>
Eaton Corporation
2003 Annual Report on Form 10-K
Item 15(c)
Exhibit 23
Consent of Independent Auditors
We consent to the incorporation by reference in the following Registration
Statements and related Prospectuses of our report dated January 20, 2004 (except
for the note titled "Two-for-One Stock Split", as to which the date is February
23, 2004), with respect to the consolidated financial statements of Eaton
Corporation included in this Annual Report (Form 10-K) for the year ended
December 31, 2003.
<TABLE>
<CAPTION>
Registration
Number Description Filing Date
- ------------ ----------- -----------
<S> <C> <C>
333-106764 Eaton Corporation - Form S-3 Registration
Statement - $250,000,000 of Debt Securities,
Debt Warrants, Preferred Shares and Common
Shares July 2, 2003
333-105786 Eaton Corporation - Form S-3 Registration
Statement - $47,850,000 of Common Shares June 3, 2003
333-104366 1996 Non-Employee Director Fee Deferral Plan -
Form S-8 Registration Statement April 8, 2003
333-104367 Eaton Savings Plan - Form S-8 Registration
Statement - 5,000,000 Shares April 8, 2003
333-97365 Eaton Corporation Incentive Compensation
Deferral Plan - Form S-8 Registration Statement July 30, 2002
333-97373 Cutler-Hammer de Puerto Rico Inc. Retirement
Savings Plan - Form S-8 Registration Statement July 30, 2002
333-97371 Eaton Corporation 2002 Stock Plan - Form S-8
Registration Statement July 30, 2002
333-43876 Eaton Corporation 401(k) Savings Plan - Form
S-8 Registration Statement - 500,000 Shares August 16, 2000
333-35946 Deferred Incentive Compensation Plan - Form
S-8 Registration Statement - 375,000 Shares May 1, 2000
333-86389 Eaton Corporation Executive Strategic Incentive
Plan - Form S-8 Registration Statement Sept. 2, 1999
333-77245 Eaton Corporation 401(k) Savings Plan -
Form S-8 Registration Statement April 28, 1999
333-77243 Eaton Corporation Share Purchase and Investment
Plan - Form S-8 Registration Statement April 28, 1999
333-74355 Eaton Corporation $1,400,000,000 of Debt
Securities, Debt Warrants, Common Shares and
Preferred Shares - Form S-3 Registration
Statement (Including Post-Effective Amendment
No. 1 filed on April 23, 1999 and Amendment
No. 2 filed on May 11, 1999) March 12, 1999
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C>
333-62375 Eaton Corporation 1998 Stock Plan -
Form S-8 Registration Statement August 27, 1998
333-62373 Eaton Holding Limited U.K. Savings - Related
Share Option Scheme [1998] - Form S-8
Registration Statement August 27, 1998
333-35697 Cutler-Hammer de Puerto Rico Company Retirement
Savings Plan - Form S-8 Registration Statement Sept. 16, 1997
333-28869 Eaton 401(k) Savings Plan and Trust -
Form S-8 Registration Statement June 10, 1997
333-25693 Eaton Corporation Shareholder Dividend Reinvestment
Plan - Form S-3 Registration Statement April 23, 1997
333-23539 Eaton Non-Employee Director Fee Deferral Plan -
Form S-8 Registration Statement March 18, 1997
333-22597 Eaton Incentive Compensation Deferral Plan -
Form S-8 Registration Statement March 13, 1997
333-03599 Eaton Corporation Share Purchase and Investment
Plan - Form S-8 Registration Statement May 13, 1996
333-01365 Eaton Corporation Incentive Compensation Deferral
Plan - Form S-3 Registration Statement March 1, 1996
33-64201 Eaton Corporation $120,837,500 of Debt Securities
and Debt Warrants - Form S-3 Registration
Statement Nov. 14, 1995
33-60907 Eaton 1995 Stock Plan - Form S-8 Registration
Statement July 7, 1995
33-52333 Eaton Corporation $600,000,000 of Debt Securities,
Debt Warrants, Common Shares and Preferred Shares -
Form S-3 Registration Statement Feb. 18, 1994
33-49393& Eaton Corporation Stock Option Plans - Form S-8
33-12842 Registration Statement March 9, 1993
</TABLE>
/s/ Ernst & Young LLP
---------------------
Cleveland, Ohio
March 10, 2004
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-24
<SEQUENCE>8
<FILENAME>l06255aexv24.txt
<DESCRIPTION>EX-24 POWER OF ATTORNEY
<TEXT>
<PAGE>
Eaton Corporation
2003 Annual Report on Form 10-K
Item 15(c)
Exhibit 24
Power of Attorney
KNOW ALL MEN BY THESE PRESENTS: That each person whose name is signed
below has made, constituted and appointed, and by this instrument does make,
constitute and appoint, Richard H. Fearon, Billie K. Rawot or William J. Nowak
his or her true and lawful attorney, for him or her and in his or her name,
place and stead to subscribe, as attorney-in-fact, his or her signature as
Director or Officer or both, as the case may be, of Eaton Corporation, an Ohio
corporation, to its Annual Report on Form 10-K for the year ended December 31,
2003 pursuant to the Securities Exchange Act of 1934, and to any and all
amendments to that Annual Report, hereby giving and granting unto each such
attorney-in-fact full power and authority to do and perform every act and thing
whatsoever necessary to be done in the premises, as fully as he or she might or
could do if personally present, hereby ratifying and confirming all that each
such attorney-in-fact shall lawfully do or cause to be done by virtue hereof.
This Power of Attorney shall not apply to any Annual Report on Form
10-K or amendment thereto filed after December 31, 2004.
IN WITNESS WHEREOF, this Power of Attorney has been signed at
Cleveland, Ohio this 25th day of February 2004.
/s/ Alexander M. Cutler /s/ Richard H. Fearon
- ------------------------------ -------------------------------
Alexander M. Cutler, Chairman Richard H. Fearon,
and Chief Executive Officer; Executive Vice President--Chief
President; Principal Executive Financial and Planning Officer;
Officer; Director Principal Financial Officer
/s/ Billie K. Rawot /s/ Michael J. Critelli
- ------------------------------ -----------------------------
Billie K. Rawot, Michael J. Critelli, Director
Vice President and Controller;
Principal Accounting Officer
/s/ Ned C. Lautenbach
- --------------------- ---------------------------
Ernie Green, Director Ned C. Lautenbach, Director
/s/ Deborah L. McCoy /s/ John R. Miller
- -------------------------- ------------------------
Deborah L. McCoy, Director John R. Miller, Director
/s/ Gregory R. Page /s/ Kiran M. Patel
- ------------------------- ------------------------
Gregory R. Page, Director Kiran M. Patel, Director
/s/ Victor A. Pelson /s/ Gary L. Tooker
- -------------------------- ------------------------
Victor A. Pelson, Director Gary L. Tooker, Director
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-31.1
<SEQUENCE>9
<FILENAME>l06255aexv31w1.txt
<DESCRIPTION>EX-31.1 SECTION 302 CERTIFICATION
<TEXT>
<PAGE>
Eaton Corporation
2003 Annual Report on Form 10-K
Item 15(c)
Exhibit 31.1
Certification
I, Alexander M. Cutler, certify that:
1. I have reviewed this annual report on Form 10-K of Eaton Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control over
financial reporting that occurred during the registrant's most recent fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of registrant's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: March 12, 2004 /s/ Alexander M. Cutler
------------------------------------
Alexander M. Cutler
Chairman and Chief Executive Officer
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-31.2
<SEQUENCE>10
<FILENAME>l06255aexv31w2.txt
<DESCRIPTION>EX-31.2 SECTION 302 CERTIFICATION
<TEXT>
<PAGE>
Eaton Corporation
2003 Annual Report on Form 10-K
Item 15(c)
Exhibit 31.2
Certification
I, Richard H. Fearon, certify that:
1. I have reviewed this annual report on Form 10-K of Eaton Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal control over
financial reporting that occurred during the registrant's most recent fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of registrant's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: March 12, 2004 /s/ Richard H. Fearon
------------------------------------
Richard H. Fearon
Executive Vice President -
Chief Financial and Planning Officer
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-32.1
<SEQUENCE>11
<FILENAME>l06255aexv32w1.txt
<DESCRIPTION>EX-32.1 SECTION 906 CERTIFICATION
<TEXT>
<PAGE>
Eaton Corporation
2003 Annual Report on Form 10-K
Item 15(c)
Exhibit 32.1
Certification
This written statement is submitted in accordance with Section 906 of the
Sarbanes-Oxley Act of 2002. It accompanies Eaton Corporation's Annual Report on
Form 10-K for the year ended December 31, 2003 ("10-K Report").
I hereby certify that, based on my knowledge, the 10-K Report fully complies
with the requirements of Section 13(a) of the Securities Exchange Act of 1934
(15 U.S.C 78m), and information contained in the 10-K Report fairly presents, in
all material respects, the financial condition and results of operations of
Eaton Corporation and its consolidated subsidiaries.
Date: March 12, 2004 /s/ Alexander M. Cutler
------------------------------------
Alexander M. Cutler
Chairman and Chief Executive Officer
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-32.2
<SEQUENCE>12
<FILENAME>l06255aexv32w2.txt
<DESCRIPTION>EX-32.2 SECTION 906 CERTIFICATION
<TEXT>
<PAGE>
Eaton Corporation
2003 Annual Report on Form 10-K
Item 15(c)
Exhibit 32.2
Certification
This written statement is submitted in accordance with Section 906 of the
Sarbanes-Oxley Act of 2002. It accompanies Eaton Corporation's Annual Report on
Form 10-K for the year ended December 31, 2003 ("10-K Report").
I hereby certify that, based on my knowledge, the 10-K Report fully complies
with the requirements of Section 13(a) of the Securities Exchange Act of 1934
(15 U.S.C 78m), and information contained in the 10-K Report fairly presents, in
all material respects, the financial condition and results of operations of
Eaton Corporation and its consolidated subsidiaries.
Date: March 12, 2004 /s/ Richard H. Fearon
------------------------------------
Richard H. Fearon
Executive Vice President -
Chief Financial and Planning Officer
</TEXT>
</DOCUMENT>
</SEC-DOCUMENT>
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