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<SEC-DOCUMENT>0000950152-06-001969.txt : 20060310
<SEC-HEADER>0000950152-06-001969.hdr.sgml : 20060310
<ACCEPTANCE-DATETIME>20060310164107
ACCESSION NUMBER: 0000950152-06-001969
CONFORMED SUBMISSION TYPE: 10-K
PUBLIC DOCUMENT COUNT: 13
CONFORMED PERIOD OF REPORT: 20051231
FILED AS OF DATE: 20060310
DATE AS OF CHANGE: 20060310
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: EATON CORP
CENTRAL INDEX KEY: 0000031277
STANDARD INDUSTRIAL CLASSIFICATION: MISC INDUSTRIAL & COMMERCIAL MACHINERY & EQUIPMENT [3590]
IRS NUMBER: 340196300
STATE OF INCORPORATION: OH
FISCAL YEAR END: 1231
FILING VALUES:
FORM TYPE: 10-K
SEC ACT: 1934 Act
SEC FILE NUMBER: 001-01396
FILM NUMBER: 06679831
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>l17977ae10vk.txt
<DESCRIPTION>EATON CORPORATION 10-K
<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, 2005
COMMISSION FILE NUMBER 1-1396
EATON CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Ohio 34-0196300
- --------------------------------------- ------------------------------------
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
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:
Title of each class Name of each exchange on which registered
- ----------------------------- -----------------------------------------
Common Share ($.50 par value) The New York Stock Exchange
The Chicago Stock Exchange
The Pacific Exchange
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. No [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months 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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). No [X]
The aggregate market value of Common Stock held by non-affiliates of the
registrant as of June 30, 2005 was $8.8 billion.
As of January 31, 2006, there were 148.9 million Common Shares outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2006 annual shareholders' meeting are
incorporated by reference into Part III.
================================================================================
<PAGE>
Part I
ITEM 1. BUSINESS
Eaton Corporation (Eaton or Company) is a diversified industrial manufacturer
having 2005 sales of $11.1 billion. Eaton was incorporated in Ohio in 1916, as a
successor to a New Jersey company incorporated in 1911. The Company is a global
leader in the design, manufacture, marketing and servicing of electrical systems
and components for power quality, distribution and control; fluid power systems
and services for industrial, mobile and aircraft equipment; intelligent truck
drivetrain systems for safety and fuel economy; and automotive engine air
management systems, powertrain solutions and specialty controls for performance,
fuel economy and safety. Headquartered in Cleveland, Ohio, Eaton had 59,000
employees at year-end 2005 and sells products in more than 125 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 http://www.sec.gov.
RECENT DEVELOPMENTS
In light of its strong results for 2005 and future prospects, on January 23,
2006 Eaton announced that it was taking the following actions:
- -- Increasing the quarterly dividend on its Common Shares by 13%, from $.31 per
share to $.35 per share, effective for the February 2006 dividend
- -- Making a voluntary contribution of $100 million to its qualified pension plan
in the United States
- -- Beginning to implement its Excel 07 program. Information on Excel 07 is
presented in "Outlook for 2006" on page F-35 of this report.
In 2005, Eaton acquired certain businesses and formed joint ventures in separate
transactions for a combined net cash purchase price of $911 million. The
Statements of Consolidated Income include the results of these businesses from
the effective dates of acquisition or formation. A summary of these transactions
for 2005 follows (millions of dollars):
<TABLE>
<CAPTION>
Date of Business
Acquired business acquisition segment Annual sales
- ---------------------------------------------------------- ---------------- ----------- ----------------------
<S> <C> <C> <C>
Aerospace division of PerkinElmer, Inc. December 6, 2005 Fluid Power $150 for the year
A U.S. based provider of sealing and pneumatic ended June 30, 2005
systems for large commercial aircraft and regional jets
Aerospace fluid and air division of Cobham plc November 1, 2005 Fluid Power $210 for 2004
A U.K. based company that provides low-pressure
airframe fuel systems, electro-mechanical
actuation, air ducting, hydraulic and power
generation, and fluid distribution systems for
fuel, hydraulics and air
October 11, 2005 Electrical $6 for 2004, one-third
Assets of Pringle Electrical Manufacturing Company of which were to Eaton
A U.S. manufacturer of bolted contact switches and
other specialty switches
Industrial filtration business of Hayward September 6, 2005 Fluid Power $100 for the year
Industries, Inc. ended June 30, 2005
A U.S. based producer of filtration systems for
industrial and commercial customers
Tractech Holdings, Inc. August 17, 2005 Automotive $43 for 2004
A U.S. based manufacturer of specialized
differentials and clutch components for the commercial
and specialty vehicle markets
Morestana S.A. de C.V. June 30, 2005 Automotive $13 for 2004
A Mexican producer of hydraulic lifters for automotive
engine manufacturers and the automotive aftermarket
Eaton Electrical (Zhongshan) Co., Ltd. (a 51%-owned June 17, 2005 Electrical N/A
joint venture)
A Chinese manufacturer of medium-voltage
switchgear components, including circuit
breakers, meters and relays
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Date of Business
Acquired business acquisition segment Annual sales
- ---------------------------------------------------------- ---------------- ----------- ----------------------
<S> <C> <C> <C>
Winner Group Holdings Ltd. March 31, 2005 Fluid Power $26 for 2004
A Chinese producer of hydraulic hose fittings and
adapters
Pigozzi S.A. Engrenagens e Transmissoes March 1, 2005 Truck $42 for 2004
A Brazilian agricultural powertrain business that
produces transmissions, rotors and other drivetrain
components
</TABLE>
BUSINESS SEGMENT INFORMATION
Information by business segment and geographic region regarding principal
products, principal markets, methods of distribution, net sales, operating
profit and assets is presented in "Business Segment & Geographic Region
Information" on pages F-25 through F-27 of this report. Additional information
regarding Eaton's segments and business is presented below.
ELECTRICAL
Seasonal Fluctuations -- Sales of this segment are historically lower in the
first quarter, and higher in the third and fourth quarters of a year.
Significant Customers -- Approximately 10% of this segment's net sales in 2005
were made to one customer, located in the United States, which is not a
significant customer of any other segment.
Competition -- Principal methods of competition in this segment are price,
geographic coverage, service and product performance. Eaton has 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.
FLUID POWER
Seasonal Fluctuations -- Sales of this segment are not affected by seasonal
fluctuations.
Significant Customers -- Approximately 10% of this segment's net sales in 2005
were made to five original equipment manufacturers of vehicles in the United
States and Europe. Three of these customers are also significant customers of
the Automotive segment, and two of these customers are also significant
customers of the Truck segment. Also, approximately 5% of this segment's net
sales in 2005 were made to two manufacturers of off-highway agricultural and
construction vehicles.
Competition -- Principal methods of competition in this segment are price,
geographic coverage, service and product performance. Eaton has 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.
TRUCK
Seasonal Fluctuations -- Sales of this segment are not affected by seasonal
fluctuations.
Significant Customers -- Approximately 77% of this segment's net sales in 2005
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 and Fluid Power segments.
Competition -- Principal methods of competition in this segment are price,
service and product performance. Eaton has 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.
AUTOMOTIVE
Seasonal Fluctuations -- Sales of this 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.
Significant Customers -- Approximately 58% of this segment's net sales in 2005
were made to divisions and subsidiaries of four large original equipment
manufacturers of vehicles and two automotive component suppliers. All of these
customers are concentrated in North America and Europe. Three of these customers
are also significant customers of the Fluid Power segment, and two of these
customers are also significant customers of the Truck segment.
Competition -- Principal methods of competition in this segment are price,
service and product performance. Eaton has 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.
<PAGE>
INFORMATION CONCERNING EATON'S BUSINESS IN GENERAL
RAW MATERIALS -- Principal raw materials used are iron, steel, copper, nickel,
aluminum, brass, silver, molybdenum, titanium, vanadium, rubber, plastic and
insulating materials. Materials are purchased in various forms, such as
extrusions, castings, powder metal, 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. In 2005, due to raw materials
supply shortages resulting from higher global demand, Eaton paid higher prices
for basic metals. At the end of 2005, the Company maintained higher levels of
inventory to guard against basic metals shortages.
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 in the future. 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 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 trucks, off-highway vehicles and passenger
cars 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, 2005 and 2004 was approximately $2.0 billion and $1.5 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 2005, 2004 and 2003 (in millions) were
$287, $261 and $223, 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 2006 and 2007. Information
regarding the Company's liabilities related to environmental matters is
presented in "Protection of the Environment" on page F-20 of this report.
FOREIGN OPERATIONS -- Financial information related to Eaton's foreign
operations is presented in "Business Segment & Geographic Information" on page
F-26 of this report. Information regarding risks that may affect Eaton's foreign
operations is presented in Item 1A of this Form 10-K.
ITEM 1A. RISK FACTORS
Among the risks that could materially adversely affect Eaton's business,
financial condition or results of operations are the following:
DOWNTURNS IN THE END MARKETS THAT EATON SERVES MAY NEGATIVELY IMPACT EATON'S
SEGMENT REVENUES AND PROFITABILITY.
Eaton's segment revenues, operating results and profitability have varied in the
past and may vary from quarter to quarter in the future. Profitability can be
negatively impacted by volatility in the end markets that Eaton serves, although
the Company has undertaken measures to reduce the impact of such volatility.
Future downturns in any of the markets that Eaton serves could adversely affect
the Company's overall sales and operating results.
EATON'S OPERATING RESULTS DEPEND IN PART ON CONTINUED SUCCESSFUL RESEARCH,
DEVELOPMENT AND MARKETING OF NEW AND/OR IMPROVED PRODUCTS AND SERVICES, AND
THERE CAN BE NO ASSURANCE THAT EATON WILL CONTINUE TO SUCCESSFULLY INTRODUCE NEW
PRODUCTS AND SERVICES.
The success of new and improved products and services depends on their initial
and continued acceptance by Eaton's customers. The Company's businesses are
affected by varying degrees of technological change and corresponding shifts in
customer demand, which could result in unpredictable product transitions or
shortened life cycles. Eaton may experience difficulties or delays in the
research, development, production and/or marketing of new products and services
which may negatively impact the Company's operating results and prevent Eaton
from recouping or realizing a return on the investments required to bring new
products and services to market.
<PAGE>
EATON'S OPERATIONS DEPEND ON PRODUCTION FACILITIES THROUGHOUT THE WORLD, MANY OF
WHICH ARE LOCATED OUTSIDE THE UNITED STATES AND ARE SUBJECT TO INCREASED RISKS
OF DISRUPTED PRODUCTION.
Eaton manages businesses with manufacturing facilities worldwide, many of which
are located outside the United States. The Company's manufacturing facilities
and operations could be disrupted by a natural disaster, labor strike, war,
political unrest, terrorist activity or public health concerns. Eaton's
non-United States (foreign) manufacturing facilities also may be more
susceptible to economic and political upheaval than Eaton's domestic facilities.
Any such disruption could cause delays in shipments of products and the loss of
sales and customers, and insurance proceeds may not adequately compensate the
Company.
EATON'S SUBSTANTIAL FOREIGN SALES SUBJECT IT TO ECONOMIC RISK AS EATON'S RESULTS
OF OPERATIONS MAY BE ADVERSELY AFFECTED BY CHANGES IN LOCAL GOVERNMENT
REGULATIONS AND POLICIES AND FOREIGN CURRENCY FLUCTUATIONS.
As noted above in Item 1 "Foreign Operations", a significant portion of Eaton's
sales are outside the United States, and the Company expects sales in foreign
markets to continue to represent a significant portion of Eaton's total sales.
Foreign sales and operations are subject to changes in local government
regulations and policies, including those related to tariffs and trade barriers,
investments, taxation, exchange controls, and repatriation of earnings. Changes
in the relative values of currencies occur from time to time and could affect
Eaton's operating results. While the Company monitors exchange rate exposures
and attempts to reduce these exposures through hedging activities, these risks
could adversely affect the Company's operating results.
EATON USES A VARIETY OF RAW MATERIALS AND COMPONENTS IN ITS BUSINESSES, AND
SIGNIFICANT SHORTAGES OR PRICE INCREASES COULD INCREASE OPERATING COSTS AND
ADVERSELY IMPACT THE COMPETITIVE POSITIONS OF EATON'S PRODUCTS.
Eaton's major requirements for raw materials include iron, steel, copper,
nickel, aluminum, brass, silver, molybdenum, titanium, vanadium, rubber, plastic
and insulating materials. The Company has multiple sources of supply for each of
its major requirements and is not significantly dependent on any one or a few
suppliers. In 2005, Eaton experienced price increases for basic metals due to
raw materials supply shortages resulting from higher global demand. At the end
of 2005, Eaton maintained higher levels of inventory to guard against basic
metals shortages. Nonetheless, significant shortages in excess of those
experienced in 2005 could affect the prices Eaton's affected businesses are
charged and the competitive position of their products and services, all of
which could adversely affect Eaton's results of operations.
EATON ENGAGES IN ACQUISITIONS, AND MAY ENCOUNTER UNEXPECTED DIFFICULTIES
IDENTIFYING, PRICING OR INTEGRATING THOSE BUSINESSES.
Eaton seeks to grow, in part, through strategic acquisitions and joint venture
arrangements intended to complement or expand the Company's businesses, and will
continue to do so in the future. The success of these transactions will depend
on Eaton's ability to identify and price these arrangements. Success will also
depend on the Company's ability to integrate assets and personnel acquired in
these transactions and to cooperate with the Company's strategic partners. Eaton
may encounter unexpected difficulties in integrating acquisitions with Eaton's
existing operations, and in managing strategic investments. Furthermore, the
Company may not realize the degree, or timing, of benefits Eaton anticipated
when it first entered into a transaction. Any of the foregoing could adversely
affect the Company's business and results of operations.
EATON MAY BE UNABLE TO ADEQUATELY PROTECT ITS INTELLECTUAL PROPERTY RIGHTS,
WHICH COULD AFFECT THE COMPANY'S ABILITY TO COMPETE.
Protecting Eaton's intellectual property rights is critical to the Company's
ability to compete and succeed as a company. The Company owns a large number of
United States and foreign patents and patent applications, as well as trademark
and copyright registrations that are necessary, and contribute significantly, to
the preservation of Eaton's competitive position in the market. Although
management believes that the loss or expiration of any single intellectual
property right would not have a material effect on the results of operations or
financial position of Eaton or its business segments, there can be no assurance
that any one, or more, of these patents and other intellectual property will not
be challenged, invalidated or circumvented by third parties. Eaton enters into
confidentiality and invention assignment agreements with the Company's
employees, and into non-disclosure agreements with Eaton's suppliers and
appropriate customers so as to limit access to and disclosure of the Company's
proprietary information. These measures may not suffice to deter
misappropriation or independent third party development of similar technologies.
Moreover, the protection provided to Eaton's intellectual property by the laws
and courts of foreign nations may not be as advantageous to Eaton as the
remedies available under United States law.
<PAGE>
EATON IS SUBJECT TO LITIGATION AND ENVIRONMENTAL REGULATIONS THAT COULD
ADVERSELY IMPACT EATON'S OPERATING RESULTS.
At any given time, Eaton may be subject to litigation, the disposition of which
may have a material adverse effect on the Company. Information regarding the
Company's current legal proceedings is presented in "Protection of the
Environment" and "Contingencies" on page F-20 of this report.
EATON ENGAGES IN MARKETS THAT ARE COMPETITIVE AND EATON'S RESULTS COULD BE
ADVERSELY IMPACTED BY COMPETITORS' ACTIONS.
Eaton's businesses operate in competitive markets. The Company competes against
other global manufacturers on the basis of price and quality, in addition to
other factors. While Eaton's pricing and quality initiatives have been
competitive strengths in the past, actions by Eaton's competitors could lead to
downward pressure on prices and/or a decline in the Company's market share,
either of which could adversely affect Eaton's results.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Eaton received comment letters from the Securities and Exchange Commission on
November 4 and November 25, 2005. There are no unresolved staff comments.
ITEM 2. PROPERTIES
Eaton's world headquarters is located in Cleveland, Ohio. The Company maintains
manufacturing facilities at 210 locations in 32 countries, including 31
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 existing
manufacturing facilities are adequate for operations, and such facilities are
maintained in good condition.
ITEM 3. LEGAL PROCEEDINGS
Information regarding the Company's current legal proceedings is presented in
"Protection of the Environment" and "Contingencies" on page F-20 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 2005 and 2004 is
presented in "Quarterly Data" on page F-44 of this report. At December 31, 2005,
there were 9,265 holders of record of the Company's Common Shares. Additionally,
21,109 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.
ITEM 6. SELECTED FINANCIAL DATA
Information regarding selected financial data is presented in the "Ten-Year
Consolidated Financial Summary" on page F-43 of this report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
"Management's Discussion & Analysis of Financial Condition & Results of
Operations" is presented on pages F-28 through F-42 of this report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information regarding market risk is presented in "Market Risk Disclosure &
Contractual Obligations" on pages F-37 and F-38 of this report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The report of the independent registered public accounting firm, consolidated
financial statements, and notes to consolidated financial statements are
presented on pages F-1 through F-27 of this report.
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
<PAGE>
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure 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; President 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, 2005.
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.
Changes in Internal Control Over Financial Reporting -- During fourth quarter
2005, there was no change in Eaton's internal control over financial reporting
that materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
"Management's Report on Internal Control Over Financial Reporting" is presented
on page F-4 of this report.
"Report of Independent Registered Public Accounting Firm" on "Management's
Report on Internal Control Over Financial Reporting" is presented on page F-3 of
this report.
ITEM 9B. OTHER INFORMATION
None.
<PAGE>
Part III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
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 17, 2006, and is incorporated by
reference.
A listing of Eaton's elected executive officers, their ages, positions and
offices held over the past five years, as of January 31, 2006, follows:
<TABLE>
<CAPTION>
Name Age Position (Date elected to position)
- ----------------------- ------ ------------------------------------------------------------------------------------------------
<S> <C> <C>
Alexander M. Cutler 54 Chairman and Chief Executive Officer; President (August 1, 2000 -- present)
Director (1993 -- present)
Richard H. Fearon 49 Executive Vice President -- Chief Financial and Planning Officer (April 24, 2002 -- present)
Partner, Willow Place Partners LLC (2001--2002)
Craig Arnold 45 Senior Vice President and President -- Fluid Power Group (October 25, 2000 -- present)
Stephen M. Buente 55 Senior Vice President and President -- Automotive Group (August 21, 2000 -- present)
Randy W. Carson 55 Senior Vice President and President -- Electrical Group (January 1, 2000 -- present)
James E. Sweetnam 53 Senior Vice President and President -- Truck Group (July 1, 2001 -- present)
Vice President -- Heavy-Duty Transmission, Clutch and Aftermarket (2000 -- 2001)
William W. Blausey, Jr. 41 Vice President -- Chief Information Officer (January 25, 2006 -- present)
Vice President -- Information Technology, Fluid Power (January 2005 -- January 24, 2006)
Group Director -- IT (August 16, 2001 -- January 2005)
Director -- IT (January 1, 2001 -- August 15, 2001)
Susan J. Cook 58 Vice President -- Human Resources (January 16, 1995 -- present)
Earl R. Franklin 62 Vice President and Secretary (April 24, 2002 -- present)
Secretary and Associate General Counsel (September 1, 1991 -- April 23, 2002)
James W. McGill 50 Vice President -- Eaton Business System (July 16, 2004 -- present)
Vice President and General Manager -- Industrial Controls Division (January 1, 2001 --
July 2004)
Donald J. McGrath, Jr. 53 Vice President -- Communications (January 25, 2006 -- present)
Vice President, Corporate Communications, BASF Corporation (2002 --2005)
Vice President, Global Communications, Rockwell Automation, Inc. (2000 --2002)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Name Age Position (Date elected to position)
- ----------------------- ------ ------------------------------------------------------------------------------------------------
<S> <C> <C>
Mark M. McGuire 48 Vice President and General Counsel (December 1, 2005 -- present)
Vice President and Deputy General Counsel, International Paper Company (2003 -- 2005)
Associate General Counsel, International Paper Company (March 2001 -- 2003)
General Counsel -- Europe, International Paper Company (December 1997 -- March 2001)
John S. Mitchell 49 Vice President -- Taxes (November 22, 1999 -- present)
Robert E. Parmenter 53 Vice President and Treasurer (January 1, 1997 -- present)
Billie K. Rawot 54 Vice President and Controller (March 1, 1991 -- present)
Ken D. Semelsberger 44 Vice President -- Strategic Planning (April 28, 1999 -- present)
Yannis P. Tsavalas 50 Vice President and Chief Technology Officer (February 14, 2005 -- present)
General Manager, Global Lighting Technology, General Electric (2004 -- 2005)
Global Technology Leader, GE Lighting, General Electric (2003-2004)
Global Product Line Manager, GE Lighting, General Electric (August 2000 -- 2003)
</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.
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 (chair), John R. Miller, Kiran M.
Patel, and Gary L. Tooker. The Board of Directors of Eaton has determined that
John R. Miller qualifies as an audit committee financial expert as defined by
Item 401(h) of Regulation S-K of the Exchange Act and is independent within the
meaning of Item 7(d)(3)(iv) of Schedule 14A of the Exchange Act.
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 17, 2006, and is incorporated by reference.
The Company has adopted a Code of Ethics, which applies to the Directors,
officers (including its Chairman and Chief Executive Officer; President,
Executive Vice President--Chief Financial and Planning Officer, and Vice
President and Controller) and employees worldwide. The Code of Ethics is
included as an exhibit in the Company's definitive Proxy Statement to be filed
on or about March 17, 2006, 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.
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 17, 2006, and is incorporated by reference.
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information required with respect to security ownership of certain beneficial
owners is set forth under the caption "Share Ownership Tables" in the Company's
definitive Proxy Statement to be filed on or about March 17, 2006, and is
incorporated by reference.
EQUITY COMPENSATION PLANS
The following table summarizes information, as of December 31, 2005, relating to
equity compensation plans of the Company pursuant to which grants of options,
restricted stock, deferred compensation units or other rights to acquire Company
common shares may be granted from time to time.
<TABLE>
<CAPTION>
(A) (B) (C)
Number of Securities
Remaining Available for
Number of Securities Weighted-Average Future Issuance Under
to be Issued Upon Exercise Price of Equity Compensation
Exercise of Outstanding Plans (Excluding
Outstanding Options, Options, Warrants Securities Reflected in
Plan category Warrants and Rights and Rights Column (A))
- -------------------------------------------------------------- -------------------- ----------------- -----------------------
<S> <C> <C> <C>
Equity compensation plans approved by security holders (1) 15,133,033(3) $ 42.95(5) 6,914,111
Equity compensation plans not approved by security holders (2) 1,705,747(4) N/A N/A(2)
-------------------- ----------------- -----------------------
Total 16,838,780 $ 42.95 6,914,111
==================== ================= =======================
</TABLE>
- ----------
(1) These plans are the Company's 2004 Stock Plan, 2002 Stock Plan, 1998
Stock Plan, 1995 Stock Plan, 1991 Stock Option Plan, and the Incentive
Compensation Deferral Plans.
(2) The 2005 Non-Employee Director Fee Deferral Plan (the "2005 Plan"), the
1996 Non-Employee Director Fee Deferral Plan (the "1996 Plan") and the
Deferred Incentive Compensation Plan (the "DIC Plan") are not
considered "equity compensation plans" requiring shareholder approval
under the rules of the New York Stock Exchange. Under the 2005 Plan and
the 1996 Plan, all non-employee directors are entitled to defer payment
of their fees and allocate the deferred amounts between short-term
deferred fees and retirement deferred fees, which differ in terms of
earnings and method and timing of distribution. Short-term deferred
fees are credited with interest based on the quarterly average yield of
the 13-week U.S. Treasury bill and are distributable in cash. At least
50% of deferred amounts allocated to retirement deferred fees are
converted into Company share units, earn Company share price
appreciation plus dividend equivalents, and are distributable in
Company shares. The balance of retirement deferred fees earn 10-year
U.S. Treasury note returns plus 300 basis points and are distributable
in cash. Under the 2005 Plan, prior to the beginning of each calendar
year, plan participants elect the method and timing of payment with
respect to the fees to be earned in that year. For short-term deferred
fees, participants can elect to receive distributions in a lump sum or
in equal annual installments over a period not to exceed five years
commencing in the year selected by the plan participant, which cannot
be earlier than the second year following the calendar year in which
fees are deferred. For retirement deferred fees, plan participants can
elect to receive distributions in a lump sum or in equal annual
installments over a period not to exceed 15 years following retirement.
Under the 1996 Plan, the Governance Committee determines, upon the
participant's retirement or other termination of services as a
director, whether fees deferred are distributable in a lump sum or in
equal annual installments and whether the amounts converted to Company
share units are distributable in cash or Company common shares. Both
the 2005 Plan and the 1996 Plan provide for accelerated payout upon the
occurrence of certain events including those involving a change in
control of the Company. Under the DIC Plan, participants, including
officers and other eligible executives, are able to defer receipt of
their annual incentive compensation award as either short-term
deferrals (five years) or retirement compensation. Amounts deferred as
retirement compensation earn the greater of Company share price
appreciation plus dividend equivalents or 13-week U.S. Treasury bill
returns until paid. This determination is made at the time of each
payment, whether made in a lump sum or installments. Short-term
deferrals earn 13-week U.S. Treasury bill returns. Amounts deferred as
retirement compensation which are converted to Company share units are
payable in Company common shares, either in a lump sum or periodic
installments, as determined by the Company's Corporate Compensation
Committee which is comprised of Company officers. Participants were
able to defer the full amount of eligible cash compensation under the
2005 Plan, the 1996 Plan and the EIC Plan. To the extent cash
compensation is deferred pursuant to these Plans, or pursuant to the
Incentive Compensation Deferral Plan, the Company may be able to
preserve the deductibility of the compensation under Section 162(m) of
the Internal Revenue Code. However, in some circumstances cash
compensation paid to executive officers is not deductible by the
Company.
<PAGE>
(3) Includes an aggregate of 263,040 restricted shares, 2,423,690
performance-vested stock options and 475,329 shares underlying stock
units, payable on a one-for-one basis, credited to stock unit accounts
as of December 31, 2005 under the Incentive Compensation Deferral
Plans.
(4) Represents shares underlying stock units, payable on a one-for-one
basis, credited to stock unit accounts as of December 31, 2005 under
the 2005 Non-Employee Director Fee Deferral Plan, the 1996 Non-Employee
Director Fee Deferral Plan and the Deferred Incentive Compensation
Plan.
(5) Weighted average exercise price of outstanding stock options; excludes
restricted stock and deferred compensation share units.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None required to be reported.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information required with respect to principal accounting 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 17, 2006, and is incorporated by
reference.
<PAGE>
Part IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) The report of the independent registered public accounting firm,
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 Registered Public Accounting Firm -- Page F-1
Statements of Consolidated Income -- Years ended December 31, 2005,
2004 and 2003 -- Page F-5
Consolidated Balance Sheets -- December 31, 2005 and 2004 -- Page F-6
Statements of Consolidated Cash Flows -- Years ended December 31, 2005,
2004 and 2003 -- Page F-7
Statements of Consolidated Shareholders' Equity -- Years ended December
31, 2005, 2004 and 2003 -- Pages F-8 and F-9
Notes to Consolidated Financial Statements -- Pages F-10 through F-27
(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(i) Amended Articles of Incorporation (amended and restated April
27, 1994) -- Incorporated by reference to the Form 10-K for
the year ended December 31, 2002
3(ii) Amended Regulations (amended and restated 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)
10 Material contracts
(a) Master Purchase and Sale Agreement by and between
PerkinElmer, Inc. and Eaton Corporation dated October
6, 2005 -- Filed in conjunction with this Form 10-K
(b) Executive Incentive Compensation Plan (effective
January 1, 2005) -- Filed in conjunction with this
Form 10-K
(c) 2005 Non-Employee Director Fee Deferral Plan
(effective January 1, 2005) -- Incorporated by
reference to the Form 10-K for the year ended
December 31, 2004
(d) Deferred Incentive Compensation Plan II (effective
January 1, 2005) -- Incorporated by reference to the
Form 10-K for the year ended December 31, 2004
(e) Excess Benefits Plan II (effective January 1, 2005)
-- Incorporated by reference to the Form 10-K for the
year ended December 31, 2004
(f) Incentive Compensation Deferral Plan II (effective
January 1, 2005) -- Incorporated by reference to the
Form 10-K for the year ended December 31, 2004
(g) Limited Eaton Service Supplemental Retirement Income
Plan II (effective January 1, 2005) -- Incorporated
by reference to the Form 10-K for the year ended
December 31, 2004
(h) Supplemental Benefits Plan II (effective January 1,
2005) -- Incorporated by reference to the Form 10-K
for the year ended December 31, 2004
(i) Amendment to the Plan (originally adopted in 1985)
for the Deferred Payment of Directors' Fees
(effective January 1, 2005) -- Incorporated by
reference to the Form 10-K for the year ended
December 31, 2004
(j) Form of Restricted Share Award Agreement --
Incorporated by reference to the Form 10-K for the
year ended December 31, 2004
(k) Form of Stock Option Agreement for Executives --
Incorporated by reference to the Form 10-K for the
year ended December 31, 2004
<PAGE>
(l) Form of Stock Option Agreement for Non-Employee
Directors - Incorporated by reference to the Form
10-K for the year ended December 31, 2004
(m) 2004 Stock Plan -- Incorporated by reference to the
definitive Proxy Statement dated March 19, 2004
(n) Plan for the Deferred Payment of Directors' Fees
(originally adopted in 1985 and amended effective
September 24, 1996, January 28, 1998, January 23,
2002 and February 24, 2004) -- Incorporated by
reference to the Form 10-Q for the three months ended
March 31, 2004
(o) Limited Eaton Service Supplemental Retirement Income
Plan (amended and restated January 1, 2003) --
Incorporated by reference to the Form 10-K for the
year ended December 31, 2002
(p) Vehicle Allowance Program (effective January 1, 2003)
-- Incorporated by reference to the Form 10-K for the
year ended December 31, 2003
(q) 2002 Stock Plan -- Incorporated by reference to the
definitive Proxy Statement dated March 15, 2002
(r) 1996 Non-Employee Director Fee Deferral Plan (amended
and restated October 22, 2002) -- Incorporated by
reference to the Form 10-K for the year ended
December 31, 2002
(s) 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
(t) 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
(u) Executive Strategic Incentive Plan I (amended and
restated January 1, 2001) -- Incorporated by
reference to the Form 10-K for the year ended
December 31, 2002
(v) Executive Strategic Incentive Plan II (effective
January 1, 2001) -- Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(w) Deferred Incentive Compensation Plan (amended and
restated March 31, 2000) -- Incorporated by reference
to the Form 10-K for the year ended December 31, 2000
(x) 1998 Stock Plan -- Incorporated by reference to the
definitive Proxy Statement dated March 13, 1998
(y) Incentive Compensation Deferral Plan (amended and
restated October 1, 1997) -- Incorporated by
reference to the Form 10-K for the year ended
December 31, 2000
(z) 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
(aa) Trust Agreement -- Officers and Employees (dated
December 6, 1996) -- Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(bb) Trust Agreement -- Outside Directors (dated December
6, 1996) -- Incorporated by reference to the Form
10-K for the year ended December 31, 2002
(cc) 1995 Stock Plan -- Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(dd) Group Replacement Insurance Plan (GRIP) (effective
June 1, 1992) -- Incorporated by reference to the
Form 10-K for the year ended December 31, 1992
(ee) 1991 Stock Option Plan -- Incorporated by reference
to the Form 10-K for the year ended December 31, 2002
(ff) 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
<PAGE>
(gg) Supplemental Benefits Plan (amended and restated
January 1, 1989) (which provides supplemental
retirement benefits) -- Incorporated by reference to
the Form 10-K for the year ended December 31, 2002
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 17, 2006
21 Subsidiaries of Eaton Corporation -- Filed in conjunction with
this Form 10-K
23 Consent of Independent Registered Public Accounting Firm --
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) Exhibits
Certain exhibits required by this portion of Item 15 are filed as a separate
section of this Form 10-K.
(c) 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 10, 2006 /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 10, 2006
<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
*
- --------------------
Ernie Green Director
*
- --------------------
Ned C. Lautenbach Director
*
- --------------------
Deborah L. McCoy Director
*
- --------------------
John R. Miller Director
*
- --------------------
Gregory R. Page Director
*
- --------------------
Kiran M. Patel Director
*
- --------------------
Victor A. Pelson Director
*
- --------------------
Gary L. Tooker Director
</TABLE>
* By /s/ Richard H. Fearon
-------------------------------------------------------------------------
Richard H. Fearon, Attorney-in-Fact for the officers and directors signing
in the capacities indicated
<PAGE>
Consolidated Financial Statements of Eaton Corporation
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors & Shareholders
Eaton Corporation
We have audited the accompanying consolidated balance sheets of Eaton
Corporation as of December 31, 2005 and 2004, and the related statements of
consolidated income, shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 2005. 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 the standards of the Public Company
Accounting Oversight Board (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, 2005 and 2004, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December 31,
2005, in conformity with United States generally accepted accounting principles.
We also have audited in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Eaton
Corporation's internal control over financial reporting as of December 31, 2005,
based on criteria established in Internal Control -- Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated February 10, 2006 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
- ---------------------
Cleveland, Ohio
February 10, 2006
F-1
<PAGE>
MANAGEMENT'S REPORT ON FINANCIAL STATEMENTS
We have prepared the accompanying consolidated financial statements and related
information of Eaton Corporation included herein for the three years ended
December 31, 2005. The primary responsibility for the integrity of the financial
information included in this annual report rests with management. The financial
information included in this annual report has been prepared in accordance with
accounting principles generally accepted in the United States based on our best
estimates and judgments and giving due consideration to materiality. The opinion
of Ernst & Young LLP, Eaton's independent registered public accounting firm, on
those financial statements is included herein.
Eaton has high standards of ethical business practices supported by the Eaton
Code of Ethics and corporate policies. Careful attention is given to selecting,
training and developing personnel, to ensure that management's objectives of
establishing and maintaining adequate internal controls and unbiased, uniform
reporting standards are attained. Our policies and procedures provide reasonable
assurance that operations are conducted in conformity with law and with the
Company's commitment to a high standard of business conduct.
The Board of Directors pursues its responsibility for the quality of Eaton's
financial reporting primarily through its Audit Committee, which is composed of
four independent directors. The Audit Committee meets regularly with management,
the internal auditors and the independent registered public accounting firm to
ensure that they are meeting their responsibilities and to discuss matters
concerning accounting, control, audits and financial reporting. The internal
auditors and independent registered public accounting firm have full and free
access to senior management and the Audit Committee.
<TABLE>
<S> <C> <C>
/s/ Alexander M. Cutler /s/ Richard H. Fearon /s/ Billie K. Rawot
- ----------------------------------- ---------------------------------- --------------------------------
Chairman and Chief Executive Vice President -- Vice President and Controller
Executive Officer; Chief Financial and Planning
President Officer
</TABLE>
February 10, 2006
F-2
<PAGE>
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors & Shareholders
Eaton Corporation
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that Eaton
Corporation maintained effective internal control over financial reporting as of
December 31, 2005, based on criteria established in Internal Control --
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Eaton Corporation's management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the Company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
As indicated in the accompanying Management's Report on Internal Control Over
Financial Reporting, management's assessment of and conclusion on the
effectiveness of internal control over financial reporting excluded entities
that were acquired during 2005. On a combined basis, these entities represented
approximately 1% of net sales for 2005 and 4% of total assets at December 31,
2005. Our audit of internal control over financial reporting of Eaton
Corporation also did not include an evaluation of the internal control over
financial reporting for entities acquired in 2005.
In our opinion, management's assessment that Eaton Corporation maintained
effective internal control over financial reporting as of December 31, 2005, is
fairly stated, in all material respects, based on the COSO criteria. Also in our
opinion, Eaton Corporation maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2005, based on the
COSO criteria.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Eaton Corporation as of December 31, 2005 and 2004, and the related statements
of consolidated income, shareholders' equity, and cash flows for each of the
three years in the period ended December 31, 2005 and our report dated February
10, 2006 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
- ---------------------
Cleveland, Ohio
February 10, 2006
F-3
<PAGE>
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Eaton Corporation is responsible for establishing and
maintaining adequate internal control over financial reporting (as defined in
Exchange Act rules 13a-15(f)).
Under the supervision and with the participation of Eaton's management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of the effectiveness of the Company's internal control
over financial reporting as of December 31, 2005. Our evaluation of internal
control over financial reporting excluded those entities that were acquired
during 2005. On a combined basis, these entities represented approximately 1% of
net sales for 2005 and 4% of total assets at December 31, 2005. In conducting
this evaluation, we used the framework set forth by the Committee of Sponsoring
Organizations of the Treadway Commission in Internal Control - Integrated
Framework. Based on this evaluation under the framework referred to above,
management concluded that the Company's internal control over financial
reporting was effective as of December 31, 2005.
The independent registered public accounting firm Ernst & Young LLP has issued
an audit report on management's assessment of the effectiveness of the Company's
internal control over financial reporting as of December 31, 2005. This report
is included herein.
<TABLE>
<S> <C> <C>
/s/ Alexander M. Cutler /s/ Richard H. Fearon /s/ Billie K. Rawot
- ----------------------------------- ---------------------------------- --------------------------------
Chairman and Chief Executive Vice President -- Vice President and Controller
Executive Officer; Chief Financial and Planning
President Officer
</TABLE>
February 10, 2006
F-4
<PAGE>
EATON CORPORATION
STATEMENTS OF CONSOLIDATED INCOME
<TABLE>
<CAPTION>
Year ended December 31
-----------------------------------------
(Millions except for per share data) 2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ................................................................. $ 11,115 $ 9,817 $ 8,061
Cost of products sold ..................................................... 8,012 7,082 5,897
Selling & administrative expense .......................................... 1,757 1,587 1,351
Research & development expense ............................................ 287 261 223
Interest expense-net ...................................................... 90 78 87
Provision to exit a business .............................................. 15
Other (income) expense-net ................................................ (27) 13 (5)
---------- ---------- ----------
Income before income taxes ................................................ 996 781 508
Income taxes .............................................................. 191 133 122
---------- ---------- ----------
Net income ................................................................ $ 805 $ 648 $ 386
========== ========== ==========
Net income per Common Share assuming dilution ............................. $ 5.23 $ 4.13 $ 2.56
Average number of Common Shares outstanding assuming dilution ............. 154.0 157.1 150.5
Net income per Common Share basic ......................................... $ 5.36 $ 4.24 $ 2.61
Average number of Common Shares outstanding basic ......................... 150.2 153.1 147.9
Cash dividends paid per Common Share ...................................... $ 1.24 $ 1.08 $ .92
</TABLE>
The notes on pages F-10 to F-27 are an integral part of the consolidated
financial statements.
F-5
<PAGE>
EATON CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31
--------------------------
(Millions of dollars) 2005 2004
---------- ----------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash ................................................................................ $ 110 $ 85
Short-term investments .............................................................. 226 211
Accounts receivable ................................................................. 1,785 1,612
Inventories ......................................................................... 1,099 966
Deferred income taxes ............................................................... 243 216
Other current assets ................................................................ 115 92
---------- ----------
3,578 3,182
---------- ----------
Property, plant & equipment
Land & buildings ................................................................. 1,003 959
Machinery & equipment ............................................................ 3,652 3,526
---------- ----------
4,655 4,485
Accumulated depreciation ......................................................... (2,480) (2,338)
---------- ----------
2,175 2,147
Goodwill ............................................................................ 3,139 2,433
Other intangible assets ............................................................. 626 644
Deferred income taxes & other assets ................................................ 700 669
---------- ----------
$ 10,218 $ 9,075
========== ==========
LIABILITIES & SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term debt ..................................................................... $ 394 $ 13
Current portion of long-term debt ................................................... 240 26
Accounts payable .................................................................... 810 776
Accrued compensation ................................................................ 277 270
Accrued income & other taxes ........................................................ 305 283
Other current liabilities ........................................................... 942 899
---------- ----------
2,968 2,267
---------- ----------
Long-term debt ...................................................................... 1,830 1,734
Postretirement benefits other than pensions ......................................... 537 549
Pensions & other liabilities ........................................................ 1,105 919
Shareholders' equity
Common Shares (148.5 million outstanding in 2005 and 153.3 million in 2004) ...... 74 77
Capital in excess of par value ................................................... 2,013 1,993
Retained earnings ................................................................ 2,376 2,112
Accumulated other comprehensive loss ............................................. (649) (538)
Deferred compensation plans ...................................................... (36) (38)
---------- ----------
3,778 3,606
---------- ----------
$ 10,218 $ 9,075
========== ==========
</TABLE>
The notes on pages F-10 to F-27 are an integral part of the consolidated
financial statements.
F-6
<PAGE>
EATON CORPORATION
STATEMENTS OF CONSOLIDATED CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31
------------------------------------------
(Millions) 2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Net cash provided by operating activities
Net income ..................................................................... $ 805 $ 648 $ 386
Adjustments to reconcile to net cash provided by operating activities
Depreciation & amortization ................................................. 409 400 394
Deferred income taxes ....................................................... (20) (133) (54)
Pensions .................................................................... 145 86 45
Other long-term liabilities ................................................. 4 55 27
Other non-cash items in income .............................................. (1) (1) 11
Changes in working capital, excluding acquisitions of businesses
Accounts receivable ...................................................... (104) (218) (51)
Inventories .............................................................. (28) (102) 79
Accounts payable ......................................................... 25 143 (41)
Accrued income & other taxes ............................................. 27 46 35
Other current liabilities ................................................ (29) (122) 32
Other working capital accounts ........................................... (37) 76 (12)
Voluntary contributions to United States & United Kingdom
qualified pension plans .................................................. (64) (93) (11)
Other-net ................................................................... 3 53 34
---------- ---------- ----------
1,135 838 874
---------- ---------- ----------
Net cash used in investing activities
Expenditures for property, plant & equipment ................................... (363) (330) (273)
Acquisitions of businesses ..................................................... (911) (627) (252)
(Purchases) sales of short-term investments-net ................................ (4) 606 (436)
Other-net ...................................................................... 10 18 (8)
---------- ---------- ----------
(1,268) (333) (969)
---------- ---------- ----------
Net cash provided by (used in) financing activities
Borrowings with original maturities of more than three months
Proceeds .................................................................... 393 75
Payments .................................................................... (63) (248) (155)
Borrowings with original maturities of less than three months-net,
primarily commercial paper .................................................. 392 (33) (39)
Cash dividends paid ............................................................ (184) (163) (134)
Proceeds from exercise of employee stock options ............................... 68 138 113
(Purchase) sale of Common Shares ............................................... (450) (250) 296
Other .......................................................................... 2
---------- ---------- ----------
158 (481) 81
---------- ---------- ----------
Total increase (decrease) in cash .............................................. 25 24 (14)
Cash at beginning of year ...................................................... 85 61 75
---------- ---------- ----------
Cash at end of year ............................................................ $ 110 $ 85 $ 61
========== ========== ==========
</TABLE>
The notes on pages F-10 to F-27 are an integral part of the consolidated
financial statements.
F-7
<PAGE>
EATON CORPORATION
STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated Total
Common Shares Capital in other Deferred Share-
--------------- excess of Retained comprehensive compensation holders'
(Millions) Shares Dollars par value earnings loss plans equity
------ ------- ---------- -------- ------------- ------------ --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 2003 ...................... 141.2 $ 70 $ 1,413 $ 1,568 $ (699) $ (50) $ 2,302
Net income ...................................... 386 386
Foreign currency translation
adjustments and related hedging
instruments (including income
tax benefits of $22) ......................... 126 126
Unrealized gain on
available for sale investments ............... 1 1
Deferred gain on cash flow hedges
(net of income taxes of $2) .................. 4 4
Minimum pension liability
adjustment (net of income tax
benefits of $10) ............................. (17) (17)
--------
Other comprehensive income ...................... 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 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
Net income ...................................... 648 648
Foreign currency translation
adjustments and related hedging
instruments (including income
tax benefits of $5) .......................... 99 99
Unrealized loss on available for sale
investments (net of income tax benefits of $1) (2) (2)
Deferred loss on cash flow hedges (net of
income tax benefits of $1) ................... (2) (2)
Minimum pension liability adjustment (net of
income tax benefits of $25) .................. (48) (48)
--------
Other comprehensive income ...................... 47
--------
Total comprehensive income ...................... 695
Cash dividends paid ............................. (163) (163)
Issuance of shares under employee
benefit plans, including tax benefit ......... 4.5 3 188 (2) 10 199
Issuance of shares to trust ..................... 2 (2) 0
Purchase of shares .............................. (4.2) (2) (53) (195) (250)
Other-net ....................................... 8 8
------ ------- ---------- -------- ------------- ------------ --------
Balance at December 31, 2004 .................... 153.3 77 1,993 2,112 (538) (38) 3,606
</TABLE>
F-8
<PAGE>
<TABLE>
<CAPTION>
Accumulated Total
Common Shares Capital in other Deferred Share-
--------------- excess of Retained comprehensive compensation holders'
(Millions) Shares Dollars par value earnings loss plans equity
------ ------- ---------- -------- ------------- ------------ --------
<S> <C> <C> <C> <C> <C> <C> <C>
Net income ...................................... 805 805
Foreign currency translation adjustments and
related hedging instruments (including income
taxes of $33)................................. (53) (53)
Deferred gain on cash flow hedges (net of
income taxes of $2) .......................... 6 6
Minimum pension liability adjustment (net of
income tax benefits of $36) .................. (64) (64)
--------
Other comprehensive loss ........................ (111)
--------
Total comprehensive income ...................... 694
Cash dividends paid ............................. (184) (184)
Issuance of shares under employee benefit plans,
including tax benefit ........................ 2.1 1 104 (2) 10 113
Issuance of shares to trust ..................... .1 8 (8) 0
Purchase of shares .............................. (7.0) (4) (92) (354) (450)
Other-net ....................................... (1) (1)
------ ------- ---------- -------- ------------- ------------ --------
Balance at December 31, 2005 .................... 148.5 $ 74 $ 2,013 $ 2,376 $ (649) $ (36) $ 3,778
====== ======= ========== ======== ============= ============ ========
</TABLE>
The notes on pages F-10 to F-27 are an integral part of the consolidated
financial statements.
F-9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Dollars in millions, except per share data (per share data assume dilution)
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.
Eaton does not have off-balance sheet arrangements or financings with
unconsolidated entities or other persons. In the ordinary course of business,
the Company leases certain real properties and equipment, as described in "Lease
Commitments" in the Notes 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. Cost components include raw materials,
purchased components, direct labor, indirect labor, utilities, depreciation,
inbound freight charges, purchasing and receiving costs, inspection costs,
warehousing costs, internal transfer costs, and costs of the distribution
network.
In November 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 151, "Inventory Costs".
SFAS No. 151 amends the guidance in Accounting Research Bulletin No. 43, Chapter
4, "Inventory Pricing", to clarify the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage). SFAS
No. 151 will be effective for Eaton in 2006 and is not expected to have a
material effect on the Company's financial position, results of operations or
cash flows.
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 3 to 10 years. At December 31, 2005,
the amortization periods for intangible assets subject to amortization were 7 to
14 years for patents, 20 years for tradenames, 15 to 30 years for distributor
channels, and 5 to 16 years for manufacturing technology and customer
agreements. Software is amortized over a range of 3 to 5 years.
Long-lived assets, except goodwill and indefinite life intangible assets as
described in the Notes 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
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets", Eaton
does not amortize goodwill and indefinite life intangible assets recorded in
connection with business acquisitions. Indefinite life intangible assets
primarily consist of trademarks. The Company completed the annual impairment
tests for goodwill and indefinite life intangible assets required by SFAS No.
142. 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.
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, foreign currency swaps, interest rate swaps and, to a minor extent,
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. 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. Such
financial instruments are not bought and sold solely for trading purposes,
except for nominal amounts authorized under limited, controlled circumstances.
No such financial instruments were purchased or sold for trading purposes in
2005 and 2004. Such transactions resulted in a net loss in 2003 that was not
material.
F-10
<PAGE>
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 instruments can be
designated 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; 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 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
recognized in income immediately to offset the gain or loss on the hedged item;
or deferred and reported as a component of Accumulated 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.
ASSET RETIREMENT OBLIGATIONS
In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations" (FIN 47), to clarify the term
"conditional asset retirement" as used in SFAS No. 143, "Accounting for Asset
Retirement Obligations". FIN 47 requires that a liability be recognized for the
fair value of a conditional asset retirement obligation when incurred, if the
fair value of the liability can be reasonably estimated. Uncertainty about the
timing or method of settlement of a conditional asset retirement obligation
would be factored into the measurement of the liability when sufficient
information exists. Eaton believes that for substantially all of its asset
retirement obligations, there is an indeterminate settlement date because the
range of time over which the Company may settle the obligation is unknown or
cannot be estimated. Since these obligations are not reasonably estimable due to
insufficient information about the timing and method of settlement of the
obligation, these obligations have not been recorded in the consolidated
financial statements, in accordance with SFAS No. 143. A liability for these
obligations will be recorded in the period when sufficient information regarding
timing and method of settlement becomes available to make a reasonable estimate
of the liability's fair value.
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, as allowed by SFAS No.
123, "Accounting for Stock-Based Compensation". 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.
Eaton has adopted the disclosure-only provisions of SFAS No. 123. If the Company
recognized compensation expense for its stock options under the fair-value-based
method of SFAS No. 123, net income per Common Share assuming dilution would have
been reduced by $.12 in 2005 and $.08 in 2004 and 2003, as further described in
the "Shareholders' Equity" Note below.
In December 2004, the FASB issued SFAS No. 123(R). This Statement eliminates the
alternative of using the intrinsic-value-based method of accounting for stock
options that was provided in SFAS No. 123. The Statement requires entities to
recognize the expense of employee and director services received in exchange for
stock options, based on the grant date fair value of those awards. That expense
will be recognized over the period the employee or director is required to
provide service in exchange for the award.
On April 14, 2005, the Securities and Exchange Commission (SEC) published a rule
that had the effect of allowing companies with fiscal years ending December 31
to delay the quarter in which they begin to expense stock options to first
quarter 2006. Eaton will expense stock options beginning in first quarter 2006.
The Company estimates that the adoption of SFAS No. 123(R) will reduce net
income per Common Share assuming dilution in 2006 by approximately $.16.
REVENUE RECOGNITION
Sales are recognized when products are shipped to unaffiliated customers, all
significant risks of ownership have been transferred to the customer, title has
transferred in accordance with shipping terms (FOB shipping point or FOB
destination), the selling price is fixed and determinable, all significant
related acts of performance have been completed, and no other significant
uncertainties exist. Shipping and handling costs billed to customers are
included in Net sales and the related costs in Cost of products sold. Other
revenues for service contracts are recognized as the services are provided.
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
accompanying consolidated financial statements and notes. Actual results could
differ from these estimates.
FINANCIAL PRESENTATION CHANGES
Certain amounts for prior years have been reclassified to conform to the current
year presentation.
F-11
<PAGE>
ACQUISITIONS OF BUSINESSES
In 2005, 2004, and 2003, Eaton acquired certain businesses and formed joint
ventures in separate transactions for a combined net cash purchase price of $911
in 2005, $627 in 2004 and $252 in 2003. The Statements of Consolidated Income
include the results of these businesses from the effective dates of acquisition
or formation. A summary of these transactions for 2005, and larger transactions
in 2004 and 2003, follows:
<TABLE>
<CAPTION>
Business
Acquired business Date of acquisition segment Annual sales
- ---------------------------------------------------------- ------------------- ----------- ----------------------
<S> <C> <C> <C>
Aerospace division of PerkinElmer, Inc. December 6, 2005 Fluid Power $150 for the year
A U.S. based provider of sealing and pneumatic systems ended June 30, 2005
for large commercial aircraft and regional jets
Aerospace fluid and air division of Cobham plc November 1, 2005 Fluid Power $210 for 2004
A U.K. based company that provides low-pressure
airframe fuel systems, electro-mechanical actuation,
air ducting, hydraulic and power generation, and fluid
distribution systems for fuel, hydraulics and air
Assets of Pringle Electrical Manufacturing Company October 11, 2005 Electrical $6 for 2004,
A U.S. manufacturer of bolted contact switches and other one-third of which
specialty switches were to Eaton
Industrial filtration business of Hayward Industries, Inc. September 6, 2005 Fluid Power $100 for the year
A U.S. based producer of filtration systems for ended June 30, 2005
industrial and commercial customers
Tractech Holdings, Inc. August 17, 2005 Automotive $43 for 2004
A U.S. based manufacturer of specialized differentials
and clutch components for the commercial and specialty
vehicle markets
Morestana S.A. de C.V. June 30, 2005 Automotive $13 for 2004
A Mexican producer of hydraulic lifters for automotive
engine manufacturers and the automotive aftermarket
Eaton Electrical (Zhongshan) Co., Ltd. (a 51%-owned joint June 17, 2005 Electrical N/A
venture)
A Chinese manufacturer of medium-voltage switchgear
components, including circuit breakers, meters and
relays
Winner Group Holdings Ltd. March 31, 2005 Fluid Power $26 for 2004
A Chinese producer of hydraulic hose fittings and
adapters
Pigozzi S.A. Engrenagens e Transmissoes March 1, 2005 Truck $42 for 2004
A Brazilian agricultural powertrain business that
produces transmissions, rotors and other drivetrain
components
Walterscheid Rohrverbindungstechnik GmbH September 1, 2004 Fluid Power $52 for 2003
A German manufacturer of hydraulic tube connectors and
fittings primarily for the European market
Powerware Corporation June 9, 2004 Electrical $775 for the year
A U.S. based supplier of Uninterruptible Power Systems ended March 31, 2004
(UPS), DC Power products and power quality services
for computer manufacturers, industrial companies,
governments, telecommunications firms, medical
institutions, data centers and other businesses
FAW Eaton Transmission Co., Ltd. (a 50%-owned joint March 31, 2004 Truck N/A
venture)
Manufacturer of medium-duty transmissions for the
Chinese market
Electrical Division of Delta plc January 31, 2003 Electrical $326 for 2002
A U.K. based manufacturer of electrical products with
brands including MEM(R), HolecTM, BillTM, Home
AutomationTM, ElekTM and TabulaTM
</TABLE>
As described above, on June 9, 2004, Eaton acquired Powerware Corporation, the
electrical power systems business of Invensys plc, for a final cash purchase
price of $573, less cash acquired of $27. Powerware's assets and liabilities
were recorded at estimated fair values as determined by Eaton's management. The
allocation of the purchase price for this acquisition is summarized below:
F-12
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Current assets .............................. $ 302
Property, plant & equipment ................. 35
Goodwill .................................... 397
Other intangible assets ..................... 96
Other assets ................................ 53
----------
Total assets acquired .................... 883
Total liabilities assumed ................... 337
----------
Net assets acquired ...................... $ 546
==========
</TABLE>
Other intangible assets of $96 included $24 related to trademarks that are not
subject to amortization. The remaining $72 was assigned to patents and other
intangible assets that have a weighted-average useful life of 8 years. Goodwill
of $397 relates to the Electrical segment, substantially all of which is
non-deductible for income tax purposes.
Unaudited pro forma results of operations for 2004, as if Eaton and Powerware
had been combined as of the beginning of that year, follow. The pro forma
results include estimates and assumptions, which Eaton's management believes are
reasonable. However, the pro forma results do not include any cost savings or
other effects of the planned integration of Powerware, and, accordingly, are not
necessarily indicative of the results which would have occurred if the business
combination had been in effect in 2004.
Pro Forma Results of Operations
<TABLE>
<CAPTION>
2004
----------
<S> <C>
Net sales ................................... $ 10,153
Net income .................................. 636
Net income per Common Share
Assuming dilution ........................ $ 4.05
Basic .................................... 4.16
</TABLE>
RESTRUCTURING CHARGES
In 2005, 2004 and 2003, Eaton incurred restructuring charges primarily related
to the integration of acquired businesses. In accordance with generally accepted
accounting principles, these charges were recorded as expense as incurred. A
summary of these charges follows:
<TABLE>
<CAPTION>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Electrical .................................. $ 21 $ 33 $ 22
Fluid Power ................................. 7 8 14
Truck ....................................... 4
Automotive .................................. 4
---------- ---------- ----------
36 41 36
Corporate restructuring charges ............. 1
---------- ---------- ----------
Pretax charges .............................. $ 36 $ 41 $ 37
========== ========== ==========
After-tax charges ........................... $ 24 $ 27 $ 24
Per Common Share ............................ $ .15 $ .17 $ .16
</TABLE>
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 Other corporate expense-net,
as appropriate.
2005 CHARGES
Restructuring charges related to the integration of primarily the following
acquisitions: Powerware, the electrical power systems business acquired in June
2004; the electrical division of Delta plc acquired in January 2003; several
acquisitions in Fluid Power, including Winner, Walterscheid, and Boston
Weatherhead acquired in November 2002; the Pigozzi agricultural powertrain
business; and the Morestana automotive lifter business.
Restructuring charges in the Electrical segment consisted of $20 for plant
consolidations, integration and other expenses, and $1 for workforce reductions.
The charges primarily related to Powerware and the electrical division of Delta
plc.
Restructuring charges in the Fluid Power segment consisted of $7 of plant
consolidations, integration and other expenses. The charges primarily related to
Winner, Walterscheid and Boston Weatherhead.
2004 CHARGES
Restructuring charges in the Electrical segment consisted of $32 for plant
consolidations, integration and other expenses, and $1 of workforce reductions.
The charges primarily related to integrating plants in Necedah, Wisconsin,
Chadderton, United Kingdom, and Neuss, Germany, along with other integration
actions. The charges primarily related to Powerware and the electrical division
of Delta plc.
F-13
<PAGE>
Restructuring charges in the Fluid Power segment consisted of $8 for plant
consolidations, integration and other expenses. The charges primarily related to
Boston Weatherhead.
2003 CHARGES
Restructuring charges in the Electrical segment consisted of $20 for plant
consolidations primarily related to the electrical division of Delta plc,
including the Ottery St. Mary, United Kingdom plant, integration and other
expenses, and $2 of workforce reductions.
Restructuring charges in the Fluid Power segment, primarily related to Boston
Weatherhead, consisted of $13 for plant consolidations, integration and other
expenses, and $1 for workforce reductions. The charges primarily related to the
closure of facilities in Norwood and Mooresville, North Carolina.
SUMMARY OF RESTRUCTURING CHARGES
A comparison of restructuring charges and utilization of the various components
for 2005, 2004 and 2003 follows:
<TABLE>
<CAPTION>
Workforce reductions Plant
-------------------------- integration
Employees Dollars & other Total
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Balance remaining at January 1, 2003 ........ 494 $ 11 $ 5 $ 16
2003 charges ................................ 227 3 34 37
Utilized in 2003 ............................ (700) (12) (31) (43)
---------- ---------- ----------- ----------
Balance remaining at December 31, 2003 ...... 21 2 8 10
2004 charges ................................ 10 1 40 41
Utilized in 2004 ............................ (31) (3) (45) (48)
---------- ---------- ----------- ----------
Balance remaining at December 31, 2004 ...... 0 0 3 3
2005 charges ................................ 173 4 32 36
Utilized in 2005 ............................ (7) (1) (34) (35)
---------- ---------- ----------- ----------
Balance remaining at December 31, 2005 ...... 166 $ 3 $ 1 $ 4
========== ========== =========== ==========
</TABLE>
EXIT & SALE OF BUSINESS
In December 2004, Eaton announced that it would exit its tire and refrigeration
valve manufacturing business. The Company incurred charges of $15 ($10
after-tax, or $.06 per Common Share) principally for the write-down of fixed
assets and workforce reductions. This business is in the Automotive segment. In
the Statements of Consolidated Income and Business Segment Information, these
charges were reported as a separate line item. This business was sold in March
2005.
CONTRIBUTION TO EATON CHARITABLE FUND
In 2004, a charge of $13 was recorded for a contribution to the Eaton Charitable
Fund ($8 after-tax, or $.05 per Common Share). In the Statements of Consolidated
Income, the charge was included in Other (income) expense-net. In Business
Segment Information, the charge was included in Other corporate expense-net.
GOODWILL & OTHER INTANGIBLE ASSETS
A summary of goodwill follows:
<TABLE>
<CAPTION>
2005 2004
---------- ----------
<S> <C> <C>
Electrical .................................. $ 1,016 $ 944
Fluid Power ................................. 1,811 1,235
Truck ....................................... 145 133
Automotive .................................. 167 121
---------- ----------
$ 3,139 $ 2,433
========== ==========
</TABLE>
The increase in goodwill in 2005 was due to the acquisitions of businesses
during the year, and the final allocation of purchase price to acquisitions
completed prior to 2005. These transactions are described in the "Acquisitions
of Businesses" Note above.
F-14
<PAGE>
A summary of other intangible assets follows:
<TABLE>
<CAPTION>
2005 2004
------------------------- -------------------------
Historical Accumulated Historical Accumulated
cost amortization cost amortization
---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Intangible assets not subject to amortization
(primarily trademarks) $ 381 $ 380
========== ==========
Intangible assets subject to amortization
Patents .................................. $ 191 $ 90 $ 198 $ 80
Other .................................... 209 65 194 48
---------- ------------ ---------- ------------
$ 400 $ 155 $ 392 $ 128
========== ============ ========== ============
</TABLE>
Expense related to intangible assets subject to amortization for 2005 was $30.
Estimated annual pretax expense for intangible assets subject to amortization
for each of the next five years is $29 in 2006 through 2009 and $27 in 2010.
DEBT & OTHER FINANCIAL INSTRUMENTS
Short-term debt of $394 at December 31, 2005 included $365 of short-term
commercial paper for operations in the United States and $29 for operations
outside the United States. Borrowings for operations in the United States
included Euro 200 million of commercial paper. The foreign exchange translation
gain or loss related to the Euro denominated commercial paper is recorded in
Accumulated other comprehensive income (loss) in Shareholders' equity, since
these borrowings serve as a hedge of the Company's net assets of operations in
Europe. Borrowings for operations outside the United States were largely
denominated in local currencies. The weighted-average interest rate on the $365
of short-term commercial paper was 3.1% at December 31, 2005. The
weighted-average interest rate on short-term debt for operations outside the
United States was 5.0% at December 31, 2005 and 15.7% at December 31, 2004,
which included the effect of $10 of debt in Brazil with an interest rate of
18.2% at the end of 2004. Operations outside the United States have available
short-term lines of credit aggregating $291 from various banks worldwide.
A summary of long-term debt, including the current portion, follows:
<TABLE>
<CAPTION>
2005 2004
---------- ----------
<S> <C> <C>
6.40% notes due 2005 ............................................................................... $ 15
1.62% Yen notes due 2006 ........................................................................... $ 43 49
8% debentures due 2006 (converted to floating rate by interest rate swap) .......................... 86 86
8.90% debentures due 2006 (converted to floating rate by interest rate swap) ....................... 100 100
6% Euro 200 million notes due 2007 (100 million converted to floating rate by interest rate swap) .. 236 273
7.37% notes due 2007 (converted to floating rate by interest rate swap) ............................ 20 20
7.14% notes due 2007 ............................................................................... 3 3
6.75% notes due 2007 (converted to floating rate by interest rate swap) ............................ 25 25
Euro 100 million floating rate notes due 2008 (2.7378% at December 31, 2005 -- EURIBOR+.375%) ...... 118
7.40% notes due 2009 (converted to floating rate by interest rate swap) ............................ 15 15
5.75% notes due 2012 ($225 converted to floating rate by interest rate swap) ....................... 300 300
7.58% notes due 2012 (converted to floating rate by interest rate swap) ............................ 12 12
5.80% notes due 2013 ............................................................................... 7 7
12.5% debentures due 2014 .......................................................................... 10 11
4.65% notes due 2015 (converted to floating rate by interest rate swap) ............................ 100
7.09% notes due 2018 (converted to floating rate by interest rate swap) ............................ 25 25
6.89% notes due 2018 ............................................................................... 6 6
7.07% notes due 2018 ............................................................................... 2 2
6.875% notes due 2018 .............................................................................. 3 3
8-7/8% debentures due 2019 ($25 converted to floating rate by interest rate swap) .................. 38 38
8.10% debentures due 2022 ($50 converted to floating rate by interest rate swap) ................... 100 100
</TABLE>
F-15
<PAGE>
<TABLE>
<S> <C> <C>
7-5/8% debentures due 2024 ($55 converted to floating rate by interest rate swap) .................. 66 66
6-1/2% debentures due 2025 ......................................................................... 145 145
7.875% debentures due 2026 ......................................................................... 72 72
7.65% debentures due 2029 ($75 converted to floating rate by interest rate swap) ................... 200 200
5.45% debentures due 2034 ($100 converted to floating rate by interest rate swap) .................. 150 75
5.25% notes due 2035 ($50 converted to floating rate by interest rate swap) ........................ 100
Other .............................................................................................. 88 112
---------- ----------
Total long-term debt ............................................................................... 2,070 1,760
Less current portion of long-term debt ............................................................. (240) (26)
---------- ----------
Long-term debt less current portion ................................................................ $ 1,830 $ 1,734
========== ==========
</TABLE>
Eaton's United States operations have long-term revolving credit facilities of
$1 billion, of which $300 will expire in May 2008 and the remaining $700 in
March 2010. One of the Company's international subsidiaries has a long-term line
of credit of Euro 100 million. The Euro 100 million floating rate notes due
2008, which have a U.S. dollar equivalent of $118 at December 31, 2005, were
borrowed under this line of credit.
Aggregate mandatory annual maturities of long-term debt for each of the next
five years are $240 in 2006, $291 in 2007, $121 in 2008, $17 in 2009, and $0 in
2010. Interest paid was $113 in 2005, $96 in 2004, and $105 in 2003.
Eaton has entered into fixed-to-floating interest rate swaps to manage interest
rate risk. These interest rate swaps are accounted for as fair value hedges of
certain of the Company's long-term debt. The maturity of the swap corresponds
with the maturity of the debt instrument as noted in the table of long-term debt
above. A summary of interest rate swaps outstanding at December 31, 2005,
follows (currency in millions):
<TABLE>
<CAPTION>
Interest rates at December 31, 2005
---------------------------------------------------------------------------
Fixed Floating
interest interest
Notional rate rate Basis for contracted
amount received paid floating interest rate paid
- --------- -------- -------- ---------------------------
<S> <C> <C> <C>
$86 8.00% 8.64% 6 month LIBOR+4.39%
$100 8.90% 7.92% 6 month LIBOR+3.89%
E100 6.00% 2.73% 6 month LIBOR+0.54%
$20 7.37% 8.91% 6 month LIBOR+4.47%
$25 6.75% 5.95% 6 month LIBOR+1.50%
$15 7.40% 6.40% 6 month LIBOR+1.95%
$225 5.75% 4.60% 6 month LIBOR+0.78%
$12 7.58% 6.21% 6 month LIBOR+1.76%
$100 4.65% 4.62% 6 month LIBOR+0.12%
$25 7.09% 6.85% 6 month LIBOR+2.40%
$25 8.88% 8.51% 6 month LIBOR+3.84%
$50 8.10% 6.47% 6 month LIBOR+2.44%
$55 7.63% 6.38% 6 month LIBOR+2.16%
$75 7.65% 7.13% 6 month LIBOR+2.58%
$100 5.45% 4.77% 6 month LIBOR+0.43%
$50 5.25% 4.84% 6 month LIBOR+0.17%
</TABLE>
The carrying values of cash, short-term investments and short-term debt in the
balance sheet approximate their estimated fair values. The estimated fair values
of other financial instruments outstanding follow:
<TABLE>
<CAPTION>
2005 2004
-------------------------------------- --------------------------------------
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) ...................... $ (2,070) $ (2,103) $ (1,760) $ (1,975)
Foreign currency principal swaps ......... $ 83 (2) (2) $ 72 (8) (8)
Foreign currency forward exchange
contracts ............................... 12 5 5 151 (5) (5)
Fixed to floating interest rate swaps .... 1,080 12 12 975 50 50
</TABLE>
- ----------
(a) Includes foreign currency denominated debt.
F-16
<PAGE>
The estimated fair values of financial instruments were principally based on
quoted market prices where such prices were available, and where unavailable,
fair values were estimated based on comparable contracts, utilizing information
obtained from established, independent providers. The fair value of foreign
currency principal swaps, which related to the Japanese Yen, and foreign
currency forward exchange contracts, which primarily related to the Euro, Pound
Sterling , Japanese Yen and U.S. Dollar, were estimated based on quoted market
prices of comparable contracts, adjusted through interpolation where necessary
for maturity differences. These contracts mature during 2006 through 2008.
RETIREMENT BENEFIT PLANS
Eaton has defined benefit pension plans and other postretirement benefit plans.
Components of plan obligations and assets, and recorded assets (liabilities),
follow:
<TABLE>
<CAPTION>
Other postretirement
Pension benefits benefits
-------------------------- --------------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Changes in projected benefit obligation
Benefit obligation at beginning of year .......... $ (2,601) $ (2,304) $ (896) $ (937)
Service cost ..................................... (119) (103) (16) (17)
Interest cost .................................... (141) (134) (48) (53)
Actuarial (loss) gain ............................ (190) (165) 3 (5)
Benefits paid .................................... 206 188 97 99
Plan amendments .................................. (1) (7) 2 18
Foreign currency translation ..................... 83 (55)
Business acquisitions ............................ (13) (14) (2)
Other ............................................ (6) (7) (13) (1)
---------- ---------- ---------- ----------
Benefit obligation at end of year ................ (2,782) (2,601) (873) (896)
---------- ---------- ---------- ----------
Change in plan assets
Fair value of plan assets at beginning of year ... 1,852 1,670
Actual return on plan assets ..................... 204 194
Employer contributions ........................... 97 134 97 99
Benefits paid .................................... (206) (188) (97) (99)
Foreign currency translation ..................... (50) 34
Business acquisitions ............................ 13 2
Other ............................................ 6 6
---------- ---------- ---------- ----------
Fair value of plan assets at end of year ......... 1,916 1,852 0 0
---------- ---------- ---------- ----------
Benefit obligation in excess of plan assets ...... (866) (749) (873) (896)
Unrecognized net actuarial loss .................. 1,053 1,005 246 247
Unrecognized prior service cost .................. 23 26 (7) (5)
Other ............................................ 2 2 8 8
---------- ---------- ---------- ----------
Net amount recognized ............................ $ 212 $ 284 $ (626) $ (646)
========== ========== ========== ==========
</TABLE>
Amounts recognized in the balance sheet consist of:
<TABLE>
<CAPTION>
Other postretirement
Pension benefits benefits
-------------------------- --------------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Accrued asset .................................... $ 4 $ 29
Accrued liability ................................ (632) (488) $ (626) $ (646)
Intangible asset ................................. 23 26
Accumulated other comprehensive loss ............. 817 717
---------- ---------- ---------- ----------
Net amount recognized ............................ $ 212 $ 284 $ (626) $ (646)
========== ========== ========== ==========
</TABLE>
PENSION PLANS
SFAS 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 2005, 2004 and 2003, Eaton recorded
non-cash charges in Accumulated other comprehensive loss in Shareholders' equity
of $100, $73 and $27, respectively, ($64, $48, and $17 after-tax, respectively)
related to the additional minimum liability for certain underfunded pension
plans. Pension funding requirements are not affected by the recording of these
charges.
The total accumulated benefit obligation for all pension plans at December 31,
2005 was $2,544 and at year-end 2004 was $2,329. The components of pension plans
with an accumulated benefit obligation in excess of plan assets at December 31
follow:
F-17
<PAGE>
<TABLE>
<CAPTION>
2005 2004
---------- ----------
<S> <C> <C>
Projected benefit obligation ...... $ 2,771 $ 2,523
Accumulated benefit obligation .... 2,533 2,260
Fair value of plan assets ......... 1,902 1,773
</TABLE>
The measurement date for all pension plans is November 30. Assumptions used to
determine pension benefit obligations at year-end follow:
<TABLE>
<CAPTION>
United States & non-United
States plans (weighted-
United States plans average)
-------------------------- --------------------------
2005 2004 2005 2004
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Discount rate ..................... 5.75% 6.00% 5.51% 5.81%
Rate of compensation increase ..... 3.50% 3.50% 3.67% 3.60%
</TABLE>
United States pension plans represent 70% and 69% of the benefit obligation in
2005 and 2004, respectively.
The components of pension benefit cost follow:
<TABLE>
<CAPTION>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Service cost ...................... $ (119) $ (103) $ (96)
Interest cost ..................... (141) (134) (129)
Expected return on plan assets .... 166 179 181
Other ............................. (49) (26) (7)
---------- ---------- ----------
(143) (84) (51)
Curtailment loss .................. (1) (2) (1)
Settlement loss ................... (34) (31) (34)
---------- ---------- ----------
$ (178) $ (117) $ (86)
========== ========== ==========
</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)
-------------------------------------- --------------------------------------
2005 2004 2003 2005 2004 2003
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Discount rate ..................... 6.00% 6.25% 6.75% 5.81% 6.11% 6.53%
Expected long-term return on plan
assets ........................... 8.75% 8.75% 8.75% 8.41% 8.50% 8.71%
Rate of compensation increase ..... 3.50% 3.50% 3.75% 3.60% 3.60% 3.73%
</TABLE>
The expected long-term rate of return on pension plan assets was determined
separately for each country and reflects long-term historical data, with greater
weight given to recent years, and takes into account each plan's target asset
allocation.
The weighted-average pension plan asset allocations by asset category at
December 31, 2005 and 2004 are as follows:
<TABLE>
<CAPTION>
2005 2004
---------- ----------
<S> <C> <C>
Equity securities ................. 79% 80%
Debt securities ................... 18% 19%
Other ............................. 3% 1%
---------- ----------
100% 100%
========== ==========
</TABLE>
Investment policies and strategies are developed on a country specific basis.
The United States plan represents 71% of worldwide pension assets and its target
allocation is 85% diversified equity, 12% United States Treasury
Inflation-Protected Securities, and 3% cash equivalents. The United Kingdom plan
represents 23% of worldwide pension assets and its target allocation is 70%
diversified equity securities and 30% United Kingdom Government Bonds.
In 2006, Eaton expects to contribute $146 to pension plans, primarily consisting
of a voluntary contribution of $100 in the United States, which was announced in
January 2006, and a $13 voluntary contribution in the United Kingdom. In 2005,
Eaton made pension contributions of $97, which included voluntary contributions
of $50 in the United States and $14 in the United Kingdom, as well as other
contributions of $33. In 2004, the Company made pension contributions of $134,
which included voluntary contributions of $75 in the United States and $18 in
the United Kingdom, as well as other contributions of $41.
F-18
<PAGE>
At December 31, 2005, expected pension benefit payments for each of the next
five years and the five years thereafter in the aggregate are $167 in 2006, $175
in 2007, $189 in 2008, $198 in 2009, $205 in 2010, and $1,185 in 2011-2015.
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 $48 in 2005, $44 in 2004, and $40
in 2003.
OTHER POSTRETIREMENT BENEFIT PLANS
The components of other postretirement benefits cost follow:
<TABLE>
<CAPTION>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Service cost ...................... $ (16) $ (17) $ (15)
Interest cost ..................... (48) (53) (56)
Other ............................. (10) (9) (9)
---------- ---------- ----------
(74) (79) (80)
Curtailment loss .................. (1)
---------- ---------- ----------
$ (74) $ (80) $ (80)
========== ========== ==========
</TABLE>
The measurement date for all other postretirement benefit plans is November 30.
Assumptions used to determine other postretirement benefit obligations and cost
follow:
<TABLE>
<CAPTION>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Assumptions used to determine benefit obligation at year-end
Discount rate ................................................... 5.75% 6.00% 6.25%
Health care cost trend rate assumed for next year ............... 9.60% 10.00% 9.00%
Ultimate health care cost trend rate ............................ 4.75% 4.75% 5.00%
Year ultimate health care cost trend rate is achieved ........... 2014 2014 2007
Assumptions used to determine cost
Discount rate ................................................... 6.00% 6.25% 6.75%
Initial health care cost trend rate ............................. 10.00% 9.00% 10.00%
Ultimate health care cost trend rate ............................ 4.75% 5.00% 5.00%
Year ultimate health care cost trend rate is achieved ........... 2014 2007 2007
</TABLE>
Assumed health care cost trend rates may have a significant effect on the
amounts reported for the health care plans. A 1-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............. $ 1 $ (1)
Effect on other postretirement benefit obligation........ 23 (20)
</TABLE>
The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the
Act) was passed on December 8, 2003. The Act provides for prescription drug
benefits under Medicare Part D and contains a subsidy to plan sponsors who
provide actuarially equivalent prescription plans. Eaton recognized the initial
effect of the Act in 2004. At that time, the accumulated postretirement benefit
obligation decreased by $51, with an offsetting change in unrecognized net
actuarial loss. The reduction was attributable to the Federal subsidy and an
expected reduction in the number of retirees electing coverage under the
Company's other postretirement benefit plans. In addition, the Act reduced 2004
net periodic other postretirement benefit costs by $6. In January 2005, final
guidance was issued to plan sponsors regarding the determination of actuarial
equivalence. Based on this guidance, the Company will continue to qualify for
the retiree drug subsidy. The final guidance further reduced Eaton's accumulated
postretirement benefit obligation by $60 in 2005, with an offsetting change in
unrecognized net actuarial loss, and reduced 2005 net periodic other
postretirement benefit costs by an additional $7. The reduction in the
accumulated postretirement benefit obligation and ongoing net periodic cost did
not require a modification or amendment of the Company's benefit plans. However,
if certain plans were amended, the Act could further reduce both the accumulated
postretirement benefit obligation and ongoing net periodic cost.
At December 31, 2005, expected other postretirement benefit payments for each of
the next five years and the five years thereafter in the aggregate are $97 in
2006, $98 in 2007, $97 in 2008, $95 in 2009, $94 in 2010, and $425 in 2011-2015.
The expected subsidy receipts related to the Act that are included in the other
postretirement benefit payments listed above for each of the next five years and
the five years thereafter in the aggregate are $8 in 2006, $9 in 2007 and 2008,
$10 in 2009 and 2010, and $53 in 2011-2015.
F-19
<PAGE>
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, 2005 and 2004, the balance sheet included a liability for these costs of $75
and $69, respectively.
Based upon Eaton's analysis and subject to the difficulty in estimating these
future costs, the Company expects that any sum it may be required to pay in
connection with environmental matters is not reasonably likely to exceed the
liability by an amount that would have a material adverse effect on its
financial position, results of operations or cash flows. All of these estimates
are forward-looking statements and, given the inherent uncertainties in
evaluating environmental exposures, actual results can differ from these
estimates.
CONTINGENCIES
Eaton is subject to a broad range of claims, administrative proceedings,
and legal proceedings, such as lawsuits that relate to contractual
allegations, patent infringement, personal injuries (including asbes-
tos claims) and employment-related matters. Although it is not pos-
sible to predict with certainty the outcome or cost of these matters,
the Company believes that these matters will not have a material ad-
verse effect on its financial position, results of operations or cash flows.
SHAREHOLDERS' EQUITY
There are 300 million Common Shares authorized ($.50 par value per share), 148.5
million of which were issued and outstanding at year-end 2005. At December 31,
2005, there were 9,265 holders of record of Common Shares. Additionally, 21,109
current and former employees were shareholders through participation in the
Eaton Savings Plan (ESP) and Eaton Personal Investment Plan (EPIP).
On April 18, 2005, Eaton's Board of Directors authorized the Company to
repurchase up to 10 million of its Common Shares. In second quarter 2005, 3.38
million shares were repurchased in the open market at a total cost of $200. No
shares were repurchased in the third or fourth quarters of 2005. The remainder
of the shares are expected to be repurchased over time, depending on market
conditions, share price, capital levels and other considerations.
During first quarter 2005, Eaton repurchased 3.63 million Common Shares in the
open market at a total cost of $250. This completed the plan announced on
January 24, 2005 to repurchase $250 of shares to help offset dilution from
shares issued during 2004 from the exercise of stock options.
During first quarter 2004, Eaton repurchased 4.2 million Common Shares in the
open market at a total cost of $250. This completed the plan announced on
January 21, 2004 to repurchase 4.2 million shares to help offset dilution from
shares issued during 2003 from the exercise of stock options.
In June 2003, Eaton sold 7.4 million shares 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 $32 of Common Shares and
marketable securities into a trust at December 31, 2005 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
Under various plans, stock options have been granted to certain employees and
directors to purchase Common Shares at prices equal to fair market value on the
date of grant. Substantially all of these options vest ratably during the
three-year period following the date of grant and expire 10 years from the date
of grant.
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, 2005, 2.4 million special
performance-vested stock options were outstanding of which .5 million were
exercisable.
F-20
<PAGE>
A summary of stock option activity follows (shares in millions):
<TABLE>
<CAPTION>
2005 2004 2003
------------------------- ------------------------- ------------------------
Average Average Average
price per price per price per
option Options option Options option Options
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding January 1 .................. $ 37.97 14.7 $ 33.22 17.2 $ 31.70 19.2
Granted ................................ 68.09 2.2 59.12 2.4 35.46 2.6
Exercised .............................. 32.78 (2.2) 30.78 (4.6) 27.43 (4.2)
Canceled ............................... 56.07 (.3) 41.34 (.3) 35.28 (.4)
---------- ---------- ----------
Outstanding December 31 ................ $ 42.95 14.4 $ 37.97 14.7 $ 33.22 17.2
========== ========== ==========
Exercisable December 31 ................ $ 36.95 8.3 $ 33.65 8.2 $ 31.50 10.5
Reserved for future grants December 31 . 6.9 9.0 4.0
</TABLE>
The following table summarizes information about stock options outstanding and
exercisable at December 31, 2005 (shares in millions):
<TABLE>
<CAPTION>
Options outstanding Options exercisable
----------------------------------------- -------------------------
Weighted-
average Weighted- Weighted-
remaining average average
contractual exercise exercise
Range of exercise prices per option Options life (years) price Options price
- ----------------------------------- ---------- ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
$22.81 ............................ .2 .1 $ 22.81 .2 $ 22.81
29.44 -- $30.91 ................... 4.3 2.3 30.81 2.9 30.76
31.93 -- 39.68 .................... 4.1 5.3 36.17 3.0 36.10
40.58 -- 40.60 .................... 1.4 6.0 40.60 1.3 40.60
40.98 -- 47.88 .................... .2 5.3 43.09 .2 43.08
59.07.............................. 2.1 8.2 59.07 .6 59.07
59.11 -- 67.55 .................... .1 8.8 63.35 .1 63.75
68.22 -- 71.82 .................... 2.0 9.2 68.24
---------- ----------
14.4 8.3
========== ==========
</TABLE>
Eaton has adopted the disclosure-only provisions of 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>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Net income
As reported ................................................ $ 805 $ 648 $ 386
Stock-based compensation expense, net of income taxes ...... (18) (13) (11)
---------- ---------- ----------
Assuming fair-value-based method ........................... $ 787 $ 635 $ 375
========== ========== ==========
Net income per Common Share assuming dilution
As reported ................................................ $ 5.23 $ 4.13 $ 2.56
Stock-based compensation expense, net of income taxes ...... (.12) (.08) (.08)
---------- ---------- ----------
Assuming fair-value-based method ........................... $ 5.11 $ 4.05 $ 2.48
========== ========== ==========
Net income per Common Share basic
As reported ................................................ $ 5.36 $ 4.24 $ 2.61
Stock-based compensation expense, net of income taxes ...... (.12) (.09) (.08)
---------- ---------- ----------
Assuming fair-value-based method ........................... $ 5.24 $ 4.15 $ 2.53
========== ========== ==========
</TABLE>
F-21
<PAGE>
The fair value of each option grant was estimated using the Black-Scholes option
pricing model with the following assumptions:
<TABLE>
<CAPTION>
2005 2004 2003
------------ ------------ ------------
<S> <C> <C> <C>
Dividend yield ................................................................. 2.0% 2.5% 2.5%
Expected volatility ............................................................ 27% 28% 28%
Risk-free interest rate ........................................................ 3.7% to 4.4% 3.1% to 3.8% 2.2% to 3.5%
Expected option life in years .................................................. 5 5 5
Weighted-average per share fair value of options granted during the year ....... $ 16.73 $ 13.29 $ 7.84
</TABLE>
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The components of Accumulated other comprehensive income (loss) as reported in
the Statement of Consolidated Shareholders' Equity follow:
<TABLE>
<CAPTION>
2005 2004
---------- ----------
<S> <C> <C>
Foreign currency translation adjustments and related hedging instruments (net of income tax benefits
of $6 in 2005 and $39 in 2004) .................................................................. $ (117) $ (64)
Deferred gain (loss) on cash flow hedges (net of income taxes of $2 in 2005 and income tax benefits
of $1 in 2004) .................................................................................. 4 (2)
Minimum pension liability adjustment (net of income tax benefits of $281 in 2005 and $245
in 2004) ........................................................................................ (536) (472)
---------- ----------
$ (649) $ (538)
========== ==========
</TABLE>
A discussion of the minimum pension liability adjustment is included in the
"Retirement Benefit Plans" Note above.
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
----------------------------------------
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
United States ..................... $ 208 $ 124 $ 78
Non-United States ................. 788 657 430
---------- ---------- ----------
$ 996 $ 781 $ 508
========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
Income tax expense
------------------------------------------
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Current
United States
Federal ........................ $ 72 $ 131 $ 97
State & local .................. 3 5 17
Non-United States ................. 140 128 70
---------- ---------- ----------
215 264 184
---------- ---------- ----------
Deferred
United States ..................... (9) (131) (67)
Non-United States ................. (15) 5
---------- ---------- ----------
(24) (131) (62)
---------- ---------- ----------
$ 191 $ 133 $ 122
========== ========== ==========
</TABLE>
F-22
<PAGE>
Reconciliations of income taxes from the United States Federal statutory rate to
the effective income tax rate follow:
<TABLE>
<CAPTION>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Income taxes at the United States statutory rate .................................... 35.0% 35.0% 35.0%
United States state & local income taxes ............................................ .4% .6% 3.2%
Other United States-net ............................................................. (3.6%) (5.1%) (1.4%)
Non-United States operations (earnings taxed at other than United States tax rate) .. (12.6%) (13.5%) (12.8%)
---------- ---------- ----------
19.2% 17.0% 24.0%
========== ========== ==========
</TABLE>
In fourth quarter 2004, Eaton recorded an income tax benefit of $30 resulting
from the favorable resolution of multiple international and United States income
tax items. This income tax benefit reduced the effective income tax rate for
full year 2004 from 20.8% to 17.0%.
Eaton has manufacturing operations in Puerto Rico that operate under certain
United States tax law incentives related to the repatriation of earnings that
will not be available after 2005. Income tax credits claimed under these
incentives were $33 in 2005 and 2004, and $32 in 2003. 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>
2005 2004
-------------------------- --------------------------
Long- Long-
Current term Current term
assets assets assets assets
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Accruals & other adjustments
Employee benefits ....................................... $ 85 $ 470 $ 57 $ 427
Depreciation & amortization ............................. (288) (5) (279)
Other accruals & adjustments ............................ 147 52 161 80
Other items ................................................ 14 11 3 8
United States Federal income tax credit carryforwards ...... 110 86
United States Federal tax loss carryforwards ............... 1 7
United States state & local tax loss carryforwards
and tax credit carryforwards ............................ 91 82
Non-United States tax loss carryforwards ................... 92 80
Valuation allowance ........................................ (3) (187) (162)
---------- ---------- ---------- ----------
$ 243 $ 352 $ 216 $ 329
========== ========== ========== ==========
</TABLE>
At the end of 2005, United States Federal income tax credit carryforwards of
$110 were available to reduce future Federal income tax liabilities. These
credits include $57 that expire in 2021 through 2025, and $53 of which are not
subject to expiration. A valuation allowance of $9 has been recorded for these
income tax credit carryforwards. United States state and local tax loss
carryforwards with a future tax benefit of $61 are also available at the end of
2005. Their expiration dates are $9 in 2006 through 2011, $12 in 2012 through
2016, $23 in 2017 through 2021, and $17 in 2022 through 2026. A full valuation
allowance has been recorded for these state and local tax loss carryforwards.
There are also United States state and local tax credit carryforwards with a
future tax benefit of $30 available at the end of 2005. Their expiration dates
are $4 in 2006 through 2011, $15 in 2012 through 2016, $8 in 2017 through 2021,
and $3 in 2022 through 2026. A valuation allowance of $29 has been recorded for
the state and local tax credit carryforwards. A valuation allowance of $9 has
also been recorded for certain other state and local deferred income tax assets.
At December 31, 2005, certain non-United States subsidiaries had tax loss
carryforwards aggregating $302 that are available to offset future taxable
income. Carryforwards of $83 expire at various dates from 2006 through 2015 and
the balance have no expiration date. A deferred tax asset of $92 has been
recorded for these tax loss carryforwards and a valuation allowance of $82 has
also been recorded for these tax loss carryforwards.
No provision has been made for income taxes on undistributed earnings of
consolidated non-United States subsidiaries of $2,011 at December 31, 2005,
since it is the Company's intention to indefinitely reinvest undistributed
earnings of its foreign 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. On October 22, 2004,
the American Jobs Creation Act of 2004 (the Act) was signed into law. The Act
provided for a special one-time tax deduction of 85% of certain foreign earnings
that are repatriated (as defined in the Act) in 2005. In fourth quarter 2005,
Eaton recorded income tax expense of $3 for the repatriation of $66 of foreign
earnings under the Act.
Worldwide income tax payments were $171 in 2005, $161 in 2004 and $137 in 2003.
F-23
<PAGE>
OTHER INFORMATION
ACCOUNTS RECEIVABLE
Accounts receivable were net of an allowance for doubtful accounts of $21 and
$32 at December 31, 2005 and 2004, respectively.
INVENTORIES
The components of inventories follow:
<TABLE>
<CAPTION>
2005 2004
---------- ----------
<S> <C> <C>
Raw materials ..................... $ 469 $ 398
Work-in-process ................... 265 206
Finished goods .................... 442 412
---------- ----------
Inventories at FIFO ............... 1,176 1,016
Excess of FIFO over LIFO cost ..... (77) (50)
---------- ----------
$ 1,099 $ 966
========== ==========
</TABLE>
Inventories at FIFO accounted for using the LIFO method were 51% and 56% at the
end of 2005 and 2004, respectively.
WARRANTY LIABILITIES
A summary of the current and long-term liabilities for warranties follows:
<TABLE>
<CAPTION>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Balance at the beginning of the year ... $ 152 $ 125 $ 127
Current year provision ................. 93 108 81
Business acquisitions .................. 3 12
Claims paid/satisfied .................. (87) (94) (82)
Other .................................. (4) 1 (1)
---------- ---------- ----------
Balance at the end of the year ......... $ 157 $ 152 $ 125
========== ========== ==========
</TABLE>
LEASE COMMITMENTS
Eaton leases certain real properties and equipment. Minimum rental commitments
under noncancelable operating leases, which expire at various dates and in most
cases contain renewal options, for each of the next five years and thereafter in
the aggregate were $91 in 2006, $67 in 2007, $47 in 2008, $32 in 2009, $23 in
2010, and $34 thereafter.
Rental expense was $116 in 2005, $113 in 2004, and $115 in 2003.
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>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Net income ...................................................... $ 805 $ 648 $ 386
========== ========== ==========
Average number of Common Shares outstanding assuming dilution ... 154.0 157.1 150.5
Less dilutive effect of stock options ........................... 3.8 4.0 2.6
---------- ---------- ----------
Average number of Common Shares outstanding basic ............... 150.2 153.1 147.9
========== ========== ==========
Net income per Common Share
Assuming dilution ............................................ $ 5.23 $ 4.13 $ 2.56
Basic ........................................................ 5.36 4.24 2.61
</TABLE>
F-24
<PAGE>
BUSINESS SEGMENT & GEOGRAPHIC REGION INFORMATION
Eaton is a diversified industrial manufacturer having 2005 sales of $11.1
billion. The Company is a global leader in the design, manufacture, marketing
and servicing of electrical systems and components for power quality,
distribution and control; fluid power systems and services for industrial,
mobile and aircraft equipment; intelligent truck drivetrain systems for safety
and fuel economy; and automotive engine air management systems, powertrain
solutions and specialty controls for performance, fuel economy and safety. The
Company had 59,000 employees at the end of 2005 and sells products to customers
in more than 125 countries. Major products included in each business segment and
other information follows.
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; 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; a
full range of AC and DC Uninterruptible Power Systems (UPS); power management
software, remote monitoring, turnkey integration services and site support
engineering services for electrical power and control systems
FLUID POWER
All pressure ranges of hose, fittings, adapters, couplings and other fluid power
connectors; hydraulic pumps, motors, valves, cylinders, power steering units,
tube connectors, fittings, 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, 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, valves, sealing and pneumatic systems for large commercial
aircraft and regional jets, products for aircraft engines, fuel systems, cabin
air and de-icing systems, hydraulic systems, low-pressure airframe fuel systems,
electromechanical actuation, air ducting, hydraulic and power generation, and
fluid distribution systems for fuel, hydraulics and air; filtration systems,
industrial equipment, clutches and brakes for industrial machines; golf grips
and precision molded and extruded plastic products
TRUCK
Heavy-, medium-, and light-duty and agricultural mechanical transmissions;
heavy- and medium-duty automated transmissions; heavy- and medium-duty clutches;
and a variety of other products including gears and shafts, transfer boxes,
gearshift mechanisms, rotors, electronic diagnostic equipment for commercial
vehicles, and collision warning systems
AUTOMOTIVE
Engine valves, valve actuation components, engine displacement control
components, advanced valvetrain systems to enhance fuel economy and emissions,
cylinder heads, superchargers, superturbo compounding, limited slip and locking
differentials, electronically controlled traction modification devices,
precision gear forgings, compressor control clutches for mobile refrigeration,
mirror actuators, transmission controls, on-board vapor recovery systems, fuel
level senders, exhaust gas recirculation valves for heavy-duty engines, flow and
pressure controls for direct injection diesel engines, turbocharger waste gate
controls, and intake manifold control valves
OTHER INFORMATION
The principal markets for the Electrical segment 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.
The principal markets for the Fluid Power, Truck and Automotive segments are
original equipment manufacturers and after-market customers of off-highway
agricultural and construction vehicles, industrial equipment, heavy-, medium-,
and light-duty trucks, passenger cars, and customers involved with aerospace
products and systems. These manufacturers are located globally and most sales of
these products are made directly to such manufacturers.
No single customer represented more than 10% of net sales in 2005, 2004 or 2003.
Sales from United States and Canadian operations to customers in foreign
countries were $568 in 2005, $504 in 2004 and $437 in 2003 (5% of sales in 2005,
2004, and 2003).
The accounting policies of the business 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.
In accordance with SFAS No. 131, for purposes of business segment performance
measurement, the Company does not allocate to the business segments items that
are of a non-operating nature or corporate organizational and functional
expenses of a governance nature. Corporate expenses consist of corporate office
expenses including compensation, benefits, occupancy, depreciation, and other
administrative costs. Identifiable assets of the business segments exclude
goodwill, other intangible assets, and 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-25
<PAGE>
GEOGRAPHIC REGION INFORMATION
<TABLE>
<CAPTION>
Segment
operating Long-lived
Net sales profit assets
---------- ---------- ----------
<S> <C> <C> <C>
2005
United States ..................... $ 7,699 $ 1,021 $ 1,191
Canada ............................ 315 48 16
Europe ............................ 2,147 114 533
Latin America ..................... 1,036 136 298
Asia/Pacific ...................... 797 80 137
Eliminations ...................... (879)
---------- ----------
$ 11,115 $ 2,175
========== ==========
2004
United States ..................... $ 6,843 $ 780 $ 1,215
Canada ............................ 261 37 16
Europe ............................ 1,990 150 547
Latin America ..................... 774 107 244
Asia/Pacific ...................... 679 79 125
Eliminations ...................... (730)
---------- ----------
$ 9,817 $ 2,147
========== ==========
2003
United States ..................... $ 5,758 $ 546 $ 1,264
Canada ............................ 209 28 16
Europe ............................ 1,581 94 491
Latin America ..................... 516 65 205
Asia/Pacific ...................... 504 64 100
Eliminations ...................... (507)
---------- ----------
$ 8,061 $ 2,076
========== ==========
</TABLE>
Net sales and segment 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.
Segment operating profit was reduced by restructuring charges as follows:
<TABLE>
<CAPTION>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
United States ..................... $ 17 $ 22 $ 22
Europe ............................ 7 18 11
Latin America ..................... 4
Asia/Pacific ...................... 8 1 3
---------- ---------- ----------
$ 36 $ 41 $ 36
========== ========== ==========
</TABLE>
F-26
<PAGE>
BUSINESS SEGMENT INFORMATION
<TABLE>
<CAPTION>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Net sales
Electrical ............................................ $ 3,758 $ 3,072 $ 2,313
Fluid Power ........................................... 3,240 3,098 2,786
Truck ................................................. 2,288 1,800 1,272
Automotive ............................................ 1,829 1,847 1,690
---------- ---------- ----------
$ 11,115 $ 9,817 $ 8,061
========== ========== ==========
Operating profit
Electrical ............................................ $ 375 $ 243 $ 158
Fluid Power ........................................... 339 338 247
Truck ................................................. 453 329 168
Automotive ............................................ 232 243 224
Corporate
Amortization of intangible assets ..................... (30) (25) (21)
Interest expense-net .................................. (90) (78) (87)
Minority interest ..................................... (5) (7) (12)
Pension & other postretirement benefit expense ........ (120) (75) (52)
Provision to exit a business .......................... (15)
Other corporate expense--net .......................... (158) (172) (117)
---------- ---------- ----------
Income before income taxes ............................ 996 781 508
Income taxes .......................................... 191 133 122
---------- ---------- ----------
Net income ............................................ $ 805 $ 648 $ 386
========== ========== ==========
</TABLE>
Income before income taxes was reduced by restructuring charges as follows:
<TABLE>
<CAPTION>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Electrical ........................ $ 21 $ 33 $ 22
Fluid Power ....................... 7 8 14
Truck ............................. 4
Automotive ........................ 4
Corporate ......................... 1
---------- ---------- ----------
$ 36 $ 41 $ 37
========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
2005 2004 2003
---------- ---------- ----------
<S> <C> <C> <C>
Identifiable assets
Electrical ....................................... $ 1,454 $ 1,469 $ 1,072
Fluid Power ...................................... 1,787 1,527 1,422
Truck ............................................ 1,064 940 690
Automotive ....................................... 960 974 872
---------- ---------- ----------
5,265 4,910 4,056
Goodwill ......................................... 3,139 2,433 2,095
Other intangible assets .......................... 626 644 541
Corporate ........................................ 1,188 1,088 1,531
---------- ---------- ----------
Total assets ..................................... $ 10,218 $ 9,075 $ 8,223
========== ========== ==========
Expenditures for property, plant & equipment
Electrical ....................................... $ 59 $ 55 $ 37
Fluid Power ...................................... 76 83 60
Truck ............................................ 99 90 71
Automotive ....................................... 108 91 86
---------- ---------- ----------
342 319 254
Corporate ........................................ 21 11 19
---------- ---------- ----------
$ 363 $ 330 $ 273
========== ========== ==========
Depreciation of property, plant & equipment
Electrical ....................................... $ 84 $ 83 $ 80
Fluid Power ...................................... 94 91 92
Truck ............................................ 70 61 54
Automotive ....................................... 89 84 77
---------- ---------- ----------
337 319 303
Corporate ........................................ 19 23 19
---------- ---------- ----------
$ 356 $ 342 $ 322
========== ========== ==========
</TABLE>
F-27
<PAGE>
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS
Dollars in millions, except for per share data (per share data assume dilution)
OVERVIEW OF THE COMPANY
Eaton is a diversified industrial manufacturer having 2005 sales of $11.1
billion. The Company is a global leader in the design, manufacture, marketing
and servicing of electrical systems and components for power quality,
distribution and control; fluid power systems and services for industrial,
mobile and aircraft equipment; intelligent truck drivetrain systems for safety
and fuel economy; and automotive engine air management systems, powertrain
solutions and specialty controls for performance, fuel economy and safety. The
principal markets for the Electrical segment are industrial, construction,
commercial, automotive and government customers. The principal markets for the
Fluid Power, Truck and Automotive segments are original equipment manufacturers
and after-market customers of off-highway agricultural and construction
vehicles, industrial equipment, passenger cars, heavy-, medium-, and light-duty
trucks, and customers involved with aerospace products and systems. The Company
had 59,000 employees at the end of 2005 and sells products to customers in more
than 125 countries.
HIGHLIGHTS OF RESULTS FOR 2005
Eaton experienced strong economic conditions in 2005 in most of its end markets
and posted record financial results, with the Electrical, Fluid Power and Truck
business segments reporting improved performance during 2005 compared to 2004.
Results of the Automotive segment were hurt by both the flat North American
Automotive market and the lower European market. During 2005, Eaton continued to
make progress towards key corporate goals of 1) accelerating organic growth by
outgrowing end markets, 2) acquiring and integrating new businesses and 3)
managing its capital.
<TABLE>
<CAPTION>
2005 2004 Increase
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ........................................ $ 11,115 $ 9,817 13%
Gross margin ..................................... 3,103 2,735 13%
Percent of net sales .......................... 27.9% 27.9%
Net income ....................................... 805 648 24%
Net income per Common Share assuming dilution .... $ 5.23 $ 4.13 27%
Return on Shareholders' equity ................... 22.2% 19.9%
</TABLE>
Net sales in 2005 were a new record for Eaton, surpassing the previous record
set in 2004. Sales growth of 13% in 2005 consisted of 7% from organic growth, 5%
from acquisitions of businesses (primarily the full-year effect of the Powerware
electrical power systems business acquired on June 9, 2004), and 1% from foreign
exchange rates. Organic growth included 5% from end-market growth and 2% from
outgrowing end markets.
Gross margin increased 13% in 2005 primarily due to sales growth, the benefits
of integrating acquired businesses, continued productivity improvements driven
by the Eaton Business System (EBS), and the full-year effect of the acquisition
of Powerware. Improved gross margin in 2005 was also partially due to reduced
restructuring charges in 2005. These improvements in gross margin were partially
offset by higher pensions costs, and higher prices paid, primarily for basic
metals, in 2005.
Net income and net income per Common Share assuming dilution for 2005 were also
new records for Eaton, increasing 24% and 27%, respectively, over 2004. These
improvements were primarily due to sales growth and other factors described
above. The improvement in net income also reflected pretax expenses in 2004 of
$15 to exit a business and a $13 contribution to the Eaton Charitable Fund, with
no similar expenses recorded in 2005. These factors contributing to the increase
in net income were partially offset by higher interest expense and a higher
effective income tax rate in 2005. Earnings per share also benefited from lower
average shares outstanding in 2005 compared to 2004, due to the repurchase of
7.01 million shares in 2005, at a total cost of $450.
In 2005, Eaton acquired various businesses in separate transactions. The
Statements of Consolidated Income include the results of these businesses from
the effective dates of acquisition. These acquisitions are summarized below:
- -- On December 6, 2005, Eaton acquired the aerospace division of
PerkinElmer, Inc., a provider of sealing and pneumatic systems for
large commercial aircraft and regional jets. This business had sales of
$150 for the 12 months ended June 30, 2005 and is included in the Fluid
Power segment.
- -- On November 1, 2005, the Company acquired the aerospace fluid and air
division of Cobham plc, a provider of low-pressure airframe fuel
systems, electro-mechanical actuation, air ducting, hydraulic and power
generation, and fluid distribution systems for fuel, hydraulics and
air. This business had 2004 sales of $210 and is included in the Fluid
Power segment.
- -- On October 11, 2005, the Company acquired the assets of one of its
suppliers, Pringle Electrical Manufacturing Company. This business
manufactures bolted contact switches and other specialty switches and
had 2004 sales of $6, with one-third of these sales to Eaton. This
business is included in the Electrical segment.
F-28
<PAGE>
- -- On September 6, 2005, the industrial filtration business of Hayward
Industries, Inc., which produces filtration systems for industrial and
commercial customers, was acquired. This business had sales of $100 for
the 12 months ended June 30, 2005 and is included in the Fluid Power
segment.
- -- On August 17, 2005, Tractech Holdings, Inc., a manufacturer of
specialized differentials and clutch components for the commercial and
specialty vehicle markets, was acquired. This business had 2004 sales
of $43 and is included in the Automotive segment.
- -- On June 30, 2005, Morestana S.A. de C.V. (Morestana), a Mexican
producer of hydraulic lifters for automotive engine manufacturers and
the automotive aftermarket, was acquired. This business had 2004 sales
of $13 and is included in the Automotive segment.
- -- On June 17, 2005, the Company formed a joint venture to manufacture
medium-voltage switchgear components in southern China. Eaton has 51%
ownership of the joint venture. This business is included in the
Electrical segment.
- -- On March 31, 2005, Eaton acquired Winner Group Holdings Ltd. (Winner),
a producer of hydraulic hose fittings and adapters for the Chinese
market. This business had 2004 sales of $26 and is included in the
Fluid Power segment.
- -- On March 1, 2005, Pigozzi S.A. Engrenagens e Transmissoes (Pigozzi), a
Brazilian agricultural powertrain business that produces transmissions,
rotors and other drivetrain components, was acquired. This business had
2004 sales of $42 and is included in the Truck segment.
Total debt of $2,464 at the end of 2005 increased $691 from $1,773 at year-end
2004. The increase was primarily due to the $381 increase in short-term debt,
primarily commercial paper, and the issuance of $393 of long-term notes and
debentures. The proceeds from the issuance of long-term debt and commercial
paper were used as part of the financing for the purchase price of businesses
acquired in 2005, which had a combined cash price of $911, and for the
repurchase of 7.01 million Common Shares during the first half of 2005 at a
total cost of $450. The net-debt-to-capital ratio was 36.0% at the end of 2005
compared to 29.1% at year-end 2004. The increase in this ratio reflected the
$651 increase in net debt (total debt less cash and short-term investments),
offset by the $172 increase in Shareholders' equity. Shareholders' equity of
$3,778 was a new record, increasing from $3,606 at year-end 2004, primarily the
result of net income of $805 in 2005, partially offset by the repurchase of 7.01
million Common Shares at a total cost of $450, as discussed above, and cash
dividends paid of $184.
Cash generated from operating activities of $1,135 in 2005 was a new record for
Eaton, increasing by $297 over cash generated from operating activities of $838
in 2004. The increase was primarily due to higher net income in 2005, which rose
$157 in 2005 over 2004, and also included a $50 contribution to the Company's
United States qualified pension plan in 2005, which was lower than a similar
contribution of $75 in 2004. Cash and short-term investments totaled $336 at the
end of 2005, up $40 from $296 at year-end 2004.
Net working capital of $610 at the end of 2005 decreased by $305 from $915 at
year-end 2004. The decrease was primarily due to the $381 increase in short-term
debt as described above and a $214 increase in current portion of long-term
debt, which reflected the reclassification of certain long-term debt that will
mature in 2006 to current liabilities. These decreases in working capital were
partially offset by increases in accounts receivable due to higher sales in 2005
and in inventories due to high levels of inventory related to acquisitions of
businesses completed during 2005 and purchases of additional inventory to guard
against basic metals shortages. The current ratio was 1.2 at the end of 2005 and
1.4 at year-end 2004.
In light of its strong results and future prospects, on January 23, 2006, Eaton
announced that it was taking the following actions:
- -- Increasing the quarterly dividend on its Common Shares by 13%, from
$.31 per share to $.35 per share, effective for the February 2006
dividend
- -- Making a voluntary contribution of $100 to its qualified pension plan
in the United States
RESULTS OF OPERATIONS -- 2005 COMPARED TO 2004
<TABLE>
<CAPTION>
2005 2004 Increase
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ........................................ $ 11,115 $ 9,817 13%
Gross margin ..................................... 3,103 2,735 13%
Percent of net sales .......................... 27.9% 27.9%
Net income ....................................... 805 648 24%
Net income per Common Share assuming dilution .... $ 5.23 $ 4.13 27%
</TABLE>
Sales for 2005 grew 13% compared to 2004 and were a record for Eaton. Sales
growth in 2005 consisted of 7% from organic growth, 5% from acquisitions of
businesses (primarily the full-year effect of the Powerware electrical power
systems business acquired on June 9, 2004), and 1% from foreign exchange rates.
Organic growth of 7% was comprised of 5% growth in Eaton's end markets and 2%
from outgrowing end markets.
F-29
<PAGE>
Gross margin increased 13% in 2005, primarily due to sales growth, the benefits
of integrating acquired businesses, continued productivity improvements driven
by the Eaton Business System (EBS), and the full-year effect of the acquisition
of Powerware. Improved gross margin in 2005 was also partially due to reduced
restructuring charges in 2005, which were $36 compared to $41 in 2004. These
increases in gross margin were partially offset by higher pension costs and
higher prices paid, primarily for basic metals, in 2005.
RESULTS BY GEOGRAPHIC REGION
<TABLE>
<CAPTION>
Net sales Operating profit Operating margin
--------------------------------------- ------------------------------------ ------------------------
Increase
2005 2004 Increase 2005 2004 (Decrease) 2005 2004
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
United States ...... $ 7,699 $ 6,843 13% $ 1,021 $ 780 31% 13.3% 11.4%
Canada ............. 315 261 21% 48 37 30% 15.2% 14.2%
Europe ............. 2,147 1,990 8% 114 150 (24%) 5.3% 7.5%
Latin America ...... 1,036 774 34% 136 107 27% 13.1% 13.8%
Asia/Pacific ....... 797 679 17% 80 79 1% 10.0% 11.6%
Eliminations ....... (879) (730)
---------- ----------
$ 11,115 $ 9,817 13%
========== ==========
</TABLE>
Growth in sales in the United States of 13% was due to higher sales in
Electrical, which included the full-year effect of the acquisition of Powerware;
sharply higher sales in Truck due to strong end market demand; and, to a lesser
extent, increased sales in Fluid Power, which included sales of the aerospace
division of PerkinElmer, Inc., the aerospace fluid and air division of Cobham
plc, and the industrial filtration business of Hayward Industries, Inc., all of
which were acquired in the second half of 2005. These increases in sales were
partially offset by a sales reduction in Automotive. The 31% increase in
operating profit in the United States was primarily the result of strong sales
in Truck; higher profit of Electrical, including the full-year effect of the
acquisition of Powerware; the benefits of integrating acquired businesses; and,
to a lesser extent, increased profit of Fluid Power and Automotive.
In Canada, growth of 21% in sales and 30% in operating profit were due to the
full-year effect of the acquisition of Powerware and improved results in other
Electrical businesses.
Sales growth in Europe of 8% was due to higher sales in Electrical, largely the
result of the full-year effect of the acquisition of Powerware; and, to a lesser
extent, growth in Fluid Power, which included sales of the aerospace fluid and
air division of Cobham plc, as well as growth in Automotive and Truck. Lower
operating profit of 24% in Europe was primarily the result of a significant
reduction in revenues in Fluid Power's automotive fluid connectors business, and
reduced profit of Automotive, which included costs incurred in the fourth
quarter to start-up new facilities in Eastern Europe.
In Latin America, growth of 34% in sales and 27% in operating profit were
largely due to significantly higher sales in Truck, which included the Pigozzi
agricultural powertrain business acquired in March 2005; and, to a lesser
extent, higher sales in Electrical, including the full-year effect of the
acquisition of Powerware, and sales growth in Automotive, which included the
Morestana hydraulic lifters business acquired in June 2005.
Growth of 17% in sales of Asia/Pacific was due to the full-year effect of the
acquisition of Powerware and higher sales of Fluid Power, which included the
Winner hydraulics business acquired in March 2005. The 1% increase in operating
profit primarily related to the full-year effect of the acquisition of Powerware
and improved results of Fluid Power, partially offset by lower profit in
Automotive and by start-up losses related to new operations of Truck.
OTHER RESULTS OF OPERATIONS
In 2005 and 2004, Eaton incurred restructuring charges related to the
integration of primarily the following acquisitions: Powerware, the electrical
power systems business acquired in June 2004; the electrical division of Delta
plc acquired in January 2003; several acquisitions in Fluid Power, including
Winner, Walterscheid acquired in September 2004, and Boston Weatherhead acquired
in November 2002; the Pigozzi agricultural powertrain business; and the
Morestana automotive lifter business. A summary of these charges follows:
<TABLE>
<CAPTION>
2005 2004
---------- ----------
<S> <C> <C>
Electrical ........................ $ 21 $ 33
Fluid Power ....................... 7 8
Truck ............................. 4
Automotive ........................ 4
---------- ----------
Pretax charges .................... $ 36 $ 41
========== ==========
After-tax charges ................. $ 24 $ 27
Per Common Share .................. $ .15 $ .17
</TABLE>
F-30
<PAGE>
Restructuring charges in 2005 included $17 for the United States, $7 for Europe,
$4 for Latin America and $8 for Asia/Pacific. Restructuring charges in 2004
included $22 for the United States, $18 for Europe and $1 for Asia/Pacific. 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 charges reduced Operating profit of the
related business segment or were included in Other corporate expense-net, as
appropriate.
Pretax income for 2005 was reduced by $55 ($35 after-tax, or $.23 per Common
Share) compared to 2004 due to increased pension and other postretirement
benefit expense in 2005. This primarily resulted from the effect of the lower
discount rates used in determining pension and other postretirement benefit
liabilities at year-end 2004, coupled with the impact of declines during 2000
through 2002 in the market related value of equity investments held by Eaton's
pension plans. Increased costs for other postretirement benefit expense were
partially offset by the effect of the Medicare Prescription Drug, Improvement,
and Modernization Act of 2003, as further explained in "Retirement Benefit
Plans" in the Notes to the Consolidated Financial Statements.
Net interest expense of $90 in 2005 increased by $12 from $78 in 2004. The
increase was primarily due to the $691 net increase in total debt at the end of
2005 compared to the end of 2004, and, to a lesser extent, the increase in the
interest rate on short-term debt during 2005.
In December 2004, Eaton announced that it would exit its tire and refrigeration
valve manufacturing business. The Company incurred charges of $15 ($10
after-tax, or $.06 per Common Share) principally for the write-down of fixed
assets and workforce reductions. This business is in the Automotive segment. In
the Statements of Consolidated Income and Business Segment Information, these
charges were reported as a separate line item. This business was sold in March
2005.
In 2004, a charge of $13 was recorded for a contribution to the Eaton Charitable
Fund ($8 after-tax, or $.05 per Common Share). In the Statements of Consolidated
Income, the charge was included in Other (income) expense-net. In Business
Segment Information, the charge was included in Other corporate expense-net.
The effective income tax rate for 2005 was 19.2% compared to 17.0% for 2004. The
lower rate in 2004 was primarily due to an income tax benefit of $30 resulting
from the favorable resolution in the fourth quarter of 2004 of multiple
international and U.S. income tax issues. In fourth quarter 2005, Eaton recorded
income tax expense of $3 for the repatriation of $66 of foreign earnings under
the American Jobs Creation Act of 2004. This distribution does not change the
Company's intention to indefinitely reinvest undistributed earnings of its
foreign subsidiaries and, therefore, no U.S. income tax provision has been
recorded on the remaining amount of unremitted earnings. The change in the
effective income tax rate in 2005 compared to 2004 is further explained in
"Income Taxes" in the Notes to the Consolidated Financial Statements.
Net income and net income per Common Share assuming dilution for 2005 were new
records for Eaton, increasing 24% and 27%, respectively, over 2004. These
improvements were primarily due to sales growth and other factors described
above. The improvement in net income also reflected pretax expenses in 2004 of
$15 to exit a business and a $13 contribution to the Eaton Charitable Fund, with
no similar expenses recorded in 2005. These improvements contributing to the
increase in net income were partially offset by higher interest expense and a
higher effective income tax rate in 2005. The increase in earnings per share
also reflected lower average shares outstanding for periods in 2005 compared to
2004, due to the repurchase of 7.01 million shares in 2005, at a total cost of
$450.
RESULTS BY BUSINESS SEGMENT
ELECTRICAL
<TABLE>
<CAPTION>
2005 2004 Increase
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ......................... $ 3,758 $ 3,072 22%
Operating profit .................. 375 243 54%
Operating margin .................. 10.0% 7.9%
</TABLE>
Sales of the Electrical segment in 2005 reached record levels. Of the 22% sales
increase, 11% was from acquisitions, 10% was due to volume growth, and 1% from
foreign exchange rates. Acquisitions included the Powerware electrical power
systems business acquired on June 9, 2004. Operating results for 2005 and 2004
include the results of Powerware from the date of acquisition. Volume growth of
10% in 2005 was driven by growth in end markets of approximately 3% and sales
above end-market growth of an additional 7%.
Operating profit rose 54% in 2005, and was also a new record for this segment.
The increase was largely due to growth in sales, continued productivity
improvements, the full-year effect of the acquisition of Powerware, benefits of
integrating Powerware, and favorable product mix. These improvements in
operating profit were partially offset by higher prices paid, primarily for
basic metals. The operating margin on overall sales growth was 19%. Increased
sales from acquisitions generated a 6% operating margin. Increased sales from
organic growth generated a 29% operating margin. The improved operating margin
in 2005 also reflected reduced restructuring charges in 2005. Restructuring
charges in 2005 were $21 compared to $33 in 2004, reducing operating margins by
0.6% in 2005 and 1.1% in 2004, and reducing the incremental profit margin by
1.7%. Restructuring charges in 2005 and 2004 related primarily to the
integration of Powerware as well as the electrical division of Delta plc
acquired in January 2003.
F-31
<PAGE>
On October 11, 2005, Eaton acquired the assets of one of its suppliers, Pringle
Electrical Manufacturing Company. This business manufactures bolted contact
switches and other specialty switches and had 2004 sales of $6, with one-third
of these sales to Eaton.
On June 17, 2005, Eaton signed an agreement to form a joint venture with
Zhongshan Ming Yang Electrical Appliances Co., Ltd. to manufacture and market
switchgear components in southern China. Eaton has 51% ownership of the joint
venture, which is called Eaton Electrical (Zhongshan) Co., Ltd. The joint
venture began operations in third quarter 2005.
On June 9, 2004, Eaton acquired Powerware Corporation, the power systems
business of Invensys plc, for a final cash purchase price of $573, less cash
acquired of $27. Powerware, based in Raleigh, North Carolina, is a supplier of
Uninterruptible Power Systems (UPS), DC Power products and power quality
services that had revenues of $775 for the year ended March 31, 2004. Powerware
has operations in the United States, Canada, Europe, South America and
Asia/Pacific that provide products and services utilized by computer
manufacturers, industrial companies, governments, telecommunications firms,
medical institutions, data centers and other businesses.
FLUID POWER
<TABLE>
<CAPTION>
2005 2004 Increase
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ......................... $ 3,240 $ 3,098 5%
Operating profit .................. 339 338 --
Operating margin .................. 10.5% 10.9%
</TABLE>
Sales of the Fluid Power segment were at record levels in 2005. The increase in
sales in 2005 over 2004 was due to acquisitions of businesses in 2005 and 2004
contributing 5%, with growth in end markets contributing another 3%, driven by
strength in end markets for hydraulics and commercial aerospace, partially
offset by weakness in end markets for defense aerospace and automotive fluid
connectors. Sales in 2005 also reflected a significant sales decrease in the
automotive fluid connector business reflecting the impact of expiring programs.
Acquisitions in 2005 included the following businesses, which are described
below: the aerospace operations of PerkinElmer, Inc. and the aerospace fluid and
air division of Cobham plc; the industrial filtration business of Hayward
Industries, Inc.; and the hydraulic hose fittings and adapters business in China
of Winner Group Holdings Ltd. The sales increase also reflected the full-year
effect of the acquisition of Walterscheid, a German manufacturer of hydraulic
tube connectors and fittings, in September 2004. Growth in Fluid Power markets
during 2005 was mixed, with global hydraulics shipments up 7%, commercial
aerospace markets up 8%, defense aerospace markets down 7%, and European
automotive production down 2%. Growth in the mobile and industrial hydraulics
markets in 2005 slowed from 2004. In particular, agricultural equipment sales
were sluggish due to a combination of drought conditions and reductions in farm
income in several markets around the world.
Operating margins were helped by the operating profit of acquired businesses,
which generated incremental profit of 13% on the sales contributed, benefits of
restructuring actions to integrate acquired businesses, and continued
productivity improvements. Operating profit and margins were also affected by
the significant reduction in revenues in the automotive fluid connectors
business, which had a 26% reduction in profits on the lost volume. Additional
program costs within the aerospace business, slowing demand in the agricultural
equipment sector, and higher prices paid, primarily for basic metals, also
contributed to the lower operating margin. Restructuring charges in 2005 related
to acquired businesses were $7 compared to $8 in 2004, reducing operating
margins by 0.2% in 2005 and 0.3% in 2004. These restructuring charges related to
the integration of recent acquisitions including Winner, Walterscheid acquired
in September 2004, and Boston Weatherhead acquired in November 2002.
On December 6, 2005, Eaton acquired the aerospace division of PerkinElmer, Inc.,
which is a provider of sealing and pneumatic systems for large commercial
aircraft and regional jets. This business had sales of $150 for the 12 months
ended June 30, 2005.
On November 1, 2005, the Company acquired the aerospace fluid and air division
of Cobham plc. This business provides low-pressure airframe fuel systems,
electro-mechanical actuation, air ducting, hydraulic and power generation, and
fluid distribution systems for fuel, hydraulics and air. This business had 2004
sales of $210.
On September 6, 2005, the industrial filtration business of Hayward Industries,
Inc. was acquired. Hayward produces filtration systems for industrial and
commercial customers. This business had sales of $100 for the 12 months ended
June 30, 2005.
On March 31, 2005, Eaton acquired Winner Group Holdings Ltd., a producer of
hydraulic hose fittings and adapters for the Chinese market. This business had
2004 sales of $26.
TRUCK
<TABLE>
<CAPTION>
2005 2004 Increase
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ......................... $ 2,288 $ 1,800 27%
Operating profit .................. 453 329 38%
Operating margin .................. 19.8% 18.3%
</TABLE>
F-32
<PAGE>
The Truck segment posted record sales in 2005, growing 27% compared to 2004. Of
the sales increase in 2005, 21% was due to organic growth, 5% from foreign
exchange rates, and 1% from the acquisition of Pigozzi, as described below.
Organic growth was attributable to strong end-market demand, primarily in NAFTA
heavy-duty truck production, which rose 27% in 2005 to 341,000 units. Other
markets also grew in 2005, with NAFTA medium-duty truck production increasing 5%
in 2005 compared to 2004, European truck production increasing 6%, and Brazilian
vehicle production increasing 8%.
Operating profit, which grew 38% in 2005, and the operating margin of 19.8%,
were also records for this segment. The incremental profit margin on the
increased sales volume was 25% and also reflected the benefits of productivity
improvements. These improvements in operating margin were offset by higher
prices paid, primarily for basic metals. Operating profit in 2005 was also
reduced by 0.2% due to restructuring charges of $4 related to the integration of
Pigozzi.
On March 1, 2005, Pigozzi S.A. Engrenagens e Transmissoes, a Brazilian
agricultural powertrain business that produces transmissions, rotors and other
drivetrain components, was acquired. This business had 2004 sales of $42.
In the third quarter of 2005, Eaton was notified that it had been selected by
the National Highway Transportation Safety Administration to be part of a group
of companies to evaluate crash-avoidance technologies for both cars and
commercial vehicles. The government has budgeted $31 for this four-year study.
During second quarter 2005, Eaton was awarded a contract to supply medium-duty
transmissions to Hyundai for the Korean market. The Company anticipates annual
sales of $20, with production starting in 2007.
AUTOMOTIVE
<TABLE>
<CAPTION>
2005 2004 (Decrease)
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ......................... $ 1,829 $ 1,847 (1)%
Operating profit .................. 232 243 (5)%
Operating margin .................. 12.7% 13.2%
</TABLE>
Sales of the Automotive segment decreased 1% in 2005. The reduction in sales
reflected sales volume that was lower by 2% in 2005, offset by a 1% increase due
to foreign exchange rates. Automotive production in 2005 for NAFTA was flat
compared to 2004, and in Europe decreased 2% from 2004. The change in sales also
reflected additional sales volume from the acquisitions in 2005 of Tractech
Holdings, Inc. and Morestana S.A. de C.V , as described below, partially offset
by the sale of the tire and refrigeration valve manufacturing business in March
2005.
The 5% decrease in operating profit in 2005 resulted from the sales reduction in
2005, costs incurred to start-up new facilities in Eastern Europe and to exit a
product line, and $4 of restructuring charges related to the acquisition of
Morestana described below. Operating profit in 2005 was helped by continued
productivity improvements, but was also hurt by higher prices paid, primarily
for basic metals. Restructuring charges related to the integration of Morestana
reduced operating margin by 0.2% in 2005.
On August 17, 2005, Tractech Holdings, Inc., a manufacturer of specialized
differentials and clutch components for the commercial and specialty vehicle
markets, was acquired. This business had 2004 sales of $43.
On June 30, 2005, Morestana S.A. de C.V., a Mexican producer of hydraulic
lifters for automotive engine manufacturers and the automotive aftermarket, was
acquired. This business had 2004 sales of $13.
During third quarter 2005, Eaton started production of a small supercharger that
is combined with turbocharger technology in the new 1.4 liter Volkswagen Golf
TSI. The combination allows an automaker the option to provide a smaller
displacement gasoline engine while improving performance, and reducing fuel
consumption and emissions.
CORPORATE
Net interest expense of $90 in 2005 increased by $12 from $78 in 2004. The
increase was primarily due to the $691 net increase in total debt at the end of
2005 compared to the end of 2004, and, to a lesser extent, the increase in the
interest rate on short-term debt during 2005.
Pension and other postretirement benefit expense included in corporate increased
to $120 in 2005 from $75 in 2004. The increase primarily resulted from the
effect of the lower discount rates used in determining pension and other
postretirement benefit liabilities at year-end 2004, coupled with the impact of
declines during 2000 through 2002 in the market related value of equity
investments held by Eaton's pension plans. Increased costs for other
postretirement benefit expense were partially offset by the effect of the
Medicare Prescription Drug, Improvement, and Modernization Act of 2003, as
further explained in "Retirement Benefit Plans" in the Notes to the Consolidated
Financial Statements.
In December 2004, Eaton announced that it would exit its tire and refrigeration
valve manufacturing business. The Company incurred charges of $15 principally
for the write-down of fixed assets and workforce reductions. This business was
sold in March 2005.
Other corporate expense-net in 2005 was $158 compared to $172 for 2004. The
reduction was largely attributable to a charge of $13 for contributions to the
Eaton Charitable Fund that was recorded in 2004, with no similar expense in
2005.
F-33
<PAGE>
CHANGES IN FINANCIAL CONDITION DURING 2005
Throughout 2005, Eaton maintained a focus on management of its capital. Net
working capital of $610 at the end of 2005 decreased by $305 from $915 at
year-end 2004. The decrease was primarily due to the $381 increase in short-term
debt, primarily commercial paper, and the $214 increase in current portion of
long-term debt. The increase in short-term debt was part of the financing for
the purchase of business acquisitions completed in 2005 at a combined cash
purchase price of $911. The increase in current portion of long-term debt was
due to the reclassification of $229 of long-term debt that will mature in 2006
to current liabilities. These decreases in working capital were partially offset
by increases of $173 in accounts receivable and $133 in inventories. Accounts
receivable increased due to higher sales of $1.3 billion in 2005. Accounts
receivable days outstanding were 56 days at the end of 2005, virtually unchanged
from the end of 2004. Inventory days on hand at the end of 2005 increased to 47
days compared to 46 days at year-end 2004, primarily due to high levels of
inventory related to acquisitions of businesses completed during 2005 and
purchases of additional inventory to guard against basic metals shortages. The
current ratio was 1.2 at the end of 2005 and 1.4 at year-end 2004. Cash and
short-term investments totaled $336 at the end of 2005, up $40 from $296 at
year-end 2004.
Cash generated from operating activities of $1,135 in 2005 was a new record for
Eaton, increasing by $297 from $838 in 2004. The increase was primarily due to
higher net income in 2005, which rose $157 in 2005 compared to 2004, and also
included a $50 contribution to the Company's United States qualified pension
plan in 2005, which was lower than a similar contribution of $75 in 2004. In
January 2006, Eaton made an additional voluntary contribution of $100 to its
United States qualified pension plan.
Total debt of $2,464 at the end of 2005 increased $691 from $1,773 at year-end
2004. The increase was primarily due to the $381 increase in short-term debt,
primarily commercial paper, and the issuance of $393 of long-term notes and
debentures. The proceeds from the issuance of long-term debt and commercial
paper were used as part of the financing for the purchase price of business
acquisitions completed in 2005, which had a combined cash purchase price of
$911, and for the repurchase of 7.01 million Common Shares during the first half
of 2005 at a total cost of $450. The net-debt-to-capital ratio was 36.0% at the
end of 2005 compared to 29.1% at year-end 2004. The increase in this ratio
reflected the $651 increase in net debt (total debt less cash and short-term
investments), offset by the $172 increase in Shareholders' equity. Shareholders'
equity of $3,778 was a new record, rising $172 from $3,606 at year-end 2004,
primarily the result of net income of $805 in 2005, offset by the repurchase of
7.01 million Common Shares at a total cost of $450, as discussed above, and cash
dividends paid of $184.
On June 14, 2005, Standard & Poor's raised the Company's long-term credit rating
to "A" from "A-minus" and its commercial paper rating to "A-1" from "A-2",
stating that improved operating performance at Eaton is expected to result in
stronger cash flows. On August 30, 2005, Moody's affirmed Eaton's long-term debt
rating but changed its outlook on Eaton's long-term debt to negative from stable
citing the possibility of periodically elevated debt levels as the Company grows
through acquisition.
On November 17, 2005, the Company issued Euro 100 million floating rate notes
due November 2008. In June 2005, Eaton issued $100 of 5.25% Notes, which will
mature in 2035, and $100 of 4.65% Notes, which will mature in 2015. On January
28, 2005, the Company issued $75 of 5.45% Senior Debentures, which will mature
in 2034.
On April 18, 2005, Eaton's Board of Directors authorized the Company to
repurchase up to 10 million of its Common Shares. In the second quarter, 3.38
million shares were repurchased at a total cost of $200. No shares were
repurchased in the third or fourth quarters of 2005. The remainder of the shares
are expected to be repurchased over time, depending on market conditions, share
price, capital levels and other considerations.
During first quarter 2005, Eaton repurchased 3.63 million Common Shares at a
total cost of $250. This completed the plan announced on January 24, 2005 to
repurchase $250 of shares to help offset dilution from shares issued during 2004
from the exercise of stock options.
In March 2005, Eaton entered into a new $700 long-term revolving credit
facility, which will expire in March 2010. Eaton has long-term revolving credit
facilities of $1 billion, of which $300 will expire in May 2008 and the
remaining $700 in March 2010.
OUTLOOK FOR 2006
As Eaton surveyed its end markets in mid-January 2006, it anticipated growth of
approximately 3% for full year 2006. The Company expects to outgrow its end
markets by well over 50%, and expects to also record approximately $475 of
growth from the full-year impact of the eight acquisitions and one joint venture
concluded in 2005. As a result, overall growth in sales in 2006 is expected to
be approximately 10%. The Company's guidance for net income per Common Share for
the full year of 2006 is $5.75 to $6.05, after restructuring charges to
integrate recent acquisitions of $.20 per share. For the first quarter of 2006,
Eaton anticipates net income per share of $1.20 to $1.30, after restructuring
charges to integrate recent acquisitions of $.05 per share.
For 2006, in the Electrical segment, Eaton expects end markets to grow 4 to 5%,
with the nonresidential electric markets becoming a more important source of
growth than in 2005. For Fluid Power, Eaton expects end markets to also grow 4
to 5%, with growth in both the agricultural and construction equipment markets
expected to be lower than in 2005, while industrial markets should have growth
similar to 2005. The commercial aerospace market is expected to post
significantly higher growth in 2006, while defense aerospace markets are
expected to be flat. In the Truck segment, production of NAFTA heavy-duty trucks
in 2005 totaled 341,000 units, and the Company believes that production in 2006
will likely stay at about the same level. For the Automotive segment, Eaton
expects slightly weaker production in NAFTA and a slight increase in production
in Europe.
F-34
<PAGE>
On January 23, 2006, Eaton announced that it was beginning to implement its
Excel 07 program. This program is a series of actions intended to address
businesses that underperformed in 2005, or where activity in end markets is
expected to decline over the next couple of years. The Company has not announced
the bulk of the specific actions that will be taken throughout 2006, but they
are expected to include the relocation of several product lines and
manufacturing facilities. The guidance for net income per share for the first
quarter of 2006 reflected in the first paragraph of this section includes
estimated expenses of approximately $.10 per share, net of savings, related to
the Excel 07 program.
FORWARD-LOOKING STATEMENTS
This Annual Report to Shareholders contains forward-looking statements
concerning Eaton's first quarter 2006 and full year 2006 net income per Common
Share, worldwide end markets, growth in relation to end markets, and growth from
acquisitions and joint ventures. 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 the Company'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; unanticipated difficulties
integrating acquisitions; 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. Application 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
Sales are recognized when products are shipped to unaffiliated customers, all
significant risks of ownership have been transferred to the customer, title has
transferred in accordance with shipping terms (FOB shipping point or FOB
destination), the selling price is fixed and determinable, all significant
related acts of performance have been completed, and no other significant
uncertainties exist. Shipping and handling costs billed to customers are
included in Net sales and the related costs in Cost of products sold. Other
revenues for service contracts are recognized as the services are provided.
IMPAIRMENT OF LONG-LIVED ASSETS
Statement of Financial Accounting Standards (SFAS) No. 142 "Goodwill and Other
Intangible Assets" provides that 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. During 2005, Eaton completed the annual
impairment tests for goodwill and indefinite life intangible assets as required
by SFAS No. 142. 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.
Goodwill and other intangible assets totaled $3.8 billion at the end of 2005 and
represented 37% of total assets. These assets resulted primarily from the 1999
$1.6 billion acquisition of Aeroquip-Vickers, Inc., a mobile and industrial
hydraulics business, the 1994 $1.1 billion acquisition of the electrical
distribution and controls business unit of Westinghouse, and the 2004 $573
acquisition of Powerware Corporation, the electrical power systems business.
These businesses, as well as many of the Company's other recent business
acquisitions, have a long history of operating success and profitability and
hold significant market positions in the majority of their product lines. Their
products are not subject to rapid technological or functional obsolescence.
These factors, coupled with continuous strong product demand, support the
recorded values of the goodwill and intangible assets related to acquired
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 certain United States Federal income tax
credit carryforwards, most United States state and local income tax loss
carryforwards and tax credit carryforwards, and tax loss carryforwards at
certain international operations. Therefore, a valuation allowance of $190 has
been recognized for these deferred tax assets.
F-35
<PAGE>
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
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.
The discount rate for United States plans was determined by constructing a
zero-coupon spot yield curve derived from a universe of high-quality bonds as of
the measurement date, which was designed to match the discounted expected
benefit payments. The bond data (rated "Aa" or better by Moody's Investor
Services) was obtained from Bloomberg. Callable bonds with explicit call
schedules were excluded and bonds with "make-whole" call provisions were
included. In addition, a portion of the bonds were deemed outliers and excluded
from consideration.
The discount rates for non-United States plans are appropriate for each region
and are based on high quality long-term corporate and government bonds.
Consideration has been given to the duration of the liabilities in each plan for
selecting the bonds to be used in determining the discount rate.
At the end of 2005, 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 8.41% to 8.35% and the discount rate
from 5.81% to 5.51%. At the end of 2004, the assumed return on pension plan
assets was lowered from 8.50% to 8.41% and the discount rate from 6.11% to
5.81%.
The changes in these assumptions, coupled with the effect of the decline in
market related value of equity investments held by Eaton's pension plans during
2000 through 2002, resulted in increased pretax pension and postretirement
expense of $55 in 2005 compared to 2004. These changes increased pretax pension
and other postretirement benefit expense $31 in 2004 compared to 2003, and are
expected to result in increased pretax pension and other postretirement benefit
expense of approximately $45 in 2006 over 2005.
A 1-percentage point change in the assumed rate of return on pension plan assets
is estimated to have approximately a $20 effect on pension expense. Likewise, a
1-percentage point change in the discount rate is estimated to have
approximately a $42 effect on pension expense. A 1-percentage point change in
the discount rate is estimated to have approximately a $2 effect on expense for
other postretirement benefit plans. Additional 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
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, 2005, the balance sheet included a liability for these costs of $75. 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.
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, as allowed by SFAS No.
123, "Accounting for Stock-Based Compensation". 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.
Eaton has adopted the disclosure-only provisions of SFAS No. 123. If the Company
recognized compensation expense for its stock options under the fair-value-based
method of SFAS No. 123, net income per Common Share assuming dilution would have
been reduced by $.12 in 2005, and $.08 in 2004 and 2003, as further described in
"Shareholders' Equity" in the Notes to the Consolidated Financial Statements.
In December 2004, the FASB issued SFAS No. 123(R). This Statement eliminates the
alternative of using the intrinsic-value-based method of accounting for stock
options that was provided in SFAS No. 123. The Statement requires entities to
recognize the expense of employee and director services received in exchange for
stock options, based on the grant date fair value of those awards. That expense
will be recognized over the period the employee or director is required to
provide service in exchange for the award.
F-36
<PAGE>
On April 14, 2005, the Securities and Exchange Commission (SEC) published a rule
that had the effect of allowing companies with fiscal years ending December 31
to delay the quarter in which they begin to expense stock options to first
quarter 2006. Eaton will expense stock options beginning in first quarter 2006.
The Company estimates that the adoption of SFAS No. 123(R) will reduce net
income per Common Share assuming dilution in 2006 by approximately $.16.
OFF-BALANCE SHEET ARRANGEMENTS
Eaton does not have off-balance sheet arrangements or financings with
unconsolidated entities or other persons. 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 $14.
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, 2005, the market value of the
Company's debt and interest rate swap portfolio, in aggregate, would increase by
$89.
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 $662 at December 31,
2005. To augment Eaton's non-U.S. Dollar debt portfolio, the Company also enters
into forward foreign exchange contracts and foreign currency swaps 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, 2005, the aggregate balance
of such contracts was $95. 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 2005.
Other than the above noted debt and financial derivative arrangements, there
were no material derivative instrument transactions in place or undertaken
during 2005.
A summary of contractual obligations as of December 31, 2005 follows:
<TABLE>
<CAPTION>
2007 2009
to to After
2006 2008 2010 2010 Total
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Long-term debt ................................... $ 240 $ 412 $ 17 $ 1,401 $ 2,070
Interest expense related to long-term debt ....... 136 223 208 1,130 1,697
Reduction of interest expense from
interest rate swap agreements related
to long-term debt ............................. (16) (19) (9) (57) (101)
Operating leases ................................. 91 114 55 34 294
Purchase obligations ............................. 318 73 40 20 451
Other long-term liabilities ...................... 156 26 25 33 240
---------- ---------- ---------- ---------- ----------
$ 925 $ 829 $ 336 $ 2,561 $ 4,651
========== ========== ========== ========== ==========
</TABLE>
F-37
<PAGE>
Long-term debt includes obligations under capital leases, which are not
material. Interest expense related to long-term debt is based on the fixed
interest rate, or other applicable interest rate related to the debt instrument,
at December 31, 2005. The reduction of interest expense due to interest rate
swap agreements related to long-term debt is based on the difference in the
fixed interest rate the Company receives from the swap, compared to the floating
interest rate the Company pays on the swap, at December 31, 2005. 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 $146 of contributions to pension plans in 2006 and $94 of
deferred compensation earned under various plans for which the participants have
elected to receive disbursement at a later date. The table above does not
include future expected pension benefit payments or expected other
postretirement benefit payments for each of the next five years and the five
years thereafter. Information related to the amounts of these future payments is
described in "Retirement Benefit Plans" in the Notes to the Consolidated
Financial Statements.
RESULTS OF OPERATIONS -- 2004 COMPARED TO 2003
<TABLE>
<CAPTION>
2004 2003 Increase
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ......................... $ 9,817 $ 8,061 22%
Gross margin ...................... 2,735 2,164 26%
Percent of net sales ........... 27.9% 26.8%
Net income ........................ 648 386 68%
Net income per Common
Share assuming dilution ........ $ 4.13 $ 2.56 61%
</TABLE>
Net sales in 2004 were at a record level for Eaton, surpassing the record set in
2003. Sales growth of 22% in 2004 consisted of 12% from organic growth, 7% from
acquisitions of businesses, and 3% from foreign exchange rates. Organic growth
consisted of 8% from end-market growth and 4% from outgrowing end markets.
Gross margin in 2004 increased primarily due to sales growth and the benefits of
restructuring actions taken in recent years to improve profit performance of the
Company. These increases were partially offset by higher prices paid, primarily
for basic metals in 2004. The impact of higher metals costs, partially offset by
increased selling prices to recover these higher costs, was a 1.0 percentage
point reduction in gross margin. Gross margin was reduced by 0.4% in both 2004
and 2003 due to restructuring charges. Gross margin in 2004 increased compared
to 2003 despite higher prices paid, primarily for basic metals, and the addition
of the Powerware business, whose margins are currently lower than the rest of
the Electrical segment.
RESULTS BY GEOGRAPHIC REGION
<TABLE>
<CAPTION>
Net sales Operating profit Operating margin
--------------------------------------- ------------------------------------- ------------------------
2004 2003 Increase 2004 2003 Increase 2004 2003
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
United States ...... $ 6,843 $ 5,758 19% $ 780 $ 546 43% 11.4% 9.5%
Canada ............. 261 209 25% 37 28 32% 14.2% 13.4%
Europe ............. 1,990 1,581 26% 150 94 60% 7.5% 6.0%
Latin America ...... 774 516 50% 107 65 65% 13.8% 12.6%
Asia/Pacific ....... 679 504 35% 79 64 23% 11.6% 12.7%
Eliminations ....... (730) (507)
---------- ----------
$ 9,817 $ 8,061 22%
========== ==========
</TABLE>
Growth in sales of 19% in the United States was due to higher sales in
Electrical, largely the result of the acquisition of Powerware in June 2004;
significantly higher sales in Truck due to strong demand in many of Truck's
markets; and, to a lesser extent, increased sales in Fluid Power and Automotive.
The 43% increase in operating profit in the United States was primarily the
result of strong sales in Truck; the acquisition of Powerware; the benefits of
restructuring actions taken in recent years; and integration of recently
acquired businesses.
In Canada, growth of 25% in sales and 32% in operating profit were due to the
acquisition of Powerware and improved results in other Electrical businesses.
Sales growth of 26% in Europe was due to higher sales in Electrical, largely the
result of the acquisition of Powerware; growth in Fluid Power, Automotive and
Truck; and from foreign exchange rates. Higher operating profit in Europe of 60%
was the result of increased sales and the benefits of restructuring actions
taken in recent years that were reflected in improved returns in each of the
Company's four business segments.
In Latin America, growth of 50% in sales and 65% in operating profit were due to
higher sales in Truck, the acquisition of Powerware adding sales in Electrical,
and, to a lesser extent, sales growth in Fluid Power and Automotive.
Growth of 35% in sales in Asia/Pacific was due to the acquisition of Powerware
and the strong performance of Fluid Power and Truck. The 23% increase in
operating profit in Asia/Pacific primarily related to the acquisition of
Powerware and improved results of Fluid Power.
F-38
<PAGE>
OTHER RESULTS OF OPERATIONS
In 2004, Eaton incurred restructuring charges related primarily to the
integration of: Powerware, the electrical power systems business acquired in
June 2004; the electrical division of Delta plc acquired in January 2003; and
the Boston Weatherhead fluid power business acquired in November 2002. In 2003,
restructuring charges related primarily to the integration of the electrical
division of Delta plc and the Boston Weatherhead fluid power business. A summary
of these charges follows:
<TABLE>
<CAPTION>
2004 2003
---------- ----------
<S> <C> <C>
Electrical ........................ $ 33 $ 22
Fluid Power ....................... 8 14
---------- ----------
41 36
Corporate ......................... 1
---------- ----------
Pretax charges .................... $ 41 $ 37
========== ==========
After-tax charges ................. $ 27 $ 24
Per Common Share .................. $ .17 $ .16
</TABLE>
Restructuring charges in 2004 included $22 for the United States, $18 for Europe
and $1 for Asia/Pacific. Similar charges in 2003 included $23 for the United
States, $11 for Europe and $3 for Asia/Pacific. 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 charges reduced Operating profit of the related business
segment or were included in Other corporate expense-net, as appropriate.
Pretax income for 2004 was reduced by $31 ($20 after-tax, or $.13 per Common
Share) compared to 2003 due to increased pension and other postretirement
benefit expense in 2004. This resulted from the effect of the lowering of
discount rates associated with pension and other postretirement benefit
liabilities at year-end 2003, coupled with the decline during 2000 through 2002
in the market related value of equity investments held by Eaton's pension plans.
These increased costs were partially offset by the effect of the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003, as further
explained in "Retirement Benefit Plans" in the Notes to the Consolidated
Financial Statements.
Net interest expense of $78 in 2004 fell by $9 from $87 in 2003. The decrease
largely related to the $180 net reduction in total debt from the end of 2003 to
the end of 2004, offset by a slight increase in the interest rates for
short-term debt in 2004.
In December 2004, Eaton announced that it would exit its tire and refrigeration
valve manufacturing business. The Company incurred charges of $15 ($10
after-tax, or $.06 per Common Share) principally for the write-down of fixed
assets and workforce reductions. This business is in the Automotive segment. In
the Statements of Consolidated Income and Business Segment Information, these
charges were reported as a separate line item. This business was sold in March
2005.
In 2004, a charge of $13 was recorded for a contribution to the Eaton Charitable
Fund ($8 after-tax, or $.05 per Common Share). In the Statements of Consolidated
Income, the charge was included in Other (income) expense-net. In Business
Segment Information, the charge was included in Other corporate expense-net.
The effective income tax rate for 2004 was 17.0% compared to 24.0% in 2003. The
lower rate in 2004 was primarily due to an income tax benefit of $30 resulting
from the favorable resolution of multiple international and U.S. income tax
issues in fourth quarter 2004, higher earnings in international tax
jurisdictions with lower income tax rates, increased use of foreign tax credit
carryforwards, and implementation of international tax planning initiatives. The
change in the effective income tax rate in 2004 compared to 2003 is further
discussed in "Income Taxes" in the Notes to the Consolidated Financial
Statements.
Net income and net income per Common Share assuming dilution were also records
for Eaton in 2004. These record results were primarily due to the sales growth
in 2004 and the benefits of restructuring actions taken in recent years. In
addition, lower net interest expense and a reduction in the effective income tax
rate helped the Company to post improved net income. These increases in net
income in 2004 were partially offset by higher prices paid, primarily for basic
metals, higher costs for pensions and other postretirement benefits, a provision
of $15 to exit a business, and a $13 contribution to the Eaton Charitable Fund.
RESULTS BY BUSINESS SEGMENT
ELECTRICAL
<TABLE>
<CAPTION>
2004 2003 Increase
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ......................... $ 3,072 $ 2,313 33%
Operating profit .................. 243 158 54%
Operating margin .................. 7.9% 6.8%
</TABLE>
F-39
<PAGE>
Sales of the Electrical segment grew 33% in 2004. Of the 33% sales growth, 24%
was from acquisitions, 7% was due to volume growth, and 2% was from foreign
exchange rates. Acquisitions included the Powerware electrical power systems
business acquired on June 9, 2004 and Electrum Group acquired in March 2004, as
described below. Also contributing to sales growth from acquisitions in 2004 was
the electrical division of Delta plc acquired in January 2003, and the
electrical switchgear business formed with Caterpillar in August 2003. Eaton's
operating results for 2004 and 2003 include the results of acquired businesses
from the dates of acquisition. Volume growth of 7% in 2004 was driven by growth
in Electrical end markets of about 4% and sales above end-market growth of an
additional 3%.
The 54% increase in operating profit in 2004 was largely due to growth in sales
from both acquisitions and end-market growth. The operating margin on overall
sales growth was 13%. The increased sales from acquisitions generated a 7%
operating margin. Increased sales from organic growth generated a 27% operating
margin. These improvements in operating margin were partially offset by
increased restructuring charges in 2004. Restructuring charges in 2004 were $33
compared to $22 in 2003, reducing operating margins by 1.1% in 2004 and 1.0% in
2003, and reducing the incremental profit margin by 1%. Restructuring charges in
2004 related primarily to the integration of Powerware and the electrical
division of Delta plc acquired in January 2003. Restructuring charges in 2003
related largely to the integration of the electrical division of Delta plc. The
incremental margins were helped by the benefits of restructuring actions to
integrate acquired businesses and continued productivity improvements, but were
hurt by higher prices paid, primarily for basic metals.
On June 9, 2004, Eaton acquired Powerware Corporation, the electrical power
systems business of Invensys plc, for a final cash purchase price of $573, less
cash acquired of $27. Powerware, based in Raleigh, North Carolina, is a supplier
of Uninterruptible Power Systems (UPS), DC Power products and power quality
services that had revenues of $775 for the year ended March 31, 2004. Powerware
has operations in the United States, Canada, Europe, South America and
Asia/Pacific that provide products and services utilized by computer
manufacturers, industrial companies, governments, telecommunications firms,
medical institutions, data centers and other businesses.
In March 2004, Eaton acquired the Electrum Group Ltd., which provides power
management services and web-based software for telecommunications, data center
and government applications. The purchase price, net sales and operating profit
of this business, were not material in 2004.
During second quarter 2004, the Electrical business was awarded a contract from
the U.S. Postal Service to test and maintain electrical switchgear, which is
anticipated to generate annual sales of $6 over the next four years, and a
contract worth $12 to supply distribution and control equipment for a new power
plant being constructed by Hitachi.
FLUID POWER
<TABLE>
<CAPTION>
2004 2003 Increase
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ......................... $ 3,098 $ 2,786 11%
Operating profit .................. 338 247 37%
Operating margin .................. 10.9% 8.9%
</TABLE>
Sales of the Fluid Power segment grew 11% in 2004. The 11% increase in sales in
2004 included 8% growth attributed to volume growth and 3% due to foreign
exchange rates. Volume growth was driven by the mix of markets in which this
segment participates. The majority of sales growth in 2004 resulted from the
strong performance of mobile and industrial hydraulics markets. The commercial
aerospace market also began to recover in 2004, growing in the fourth quarter at
its fastest rate in over two years. Global hydraulics markets were up an
estimated 13%, commercial aerospace markets were flat, defense aerospace markets
were up 5%, and European automotive production flat. Operating results for 2004
included Walterscheid, a manufacturer of hydraulic tube connectors and fittings
primarily for the European market, from the date of acquisition on September 1,
2004, with less than 1% of the increase in sales attributed to this acquisition
in 2004.
Operating profit in 2004 increased 37%. Higher operating profit in 2004 was
largely due to sales growth, which generated an incremental 27% profit.
Increased operating profit was also due to lower restructuring charges in 2004,
which were $8 compared to $14 in 2003, reducing operating margins by 0.3% in
2004 and 0.5% in 2003. The restructuring charges in 2004 and 2003 related
primarily to the integration of the Boston Weatherhead business acquired in late
2002. The incremental margins were helped by the benefits of restructuring
actions to integrate acquired businesses and continued productivity
improvements, but were hurt by higher prices paid, primarily for basic metals.
In January 2004, Eaton acquired Ultronics Limited with its electro-hydraulic
valve system technology that is utilized in mobile applications in construction,
forestry, agriculture and other markets. In early 2004, Eaton invested in Eaton
Senstar Automotive Fluid Connector (Shanghai) Co., Ltd. This business, 55%-owned
by Eaton, was formed with Changzhou Senstar Automobile Air Conditioner Co. Ltd.
to produce automotive air conditioning hose and tube assemblies and power
steering hose and tube assemblies in Shanghai for Volkswagen's China operations.
The purchase prices, net sales and operating profit of these businesses, were
not material in 2004.
F-40
<PAGE>
In November 2004, Eaton announced that its aerospace business began work with
Lockheed Martin to increase the Company's role on the F-35 Joint Strike Fighter
by expanding its scope of work on the wing fluid delivery system. The expanded
wing fluid delivery work and increased technical assistance will increase
Eaton's potential revenue on the F-35 by $1 billion, based on production of
2,600 aircraft over the life of the program, which is expected to continue
through 2027. The $1 billion increase brings the expected Joint Strike Fighter
related revenue over the life of the program to almost $3 billion, including the
hydraulic power generation system, general actuation and the expanded wing fluid
delivery system work.
TRUCK
<TABLE>
<CAPTION>
2004 2003 Increase
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ......................... $ 1,800 $ 1,272 42%
Operating profit .................. 329 168 96%
Operating margin .................. 18.3% 13.2%
</TABLE>
Net sales of the Truck segment were up 42% in 2004. Of the 42% increase, 40% was
due to volume growth and 2% to foreign exchange. The significant volume growth
was attributable to strong end-market demand, primarily NAFTA heavy-duty truck
production, which increased 48% in 2004. Other end markets also grew during 2004
with NAFTA medium-duty truck production increasing 24% in 2004 compared to 2003,
European truck production increasing 7%, and Brazilian vehicle production
increasing 20%.
Operating profit improved 96% in 2004, reflecting increased sales throughout all
geographic regions. The incremental profit margin on the increased sales volume
was 30% and reflected the benefits of higher production levels without a
significant increase in fixed costs and the benefits of productivity
improvements, offset by higher prices paid, primarily for basic metals.
Eaton made significant progress during 2004 on both of its new truck businesses
in China. The joint venture with FAW Jiefang Automotive Co., Ltd. formally
started production in September 2004 with Eaton contributing $28 of cash to
purchase a 50% interest in the venture. Operating results of this venture were
immaterial in 2004.
In addition, the Company started production in the Eaton Fast Gear (EFG)
heavy-duty truck transmission business in fourth quarter 2004. The formation of
EFG was announced in third quarter 2003. Eaton's partners in EFG are Shaanxi
Fast Gear Co., Ltd., and Xiang Torch Investment Co., Ltd. Eaton has 55%
ownership of the business. The purchase price, annual sales and operating profit
of this business were not material in 2004.
AUTOMOTIVE
<TABLE>
<CAPTION>
2004 2003 Increase
---------- ---------- ----------
<S> <C> <C> <C>
Net sales ......................... $ 1,847 $ 1,690 9%
Operating profit .................. 243 224 8%
Operating margin .................. 13.2% 13.3%
</TABLE>
Sales in the Automotive segment in 2004 grew 9%. Growth above 2003 included 6%
due to volume growth, including new program launches and new contract wins,
primarily in the valvetrain, and air induction and cylinder heads systems
operations. Sales in 2004 also improved by 3% due to foreign exchange rates. The
growth in Automotive's sales considerably exceeded the growth in its end
markets. Automotive production for 2004 in NAFTA was lower by 1% and in Europe
increased 1% compared to 2003.
The 8% increase in operating profit in 2004 resulted from increased sales, which
generated an incremental profit on the increased sales of 12%. The incremental
profit rate was helped by continued productivity improvements, but was hurt by
higher prices paid, primarily for basic metals.
In first quarter 2004, Eaton won contracts to supply locking differentials to
Hyundai and Kia for several new vehicle programs. Revenues from these contracts
are expected to total approximately $67 over the next six years.
CORPORATE
Net interest expense of $78 in 2004 fell by $9 from $87 in 2003. The decrease
largely related to the $180 net reduction in total debt from the end of 2003 to
the end of 2004, offset by a slight increase in the interest rates for
short-term debt in 2004.
Pension and other postretirement benefit expense included in corporate increased
to $75 in 2004 from $52 in 2003. The increase primarily resulted from the effect
of the lower discount rates used in determining pension and other postretirement
benefit liabilities at year-end 2003, coupled with the decline during 2000
through 2002 in the market related value of equity investments held by Eaton's
pension plans. These increased costs were partially offset by the effect of the
Medicare Prescription Drug, Improvement, and Modernization Act of 2003, as
further explained in "Retirement Benefit Plans" in the Notes to the Consolidated
Financial Statements.
In December 2004, Eaton announced that it would exit its tire and refrigeration
valve manufacturing business. The Company incurred charges of $15 principally
for the write-down of fixed assets and workforce reductions. This business was
sold in March 2005.
F-41
<PAGE>
Other corporate expense-net in 2004 was $172 compared to $117 for 2003. The
increase was largely attributable to a charge of $13 for contributions to the
Eaton Charitable Fund, foreign exchange expense, and higher corporate
administrative costs, as well as favorable legal settlements in 2003.
F-42
<PAGE>
TEN-YEAR CONSOLIDATED FINANCIAL SUMMARY
<TABLE>
<CAPTION>
(Millions except for per share data) 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996
------- ------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Continuing operations
Net sales ....................... $11,115 $9,817 $8,061 $7,209 $7,299 $8,309 $8,005 $6,358 $7,104 $6,515
Income before income taxes ...... 996 781 508 399 278 552 943 616 730 428
Income after income taxes ....... 805 648 386 281 169 363 603 430 526 305
Percent of net sales ............ 7.2% 6.6% 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 ......................... $ 805 $ 648 $ 386 $ 281 $ 169 $ 453 $ 617 $ 349 $ 410 $ 349
======= ====== ====== ====== ====== ====== ====== ====== ====== ======
Net income per Common Share
assuming dilution
Continuing operations ........... $ 5.23 $ 4.13 $ 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
------- ------ ------ ------ ------ ------ ------ ------ ------ ------
$ 5.23 $ 4.13 $ 2.56 $ 1.96 $ 1.20 $ 3.12 $ 4.18 $ 2.40 $ 2.62 $ 2.23
======= ====== ====== ====== ====== ====== ====== ====== ====== ======
Average number of Common Shares
outstanding assuming dilution ...... 154.0 157.1 150.5 143.4 141.0 145.2 147.4 145.4 156.4 156.4
Net income per Common Share basic
Continuing operations ........... $ 5.36 $ 4.24 $ 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
------- ------ ------ ------ ------ ------ ------ ------ ------ ------
$ 5.36 $ 4.24 $ 2.61 $ 1.99 $ 1.22 $ 3.16 $ 4.26 $ 2.45 $ 2.67 $ 2.25
======= ====== ====== ====== ====== ====== ====== ====== ====== ======
Average number of Common Shares
outstanding basic .................. 150.2 153.1 147.9 141.2 138.8 143.6 145.0 142.8 153.6 154.8
Cash dividends paid per
Common Share ....................... $ 1.24 $ 1.08 $ .92 $ .88 $ .88 $ .88 $ .88 $ .88 $ .86 $ .80
Total assets ....................... $10,218 $9,075 $8,223 $7,138 $7,646 $8,180 $8,342 $5,570 $5,497 $5,290
Long-term debt ..................... 1,830 1,734 1,651 1,887 2,252 2,447 1,915 1,191 1,272 1,062
Total debt ......................... 2,464 1,773 1,953 2,088 2,440 3,004 2,885 1,524 1,376 1,092
Shareholders' equity ............... 3,778 3,606 3,117 2,302 2,475 2,410 2,624 2,057 2,071 2,160
Shareholders' equity per
Common Share .................... $ 25.44 $23.52 $20.37 $16.30 $17.80 $17.64 $17.72 $14.34 $13.86 $14.00
Common Shares outstanding .......... 148.5 153.3 153.0 141.2 139.0 136.6 148.0 143.4 149.4 154.2
</TABLE>
F-43
<PAGE>
QUARTERLY DATA
<TABLE>
<CAPTION>
Quarter ended in 2005 Quarter ended in 2004
--------------------------------------- ---------------------------------------
(Millions except for per share data) Dec. 31 Sept. 30 June 30 March 31 Dec. 31 Sept. 30 June 30 March 31
-------- -------- ------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales .......................... $ 2,838 $ 2,789 $ 2,834 $ 2,654 $ 2,633 $ 2,543 $ 2,403 $ 2,238
Gross margin ....................... 779 788 795 741 734 707 677 617
Percent of net sales ............ 27.4% 28.3% 28.0% 27.9% 27.9% 27.8% 28.2% 27.6%
Income before income taxes ......... 244 249 267 236 194 211 203 173
Net income ......................... 210 199 209 187 183 170 161 134
Net income per Common Share
Assuming dilution ............... $ 1.38 $ 1.30 $ 1.37 $ 1.19 $ 1.16 $ 1.09 $ 1.03 $ .85
Basic ........................... 1.41 1.33 1.40 1.22 1.19 1.12 1.06 .87
Cash dividends paid per
Common Share .................... $ .31 $ .31 $ .31 $ .31 $ .27 $ .27 $ .27 $ .27
Market price per Common
Share
High ............................ $ 67.82 $ 67.55 $ 65.04 $ 71.13 $ 72.64 $ 65.88 $ 64.84 $ 62.13
Low ............................. 56.68 60.13 57.55 64.17 59.49 59.20 54.23 52.74
</TABLE>
Earnings per Common Share for the four quarters in a year may not equal
full-year earnings per share.
F-44
<PAGE>
Eaton Corporation
2005 Annual Report on Form 10-K
Exhibit Index
Exhibits
3(i) Amended Articles of Incorporation (amended and restated April
27, 1994) -- Incorporated by reference to the Form 10-K for
the year ended December 31, 2002
3(ii) Amended Regulations (amended and restated 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)
10 Material contracts
(a) Master Purchase and Sale Agreement by and between
PerkinElmer, Inc. and Eaton Corporation dated October
6, 2005 -- Filed in conjunction with this Form 10-K
(b) Executive Incentive Compensation Plan (effective
January 1, 2005) -- Filed in conjunction with this
Form 10-K
(c) 2005 Non-Employee Director Fee Deferral Plan
(effective January 1, 2005) -- Incorporated by
reference to the Form 10-K for the year ended
December 31, 2004
(d) Deferred Incentive Compensation Plan II (effective
January 1, 2005) -- Incorporated by reference to the
Form 10-K for the year ended December 31, 2004
(e) Excess Benefits Plan II (effective January 1, 2005)
-- Incorporated by reference to the Form 10-K for the
year ended December 31, 2004
(f) Incentive Compensation Deferral Plan II (effective
January 1, 2005) -- Incorporated by reference to the
Form 10-K for the year ended December 31, 2004
(g) Limited Eaton Service Supplemental Retirement Income
Plan II (effective January 1, 2005) -- Incorporated
by reference to the Form 10-K for the year ended
December 31, 2004
(h) Supplemental Benefits Plan II (effective January 1,
2005) -- Incorporated by reference to the Form 10-K
for the year ended December 31, 2004
(i) Amendment to the Plan (originally adopted in 1985)
for the Deferred Payment of Directors' Fees
(effective January 1, 2005) -- Incorporated by
reference to the Form 10-K for the year ended
December 31, 2004
(j) Form of Restricted Share Award Agreement --
Incorporated by reference to the Form 10-K for the
year ended December 31, 2004
(k) Form of Stock Option Agreement for Executives --
Incorporated by reference to the Form 10-K for the
year ended December 31, 2004
(l) Form of Stock Option Agreement for Non-Employee
Directors - Incorporated by reference to the Form
10-K for the year ended December 31, 2004
(m) 2004 Stock Plan -- Incorporated by reference to the
definitive Proxy Statement dated March 19, 2004
(n) Plan for the Deferred Payment of Directors' Fees
(originally adopted in 1985 and amended effective
September 24, 1996, January 28, 1998, January 23,
2002 and February 24, 2004) -- Incorporated by
reference to the Form 10-Q for the three months ended
March 31, 2004
(o) Limited Eaton Service Supplemental Retirement Income
Plan (amended and restated January 1, 2003) --
Incorporated by reference to the Form 10-K for the
year ended December 31, 2002
(p) Vehicle Allowance Program (effective January 1, 2003)
-- Incorporated by reference to the Form 10-K for the
year ended December 31, 2003
<PAGE>
(q) 2002 Stock Plan -- Incorporated by reference to the
definitive Proxy Statement dated March 15, 2002
(r) 1996 Non-Employee Director Fee Deferral Plan (amended
and restated October 22, 2002) -- Incorporated by
reference to the Form 10-K for the year ended
December 31, 2002
(s) 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
(t) 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
(u) Executive Strategic Incentive Plan I (amended and
restated January 1, 2001) -- Incorporated by
reference to the Form 10-K for the year ended
December 31, 2002
(v) Executive Strategic Incentive Plan II (effective
January 1, 2001) -- Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(w) Deferred Incentive Compensation Plan (amended and
restated March 31, 2000) -- Incorporated by reference
to the Form 10-K for the year ended December 31, 2000
(x) 1998 Stock Plan -- Incorporated by reference to the
definitive Proxy Statement dated March 13, 1998
(y) Incentive Compensation Deferral Plan (amended and
restated October 1, 1997) -- Incorporated by
reference to the Form 10-K for the year ended
December 31, 2000
(z) 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
(aa) Trust Agreement -- Officers and Employees (dated
December 6, 1996) -- Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(bb) Trust Agreement -- Outside Directors (dated December
6, 1996) -- Incorporated by reference to the Form
10-K for the year ended December 31, 2002
(cc) 1995 Stock Plan -- Incorporated by reference to the
Form 10-K for the year ended December 31, 2002
(dd) Group Replacement Insurance Plan (GRIP) (effective
June 1, 1992) -- Incorporated by reference to the
Form 10-K for the year ended December 31, 1992
(ee) 1991 Stock Option Plan -- Incorporated by reference
to the Form 10-K for the year ended December 31, 2002
(ff) 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
(gg) Supplemental Benefits Plan (amended and restated
January 1, 1989) (which provides supplemental
retirement benefits) -- Incorporated by reference to
the Form 10-K for the year ended December 31, 2002
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 17, 2006
21 Subsidiaries of Eaton Corporation -- Filed in conjunction with
this Form 10-K
23 Consent of Independent Registered Public Accounting Firm --
Filed in conjunction with this Form 10-K
24 Power of Attorney -- Filed in conjunction with this Form 10-K
<PAGE>
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.A
<SEQUENCE>2
<FILENAME>l17977aexv10wa.htm
<DESCRIPTION>EXHIBIT 10A MASTER PURCHASE AND SALE AGREEMENT
<TEXT>
<HTML>
<HEAD>
<TITLE>Exhibit 10A</TITLE>
</HEAD>
<BODY bgcolor="#FFFFFF">
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<H5 align="left" style="page-break-before:always"> </H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center" style="font-size: 10pt; margin-top: 18pt">Eaton Corporation<BR>
2005 Annual Report on Form 10-K<BR>
Item 15 (b)<BR>
Exhibit 10.a
</DIV>
<DIV align="Center" style="font-size: 10pt; margin-top: 6pt">MASTER PURCHASE AND SALE AGREEMENT
</DIV>
<DIV align="Center" style="font-size: 10pt; margin-top: 6pt">BY AND BETWEEN
</DIV>
<DIV align="Center" style="font-size: 10pt; margin-top: 6pt">PERKINELMER, INC.
</DIV>
<DIV align="Center" style="font-size: 10pt; margin-top: 6pt">and
</DIV>
<DIV align="Center" style="font-size: 10pt; margin-top: 6pt">EATON CORPORATION
</DIV>
<DIV align="Center" style="font-size: 10pt; margin-top: 6pt">October 6, 2005
</DIV>
<P align="center" style="font-size: 10pt">
</DIV>
<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"> </H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>TABLE OF CONTENTS</B>
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
<TD width="4%"> </TD>
<TD width="3%"> </TD>
<TD width="87%"> </TD>
<TD width="3%"> </TD>
<TD width="1%"> </TD>
<TD width="1%"> </TD>
<TD width="1%"> </TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
<TD colspan="3" align="left">ARTICLE I STOCK AND ASSET PURCHASE</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">3</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">1.1</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Sale and Transfer of Stock and Assets; Assumption of Liabilities</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">3</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">1.2</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Purchase Price and Related Matters</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">12</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">1.3</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">The Closing</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">14</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">1.4</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Post-Closing Adjustment</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">18</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">1.5</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Consents to Assignment</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">22</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">1.6</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Further Assurances</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">23</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD colspan="3" align="left">ARTICLE II REPRESENTATIONS AND WARRANTIES OF PKI</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">23</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.1</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Organization, Qualification and Corporate Power</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">23</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.2</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Capitalization; Title to Property</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">25</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.3</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Authority</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">27</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.4</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Noncontravention</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">27</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.5</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Subsidiaries</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">28</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.6</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Financial Statements</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">28</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.7</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Absence of Certain Changes</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">29</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.8</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Undisclosed Liabilities</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">31</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.9</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Tax Matters</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">32</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.10</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Tangible Personal Property</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">35</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.11</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Real Property</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">35</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.12</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Intellectual Property</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">36</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.13</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Contracts</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">37</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.14</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Litigation</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">40</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.15</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Labor Matters</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">40</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.16</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Employee Benefits</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">41</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.17</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Environmental Matters</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">45</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.18</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Legal Compliance</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">48</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.19</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Permits</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">48</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.20</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Business Relationships with Affiliates</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">48</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.21</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Brokers’ Fees</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">49</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.22</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Entire Business</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">49</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.23</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Condition of Assets</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">49</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.24</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Asbestos Matters</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">49</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.25</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Government Contracts</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">50</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.26</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Insurance</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">51</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.27</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">No Gifts or Similar Benefits</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">52</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.28</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Suppliers and Customers</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">52</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">2.29</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Product Warranty Claims</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">53</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD colspan="3" align="left">ARTICLE III REPRESENTATIONS AND WARRANTIES OF BUYER</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">53</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">3.1</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Organization</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">53</TD>
<TD> </TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 6pt">- i -
</DIV>
<P align="center" style="font-size: 10pt">
</DIV>
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<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"> </H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
<TD width="4%"> </TD>
<TD width="3%"> </TD>
<TD width="87%"> </TD>
<TD width="3%"> </TD>
<TD width="1%"> </TD>
<TD width="1%"> </TD>
<TD width="1%"> </TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">3.2</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Authorization of Transaction</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">53</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">3.3</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Noncontravention</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">54</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">3.4</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Broker’s Fees</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">55</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">3.5</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Litigation</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">55</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">3.6</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Investment Intent</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">55</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">3.7</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Financing</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">55</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">3.8</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Solvency</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">56</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD colspan="3" align="left">ARTICLE IV PRE-CLOSING COVENANTS</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">56</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">4.1</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Efforts; Hart-Scott-Rodino Act</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">56</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">4.2</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Replacement of Guarantees and Letters of Comfort</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">57</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">4.3</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Operation of Business</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">57</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">4.4</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Access</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">60</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">4.5</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Elimination of Intercompany Items</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">60</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">4.6</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Negotiation of Additional Agreements</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">61</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">4.7</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Deferred Sale of French Real Estate</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">61</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD colspan="3" align="left">ARTICLE V CONDITIONS PRECEDENT TO CLOSING</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">61</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">5.1</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Conditions to Obligations of Buyer</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">61</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">5.2</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Conditions to Obligations of PKI</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">63</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD colspan="3" align="left">ARTICLE VI INDEMNIFICATION</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">65</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">6.1</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Indemnification by PKI</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">65</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">6.2</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Indemnification by Buyer</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">66</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">6.3</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Claims for Indemnification</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">67</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">6.4</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Survival</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">69</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">6.5</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Limitations</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">70</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">6.6</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Treatment of Indemnification Payments</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">74</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD colspan="3" align="left">ARTICLE VII TERMINATION</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">74</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">7.1</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Termination of Agreement</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">74</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">7.2</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Effect of Termination</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">75</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD colspan="3" align="left">ARTICLE VIII ENVIRONMENTAL MATTERS</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">75</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">8.1</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Definitions</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">75</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">8.2</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Environmental Indemnification by PKI</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">76</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">8.3</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Limitations</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">77</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">8.4</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Environmental Indemnification by Buyer</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">80</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD colspan="3" align="left">ARTICLE IX TAX MATTERS</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">80</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">9.1</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Preparation and Filing of Tax Returns; Payment of Taxes</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">80</TD>
<TD> </TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 6pt">- ii -
</DIV>
<P align="center" style="font-size: 10pt">
</DIV>
<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"> </H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
<TD width="4%"> </TD>
<TD width="3%"> </TD>
<TD width="87%"> </TD>
<TD width="3%"> </TD>
<TD width="1%"> </TD>
<TD width="1%"> </TD>
<TD width="1%"> </TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">9.2</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Allocation of Certain Taxes</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">82</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">9.3</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Refunds and Carrybacks</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">84</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">9.4</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Cooperation on Tax Matters; Tax Audits</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">84</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">9.5</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Termination of Tax Sharing Agreements</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">86</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">9.6</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Certain Elections under Code Section 338</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">87</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD colspan="3" align="left">ARTICLE X FURTHER AGREEMENTS</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">87</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">10.1</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Access to Information; Record Retention; Cooperation</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">87</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">10.2</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Director and Officer Indemnification</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">91</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">10.3</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Covenant Not to Compete; Nonsolicitation</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">91</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">10.4</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Disclosure Generally</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">93</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">10.5</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Acknowledgments by Buyer</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">94</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">10.6</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Certain Employee Benefits Matters</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">95</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">10.7</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Resignations</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">98</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">10.8</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Use of Name for Transition Period</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">98</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">10.9</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Seller Guarantees</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">99</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD colspan="3" align="left">ARTICLE XI MISCELLANEOUS</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">100</TD>
<TD> </TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.1</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Press Releases and Announcements</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">100</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.2</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">No Third Party Beneficiaries</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">100</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.3</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Action to be Taken by Affiliates</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">101</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.4</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Entire Agreement</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">101</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.5</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Succession and Assignment</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">101</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.6</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Counterparts</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">102</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.7</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Headings</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">102</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.8</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Notices</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">102</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.9</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Governing Law</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">103</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.10</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Amendments and Waivers</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">104</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.11</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Severability</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">104</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.12</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Expenses</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">104</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.13</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Specific Performance</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">104</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.14</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Dispute Resolution</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">105</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.15</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Bulk Transfer Laws</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">110</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.16</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Construction</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">110</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.17</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Foreign Exchange Conversions</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">111</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.18</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Waiver of Jury Trial</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">111</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.19</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Incorporation of Exhibits and Schedules</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">112</TD>
<TD> </TD>
</TR>
<TR valign="bottom">
<TD align="center"><DIV style="margin-left:15px; text-indent:-15px">11.20</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Facsimile Signature</TD>
<TD> </TD>
<TD> </TD>
<TD align="right">112</TD>
<TD> </TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 6pt">- iii -
</DIV>
<P align="center" style="font-size: 10pt">
</DIV>
<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"> </H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><U>Disclosure Schedule</U>
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
<TD width="12%"> </TD>
<TD width="4%"> </TD>
<TD width="2%"> </TD>
<TD width="4%"> </TD>
<TD width="82%"> </TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
<TD nowrap align="left" style="border-bottom: 1px solid #000000">Other Schedules</TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
<TD valign="top" nowrap><DIV style="margin-left:0px; text-indent:-0px">Schedule 1.1(b)(i)
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Owned Real Property</TD>
</TR>
<TR valign="bottom">
<TD valign="top" nowrap><DIV style="margin-left:0px; text-indent:-0px">Schedule 1.1(b)(ii)
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Leased Facilities</TD>
</TR>
<TR valign="bottom">
<TD valign="top" nowrap><DIV style="margin-left:0px; text-indent:-0px">Schedule 1.1(b)(vi)
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Certain Excluded Contracts and Agreements</TD>
</TR>
<TR valign="bottom">
<TD valign="top" nowrap><DIV style="margin-left:0px; text-indent:-0px">Schedule 1.1(b)(vii)
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Patents and Patent Applications</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Schedule 1.2
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Preliminary Allocation of Purchase Price</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Schedule 1.4(a)
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Calculation of Closing Working Capital</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Schedule 5.1(a)
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Required Consents</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Schedule 10.4(a)
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Knowledge Persons</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
<TD width="8%"> </TD>
<TD width="4%"> </TD>
<TD width="2%"> </TD>
<TD width="4%"> </TD>
<TD width="86%"> </TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
<TD nowrap align="left" style="border-bottom: 1px solid #000000">Exhibits</TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
<TD> </TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit A
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Form of Assumption Agreement</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit B
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Form of Bill of Sale</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit C
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Form of French Agreement</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit D
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Form of Patent Assignment</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit E
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Form of Trademark Assignment</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit F
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Form of Copyright Assignment</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit G
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Form of Lease Assignment and Assumption Agreement</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit H
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Form of French Real Property Deed</TD>
</TR>
<TR valign="bottom">
<TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit I
</DIV></TD>
<TD> </TD>
<TD align="center" valign="top">—
</TD>
<TD> </TD>
<TD align="left" valign="top">Form of Transition Services Agreement</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 6pt">- iv -
</DIV>
<P align="center" style="font-size: 10pt">
</DIV>
<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"> </H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>TABLE OF DEFINED TERMS</B>
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
<TD width="70%"> </TD>
<TD width="10%"> </TD>
<TD width="20%"> </TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
<TD nowrap align="left" style="border-bottom: 1px solid #000000"><B>Defined Term</B></TD>
<TD> </TD>
<TD nowrap align="left" style="border-bottom: 1px solid #000000"><B>Section</B></TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom"><!-- Blank Space -->
<TD><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">1060 Forms</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.2(b)(iv)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Accounts Receivable</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)(ix)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Acquired Assets</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Adjusted Purchase Price</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.4(i)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">ADR</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">11.14(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Affiliate</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.12(d)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Agreed Amount</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">6.3(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Agreement</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Preliminary Statement</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Allocation Schedule</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.2(b)(i)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Asset Seller</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Introduction</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Asset Sellers</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Introduction</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Assumed Liabilities</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(d)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Assumption Agreement</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(d)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Authorized Individuals</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">11.14(a)(iii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Balance Sheet Date</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.6</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Business</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Introduction</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Business Day</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.3(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Business Collective Bargaining Agreement</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.6(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Business Employees</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(g)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Business Material Adverse Effect</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.1(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Business Properties</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.17(a)(viii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Buyer</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Preliminary Statement</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Buyer Material Adverse Effect</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">3.3(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Buyer’s Plans</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.6(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">CERCLA</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.17(a)(i)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Claim Notice</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">6.3(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Claimed Amount</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">6.3(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Closing</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.3(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Closing Date</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.3(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Closing Working Capital Amount</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.4(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Closing Working Capital Statement</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.4(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">COBRA</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(i)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Code</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.2(b)(iv)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Competitive Business</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.3(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Confidentiality Agreement</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">4.4</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Consents</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">5.1(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Contracts</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)(vi)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Damages</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">6.1; 6.3(a); 8.1(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Deferred Consent</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.5</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Deferred Item</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.5</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Designated Contracts</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.13(c)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Designated Intellectual Property</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.12(a)</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 6pt">- v -
</DIV>
<P align="center" style="font-size: 10pt">
</DIV>
<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"> </H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
<TD width="70%"> </TD>
<TD width="10%"> </TD>
<TD width="20%"> </TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
<TD nowrap align="left" style="border-bottom: 1px solid #000000"><B>Defined Term</B></TD>
<TD> </TD>
<TD nowrap align="left" style="border-bottom: 1px solid #000000"><B>Section</B></TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom"><!-- Blank Space -->
<TD><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Develop; Development</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">8.1(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Disclosing Party</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.1(f)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Disclosure Schedule</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Article II</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Dispute Notice</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.4(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Dispute Resolution Party</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">11.14(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Environment</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.17(a)(iii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Environmental Indemnity Claim</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">8.2(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Environmental Law</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.17(a)(v)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Environmental Matters</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.17(a)(vi)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Equipment</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)(iii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">ERISA</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(ii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">ERISA Affiliate</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(iii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Excluded Asset</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(c)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Excluded Liabilities</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(e)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Final Closing Working Capital Amount</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.4(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Final Closing Working Capital Statement</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.4(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Financial Statements</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.6</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Foreign Business Benefit Arrangement</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(iv)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Foreign Business Benefit Plan</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(v)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Foreign Business Employee</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(vi)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Foreign Business Pension Plan</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(vii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Foreign Business Welfare Plan</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(viii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">French Agreement</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.3(b)(v)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">French Owned Property</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">4.7</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">French Real Property Deed</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.3(b)(xv)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Goodwill</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)(xii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Government Contract</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.25(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Governmental Entity</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.4(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Hart-Scott-Rodino Act</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.4</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Inactive Business Employees</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(g)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Indemnified Party</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">6.3(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Indemnifying Party</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">6.3(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Information</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.1(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Insurance Policies</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.26</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Intangible Assets</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)(vii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Intellectual Property</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)(vii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Inventory</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)(iv)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Lease Assignment and Assumption Agreements</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.3(b)(xiii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Leased Facilities</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)(ii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Leases</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.11(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Materials of Environmental Concern</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.17(a)(iv)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Most Recent Balance Sheet</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.6</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Multiemployer Plan</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(ix)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Required Environmental Remediation</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">8.1(d)</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 6pt">- vi -
</DIV>
<P align="center" style="font-size: 10pt">
</DIV>
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<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"> </H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
<TD width="70%"> </TD>
<TD width="10%"> </TD>
<TD width="20%"> </TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
<TD nowrap align="left" style="border-bottom: 1px solid #000000"><B>Defined Term</B></TD>
<TD> </TD>
<TD nowrap align="left" style="border-bottom: 1px solid #000000"><B>Section</B></TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom"><!-- Blank Space -->
<TD><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Pre-Closing Period</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">9.2(c)(i)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Retention Agreements</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(d)(xv)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">US Business Benefit Arrangement</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(x)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">US Business Benefit Plan</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(xi)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">US Business Employee</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(xii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">US Business Pension Plan</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(xiii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">US Business Welfare Plan</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(ix)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Natural Resources Damages</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">8.1(d)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Neutral</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">11.4(c)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Neutral Accountant</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.4(c)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">New Disclosure</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.4(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Noncompetition Party</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.3(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Noncompetition Period</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.3(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Off-Site Liabilities</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.17(a)(vii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Owned Real Property</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)(i)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Party, Parties</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Preliminary Statement</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Permits</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.19</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">PKI</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Preliminary Statement</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">PKI France</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Introduction</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">PKI Indonesia</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Introduction</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">PKI Singapore</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Introduction</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">PKI Singapore Parent</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Introduction</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">PKL</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Introduction</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">PKL Business</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Introduction</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Prepaid Assets</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)(x)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Purchase Price</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.2(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Receiving Party</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.1(f)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Release</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.17(a)(ii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Response Costs</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">8.1(e)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Retained Marks</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.8(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Securities Act</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.2(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Security Interest</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.2(d)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Seller Guarantees</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">4.2</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Sellers</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Introduction</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Stock</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">Introduction</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Systems and Information</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(b)(v)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Target Working Capital Amount</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.4(h)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Tax Audit</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">9.4(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Tax Returns</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.9(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Taxes</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.9(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Taxing Authority</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">9.4(a)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Tentative Assumed Liabilities</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.2(b)(i)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Third Party IP Rights</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.12(b)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Transferred Employees</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.6(a)</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 6pt">- vii -
</DIV>
<P align="center" style="font-size: 10pt">
</DIV>
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<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"> </H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
<TD width="70%"> </TD>
<TD width="10%"> </TD>
<TD width="20%"> </TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
<TD nowrap align="left" style="border-bottom: 1px solid #000000"><B>Defined Term</B></TD>
<TD> </TD>
<TD nowrap align="left" style="border-bottom: 1px solid #000000"><B>Section</B></TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom"><!-- Blank Space -->
<TD><DIV style="margin-left:15px; text-indent:-15px"> </DIV></TD>
<TD> </TD>
<TD align="left" valign="top"> </TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">US Business Benefit Arrangements</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(x)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">US Business Benefit Plan</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(xi)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">US Business Employee</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(xii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">US Business Pension Plan</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(xiii)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">US Business Welfare Plan</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">2.16(a)(xiv)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">U.S. GAAP</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.1(d)(i)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">WARN</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">10.6(c)</TD>
</TR>
<TR valign="bottom">
<TD><DIV style="margin-left:15px; text-indent:-15px">Working Capital</DIV></TD>
<TD> </TD>
<TD align="left" valign="top">1.4(a)</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 6pt">- viii -
</DIV>
<P align="center" style="font-size: 10pt">
</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>MASTER PURCHASE AND SALE AGREEMENT</B>
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> This MASTER PURCHASE AND SALE AGREEMENT (the “<U>Agreement</U>”) is entered into as of
October 6, 2005 by and between PerkinElmer, Inc., a Massachusetts corporation (“<U>PKI</U>”), and
Eaton Corporation, an Ohio corporation (“<U>Buyer</U>”). PKI and Buyer are sometimes referred to
herein individually as a “<U>Party</U>” and together as the “<U>Parties</U>.”
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>INTRODUCTION</B>
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 1. PKI and certain of its direct and indirect subsidiaries are engaged in, among other
matters, the business of developing, manufacturing, marketing, servicing and repairing sealing
valve and pneumatic products and systems and ducting products for the aerospace and industrial
market, and design and manufacturing support services for aircraft engine manufacturers and
airframe OEMs (such business, as conducted by PKI and such subsidiaries on the date hereof, being
referred to herein as the “<U>Business</U>”); <U>provided</U>, <U>however</U>; that the
definition of Business as used herein shall not include the business and operations of PKL, LLC, a
Delaware limited liability company (“<U>PKL</U>”), which involves primarily the machining and
assembly of tools used in the manufacture of valves, seals, bellows and pneumatic joints (the
“<U>PKL Business</U>”);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 2. PerkinElmer Singapore Pte Ltd. (“PKI Singapore Parent”), in its capacity as a holder of
outstanding shares of the capital stock of PKI Indonesia, a private limited company organized under
the laws of Singapore and an indirect subsidiary of PKI, owns all of the outstanding shares of
capital stock of Fluid Sciences Singapore Pte Ltd., a private limited company organized under the
laws of Singapore (“<U>PKI Singapore</U>”); and PKI Singapore, in its capacity as a holder of
outstanding shares of capital stock of PKI Indonesia (as defined below),
</DIV>
<P align="center" style="font-size: 10pt">- 1 -
</DIV>
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<H5 align="left" style="page-break-before:always"> </H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">and PKI Singapore Parent together own all of the outstanding shares of capital stock of P.T.
Fluid Sciences Batam, a corporation organized under the laws of Indonesia (“<U>PKI
Indonesia</U>”);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 3. PKI, PKI Singapore and PKI’s indirect subsidiary PerkinElmer S.A.S., a corporation
organized under the laws of France (“<U>PKI France</U>”, and together with PKI and PKI Singapore,
the “<U>Asset Sellers</U>”), collectively own or lease all of the Acquired Assets (as defined in
Section 1.1(b)). PKI, PKI Singapore and PKI France, in their capacity as the Asset Sellers, and
PKI Singapore Parent and PKI Singapore, in their capacity as a holder of outstanding shares of
capital stock of PKI Indonesia, are collectively referred to herein as the “<U>Sellers</U>”;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 4. Buyer desires to purchase from PKI Singapore Parent and PKI Singapore, and PKI desires to
cause PKI Singapore Parent and PKI Singapore to sell to Buyer, all of the outstanding shares of
capital stock of PKI Indonesia (the “<U>Stock</U>”), upon the terms and subject to the conditions
set forth herein;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 5. Buyer desires to purchase from the Asset Sellers, and PKI desires, and desires to cause PKI
France and PKI Singapore, to sell to Buyer, the Acquired Assets, subject to the assumption of
certain liabilities and upon the terms and subject to the conditions set forth herein; and
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 6. Although the Parties expect to enter into such ancillary agreements, deeds and instruments
of conveyance and assumption as may be required under applicable law (including without limitation
the laws of France) or otherwise desirable in order to fully consummate the transactions
contemplated hereby, including without limitation the purchase and sale of the
Acquired Assets and assumption of the Assumed Liabilities (as defined in Section 1.1(d)), the
</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Parties have entered into this Agreement as the master and primary agreement governing the terms
and conditions of the transactions contemplated hereby.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> NOW, THEREFORE, in consideration of the representations, warranties, covenants and agreements
contained in this Agreement and other good and valuable consideration, the receipt of which is
hereby acknowledged, the Parties agree as follows:
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>ARTICLE I</B>
</DIV>
<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><B>STOCK AND ASSET PURCHASE</B>
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 1.1 <U>Sale and Transfer of Stock and Assets; Assumption of Liabilities</U>.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (a) <U>Sale and Transfer of Stock</U>. On the terms and subject to the conditions of this
Agreement, on the Closing Date (as defined in Section 1.3(a)), PKI shall cause PKI Singapore Parent
and PKI Singapore to sell, convey, assign, transfer and deliver to Buyer (or its designee), and
Buyer (or its designee) shall purchase and acquire from PKI Singapore Parent and PKI Singapore, the
Stock.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (b) <U>Sale and Transfer of Assets</U>. On the terms and subject to the conditions of this
Agreement, on the Closing Date, PKI shall, and shall cause PKI France and PKI Singapore to, sell,
convey, assign, transfer and deliver to Buyer (or its designee), and Buyer (or its designee) shall
purchase and acquire from each Asset Seller, all of such Asset Seller’s right, title and interest
in all assets, rights, properties, claims, contracts and business of such Asset Seller as of the
Closing Date, in each case to the extent used primarily by such Asset Seller in the conduct of the
Business (such assets, rights, properties, claims, contracts and business of each Asset
Seller collectively, the “<U>Acquired Assets</U>”). The Acquired Assets include, without
limitation, the following assets, rights, properties, claims, contracts and business of each Asset
Seller, in each
</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">case to the extent used primarily by such Asset Seller in the conduct of the
Business, but the Acquired Assets specifically exclude the Excluded Assets as described in Section
1.1(c):
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (i) The real property described on <U>Schedule 1.1(b)(i)</U> attached hereto (the
“<U>Owned
Real Property</U>”);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ii) The leasehold interests in real property described on <U>Schedule 1.1(b)(ii)</U>
attached hereto (the “<U>Leased Facilities</U>”);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iii) All equipment, furniture, furnishings, fixtures, machinery, vehicles, tools and other
tangible personal property (collectively, the “<U>Equipment</U>”) and all warranties and
guarantees, if any, express or implied, existing for the benefit of such Asset Seller in connection
with the Equipment to the extent transferable;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iv) All inventory of raw materials, work in process, finished goods, office supplies,
maintenance supplies and packaging materials, together with spare parts, supplies, promotional
materials and inventory (collectively, the “<U>Inventory</U>”);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (v) All management information systems, including hardware and software, to the extent that
such systems and software are transferable, and all customer lists, vendor lists, catalogs,
research material, technical information, trade secrets, technology, know-how, specifications,
designs, drawings and processes and quality control data, if any (collectively, the “<U>Systems
and Information</U>”); <U>provided</U>, <U>however</U>, that Buyer and PKI shall each pay one
half (1/2) of all payments to third parties required to effect the transfer of such Systems and
Information (except that PKI shall cooperate with Buyer with respect to, but the Buyer shall
pay all amounts payable to, Microsoft Corporation in connection with any consents or
additional licenses required from Microsoft Corporation);
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (vi) All contracts, maintenance and service agreements, joint venture agreements, purchase
commitments for materials and other services, advertising and promotional agreements, real and
personal property leases, collective bargaining agreements (to the extent assignable and subject to
the limitations set forth in Section 10.6(b)) and other agreements (including any agreements of
such Asset Seller with customers, suppliers, sales representatives, agents, personal property
lessors, personal property lessees, licensors, licensees, consignors and consignees specified
therein), except for those contracts, agreements (including collective bargaining agreements),
commitments or leases set forth on <U>Schedule 1.1(b)(vi)</U> attached hereto (collectively, the
“<U>Contracts</U>”);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (vii) The patents, patent registrations and patent applications set forth on <U>Schedule
1.1(b)(vii)</U>, and all trademarks, trademark registrations and trademark applications, trade
names (together with the goodwill associated therewith), copyrights, copyright applications and
copyright registrations, including all rights to sue for past infringement (collectively,
“<U>Intellectual Property</U>”, and together with the Systems and Information, the “<U>Intangible
Assets</U>”);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (viii) All licenses, permits or franchises issued by any federal, state, municipal or foreign
authority relating to the development, use, maintenance or occupation of the Owned Real Property,
the Leased Facilities or the operations of the Business, to the extent that such licenses, permits
or franchises are transferable;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ix) All accounts receivable and other receivables in existence at the Closing Date (whether
or not billed) (collectively, the “<U>Accounts Receivable</U>”);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (x) All goods and services and all other economic benefits to be received subsequent to the
Closing Date arising out of prepayments and payments by the Asset Seller prior to the Closing Date
(collectively, the “<U>Prepaid Assets</U>”);
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xi) All books (other than stock record books), records, accounts, ledgers, files, documents,
correspondence, employment records, studies, reports and other printed or written materials,
including, without limitation, historical financial and manufacturing information; and
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xii) All goodwill (the “<U>Goodwill</U>”).
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (c) <U>Excluded Assets</U>. It is expressly understood and agreed that, notwithstanding
anything to the contrary set forth herein, the Acquired Assets shall not include each Asset
Seller’s right, title or interest in or to any of the following (each, an “<U>Excluded
Asset</U>”):
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (i) Any assets (including all rights, properties, claims, contracts, business, real property,
leasehold interests in real property, equipment, machinery, vehicles, tools and other tangible
personal property) other than those primarily used by such Asset Seller in the conduct of the
Business;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ii) The capital stock of all subsidiaries of the Asset Sellers (other than the Stock);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iii) All cash and cash equivalents or similar type investments, bank accounts, certificates
of deposit, Treasury bills and other marketable securities;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iv) The contracts and agreements listed on <U>Schedule 1.1(b)(vi)</U> attached hereto;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (v) All insurance policies and all rights of such Asset Seller to insurance claims, related
refunds and proceeds thereunder;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (vi) The rights which accrue or will accrue under this Agreement;
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (vii) All refunds of Taxes (as defined in Section 2.9(a)) relating to all periods ending
on or
prior to the Closing Date;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (viii) All actions, claims, causes of action, rights of recovery, choses in action and rights
of setoff of any kind arising before, on or after the Closing Date relating to the items set forth
above in this Section 1.1(c) or to any Excluded Liabilities; and
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ix) All assets of any US or Foreign Business Benefits Plans relating to the Business.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (d) <U>Assumed Liabilities</U>. On the Closing Date, Buyer shall deliver to each Asset
Seller an undertaking (the “<U>Assumption Agreement</U>”), in the form attached hereto as
<U>Exhibit A</U>, pursuant to which Buyer, on and as of the Closing Date, shall assume and agree
to pay, perform and discharge when due all liabilities and obligations (other than Excluded
Liabilities) of each Asset Seller, of every kind, nature, character and description, whether known
or unknown, primary or secondary, direct or indirect, absolute or contingent, due or to become due,
in each case to the extent primarily arising out of or relating primarily to the Acquired Assets or
the conduct of the Business before, on or after the Closing Date, including (without intending to
expand or reduce the scope of the foregoing provisions) the following obligations and liabilities,
in each case to the extent primarily arising out of or relating primarily to the Business or the
Acquired Assets (collectively, the “<U>Assumed Liabilities</U>”):
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (i) All obligations and liabilities (A) reflected on the Most Recent Balance Sheet (as
defined
in Section 2.6) or (B) otherwise arising out of or relating to the Business or the Acquired Assets
as of the date of the Most Recent Balance Sheet and which are not required to be reflected thereon
according to United States generally accepted accounting
</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">principles (“<U>U.S. GAAP</U>”), except to the extent that such obligations and liabilities are satisfied prior to the Closing;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ii) All obligations and liabilities incurred subsequent to the Balance Sheet Date (as defined
in Section 2.6) and on or prior to the Closing Date, except to the extent that such obligations and
liabilities are satisfied prior to the Closing;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iii) All obligations and liabilities arising or incurred by Buyer on or after the Closing
Date;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iv) All obligations and liabilities which arise out of Buyer’s operation of the Business,
the
use of the Acquired Assets and/or sale of any products manufactured and/or sold by Buyer or any of
its Affiliates (as defined in Section 2.12(d)) on or after the Closing Date;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (v) All obligations and liabilities under or arising out of the contracts, agreements,
commitments and leases transferred pursuant to Section 1.1(b)(vi);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (vi) All obligations and liabilities under the licenses, permits and franchises transferred
pursuant to Section 1.1(b)(viii);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (vii) All obligations and liabilities arising out of the ownership or operation of any Owned
Real Property, whether incurred prior to, on or following the Closing Date, except for Taxes which
shall be allocated in accordance with Section 9.2(b);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (viii) All obligations and liabilities arising out of the ownership, leasing or operation of
any Leased Facility, whether incurred prior to, on or following the Closing Date;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ix) All obligations and liabilities in respect of Transferred Employees assumed by, or which
are otherwise the responsibility of, Buyer pursuant to Section 10.6;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (x) All obligations and liabilities for any Taxes and expenses assumed by, or which are
otherwise the responsibility of, Buyer pursuant to Article IX;
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xi) All obligations and liabilities arising out of or relating to Deferred Items (as defined
in Section 1.5) under Section 1.5 except for PKI’s obligation to pay one-half of any payments made
to a third party to obtain a Deferred Consent;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xii) All obligations and liabilities constituting Environmental Matters (as defined in
Section 2.17(a)(vi)) assumed by Buyer, or which are otherwise the responsibility of Buyer, pursuant
to Article VIII;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xiii) All obligations and liabilities with respect to all actions, suits, proceedings,
disputes, claims or investigations arising out of or relating to the Acquired Assets or the conduct
and operation of the Business prior to, on or after the Closing Date, regardless of whether any
such action, suit, proceeding, dispute, claim or investigation was commenced prior to, on or after
the Closing Date;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xiv) All obligations and liabilities arising out of or relating to the repair, rework,
replacement or return of, or any claim for breach of warranty in respect of or refund of the
purchase price of, products or goods of the Business manufactured or sold prior to, on or after the
Closing Date, regardless of whether any such claim was brought prior to, on or after the Closing
Date;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xv) The first $2,000,000 of obligations and liabilities arising out of or relating to any
retention agreements, including without limitation those listed on <U>Schedule 1.1(b)(vi)</U> (the
“Retention Agreements”) (it being understood, however, that all liabilities and obligations in
excess of $2,000,000 in the aggregate under such retention agreements shall constitute Excluded
Liabilities);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xvi) All obligations and liabilities arising out of or relating to any product liability
claim (including any such claim arising out of or relating to injury to or death of
</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">persons), damage to or destruction of property or any worker’s compensation claim, in each case relating to
products or goods of the Business manufactured or sold prior to, on or after the Closing Date,
regardless of whether any such claim was brought prior to, on or after the Closing Date;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xvii) All obligations and liabilities relating to the termination of employment of any
Business Employee or the offer (or failure to offer) employment to any Business Employee; and
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xviii) One-half of the first $3,000,000 of obligations and liabilities arising out of or
relating to the carbon seal product warranty issue described on Schedule 1.1(e)(ix) (it being
understood that all such obligations and liabilities in excess thereof are Excluded Liabilities).
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (e) <U>Excluded Liabilities</U>. It is expressly understood and agreed that, notwithstanding
anything to the contrary in this Agreement, Assumed Liabilities shall not include the following
(collectively, the “<U>Excluded Liabilities</U>”):
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (i) All obligations and liabilities arising out of or relating to the Excluded Assets, which
include any properties formerly owned, occupied or operated by the Business;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ii) All obligations and liabilities assumed by, or which are otherwise the responsibility of,
any Asset Seller pursuant to this Agreement in accordance with Articles VIII and IX;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iii) All liabilities and obligations of any Asset Seller for costs and expenses incurred in
connection with this Agreement or the consummation of the transactions
</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">contemplated by this Agreement (it being understood, however, that the first $2,000,000 of liabilities and obligations
under the Retention Agreements shall constitute Assumed Liabilities);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iv) All liabilities for indebtedness for borrowed money of Sellers to third parties or to
Sellers or any of their subsidiaries or Affiliates, or any guarantees or obligations to reimburse a
bank or any other person under any letter of credit or similar obligations;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (v) All obligations and liabilities arising in connection with any disposition prior to the
Closing Date by Sellers, or any of their affiliates, of stock or assets (whether by stock or asset
sale, merger or other transaction) formerly comprising a product line, segment, portion or division
of the Business (by way of merger, consolidation, sale or otherwise);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (vi) All obligations and liabilities related to all US and Foreign Business Benefit Plans that
are the responsibility of Sellers pursuant to Section 10.6;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (vii) All fines, penalties or other assessments by a Governmental Entity for violations of
Environmental Laws (as defined in Section 2.17), and all Off Site Liabilities (as defined in
Section 2.17), in each case, to the extent related to ownership or operation of the Business prior
to the Closing Date;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (viii) All liabilities related to any asbestos or any asbestos-containing materials (A) to
the
extent such liabilities arise within any Business Property (as defined in Section 2.17(a)(viii)) on
or prior to the Closing Date; or (B) arising in connection with exposure to such materials
contained in any products of the Business that were manufactured, distributed, marketed, processed
or sold prior to the Closing Date;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ix) Taxes, except as specifically provided for in Article IX; and
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (x) One-half of the first $3,000,000 of obligations and liabilities arising out of or relating
to the carbon seal product warranty issue described on Schedule 1.1(e)(ix) and all of such
obligations and liabilities in excess thereof.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 1.2 <U>Purchase Price and Related Matters</U>.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (a) <U>Purchase Price</U>. Regardless of whether the transfer of any Acquired Asset has been
deferred pursuant to the provisions of Section 1.5, in consideration for the sale and transfer of
the Stock and the Acquired Assets, and subject to the terms and conditions of this Agreement, Buyer
shall on the Closing Date assume the Assumed Liabilities as provided in Section 1.1(d) hereof and
shall pay to Sellers in cash, by wire transfer of immediately available funds, (i) U.S.
$333,000,000, less (ii) the amount of any capitalized lease obligations included on the balance
sheet of the Business as of the Closing Date and less the amount by which $1,300,000 exceeds the
payments made by PKI pursuant to Section 4.1 hereof, plus (iii) the
amount, if any, of any payment of the participation fee made by any Seller to General Electric
under the General Electric RSP Agreement for the CF6 engine program and the GE RSP Agreement for
the CFM56 engine program, each dated June 30, 2005 (the “<U>Purchase Price</U>”).
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (b) <U>Allocation</U>. (i) The Purchase Price shall be allocated among the Sellers as set
forth on <U>Schedule 1.2</U> attached hereto. As soon as practicable following the determination
of the Adjusted Purchase Price (as defined in Section 1.4(i)), PKI shall prepare and deliver to
Buyer an allocation schedule (the “<U>Allocation Schedule</U>”) allocating the Adjusted Purchase
Price and the Assumed Liabilities (to the extent treated as liabilities for United States federal
income tax purposes) among the Sellers and among the Acquired Assets, the Stock and the covenant
contained in Section 10.3 hereof, and which shall be identical to <U>Schedule 1.2</U> except that
it will take into account the following adjustments:
</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (A) If the Adjusted Purchase Price exceeds the Purchase Price,
the amount of such excess shall
increase the amount allocated to the Tax jurisdiction(s) to which the increase in Working Capital
that gave rise to such excess relates as determined in good faith by PKI;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (B) If the Purchase Price exceeds the Adjusted Purchase Price,
the amount of such excess shall
decrease the amount allocated to the Tax jurisdiction(s) to which the decrease in Working Capital
that gave rise to such excess relates as determined in good faith by PKI; and
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (C) The amount of Assumed Liabilities (to the extent treated as
liabilities for United States
federal income tax purposes) shall increase the amount allocated to
the Tax jurisdiction(s) to which such Assumed Liabilities relate as determined in good faith
by PKI.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ii) As soon as practicable following the delivery of the Allocation Schedule to the Buyer,
Buyer shall review such proposed Allocation Schedule and shall notify PKI of any proposed revisions
thereto. Buyer and PKI shall negotiate in good faith in an attempt to reach agreement as to the
proposed allocations. If Buyer and PKI fail to agree on a final version of the Allocation Schedule
within 60 days of the date that the proposed Allocation Schedule was first delivered to Buyer, the
items in dispute shall be referred to the Neutral Accountant for resolution in accordance with the
procedures set forth in Section 1.4 hereof.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iii) In the event that any subsequent adjustment to the Purchase Price or Adjusted Purchase
Price occurs as a result of (i) any indemnity payments made pursuant to this Agreement, or (ii) for
any other reason, PKI and the Buyer shall adjust the allocations under this Section 1.2(b) in such
manner as they shall agree.
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iv) The Parties agree to act in accordance with the computations and allocations contained in
the Allocation Schedule as finally agreed upon or determined by the Neutral Accountant (as they may
be subsequently adjusted pursuant to Section 1.2(b)(iii)) in any relevant Tax Returns (as defined
in Section 2.9(a)) or filings (including any forms or reports required to be filed pursuant to
Section 1060 of the Internal Revenue Code of 1986, as amended (the “<U>Code</U>”), or pursuant to
any similar provisions of local, state and foreign Tax laws (the “<U>1060 Forms</U>”) unless
otherwise required by law or pursuant to a determination as defined in Section 1313(a) of the Code
or any similar provision of local, state or foreign law. They further agree to prepare all other
forms, financial statements, reports and similar items in a manner that
is consistent with the allocations to Tax jurisdictions contained in the Allocation Schedule,
to cooperate in the preparation of any 1060 Forms and to file such 1060 Forms in the manner
required by law. In the event that any Section 1060 Form is required to be filed with any Taxing
authority prior to final resolution of the Allocation Schedules, the Parties shall file all such
1060 Forms in a manner that is consistent with Schedule 1.2.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 1.3 <U>The Closing.</U>
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (a) <U>Time and Location</U>. The closing of the transactions contemplated by this Agreement
(the “<U>Closing</U>”) shall take place at the offices of Wilmer Cutler Pickering Hale and Dorr
LLP in Boston, Massachusetts, commencing at 10:00 a.m., local time, on October 31, 2005, or, if all
of the conditions to the obligations of the Parties to consummate the transactions contemplated
hereby (excluding the delivery of any documents to be delivered at the Closing by any of the
Parties and other than satisfaction of those conditions that by their terms are to be satisfied or
waived at Closing, it being understood that the occurrence of the Closing shall remain subject to
the delivery of such documents and the satisfaction or waiver of such
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">conditions) have not been
satisfied or waived by such date, on such mutually agreeable later date as soon as practicable (but
in no event more than three Business Days (as defined below)) after the first date on which the
conditions to the obligations of the Parties to consummate the transactions contemplated hereby
(excluding the delivery of any documents to be delivered at the Closing by any of the Parties and
other than satisfaction of those conditions that by their terms are to be satisfied or waiver at
Closing, it being understood that the occurrence of the Closing shall remain subject to the
delivery of such documents and the satisfaction or waiver of such conditions) have been satisfied
or waived (the “<U>Closing Date</U>”). For purposes of this Agreement,
a “<U>Business Day</U>” shall be any day other than (i) a Saturday or Sunday or (ii) a day on
which banking institutions located in New York, New York are permitted or required by law,
executive order or governmental decree to remain closed.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (b) <U>Actions at the Closing</U>.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> At the Closing:
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (i) PKI shall deliver (or cause to be delivered) to Buyer the various certificates,
instruments and documents required to be delivered under Section 5.1;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ii) Buyer shall deliver (or cause to be delivered) to Sellers the various certificates,
instruments and documents required to be delivered under Section 5.2;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iii) PKI shall deliver (or cause to be delivered) to Buyer certificate(s) evidencing all of
the Stock, duly endorsed in blank, or with stock powers or other instruments of transfer reasonably
acceptable to Buyer duly executed by PKI Singapore Parent and PKI Singapore;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iv) PKI shall, and shall cause PKI France to, deliver to Buyer an executed Bill of Sale in
substantially the form attached hereto as <U>Exhibit B</U>;
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (v) PKI shall cause PKI France to deliver to Buyer, and Buyer shall deliver to PKI France, an
executed Sale of an On Going Concern Agreement in substantially the form attached hereto as
<U>Exhibit C</U>, which Sale of an On Going Concern Agreement shall, among other things, evidence
(A) the sale, conveyance, assignment, transfer and delivery by PKI France to Buyer of all of PKI
France’s right, title and interest in the Acquired Assets and (B) the assumption and agreement by
Buyer to pay, perform and discharge when due all of the Assumed Liabilities of PKI France (the
“<U>French Agreement</U>”). For the avoidance of doubt, the Parties
hereby agree that the French Agreement shall not expand or reduce the rights and obligations
and liabilities of the Parties under this Agreement, and, if there is any conflict between this
Agreement and the French Agreement, this Agreement shall control;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (vi) PKI shall deliver to Buyer an executed Patent Assignment in substantially the form
attached hereto as <U>Exhibit D</U>;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (vii) PKI shall deliver to Buyer an executed Trademark Assignment in substantially the form
attached hereto as <U>Exhibit E</U>;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (viii) PKI shall deliver to Buyer an executed Copyright Assignment in substantially the form
attached hereto as <U>Exhibit F</U>;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ix) PKI shall deliver (or cause to be delivered) such other instruments of conveyance as
Buyer may reasonably request in order to effect the sale, transfer, conveyance and assignment to
Buyer of valid ownership of the Acquired Assets owned by the Asset Sellers;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (x) PKI shall transfer (or cause to be transferred) all the books, records, files and other
data (or copies thereof) (other than stock record books) within the possession of the Asset Sellers
relating primarily to the Acquired Assets and reasonably necessary for the continued operation of
the Business by Buyer;
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xi) PKI shall deliver or make available (or shall cause to be delivered or made available) to
Buyer the minute books, stock books, ledgers and registers, corporate seals and other similar
corporate records of PKI Indonesia;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xii) Buyer shall deliver to each Asset Seller an executed Assumption Agreement and such other
instruments as PKI may reasonably request in order to effect the assumption by Buyer of the Assumed
Liabilities;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xiii) Buyer shall deliver to each applicable Asset Seller an executed Lease Assignment and
Assumption Agreement in substantially the form attached hereto as <U>Exhibit G</U> (or such other
form as may be reasonably requested by the applicable Asset Seller or landlord) (collectively, the
“<U>Lease Assignment and Assumption Agreements</U>”) in connection with those Leases (as defined
in Section 2.11(b)) as are designated by the Asset Sellers;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xiv) Buyer shall pay to Sellers the Purchase Price in cash by wire transfer of immediately
available funds to one or more accounts designated by PKI;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xv) PKI shall cause PKI France to deliver to Buyer an executed Deed in substantially the form
attached hereto as <U>Exhibit H</U> in connection with the sale and transfer by PKI France to
Buyer of the Owned Real Property (as defined in Section 2.11(a)) located at 2 Rue Lavoisier,
Coignieres, France (the “<U>French Real Property Deed</U>”);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xvi) PKI shall deliver (or cause to be delivered) to Buyer, or otherwise put Buyer (or cause
Buyer to be put) in possession and control of, all of the Acquired Assets of a tangible nature
owned by the Asset Sellers;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xvii) The Parties shall execute and deliver to each other a cross-receipt evidencing the
transactions referred to above; and
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (xviii) The Parties shall execute and deliver the Transition Services Agreement in
substantially the form attached hereto as <U>Exhibit I</U>.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 1.4 <U>Post-Closing Adjustment</U>. The Purchase Price shall be subject to adjustment after
the Closing Date as follows:
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (a) Within 45 days after the Closing Date, PKI shall prepare and deliver to Buyer a statement
(the “<U>Closing Working Capital Statement</U>”) calculating the Working Capital
(as defined in this Section 1.4(a)) of the Business as of the Closing Date (the “<U>Closing
Working Capital Amount</U>”). PKI shall conduct full physical inventories as of the Closing Date
within 30 calendar days prior to or following the Closing Date, and the results of such
inventories, after appropriately adjusting for intervening activity between the date of such
physical inventories and the Closing Date, shall be used in preparing the Closing Working Capital
Statement. Representatives of PKI and Buyer will be permitted to observe the physical inventories.
For purposes of this Agreement, “<U>Working Capital</U>” shall mean the current assets of the
Business as of the Closing Date (including accounts receivable (net of allowance for doubtful
accounts), inventory (net of reserve for excess and obsolete inventory but excluding the LIFO
reserve and the related LIFO excess and obsolete reserve adjustment) and other current assets,
excluding prepaid Taxes and deferred Tax assets, investments and cash and cash equivalents, which
cash and cash equivalents shall be distributed to, or retained by, Sellers prior to the Closing),
less the current liabilities of the Business as of the Closing Date (including accounts payable,
accrued expenses, but excluding Tax liabilities, deferred Taxes, restructuring liabilities, capital
lease obligations, accrued management incentives, employee labor costs for employees of the
business who are not Transferred Employees, accrued Pension costs for employees of the Business who
work primarily at the Warwick, Rhode Island facility and accrued revenue sharing agreement
</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">liabilities), and shall be calculated in accordance with U.S. GAAP on a basis consistent with PKI’s
accounting methods, treatments, principles and procedures used in the preparation of the Financial
Statements referred to in Section 2.6 of this Agreement. For the avoidance of doubt, Working
Capital shall exclude all Excluded Assets and Excluded Liabilities.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (b) If Buyer in good faith disputes the Closing Working Capital Amount as shown on the Closing
Working Capital Statement prepared by PKI, Buyer shall deliver to PKI within 60 days after receipt
of the Closing Working Capital Statement a statement (the “<U>Dispute Notice</U>”) setting forth
Buyer’s calculation of the correct Closing Working Capital Amount and describing in reasonable
detail the basis for the determination of such different Closing Working Capital Amount. The
Parties shall use reasonable efforts to resolve such differences regarding the determination of the
Closing Working Capital Amount for a period of 30 days after Buyer has given the Dispute Notice.
If the Parties resolve such differences, the Closing Working Capital Amount agreed to by the
Parties shall be deemed to be the “<U>Final Closing Working Capital Amount</U>” and the Closing
Working Capital Statement agreed to by the Parties shall be deemed to be the “<U>Final Closing
Working Capital Statement</U>.”
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (c) If the Parties do not reach a final resolution on the Closing Working Capital Amount
within 30 days after Buyer has given the Dispute Notice, unless the Parties mutually agree to
continue their efforts to resolve such differences, KPMG LLP (the “<U>Neutral Accountant</U>”)
shall resolve such differences, pursuant to an engagement agreement executed by the Parties and the
Neutral Accountant, in the manner provided below. The Parties shall each be entitled to make a
presentation to the Neutral Accountant, pursuant to procedures to be agreed to among PKI, Buyer and
the Neutral Accountant (or, if they cannot agree on such procedures, pursuant to procedures
determined by the Neutral Accountant), regarding such Party’s
</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">calculation of the Closing Working
Capital Amount; and the Neutral Accountant shall be required to resolve the differences between the
Parties and determine the Closing Working Capital Amount within twenty (20) Business Days after
such presentations have been made. The
Closing Working Capital Amount determined by the Neutral Accountant shall be deemed to be the
Final Closing Working Capital Amount and the Closing Working Capital Statement, as adjusted to
reflect such determination, shall be deemed to be the Final Closing Working Capital Statement.
Such determination by the Neutral Accountant shall be conclusive and binding upon the Parties,
absent fraud or manifest error.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (d) The Neutral Accountant shall not be authorized or permitted to:
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (i) determine any questions or matters whatsoever under or in connection with this Agreement
except for the resolution of differences between the Parties regarding the determination of the
Closing Working Capital Amount in accordance with this Section 1.4;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (ii) resolve any such differences by making an adjustment to the Closing Working Capital
Statement that is outside of the range defined by amounts as finally proposed by the Parties; or
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (iii) apply any accounting methods, treatments, principles or procedures other than as
described in Section 1.4(a).
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (e) PKI, on the one hand, and Buyer, on the other hand, shall each pay one half of the fees
and expenses of the Neutral Accountant; provided that if the Neutral Accountant determines that one
Party has adopted a position or positions with respect to the Closing Working Capital Statement
that is frivolous or clearly without merit, the Neutral Accountant (i) may, in its discretion,
assign a greater portion of any such fees and expenses to such Party and
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">(ii) shall provide to the
Parties a written explanation of its reasons for making such a determination.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (f) The Parties agree that the procedure set forth in this Section 1.4 for resolving disputes
with respect to the Closing Working Capital Amount shall be the sole and exclusive method for
resolving any such disputes, provided that this provision shall not prohibit any Party from
instituting litigation to enforce the ruling of the Neutral Accountant.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (g) Failure of Buyer to deliver a Dispute Notice within 60 days after receiving the Closing
Working Capital Statement shall constitute acceptance of the Closing Working Capital Amount set
forth on the Closing Working Capital Statement, whereupon such Closing Working Capital Amount shall
be deemed to be the Final Closing Working Capital Amount and the Closing Working Capital Statement
shall be deemed to be the Final Closing Working Capital Statement. Delivery by Buyer of a Dispute
Notice shall constitute final and binding acceptance by Buyer of all portions of the Closing
Working Capital Statement other than those specifically identified in the Dispute Notice as being
subject to a good faith dispute.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (h) If the Final Closing Working Capital Amount is less than $22,900,000, as adjusted to
exclude all Tax assets and liabilities of Sellers and PKI Indonesia as of the Balance Sheet Date,
including without limitation accrued payroll taxes, accrued real estate taxes, accrued personal
property taxes, accrued sales and use taxes, accrued employment taxes and accrued value-added taxes
(the “<U>Target Working Capital Amount</U>”), then PKI shall pay to Buyer an amount equal to the
difference between the Target Working Capital Amount and the Final Closing Working Capital Amount.
If the Final Closing Working Capital Amount is more than the Target Working Capital Amount, then
Buyer shall pay to Sellers an amount equal to the difference between the Final Closing Working
Capital Amount and the Target Working Capital
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Amount. Any payment pursuant to this Section 1.4(h)
shall be made in cash by wire transfer of
immediately available funds into an account or accounts designated by the Buyer or Sellers, as
the case may be, within five Business Days after the date on which the Final Closing Working
Capital Amount is determined pursuant to this Section 1.4.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (i) For purposes of this Agreement, “<U>Adjusted Purchase Price</U>” means the Purchase Price
plus, if applicable, the amount of the payment required to be made by Buyer to PKI pursuant to the
second sentence of Section 1.4(h) or minus, if applicable, the amount of the payment required to be
made by PKI to Buyer pursuant to the first sentence of Section 1.4(h).
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 1.5 <U>Consents to Assignment</U>. Anything in this Agreement to the contrary notwithstanding,
this Agreement shall not constitute an agreement to assign or transfer any asset, agreement, lease,
authorization, license or permit, or any claim, right or benefit arising thereunder or resulting
therefrom, if an attempted assignment or transfer thereof, without the consent of a third party
thereto or of the issuing Governmental Entity (as defined in Section 2.4(b)), as the case may be,
would constitute a breach or default thereof, would result in a violation of the rights of any such
third party, would be ineffective, or would in any way adversely affect the rights of PKI or Buyer
thereunder. If such consent (a “<U>Deferred Consent</U>”) is not obtained, then (a) the asset, agreement,
lease, authorization, license or permit to which such Deferred
Consent relates (a “<U>Deferred Item</U>”)
shall be withheld from sale pursuant to this Agreement without any reduction in the Purchase Price,
(b) from and after the Closing, the Sellers and Buyer will cooperate, in all reasonable respects,
to obtain such Deferred Consent as soon as practicable after the Closing, provided that (i) no
Party shall be required to make any material payments or agree to any material undertakings in
connection therewith and (ii) if the Parties agree to make any payments (whether or not material)
to a third party to obtain a
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Deferred Consent, all such payments that are made shall be paid one half (1/2) by the
Buyer and one half (1/2) by PKI, and (c) until such Deferred Consent is obtained, the Sellers and
the Buyer shall cooperate, in all reasonable respects, in any lawful and commercially reasonable
arrangement reasonably proposed by the Buyer under which (i) the Buyer would obtain (without
infringing upon the legal rights of any third party) the economic claims, rights and benefits (net
of the amount of any related Tax costs and any other liabilities or obligations imposed on the
Sellers or any of their Affiliates under the Deferred Item) and (ii) the Buyer would assume any
related economic burden (including the amount of any related Tax costs and any other liabilities or
obligations imposed on the Sellers or any of their Affiliates) with respect to the Deferred Item.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 1.6 <U>Further Assurances</U>. At any time and from time to time after the Closing Date, as
and when reasonably requested by any Party hereto and at such Party’s expense (it being understood
that such Party shall be required to reimburse only out-of-pocket expenses paid to third parties,
and not internal costs), the other Party shall promptly execute and deliver, or cause to be
executed and delivered, all such documents, instruments and certificates and shall take, or cause
to be taken, all such further or other actions as are necessary to evidence and effectuate the
transactions contemplated by this Agreement.
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>ARTICLE II</B>
</DIV>
<DIV align="center" style="font-size: 10pt; margin-top: 6pt"><B>REPRESENTATIONS AND WARRANTIES OF PKI</B>
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> PKI represents and warrants to Buyer that, except as set forth in the disclosure schedule
provided by PKI to Buyer (the “<U>Disclosure Schedule</U>”):
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 2.1 <U>Organization, Qualification and Corporate Power</U>.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (a) <U>Sellers</U>. Each of the Sellers is a corporation duly organized, validly existing
and, where applicable, in good standing under the laws of its respective jurisdiction of
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">organization and is duly qualified to conduct business under the laws of each jurisdiction where
the character of the properties owned, leased or operated by it or the nature of its activities, in
each case as they relate exclusively to the Business, makes such qualification necessary, except
for any such failures to be qualified that would not reasonably be expected to result in a Business
Material Adverse Effect (as defined below). Each of the Sellers has all requisite corporate power
and authority to carry on the business in which it is now engaged and to own and use the properties
now owned and used by it. For purposes of this Agreement, “<U>Business Material Adverse
Effect</U>” means any change, effect or circumstance that (i) is materially adverse to the
business, financial condition or results of operations of the Business or (ii) materially impairs
the ability of the Sellers to consummate the transactions contemplated by this Agreement;
<U>provided</U>, <U>however</U>, that a “Business Material Adverse Effect” shall not include any
adverse change, effect or circumstance resulting from or arising out of (I) the actions
contemplated by the Parties in connection with this Agreement, (II) the announcement or
performance of this Agreement or the transactions contemplated by this Agreement, (III) changes,
effects or circumstances resulting from conditions in the Business’s industry or in markets
generally, except to the extent the effect
of such conditions on the Business and PKI Indonesia is materially disproportionate to the
effect of such conditions on other participants in industries in which the Business and PKI
Indonesia are engaged, (IV) changes in national or international general economic conditions or (V)
national or international political conditions or instability, including the engagement by the
United States in hostilities, whether or not pursuant to a declaration of emergency or war, or the
occurrence of any military or terrorist attack upon the United States or any other nation.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (b) <U>PKI Indonesia</U>. PKI Indonesia is a corporation duly organized, validly existing
and, if applicable, in good standing under the laws of its jurisdiction of organization and
</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">is duly
qualified to conduct business under the laws of each jurisdiction where the character of the
properties owned, leased or operated by it or the nature of its activities makes such qualification
necessary, except for any such failures to be qualified that would not reasonably be expected to
result in a Business Material Adverse Effect. PKI Indonesia has all requisite corporate power and
authority to carry on the business in which it is now engaged and to own and use the properties now
owned and used by it.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (c) <U>Charter and Corporate Records</U>. PKI Indonesia has made available to Buyer correct
and complete copies of its corporate charter and bylaws or other organizational documents (as
amended to date). The minute books (containing the records of meetings of the stockholders and the
board of directors) and the stock record books of PKI Indonesia are correct and complete in all
material respects. PKI Indonesia is not in default under or in violation of any provision of its
corporate charter or bylaws or other organizational documents.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 2.2 <U>Capitalization; Title to Property</U>.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (a) The capitalization of PKI Indonesia is set forth in Section 2.2 of the Disclosure
Schedule. All of the issued and outstanding shares of Stock of PKI Indonesia are duly authorized,
validly issued, fully paid and nonassessable. Except for the Stock, there are no shares of capital
stock or other equity securities of PKI Indonesia outstanding. There are no outstanding or
authorized options, warrants, rights, agreements or commitments to which PKI Indonesia is a party
or which are binding upon PKI Indonesia providing for the issuance, disposition or acquisition of
any shares of capital stock of PKI Indonesia. There are no outstanding or authorized stock
appreciation, phantom stock or similar rights (i) providing for the issuance, disposition or
acquisition of any shares of capital stock of PKI Indonesia or (ii) that give any person the right
to receive any benefits or rights similar to any rights enjoyed by or
</DIV>
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</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">accruing to the holders of
shares of capital stock of PKI Indonesia. There are no agreements, voting trusts or proxies with
respect to the voting, or registration under the Securities Act of 1933, as amended (the
“<U>Securities Act</U>”), of the Stock.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (b) All of the issued and outstanding shares of Stock are owned of record and beneficially by
PKI Singapore Parent and PKI Singapore, and PKI Singapore Parent and PKI Singapore have good title
to the Stock, free and clear of any Security Interest (as defined in Section 2.2(d)), contractual
restriction or covenant, option or other adverse claim (whether arising by contract or by operation
of law), other than applicable securities law restrictions.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (c) Each Asset Seller has good title to, or a valid leasehold interest in, the material
property included in the Acquired Assets of such Asset Seller, free and clear of any Security
Interests. Upon consummation of the Closing, Buyer (or its designees) will have good title to, or
a valid leaseholder interest in, the Acquired Assets and the Stock, free and clear of any
Security Interests (other than any Securities Interests created by or as a result of the
identity of Buyer (or its designees)).
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (d) For purposes of this Agreement, “<U>Security Interest</U>” means any mortgage, pledge,
security interest, encumbrance, charge or other lien (whether arising by contract or by operation
of law), other than (i) mechanic’s, materialmen’s, landlord’s and similar liens, (ii) liens arising
under worker’s compensation, unemployment insurance, social security, retirement and similar
legislation, (iii) liens on goods in transit incurred pursuant to documentary letters of credit, in
each case arising in the ordinary course of business, (iv) liens for Taxes not yet due and payable,
(v) liens for Taxes which are being contested in good faith and by appropriate proceedings, to the
extent such Taxes are accrued for on the Most Recent Balance Sheet or were incurred after the date
of the Most Recent Balance Sheet in the ordinary course of business, (vi)
</DIV>
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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">liens relating to
capitalized lease financings or purchase money financings that have been entered into in the
ordinary course of business and (vii) liens arising solely by action of Buyer.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 2.3 <U>Authority</U>. PKI has all requisite corporate power and authority to execute and
deliver this Agreement and each Seller has all requisite corporate power and authority to perform
its obligations hereunder. The execution and delivery of this Agreement by PKI, the performance by
each Seller of its obligations hereunder and the consummation by each Seller of the transactions
contemplated hereby have been duly and validly authorized by all necessary corporate action on the
part of each such Seller. This Agreement has been duly and validly executed and delivered by PKI
and, assuming this Agreement constitutes the valid and binding agreement of Buyer, constitutes a
valid and binding obligation of PKI, enforceable against PKI in accordance with its terms, except
as enforceability may be limited by bankruptcy, insolvency,
fraudulent transfer, reorganization, moratorium or other similar laws relating to or affecting
the rights of creditors generally and by equitable principles, including those limiting the
availability of specific performance, injunctive relief and other equitable remedies and those
providing for equitable defenses.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 2.4 <U>Noncontravention</U>. Subject to compliance with the applicable requirements of the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “<U>Hart-Scott-Rodino
Act</U>”), applicable Environmental Laws (as defined in Section 2.17(a)(v)), and applicable foreign
antitrust or trade regulation laws, neither the execution and delivery of this Agreement by PKI,
nor the consummation by any Seller of the transactions contemplated hereby, will:
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (a) conflict with or violate any provision of the charter or bylaws or other organizational
documents of PKI Indonesia or any Seller;
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (b) require on the part of PKI Indonesia or any Seller any material filing with, or any
material permit, authorization, consent or approval of, any court, arbitrational tribunal,
administrative agency or commission or other governmental or regulatory authority or agency (a
“<U>Governmental Entity</U>”);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (c) materially conflict with, result in a material breach of, constitute (with or without due
notice or lapse of time or both) a material default under, result in the acceleration of, create in
any party the right to accelerate, terminate, materially modify or cancel, or require any material
notice, consent or waiver under, any material contract (including, without limitation, any
Designated Contract), lease, sublease, license, sublicense, franchise, permit, indenture, agreement
or mortgage for borrowed money, instrument of indebtedness or Security Interest to
which PKI Indonesia or any Seller is a party or by which PKI Indonesia or any Seller is bound
or to which any of their respective assets is subject; or
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (d) violate any material order, writ, injunction or decree specifically naming, or material
statute, rule or regulation applicable to, PKI Indonesia or any Seller or any of or their
respective properties or assets.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 2.5 <U>Subsidiaries</U>. None of PKI Singapore or, with respect to the Business, the Asset
Sellers controls, directly or indirectly, or has any direct or indirect equity participation in,
any corporation, limited liability company, partnership, trust or other business association (other
than in a money market, mutual fund or other short-term investment and, in the case of (a) PKI, in
PKI France, PKI Singapore and PKI Indonesia and (b) PKI Singapore, in PKI Indonesia).
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 2.6 <U>Financial Statements</U>. PKI has provided to Buyer copies of the consolidated
balance sheets as of the last day of each of the three fiscal years in the period ended January 2,
2005 and as of July 3 and August 28, 2005, and consolidated statements of operations and cash
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">flows
of the Business for each of the two fiscal years in the period ended January 2, 2005 and for the
six and eight-month periods ended July 3 and August 28, 2005, respectively (collectively, the
“<U>Financial Statements</U>”). The consolidated balance sheet as of August 28, 2005 is referred
to herein as the “<U>Most Recent Balance Sheet</U>” and the date of such Most Recent Balance
Sheet, August 28, 2005, is referred to herein as the “<U>Balance Sheet Date</U>”. Such Financial
Statements have been prepared in accordance with U.S. GAAP and fairly present, in all material
respects, the financial condition and consolidated results of operations and cash flows of the
Business as of the respective dates thereof and for the periods referred to therein;
<U>provided</U>, <U>however</U>, that (i) the Financial Statements as of, and for the six and
eight-month periods ended July 3 and August
28, 2005, respectively, are subject to year-end adjustments and (ii) all of the Financial
Statements do not include footnotes and do not include allocations of corporate expenses that are
made on a periodic basis.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> 2.7 <U>Absence of Certain Changes</U>. Except as contemplated by this Agreement (including
those matters contemplated by Section 4.3 of this Agreement or listed on <U>Schedule 4.3</U>),
since the Balance Sheet Date, there have not been any adverse changes in the financial condition or
results of operations of the Business, except for any adverse changes that would not reasonably be
expected to result in a Business Material Adverse Effect. Except as contemplated by this Agreement
(including those matters contemplated by Section 4.3 of this Agreement or listed on <U>Schedule
4.3</U>), since the Balance Sheet Date, no Seller has taken any of the following actions:
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (a) sold, assigned or transferred any portion of the Acquired Assets or any assets of PKI
Indonesia, in each case that is material to the Business, other than (i) in the
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">ordinary course of
business or (ii) sales or other dispositions of obsolete or excess equipment or other assets not
used in the Business;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (b) waived any rights of material value to the Business;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (c) issued, sold or transferred any Stock or other equity securities, securities convertible
into Stock or other equity securities or warrants, options or other rights to acquire Stock or
other equity securities of PKI Indonesia;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (d) declared or paid any dividends or made any distributions on Stock or other equity
securities of PKI Indonesia or redeemed or purchased any shares of Stock or other equity
securities of PKI Indonesia, except for dividends, distributions or redemptions paid solely in
cash, cash equivalents and/or other short term liquid investments;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (e) except as required by law, granted any rights to severance benefits, “stay pay” or
termination pay to any director, officer or other employee of the Business or increased benefits
payable or potentially payable to any such director, officer or other employee of the Business
under any previously existing severance benefits, “stay-pay” or termination pay arrangements (in
each case, other than grants or increases that are substantially consistent with the past practice
of the Business or grants or increases for which neither the Business nor the Buyer will be
obligated following the Closing);
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (f) except in the ordinary course of business or in accordance with the Business’ capital
expenditure budget attached to Section 2.7(f) of the Disclosure Schedule, made any capital
expenditures or commitments therefor with respect to the Business in an amount in excess of
$500,000 in the aggregate;
</DIV>
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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (g) acquired any entity or business (whether by the acquisition of stock, the acquisition of
assets, merger or otherwise), other than acquisitions that have not or will not become integrated
into the Business;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (h) except in the ordinary course of business, entered into any employment, compensation or
deferred compensation agreement (or any amendment to any such existing agreement) with any officer
or other employee of the Business whose annual base salary exceeds $150,000;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (i) amended the terms of any existing US or Foreign Business Benefit Plan (each as defined in
Section 2.16(a)), except (i) as required by law, (ii) in a manner substantially
consistent with the past practices of the Business or (iii) in any manner that would not
reasonably be expected to result in a Business Material Adverse Effect;
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"> (j) materially changed the accounting principles, methods or practices of the Business, except
in each case to co