United States
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the period ended September 30, 2002
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Commission file number 1-1396
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Eaton Corporation
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(Exact name of registrant as specified in its charter)
Ohio 34-0196300
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(State of incorporation) (I.R.S. Employer
Identification No.)
Eaton Center, Cleveland, Ohio 44114-2584
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(Address of principal executive offices) (Zip Code)
(216) 523-5000
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(Registrant's telephone number, including area code)
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 90 days. Yes X
There were 70.5 million Common Shares outstanding as of September 30, 2002.
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Eaton Corporation
Condensed Consolidated Balance Sheets
September 30, December 31,
(Millions) 2002 2001
---- ----
ASSETS
Current assets
Cash & short-term investments $ 379 $ 311
Accounts receivable 1,139 1,070
Inventories 634 681
Deferred income taxes & other
current assets 311 325
------ ------
2,463 2,387
Property, plant & equipment-net 1,898 2,050
Goodwill 1,893 1,902
Other intangible assets 505 533
Other assets 711 774
------ ------
$7,470 $7,646
====== ======
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities
Short-term debt & current portion of
long-term debt $ 199 $ 188
Accounts payable 368 418
Accrued compensation 189 158
Accrued income & other taxes 304 258
Other current liabilities 764 647
------ ------
1,824 1,669
Long-term debt 1,833 2,252
Postretirement benefits other than pensions 657 670
Deferred income taxes & other liabilities 551 580
Shareholders' equity 2,605 2,475
------ ------
$7,470 $7,646
====== ======
See accompanying notes.
Eaton Corporation
Statements of Consolidated Income
Three Months Ended Nine Months Ended
September 30 September 30
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(Millions except for per share data) 2002 2001 2002 2001
---- ---- ---- ----
Net sales $1,830 $1,750 $5,434 $5,604
Costs & expenses
Cost of products sold 1,316 1,326 3,966 4,223
Selling & administrative 302 300 917 924
Research & development 51 56 156 177
------ ------ ------ ------
1,669 1,682 5,039 5,324
------ ------ ------ ------
Income from operations 161 68 395 280
Other income (expense)
Interest expense-net (26) (33) (80) (113)
Gains on sales of businesses 18 23 18 61
Other-net (21) 3 (26) 11
------ ------ ------ ------
(29) (7) (88) (41)
------ ------ ------ ------
Income before income taxes 132 61 307 239
Income taxes 39 21 93 100
------ ------ ------ ------
Net income $ 93 $ 40 $ 214 $ 139
====== ====== ====== ======
Net income per Common Share
assuming dilution $ 1.30 $ .57 $ 2.98 $ 1.97
Average number of Common Shares
outstanding 71.9 70.9 71.7 70.5
Net income per Common Share basic $ 1.32 $ .58 $ 3.03 $ 2.01
Average number of Common Shares
outstanding 70.8 69.6 70.5 69.3
Cash dividends paid per Common Share $ .44 $ .44 $ 1.32 $ 1.32
See accompanying notes.
Eaton Corporation
Condensed Statements of Consolidated Cash Flows
Nine Months Ended
September 30
-----------------
(Millions) 2002 2001
---- ----
Net cash provided by operating activities
Net income $ 214 $ 139
Adjustments to reconcile to net cash provided
by operating activities
Depreciation & amortization 265 267
Amortization of goodwill & other intangible assets 16 72
Gains on sales of businesses (18) (61)
Changes in operating assets & liabilities,
excluding acquisitions and sales of
businesses 127 146
Other-net 39 (68)
------ ------
643 495
Net cash provided by (used in) investing activities
Expenditures for property, plant & equipment (139) (203)
Acquisitions of businesses, less cash acquired (11) (33)
Sales of businesses 95 403
Net increase in short-term investments (77) (70)
Other-net (5) 13
------ ------
(137) 110
Net cash used in financing activities
Borrowings with original maturities of more
than three months
Proceeds 419 1,182
Payments (639) (1,334)
Borrowings with original maturities of less
than three months-net (258) (359)
Cash dividends paid (92) (90)
Proceeds from exercise of employee stock options 41 27
Purchase of Common Shares (13)
------ ------
(529) (587)
------ ------
Total (decrease) increase in cash (23) 18
Cash at beginning of period 112 82
------ ------
Cash at end of period $ 89 $ 100
====== ======
See accompanying notes.
The following notes are included in accordance with the requirements of
Regulation S-X and Form 10-Q:
Dollars and shares in millions, except per share data (per share data assume
dilution)
Preparation of Financial Statements
- -----------------------------------
The condensed consolidated financial statements of Eaton Corporation (Eaton or
the Company) are unaudited. However, in the opinion of management, all
adjustments have been made which are necessary for a fair presentation of
financial position, results of operations and cash flows for the stated periods
These financial statements should be read in conjunction with the consolidated
financial statements and related notes included in the Company's 2001 Annual
Report on Form 10-K. The interim period results are not necessarily indicative
of the results to be expected for the full year.
Unusual Charges
- ---------------
As the weak economic conditions of 2001 continued into 2002, Eaton undertook
additional restructuring actions during the first nine months of 2002 to
further reduce fixed operating costs across its business segments and certain
corporate functions as described below.
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
---- ---- ---- ----
Operational restructuring
charges
Fluid Power $ 6 $ 4 $ 24 $ 18
Industrial & Commercial
Controls 19 15 23
Automotive 1
Truck 6 14 49
Corporate restructuring charges 4 4 4
---- ---- ---- ----
6 33 58 94
Other corporate charges 10 10 10
---- ---- ---- ----
Total unusual charges $ 16 $ 33 $ 68 $104
==== ==== ==== ====
After-tax $ 10 $ 22 $ 45 $ 69
Per Common Share .14 .30 .62 .98
The operational restructuring charges are included in the Statements of
Consolidated Income in Income from operations and in Business Segment
Information in reduced operating profit of the related business segment. The
corporate restructuring charges are included in the Statements of Consolidated
Income in Income from operations and the Other corporate charges are included
in Other expense-net. All of the corporate restructuring and other corporate
charges are included in Business Segment Information in Corporate & other-net.
The Other corporate charge of $10 in the third quarter of 2002 represents a
contribution to the Eaton Charitable Fund. The Other corporate charge of $10
taken in the second quarter of 2001 resulted from an arbitration award related
to a contractual dispute over supply arrangements initiated in February 1999
against Vickers, Incorporated, a subsidiary of Aeroquip-Vickers, Inc., which
was acquired by Eaton in April 1999.
Restructuring liabilities recorded at December 31, 2001, those recorded in
2002 as described above, and those utilized thus far in 2002, are summarized as
follows:
Workforce reductions Inventory & Plant
-------------------- other asset consolidation
Employees Dollars write-downs & other Total
--------- ------- ----------- ------------- -----
Liabilities remaining
at December 31, 2001 344 $ 21 $ 0 $ 2 $ 23
2002 charges 1,930 42 9 7 58
Utilized in 2002 (1,618) (46) (9) (6) (61)
----- ---- ---- ---- ----
Liabilities remaining
at September 30,
2002 656 $ 17 $ 0 $ 3 $ 20
===== ==== ==== ==== ====
Gains on Sales of Businesses
- ----------------------------
During the third quarter of 2002, the Company sold its Navy Controls business.
The sale of this business resulted in a pretax gain of $18 ($13 after-tax, or
$.18 per Common Share).
During the third quarter of 2001, the Company sold its Air Conditioning &
Refrigeration business and certain assets of the Automotive business. The
sales of these businesses resulted in a net pretax gain of $23 ($15 after-tax,
or $.21 per share). During the first nine months of 2001, Eaton sold
businesses resulting in a net pretax gain of $61 ($22 after-tax, or $.31 per
share) including the businesses sold in the third quarter of 2001 as discussed
previously, and the Vehicle Switch/Electronics Division (VS/ED) and certain
assets of the Truck business sold in the first quarter of 2001. In Business
Segment Information, the operating results of VS/ED are included in divested
operations for 2001.
Goodwill and Other Intangible Assets
- ------------------------------------
Effective January 1, 2002, Eaton adopted Statement of Financial Accounting
Standards (SFAS) No. 142 "Goodwill and Other Intangible Assets". Upon adoption,
the Company discontinued the amortization of goodwill and indefinite life
intangible assets recorded in connection with previous business combinations.
Third quarter 2002 results were impacted favorably by this reduction in
amortization expense of $19 ($16 after-tax, or $.22 per Common Share). Results
for the first nine months of 2002 were similarly impacted by this reduction in
amortization expense of $56 ($48 after-tax, or $.67 per share). A
reconciliation of net income and earnings per Common Share for the third quarter
and first nine months of 2001, as if SFAS No. 142 had been adopted as of the
beginning of that year, follows:
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
---- ---- ---- ----
Reported net income $ 93 $ 40 $ 214 $ 139
Add back amortization of goodwill &
indefinite life intangible assets,
net of tax 16 48
----- ----- ----- -----
Adjusted net income $ 93 $ 56 $ 214 $ 187
===== ===== ===== =====
Reported net income per Common Share
assuming dilution $1.30 $ .57 $2.98 $1.97
Add back amortization of goodwill &
indefinite life intangible assets,
net of tax .22 .67
----- ----- ----- -----
Adjusted net income per Common Share $1.30 $ .79 $2.98 $2.64
===== ===== ===== =====
SFAS No. 142 changes the accounting for goodwill and indefinite life intangible
assets from an amortization approach to a non-amortization approach requiring
periodic testing for impairment of the asset. In the second quarter of 2002,
Eaton completed the initial impairment test for goodwill and indefinite life
intangible assets as of January 1, 2002. This test confirmed that the fair
value of the Company's reporting units exceeds their respective carrying
values, and that no impairment loss needed to be recognized upon adoption of
SFAS No. 142.
A summary of goodwill and other intangible assets follows:
September 30, 2002 December 31, 2001
------------------------- -------------------------
Historical Accumulated Historical Accumulated
cost amortization cost amortization
---------- ------------ ---------- ------------
Goodwill $2,215 $322 $2,218 $316
====== ==== ====== ====
Intangible assets not
subject to amortization
(primarily trademarks) $ 333 $ 24 $ 330 $ 24
====== ==== ====== ====
Intangible assets subject to
amortization
Patents $ 192 $ 74 $ 190 $ 63
Other 142 64 176 76
------ ---- ------ ----
$ 334 $138 $ 366 $139
====== ==== ====== ====
Expense related to intangible assets subject to amortization for the first nine
months of 2002 was $16. Estimated annual pretax expense for intangible assets
subject to amortization for each of the next five years follows: 2002, $22;
2003, $21; 2004, $16; 2005, $15; and 2006, $15.
Pension and Other Postretirement Benefit Expense
- ------------------------------------------------
Pretax income for the third quarter of 2002 was reduced by $13 ($9 after-tax, or
$.12 per Common Share) compared to the same period in 2001 due to the effect on
pension income of the decline in the market value of stocks in Eaton's pension
fund, coupled with lower discount rates associated with pension and other
postretirement benefit liabilities. Pretax income for the first nine months of
2002 was similarly reduced by $46 ($30 after-tax, or $.42 per share) compared to
the same period in 2001.
Income Taxes
- ------------
The effective income tax rate for the first nine months of 2002 was 30.4%
compared to 41.8% for the same period in 2001. The higher rate in 2001 was
primarily the result of the tax effect of book/tax basis differences related to
businesses sold in the first quarter of 2001, which increased tax expense by
$18. Excluding the negative tax consequences related to the sales of businesses
in 2001, the effective tax rate for the first nine months of 2001 was 34.0%
compared to 30.4% in 2002, primarily the result of the discontinuance of
amortization of non-deductible goodwill in 2002 compared to 2001.
Inventories
- -----------
September 30, December 31,
2002 2001
---- ----
Raw materials $ 185 $ 260
Work-in-process and
finished goods 482 455
----- -----
Gross inventories at FIFO 667 715
Excess of current cost
over LIFO cost (33) (34)
----- -----
Net inventories $ 634 $ 681
===== =====
Net Income per Common Share
- ---------------------------
The calculation of net income per Common Share assuming dilution and basic
follows:
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
---- ---- ---- ----
Net income $ 93 $ 40 $ 214 $ 139
===== ===== ===== =====
Average number of Common Shares
outstanding assuming dilution 71.9 70.9 71.7 70.5
Less dilutive effect of stock
options 1.1 1.3 1.2 1.2
----- ----- ----- -----
Average number of Common Shares
outstanding basic 70.8 69.6 70.5 69.3
===== ===== ===== =====
Net income per Common Share
Assuming dilution $1.30 $ .57 $2.98 $1.97
Basic 1.32 .58 3.03 2.01
Comprehensive Income
- --------------------
The principal difference between net income as historically reported in the
Statements of Consolidated Income and comprehensive income is foreign currency
translation adjustments recorded in Shareholders' Equity. Comprehensive income
is as follows:
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
2002 2001 2002 2001
---- ---- ---- ----
Net income $ 93 $ 40 $214 $139
Foreign currency translation and
other adjustments (40) (7) (56) (38)
Deferred gain (loss) on cash flow
hedges (1) (1) 2 (3)
---- ---- ---- ----
Comprehensive income $ 52 $ 32 $160 $ 98
==== ==== ==== ====
New Accounting Pronouncement
- ----------------------------
In the second quarter of 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 addresses the
reporting of expenses related to exit and disposal activities, including
business restructurings, initiated in 2003. The Statement requires expenses to
be recorded when the liability is incurred, rather than when management commits
and announces a plan to exit, dispose or restructure a business. Statement No.
146 will require an evaluation of the facts and circumstances related to each
exit or disposal activity. It is expected the Statement will spread out the
reporting of these expenses, but not alter the related cash flows.
Business Segment Information
- ----------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ ------------------
2002 2001 2002 2001
---- ---- ---- ----
Net sales
Fluid Power $ 609 $ 600 $1,834 $1,929
Industrial & Commercial Controls 506 548 1,511 1,671
Automotive 393 349 1,197 1,125
Truck 322 253 892 794
------ ------ ------ ------
Total ongoing operations 1,830 1,750 5,434 5,519
Divested operations 85
------ ------ ------ ------
Total net sales $1,830 $1,750 $5,434 $5,604
====== ====== ====== ======
Operating profit (loss)
Fluid Power $ 44 $ 31 $ 145 $ 146
Industrial & Commercial Controls 49 27 109 126
Automotive 52 41 172 150
Truck 45 (6) 65 (49)
------ ------ ------ ------
Total ongoing operations 190 93 491 373
Divested operations 7
Amortization of goodwill & other
intangible assets (5) (24) (16) (72)
Interest expense-net (26) (33) (80) (113)
Gains on sales of businesses 18 23 18 61
Corporate & other-net (45) 2 (106) (17)
------ ------ ------ ------
Income before income taxes 132 61 307 239
Income taxes 39 21 93 100
------ ------ ------ ------
Net income $ 93 $ 40 $ 214 $ 139
====== ====== ====== ======
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
- ---------------------
Sales for the third quarter of 2002 were $1,830, 5% above the same period in
2001. Sales for the first nine months of 2002 of $5,434 were down 3% from
the same period in 2001. The increase in sales for the third quarter marked
the second quarter in a row of revenue growth and achievement of operating
margins in excess of 10%. This performance was primarily the result of
continued strong performance in our Automotive and Truck segments and the
benefits of the restructuring actions taken over the last two years to resize
the Company. Sales for the third quarter of 2002 increased by 6%, after
excluding the sales of the Navy Controls business from the third quarter of
2001. Excluding the impact of the divestitures of the Navy Controls business
and VS/ED in 2001, sales for the first nine months of 2002 declined 1%
compared to the same period one year ago.
Net income for the third quarter of 2002 was more than double the same period
in 2001, with net income in 2002 of $93 and earnings per Common Share of
$1.30, compared to $40 and $.57 per share in 2001. Net income for the first
nine months of 2002 was $214 and earnings per share was $2.98, increases of
54% and 51%, respectively, over the same period in 2001. These increases
were partially the result of the benefits of the restructuring actions taken
over the last two years to resize the Company. Improved income was also due
to higher sales in the third quarter of 2002, lower restructuring expenses in
2002, lower interest expense in 2002 and reduced expense related to the
amortization of goodwill and indefinite life intangible assets in 2002.
Income in 2002 also reflected lower gains on the sales of businesses in 2002.
Income was negatively affected by reduced pension income and higher expense
for other postretirement benefits in 2002 and unusual corporate charges of
$10 in the third quarter of 2002 and the second quarter of 2001, as discussed
below. Before restructuring and the other corporate charges and gains on the
sales of businesses, operating earnings for the third quarter of 2002 were
$90, or $1.26 per share, both 91% above one-year earlier results on a similar
basis. Before restructuring and other corporate charges and gains on sales of
businesses, operating earnings for the first nine months of 2002 were $246,
or $3.42 per share, compared to $186, or $2.64 per share, for the same period
in 2001.
As the weak economic conditions of 2001 continued into 2002, Eaton undertook
additional restructuring actions in the first nine months of 2002 to further
reduce fixed operating costs across its business segments and certain corporate
functions. During the third quarter of 2002, $6 of operational restructuring
charges were recorded, bringing year-to-date restructuring charges to $58, which
included $4 to restructure certain corporate functions. Also, in the third
quarter of 2002, a corporate charge of $10 was recorded representing a
contribution to the Eaton Charitable Fund. On an after-tax basis, these unusual
charges reduced net income for the third quarter of 2002 by $10 ($.14 per Common
Share) and for the first nine months of 2002 by $45 ($.62 per share).
Restructuring expenses for the full year of 2002 are expected to be
approximately $60.
In the third quarter of 2001, $29 of operational restructuring charges were
recorded, along with $4 of corporate restructuring charges. In the first nine
months of 2001, $90 of operational restructuring charges and $4 of corporate
restructuring charges were recorded, along with a corporate charge of $10
recorded in the second quarter of 2001 for an arbitration award. On an after-
tax basis, these unusual charges reduced net income for the third quarter 2001
by $22 ($.30 per Common Share) and for the first nine months of 2001 by $69
($.98 per share).
The operational restructuring charges for 2002 and 2001 are included in the
Statements of Consolidated Income in Income from operations and in Business
Segment Information in reduced operating profit of the related business segment.
The corporate restructuring charges are included in the Statements of
Consolidated Income in Income from operations and the other corporate charges
are included in Other expense-net. All of the corporate restructuring and other
corporate charges are included in Business Segment Information in Corporate &
other-net.
Results for 2002 were favorably impacted by the adoption of SFAS No. 142, which
eliminated the amortization of goodwill and indefinite life intangible assets
recorded in connection with previous business acquisitions. This accounting
change increased pretax income for the third quarter of 2002 by $19 ($16 after-
tax, or $.22 per Common Share) and for the first nine months of 2002 by $56 ($48
after-tax, or $.67 per share).
Pretax income for the third quarter of 2002 was reduced by $13 ($9 after-tax, or
$.12 per Common Share) compared to the same period in 2001 due to the effect on
pension income of the decline in the market value of stocks in Eaton's pension
fund, coupled with lower discount rates associated with pension and other
postretirement benefit liabilities. Pretax income for the first nine months of
2002 was similarly reduced by $46 ($30 after-tax, or $.42 per share) compared to
the same period in 2001. In 2003, due to the decline in stock market valuations
during 2002 and a further lowered discount rate associated with pension and
other postretirement benefit liabilities, Eaton expects pension income to be
reduced compared to 2002 by an additional $.40 to $.60 per share. In addition,
depending on the year-end 2002 view of the assumption for the return on pension
plan assets, pension income could be reduced by an additional $.15 to $.18 per
share in 2003 for every 1 percentage point reduction in the assumed return on
pension plan assets.
As displayed in the Statements of Consolidated Income, Income from operations of
$161 in the third quarter of 2002 and $395 in the first nine months of 2002,
were $93 and $115 above the comparable periods in 2001, despite most of Eaton's
end markets remaining depressed. These increases were primarily attributable to
the benefits of the aggressive restructuring actions described above, which are
expected to produce $130 of savings in 2002. The increases were also the result
of a reduction in restructuring charges recorded in the third quarter and first
nine months of 2002 compared to 2001, and increased sales in the third quarter
of 2002. Additionally, the increases reflected reduced expense in 2002 related
to amortization of goodwill and indefinite life intangible assets, offset by
reduced pension income and higher expense for other postretirement benefits in
2002, as described above.
During the third quarter of 2002, the Company sold its Navy Controls business.
The sale of this business resulted in a pretax gain of $18 ($13 after-tax, or
$.18 per Common Share).
During the third quarter of 2001, Eaton sold its Air Conditioning and
Refrigeration business and certain assets of the Automotive business. The sales
of these businesses resulted in a net pretax gain of $23 ($15 after-tax, or $.21
per share). During the first nine months of 2001, the Company sold businesses
resulting in a net pretax gain of $61 ($22 after-tax, or $.31 per share)
including the businesses sold in the third quarter of 2001 as discussed
previously, and the Vehicle Switch/Electronics Division (VS/ED) and certain
assets of the Truck business sold in the first quarter of 2001. In Business
Segment Information the operating results of VS/ED are included in divested
operations for 2001.
The effective income tax rate for the first nine months of 2002 was 30.4%
compared to 41.8% for the same period in 2001. The higher rate in 2001 was
primarily the result of the tax effect of book/tax basis differences related to
businesses sold in the first quarter of 2001, which increased tax expense by
$18. Excluding the negative tax consequences related to the sales of businesses
in 2001, the effective tax rate for the first nine months of 2001 was 34.0%
compared to 30.4% in 2002. The lower rate in 2002 was primarily due to the
discontinuance of amortization of non-deductible goodwill in 2002.
The modest recovery Eaton had anticipated in its end markets beginning in the
fourth quarter of 2002 appears to be delayed somewhat due to the slow and uneven
pace of North American economic recovery. The Company's current forecast
projects little growth in its end markets through the first half of next year,
with stronger growth likely in the second half of 2003. As a result of the
continuing soft market conditions, Eaton will continue to exercise tight control
over all expenditures. The Company expects fourth quarter operating earnings
per share to be in the $.90 to $1.00 range, with estimates of full-year
operating earnings per share of $4.30 to $4.40.
Business Segments
- -----------------
Fluid Power
- -----------
Third quarter 2002 sales of Eaton's largest business segment, Fluid Power,
were $609, 2% above one year earlier. This compares to a decline of about 3%
in Fluid Power's markets, with North American fluid power industry shipments
up about 1%, commercial aerospace markets off about 23%, and defense
aerospace markets up 13%. Military aerospace markets have been stronger than
anticipated and should remain strong into next year. The significant decline
in the commercial aerospace market started in the second quarter. The
recovery in the traditional mobile and industrial hydraulics markets
previously forecasted for the fourth quarter is not anticipated until next
year. Sales for the first nine months of 2002 were $1,834, down 5% from one
year ago.
Operating profits in the third quarter of 2002 were $44, 42% above one year
earlier, despite weaker than anticipated conditions in end markets. This
improvement was primarily the result of the benefits of aggressive restructuring
actions taken to resize this business in prior periods. The third quarter of
2002 included $6 of restructuring charges compared to $4 in the same period in
2001. Operating profits for the first nine months of 2002 were $145, 1% below
the same period in 2001, reflecting the weak end markets and restructuring
charges of $24 in 2002 compared to $18 in 2001. Operating profits before
restructuring charges for the third quarter of 2002 were $50 (8.2% of sales)
compared to $35 (5.9% of sales) last year, and for the first nine months of 2002
were $169 (9.2% of sales) compared to $164 in the same period of 2001 (8.5% of
sales).
In the third quarter, Eaton announced a multi-year contract with Lockheed Martin
to supply the wing fluid distribution package on the supersonic multi-role
fighter, the F-35, which represents Eaton's second major contract for the Joint
Strike Fighter. The award is for the system design and development phase of the
program, which will total 14 aircraft and generate an estimated $3 of revenue
over the next two years. Based on the projected manufacture of 3,000 aircraft
and additional foreign military sales over the planned lifetime of the F-35,
this award has the potential of generating revenue for Eaton of $1,000 over the
life of the program. The Company also announced it had been selected to receive
$84 in business as a result of the U.S. Air Force's decision to purchase an
additional 60 C-17 cargo aircraft in 2004 through 2007.
During the second quarter, Eaton purchased the remaining 40% interest in its
hydraulics systems joint venture company, Jining Eaton Hydraulics Company, Ltd.
(JEHYCO), located in Jining, China. JEHYCO is the Company's fourth wholly-owned
business in China.
During the first quarter of 2002, Eaton announced a multi-year contract with
Airbus to provide products for hydraulic fluid conveyance in the new Airbus 380,
the world's largest commercial aircraft. The contract has potential revenue of
$70 over the next 20 years. This was the second contract awarded to the Company
for the Airbus A380, with the combined contracts expected to generate revenues
of approximately $270 over the next 20 years. BMW also awarded Eaton a multi-
year contract during the first quarter to provide fluid hose assemblies for two
major automobile production models. This contract is expected to have revenues
in excess of $150 over the next six years. In addition to these announcements,
several other programs were awarded to the Company in 2001 which are generating
increased revenue in 2002, helping this business continue to grow faster than
its end markets.
On October 1, 2002, Eaton announced that it had signed a contract to purchase
substantially all the assets of the Boston Weatherhead hose and fittings
business of Dana Corporation. The business had sales of $207 in 2001. The
transaction closed on November 1, 2002.
Industrial & Commercial Controls
- --------------------------------
In the Industrial & Commercial Controls segment, third quarter 2002 sales
were $506, down 8% from last year, as end markets for the Company's
electrical business continued to weaken during the third quarter. Sales were
down only 3% after adjusting for the impact of selling the Navy Controls
business at the start of the third quarter. End markets for the electrical
business continued to weaken during the third quarter, with an estimated 6%
decline in North American markets for this business compared to the same
period last year. The long-cycle, large-project portion of this business,
which is tied to commercial construction, will continue to soften through the
balance of this year, with a modest recovery not expected until the second
half of next year. The residential business has remained strong, helping this
segment grow faster than its end markets in the third quarter. Sales for the
first nine months of 2002 were $1,511, 10% below the same period in 2001.
Operating profits for the third quarter of 2002 were $49, an increase of 81%
compared to the same period in 2001, and for the first nine months of 2002
were $109, a decrease of 13% from the same period in 2001. The improvement
in third quarter 2002 relative to the third quarter of 2001 was primarily the
result of the benefits of aggressive restructuring actions taken to resize this
business in prior periods, as well as restructuring charges of $19 in the third
quarter of 2001. The decline in operating profits for the first nine months of
2002 was primarily the result of declining sales volume due to weak market
conditions in most of the sectors this segment serves and the effects of product
mix. The first nine months of 2002 also included restructuring charges of $15
compared to similar charges of $23 in 2001. Operating profits before
restructuring charges in the third quarter of 2002 were $49 (9.7% of sales), up
7% from last year's level of $46 (8.3% of sales) and for the first nine months
of 2002 were $124 (8.2% of sales) compared to $149 (8.9% of sales) in the same
period of 2001.
In the third quarter of 2002, the Company sold its Navy Controls business for
$92.
During the first quarter of 2002, Eaton announced the formation of its new
Performance Power Solutions organization, created to expand the Company's
position in the power quality and assurance market, as well as a new business
relationship with Johnson Controls, Inc. This business expansion is expected to
result in $300 of new business revenue over the next four years. Additionally,
the Company will benefit from a new three-year, $80 agreement with Caterpillar
to be the exclusive supplier of electrical switchgear for the self-contained
mobile generator set systems known as Caterpillar Power Modules. Eaton will
provide Cutler-Hammer power distribution equipment to protect and control the
generator sets contained in the modules.
Automotive
- ----------
The Automotive segment posted sales of $393 in the third quarter of 2002, 13%
over the comparable quarter of last year. The Automotive segment continued
its strong performance with sales that considerably outpaced its end markets.
NAFTA automotive production was up 12%, while European production declined
5%, compared to the same period last year. Investments in this segment's new
product development over the last several years are delivering results since
the Company has been able to accelerate the pace of new product introductions
and gain market share. Sales for the first nine months of 2002 of $1,197
were 6% above the same period in 2001. Traditionally sales for this segment
are lower in the third quarter than in the second quarter as a result of the
normal seasonal pattern of automotive industry production.
Operating profits in the third quarter of 2002 were $52, up 27% from a year ago.
Operating profits for the first nine months of 2002 were $172, 15% above the
same period in 2001. This segment produced a return on sales of 13.2% for the
third quarter and 14.4% for the first nine months of 2002 compared to 11.6% and
13.3%, respectively for the same periods in 2001.
In the third quarter of 2002, Eaton announced the acquisition of technology,
trademarks, and engineering assets representing the GerodiscTM product line from
McLaren Performance Technologies. The addition of this product line to Eaton's
existing products is expected to provide broader application for the light-duty
automotive differential market.
During the second quarter, further progress was made in growing the Company's
supercharger business. In Brazil, the smallest supercharger ever produced on a
commercial basis was launched for use on the new Ford Fiesta, and delivery began
of a high-efficiency supercharger for use with the new M-271 engine program of
Mercedes. Eaton is providing superchargers, intake and exhaust valves, roller
rocker arms and lash adjusters for the M-271 engine program. Sales of these
components are expected to exceed $375 over approximately seven years.
Truck
- -----
The Truck segment posted sales of $322 in the third quarter of 2002, a 27%
increase over the comparable period last year. NAFTA heavy-duty truck
production was up 67% and NAFTA medium-duty truck production was up 11%.
European truck production was down 7% and South American production decreased
by 4%. Sales for the first nine months of 2002 were $892, 12% above one year
earlier. The increases in sales for these periods were driven in significant
part by accelerated purchases of trucks before new engine emission standards
took effect October 1, 2002.
Operating profits in the third quarter of 2002 were $45 (14.0% of sales)
compared to breakeven performance a year ago before restructuring charges of
$6. Operating profits for the first nine months of 2002 were $65 compared to
a loss of $49 in 2001, which reflected restructuring charges of $14 in 2002
and $49 in 2001. Before restructuring charges in both periods, operating
profits for the first nine months of 2002 were $79 (8.9% of sales) compared
to breakeven performance in the same period of 2001. The positive impact of
the extensive restructuring actions over the last two years can be seen in
the $45 of increased profit in the third quarter of 2002 on increased sales
of $69, compared to the same period in 2001.
The Company expects that NAFTA heavy-duty truck production for the full year
will total 174,000 units. NAFTA heavy-duty production peaked in the third
quarter and is expected to decline sharply in the fourth quarter as a result
of the previously mentioned acceleration of shipments due to the new emission
standards. The Company plans to close its Shelbyville, Tennessee
transmission plant in the fourth quarter of 2002, as previously announced, in
an effort to keep its capacity in line with lower demand.
In October 2002, Eaton announced two new contracts in South America with
Volvo and AGCO to supply transmissions. These contracts are expected to
generate more than $190 of sales over the next 8 years.
Non-operating Income (Expense)
- ------------------------------
Results for 2002 were impacted favorably by the adoption of SFAS No. 142, which
eliminated the amortization of goodwill and indefinite life intangible assets
recorded in connection with previous business acquisitions. This accounting
change resulted in a reduction in amortization expense for the third quarter of
2002 of $19 and $56 for the first nine months of 2002.
Net interest expense of $26 in the third quarter of 2002 decreased by
$7 compared to the same period in 2001. Net interest expense of $80 in the
first nine months of 2002 decreased $33 compared to the same period in 2001.
The decreases were primarily related to the reduction in debt of $484 from
the end of the third quarter of 2001 to September 30, 2002, as well as a
reduction of interest rates experienced throughout 2001 and continuing into
2002.
Corporate and other expense-net increased to $45 in the third quarter of 2002
compared to income of $2 in the same period in 2001. This was in part due to
the result of reduced pension income of $13 in 2002 compared to 2001 due to
the effect of the decline in the market value of stocks in Eaton's pension
fund, coupled with lower discount rates associated with pension and other
postretirement benefit liabilities. The increased expenses also reflected a
contribution of $10 to the Eaton Charitable Fund. For the first nine months
of 2002, Corporate and other expense-net increased to $106 compared to $17
for the same period in 2001. The major change was a reduction in pension
income of $46 for the first nine months of 2002 compared to 2001. An
additional element of the change was the $10 contribution to the Eaton
Charitable Fund in the third quarter of 2002.
Changes in Financial Condition
- ------------------------------
The Company's financial position remained strong during the first nine months
of 2002. Due to tight controls over working capital, net working capital
decreased to $639 at September 30, 2002 from $718 at the end of 2001 (the
current ratio was 1.3 and 1.4 at September 30 and December 31, respectively).
The primary reasons for the decrease of $79 in working capital were an
increase in current liabilities of $155 and a reduction in inventories of
$47. The increase in current liabilities represents the timing of payments
of certain obligations and higher accruals for income taxes and compensation
related accruals. These decreases in working capital were offset by a $68
increase in cash and short-term investments, primarily due to cash flow from
operations, and a $69 increase in accounts receivable due to higher sales in
2002.
Eaton continued to generate strong cash flow from operating activities, which is
the primary source of funds to finance the needs of the Company. Operating
activities generated cash of $643 in the first nine months of 2002, compared to
$495 for the same period in 2001. Implementation of the Eaton Business System
helped to maintain the Company's strong financial position through continued
tight control over working capital and capital expenditures. Capital
expenditures for the first nine months of 2002 were $139, $64 below the same
period in 2001.
Total debt of $2,032 at September 30, 2002 decreased $408 from year-end 2001.
Debt was reduced by $246 in the third quarter, as a result of the strong
operating cash flows and proceeds from the sale of Navy Controls. The Company
made further progress toward its goal of strengthening the balance sheet and
reducing its net debt-to-total capital ratio during the first nine months of
2002. The ratio was reduced to 38.8% at September 30, 2002 from 46.2% at
December 31, 2001. The Company has credit facilities of $900, $500 of which
expire in 2003 and $400 in 2005.
In the third quarter of 2002, Eaton issued $300 of 5.75% Notes due 2012. The
net proceeds from the Notes were used to reduce a portion of the indebtedness
incurred in connection with the 1999 acquisition of Aeroquip-Vickers, Inc. and
to reduce commercial paper. In the third quarter of 2002, the Company also
reached an agreement with the IRS relating to the treatment of its broad-based
company-owned life insurance plans for the years 1993 through 1998. Pursuant to
the agreement, the Company terminated its remaining broad-based company-owned
life insurance plans. The settlement of this issue resulted in no material
effect on Eaton's financial position, net income or cash flows.
Due to the effect of the continued decline in stock market valuations, the value
of Eaton's pension fund assets has declined during 2002. Statement of Financial
Accounting Standards No. 87 requires recognition of a charge to the Other
Comprehensive Income component of Shareholders' Equity if the fair value of plan
assets is less than the accumulated benefit obligation at the end of the year.
The required charge is equal to the amount by which the accumulated benefit
obligation exceeds plan assets plus the amount of any asset related to the
pension plan recorded on the Company's Balance Sheet, less applicable deferred
taxes. Based on October 31, 2002 plan asset values and an estimate of the
accumulated benefit obligation at November 30, 2002 (the date at which the
liability is calculated), Eaton would be required to record a non-cash charge in
Other Comprehensive Income of approximately $400 after-tax. The above numbers
could change due to the impact of changing asset values between October 31, 2002
and November 30, 2002, a change in the interest rate used to discount the
pension liability, or funding that the Company undertakes before November 30,
2002. Pension funding requirements are not affected by the recording of this
non-cash charge to equity. Further, any charge taken would not impact earnings,
and would be reversible should the pension plan become overfunded at the end of
2003.
Forward-Looking Statements
- --------------------------
This Form 10-Q contains forward-looking statements concerning the fourth quarter
2002 and full-year 2002 operating earnings per Common Share, our worldwide
markets, volumes from new business awards and relationships (including long-term
contracts) which are not necessarily spread evenly throughout the award period,
and expenses and benefits of our restructuring programs. These statements 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; failure to implement
restructuring plans; unanticipated downturns in business relationships with
customers or their purchases from us, including pursuant to new long-term
contracts where volumes and the timing of sales can vary materially from
expectations and from year to year; competitive pressures on sales and pricing;
increase 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 or dispute resolutions; and unanticipated further deterioration of
economic and financial conditions in the United States and around the world. We
do not assume any obligation to update these forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
A discussion of market risk exposures is included in Part II, Item 7A,
"Quantitative and Qualitative Disclosure about Market Risk", of the Company's
2001 Annual Report on Form 10-K. Long-term debt decreased to $1,833 at September
30, 2002 from $2,252 at the end of 2001. The decrease was primarily due to the
repayment of $630 of commercial paper and the scheduled maturity in 2003 of $150
of variable rate notes. These decreases were offset by the offering of $300 of
5.75% Notes in the third quarter. There were no other material changes in long-
term debt during the nine months ended September 30, 2002.
PART II - OTHER INFORMATION
Item 4. Controls and Procedures
Within 90 days prior to filing this report, an evaluation was performed, under
the supervision and with the participation of Eaton's management, including
Alexander M. Cutler - Chairman and Chief Executive Officer and Richard H. Fearon
- - Executive Vice President - Chief Financial and Planning Officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures. Based on that evaluation, Eaton's management concluded that the
Company's disclosure controls and procedures were effective as of September 30,
2002. There have been no significant changes in the Company's internal controls
or in other factors that could significantly affect internal controls subsequent
to September 30, 2002.
Disclosure controls and procedures are controls and other procedures that 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 Securities and Exchange
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 as appropriate, to allow timely
decisions regarding required disclosure.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - See Exhibit Index attached.
(b) Reports on Form 8-K.
1. On July 16, 2002, the Company filed a Current Report on Form 8-K regarding
the second quarter 2002 earnings release.
2. On July 19, 2002, the Company filed a Current Report on Form 8-K regarding a
terms agreement and underwriting agreement with several underwriters for the
issuance of $300 of 5.75% Notes due 2012.
3. On August 9, 2002, the Company filed a Current Report on Form 8-K regarding
sworn certification statements of the Company's principal executive officer
and principal financial officer.
4. On August 9, 2002, the Company filed a Current Report on Form 8-K/A redating
the sworn certification statements of the Company's principal executive
officer and principal financial officer to coincide with the filing date of
the Quarterly Report on Form 10-Q for the quarter ended June 30, 2002.
5. On October 15, 2002, the Company filed a Current Report on Form 8-K
regarding the third quarter 2002 earnings release, which was amended on
October 16, 2002 because of an incorrect reference.
Signature
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: November 13, 2002 /s/ Richard H. Fearon
----------------------------
Richard H. Fearon
Executive Vice President -
Chief Financial and Planning Officer
CERTIFICATION
I, Alexander M. Cutler, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Eaton Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
stablishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing equivalent functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ Alexander M. Cutler
- ------------------------
Alexander M. Cutler
Chairman and Chief Executive Officer
Eaton Corporation
CERTIFICATION
I, Richard H. Fearon, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Eaton Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 2, 2002
/s/ Richard H. Fearon
- --------------------------
Richard H. Fearon
Executive Vice President -
Chief Financial and Planning Officer
Eaton Corporation
EATON CORPORATION
EXHIBIT INDEX
Regulation S-K,
Item 601 - Exhibit
Reference Number Exhibit
- ------------------ -------
4 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 of the Company and its
subsidiaries.
12 Ratio of Earnings to Fixed Charges
Eaton Corporation
2002 Quarterly Report on Form 10-Q
Item 6
Exhibit 12
Ratio of Earnings to Fixed Charges
Nine months
ended Year ended December 31
September 30, -----------------------------------
2002 2001 2000 1999 1998 1997
---- ---- ---- ---- ---- ----
Income from continuing
operations before income taxes
& extraordinary item $ 307 $ 278 $ 552 $ 943 $ 616 $ 730
Adjustments
Minority interests in
consolidated subsidiaries 11 8 8 2 (2) 1
Income of equity investees 0 0 (1) (1) (1) (3)
Interest expensed 80 149 182 159 93 86
Amortization of debt issue
costs 1 1 1 0 0 1
Estimated portion of rent
expense representing
interest 28 38 39 36 28 25
Amortization of capitalized
interest 10 13 10 8 7 8
Distributed income of equity
investees 0 0 1 0 1 2
----- ----- ----- ----- ----- -----
Adjusted income from continuing
operations before income
taxes & extraordinary item $ 437 $ 487 $ 792 $1,147 $ 742 $ 850
===== ===== ===== ====== ===== =====
Fixed charges
Interest expensed $ 80 $ 149 $ 182 $ 159 $ 93 $ 86
Interest capitalized 7 12 22 21 16 12
Amortization of debt issue
costs 1 1 1 0 0 1
Estimated portion of rent
expense representing
interest 28 38 39 36 28 25
----- ----- ----- ----- ----- -----
Total fixed charges $ 116 $ 200 $ 244 $ 216 $ 137 $ 124
===== ===== ===== ===== ===== =====
Ratio of earnings to fixed
charges 3.77 2.44 3.25 5.31 5.42 6.85
Income from continuing operations before income taxes & extraordinary item
for years before 2002 include amortization expense related to goodwill and other
intangible assets. Upon adoption of SFAS No. 142 on January 1, 2002 the Company
ceased amortization of goodwill and indefinite life intangible assets.