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United States
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 31, 2004
Commission file number 1-1396
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]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X]
There were 150.6 million Common Shares outstanding as of March 31, 2004.
PART I - FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
- ----------------------------
Eaton Corporation
Statements of Consolidated Income
Three months ended
March 31
---------------------
(Millions except for per share data) 2004 2003
---- ----
Net sales $2,238 $1,925
Cost of products sold 1,621 1,415
Selling & administrative expense 361 329
Research & development expense 60 55
Interest expense-net 19 24
Other (income) expense-net 4 3
------ ------
Income before income taxes 173 99
Income taxes 39 27
------ ------
Net income $ 134 $ 72
====== ======
Net income per Common Share assuming dilution $ 0.85 $ 0.50
Average number of Common Shares outstanding 157.1 144.2
Net income per Common Share basic $ 0.87 $ 0.51
Average number of Common Shares outstanding 153.1 142.3
Cash dividends paid per Common Share $ 0.27 $ 0.22
Net income per Common Share, average number of Common Shares outstanding and
cash dividends paid per Common Share have been adjusted retroactively to reflect
the two-for-one stock split effective February 23, 2004.
See accompanying notes.
2
Eaton Corporation
Condensed Consolidated Balance Sheets
Mar. 31, Dec. 31,
(Millions) 2004 2003
---- ----
ASSETS
Current assets
- --------------
Cash $ 65 $ 61
Short-term investments 514 804
Accounts receivable 1,399 1,190
Inventories 751 721
Deferred income taxes & other current assets 330 317
------ ------
3,059 3,093
Property, plant & equipment-net 2,030 2,076
Goodwill 2,086 2,095
Other intangible assets 541 541
Deferred income taxes & other assets 477 418
------ ------
$8,193 $8,223
====== ======
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities
- -------------------
Short-term debt & current portion of long-term debt $ 300 $ 302
Accounts payable 630 526
Accrued compensation 176 204
Accrued income & other taxes 295 298
Other current liabilities 811 796
------ ------
2,212 2,126
Long-term debt 1,662 1,651
Postretirement benefits other than pensions 632 636
Pensions & other liabilities 644 693
Shareholders' equity 3,043 3,117
------ ------
$8,193 $8,223
====== ======
See accompanying notes.
3
Eaton Corporation
Condensed Statements of Consolidated Cash Flows
Three months ended
March 31
-------------------
(Millions) 2004 2003
---- ----
Net cash provided by (used in) operating activities
- ---------------------------------------------------
Net income $ 134 $ 72
Adjustments to reconcile to net cash provided
by operating activities
Depreciation & amortization 100 98
Changes in operating assets & liabilities,
excluding acquisitions & sales of businesses (171) (204)
Contribution to U.S. qualified pension plans (75)
Other-net 39 30
----- -----
27 (4)
----- -----
Net cash provided by investing activities
- -----------------------------------------
Expenditures for property, plant & equipment (49) (43)
Acquisitions of businesses, less cash acquired (16) (219)
Net decrease in short-term investments 291 314
Other-net (10) (10)
----- -----
216 42
----- -----
Net cash used in financing activities
- -------------------------------------
Borrowings with original maturities of less
than three months-net (3) (29)
Cash dividends paid (41) (31)
Proceeds from exercise of employee stock options 55 6
Purchase of Common Shares (250) -
----- -----
(239) (54)
----- -----
Total increase (decrease) in cash 4 (16)
Cash at beginning of period 61 75
----- -----
Cash at end of period $ 65 $ 59
===== =====
See accompanying notes.
4
Notes To Condensed Consolidated Financial Statements
- ----------------------------------------------------
Dollars in millions, except for 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 2003 Annual
Report on Form 10-K. The interim period results are not necessarily indicative
of the results to be expected for the full year.
Two-For-One Stock Split
- -----------------------
On January 21, 2004, Eaton announced a two-for-one split of the Company's Common
Shares effective in the form of a 100% stock dividend. The record date for the
stock split was February 9, 2004, and it was distributed on February 23, 2004.
Accordingly, all per share amounts, average shares outstanding, and shares
outstanding have been adjusted retroactively to reflect the stock split.
Subsequent Event
- ----------------
On April 27, 2004, Eaton announced it signed an agreement with Invensys plc to
purchase its power systems business, Powerware Corporation, for $560 in cash.
The transaction is expected to close by the end of second quarter 2004,
following regulatory review and the approval of Invensys shareholders.
Powerware, based in Raleigh, N.C., is a global market leader in Uninterruptible
Power Systems (UPS), DC power products, and power quality services. Powerware
had estimated revenues of $775 for the year ended March 31, 2004 and has
operations in the United States, Europe and in the Asia/Pacific area that
provide products and services that are utilized by computer manufacturers,
industrial companies, governments, telecommunications firms, medical
institutions, data centers and other businesses. Powerware offers a full line of
UPS products (three-phase and single-phase) and DC power systems, power
management software, remote monitoring, integration services and site support.
This business will be included in the Electrical segment. Eaton expects to
finance this acquisition principally with cash on hand at closing, supplemented
as needed with short-term debt.
Acquisition of Business
- -----------------------
On January 31, 2003, Eaton acquired the electrical division of Delta plc for
approximately $215. First quarter 2003 includes only two months of sales and
operating results for this business. This business has operations in Europe and
in the Asia/Pacific area and had sales of $326 in 2002. This business is
included in the Electrical segment.
Restructuring Charges
- ---------------------
In 2004 and 2003, Eaton incurred restructuring charges related primarily to the
integration of the Boston Weatherhead fluid power business acquired in November
2002 and the electrical division of Delta plc acquired in January 2003. A
summary of these charges follows:
5
Three months ended
March 31
------------------
2004 2003
---- ----
Fluid Power $ 1 $ 5
Electrical 5 1
----- -----
6 6
Corporate - 1
----- -----
Total pretax charges $ 6 $ 7
===== =====
After-tax charges $ 4 $ 5
Per Common Share $0.03 $0.03
The restructuring charges are 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 are included in Other corporate
expense-net, as appropriate.
Utilization of restructuring charges for first quarter 2004 follows:
Plant
consolidation
& other
-------------
Balance remaining
at December 31, 2003 $ 10
2004 charges 6
Utilized in 2004 (8)
----
Balance remaining
at March 31, 2004 $ 8
====
Retirement Benefit Plans
- ------------------------
Pretax income for first quarter 2004 was reduced by $4 ($3 after-tax, or $0.02
per Common Share) compared to first quarter 2003 due to increased pension and
other postretirement benefit costs in 2004 resulting from the decline over the
last several years in the market value of equity investments held by Eaton's
pension plans, coupled with the effect of the lowering of discount rates
associated with pension and other postretirement benefit liabilities at year-end
2003. Also, during January 2004 Eaton made a voluntary contribution of $75 to
its United States qualified pension plans.
6
The components of benefit costs follow:
Three months ended March 31
-----------------------------------
Other
postretirement
Pension benefits benefits
---------------- --------------
2004 2003 2004 2003
---- ---- ---- ----
Service cost $ 24 $ 24 $ 4 $ 4
Interest cost 34 34 13 14
Expected return on plan assets (45) (47) - -
Other 7 1 2 2
---- ---- ---- ----
20 12 19 20
Settlement loss 7 10 - -
---- ---- ---- ----
$ 27 $ 22 $ 19 $ 20
==== ==== ==== ====
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the
Act) was passed on December 8, 2003, subsequent to the November 30 measurement
of the Company's other postretirement benefit plans. The Act provides for
prescription drug benefits under Medicare Part D and contains a subsidy to plan
sponsors who provide "actuarially equivalent" prescription plans.
In accordance with Financial Accounting Standards Board (FASB) Staff Position
FAS 106-1, Eaton has elected not to defer accounting for the effect of the Act
and adopted the accounting guidance in FAS 106-1 in first quarter 2004. As a
result, in first quarter 2004 the accumulated postretirement benefit obligation
decreased by $51, with an offsetting change in unrecognized net actuarial loss.
The reduction in the accumulated postretirement benefit obligation is
attributable to the federal subsidy and an expected reduction in the number of
retirees electing coverage under the Company's other postretirement benefit
plans. The Act will reduce other postretirement benefit costs by $6 in 2004,
comprised of $3 of service and interest cost and $3 of amortization of
unrecognized net actuarial loss. A prescription drug benefit plan must be
"actuarially equivalent" in order to qualify for the subsidy. While the United
States Department of Health and Human Services has not yet defined the tests for
"actuarially equivalent" prescription plans, Eaton has certain plans that are
non-contributory and that the Company believes will satisfy the actuarially
equivalence test and will receive the subsidy. The reduction in the accumulated
postretirement benefit obligation and ongoing net periodic other postretirement
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 the
accumulated postretirement benefit obligation and ongoing net periodic other
postretirement cost. The FASB is in the process of developing specific
authoritative guidance on accounting for the federal subsidy and that guidance,
when issued, could require the Company to change previously reported financial
information.
Income Taxes
- ------------
The effective income tax rate for first quarter 2004 was 22.5% compared to 27.0%
for first quarter 2003 and 24.0% for full-year 2003. The lower rate in 2004
reflects many factors, including higher earnings in international tax
jurisdictions with lower income tax rates and increased use of international tax
credit carryforwards.
7
Repurchase of Common Shares
- ---------------------------
In January 2004, Eaton initiated a plan to repurchase 4.2 million of its Common
Shares to offset the shares issued during 2003 from the exercise of stock
options. During first quarter 2004, the shares were repurchased at a total cost
of $250.
Net Income per Common Share
- ---------------------------
A summary of the calculation of net income per Common Share, based on the number
of shares outstanding assuming dilution and the basic number of shares
outstanding, follows (shares in millions):
Three months ended
March 31
-------------------
2004 2003
---- ----
Net income $ 134 $ 72
====== ======
Average number of Common Shares
outstanding assuming dilution 157.1 144.2
Less dilutive effect of stock options 4.0 1.9
------ ------
Average number of Common Shares
outstanding basic 153.1 142.3
====== ======
Net income per Common Share
assuming dilution $ 0.85 $ 0.50
Net income per Common Share basic 0.87 0.51
Stock Options
- -------------
Eaton has adopted the disclosure-only provisions of Statement of Financial
Accounting Standard (SFAS) No. 123 "Accounting for Stock-Based Compensation".
If the Company accounted for its stock options under the fair-value-based method
of SFAS No. 123, net income and net income per Common Share would have been as
follows:
Three months ended
March 31
------------------
2004 2003
---- ----
Net income
- ----------
As reported $ 134 $ 72
Stock-based compensation
expense, net of income taxes (3) (3)
------ ------
Assuming fair-value-method $ 131 $ 69
====== ======
Net income per Common Share
assuming dilution
- ---------------------------
As reported $ 0.85 $ 0.50
Stock-based compensation
expense, net of income taxes (0.02) (0.02)
------ ------
Assuming fair-value-method $ 0.83 $ 0.48
====== ======
8
Net income per Common Share basic
- ---------------------------------
As reported $ 0.87 $ 0.51
Stock-based compensation
expense, net of income taxes (0.02) (0.02)
------ ------
Assuming fair-value-method $ 0.85 $ 0.49
====== ======
Comprehensive Income
- --------------------
Comprehensive income is as follows:
Three months ended
March 31
------------------
2004 2003
---- ----
Net income $134 $ 72
Foreign currency translation 3 8
Cash flow hedges (2) 7
---- ----
Comprehensive income $135 $ 87
==== ====
Inventories
- -----------
The components of inventories follow:
Mar. 31, Dec. 31,
2004 2003
---- ----
Raw materials $345 $301
Work-in-process & finished goods 440 452
---- ----
Inventories at FIFO 785 753
Excess of FIFO over LIFO cost (34) (32)
---- ----
$751 $721
==== ====
9
Business Segment Information
- ----------------------------
Three months ended
March 31
------------------
2004 2003
---- ----
Net sales
- ---------
Fluid Power $ 768 $ 697
Electrical 611 514
Automotive 478 440
Truck 381 274
------ ------
$2,238 $1,925
====== ======
Operating profit
- ----------------
Fluid Power $ 81 $ 58
Electrical 45 32
Automotive 69 62
Truck 61 22
------ ------
256 174
Corporate
- ---------
Amortization of intangible assets (6) (6)
Interest expense-net (19) (24)
Minority interest (3) (3)
Pension & other postretirement
benefit expense (18) (14)
Other corporate expense-net (37) (28)
------ ------
Income before income taxes 173 99
Income taxes 39 27
------ ------
Net income $ 134 $ 72
====== ======
10
Item 2. Management's Discussion & Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Dollars in millions, except for per share data (per share data assume dilution)
Two-For-One Stock Split
- -----------------------
On January 21, 2004, Eaton announced a two-for-one split of the Company's Common
Shares effective in the form of a 100% stock dividend. The record date for the
stock split was February 9, 2004, and it was distributed on February 23, 2004.
Accordingly, all per share amounts, average shares outstanding, and shares
outstanding have been adjusted retroactively to reflect the stock split.
Overview of the Company
- -----------------------
Eaton is a diversified industrial manufacturer that is a global leader in the
design, manufacture and marketing of fluid power systems and services for
industrial, mobile and aircraft equipment; electrical systems and components for
power quality, distribution and control; automotive engine air management
systems and powertrain controls for fuel economy; and intelligent drivetrain
systems for fuel economy and safety in trucks. The principal markets for the
Fluid Power, Automotive and Truck segments are original equipment manufacturers
and after-market customers of aerospace products and systems, off-highway
agricultural and construction vehicles, industrial equipment, passenger cars and
heavy-, medium-, and light-duty trucks. The principal markets for the Electrical
segment are industrial, construction, commercial, automotive and government
customers. The Company had 51,000 employees at the end of first quarter 2004 and
sells products to customers in more than 100 countries.
Highlights of Results for 2004
- ------------------------------
The Company's operating results for first quarter 2004 and 2003 are summarized
as follows:
Three months ended March 31
---------------------------
2004 2003 Increase
---- ---- --------
Net sales $2,238 $1,925 16%
Net income 134 72 86%
Net income per Common
Share assuming dilution $ 0.85 $ 0.50 70%
Net sales in first quarter 2004 were a new quarterly record. The Company
achieved record levels of shipments in 2004 in spite of end markets being
approximately 12% below the peak of several years ago. Eaton's end markets grew
6% in first quarter 2004 and, adjusting for the effects of foreign exchange, the
Company outgrew its end markets by 4% during the quarter. Sales growth in 2004
also reflected increased sales resulting from recent business acquisitions and
new joint ventures.
The increase in net income during first quarter 2004 was primarily due to higher
sales 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 significantly higher net income in first quarter
2004. These increases were partially offset by higher costs for pensions and
other postretirement benefits in first quarter 2004. As a result of actions
11
taken in 2004 and 2003 to restructure operations and integrate acquired
businesses, Eaton incurred restructuring charges of $0.03 per Common Share in
each of first quarter 2004 and 2003. Business segment operating profit of $256
in first quarter 2004 was 11.4% of sales compared to 9.0% in first quarter
2003. Operating margins were reduced by 0.3% in 2004 and 0.4% in first quarter
2003, due to restructuring charges.
During first quarter 2004, cash generated from operating activities was $27.
Before a $75 voluntary contribution to the United States qualified pension
plans, operating activities generated cash of $102 in first quarter 2004.
Management believes cash flow from operating activities before this pension
contribution is a useful performance measure; this contribution is considered
unusual in nature because a similar pension contribution has not been made in
over a decade. Historically for the Company, the first quarter of each year
generates less cash flow from operations than other quarters of the year.
Capital expenditures of $49 in first quarter 2004 compared to $43 in first
quarter 2003. The net-debt-to-total-capital ratio increased to 31.2% at March
31, 2004 from 25.9% at year-end 2003, primarily due to the $290 decline in
short-term investments, which reflected the $75 contribution to the pension
plans and the repurchase during the quarter of 4.2 million Common Shares at a
total cost of $250.
Based on a survey of its end markets in mid-April 2004, Eaton now anticipates
that its end markets in 2004 will grow between 5 to 6% compared to the original
expectation of 4%. Mobile hydraulics markets, in particular, are stronger than
had been anticipated, as are residential electrical markets. Partially
offsetting these stronger markets is the nonresidential construction electrical
market, which is weaker than anticipated. Accordingly, in mid-April Eaton raised
its guidance for full-year 2004 net income per Common Share by $0.50, to between
$3.65 and $3.80. The Company anticipates net income per share for second quarter
2004 to be between $0.90 and $1.00. These per share amounts are net of
restructuring charges of $0.10 for full-year 2004 and $0.05 for second quarter
2004.
On April 27, 2004, Eaton announced that it signed an agreement with Invensys plc
to purchase its power systems business, Powerware Corporation. The Company
expects the acquisition of Powerware to be accretive to earnings starting in
2004. Accordingly, Eaton raised its guidance for full-year 2004 net income per
Common Share by an additional $0.05 above its mid-April guidance to between
$3.70 and $3.85. The incremental per share amount of $0.05 is net of
restructuring charges related to the acquisition of Powerware of $0.05 per
share.
Results of Operations - 2004 Compared to 2003
- ---------------------------------------------
Three months ended March 31
---------------------------
Net sales 2004 2003 Increase
- --------- ---- ---- --------
Fluid Power $ 768 $ 697 10%
Electrical 611 514 19%
Automotive 478 440 9%
Truck 381 274 39%
------ ------
$2,238 $1,925 16%
====== ======
Sales for first quarter 2004 were up sharply compared to first quarter 2003.
Sales growth of 16% in 2004 consisted of 2% from recent business acquisitions
and a new joint venture, 4% from higher foreign exchange rates, and 10% from
organic growth. Organic growth was made up of 6% growth in end markets and 4%
growth, or almost $80, from outgrowing end markets. The operating results of
each business segment are further discussed below.
12
In first quarter 2004 and 2003, Eaton incurred restructuring charges related
primarily to the integration of the Boston Weatherhead fluid power business
acquired in November 2002 and the electrical division of Delta plc acquired in
January 2003. For the Fluid Power segment, these charges were $1 in first
quarter 2004 compared to $5 in first quarter 2003. For the Electrical segment,
these charges were $5 in first quarter 2004 compared to $1 in first quarter
2003. For Corporate, there were no charges in first quarter 2004 compared to $1
in first quarter 2003. Restructuring charges are 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 are included
in Other corporate expense-net, as appropriate.
Pretax income for first quarter 2004 was reduced by $4 ($3 after-tax, or $0.02
per Common Share) compared to first quarter 2003 due to increased pension and
other postretirement benefit costs in 2004 resulting from the decline over the
last several years in the market value of equity investments held by Eaton's
pension plans, coupled with the effect of the lowering of discount rates
associated with pension and other postretirement benefit liabilities at year-end
2003.
The effective income tax rate for first quarter 2004 was 22.5% compared to 27.0%
for first quarter 2003 and 24.0% for full-year 2003. The lower rate in 2004
reflects many factors including higher earnings in international tax
jurisdictions with lower income tax rates and increased use of international tax
credit carryforwards.
Results by Business Segment
- ---------------------------
Three months ended March 31
---------------------------
Fluid Power 2004 2003 Increase
- ----------- ---- ---- --------
Net sales $ 768 $697 10%
Operating profit 81 58 40%
Operating margin 10.5% 8.3% 27%
First quarter 2004 sales of Fluid Power, Eaton's largest business segment, were
an all-time quarterly record. The increase in sales compares to an increase of
8% in Fluid Power's markets, with North American fluid power industry shipments
up 10%, commercial aerospace markets up 6%, and defense aerospace markets up
13%. Mobile and industrial hydraulics markets had strong growth in both sales
and orders during first quarter 2004. The Company anticipates the growth in
mobile hydraulics is likely to continue throughout 2004. Commercial and defense
aerospace markets were also a bit stronger than expected in first quarter 2004.
Operating profit in first quarter 2004 was an all-time quarterly record.
Increased operating profit in 2004 was primarily due to higher sales, the
benefits of restructuring actions taken in recent years to resize this business
and reduced restructuring charges in 2004. Restructuring charges in 2004 were $1
compared to $5 in first quarter 2003 and related primarily to the acquisition of
the Boston Weatherhead business in late 2002. Restructuring charges reduced
operating margins by 0.1% in first quarter 2004 and 0.7% in first quarter 2003.
13
Three months ended March 31
---------------------------
Electrical 2004 2003 Increase
- ---------- ---- ---- --------
Net sales $611 $514 19%
Operating profit 45 32 41%
Operating margin 7.4% 6.2% 19%
In the Electrical segment, first quarter 2004 sales were up substantially from
first quarter 2003. Sales growth in 2004 included 7% from the acquisition of the
electrical division of Delta plc and the joint venture formed in August 2003
with Caterpillar. End markets for the electrical business grew about 2% during
first quarter 2004. End market growth appears to be accelerating modestly, but
significant pockets of weakness still exist, particularly for larger industrial
and commercial projects.
Increased operating profit in first quarter 2004 was primarily due to higher
sales and the benefits of restructuring actions taken in recent years to resize
this business and integrate acquired businesses, partially offset by increased
restructuring charges in first quarter 2004. Restructuring charges recorded in
2004 were $5 compared to $1 in first quarter 2003, and related to the acquired
businesses. Restructuring charges reduced operating margins by 0.8% in first
quarter 2004 and 0.2% in first quarter 2003.
On April 27, 2004, Eaton announced it signed an agreement with Invensys plc to
purchase its power systems business, Powerware Corporation, for $560 in cash.
The transaction is expected to close by the end of the second quarter, following
regulatory review and the approval of Invensys shareholders. Powerware, based in
Raleigh, N.C., is a global market leader in Uninterruptible Power Systems (UPS),
DC power products, and power quality services. Powerware had estimated revenues
of $775 for the year ended March 31, 2004 and has operations in the United
States, Europe and in the Asia/Pacific area that provide products and services
that are utilized by computer manufacturers, industrial companies, governments,
telecommunications firms, medical institutions, data centers and other
businesses. Powerware offers a full line of UPS products (three-phase and
single-phase) and DC power systems, power management software, remote
monitoring, integration services and site support.
In March 2004, Eaton announced the acquisition of the Electrum Group Ltd., a New
Jersey-based company that provides power management services and web-based
software for telecommunications, data center and government applications.
Electrum had $3.1 of sales in 2003. Electrum, while small in size, significantly
expands the Company's capabilities to serve the telecommunications, data center
and government power markets.
Three months ended March 31
---------------------------
Automotive 2004 2003 Increase
- ---------- ---- ---- --------
Net sales $ 478 $ 440 9%
Operating profit 69 62 11%
Operating margin 14.4% 14.1% 2%
The Automotive segment posted strong revenue growth in first quarter 2004
despite flat markets, reflecting the significant product and platform wins
generated by the business over the last couple of years. Automotive production
in NAFTA and in Europe was flat in 2004 compared to first quarter 2003. Eaton
14
continues to expect that, for 2004 as a whole, both the NAFTA and Europe
automobile markets will be flat.
Increased operating profit was the result of increased sales in 2004.
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 $150 over the next six years.
Three months ended March 31
---------------------------
Truck 2004 2003 Increase
- ----- ---- ---- --------
Net sales $ 381 $274 39%
Operating profit 61 22 177%
Operating margin 16.0% 8.0% 100%
The Truck segment posted sales in first quarter 2004 that were up sharply
compared to first quarter 2003. In first quarter 2004, NAFTA heavy-duty truck
production of 53,000 units was up 48% and NAFTA medium-duty truck production was
up 22% compared to first quarter 2003. European truck production was down 2% and
Brazilian vehicle production was up 14%. Monthly orders for new NAFTA heavy-duty
trucks during first quarter 2004 have been running above 30,000 units. As a
result, Eaton is growing increasingly confident that the NAFTA heavy-duty market
in 2004 is likely to total at least 240,000 units.
Operating profit in first quarter 2004 was nearly three times the operating
profit earned in first quarter 2003. Increased operating profit in 2004 was
primarily due to increased sales in first quarter 2004 and the benefits of the
new operating model implemented by Truck in recent years.
In March 2004, Eaton announced that it signed an agreement to form a 50%-owned
joint venture with FAW Jiefang Automotive Co., Ltd., in Changchun, China to
produce a complete line of medium-duty transmissions for commercial vehicles and
buses for the growing Chinese market. FAW Jiefang Automotive Co., Ltd. is the
commercial vehicle subsidiary of China First Auto Works Group Company (FAW)
which is the largest manufacturer of commercial vehicles in China. Eaton and FAW
Jiefang will have equal ownership of the joint venture, which will be called FAW
Eaton Transmission Co., Ltd. The venture is expected to receive Chinese
government approval in the next few months with production expected to begin
this summer.
Changes in Financial Condition During 2004
- ------------------------------------------
Net working capital of $847 at March 31, 2004 decreased from $967 at year-end
2003. The current ratio was 1.4 at March 31, 2004 and December 31, 2003. The
decrease in net working capital was primarily due to a reduction in short-term
investments which reflected a $75 contribution to the United States qualified
pension plans and the repurchase of 4.2 million Common Shares at a total cost of
$250, offset by higher accounts receivable resulting from increased sales in
first quarter 2004.
During first quarter 2004, cash generated from operating activities was $27.
Before a $75 voluntary contribution to the United States qualified pension
plans, operating activities generated cash of $102 in 2004. Management believes
cash flow from operating activities before this pension contribution is a useful
performance measure; this contribution is considered unusual in nature because a
similar pension contribution has not been made in over a decade. Historically
for the Company, the first quarter of each year generates less cash flow from
operations than other quarters of the year. Expenditures for property, plant and
equipment for first quarter 2004 were $49 compared to $43 for first quarter
2003.
15
Total debt of $1,962 at March 31, 2004 increased slightly from $1,953 at the end
of 2003. The net-debt-to-capital ratio increased to 31.2% at March 31 from 25.9%
at year-end 2003, primarily due to the $290 reduction of short-term investments,
which reflected the $75 contribution to the pension plans and the repurchase of
4.2 million Common Shares at a total cost of $250. In March 2004, Eaton entered
into a new $50 revolving credit facility which will expire in May 2008. Eaton
has long-term credit facilities of $700, of which $400 expire in April 2005 and
the remaining $300 in May 2008.
As discussed above in the notes to the condensed consolidated financial
statements, on April 27, 2004, Eaton announced that it signed an agreement with
Invensys plc to purchase its power systems business, Powerware Corporation, for
$560 in cash. The Company expects to finance this acquisition principally with
cash on hand at closing, supplemented as needed with short-term debt.
Forward-Looking Statements
- --------------------------
This Form 10-Q contains forward-looking statements concerning the second quarter
2004 and full year 2004 net income per share and Eaton's worldwide markets.
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, energy and other
production costs, or unexpected costs that cannot be recouped in product
pricing; the introduction of competing technologies; unexpected technical or
marketing difficulties; unexpected claims, charges, litigation or dispute
resolutions; acquisitions and divestitures; new laws and governmental
regulations; interest rate changes; stock market fluctuations; and unanticipated
deterioration of economic and financial conditions in the United States and
around the world. Eaton does not assume any obligation to update these
forward-looking statements.
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 Eaton's 2003
Annual Report on Form 10-K. There have been no material changes in reported
market risk since the inclusion of this discussion in the Company's 2003 Annual
Report on Form 10-K referenced above.
Item 4. Controls and Procedures
- -------------------------------
Pursuant to SEC Rule 13a-15, an evaluation was performed, under the supervision
and with the participation of Eaton's management, including Alexander M. Cutler
- - Chairman and Chief Executive Officer and Richard H. Fearon - Executive Vice
President - Chief Financial and Planning Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures. Based
on that evaluation, Eaton's management concluded that the Company's disclosure
controls and procedures were effective as of March 31, 2004.
Disclosure controls and procedures are designed to ensure that information
required to be disclosed in Company reports filed or submitted under the
Securities Exchange Act of 1934 (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
16
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.
PART II - OTHER INFORMATION
---------------------------
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
- -----------------------------------------------------------------------------
Total Maximum
number number (or
of shares approximate
purchased dollar value)
Total Average as part of of shares
number price publicly that may yet
of shares paid announced be purchased
Month purchased per share plans under the plans
- ----- --------- --------- ---------- ---------------
January 2004 685,200 $59.35 685,200
February 2004 2,296,100 58.80 2,296,100
March 2004 1,267,700 58.26 1,267,700
--------- ------ --------- -------------
4,249,000 $58.73 4,249,000 $417 million*
========= ====== ========= =============
On January 21, 2004, Eaton announced a plan to repurchase 4.2 million Common
Shares to offset the shares issued during 2003 from the exercise of stock
options. During first quarter 2004, Eaton completed the plan by repurchasing
4,249,000 shares at an average price of $58.73 per share, for a total cost
of $250.
*The remainder of the Company's share repurchase authorizations, which were
originally granted by the Company's Board of Directors in 2000, is $417 million.
However, it does not intend to use that authority other than, from time to time
and depending on circumstances, to help offset dilution resulting from shares
issued as a result of stock options exercised over the course of 2004.
Item 4. Submission of Matters to a Vote of Security Holders
- -----------------------------------------------------------
At Eaton's Annual Meeting of Shareholders on April 28, 2004, the shareholders
re-elected three directors (Michael J. Critelli, Ernie Green and Kiran M.
Patel), approved the 2004 Stock Plan and ratified the appointment of the
accounting firm of Ernst & Young LLP as the Company's independent auditors for
2004. Results of voting in connection with each issue were as follows:
Voting on Directors For Withheld Total
- ------------------- --- -------- -----
Michael J. Critelli 136,811,217 6,533,876 143,345,093
Ernie Green 136,810,943 6,534,150 143,345,093
Kiran M. Patel 141,666,108 1,678,985 143,345,093
17
2004 Stock Plan
- ---------------
For 95,982,013
Against 30,279,724
Abstain 1,798,426
No vote 15,284,930
-----------
Total 143,345,093
===========
Ratification of Ernst & Young LLP as Independent Auditors
- ---------------------------------------------------------
For 139,960,514
Against 2,482,145
Abstain 902,434
-----------
Total 143,345,093
===========
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) Exhibits - See Exhibit Index attached.
(b) Reports on Form 8-K.
1. On January 21, 2004, Eaton filed a Current Report on Form 8-K regarding the
fourth quarter 2003 earnings release.
2. On April 5, 2004, Eaton filed a Current Report on Form 8-K regarding 1) an
amendment to the Company's Definitive Proxy Statement dated March 19, 2004
in regard to compensation paid to an executive officer and 2) summarized
information concerning stock options outstanding and exercisable at March 1,
2004.
3. On April 14, 2004, Eaton filed a Current Report on Form 8-K regarding the
first quarter 2004 earnings release.
18
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: May 7, 2004 /s/ Richard H. Fearon
-----------------------------------
Richard H. Fearon
Executive Vice President -
Chief Financial and Planning
Officer
19
Eaton Corporation
Quarterly Report on Form 10-Q
First Quarter 2004
Exhibit Index
Exhibit
- -------
4 Instruments defining rights of security holders, including indentures
(Pursuant to Regulation to S-K Item 601(b)(4), Eaton 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 - Each of the following is either a management
contract or a compensatory plan or arrangement:
(a) Plan for the Deferred Payment of Directors' Fees (originally adopted
in 1985 and amended effective as of September 24, 1996, January 28,
1998, January 23, 2002 and February 24, 2004)
(b) Plan for Deferred Payment of Directors' Fees (originally adopted in
1980 and amended and restated in 1989, 1996 and 2002)
(c) 1996 Non-Employee Director Fee Deferral Plan
12 Ratio of Earnings to Fixed Charges
31.1 Certification of Form 10-Q (Pursuant to the Sarbanes-Oxley Act of
2002, Section 302)
31.2 Certification of Form 10-Q (Pursuant to the Sarbanes-Oxley Act of
2002, Section 302)
32.1 Certification of Form 10-Q (Pursuant to the Sarbanes-Oxley Act of
2002, Section 906)
32.2 Certification of Form 10-Q (Pursuant to the Sarbanes-Oxley Act of
2002, Section 906)
20