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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 June 30, 2004
--------------
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
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X
---
There were 151.5 million Common Shares outstanding as of June 30, 2004.
PART I - FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
- -----------------------------
Eaton Corporation
Statements of Consolidated Income
Three months ended Six months ended
June 30 June 30
------------------ ----------------
(Millions except for per share data) 2004 2003 2004 2003
---- ---- ---- ----
Net sales $2,403 $2,027 $4,641 $3,952
Cost of products sold 1,726 1,498 3,347 2,913
Selling & administrative expense 389 339 750 668
Research & development expense 64 56 124 111
Interest expense-net 19 24 38 48
Other (income) expense-net 2 (12) 6 (9)
------ ------ ------ ------
Income before income taxes 203 122 376 221
Income taxes 42 29 81 56
------ ------ ------ ------
Net income $ 161 $ 93 $ 295 $ 165
====== ====== ====== ======
Net income per Common Share
assuming dilution $ 1.03 $ 0.64 $ 1.88 $ 1.14
Average number of Common Shares
outstanding assuming dilution 156.2 147.0 156.8 145.8
Net income per Common Share basic $ 1.06 $ 0.64 $ 1.93 $ 1.15
Average number of Common Shares
outstanding basic 152.1 145.0 152.7 143.8
Cash dividends paid per Common Share $ 0.27 $ 0.22 $ 0.54 $ 0.44
See accompanying notes.
2
Eaton Corporation
Condensed Consolidated Balance Sheets
June 30, Dec. 31,
(Millions) 2004 2003
---- ----
ASSETS
Current assets
- --------------
Cash $ 86 $ 61
Short-term investments 203 804
Accounts receivable 1,579 1,190
Inventories 877 721
Deferred income taxes & other current assets 328 317
------ ------
3,073 3,093
Property, plant & equipment-net 2,059 2,076
Goodwill 2,461 2,095
Other intangible assets 574 541
Deferred income taxes & other assets 388 418
------ ------
$8,555 $8,223
====== ======
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities
- -------------------
Short-term debt & current portion of long-term debt $ 293 $ 302
Accounts payable 821 526
Accrued compensation 225 204
Accrued income & other taxes 268 298
Other current liabilities 849 796
------ ------
2,456 2,126
Long-term debt 1,614 1,651
Postretirement benefits other than pensions 626 636
Pensions & other liabilities 675 693
Shareholders' equity 3,184 3,117
------ ------
$8,555 $8,223
====== ======
See accompanying notes.
3
Eaton Corporation
Condensed Statements of Consolidated Cash Flows
Six months ended
June 30
----------------
(Millions) 2004 2003
---- ----
Net cash provided by operating activities
- -----------------------------------------
Net income $ 295 $ 165
Adjustments to reconcile to net cash provided
by operating activities
Depreciation & amortization 198 201
Changes in operating assets & liabilities,
excluding acquisitions & sales of businesses (146) (170)
Contribution to U.S. qualified pension plans (75) -
Other-net 85 59
----- -----
357 255
----- -----
Net cash used in investing activities
- -------------------------------------
Expenditures for property, plant & equipment (130) (110)
Acquisitions of businesses, less cash acquired (550) (226)
Net decrease in short-term investments 603 16
Other-net 7 (13)
----- -----
(70) (333)
----- -----
Net cash (used in) provided by financing activities
- ---------------------------------------------------
Payments of borrowings with original maturities of
more than three months (7) (141)
Borrowings with original maturities of less
than three months-net (7) (34)
Cash dividends paid (82) (62)
Proceeds from exercise of employee stock options 84 31
Purchase of Common Shares (250) -
Sale of Common Shares - 296
----- -----
(262) 90
----- -----
Total increase in cash 25 12
Cash at beginning of period 61 75
----- -----
Cash at end of period $ 86 $ 87
===== =====
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.
Acquisition of Business
- -----------------------
On June 9, 2004, Eaton acquired Powerware Corporation, the power systems
business of Invensys plc, for $560 of cash. 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 revenues of $775 for the
year ended March 31, 2004 and $388 for the six-month period ended June 30, 2004.
Powerware has operations in the United States, Canada, Europe, South America 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.
Eaton's operating results for 2004 include Powerware from the date of
acquisition. This business is included in the Electrical segment. The assets
acquired and liabilities assumed were recorded at estimated fair values as
determined by Eaton's management based on information currently available and on
current assumptions as to future operations. The allocation of the purchase
price for this acquisition is preliminary and will be finalized by the end of
second quarter 2005. Pro forma results of operations reflecting Eaton's
acquisition of Powerware have not been included in this Form 10-Q. Powerware was
previously owned by a United Kingdom-based company and did not prepare interim
financial statements in accordance with accounting principles generally accepted
in the United States. Eaton plans to include appropriate pro forma financial
information in future filings.
Restructuring Charges
- ---------------------
In 2004 and 2003, Eaton incurred restructuring charges related primarily to the
integration of the electrical division of Delta plc acquired in January 2003 and
the Boston Weatherhead fluid power business acquired in November 2002. A summary
of these charges follows:
Three months ended Six months ended
June 30 June 30
------------------ ----------------
2004 2003 2004 2003
---- ---- ---- ----
Fluid Power $ 1 $ 4 $ 2 $ 9
Electrical 7 6 12 7
----- ----- ----- -----
8 10 14 16
Corporate - - - 1
----- ----- ----- -----
Total pretax charges $ 8 $ 10 $ 14 $ 17
===== ===== ===== =====
After-tax charges $ 5 $ 6 $ 9 $ 11
Per Common Share $0.03 $0.04 $0.06 $0.07
5
The restructuring charges were included in the Statements of Consolidated
Income in Cost of products sold or Selling & administrative expense, as
appropriate. In Business Segment Information, the charges reduced Operating
profit of the related business segment or were included in Other corporate
expense-net, as appropriate.
Utilization of restructuring liabilities follows:
Plant
consolidation
& other
-------------
Balance remaining at December 31, 2003 $ 10
2004 charges 14
Utilized in 2004 (19)
----
Balance remaining at June 30, 2004 $ 5
====
Retirement Benefit Plans
- ------------------------
Pretax income for second quarter 2004 was reduced by $12 ($7 after-tax, or $0.05
per Common Share) compared to second quarter 2003 due to increased pension and
other postretirement benefit expense 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. These increased costs were partially offset by the effect of the Medicare
Prescription Drug, Improvement and Modernization Act of 2003, as discussed
below. Pretax income for first half 2004 was similarly reduced by $16 ($10
after-tax, or $0.06 per Common Share) compared to first half 2003. During
January 2004, Eaton made a voluntary contribution of $75 to its United States
qualified pension plans.
The components of benefit costs follow:
Three months ended June 30
-----------------------------------
Other
postretirement
Pension benefits benefits
---------------- --------------
2004 2003 2004 2003
---- ---- ---- ----
Service cost $ 29 $ 26 $ 4 $ 4
Interest cost 34 37 13 14
Expected return on plan assets (45) (51) - -
Other 7 3 2 2
---- ---- ---- ----
25 15 19 20
Settlement loss 11 8 - -
---- ---- ---- ----
$ 36 $ 23 $ 19 $ 20
==== ==== ==== ====
6
Six months ended June 30
----------------------------------
Other
postretirement
Pension benefits benefits
---------------- --------------
2004 2003 2004 2003
---- ---- ---- ----
Service cost $ 53 $ 50 $ 8 $ 8
Interest cost 68 71 26 28
Expected return on plan assets (90) (98) - -
Other 14 4 4 4
---- ---- ---- ----
45 27 38 40
Settlement loss 18 18 - -
---- ---- ---- ----
$ 63 $ 45 $ 38 $ 40
==== ==== ==== ====
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 Staff Positions, Eaton
elected not to defer accounting for the effect of the Act and adopted the
related accounting guidance 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 was attributable to the Federal
subsidy and an expected reduction in the number of retirees electing coverage
under the Company's other postretirement benefit plans. 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, which
is being recognized ratably during the quarterly periods in 2004. 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 equivalent" 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.
Income Taxes
- ------------
The effective income tax rates for second quarter and first half 2004 were 20.6%
and 21.5%, respectively, compared to 23.4% and 25.0% for the same periods in
2003. The lower rates in 2004 reflect many factors, including higher earnings in
international tax jurisdictions with lower income tax rates and increased use of
international tax credit carryforwards.
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.
7
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.
Net Income per Common Share
- ---------------------------
A summary of the calculation of net income per Common Share assuming dilution
and basic follows (shares in millions):
Three months ended Six months ended
June 30 June 30
------------------ ----------------
2004 2003 2004 2003
---- ---- ---- ----
Net income $ 161 $ 93 $ 295 $ 165
===== ===== ===== =====
Average number of Common Shares
outstanding assuming dilution 156.2 147.0 156.8 145.8
Less dilutive effect of stock options 4.1 2.0 4.1 2.0
----- ----- ----- -----
Average number of Common Shares
outstanding basic 152.1 145.0 152.7 143.8
===== ===== ===== =====
Net income per Common Share
assuming dilution $1.03 $0.64 $1.88 $1.14
Net income per Common Share basic 1.06 0.64 1.93 1.15
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 Six months ended
June 30 June 30
------------------ ----------------
2004 2003 2004 2003
---- ---- ---- ----
Net income
- ----------
As reported $ 161 $ 93 $ 295 $ 165
Stock-based compensation
expense, net of income taxes (4) (3) (7) (6)
------ ------ ------ ------
Assuming fair-value-method $ 157 $ 90 $ 288 $ 159
====== ====== ====== ======
8
Net income per Common Share
assuming dilution
- ---------------------------
As reported $ 1.03 $ 0.64 $ 1.88 $ 1.14
Stock-based compensation
expense, net of income taxes (0.02) (0.02) (0.04) (0.04)
------ ------ ------ ------
Assuming fair-value-method $ 1.01 $ 0.62 $ 1.84 $ 1.10
====== ====== ====== ======
Net income per Common Share basic
- ---------------------------------
As reported $ 1.06 $ 0.64 $ 1.93 $ 1.15
Stock-based compensation
expense, net of income taxes (0.02) (0.02) (0.04) (0.04)
------ ------ ------ ------
Assuming fair-value-method $ 1.04 $ 0.62 $ 1.89 $ 1.11
====== ====== ====== ======
Comprehensive Income
- --------------------
Comprehensive income is as follows:
Three months ended Six months ended
June 30 June 30
------------------ ----------------
2004 2003 2004 2003
---- ---- ---- ----
Net income $161 $ 93 $295 $165
Foreign currency translation (22) 41 (19) 51
Other 1 (1) (1) 4
---- ---- ---- ----
Comprehensive income $140 $133 $275 $220
==== ==== ==== ====
Inventories
- -----------
The components of inventories follow:
June 30, Dec. 31,
2004 2003
---- ----
Raw materials $340 $301
Work-in-process & finished goods 572 452
---- ----
Inventories at FIFO 912 753
Excess of FIFO over LIFO cost (35) (32)
---- ----
$877 $721
==== ====
9
Business Segment Information
- ----------------------------
Three months ended Six months ended
June 30 June 30
------------------ ----------------
(Millions) 2004 2003 2004 2003
---- ---- ---- ----
Net sales
- ---------
Fluid Power $ 792 $ 703 $1,560 $1,400
Electrical 697 575 1,308 1,089
Automotive 478 432 956 872
Truck 436 317 817 591
------ ------ ------ ------
$2,403 $2,027 $4,641 $3,952
====== ====== ====== ======
Operating profit
- ----------------
Fluid Power $ 91 $ 63 $ 172 $ 121
Electrical 57 33 102 65
Automotive 65 58 134 120
Truck 78 40 139 62
------ ------ ------ ------
291 194 547 368
Corporate
- ---------
Amortization of
intangible assets (5) (7) (11) (13)
Interest expense-net (19) (24) (38) (48)
Minority interest (1) (3) (4) (6)
Pension & other postretirement
benefit expense (22) (13) (40) (27)
Other corporate expense-net (41) (25) (78) (53)
------ ------ ------ ------
Income before income taxes 203 122 376 221
Income taxes 42 29 81 56
------ ------ ------ ------
Net income $ 161 $ 93 $ 295 $ 165
====== ====== ====== ======
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)
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, powertrain solutions and specialty controls for performance, fuel
economy and safety; and intelligent truck drivetrain systems for safety and fuel
economy. 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 55,000 employees at the end of second quarter 2004 and sells
products to customers in more than 100 countries.
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.
Highlights of Results for 2004
- ------------------------------
The Company's operating results for the three months and six months ended June
30, 2004 and 2003 are summarized as follows:
Three months ended June 30 Six months ended June 30
-------------------------- -------------------------
2004 2003 Increase 2004 2003 Increase
---- ---- -------- ---- ---- --------
Net sales $2,403 $2,027 19% $4,641 $3,952 17%
Net income 161 93 73% 295 165 79%
Net income per Common
Share assuming
dilution $ 1.03 $ 0.64 61% $ 1.88 $ 1.14 65%
Net sales in second quarter 2004 were an all-time quarterly record for Eaton,
having surpassed the record set in first quarter 2004. Second quarter 2004 was
also the third consecutive quarter of positive growth in end markets served by
the Company. Eaton's end markets grew 9% in second quarter 2004 and the Company
also outgrew its end markets by 5% during the quarter. Approximately 3% of the
sales growth in second quarter reflected sales from recently acquired businesses
and a new joint venture. Sales growth for first half 2004 was primarily
attributable to the same factors as second quarter 2004.
The increase in net income during second quarter and first half 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 2004. These increases in net income were partially offset by higher
basic metal prices and higher costs for pensions and other postretirement
benefits in 2004. As a result of actions taken to restructure operations and
integrate acquired businesses, Eaton incurred restructuring
11
charges of $0.03 per Common Share in second quarter 2004 and $0.04 in second
quarter 2003. For first half 2004, the Company incurred restructuring charges of
$0.06 per Common Share compared to $0.07 in first half 2003. Business segment
operating profit was $291 in second quarter 2004, or 12.1% of sales, compared to
operating profit of $194 in second quarter 2003, or 9.6% of sales. These margins
were reduced due to restructuring charges by 0.3% in second quarter 2004 and
0.5% in 2003. Business segment operating profit was $547 in first half 2004, or
11.8% of sales, compared to $368 in first half 2003, or 9.3% of sales. These
margins were reduced due to restructuring charges by 0.3% in first half 2004 and
0.4% in 2003.
During first half 2004, net cash provided by operating activities was $357
compared to $255 in first half 2003. Before a $75 voluntary contribution to the
United States qualified pension plans in first quarter 2004, the first such
contribution in over a decade, net cash provided by operating activities was
$432 in first half 2004. Management believes net cash provided by operating
activities before this pension contribution is a useful performance measure.
The net-debt-to-total-capital ratio increased to 33.7% at June 30, 2004 from
25.9% at year-end 2003, primarily due to the $601 decline in short-term
investments, which reflected the use of cash on hand to finance the acquisition
of Powerware Corporation in June 2004 for $560, the $75 contribution to the
pension plans, and the repurchase of 4.2 million Common Shares in first quarter
2004 at a total cost of $250.
On June 9, 2004, Eaton acquired Powerware Corporation, the power systems
business of Invensys plc, for $560 of cash. 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 revenues of $775 for the
year ended March 31, 2004 and $388 for the six-month period ended June 30, 2004.
Powerware has operations in the United States, Canada, Europe, South America 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.
Eaton's operating results for 2004 include Powerware from the date of
acquisition. This business is included in the Electrical segment. Pro forma
results of operations reflecting Eaton's acquisition of Powerware have not been
included in this Form 10-Q. Powerware was previously owned by a United
Kingdom-based company and did not prepare interim financial statements in
accordance with accounting principles generally accepted in the United States.
Eaton plans to include appropriate pro forma financial information in future
filings.
Based on a survey of its end markets in mid-July 2004, Eaton anticipates that
its end markets in 2004 will grow between 7 and 8% compared to the expectation
at the end of first quarter 2004 of market growth of 5 to 6%. The mobile
hydraulics and truck markets, in particular, are stronger than had been
anticipated, as are the residential electrical markets. There are still several
important end markets in which the Company has seen very little upturn, notably
nonresidential construction and the European markets, and significant growth is
not expected in these sectors until 2005. As a result of stronger expected end
markets, in mid-July Eaton increased its guidance for full-year 2004 net income
per Common Share to between $3.85 and $4.00, reflecting the continued
improvement in the Company's financial results. The Company anticipates net
income per share for third quarter 2004 to be between $1.00 and $1.10. These per
share amounts are net of restructuring charges of $0.15 for full-year 2004 and
$0.05 for third quarter 2004.
12
Results of Operations - 2004 Compared to 2003
- ---------------------------------------------
Three months ended June 30 Six months ended June 30
--------------------------- -------------------------
Net sales 2004 2003 Increase 2004 2003 Increase
- ----------- ---- ---- -------- ---- ---- --------
Fluid Power $ 792 $ 703 13% $1,560 $1,400 11%
Electrical 697 575 21% 1,308 1,089 20%
Automotive 478 432 11% 956 872 10%
Truck 436 317 38% 817 591 38%
------ ------ ------ ------
$2,403 $2,027 19% $4,641 $3,952 17%
====== ====== ====== ======
Sales for second quarter and first half 2004 were up sharply compared to similar
periods in 2003. Sales growth of 19% in second quarter 2004 consisted of 3% from
recently acquired businesses and a new joint venture, 2% from foreign exchange
rates, and 14% from organic growth. Organic growth was made up of 9% growth in
end markets and 5% growth from outgrowing end markets. Sales growth of 17% for
first half 2004 consisted of 2% from business acquisitions and a new joint
venture, 3% from foreign exchange rates, and 12% from organic growth. The
operating results of each business segment are further discussed below.
In 2004 and 2003, Eaton incurred restructuring charges related primarily to the
integration of the electrical division of Delta plc acquired in January 2003 and
the Boston Weatherhead fluid power business acquired in November 2002. A summary
of these charges follows:
Three months ended Six months ended
June 30 June 30
------------------ ----------------
2004 2003 2004 2003
---- ---- ---- ----
Fluid Power $ 1 $ 4 $ 2 $ 9
Electrical 7 6 12 7
----- ----- ----- -----
8 10 14 16
Corporate - - - 1
----- ----- ----- -----
Total pretax charges $ 8 $ 10 $ 14 $ 17
===== ===== ===== =====
After-tax charges $ 5 $ 6 $ 9 $ 11
Per Common Share $0.03 $0.04 $0.06 $0.07
Restructuring charges were included in the Statements of Consolidated Income in
Cost of products sold or Selling & administrative expense, as appropriate. In
Business Segment Information, the restructuring charges reduced Operating profit
of the related business segment or were included in Other corporate expense-net,
as appropriate.
Pretax income for second quarter 2004 was reduced by $12 ($7 after-tax, or $0.05
per Common Share) compared to second quarter 2003 due to increased pension and
other postretirement benefit expense 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. These increased costs were partially offset by the effect of the Medicare
Prescription Drug, Improvement and Modernization Act of 2003. Pretax income for
first half 2004 was similarly reduced by $16 ($10 after-tax, or $0.06 per Common
Share) compared to first half 2003.
13
The effective income tax rates for second quarter and first half 2004 were 20.6%
and 21.5%, respectively, compared to 23.4% and 25.0% for the same periods in
2003. The lower rates in 2004 reflect 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 June 30 Six months ended June 30
--------------------------- ------------------------
Fluid Power 2004 2003 Increase 2004 2003 Increase
- ----------- ---- ---- -------- ---- ---- --------
Net sales $792 $703 13% $1,560 $1,400 11%
Operating profit 91 63 44% 172 121 42%
Operating margin 11.5% 9.0% 11.0% 8.6%
Second quarter 2004 sales of Fluid Power, Eaton's largest business segment, were
an all-time record. The increase in sales of 13% compares to growth in Fluid
Power's markets of 12% over the same period in 2003, with North American fluid
power industry shipments up 21%, commercial aerospace markets up 7%, defense
aerospace markets up 11%, and European automotive production up 1%. The strong
growth in the mobile and industrial hydraulics markets in first quarter 2004
continued into second quarter 2004. The Company anticipates that the growth in
mobile and industrial hydraulics is likely to continue well into 2005. The
commercial aerospace market showed the strongest quarterly growth since 2001,
while defense aerospace posted another quarter of double-digit growth. Sales
growth for first half 2004 was primarily attributable to the same factors as
second quarter 2004.
Operating profit in second quarter 2004 was an all-time record. Increased
operating profit in second quarter and first half 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 second quarter 2004 were $1 compared to $4 in second quarter 2003,
reducing operating margins by 0.1% in 2004 and 0.6% in 2003. For first half
2004, restructuring charges were $2 compared to $9 in 2003, reducing operating
margins by 0.1% in 2004 compared to 0.6% in 2003. The restructuring charges in
2004 and 2003 related primarily to the acquisition of the Boston Weatherhead
business in late 2002.
On June 22, 2004, Eaton announced it had signed an agreement with GKN plc, a
London-based global automotive and aerospace supplier, to purchase GKN's
Walterscheid Rohrverbindungstechnik GmbH business (Walterscheid), for 40 euros
($48). Walterscheid is a German manufacturer of hydraulic tube connectors and
fittings primarily for the European market. The acquisition is expected to close
in third quarter 2004 following regulatory approval. Walterscheid had 2003 sales
of $52 and is located in Lohmar, Germany, near Cologne. Its products are used in
mobile and stationary markets such as construction, agricultural equipment and
machine tools. This acquisition expands Eaton's product range and sales channels
in Europe while also strengthening the Company's position as a systems provider.
14
Three months ended June 30 Six months ended June 30
-------------------------- ------------------------
Electrical 2004 2003 Increase 2004 2003 Increase
- ---------- ---- ---- -------- ---- ---- --------
Net sales $697 $575 21% $1,308 $1,089 20%
Operating profit 57 33 73% 102 65 57%
Operating margin 8.2% 5.7% 7.8% 6.0%
Second quarter 2004 sales of the Electrical segment were an all-time record.
Sales growth in second quarter 2004 included 11% from the 2004 acquisitions of
Powerware and Electrum Group Ltd., and the new joint venture formed with
Caterpillar in 2003. Eaton's operating results for 2004 include Powerware from
the date of acquisition. End markets for the electrical business grew about 5%
during second quarter 2004, the fastest growth since first quarter 2000. Eaton
expects steady end market growth over the balance of the year, with more
significant growth likely in 2005. Sales growth for first half 2004 included 9%
from the acquisitions of Powerware, Electrum, and the electrical division of
Delta plc acquired in January 2003, and the joint venture formed with
Caterpillar.
Increased operating profit in second quarter and first half 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 2004. Restructuring charges
recorded in second quarter 2004 were $7 compared to $6 in second quarter 2003,
reducing operating margins by 1.0% in both second quarter 2004 and 2003. For
first half 2004, restructuring charges were $12 compared to $7 in 2003, reducing
operating margins by 0.9% in 2004 compared to 0.6% in 2003. The restructuring
charges in 2004 and 2003 related primarily to the acquisition of the electrical
division of Delta plc acquired in January 2003.
During second quarter 2004, the Electrical business was awarded a contract from
the U.S. Postal Service to test and maintain electrical switchgear, which is
anticipated to generate between $12 and $15 of revenue annually over the next
four years, and a contract worth $10 to supply distribution and control
equipment for a new power plant being constructed by Hitachi.
On March 17, 2004, Eaton acquired 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 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 June 30 Six months ended June 30
-------------------------- ------------------------
Automotive 2004 2003 Increase 2004 2003 Increase
- ---------- ---- ---- -------- ---- ---- --------
Net sales $478 $432 11% $956 $872 10%
Operating profit 65 58 12% 134 120 12%
Operating margin 13.6% 13.4% 14.0% 13.8%
The Automotive segment posted strong revenue growth in second quarter 2004
despite flat markets. Automotive production in NAFTA in second quarter 2004 was
flat and in Europe was up 1% compared to second quarter 2003. Eaton expects that
the NAFTA and European markets will be flat to slightly down over the remainder
of the year. Sales growth for first half 2004 was primarily attributable to the
same factors as second quarter 2004.
Increased operating profit in second quarter and first half 2004 was primarily
the result of increased sales in 2004. Second quarter 2004 operating margin was
15
lower than the 14.4% in first quarter 2004, primarily due to higher metals
prices.
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 June 30 Six months ended June 30
-------------------------- ------------------------
Truck 2004 2003 Increase 2004 2003 Increase
- ----- ---- ---- -------- ---- ---- --------
Net sales $436 $317 38% $817 $591 38%
Operating profit 78 40 95% 139 62 124%
Operating margin 17.9% 12.6% 17.0% 10.5%
The Truck segment posted sales in second quarter 2004 that were up sharply
compared to second quarter 2003. In second quarter 2004, NAFTA heavy-duty truck
production of 63,000 units was up 41% and NAFTA medium-duty truck production was
up 15% compared to second quarter 2003. European truck production was up 9% and
Brazilian vehicle production was up 17% in second quarter 2004 over 2003.
Monthly orders for new NAFTA heavy-duty trucks during second quarter 2004
averaged 33,000 units. As a result, Eaton estimates that the NAFTA heavy-duty
market in 2004 is likely to total at least 255,000 units. Sales growth for first
half 2004 was primarily attributable to the same factors as second quarter 2004.
Operating profit in second quarter 2004 was nearly twice the profit earned in
second quarter 2003. Increased operating profit in second quarter and first half
2004 was primarily due to increased sales in 2004 and the benefits of the new
operating model implemented by Truck in recent years.
Eaton made progress during second quarter 2004 on both of its recently announced
new truck joint ventures in China. The Company expects the medium-duty joint
venture with FAW Jiefang Automotive Co., Ltd. to formally start late in the
third quarter. This 50%-owned joint venture was formed in March 2004 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.
In addition, the Company is still on target to start production in the Eaton
Fast Gear (EFG) heavy-duty joint venture in fourth quarter 2004. The formation
of EFG was announced in third quarter 2003. Eaton's partners in EFG are Shaanxi
Fast Gear Co., Ltd. and Xiang Torch Investment Co., Ltd. This venture will
produce heavy-duty truck transmissions for the growing Chinese market. Eaton has
55% ownership of the venture.
Changes in Financial Condition During 2004
- ------------------------------------------
Net working capital of $617 at June 30, 2004 decreased from $967 at year-end
2003. The current ratio was 1.2 at June 30, 2004 and 1.4 at December 31, 2003.
The decrease in net working capital was primarily due to the $601 reduction in
short-term investments reflecting the use of cash on hand to finance the
acquisition of Powerware in June 2004 for $560, and 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 in first quarter 2004. These uses of working
capital were offset by higher accounts receivable resulting from increased sales
in 2004 and strong cash flow from operating activities in first half 2004.
16
During first half 2004, net cash provided by operating activities was $357
compared to $255 in first half 2003. Before a $75 voluntary contribution to the
United States qualified pension plans in first quarter 2004, the first such
contribution in over a decade, net cash provided by operating activities was
$432 in first half 2004. Management believes net cash provided by operating
activities before this pension contribution is a useful performance measure.
Capital expenditures for first half 2004 were $130 compared to $110 in first
half 2003.
Total debt of $1,907 at June 30, 2004 decreased from $1,953 at the end of 2003.
The net-debt-to-capital ratio increased to 33.7% at June 30 from 25.9% at
year-end 2003, primarily due to the $601 reduction of short-term investments, as
described above. In March 2004, Eaton entered into a new $50 long-term revolving
credit facility which will expire in May 2008. Eaton has long-term revolving
credit facilities of $700, of which $400 expire in April 2005 and the remaining
$300 in May 2008.
Forward-Looking Statements
- --------------------------
This Form 10-Q contains forward-looking statements concerning third quarter 2004
and full year 2004 net income per share, revenue expected from contracts to be
performed, and the performance of 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; the impact of
acquisitions, divestitures, and joint ventures; 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 June 30, 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
include, without limitation, controls and procedures designed to ensure that
17
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.
During second quarter 2004, there was no change in Eaton's internal control over
financial reporting that materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
PART II - OTHER INFORMATION
---------------------------
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) Exhibits - See Exhibit Index attached.
(b) Reports on Form 8-K.
1. 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.
2. On April 14, 2004, Eaton filed a Current Report on Form 8-K regarding the
first quarter 2004 earnings release.
3. On July 15, 2004, Eaton filed a Current Report on Form 8-K regarding the
second 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: August 6, 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
Second 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)
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