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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 September 30, 2004
------------------
Commission file number 1-1396
------
Eaton Corporation
-------------------------------------------------------------
(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 151.9 million Common Shares outstanding as of September 30, 2004.
PART I - FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
- -----------------------------
Eaton Corporation
Statements of Consolidated Income
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
2004 2003 2004 2003
(Millions except for per share data) ---- ---- ---- ----
Net sales $2,543 $2,026 $7,184 $5,978
Cost of products sold 1,836 1,479 5,183 4,392
Selling & administrative expense 406 327 1,156 995
Research & development expense 72 57 196 168
Interest expense-net 20 20 58 68
Other (income) expense-net (2) 1 4 (8)
------ ------ ------ ------
Income before income taxes 211 142 587 363
Income taxes 41 35 122 91
------ ------ ------ ------
Net income $ 170 $ 107 $ 465 $ 272
====== ====== ====== ======
Net income per Common Share
assuming dilution $ 1.09 $ 0.69 $ 2.97 $ 1.83
Average number of Common Shares
outstanding assuming dilution 156.9 154.5 156.8 148.5
Net income per Common Share basic $ 1.12 $ 0.70 $ 3.05 $ 1.86
Average number of Common Shares
outstanding basic 152.8 151.8 152.8 146.3
Cash dividends paid per Common Share $ 0.27 $ 0.24 $ 0.81 $ 0.68
See accompanying notes.
2
Eaton Corporation
Condensed Consolidated Balance Sheets
Sept. 30, Dec. 31,
2004 2003
(Millions) ---- ----
ASSETS
Current assets
- --------------
Cash $ 83 $ 61
Short-term investments 267 804
Accounts receivable 1,649 1,190
Inventories 930 721
Deferred income taxes & other current assets 296 317
------ ------
3,225 3,093
Property, plant & equipment-net 2,057 2,076
Goodwill 2,496 2,095
Other intangible assets 568 541
Deferred income taxes & other assets 537 418
------ ------
$8,883 $8,223
====== ======
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities
- -------------------
Short-term debt & current portion of long-term debt $ 294 $ 302
Accounts payable 761 526
Accrued compensation 257 204
Accrued income & other taxes 295 298
Other current liabilities 917 796
------ ------
2,524 2,126
Long-term debt 1,647 1,651
Postretirement benefits other than pensions 623 636
Pensions & other liabilities 719 693
Shareholders' equity 3,370 3,117
------ ------
$8,883 $8,223
====== ======
See accompanying notes.
3
Eaton Corporation
Condensed Statements of Consolidated Cash Flows
Nine months ended
September 30
-----------------
2004 2003
(Millions) ---- ----
Net cash provided by operating activities
- -----------------------------------------
Net income $ 465 $ 272
Adjustments to reconcile to net cash provided
by operating activities
Depreciation & amortization 298 298
Changes in operating assets & liabilities,
excluding acquisitions & sales of businesses (162) (90)
Contribution to U.S. qualified pension plans (75) -
Other-net 51 37
----- -----
577 517
----- -----
Net cash used in investing activities
- -------------------------------------
Expenditures for property, plant & equipment (199) (177)
Acquisitions of businesses, less cash acquired (627) (256)
Decrease (increase) in short-term investments-net 542 (162)
Other-net 13 (7)
----- -----
(271) (602)
----- -----
Net cash (used in) provided by financing activities
- ---------------------------------------------------
Payments of borrowings with original maturities of
more than three months - (153)
Borrowings with original maturities of less
than three months-net (9) (47)
Cash dividends paid (122) (98)
Proceeds from exercise of employee stock options 97 84
Purchase of Common Shares (250) -
Sale of Common Shares - 296
----- -----
(284) 82
----- -----
Total increase (decrease) in cash 22 (3)
Cash at beginning of period 61 75
----- -----
Cash at end of period $ 83 $ 72
===== =====
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.
Acquisitions of Businesses
- --------------------------
On September 1, 2004, Eaton acquired the Walterscheid Rohrverbindungstechnik
GmbH business (Walterscheid) from GKN plc for $48 of cash. Walterscheid, a
German manufacturer of hydraulic tube connectors and fittings primarily for the
European market, had 2003 sales of $52 and is located in Lohmar, Germany. Its
products are used in mobile and stationary markets such as construction and
agricultural equipment and machine tools. Walterscheid's metric tube connectors
and fittings expand Eaton's European product range and sales channels while also
strengthening the Company's position as a systems provider. Eaton's operating
results for 2004 include Walterscheid from the date of acquisition. The
allocation of the purchase price for this acquisition is preliminary and will be
finalized by the end of third quarter 2005. This business is included in the
Fluid Power segment.
Also in September 2004, Eaton contributed $28 of cash for its 50% interest in a
new medium-duty truck transmission joint venture located in Changchun, China.
The partner in this venture is FAW Jiefang Automotive Co., Ltd., which is the
commercial vehicle subsidiary of China First Auto Works Group Company (FAW), the
largest manufacturer of commercial vehicles in China. Eaton's operating results
include this joint venture beginning in September 2004. This business is
included in the Truck segment.
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. Powerware has operations in the United States, Canada,
Europe, South America and in the Asia/Pacific area that provide products and
services utilized by computer manufacturers, industrial companies, governments,
telecommunications firms, medical institutions, data centers and other
businesses. The acquisition of Powerware will provide new products and
solutions, along with strong brand recognition and expanded channels, for
Eaton's global electrical business. Eaton's operating results for 2004 include
Powerware from the date of acquisition. The assets acquired and liabilities
assumed were recorded at estimated fair values as determined by management based
on information currently available and on current tentative 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. This
business is included in the Electrical segment.
5
Unaudited pro forma results of operations for the three-month and nine-month
periods ended September 30, 2004 and 2003, as if Eaton and Powerware had been
combined as of the beginning of those periods, follow. The pro forma results
include preliminary estimates and assumptions, which Eaton's management believes
are reasonable. However, the pro forma results do not include any cost savings
or other effects of the planned integration of Powerware, and, accordingly, are
not necessarily indicative of the results which would have occurred if the
business combination had been in effect on the dates indicated.
Pro Forma Results of Operations
----------------------------------------
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Net sales $2,543 $2,222 $7,520 $6,547
Net income 170 113 453 279
Net income per Common Share
Assuming dilution $ 1.09 $ 0.73 $ 2.89 $ 1.88
Basic 1.12 0.74 2.97 1.91
Restructuring Charges
- ---------------------
In 2004, Eaton incurred restructuring charges related primarily to the
integration of: Powerware, acquired in June 2004; the electrical division of
Delta plc, acquired in January 2003; and the Boston Weatherhead fluid power
business, acquired in November 2002. In 2003, restructuring charges related
primarily to the integration of the electrical division of Delta plc and the
Boston Weatherhead fluid power business. A summary of these charges follows:
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Fluid Power $ 3 $ 2 $ 5 $ 11
Electrical 8 5 20 12
----- ----- ----- -----
11 7 25 23
Corporate - - - 1
----- ----- ----- -----
Total pretax charges $ 11 $ 7 $ 25 $ 24
===== ===== ===== =====
After-tax charges $ 7 $ 5 $ 16 $ 16
Per Common Share $0.04 $0.03 $0.10 $0.11
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.
6
Utilization of restructuring liabilities follows:
Plant
consolidation
& other
-------------
Balance remaining at December 31, 2003 $ 10
2004 charges 25
Utilized in 2004 (32)
----
Balance remaining at September 30, 2004 $ 3
====
Retirement Benefit Plans
- ------------------------
Pretax income for third quarter 2004 was reduced by $6 ($4 after-tax, or $0.03
per Common Share) compared to third quarter 2003 due to increased pension and
other postretirement benefit expense in 2004. This resulted 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 the first nine months of 2004 was similarly reduced by
$22 ($14 after-tax, or $0.09 per Common Share) compared to the same period in
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 September 30
----------------------------------
Other
postretirement
Pension benefits benefits
---------------- --------------
2004 2003 2004 2003
---- ---- ---- ----
Service cost $ 22 $ 21 $ 5 $ 4
Interest cost 34 30 13 14
Expected return on plan assets (45) (42) - -
Other 8 2 3 2
----- ----- ----- -----
19 11 21 20
Settlement loss 8 11 - -
----- ----- ----- -----
$ 27 $ 22 $ 21 $ 20
===== ===== ===== =====
7
Nine months ended September 30
----------------------------------
Other
postretirement
Pension benefits benefits
---------------- --------------
2004 2003 2004 2003
---- ---- ---- ----
Service cost $ 75 $ 71 $ 13 $ 12
Interest cost 102 101 39 42
Expected return on plan assets (135) (140) - -
Other 22 6 7 6
----- ----- ----- -----
64 38 59 60
Settlement loss 26 29 - -
----- ----- ----- -----
$ 90 $ 67 $ 59 $ 60
===== ===== ===== =====
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 the third quarter and the first nine months
of 2004 were 19.6% and 20.8%, respectively, compared to 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
8
options. During first quarter 2004, the shares were repurchased at a total cost
of $250.
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 Nine months ended
September 30 September 30
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Net income $ 170 $ 107 $ 465 $ 272
====== ====== ====== ======
Average number of Common Shares
outstanding assuming dilution 156.9 154.5 156.8 148.5
Less dilutive effect of stock options 4.1 2.7 4.0 2.2
------ ------ ------ ------
Average number of Common Shares
outstanding basic 152.8 151.8 152.8 146.3
====== ====== ====== ======
Net income per Common Share
assuming dilution $ 1.09 $ 0.69 $ 2.97 $ 1.83
Net income per Common Share basic 1.12 0.70 3.05 1.86
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 Nine months ended
September 30 September 30
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Net income
- ----------
As reported $ 170 $ 107 $ 465 $ 272
Stock-based compensation
expense, net of income taxes (3) (3) (10) (9)
------ ------ ------ ------
Assuming fair-value-method $ 167 $ 104 $ 455 $ 263
====== ====== ====== ======
9
Net income per Common Share
assuming dilution
- ---------------------------
As reported $ 1.09 $ 0.69 $ 2.97 $ 1.83
Stock-based compensation
expense, net of income taxes (0.02) (0.02) (0.06) (0.06)
------ ------ ------ ------
Assuming fair-value-method $ 1.07 $ 0.67 $ 2.91 $ 1.77
====== ====== ====== ======
Net income per Common Share basic
- ---------------------------------
As reported $ 1.12 $ 0.70 $ 3.05 $ 1.86
Stock-based compensation
expense, net of income taxes (0.02) (0.02) (0.06) (0.06)
------ ------ ------ ------
Assuming fair-value-method $ 1.10 $ 0.68 $ 2.99 $ 1.80
====== ====== ====== ======
Comprehensive Income
- --------------------
Comprehensive income is as follows:
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Net income $170 $107 $465 $272
Foreign currency translation 34 5 15 56
Other 1 - - 4
---- ---- ---- ----
Comprehensive income $205 $112 $480 $332
==== ==== ==== ====
Inventories
- -----------
The components of inventories follow:
Sept. 30, Dec. 31,
2004 2003
---- ----
Raw materials $356 $301
Work-in-process & finished goods 611 452
---- ----
Inventories at FIFO 967 753
Excess of FIFO over LIFO cost (37) (32)
---- ----
$930 $721
==== ====
10
Business Segment Information
- ----------------------------
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
2004 2003 2004 2003
(Millions) ---- ---- ---- ----
Net sales
- ---------
Fluid Power $ 759 $ 683 $2,319 $2,083
Electrical 869 612 2,177 1,701
Automotive 430 395 1,386 1,267
Truck 485 336 1,302 927
------ ------ ------ ------
$2,543 $2,026 $7,184 $5,978
====== ====== ====== ======
Operating profit
- ----------------
Fluid Power $ 81 $ 65 $ 253 $ 186
Electrical 70 49 172 114
Automotive 50 44 184 164
Truck 93 52 232 114
------ ------ ------ ------
294 210 841 578
Corporate
- ---------
Amortization of intangible assets (7) (5) (18) (18)
Interest expense-net (20) (20) (58) (68)
Minority interest (2) (3) (6) (9)
Pension & other postretirement
benefit expense (19) (15) (59) (42)
Other corporate expense-net (35) (25) (113) (78)
------ ------ ------ ------
Income before income taxes 211 142 587 363
Income taxes 41 35 122 91
------ ------ ------ ------
Net income $ 170 $ 107 $ 465 $ 272
====== ====== ====== ======
Identifiable assets of the Electrical segment increased by approximately $350 as
a result of the acquisition of Powerware in June 2004.
11
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 third 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 nine months ended
September 30, 2004 and 2003 are summarized as follows:
Three months ended Nine months ended
September 30 September 30
------------------------- -------------------------
2004 2003 Increase 2004 2003 Increase
---- ---- -------- ---- ---- --------
Net sales $2,543 $2,026 26% $7,184 $5,978 20%
Net income 170 107 59% 465 272 71%
Net income per Common
Share assuming
dilution $ 1.09 $ 0.69 58% $ 2.97 $ 1.83 62%
Net sales in third quarter 2004 were an all-time quarterly record for Eaton,
having surpassed the record set in second quarter 2004. Third quarter 2004 was
also the fourth consecutive quarter of positive growth in end markets served by
the Company. Sales rose 26% in third quarter 2004 compared to the same quarter
in 2003. The increase was the result of end market growth of 9% in third quarter
2004, and above market growth of 4% during the quarter. An additional 11% of the
sales growth in third quarter reflected sales from recently acquired businesses
and the joint venture with Caterpillar formed in August 2003, and 2% was from
foreign exchange rates. Sales growth for the first nine months of 2004 was
primarily attributable to the same factors as third quarter 2004.
The increases in net income during the third quarter and the first nine months
of 2004 were 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
12
significantly higher net income in 2004. These increases in net income in 2004
were partially offset by higher basic metal prices, higher costs for pensions
and other postretirement benefits, and increased restructuring charges in 2004.
During the first nine months of 2004, net cash provided by operating activities
was $577 compared to $517 in the first nine months of 2003. Before a $75
voluntary contribution to the United States qualified pension plans in first
quarter 2004, net cash provided by operating activities was $652 in the first
nine months of 2004. Management believes net cash provided by operating
activities before this pension contribution is a useful performance measure,
since this was the first such contribution in over a decade. Any future pension
contributions are uncertain in terms of both timing and amount.
The net-debt-to-total-capital ratio increased to 32.1% at September 30, 2004
from 25.9% at year-end 2003. This increase was primarily due to the $537 decline
in short-term investments, which primarily resulted from the use in 2004 of cash
on hand to finance the recent business acquisitions and new joint venture
investment discussed below, the $75 contribution to the pension plans, and the
repurchase of 4.2 million Common Shares at a total cost of $250.
On September 1, 2004, Eaton acquired the Walterscheid Rohrverbindungstechnik
GmbH business (Walterscheid) from GKN plc for $48 of cash. Walterscheid, a
German manufacturer of hydraulic tube connectors and fittings primarily for the
European market, had 2003 sales of $52 and is located in Lohmar, Germany. Its
products are used in mobile and stationary markets such as construction and
agricultural equipment and machine tools. Eaton's operating results for 2004
include Walterscheid from the date of acquisition. This business is included in
the Fluid Power segment.
Also in September 2004, Eaton contributed $28 of cash for its 50% interest in a
new medium-duty truck transmission joint venture located in Changchun, China.
The partner in this venture is FAW Jiefang Automotive Co., Ltd., which is the
commercial vehicle subsidiary of China First Auto Works Group Company (FAW), the
largest manufacturer of commercial vehicles in China. Eaton's operating results
include this joint venture beginning in September 2004. This business is
included in the Truck segment.
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. Powerware has operations in the United States,
Canada, Europe, South America and in the Asia/Pacific area that provide products
and services 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.
Eaton continues to expect its end markets to grow between 7 and 8% for full year
2004. Mobile hydraulics and truck markets have continued their strong
performance, while electrical markets have posted modest growth and automotive
markets are likely to post a small decline for the year. As a result of stronger
than expected end markets, in mid-October Eaton increased its guidance for full
year 2004 net income per Common Share to between $3.95 and $4.05, reflecting the
continued improvement in the Company's financial results. The Company
anticipates net income per share for fourth quarter 2004 to be between $0.98 and
$1.08. These per share amounts are net of restructuring charges of $0.15 for
full year 2004 and $0.05 for fourth quarter 2004.
13
Results of Operations - 2004 Compared to 2003
- ---------------------------------------------
Three months ended Nine months ended
September 30 September 30
-------------------------- --------------------------
2004 2003 Increase 2004 2003 Increase
---- ---- -------- ---- ---- --------
Net sales $2,543 $2,026 26% $7,184 $5,978 20%
Operating profit 294 210 40% 841 578 46%
Operating margin 11.6% 10.4% 11.7% 9.7%
Sales for the third quarter and the first nine months of 2004 were up sharply
compared to similar periods in 2003. Sales growth in third quarter 2004
consisted of 13% from organic growth, 11% from recently acquired businesses and
the joint venture formed with Caterpillar in August 2003, and 2% from foreign
exchange rates. Organic growth was comprised of 9% in Eaton's end markets and 4%
from outgrowing its end markets. Sales growth for the first nine months of 2004
consisted of 12% from organic growth, 5% from business acquisitions and the
joint venture with Caterpillar, and 3% from foreign exchange rates. The
operating results of each business segment are further discussed below.
Increased operating profit in the third quarter and the first nine months of
2004 was primarily due to higher sales and the benefits of restructuring actions
taken in recent years. These increases were partially offset by higher basic
metal prices in 2004 and higher restructuring charges in 2004. Operating margins
were reduced due to restructuring charges by 0.4% in third quarter 2004 and 0.3%
in third quarter 2003. For the first nine months of 2004 and 2003, operating
margins were reduced due to restructuring charges by 0.4% in both periods. Third
quarter 2004 operating margins increased compared to third quarter 2003 despite
normal seasonal weakness in the automotive business, higher basic metal costs,
increased restructuring charges, and the addition of the Powerware business,
whose margins are currently lower than the rest of the Electrical segment.
In 2004, Eaton incurred restructuring charges related primarily to the
integration of: Powerware, acquired in June 2004; the electrical division of
Delta plc, acquired in January 2003; and the Boston Weatherhead fluid power
business, acquired in November 2002. In 2003, restructuring charges related
primarily to the integration of the electrical division of Delta plc and the
Boston Weatherhead fluid power business. A summary of these charges follows:
Three months ended Nine months ended
September 30 September 30
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Fluid Power $ 3 $ 2 $ 5 $ 11
Electrical 8 5 20 12
----- ----- ----- -----
11 7 25 23
Corporate - - - 1
----- ----- ----- -----
Total pretax charges $ 11 $ 7 $ 25 $ 24
===== ===== ===== =====
After-tax charges $ 7 $ 5 $ 16 $ 16
Per Common Share $0.04 $0.03 $0.10 $0.11
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
14
business segment or were included in Other corporate expense-net, as
appropriate.
Pretax income for third quarter 2004 was reduced by $6 ($4 after-tax, or $0.03
per Common Share) compared to third quarter 2003 due to increased pension and
other postretirement benefit expense in 2004. This resulted 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
the first nine months of 2004 was similarly reduced by $22 ($14 after-tax, or
$0.09 per Common Share) compared to the same period in 2003.
The effective income tax rates for the third quarter and the first nine months
of 2004 were 19.6% and 20.8%, respectively, compared to 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 Nine months ended
September 30 September 30
------------------------ -------------------------
Fluid Power 2004 2003 Increase 2004 2003 Increase
- ----------- ---- ---- -------- ---- ---- --------
Net sales $759 $683 11% $2,319 $2,083 11%
Operating profit 81 65 25% 253 186 36%
Operating margin 10.7% 9.5% 10.9% 8.9%
Third quarter 2004 sales of the Fluid Power segment were an all-time record.
Eaton's operating results for 2004 include Walterscheid from the date of
acquisition, as discussed above. The strong growth in the mobile and industrial
hydraulics markets seen in first half 2004 continued into third quarter 2004.
The increase in sales compares to growth in Fluid Power's markets of 9% over the
same period in 2003, with global hydraulics markets up an estimated 16%,
commercial aerospace markets up 7%, defense aerospace markets up 2%, and
European automotive production up 1%. Eaton anticipates that the growth in
mobile and industrial hydraulics is likely to continue well into 2005, although
the rate of growth is likely to moderate from the levels seen in 2004. The
Company now anticipates stronger commercial aerospace growth in 2005 than had
been foreseen earlier this year. Sales growth for the first nine months of 2004
was primarily attributable to the same factors as third quarter 2004.
Operating profit in third quarter 2004 was also an all-time record. Increased
operating profit in 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. Increased operating profit in the first nine
months of 2004 was primarily due to higher sales, the benefits of restructuring
actions taken in recent years, and reduced restructuring charges in 2004.
Restructuring charges in third quarter 2004 were $3 compared to $2 in third
quarter 2003, reducing operating margins by 0.4% in 2004 and 0.3% in 2003. For
the first nine months of 2004, restructuring charges were $5 compared to $11 in
the same period in 2003, reducing operating margins by 0.2% in 2004 compared to
0.5% in 2003. The restructuring charges in 2004 and 2003 related primarily to
the acquisition of the Boston Weatherhead business in late 2002.
15
Three months ended Nine months ended
September 30 September 30
------------------------ -------------------------
Electrical 2004 2003 Increase 2004 2003 Increase
- ---------- ---- ---- -------- ---- ---- --------
Net sales $869 $612 42% $2,177 $1,701 28%
Operating profit 70 49 43% 172 114 51%
Operating margin 8.1% 8.0% 7.9% 6.7%
Third quarter 2004 sales of the Electrical segment were an all-time record.
Sales growth in third quarter 2004 included 35% from the acquisition of
Powerware in June 2004, as discussed above, and the joint venture formed with
Caterpillar in August 2003. Eaton's operating results for 2004 include Powerware
from the date of acquisition. End markets for the electrical business grew about
5% during third quarter 2004. The Company expects modest end market growth over
the balance of the year, with more significant growth likely in 2005. Orders for
Powerware in third quarter 2004 were 13% higher than third quarter 2003. Sales
growth for the first nine months of 2004 included 18% from the acquisition 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 the third quarter and the first nine months of
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.
These improvements were partially offset by increased restructuring charges in
2004. The operating margin of the Powerware business is currently lower than the
rest of the Electrical segment. Restructuring charges recorded in third quarter
2004 were $8 compared to $5 in third quarter 2003, reducing operating margins by
0.9% in 2004 and 0.8% in 2003. For the first nine months of 2004, restructuring
charges were $20 compared to $12 in 2003, reducing operating margins by 0.9% in
2004 compared to 0.7% in 2003. The restructuring charges in 2004 related
primarily to the acquisition of Powerware and the electrical division of Delta
plc acquired in January 2003. Restructuring charges in 2003 related primarily to
the acquisition of the electrical division of Delta plc.
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 Nine months ended
September 30 September 30
----------------------- -------------------------
Automotive 2004 2003 Increase 2004 2003 Increase
- ---------- ---- ---- -------- ---- ---- --------
Net sales $430 $395 9% $1,386 $1,267 9%
Operating profit 50 44 14% 184 164 12%
Operating margin 11.6% 11.1% 13.3% 12.9%
16
The Automotive segment recorded strong revenue growth in third quarter 2004
despite flat markets. Third quarter 2004 automotive production in NAFTA was
lower by 2% and in Europe was up 1% compared to third quarter 2003.
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 European automotive
industry production. Eaton expects that the NAFTA and European markets will be
slightly down over the balance of the year. Sales growth for the first nine
months of 2004 were a reflection of stronger sales in first half 2004.
Increased operating profit in the third quarter and the first nine months of
2004 was primarily the result of increased sales in 2004, partially offset by
higher prices for basic metals.
In first quarter 2004, Eaton won contracts to supply locking differentials to
Hyundai and Kia for several new vehicle programs. Revenues from these contracts
are expected to total approximately $150 over the next six years.
Three months ended Nine months ended
September 30 September 30
----------------------- -------------------------
Truck 2004 2003 Increase 2004 2003 Increase
- ----- ---- ---- -------- ---- ---- --------
Net sales $485 $336 44% $1,302 $927 40%
Operating profit 93 52 79% 232 114 104%
Operating margin 19.2% 15.5% 17.8% 12.3%
The Truck segment posted record sales in third quarter 2004, with sales that
were up sharply compared to third quarter 2003. In third quarter 2004, NAFTA
heavy-duty truck production of 69,000 units was 10% above second quarter 2004
and was up 47% compared to third quarter 2003. NAFTA medium-duty truck
production was up 9% in third quarter 2004 compared to 2003, European truck
production was up 8% and Brazilian vehicle production was up 33%. Monthly orders
for new NAFTA heavy-duty trucks during third quarter 2004 averaged 28,000 units.
While order levels would support another significant growth in production in
fourth quarter 2004, given the capacity constraints faced by other suppliers to
the truck assemblers, Eaton estimates that the NAFTA heavy-duty market in 2004
is likely to total 255,000 units. Sales growth for the first nine months of 2004
was primarily attributable to the same factors as third quarter 2004.
Third quarter 2004 operating profit and operating margin were all-time records.
Increased operating profit in the third quarter and the first nine months of
2004 was primarily due to increased sales in 2004 throughout all geographic
regions.
Eaton made significant progress during third quarter 2004 on both of its
recently announced new truck joint ventures in China. The joint venture with FAW
Jiefang Automotive Co., Ltd. formally started production in September 2004 with
Eaton contributing $28 of cash for its 50% interest in the venture. This venture
was formed in March 2004 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), the largest
manufacturer of commercial vehicles in China. Eaton and FAW Jiefang will have
equal ownership of the joint venture, which is named FAW Eaton Transmission Co.,
Ltd.
In addition, the Company is still on target to start production in the Eaton
Fast Gear (EFG) heavy-duty transmission 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
17
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 $701 at September 30, 2004 decreased from $967 at
year-end 2003. The current ratio was 1.3 at September 30 and 1.4 at the end of
2003. The decrease in net working capital was primarily due to the $537
reduction in short-term investments reflecting the use of cash on hand to
finance the acquisitions of Walterscheid in September 2004 for $48 and Powerware
in June 2004 for $560, the $28 investment made in September in the FAW Eaton
Transmission Co., Ltd. joint venture, and, in first quarter 2004, 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. 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 the first nine months of 2004.
During the first nine months of 2004, net cash provided by operating activities
was $577 compared to $517 in the first nine months of 2003. Before a $75
voluntary contribution to the United States qualified pension plans in first
quarter 2004, net cash provided by operating activities was $652 in the first
nine months of 2004. Management believes net cash provided by operating
activities before this pension contribution is a useful performance measure,
since this was the first such contribution in over a decade. Any future pension
contributions are uncertain in terms of both timing and amount. Capital
expenditures for the first nine months of 2004 were $199 compared to $177 in the
first nine months of 2003.
Total debt of $1,941 at September 30, 2004 decreased slightly from $1,953 at the
end of 2003. The net-debt-to-capital ratio increased to 32.1% at September 30
from 25.9% at year-end 2003. This increase was primarily due to the $537
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.
On October 21, 2004, Eaton issued $75 of 5.45% senior debentures, which mature
in 2034. The Company expects to use the proceeds to repay a portion of the 6.95%
notes maturing on November 15, 2004 or for general corporate purposes.
Forward-Looking Statements
- --------------------------
This Form 10-Q contains forward-looking statements concerning fourth quarter
2004 and full year 2004 net income per share, the performance of Eaton's
worldwide markets, and volumes from new business awards. 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.
18
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 September 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
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 third 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 July 15, 2004, Eaton filed a Current Report on Form 8-K regarding the
second quarter 2004 earnings release.
2. On September 13, 2004, Eaton filed a Current Report on Form 8-K regarding
the reaffirmation, without modification, of the Company's previously
released 2004 earnings guidance during Morgan Stanley's CEOs Unplugged
Industrials Conference.
3. On October 14, 2004, Eaton filed a Current Report on Form 8-K regarding
the third quarter 2004 earnings release.
19
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 5, 2004 /s/ Richard H. Fearon
----------------------------
Richard H. Fearon
Executive Vice President -
Chief Financial and Planning
Officer
20
Eaton Corporation
Quarterly Report on Form 10-Q
Third 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)
99 Global 5.45% Senior Debenture, due 2034
21