United States Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
---------
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the year ended December 31, 2002
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Commission file number 1-1396
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Eaton Corporation
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(Exact name of registrant as specified in its charter)
Ohio 34-0196300
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(State of incorporation) (I.R.S. Employer Identification No.)
Eaton Center, Cleveland, Ohio 44114-2584
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(Address of principal executive offices) (Zip code)
(216) 523-5000
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
- ------------------------------ ---------------------------
Common Shares ($.50 par value) The New York Stock Exchange
The Chicago Stock Exchange
The Pacific Stock Exchange
The London Stock Exchange
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 twelve months and (2) has been subject to such filing
requirements for the past ninety days. Yes X
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes X
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X
The aggregate market value of voting stock held by non-affiliates of the
registrant as of June 30, 2002 was $5.1 billion.
As of January 31, 2003, there were 70,779,954 Common Shares outstanding.
Documents Incorporated By Reference
Portions of the Proxy Statement for the 2003 annual shareholders' meeting
are incorporated by reference into Part III.
Part I
Item 1. Business
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Eaton Corporation (Eaton or Company) is a global diversified industrial
manufacturing company. Eaton was incorporated in Ohio in 1916, as a successor to
a New Jersey company incorporated in 1911. The Company is a leader in fluid
power systems; electrical power quality, distribution and control; automotive
engine air management and fuel economy; and intelligent drivetrain systems for
fuel economy and safety in trucks. Annual sales in 2002 were $7.2 billion.
Headquartered in Cleveland, Ohio, Eaton had 48,000 employees at year-end 2002,
which increased to 51,000 in January 2003 due to the acquisition of the
electrical business of Delta plc. Eaton sells products in more than 50
countries. More information regarding the Company is available at
http://www.eaton.com.
Eaton electronically files or furnishes reports pursuant to Section 13(a)
or 15(d) of the Securities Exchange Act of 1934 (Exchange Act) to the United
States Securities and Exchange Commission (Commission), including annual reports
on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K,
as well as any amendments to those reports. As soon as reasonably practicable,
these reports are available free of charge through the Company's Internet web
site at http://www.eaton.com. These filings are also accessible on the
Commission's Internet web site at www.sec.gov.
On January 31, 2003, Eaton acquired the electrical business of Delta plc
for approximately $215 million. This business, which will be included in the
Industrial & Commercial Controls segment, had 2001 sales of approximately $379
million (at the foreign exchange rate on the date the transaction was
completed). The Delta electrical business has 3,400 employees and is
headquartered in the United Kingdom. The business' major electrical brands
include MEM(R), Holec(TM), Bill(TM), Home Automation(TM), Elek(TM) and
Tabula(TM).
In November 2002, the Boston Weatherhead business of Dana Corporation was
purchased for $130 million. This business, which had 2001 sales of $207 million,
manufactures hose, tubing, and fluid connectors for fluid power systems
primarily for industrial distribution, mobile off-highway and heavy-duty truck
markets. In June 2002, the remaining 40% interest in Jining Eaton Hydraulics
Company, Ltd. (JEHYCO), a hydraulics systems manufacturer located in Jining,
China, was acquired. This business manufactures hydraulic pumps and motors for
mobile and industrial markets. These businesses will be included in the Fluid
Power segment.
On July 15, 2002, Eaton sold the Navy Controls business for $92 million.
This business was part of the Industrial & Commercial Controls segment.
Business Segment Information
- ----------------------------
Information regarding principal products, net sales, operating profit and
long-lived assets by business segment and geographic region is presented in
"Business Segment and Geographic Region Information" on pages F-28 through F-32
of this report. Additional information regarding Eaton's segments and business
in general is presented below.
Fluid Power
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Patents and Trademarks - Eaton owns, controls, or is licensed under many
patents related to this segment. Trademarks used in connection with the
marketing of products included in this segment are EATON, EATON (logomark),
CHAR-LYNN, Q-AMP, GEROLER, HYDRAULIC LAUNCH ASSIST, HLA, ORBIT, ORBITROL,
DUFFIELD, VICKERS, BOSTON WEATHERHEAD, EVERFLEX, HYDRO-LINE, TEDECO, STERER,
ILLUMINATER, LUBRICLONE, LEVELMASTER, EEMCO, TELLITE, AEROQUIP, "FLYING A" LOGO,
AEROQUIP EXPRESS, BENCHMARK, BRUISER, AQP, HI-PAC, STC, MATCHMATE, MATCHMATE
PLUS, MATCHMATE BLUE, MATCHMATE ICE, STARTLITE, EPSILON, ZAPPER, ZAPPER PLUS,
PROCRIMP, RYNGLOK, AIRFLEX, FAWICK, and GOLF PRIDE.
Competition - Principal methods of competition in this segment are price,
geographic coverage, service and product performance. Eaton occupies a strong
competitive position in relation to the many competitors in this segment and,
with respect to many products, is considered among the market leaders.
Significant Customers - Approximately 11% of this segment's net sales in
2002 were made to two manufacturers of vehicles in the United States and Europe.
These customers are also significant customers of the Automotive segment.
Industrial & Commercial Controls
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Patents and Trademarks - Eaton owns, controls, or is licensed under many
patents related to this segment. Some of the more significant trademarks used in
connection with the marketing of products included in this segment are EATON,
EATON (logomark), CUTLER-HAMMER, CH (EMBLEM), C-H ESS, SERIES C (& DESIGN),
DE-ION, DURANT, FACTORYMATE, PANELMATE, POW-R-WAY, POW-R-LINE, POW-R-DESIGNER,
ADVANTAGE, ADVANTAGE PLUS, ADVANTAGE (& DESIGN), ADVANCED POWER CENTER, MAGNUM,
MAGNUM DS, DS, OPTIM, TRI-PAC, IMPACC, AEGIS, AFCI, INTELLIGENT TECHNOLOGIES,
IT, and HEINEMANN. In addition, the Company has the right to use the
WESTINGHOUSE trademark in marketing certain products until 2004.
Competition - Principal methods of competition in this segment are price,
geographic coverage, service and product performance. Eaton occupies a strong
competitive position in relation to the many competitors in this segment and,
with respect to many products, is considered among the market leaders.
Significant Customers - Approximately 16% of this segment's net sales in
2002 were made to one customer located in the United States, which is not a
significant customer of any other segment.
Automotive
- ----------
Patents and Trademarks - Eaton owns, controls, or is licensed under many
patents related to this segment. While the EATON and EATON (logomark) trademarks
are emphasized in marketing many products within this segment, the Company also
markets under a number of other trademarks including EATONITE, DILL,
SUPERCHARGER (& DESIGN), Fluid Condition Monitor, FCM, BLOCKER, and GERODISC.
Seasonal Fluctuations - Sales of the Automotive segment historically have
been lower in the third quarter than in the second quarter as a result of the
normal seasonal pattern of automotive industry production.
Competition - Principal methods of competition in this segment are price,
service and product performance. Eaton occupies a strong competitive position in
relation to the many competitors in this segment and, with respect to many
products, is considered among the market leaders.
Significant Customers - Approximately 56% of this segment's net sales in
2002 were made to divisions and subsidiaries of five large original equipment
manufacturers of vehicles and one automotive component supplier. All of these
customers are concentrated in North America and Europe. Eaton has been
conducting business with each of these companies for many years. Sales to these
companies include a number of different products and different models or types
of the same product, sales of which are not dependent upon one another. With
respect to many of the products sold, various divisions and subsidiaries of each
of the companies are in the nature of separate customers, and sales to one
division or subsidiary are not dependent upon sales to other divisions or
subsidiaries. Two of these customers are also significant customers of the Truck
segment, while two others are also significant customers of the Fluid Power
Segment.
Truck
- -----
Patents and Trademarks - Eaton owns, controls, or is licensed under many
patents related to this segment. Trademarks used in connection with the
marketing of products included in this segment are EATON, EATON (logomark),
FULLER, ROADRANGER, AutoShift, VORAD, SmartCruise, EASY-PEDAL, SOLO, ANGLE
SPRING, LIGHTNING SERIES and TOP 2.
Competition - Principal methods of competition in this segment are price,
service and product performance. Eaton occupies a strong competitive position in
relation to the many competitors in this segment and, with respect to many
products, is considered among the market leaders.
Significant Customers - Approximately 74% of this segment's net sales in
2002 were made to divisions and subsidiaries of five original equipment
manufacturers of heavy-, medium-, and light-duty trucks and off-highway
vehicles, concentrated in North America, Europe and South America. Two of these
customers are also significant customers of the Automotive segment.
Information Concerning Eaton's Business in General
- --------------------------------------------------
Patents - Eaton's policy is to file applications and obtain patents for its
new products including product modifications and improvements. While U.S.
patents generally expire 20 years after the patent application filing date, new
patents are issued to Eaton on a regular basis. While in the aggregate Eaton's
patents are considered important in the operation of its businesses, the loss or
expiration of any one patent would not materially affect Eaton as a whole.
Raw Materials - Principal raw materials used are iron, steel, copper,
nickel, aluminum, brass, silver, rubber, plastic and insulating materials.
Materials are purchased in various forms, such as pig iron, metal sheets and
strips, forging billets, bar stock and plastic pellets. Raw materials, as well
as parts and other components, are purchased from many suppliers and, under
normal circumstances, the Company has no difficulty obtaining them.
Order Backlog - Since a significant portion of open orders placed with
Eaton by original equipment manufacturers of cars, trucks and off-highway
vehicles are historically subject to month-to-month releases by customers during
each model year, such orders are not considered technically firm. In measuring
backlog of orders, the Company includes only the amount of such orders released
by such customers as of the dates listed. Using this criterion, total backlog at
December 31, 2002 and 2001 was approximately $1.2 billion at each year-end.
Backlog should not be relied upon as being indicative of results of operations
for future periods.
Research and Development - Research and development expenses for new
products and improvement of existing products in 2002, 2001 and 2000 (in
millions) were $203, $228 and $269, respectively. Over the past five years, the
Company has invested approximately $1.2 billion in research and development.
Protection of the Environment - Operations of the Company involve the use
and disposal of certain substances regulated under environmental protection
laws. Eaton continues to modify certain processes on an ongoing, regular basis
in order to reduce the impact on the environment, including the reduction or
elimination of certain chemicals used in and wastes generated from operations.
Compliance with Federal, State and local provisions which have been enacted or
adopted regulating the discharge of materials into the environment, or otherwise
relating to the protection of the environment, is not expected to have a
material adverse effect upon earnings or the competitive position of the
Company. Eaton's estimated capital expenditures for environmental control
facilities are not expected to be material for 2003 and 2004. Information
regarding the Company's liabilities related to environmental matters is
presented in "Protection of the Environment" on page F-20 of this report.
Item 2. Properties
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Eaton's world headquarters is located in Cleveland, Ohio. The Company
maintains manufacturing facilities at 174 locations in 25 countries, including
28 light-manufacturing and fabrication facilities. In January 2003, the number
of facilities increased to 184 locations in 26 countries due to the acquisition
of the electrical business of Delta plc. The Company is a lessee under a number
of operating leases for certain real properties and equipment, none of which are
material to its operations. Eaton's principal research facilities are located in
Southfield, Michigan, Pittsburgh, Pennsylvania and Milwaukee, Wisconsin. In
addition, certain divisions conduct research in their own facilities. Management
believes that the manufacturing facilities are adequate for operations, and such
facilities are maintained in good condition.
Item 3. Legal Proceedings
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Information regarding the Company's legal proceedings is presented in
"Protection of the Environment" and "Contingencies" on page F-20 of this
report.
Item 4. Submission of Matters to a Vote of Security Holders
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None.
Part II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
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The Company's Common Shares are listed for trading on the New York,
Chicago, Pacific and London stock exchanges. Information regarding cash
dividends paid and the high and low market price per Common Share for each
quarter in 2002 and 2001 is presented in "Quarterly Data" on page F-49 of this
report. At December 31, 2002, there were 10,611 holders of record of the
Company's Common Shares. Additionally, approximately 27,000 current and former
employees were shareholders through participation in the Eaton Savings Plan
(ESP) and Eaton Personal Investment Plan (EPIP).
Item 6. Selected Financial Data
- --------------------------------
Information regarding selected financial data is presented in the
"Seven-Year Consolidated Financial Summary" on page F-50 of this report.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
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"Management's Discussion and Analysis of Financial Condition and Results of
Operations" is presented on pages F-33 through F-48 of this report.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
- ------------------------------------------------------------------
Information regarding market risk is presented on page F-44 of this report.
Item 8. Financial Statements and Supplementary Data
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The report of independent auditors, consolidated financial statements, and
notes to consolidated financial statements are presented on pages F-1 through
F-32 of this report.
Item 9. Change in and Disagreements with Accountants on Accounting and
Financial Disclosure
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None.
Part III
Item 10. Directors and Executive Officers of the Registrant
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Information contained in the definitive Proxy Statement to be filed on or
about March 15, 2003, with respect to directors, is incorporated by reference.
A listing of Eaton's officers, their ages, positions and offices held over
the past five years, as of January 31, 2003, follows:
Name Age Position (Date elected to position)
- ---- --- -----------------------------------
Alexander M. Cutler 51 Chairman and Chief Executive Officer; President
(August 1, 2000 - present)
President and Chief Operating Officer
(September 1, 1995 - July 31, 2000)
Director (1993 - present)
Richard H. Fearon 46 Executive Vice President - Chief Financial and
Planning Officer (April 24, 2002 - Present)
Partner, Willow Place Partners LLC (2001 - 2002)
Senior Vice President - Corporate Development,
Transamerica Corporation (1997 - 2000)
Craig Arnold 42 Senior Vice President and Group Executive - Fluid
Power (October 25, 2000 - present)
Corporate Vice President of General Electric and
President of GE Lighting Services Ltd.
(1999 - 2000)
Corporate Vice President and President of GE
Plastics, Greater China (1998 - 1999)
Corporate Vice President and President of GE
Appliances, Asia (1997 - 1998)
Stephen M. Buente 52 Senior Vice President and Group Executive -
Automotive (August 21, 2000 - present)
Operations Vice President - Automotive Controls
(1999 - 2000)
Operations Vice President - Engine Components
(1995 - 1999)
Randy W. Carson 52 Senior Vice President and Group Executive -
Cutler-Hammer (January 1, 2000 - present)
Vice President - Growth Initiatives (1999)
Senior Vice President at Rockwell Automation
(1992 - 1998)
James E. Sweetnam 50 Senior Vice President and Group Executive -
Truck (July 1, 2001 - present)
Vice President - Heavy-Duty Transmission, Clutch
and Aftermarket (2000 - 2001)
Vice President and General Manager - Heavy-Duty
Transmission Division (1997 - 1999)
Kristen M. Bihary 49 Vice President - Communications
(July 28, 1999 - present)
Vice President - External Affairs, Internal and
Marketing Communications at Shell Chemical
Company (1998 - 1999)
Vice President - Public Affairs at Varity
Corporation (1995 - 1998)
Donald H. Bullock 43 Vice President - Information Technologies
(August 1, 2000 - present)
Director of Finance Reengineering
(1998 - 2000)
Principal at CSC Index (1992 - 1998)
Susan J. Cook 55 Vice President - Human Resources
(January 16, 1995 - present)
Earl R. Franklin 59 Vice President and Secretary
(April 24, 2002 - present)
Secretary and Associate General Counsel
(September 1, 1991 - April 23, 2002)
J. Robert Horst 59 Vice President and General Counsel
(January 1, 2000 - present)
Deputy General Counsel (1998 - 1999)
Associate General Counsel (1991 - 1998)
John S. Mitchell 46 Vice President - Taxes
(November 22, 1999 - present)
Vice President - Taxes at The Limited, Inc.
(1997 - 1999)
Robert E. Parmenter 50 Vice President and Treasurer
(January 1, 1997 - present)
Billie K. Rawot 51 Vice President and Controller
(March 1, 1991 - present)
Ken D. Semelsberger 41 Vice President - Strategic Planning
(April 28, 1999 - present)
Director - Corporate Development and Planning
(1998 - 1999)
Director - Strategic Planning
(1995 - 1998)
There are no family relationships among the officers listed, and there are
no arrangements or understandings pursuant to which any of them were elected as
officers. All officers hold office for one year and until their successors are
elected and qualified, unless otherwise specified by the Board of Directors;
provided, however, that any officer is subject to removal with or without cause,
at any time, by a vote of a majority of the Board of Directors.
Item 11. Executive Compensation
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Information contained in the definitive Proxy Statement to be filed on or
about March 15, 2003, with respect to executive compensation, is incorporated by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
Information contained in the definitive Proxy Statement to be filed on or
about March 15, 2003, with respect to security ownership of certain beneficial
owners and management, is incorporated by reference.
Equity Compensation Plans
- -------------------------
The following table summarizes information, as of December 31, 2002,
relating to equity compensation plans of the Company pursuant to which grants of
options, restricted stock, deferred compensation units or other rights to
acquire Company Common Shares may be granted from time to time.
Number of
securities
remaining
(A) available
Number of for future
securities Weighted- issuance
to be average under equity
issued upon exercise compensation
exercise of price of plans
outstanding outstanding (excluding)
options, options, securities
warrants warrants reflected in
Plan category and rights and rights column(A))
- ---------------------- ----------- ----------- ------------
Equity compensation
plans approved by
security holders(1) 9,792,650 (3) $63.40 (5) 3,249,313
Equity compensation
plans not approved
by security holders(2) 765,834 (4) N/A 147,040
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Total 10,558,484 $63.40 (5) 3,396,353
========== =========
(1) The equity compensation plans of the Company that have been approved by the
Company's shareholders are the 2002 Stock Plan, 1998 Stock Plan, 1995 Stock
Plan, 1991 Stock Option Plan and Incentive Compensation Deferral Plan
(amended and restated as of October 1, 1997).
(2) The equity compensation plans of the Company that have not been submitted
to the Company's shareholders for approval are the 1996 Non-Employee
Director Fee Deferral Plan and the Deferred Incentive Compensation Plan
(amended and restated as of March 31, 2000).
Under the 1996 Non-Employee Director Fee Deferral Plan, all non-employee
directors may defer payment of their fees at a rate of return which varies,
depending on whether the director defers the fees as retirement compensation or
as short-term compensation. At least 50% of retirement compensation, or any
greater portion which the director elects, is converted to Company Common Share
units and earns Common Share price appreciation and dividend equivalents. The
balance of retirement compensation earns 10-year U.S. Treasury note returns plus
300 basis points. Short-term compensation earns 13-week U.S. Treasury bill
returns. These arrangements provide for accelerated lump sum or installment
payments upon a failure by the Company to pay or termination of service in the
context of a change in control of the Company. After retirement or other
termination of services as a director, the Governance Committee of the Board
determines whether fees deferred are to be paid in a lump sum or periodic
installments and whether the amounts converted to Common Share units are to be
paid in cash or Common Shares.
Under the Deferred Incentive Compensation Plan, participants, which include
officers and other eligible executives, may elect to defer receipt of their
incentive compensation award as either short-term deferrals (5 years) or
retirement compensation. Amounts deferred until retirement earn the greater of
Company Common Share price appreciation plus dividend equivalents or 13-week
U.S. Treasury bill returns. Short-term deferrals earn 13-week U.S. Treasury bill
returns. Amounts deferred as retirement compensation which are converted to
Company Common Share units are payable in either lump sum or periodic
installments of Common Shares. The Compensation and Organization Committee of
the Board determines the method of payment for elected officers upon retirement
or other termination. The Corporate Compensation Committee, which is comprised
of Company officers, determines the method of payment for appointed officers and
other executives who participate in the plan upon retirement or other
termination.
(3) Includes 7,334,952 time-vesting stock options, 98,780 restricted shares
and 2,196,342 of performance-based stock options. Also included are 162,576
shares underlying stock units, payable on a one-for-one basis, credited to stock
unit accounts as of December 31, 2002 under the Incentive Compensation Deferral
Plan (amended and restated as of October 1, 1997).
(4) Represents shares underlying stock units, payable on a one-for-one
basis, credited to stock unit accounts as of December 31, 2002 under the 1996
Non-Employee Director Fee Deferral Plan and the Deferred Incentive Compensation
Plan (amended and restated as of March 31, 2000).
(5) Weighted average exercise price of outstanding stock options; excludes
restricted stock and deferred compensation share units.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
None required to be reported.
Item 14. Controls and Procedures
- ---------------------------------
Within 90 days prior to filing this report, an evaluation was performed,
under the supervision and with the participation of Eaton's management,
including Alexander M. Cutler - Chairman and Chief Executive Officer; President
and Richard H. Fearon - Executive Vice President - Chief Financial and Planning
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures. Based on that evaluation, Eaton's management
concluded that the Company's disclosure controls and procedures were effective
as of December 31, 2002. Subsequent to December 31, 2002, there have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls and no significant deficiencies and
material weaknesses existed which required corrective actions.
Disclosure controls and procedures are designed to ensure that information
required to be disclosed in Company reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Securities and Exchange Commission's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed in
Company reports filed under the Exchange Act is accumulated and communicated to
management, including the Company's Chief Executive Officer and Chief Financial
Officer as appropriate, to allow timely decisions regarding required disclosure.
Part IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- --------------------------------------------------------------------------
(a) (1) The report of independent auditors, consolidated financial statements
and notes to consolidated financial statements, included in Item 8
above, are filed as a separate section of this report:
Report of Independent Auditors - Page F-1
Statements of Consolidated Income - Years ended December 31, 2002,
2001 and 2000 - Page F-2
Consolidated Balance Sheets - December 31, 2002 and 2001 - Page F-3
Statements of Consolidated Cash Flows - Years ended December 31,
2002, 2001 and 2000 - Page F-4
Statements of Consolidated Shareholders' Equity - Years ended
December 31, 2002, 2001 and 2000 - Page F-5
Notes to Consolidated Financial Statements - Pages F-6 through F-32
(2) All schedules for which provision is made in Regulation S-X of the
Securities and Exchange Commission are not required under the
related instructions or are inapplicable and, therefore, have been
omitted.
(3) Exhibits
3(a) Amended Articles of Incorporation (amended and restated as of
April 27, 1994) - Filed in conjunction with this Form 10-K
3(b) Amended Regulations (amended and restated as of April 26,
2000)- Incorporated by reference to the Form 10-Q for the six
months ended June 30, 2000
4(a) Instruments defining rights of security holders, including
indentures (Pursuant to Regulation S-K Item 601(b)(4), the
Company agrees to furnish to the Commission, upon request, a
copy of the instruments defining the rights of holders of long-
term debt)
4(b) Rights Agreement (Dated as of June 28, 1995) - Filed in
conjunction with this Form 10-K
10 Material contracts - Each of the following is either a
management contract or a compensatory plan or arrangement:
(a) Deferred Incentive Compensation Plan (amended and restated as
of March 31, 2000) - Incorporated by reference to the Form
10-K for the year ended December 31, 2000
(b) Executive Strategic Incentive Plan I (Amended and Restated as
of January 1, 2001) - Filed in conjunction with this
Form 10-K
(c) Group Replacement Insurance Plan (GRIP), effective as of
June 1, 1992 - Incorporated by reference to the Form 10-K for
the year ended December 31, 1992
(d) 1991 Stock Option Plan - Filed in conjunction with this Form
10-K
(e) 1995 Stock Plan - Filed in conjunction with this Form 10-K
(f) Incentive Compensation Deferral Plan (amended and restated as
of October 1, 1997) - Incorporated by reference to the Form
10-K for the year ended December 31, 2000
(g) Form of Change of Control Agreement entered into with
officers of Eaton Corporation - Filed in conjunction with
this Form 10-K
(h) Form of Indemnification Agreement entered into with officers
of Eaton Corporation - Filed in conjunction with this Form
10-K
(i) Limited Eaton Service Supplemental Retirement Income Plan
(amended and restated as of January 1, 2003) - Filed in
conjunction with this Form 10-K
(j) Supplemental Benefits Plan (amended and restated as of
January 1, 1989) (which provides supplemental retirement
benefits) - Filed in conjunction with this Form 10-K
(k) Excess Benefits Plan (Amended and Restated Effective
January 1, 1989) (with respect to Section 415 limitations of
the Internal Revenue Code) - Filed in conjunction with this
Form 10-K
(l) Executive Incentive Compensation Plan - Incorporated by
reference to the Form 10-K for the year ended December 31,
2000
(m) Plan for the Deferred Payment of Directors' Fees (Originally
adopted in 1985 and amended effective as of September 24,
1996 and January 28, 1998) - Filed in conjunction with this
Form 10-K
(n) Plan for the Deferred Payment of Directors' Fees (Originally
adopted in 1980 and amended and restated in 1989 and 1996) -
Filed in conjunction with this Form 10-K
(o) 1996 Non-Employee Director Fee Deferral Plan (amended and
restated as of October 22, 2002) - Filed in conjunction with
this Form 10-K
(p) Trust Agreement - Outside Directors (dated December 6, 1996)
- Filed in conjunction with this Form 10-K
(q) Trust Agreement - Officers and Employees (dated December 6,
1996) - Filed in conjunction with this Form 10-K
(r) 1998 Stock Plan - Incorporated by reference to the definitive
Proxy Statement dated March 13, 1998
(s) 2002 Stock Plan - Incorporated by reference to the definitive
Proxy Statement dated March 15, 2002
(t) Executive Strategic Incentive Plan II (Effective as of
January 1, 2001) - Filed in conjunction with this Form 10-K
12 Ratio of Earnings to Fixed Charges - Filed in conjunction with this
Form 10-K
21 Subsidiaries of Eaton Corporation - Filed in conjunction with this
Form 10-K
23 Consent of Independent Auditors - Filed in conjunction with this
Form 10-K
24 Power of Attorney - Filed in conjunction with this Form 10-K
(b) Reports on Form 8-K
On October 15, 2002, the Company filed a Current Report on Form 8-K
regarding the third quarter 2002 earnings release.
On January 21, 2003, the Company filed a Current Report on Form 8-K
regarding the fourth quarter 2002 earnings release.
(c) Exhibits
Certain exhibits required by this portion of Item 15 are filed as a
separate section of this report.
(d) Financial Statement Schedules
None required to be filed.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Eaton Corporation
-----------------
Registrant
Date: March 21, 2003 /s/ Richard H. Fearon
----------------------------
Richard H. Fearon
Executive Vice President -
Chief Financial and Planning
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
Date: March 21, 2003
Signature Title
- --------- -----
*
- -------------------
Alexander M. Cutler Chairman and Chief Executive Officer; President
Director
*
- ---------------
Billie K. Rawot Vice President and Controller;
Principal Accounting Officer
*
- -------------------
Michael J. Critelli Director
*
- -----------
Ernie Green Director
*
- -----------------
Ned C. Lautenbach Director
*
- ----------------
Deborah L. McCoy Director
*
- --------------
John R. Miller Director
*
- -----------------
Furman C. Moseley Director
*
- ----------------
Victor A. Pelson Director
*
- --------------
Gary L. Tooker Director
*By /s/ Richard H. Fearon
--------------------------------------
Richard H. Fearon, Attorney-in-Fact
for the officers and directors signing
in the capacities indicated
Certification
I, Alexander M. Cutler, certify that:
1. I have reviewed this annual report on Form 10-K of Eaton Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 21, 2003 /s/ Alexander M. Cutler
-------------------------------------
Alexander M. Cutler
Chairman and Chief Executive Officer;
President
Certification
I, Richard H. Fearon, certify that:
1. I have reviewed this annual report on Form 10-K of Eaton Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 21, 2003 /s/ Richard H. Fearon
------------------------------------
Richard H. Fearon
Executive Vice President -
Chief Financial and Planning Officer
Eaton Corporation
2002 Annual Report on Form 10-K
Report of Independent Auditors
Consolidated Financial Statements
Notes to Consolidated Financial Statements
Report Of Independent Auditors
- ------------------------------
To the Board of Directors & Shareholders
Eaton Corporation
We have audited the accompanying consolidated balance sheets of Eaton
Corporation as of December 31, 2002 and 2001, and the related statements of
consolidated income, shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 2002. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Eaton
Corporation at December 31, 2002 and 2001, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States.
As discussed in "Goodwill and Other Intangible Assets" in the Notes to
Consolidated Financial Statements, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets", effective January 1, 2002.
/s/ Ernst & Young LLP
---------------------
Cleveland, Ohio
January 20, 2003
F-1
Eaton Corporation
Statements of Consolidated Income
Year ended December 31
------------------------
2002 2001 2000
(Millions except for per share data) ---- ---- ----
Net sales $7,209 $7,299 $8,309
Costs & expenses
Costs of products sold 5,272 5,503 6,092
Selling & administrative 1,217 1,220 1,299
Research & development 203 228 269
------ ------ ------
6,692 6,951 7,660
------ ------ ------
Income from operations 517 348 649
Other income (expense)
Interest expense-net (104) (142) (177)
Gains on sales of businesses 18 61
Other-net (32) 11 80
------ ------ ------
(118) (70) (97)
------ ------ ------
Income from continuing operations before
income taxes 399 278 552
Income taxes 118 109 189
------ ------ ------
Income from continuing operations 281 169 363
Income from discontinued operations 90
------ ------ ------
Net income $ 281 $ 169 $ 453
====== ====== ======
Net income per Common Share assuming dilution
Continuing operations $ 3.92 $ 2.39 $ 5.00
Discontinued operations 1.24
------ ------ ------
$ 3.92 $ 2.39 $ 6.24
====== ====== ======
Average number of Common Shares outstanding 71.7 70.5 72.6
Net income per Common Share basic
Continuing operations $ 3.98 $ 2.43 $ 5.06
Discontinued operations 1.25
------ ------ ------
$ 3.98 $ 2.43 $ 6.31
====== ====== ======
Average number of Common Shares outstanding 70.6 69.4 71.8
Cash dividends paid per Common Share $ 1.76 $ 1.76 $ 1.76
The notes on pages F-6 to F-32 are an integral part of the consolidated
financial statements.
F-2
Eaton Corporation
Consolidated Balance Sheets
December 31
---------------
2002 2001
(Millions) ---- ----
ASSETS
Current assets
Cash $ 75 $ 112
Short-term investments 353 199
Accounts receivable 1,032 1,070
Inventories 698 681
Deferred income taxes 181 153
Other current assets 118 172
------ ------
2,457 2,387
Property, plant & equipment
Land & buildings 790 763
Machinery & equipment 3,044 3,053
------ ------
3,834 3,816
Accumulated depreciation (1,879) (1,766)
------ ------
1,955 2,050
Goodwill 1,910 1,902
Other intangible assets 510 533
Other assets 306 774
------ ------
$7,138 $7,646
====== ======
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities
Short-term debt $ 47 $ 58
Current portion of long-term debt 154 130
Accounts payable 488 418
Accrued compensation 199 158
Accrued income & other taxes 225 258
Other current liabilities 621 647
------ ------
1,734 1,669
Long-term debt 1,887 2,252
Postretirement benefits other than pensions 652 670
Deferred income taxes & other liabilities 563 580
Shareholders' equity
Common Shares (70.6 in 2002 and 69.5 in 2001) 35 35
Capital in excess of par value 1,413 1,348
Retained earnings 1,603 1,447
Accumulated other comprehensive income (loss) (699) (299)
Deferred compensation plans (50) (56)
------ ------
2,302 2,475
------ ------
$7,138 $7,646
====== ======
The notes on pages F-6 to F-32 are an integral part of the consolidated
financial statements.
F-3
Eaton Corporation
Statements of Consolidated Cash Flows
Year ended December 31
----------------------
2002 2001 2000
(Millions) ---- ---- ----
Net cash provided by operating activities
of continuing operations
Income from continuing operations $ 281 $ 169 $ 363
Adjustments to reconcile to net cash provided
by operating activities
Depreciation & amortization 353 355 364
Amortization of goodwill & other
intangible assets 23 94 98
Deferred income taxes (51) 58 44
Pension assets (4) (84) (67)
Other long-term liabilities (1) 30 35
Gains on sales of businesses & corporate assets (18) (61) (22)
Other non-cash items in income 22 2 (6)
Changes in working capital, excluding
acquisitions & sales of businesses
Accounts receivable 59 98 (39)
Inventories 13 149 (13)
Accounts payable 41 64 (16)
Accrued income & other taxes 101 75 (86)
Other current liabilities (14) (129) (44)
Other working capital accounts 47 (53) (81)
Other-net 48 (2) (11)
----- ----- -----
900 765 519
Net cash used in investing activities
of continuing operations
Expenditures for property, plant & equipment (228) (295) (386)
Acquisitions of businesses, less cash acquired (153) (35) (115)
Sales of businesses & corporate assets 96 403 122
Proceeds from initial public offering of subsidiary 349
(Purchases) sales of short-term investments (135) (154) 40
Other-net 5 22 (34)
----- ----- -----
(415) (59) (24)
Net cash used in financing activities
of continuing operations
Borrowings with original maturities of more
than three months
Proceeds 419 1,481 1,555
Payments (635) (1,419) (1,560)
Borrowings with original maturities of less
than three months-net (228) (643) 150
Cash dividends paid (123) (120) (127)
Purchase of Common Shares (12) (417)
Proceeds from exercise of employee stock options 45 37 11
----- ----- -----
(522) (676) (388)
----- ----- -----
Total (decrease) increase in cash
from continuing operations (37) 30 107
Net cash used in discontinued operations (104)
----- ----- -----
Total (decrease) increase in cash (37) 30 3
Cash at beginning of year 112 82 79
----- ----- -----
Cash at end of year $ 75 $ 112 $ 82
===== ===== =====
The notes on pages F-6 to F-32 are an integral part of the consolidated
financial statements.
F-4
Eaton Corporation
Statements of Consolidated Shareholders' Equity
Accumulated Total
Common Shares Capital in other Deferred share-
--------------- excess of Retained comprehensive compensa- holders'
Shares Dollars par value earnings income (loss) tion plans equity
(Millions) ------ ------- --------- -------- ------------- ---------- -------
Balance at January 1, 2000 74.0 $37 $1,041 $1,804 $(220) $(38) $2,624
Net income 453 453
Other comprehensive income (loss) (47) (47)
------
Total comprehensive income 406
Cash dividends paid (127) (127)
Issuance of shares under
employee benefit plans,
including tax benefit .3 57 (1) 6 62
Put option obligation 7 7
Purchase of shares (6.0) (3) (112) (302) (1) (418)
Initial public offering and
spin-off of subsidiary 272 (416) (144)
Other-net 1 (1) 0
---- --- ------ ------ ----- ---- ------
Balance at December 31, 2000 68.3 34 1,266 1,410 (267) (33) 2,410
Net income 169 169
Other comprehensive income (loss) (32) (32)
------
Total comprehensive income 137
Cash dividends paid (120) (120)
Issuance of shares under
employee benefit plans,
including tax benefit 1.1 1 64 (2) (1) 62
Issuance of shares to trust .3 22 (22) 0
Purchase of shares (.2) (4) (8) (12)
Other-net (2) (2)
---- --- ------ ----- ----- ---- ------
Balance at December 31, 2001 69.5 35 1,348 1,447 (299) (56) 2,475
Net income 281 281
Other comprehensive income (loss) (400) (400)
------
Total comprehensive loss (119)
Cash dividends paid (123) (123)
Issuance of shares under
employee benefit plans,
including tax benefit 1.0 (a) 61 (2) 8 67
Issuance of shares to trust .1 5 (5) 0
Other-net (1) 3 2
---- --- ------ ------ ----- ---- ------
Balance at December 31, 2002 70.6 $35 $1,413 $1,603 $(699) $(50) $2,302
==== === ====== ====== ===== ==== ======
(a) Balance less than $1.
The notes on pages F-6 to F-32 are an integral part of the consolidated
financial statements.
F-5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------
Dollars and shares in millions, except per share data (per share data assume
dilution)
ACCOUNTING POLICIES
- -------------------
Consolidation and Basis of Presentation
- ---------------------------------------
The consolidated financial statements include accounts of Eaton and all
subsidiaries and other controlled entities. The equity method of accounting is
used for investments in associate companies where the Company has a 20% to 50%
ownership interest. These associate companies are not material either
individually, or in the aggregate, to Eaton's financial position, net income or
cash flows.
The Company does not have off-balance sheet arrangements, financings or
other relationships with unconsolidated entities or other persons known as
"special purpose entities" (SPEs). In the ordinary course of business, Eaton
leases certain real properties, primarily sales and office facilities, and
equipment, as described in "Lease Commitments" below. Transactions with related
parties are in the ordinary course of business, are conducted on an arm's-length
basis, and are not material to the Company's financial position, net income or
cash flows.
Foreign Currency Translation
- ----------------------------
The functional currency for substantially all subsidiaries outside the
United States is the local currency. Financial statements for these subsidiaries
are translated into United States dollars at year-end exchange rates as to
assets and liabilities and weighted-average exchange rates as to revenues and
expenses. The resulting translation adjustments are recorded in Accumulated
Other Comprehensive Income (Loss) in Shareholders' Equity.
Inventories
- -----------
Inventories are carried at lower of cost or market. Inventories in the
United States are generally accounted for using the last-in, first-out (LIFO)
method. Remaining United States and all other inventories are accounted for
using the first-in, first-out (FIFO) method.
Depreciation and Amortization
- -----------------------------
Depreciation and amortization are computed by the straight-line method for
financial statement purposes. Cost of buildings is depreciated over 40 years and
machinery and equipment over principally three to 10 years. Intangible assets
subject to amortization, primarily consisting of patents, tradenames and
distribution networks are amortized over a range of five to 30 years. Software
is amortized over a range of three to five years.
F-6
Effective January 1, 2002, Eaton adopted Statement of Financial Accounting
Standard (SFAS) No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets". The Statement addresses the conditions under which an
impairment charge should be recorded related to long-lived assets to be held and
used, except goodwill, and those to be disposed of by sale or otherwise.
Long-lived assets, except goodwill, are reviewed for impairment whenever events
or changes in circumstances indicate the carrying amount may not be recoverable.
Events or circumstances that would result in an impairment review primarily
include operations reporting losses, a significant change in the use of an
asset, or the planned disposal or sale of the asset. The asset would be
considered impaired when the future net undiscounted cash flows generated by the
asset are less than its carrying value. An impairment loss would be recognized
based on the amount by which the carrying value of the asset exceeds its fair
value. The adoption of this Statement did not have an impact on the Company's
financial position, net income or cash flows.
Goodwill and Indefinite Life Intangible Assets
- ----------------------------------------------
Effective January 1, 2002, Eaton adopted Statement of Financial Accounting
Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets", as further
described below. Upon adoption, the Company ceased the amortization of goodwill
and indefinite life intangible assets recorded in connection with current and
previous business acquisitions. SFAS No. 142 changes the accounting for goodwill
and indefinite life intangible assets from an amortization approach to a
non-amortization approach requiring periodic testing for impairment of the
asset. During 2002, Eaton completed the initial impairment test for goodwill and
indefinite life intangible assets as of January 1, 2002 and the required annual
impairment test. These tests confirmed that the fair value of Eaton's reporting
units exceeds their respective carrying values, and that no impairment loss
needed to be recognized upon adoption of SFAS No. 142 or for the year ended
December 31, 2002.
Financial Instruments
- ---------------------
In the normal course of business, Eaton is exposed to fluctuations in
foreign currencies, interest rates, and commodity prices. The Company uses
various financial instruments, primarily foreign currency forward exchange
contracts, interest rate swaps and commodity futures contracts to manage
exposure to price fluctuations. Financial instruments used by Eaton are
straightforward, non-leveraged, instruments for which quoted market prices are
readily available from a number of independent services. Financial instruments
generally are not bought and sold solely for trading purposes, except for
nominal amounts authorized under limited, controlled circumstances (resulted in
immaterial net gains in 2002 and 2001). Credit loss is deemed to be remote
because the counterparties to the instruments are major international financial
institutions with strong credit ratings and because of the Company's control
over the limit of positions entered into with any one counterparty.
F-7
All derivative financial instruments are recognized as either assets or
liabilities on the balance sheet and are measured at fair value. Accounting for
the gain or loss resulting from the change in the financial instrument's fair
value depends on whether it has been designated, and effective, as a hedge and,
if so, on the nature of the hedging activity. Financial instruments can be
designated 1) as hedges of changes in the fair value of a recognized fixed-rate
asset or liability, or the firm commitment to acquire an asset or liability, 2)
as hedges of variable cash flows of a recognized variable-rate asset or
liability, or the forecasted acquisition of an asset or liability, or 3) as
hedges of foreign currency exposure from a net investment in one of the
Company's foreign operations. Gains and losses related to a hedge are either 1)
recognized in income immediately to offset the gain or loss on the hedged item
or 2) deferred and reported as a component of Other Comprehensive Income (Loss)
in Shareholders' Equity and subsequently recognized in net income when the
hedged item affects net income. The ineffective portion of the change in fair
value of a financial instrument is recognized in income immediately.
The gain or loss related to financial instruments that are not designated
as hedges, are recognized immediately in net income.
Warranty Expenses
- -----------------
Estimated product warranty expenses are accrued in costs of sales at the
time the related sale is recognized. Estimates of warranty expenses are based
primarily on historical warranty claim experience and specific customer
contracts. Warranty expenses include accruals for basic warranties for products
sold, as well as accruals for product recalls and other related items when they
are known and estimable.
Stock Options Granted to Employees & Directors
- ----------------------------------------------
Stock options granted to employees and directors to purchase Common Shares
are accounted for using the intrinsic value based method. Under this method, no
compensation expense is recognized on the grant date, since on that date the
option price equals the market price of the underlying shares.
In December 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure". SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation", to provide alternative methods of
transition when a company voluntarily changes to the fair value based method of
recognizing expense in the income statement for stock-based employee
compensation, including stock options granted to employees and directors. As
allowed by SFAS No. 123, Eaton has adopted the Statement's disclosure-only
provisions and does not recognize expense for stock options granted to
employees. If Eaton accounted for stock options under the fair value based
method of expense recognition in SFAS No. 123, net income per Common Share would
have been reduced by $.19 in 2002, $.22 in 2001 and $.25 in 2000, as described
further in "Shareholders' Equity" below.
Revenue Recognition
- -------------------
Substantially all revenues are recognized when products are shipped to
unaffiliated customers and title has transferred. Shipping and handling costs
billed to customers are included in net sales and the related costs in cost of
products sold.
F-8
Estimates
- ---------
Preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions in certain circumstances that affect amounts reported
in the accompanying consolidated financial statements and notes. Actual results
could differ from these estimates.
Financial Presentation Changes
- ------------------------------
Certain amounts for prior years have been reclassified to conform to the
current year presentation.
SUBSEQUENT EVENT (Unaudited)
- ---------------------------
On January 31, 2003, Eaton acquired the electrical business of Delta plc
for approximately $215. This business had 2001 sales of approximately $379 (at
the foreign exchange rate on the date the transaction was completed). The Delta
business has 3,400 employees and is headquartered in the United Kingdom. The
business' major electrical brands include MEM(R), Holec(TM), Bill(TM), Home
Automation(TM), Elek(TM) and Tabula(TM). The Delta business will be integrated
into Eaton's Industrial & Commercial Controls segment.
ACQUISITIONS OF BUSINESSES
- --------------------------
Eaton acquired businesses for a combined net cash purchase price of $153 in
2002, $35 in 2001 and $115 in 2000. All acquisitions were accounted for by the
purchase method of accounting and, accordingly, the Statements of Consolidated
Income include the results of the acquired businesses from the effective dates
of acquisition.
In November 2002, the Boston Weatherhead business of Dana Corporation was
purchased for $130. This business, which had 2001 sales of $207, manufactures
hose, tubing, and fluid connectors for fluid power systems primarily for
industrial distribution, mobile off-highway and heavy-duty truck markets. The
allocation of the purchase price for this acquisition is preliminary and will be
finalized in 2003. In June 2002, the remaining 40% interest in Jining Eaton
Hydraulics Company, Ltd. (JEHYCO), a hydraulics systems manufacturer located in
Jining, China, was acquired. This business manufactures hydraulic pumps and
motors for mobile and industrial markets. The operating results of these
businesses are reported in Business Segment Information in Fluid Power.
In March 2001, the remaining 50% interest of Sumitomo Eaton Hydraulics
Company (now named Eaton Fluid Power Ltd.), the former joint venture with
Sumitomo Heavy Industries Ltd., was acquired. This business manufactures a
complete line of hydraulic motors under the Orbit(TM) and Orbitol(TM) brand
names, primarily for the Japanese mobile equipment market. The operating results
of this business are reported in Business Segment Information in Fluid Power.
During July 2001, the commercial clutch manufacturing assets of Transmisiones
TSP, S.A. de C.V. in Mexico were acquired. In October 2001, the European portion
of the vehicle mirror actuator business of Donnelley Corporation, located in
Manorhamilton, Ireland was acquired.
F-9
In September 2000, the industrial cylinder business of International Motion
Control Incorporated was acquired. This business manufactures industrial
cylinders which are primarily used by machine and equipment builders to transfer
and apply fluid power. The operating results of this business are reported in
Business Segment Information in Fluid Power.
SALES OF BUSINESSES AND CORPORATE ASSETS
- ----------------------------------------
Eaton sold businesses, product lines and certain corporate assets for
aggregate cash proceeds of $96 in 2002, $403 in 2001 and $122 in 2000.
In July 2002, the Navy Controls business was sold resulting in a pretax
gain of $18 ($13 after-tax, or $.18 per Common Share).
Sales of businesses in 2001 included the Vehicle Switch/Electronics
Division (VS/ED), the Air Conditioning and Refrigeration business, and certain
assets of the Automotive and Truck segments. The sales of these businesses
resulted in a net pretax gain of $61 ($22 after-tax, or $.30 per share).
Sales of certain corporate assets and product lines in 2000 resulted in a
net pretax gain of $22 ($14 after-tax or $.19 per share).
The net gains on the sales of businesses in 2002 and 2001 were reported as
a separate line item in the Statements of Consolidated Income and Business
Segment Information. The net gain on the sales of corporate assets and product
lines in 2000 was included in the Statements of Consolidated Income in Other
Income-Net and in Business Segment Information in Corporate & Other-Net. The
operating results of VS/ED are reported in Business Segment Information as
Divested Operations.
UNUSUAL CHARGES
- ---------------
2002 Charges
- ------------
Eaton undertook restructuring actions in 2002 to further reduce operating
costs across its business segments and certain corporate functions. These
actions, and their related charges, were a continuation of restructuring
programs initiated in 2001.
Additional restructuring charges related to past acquisitions were incurred
in Fluid Power. In accordance with generally accepted accounting principles,
these charges were recorded as restructuring expense as incurred. The additional
acquisition-related charges consisted of $22 of workforce reductions for 841
employees and $4 of asset write-downs and plant consolidation and other
expenses. The charges recorded primarily related to the closure of facilities in
Glenrothes, Scotland and Livorno, Italy, and for the closure of the Mooresville,
North Carolina facility, which was announced in the third quarter of 2002 and is
expected to be completed in the first quarter of 2003.
Restructuring charges of $13 in the Industrial & Commercial Controls
business consisted primarily of workforce reductions of 449 employees. The
workforce reductions, primarily in the sales force, resulted in severance and
other employee benefits being paid. Asset write-downs and plant consolidation
and other expenses of $3 were also recorded as a result of restructuring
actions.
F-10
Restructuring charges in the Truck business consisted of $6 for workforce
reductions of 251 employees and $10 for asset write-downs and plant
consolidation and other expenses. The charges primarily relate to the closure of
the heavy-duty transmission plant in Shelbyville, Tennessee due to depressed
conditions in the truck industry over the past two years and Eaton's efforts to
rationalize manufacturing capacity to better manage the cyclical nature of the
truck industry.
Restructuring charges related to corporate staff consisted of $3 of
workforce reductions for 133 employees. The Company also recorded a charge of
$10 representing a contribution to the Eaton Charitable Fund.
2001 Charges
- ------------
In connection with the acquisitions of businesses in the Fluid Power
segment, Eaton incurred acquisition integration costs. Integration charges
included $15 for plant consolidation and other expenses and $7 for workforce
reductions. Workforce reductions include severance and other related employee
benefits for the termination of 239 personnel.
Restructuring charges in the Industrial & Commercial Controls business
consisted of $21 for workforce separation costs for the termination of 887
personnel, primarily manufacturing, and $9 for plant consolidation and other
expenses.
Restructuring charges in the Truck business consisted of $35 of workforce
reductions for 1,038 employees and $20 of asset write-downs and plant
consolidation and other expenses. The workforce reductions consisted of
severance and other employee benefits for the elimination of salary positions
within the organization and manufacturing personnel at the closed facilities.
The Company completed the closure of manufacturing facilities in Hillsville,
Virginia, and in Tipton, Gloucester and Aycliffe, United Kingdom, consolidating
production to a facility in Gdansk, Poland, as well as completing the closure of
the heavy-duty transmission plant in St. Nazaire, France.
Restructuring charges related to corporate staff consisted of $8 for
workforce reductions, representing 10% of the corporate staff, as well as $4 for
asset writedowns and other expenses. A corporate charge of $10 related to an
arbitration was recorded in the second quarter of 2001. The arbitration award
related to a contractual dispute over supply arrangements initiated in February
1999 against Vickers, Incorporated (now named Eaton Hydraulics Inc.), a
subsidiary of Aeroquip-Vickers, Inc., which was acquired by Eaton in April 1999.
2000 Charges
- ------------
Integration charges related to the acquisition of Aeroquip-Vickers
consisted of $46 of plant consolidation and other expenses and $1 for workforce
reductions. The workforce reduction charges consist of severance and other
related employee benefits for the termination of approximately 110 employees,
primarily manufacturing personnel. The Company also incurred $5 of corporate
charges related to the restructuring of certain functions.
F-11
Summary of Unusual Charges
- --------------------------
Unusual charges recorded in each year follows:
2002 2001 2000
---- ---- ----
Operational restructuring charges
Fluid Power $ 26 $ 22 $ 47
Industrial & Commercial Controls 16 30
Automotive 1
Truck 16 55
Corporate restructuring charges 3 12 5
----- ----- -----
62 119 52
Other corporate charges 10 10
----- ----- -----
Pretax $ 72 $ 129 $ 52
===== ===== =====
After-tax $ 47 $ 86 $ 34
Per Common Share .66 1.21 .47
The operational restructuring charges are included in the Statements of
Consolidated Income in Income from Operations and reduced operating profit of
the related business segment. The corporate restructuring charges are included
in the Statements of Consolidated Income in Income from Operations and the other
corporate charges are included in Other Expense-Net. All of the corporate
restructuring and other corporate charges are included in Business Segment
Information in Corporate & Other-Net.
Restructuring Liabilities
- -------------------------
Restructuring liabilities of $8 remaining at December 31, 2000 were fully
utilized in 2001. Movement of the various components of restructuring
liabilities for 2002 and 2001 follows:
Plant
Workforce reductions Inventory & consoli-
-------------------- other asset dation
Employees Dollars write-downs & other Total
--------- ------- ----------- ------- -----
2001 charges 2,310 $ 71 $ 20 $ 28 $119
Utilized in 2001 (1,966) (50) (20) (26) (96)
----- ---- ---- --- ----
Liabilities remaining
at December 31, 2001 344 21 0 2 23
2002 charges 1,994 45 8 9 62
Utilized in 2002 (1,844) (55) (8) (6) (69)
----- ---- ---- --- ---
Liabilities remaining
at December 31, 2002 494 $ 11 $ 0 $ 5 $16
===== ==== ==== === ===
F-12
In 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". SFAS No. 146 addresses the reporting of
expenses related to exit and disposal activities, including business
restructurings, and is effective for actions initiated after 2002. This
Statement does not alter the accounting for exit or disposal activities
associated with acquired businesses. The Statement will require an evaluation of
the facts and circumstances in determining the proper accounting recognition of
expenses related to each exit or disposal activity. It is expected the Statement
will spread out the recognition of these expenses, but not alter the related
cash flows.
GOODWILL AND OTHER INTANGIBLE ASSETS
- ------------------------------------
As discussed in "Accounting Policies" above, effective January 1, 2002,
Eaton adopted Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets". Upon adoption, the Company ceased the
amortization of goodwill and indefinite life intangible assets recorded in
connection with previous business acquisitions. A reconciliation of income from
continuing operations and income from continuing operations per Common Share for
2001 and 2000, as if SFAS No. 142 had been adopted as of the beginning of each
year, follows:
2002 2001 2000
---- ---- ----
Reported income from continuing operations $ 281 $ 169 $ 363
Add back amortization of goodwill &
indefinite life intangible assets,
net of income taxes 63 64
----- ----- -----
Adjusted income from continuing operations $ 281 $ 232 $ 427
===== ===== =====
Reported income from continuing operations
per Common Share assuming dilution $3.92 $2.39 $5.00
Add back amortization of goodwill &
indefinite life intangible assets,
net of income taxes .88 .89
----- ----- -----
Adjusted income from continuing operations
per Common Share $3.92 $3.27 $5.89
===== ===== =====
F-13
A summary of goodwill and other intangible assets follows:
2002 2001
------------------------- -------------------------
Historical Accumulated Historical Accumulated
cost amortization cost amortization
---------- ------------ ---------- ------------
Goodwill $2,232 $322 $2,218 $316
====== ==== ====== ====
Intangible assets not
subject to amortization
(primarily trademarks) $ 333 $ 24 $ 330 $ 24
====== ==== ====== ====
Intangible assets subject
to amortization
Patents $ 192 $ 78 $ 190 $ 63
Other 153 66 176 76
------ ---- ------ ----
$ 345 $144 $ 366 $139
====== ==== ====== ====
Expense related to intangible assets subject to amortization for 2002 was
$23. Estimated annual pretax expense for intangible assets subject to
amortization recorded at December 31, 2002 for each of the next five years
follows: 2003, $22; 2004, $18; 2005, $17; 2006, $16; and 2007, $15.
DISCONTINUED OPERATIONS
- -----------------------
On June 30, 2000, the Company's semiconductor equipment operations were
reorganized into a wholly-owned subsidiary, Axcelis Technologies, Inc.
(Axcelis). In July 2000, Axcelis completed an initial public offering (IPO) for
the sale of 17.6% of its common stock. The net proceeds from the IPO were $349.
On December 29, 2000 Eaton distributed its remaining interest in Axcelis to
Eaton shareholders as a dividend (spin-off). The gain on the IPO of $272 was
recorded as a direct increase to Shareholders' Equity. The spin-off was recorded
as a direct reduction of Shareholders' Equity of $416.
The consolidated financial statements present the semiconductor equipment
operations as a discontinued operation for 2000. Operating results of
discontinued operations in 2000 were net sales of $679, pretax income of $132
and net income of $90.
DEBT AND OTHER FINANCIAL INSTRUMENTS
- ------------------------------------
Short-term debt of $47 at December 31, 2002 related to lines of credit of
subsidiaries outside the United States. These subsidiaries have available
short-term lines of credit aggregating $97 from various banks worldwide.
F-14
Long-term debt, including the current portion, follows:
2002 2001
---- ----
7.05% debentures due 2002 $ 100
Variable rate notes due 2003 $ 150 150
6.95% notes due 2004
(converted to floating rate by
interest rate swap) 250 250
1.62% Yen notes due 2006 42 38
8% debentures due 2006 86 86
8.9% debentures due 2006
(converted to floating rate by
interest rate swap) 100 100
6% Euro 200 million notes due 2007
(converted to floating rate by
interest rate swap) 209 177
5.75% notes due 2012
($175 converted to floating rate by
interest rate swap) 300
8.1% debentures due 2022 100 100
7-5/8% debentures due 2024 66 66
6-1/2% debentures due 2025
(due 2005 at option of debenture holders) 145 145
7.875% debentures due 2026 82 82
7.65% debentures due 2029 200 200
6.4% to 7.6% medium-term notes due at
various dates through 2018 131 157
Commercial paper 30 630
Other 150 101
------ ------
2,041 2,382
Less current portion of long-term debt (154) (130)
------ ------
$1,887 $2,252
====== ======
Eaton has credit facilities of $900, of which $500 expire in May 2003 and
$400 expire in April 2005.
The Company has entered into interest rate swaps to manage interest rate
risk. A summary of these instruments outstanding at December 31, 2002, excluding
certain immaterial instruments, follows (currency in millions):
Interest rates(b)
Interest rate Hedge Notional ---------------- Floating interest
rate swaps (a) type amount Receive Pay rate basis
- ----------------- ---------- ------ ------- --- --------------------
Fixed to floating Fair value $250 6.95% 5.1% 6 month LIBOR+3.7%
Fixed to floating Fair value $100 8.9% 5.6% 6 month LIBOR+3.9%
Fixed Euro to
floating Euro Fair value 200 6.0% 3.8% 6 month EURIBOR+.54%
Euro
Fixed to floating Fair value $175 5.75% 2.5% 6 month LIBOR+0.58%
a The maturity of the swaps correspond with the maturity of the hedged item
as noted in the long-term debt table.
b Interest rates are as of year-end 2002.
F-15
The weighted-average interest rate on short-term borrowings, including
commercial paper classified as long-term debt, was 3.9% at December 31, 2002 and
3.3% at December 31, 2001.
Aggregate mandatory annual maturities of long-term debt for each of the
next five years are as follows: 2003, $154; 2004, $255; 2005, $47; 2006, $231;
and 2007, $261.
Interest paid was $116 in 2002, $175 in 2001, and $205 in 2000.
The carrying values of cash, short-term investments and short-term debt in
the balance sheet approximate their estimated fair values. The estimated fair
values of other financial instruments outstanding are as follows:
2002 2001
--------------------------- ---------------------------
Notional Carrying Fair Notional Carrying Fair
amount value value amount value value
------ ----- ----- ------ ----- -----
Long-term debt,
current portion
of long-term debt
& foreign currency
principal swaps $(2,041) $(2,202) $(2,382) $(2,514)
Commodity contracts $ 10 (a) (a) $ 14 (a) (a)
Foreign currency
forward exchange
contracts 275 (7) (6) 122 (5) (11)
Interest rate swaps
Fixed to floating 811 59 59 509 10 10
Floating to floating 92 (a) (a)
Floating to fixed 13 (3) (3) 113 (3) (3)
(a) Balance less than $1.
The estimated fair values of financial instruments are principally based on
quoted market prices. The fair value of foreign currency forward exchange
contracts, which primarily relate to the Euro, British Pound and Japanese Yen
and which mature in 2003, and foreign currency principal and interest rate swaps
were estimated based on quoted market prices of comparable contracts, adjusted
through interpolation where necessary for maturity differences.
F-16
RETIREMENT BENEFIT PLANS
- ------------------------
The Company has defined benefit pension plans and other postretirement
benefit plans, primarily health care and life insurance. Components of plan
obligations and assets and the net amounts recognized in the balance sheets are
as follows:
Other
postretirement
Pension benefits benefits
----------------- --------------
2002 2001 2002 2001
---- ---- ---- ----
Projected benefit obligation
at beginning of year $(1,856) $(1,762) $(894) $(827)
Service cost (76) (61) (15) (14)
Interest cost (126) (124) (60) (62)
Actuarial loss (118) (128) (3) (72)
Benefits paid 205 213 91 79
Effect of translation (43) 14
Other 18 (8) 3 2
------- ------- ----- -----
Projected benefit obligation
at end of year (1,996) (1,856) (878) (894)
------- ------- ----- -----
Fair value of plan assets at
beginning of year 1,836 2,209
Actual return on plan assets (196) (183)
Employer contributions 30 37 92 80
Benefits paid (205) (213) (91) (79)
Effect of translation 25 (11)
Other (10) (3) (1) (1)
------- ------- ----- -----
Fair value of plan assets at
end of year 1,480 1,836 0 0
------- ------- ----- -----
Benefit obligations with
no plan assets (91) (82) (878) (894)
Benefit obligations
(in excess of)less than
plan assets (425) 62
Not recognized through net income
Net loss 846 333 186 190
Prior service cost 12 33 3 (2)
Other 2 1 9 7
------- ------- ----- -----
Net amount recognized $ 344 $ 347 $(680) $(699)
======= ======= ===== =====
Amounts recognized in the balance
sheet consist of:
Accrued asset $ 23 $ 430
Accrued liability (310) (121) $(680) $(699)
Intangible asset 14 7
Accumulated other comprehensive
income 617 31
------- ------- ----- -----
Net amount recognized $ 344 $ 347 $(680) $(699)
======= ======= ===== =====
F-17
Statement of Financial Accounting Standards No. 87 requires recognition of
a minimum liability for those pension plans with accumulated benefit obligations
in excess of the fair values of plan assets at the end of the year. Accordingly,
in the fourth quarter of 2002, Eaton recorded a non-cash charge of $586 ($386
after-tax) related to the additional minimum liability for certain underfunded
pension plans which reduced Accumulated Other Comprehensive Income in
Shareholders' Equity. Pension funding requirements are not currently affected by
the recording of this charge. Further, the charge did not impact net income, and
will be reversible should the fair value of the pension plans' assets again
exceed the accumulated benefit obligations at the end of 2003.
The components of pension benefit income (cost) for continuing operations are
as follows:
2002 2001 2000
---- ---- ----
Service cost $ (76) $ (61) $ (63)
Interest cost (126) (124) (119)
Expected return on plan assets 213 213 200
Other (8) 6 6
----- ----- -----
3 34 24
Curtailment loss (4) (3) (2)
Settlement (loss) gain (21) 21 18
----- ----- -----
$ (22) $ 52 $ 40
===== ===== =====
Actuarial assumptions used in the calculation of amounts recognized for
pensions are as follows:
United States &
non-United States
United States plans plans weighted-average
------------------- ----------------------
2002 2001 2002 2001
---- ---- ---- ----
Return on pension plan assets 10.00% 10.00% 9.85% 9.85%
Rate of compensation increase 3.75% 4.00% 3.73% 3.74%
Discount rate 6.75% 7.25% 6.53% 6.56%
United States pension plans represent 76% of the total projected benefit
obligation. For non-United States plans, assumptions reflect economic conditions
applicable to the respective country.
The return on pension plan assets of 10.00% for United States plans and the
weighted-average rate of 9.85% for United States and non-United States plans for
2002 and 2001 were utilized in the calculation of benefit cost for the
respective year. The return on pension plan assets for 2003 will be lowered to
8.75% for United States plans and a weighted-average rate of 8.71% for United
States and non-United States plans.
F-18
The discount rates of 6.75% and 7.25% for United States plans and the
weighted-average rates of 6.53% and 6.56% for United States and non-United
States plans for 2002 and 2001, respectively, were utilized in the calculation
of the amounts recognized in the balance sheet at year-end. The discount rates
also affect the benefit cost expensed in the prospective year.
The Company also has various defined-contribution benefit plans, primarily
consisting of the Eaton Savings Plan (ESP). Total contributions related to these
plans charged to expense were $34 in 2002, $43 in 2001, and $75 in 2000.
The components of other postretirement benefit cost of continuing
operations are as follows:
2002 2001 2000
---- ---- ----
Service cost $ (15) $ (14) $ (16)
Interest cost (60) (62) (60)
Net amortization (4) 3
----- ----- -----
(79) (73) (76)
Curtailment gain 1
Settlement loss (2)
----- ----- -----
$ (81) $ (73) $ (75)
===== ===== =====
Actuarial assumptions used in the calculation of amounts recognized for
other postretirement benefits are as follows:
2002 2001
---- ----
Discount rate 6.75% 7.25%
Projected health care cost trend rate 10.00% 8.00%
Ultimate health care cost trend rate 5.00% 5.00%
Year ultimate health care cost trend
rate is achieved 2007 2007
The discount rates of 6.75% and 7.25% for 2002 and 2001, respectively, were
utilized in the calculation of the amounts recognized in the balance sheet at
year-end. The discount rates also affect the benefit cost expensed in the
prospective year.
Assumed health care cost trend rates have a significant effect on the
amounts reported for other postretirement benefits. A one-percentage point
change in the assumed health care cost trend rates would have the following
effects:
1% Increase 1% Decrease
----------- -----------
2002 benefit cost $ 2 $ (2)
Recorded liability
at December 31, 2002 28 (25)
F-19
PROTECTION OF THE ENVIRONMENT
- -----------------------------
The Company has established policies to ensure that its operations are
conducted in keeping with good corporate citizenship and with a positive
commitment to the protection of the natural and workplace environments. For
example, each manufacturing facility has a person responsible for environmental,
health and safety (EHS) matters. All of Eaton's manufacturing facilities are
becoming certified under ISO 14001, an international standard for environmental
management systems. The Company routinely reviews EHS performance at each of its
facilities and continuously strives to improve pollution prevention at its
facilities.
As a result of past operations, Eaton is involved in remedial response and
voluntary environmental remediation at a number of sites, including certain of
its currently-owned or formerly-owned plants. The Company has also been named a
potentially responsible party (PRP) under the Federal Superfund law at a number
of waste disposal sites.
A number of factors affect the cost of environmental remediation, including
the number of parties involved at a particular site, the determination of the
extent of contamination, the length of time the remediation may require, the
complexity of environmental regulations, and the continuing advancement of
remediation technology. Taking these factors into account, Eaton has estimated
(without discounting) the costs of remediation, which will be incurred over a
period of several years. The Company accrues an amount consistent with the
estimates of these costs when it is probable that a liability has been incurred.
At December 31, 2002 and 2001, the balance sheet included a liability for these
costs of $64 and $62, respectively. With regard to some of the matters included
in the liability, Eaton has rights of recovery from non-affiliated parties for a
portion of these estimated costs.
Based upon the Company's analysis and subject to the difficulty in
estimating these future costs, Eaton expects that any sum it may be required to
pay in connection with environmental matters is not reasonably likely to exceed
the liability by an amount that would have a material adverse effect on its
financial position, net income or cash flows. All of these estimates are
forward-looking statements and, given the inherent uncertainties in evaluating
environmental exposures, actual results can differ from these estimates.
CONTINGENCIES
- -------------
The Company is subject to various investigations, claims, legal and
administrative proceedings, covering a wide range of matters that arise in the
ordinary course of business activities. Any liability that may result from these
proceedings is not expected to have a material adverse effect on Eaton's
financial position, net income or cash flows.
SHAREHOLDERS' EQUITY
- --------------------
There are 300 million Common Shares authorized ($.50 par value per share),
70.6 million of which are issued and outstanding at year-end 2002. At December
31, 2002, there were 10,611 holders of record of Common Shares. Additionally,
approximately 27,000 current and former employees were shareholders through
participation in the Eaton Savings Plan (ESP) and Eaton Personal Investment Plan
(EPIP).
F-20
The Company has plans which permit certain employees and directors to defer
a portion of their compensation. Eaton has deposited $45 of Common Shares and
marketable securities into a trust to fund a portion of these liabilities. The
marketable securities are included in Other Assets and the Common Shares are
included in Shareholders' Equity.
Stock Options
- -------------
Stock options have been granted to certain employees and directors, under
various plans, to purchase Common Shares at prices equal to fair market value as
of the date of grant. Historically, the majority of these options vest ratably
during the three-year period following the date of grant and expire 10 years
from the date of grant.
During 1997 and 1998, the Company granted special performance-vested stock
options with a 10-year vesting term in lieu of more standard employee stock
options. These options have a provision for accelerated vesting if and when
Eaton achieves certain net income and Common Share price targets. If the targets
are not achieved, these options become exercisable 10 days before the expiration
of their 10-year term. As of December 31, 2002, 2.2 special performance-vested
stock options were outstanding of which .9 were exercisable.
A summary of stock option activity follows:
2002 2001 2000
--------------- ---------------- ---------------
Average Average Average
price price price
per per per
option Options option Options option Options
------ ------- ------ ------- ------ -------
Outstanding January 1 $59.97 9.9 $57.30 10.2 $65.89 8.7
Granted 80.85 1.1 72.67 1.1 71.90 1.5
Exercised 46.67 (1.0) 42.00 (.9) 33.76 (.3)
Canceled 70.55 (.4) 67.04 (.5) 83.05 (.6)
---- ---- ----
Options outstanding before
spin-off of Axcelis 66.89 9.3
Cancellation of options
of Axcelis employees 72.39 (.5)
Adjustment for spin-off
of Axcelis 1.4
---- ---- ----
Outstanding December 31 $63.40 9.6 $59.97 9.9 $57.30 10.2
==== ==== ====
Exercisable December 31 $58.87 6.3 $55.94 6.1 $51.51 5.8
Reserved for future
grants December 31 3.1 1.4 2.0
F-21
The following table summarizes information about stock options outstanding and
exercisable at December 31, 2002:
Weighted- Weighted-
Weighted- average average
average exercise exercise
Options remaining price per Options price per
Range of exercise out- contractual outstanding exerci- exercisable
prices per option standing life (years) option sable option
- ----------------- -------- ----------- ----------- ----- -----------
$33.86 - $39.99 .1 .1 $33.91 .1 $33.91
$40.00 - $49.99 1.7 2.2 45.50 1.7 45.50
$50.00 - $59.99 .1 6.8 57.76 .1 57.47
$60.00 - $69.99 4.6 5.5 61.79 3.5 61.78
$70.00 - $79.99 1.9 6.8 74.27 .8 74.38
$80.00 - $88.41 1.2 8.8 82.00 .1 87.67
--- ---
9.6 6.3
=== ===
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standard (SFAS) No. 123, "Accounting for Stock-Based
Compensation". If Eaton accounted for its stock options under the fair value
method of SFAS No. 123, net income and net income per Common Share would have
been as indicated below:
2002 2001 2000
---- ---- ----
Net income
As reported $ 281 $ 169 $ 453
Assuming fair value method 267 153 435
Net income per Common Share assuming
dilution
As reported $3.92 $2.39 $6.24
Assuming fair value method 3.73 2.17 5.99
Net income per Common Share basic
As reported $3.98 $2.43 $6.31
Assuming fair value method 3.79 2.21 6.06
The fair value of each option grant was estimated using the Black-Scholes
option pricing model with the following assumptions:
2002 2001 2000
---- ---- ----
Dividend yield 2.5% 2.5% 3%
Expected volatility 29% 26% 23%
Risk-free interest rate 2.6% to 4.3% 3.7% to 5% 6% to 6.8%
Expected option life in years 4 4 4 or 5
Weighted-average per
share fair value of
options granted
during the year $18.34 $15.71 $15.47
F-22
Preferred Share Purchase Rights
- -------------------------------
In 1995, the Company declared a dividend of one Preferred Share Purchase
Right for each outstanding Common Share. The Rights become exercisable only if a
person or group acquires, or offers to acquire, 20% or more of Eaton's Common
Shares. The Company is authorized to reduce that threshold for triggering the
Rights to not less than 10%. The Rights expire on July 12, 2005, unless redeemed
earlier at one cent per Right.
When the Rights become exercisable, the holder of each Right, other than
the acquiring person, is entitled 1) to purchase for $250, one one-hundredth of
a Series C Preferred Share, 2) to purchase for $250, that number of Eaton's
Common Shares or common stock of the acquiring person having a market value of
twice that price, or 3) at the option of the Company, to exchange each Right for
one Common Share or one one-hundredth of a Preferred Share.
Comprehensive Income (Loss)
- ---------------------------
The components of Accumulated Other Comprehensive Income (Loss) as reported
in the Statement of Consolidated Shareholders' Equity are as follows:
Unrealized Deferred Minimum
Foreign gain (loss) gain pension
currency on available (loss)on liability
translation for sale cash flow adjust-
adjustments investments hedges ment Total
----------- ----------- --------- --------- -----
Balance at
January 1, 2000 $(220) $ 0 $ 0 $ 0 $(220)
2000 adjustment,
net of income taxes (47) (4) (51)
Adjustment for
spin-off of Axcelis 4 4
----- --- --- ----- -----
Balance at
December 31, 2000 (263) (4) 0 0 (267)
2001 adjustment,
net of income taxes (20) 5 (5) (21) (41)
Recognition in income
of adjustment related
to divested businesses 9 9
----- --- --- ----- -----
Balance at
December 31, 2001 (274) 1 (5) (21) (299)
2002 adjustment,
net of income taxes (15) 1 (386) (400)
----- --- --- ----- -----
Balance at
December 31, 2002 $(289) $ 1 $(4) $(407) $(699)
===== === === ===== =====
A discussion of the minimum pension liability adjustment recorded in 2002
is included in "Retirement Benefit Plans" above.
F-23
INCOME TAXES
- ------------
For financial statement reporting purposes, income from continuing
operations before income taxes, based on the geographic location of the
operation to which such earnings are attributable, is summarized below. Certain
foreign operations are branches of Eaton and are, therefore, subject to United
States as well as foreign income tax regulations. As a result, pretax income by
location and the components of income tax expense by taxing jurisdiction are not
directly related. For purposes of this note to the consolidated financial
statements, non-United States operations include Puerto Rico.
Income from continuing
operations before income taxes
------------------------------
2002 2001 2000
---- ---- ----
United States $ 56 $ 60 $264
Non-United States 343 227 288
Write-off of foreign currency translation
adjustments related to divested businesses (9)
---- ---- ----
$399 $278 $552
==== ==== ====
Income tax expense of continuing operations follows:
2002 2001 2000
---- ---- ----
Current
United States
Federal $123 $ (8) $ 89
State & local 6 (5) 10
Non-United States 42 65 56
---- ---- ----
171 52 155
Deferred
United States Federal (71) 64 27
Non-United States 18 (7) 7
---- ---- ----
(53) 57 34
---- ---- ----
$118 $109 $189
==== ==== ====
F-24
Reconciliations of income taxes of continuing operations at the United
States Federal statutory rate to the effective income tax rate follow:
2002 2001 2000
---- ---- ----
Income taxes at the United States
statutory rate 35.0% 35.0% 35.0%
United States state & local income taxes 1.4 (1.7) 1.8
Other United States-net 1.4 (9.3) 4.9
Non-United States operations (earnings
taxed at other than United States tax (8.3) 4.2 (10.1)
rate)
Amortization of goodwill 4.8 2.6
Sales of businesses 6.4
---- ---- ----
29.5% 39.4% 34.2%
==== ==== ====
Eaton has manufacturing operations in Puerto Rico which operate under
certain United States tax law incentives related to the repatriation of earnings
that, at this point, are not expected to be available after 2005. Management
believes that the loss of these incentives will not have a material adverse
impact on net income. Income tax credits claimed under these incentives were $33
in 2002, $41 in 2001 and $46 in 2000.
Significant components of current and long-term deferred income taxes follow:
2002 2001
-------------------- ---------------------
Current Long-term Current Long-term
assets assets assets liabilities
------- --------- ------- -----------
Accruals & other
adjustments
Employee benefits $ 53 $ 346 $ 56 $ 167
Depreciation &
amortization (405) (436)
Other 117 36 89 23
Other items 11 8 8 12
United States income
tax credit carryforwards 46 14
United States foreign tax
credit carryforwards 33 38
Tax loss carryforwards 54 61
Valuation allowance (78) (87)
---- ----- ---- -----
$181 $ 40 $153 $(208)
==== ===== ==== =====
At the end of 2002, United States income tax credit carryforwards of $46
are available to reduce future Federal income tax liabilities, including $26
which expire at the end of 20 years and $20 of which are not subject to
expiration. Foreign tax credit carryforwards of $33 are also available to reduce
United States Federal income tax liabilities during the next five years. A full
valuation allowance has been recorded for the foreign tax credit carryforwards.
F-25
At December 31, 2002, certain non-United States subsidiaries had tax loss
carryforwards aggregating $161 that are available to offset future taxable
income. Carryforwards of $107 expire at various dates from 2003 through 2012 and
the balance have no expiration date. A valuation allowance of $45 has been
recorded for the tax effect of these tax loss carryforwards.
No provision has been made for income taxes on undistributed earnings of
consolidated non-United States subsidiaries of $873 at December 31, 2002, since
the earnings retained have been reinvested by the subsidiaries. It is not
practicable to estimate the additional income taxes and applicable foreign
withholding taxes that would be payable on the remittance of such undistributed
earnings.
Worldwide income tax cash flows were payments of $61 in 2002 and $210 in
2000, and a refund of $11 in 2001.
OTHER INFORMATION
- -----------------
Assets
- ------
Accounts receivable are net of an allowance for doubtful accounts of $26 at
the end of 2002 and $20 at the end of 2001.
The components of inventories follow:
2002 2001
---- ----
Raw materials $ 283 $ 260
Work in process 160 217
Finished goods 289 238
----- ----
Inventories at FIFO 732 715
Excess of FIFO over LIFO cost (34) (34)
----- -----
Net inventories $ 698 $ 681
===== =====
Gross inventories accounted for using the LIFO method were $478 at the end
of 2002 and $440 at the end of 2001.
Liabilities
- -----------
A summary of the current and long-term liabilities for warranties follows:
2002 2001
---- ----
Balance at the beginning of the year $ 128 $ 157
Current year accruals 129 92
Claims paid/satisfied (119) (108)
Other (11) (13)
----- -----
Balance at the end of the year $ 127 $ 128
===== =====
F-26
Lease Commitments
- -----------------
The Company leases certain real properties, primarily sales and office
facilities, and equipment. Minimum rental commitments for 2003 under
noncancelable operating leases, which expire at various dates and in most cases
contain renewal options, are $83 and decline substantially thereafter.
Rental expense was $102 in 2002, $113 in 2001, and $118 in 2000.
Net Income per Common Share
- ---------------------------
The calculation of net income per Common Share assuming dilution and basic
follows:
2002 2001 2000
---- ---- ----
Net income $ 281 $ 169 $ 453
===== ===== =====
Average number of Common Shares
outstanding assuming dilution 71.7 70.5 72.6
Less dilutive effect of stock options 1.1 1.1 .8
----- ----- -----
Average number of Common Shares
outstanding basic 70.6 69.4 71.8
===== ===== =====
Net income per Common Share
assuming dilution
Continuing operations $3.92 $2.39 $5.00
Discontinued operations 1.24
----- ----- -----
$3.92 $2.39 $6.24
===== ===== =====
Net income per Common Share
basic
Continuing operations $3.98 $2.43 $5.06
Discontinued operations 1.25
----- ----- -----
$3.98 $2.43 $6.31
===== ===== =====
Employee and director stock options to purchase 3.0 Common Shares in 2002,
2.2 in 2001, and 6.0 in 2000 were outstanding but were not included in the
computation of net income per Common Share assuming dilution, since they would
have had an antidilutive effect on earnings per share.
F-27
BUSINESS SEGMENT AND GEOGRAPHIC REGION INFORMATION
- ---------------------------------------------------
Eaton is a global diversified industrial manufacturer with annual sales of
$7.2 billion. The Company is a leader in fluid power systems; electrical power
quality, distribution and control; automotive engine air management and fuel
economy; and intelligent drivetrain systems for fuel economy and safety in
trucks. Eaton had 48,000 employees at the end of 2002, which increased to 51,000
in 2003 due to the acquisition of the electrical business of Delta plc, and
sells products in more than 50 countries. Major products included in each
segment and other information follows.
Fluid Power
- -----------
All pressure ranges of hose, fittings, adapters, couplings and other fluid
power connectors; hydraulic pumps, motors, valves, cylinders, power steering
units, transaxles and transmissions; electronic and hydraulic controls; electric
motors and drives; filtration products and fluid-evaluation products and
services; aerospace products and systems -- hydraulic and electrohydraulic
pumps, motors, electric motor pumps, hydraulic motor driven generators and
integrated system packages, hydraulic and electromechanical actuators, flap and
slat systems, nose wheel steering systems, cockpit controls, power and load
management systems, sensors, fluid debris monitoring products, illuminated
displays, integrated displays and panels, relays and valves; clutches and brakes
for industrial machines; golf grips and precision molded and extruded plastic
products
Industrial & Commercial Controls
- ----------------------------------
Vacuum interrupters, a wide range of circuit breakers and a variety of
power distribution and control assemblies and components used in managing
distribution of electricity to homes, businesses and industrial facilities;
engineering systems and diagnostic and support services to support customer
power and control system requirements; thermal circuit breakers and power
control and conversion equipment used in commercial and military applications;
drives, contactors, starters, and other motor control products used in the
control and protection of electric motors; a wide range of sensors used for
position sensing; automation personal computers and programmable logic
controllers for controlling machine logic; a full range of operator interface
hardware and software for interfacing with machines
Automotive
- ----------
Valvetrain systems, intake and exhaust valves, lash compensation lifters
and lash adjusters, cylinder heads, superchargers, limited slip and locking
differentials, transmission dampers, precision gear forgings, air control
valves, engine sensors and controls, mirror actuators, transmission controls,
on-board vapor recovery systems, fuel level senders and pressure control valves
Truck
- -----
Heavy-, medium-, and light-duty mechanical transmissions, heavy-duty
automated transmissions, heavy- and medium-duty clutches, gears and shafts,
traction control systems, transfer boxes, power take-off units, splitter boxes,
gearshift mechanisms, transmissions for off-highway construction equipment, and
collision warning systems
F-28
Other Information
- -----------------
The principal markets for Fluid Power, Automotive and Truck 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. These
manufacturers are generally concentrated in North America and Europe; however,
sales are made globally. Most sales of these products are made directly to such
manufacturers.
The principal markets for Industrial & Commercial Controls are industrial,
construction, commercial, automotive and government customers. These customers
are generally concentrated in North America; however, sales are made globally.
Sales are made directly by the Company and indirectly through distributors and
manufacturers' representatives to such customers.
No single customer represented more than 10% of net sales of continuing
operations in 2002, 2001 or 2000. Sales from ongoing United States and Canadian
operations to customers in foreign countries were $503 in 2002, $520 in 2001 and
$599 in 2000 (7% of sales for all years presented).
The accounting policies of the segments are generally the same as the
policies described under "Accounting Policies" above, except that inventories
and related cost of products sold of the segments are accounted for using the
FIFO method and operating profits only reflect the service cost component
related to pensions and other postretirement benefits. Intersegment sales and
transfers are accounted for at the same prices as if the sales and transfers
were made to third parties.
Identifiable assets exclude general corporate assets, which principally
consist of cash, short-term investments, deferred income taxes, certain accounts
receivable, certain property, plant and equipment, and certain other assets.
F-29
Business Segment Information
2002 2001 2000
---- ---- ----
Net sales
Fluid Power $2,456 $2,507 $2,607
Industrial & Commercial Controls 1,993 2,199 2,421
Automotive 1,594 1,479 1,502
Truck 1,166 1,029 1,456
------ ------ ------
Total ongoing operations 7,209 7,214 7,986
Divested operations 85 323
------ ------ ------
Total net sales $7,209 $7,299 $8,309
====== ====== ======
Operating profit (loss)
Fluid Power $ 187 $ 183 $ 235
Industrial & Commercial Controls 149 163 251
Automotive 225 194 214
Truck 90 (64) 107
------ ------ ------
Total ongoing operations 651 476 807
Corporate
Divested operations 6 8
Amortization of goodwill & other
intangible assets (23) (94) (95)
Interest expense-net (104) (142) (177)
Gains on sales of businesses 18 61
Corporate & other-net (143) (29) 9
------ ------ ------
Income from continuing operations before
income taxes 399 278 552
Income taxes 118 109 189
------ ------ ------
Income from continuing operations 281 169 363
Income from discontinued operations 90
------ ------ ------
Net income $ 281 $ 169 $ 453
====== ====== ======
Income from continuing operations before income taxes was reduced by
unusual items as follows:
Fluid Power $ 26 $ 22 $ 47
Industrial & Commercial Controls 16 30
Automotive 1
Truck 16 55
Corporate 13 22 5
------ ------ ------
$ 72 $ 129 $ 52
====== ====== ======
F-30
2002 2001 2000
---- ---- ----
Identifiable assets
Fluid Power $1,439 $1,345 $1,518
Industrial & Commercial Controls 847 1,016 1,099
Automotive 819 781 816
Truck 605 651 710
------ ------ ------
Total ongoing operations 3,710 3,793 4,143
Goodwill 1,910 1,902 1,985
Other intangible assets 510 533 553
Corporate 1,008 1,418 1,215
Divested operations 284
------ ------ ------
Total assets $7,138 $7,646 $8,180
====== ====== ======
Expenditures for property, plant & equipment
Fluid Power $ 53 $ 61 $ 95
Industrial & Commercial Controls 34 54 71
Automotive 75 96 96
Truck 56 64 81
------ ------ ------
Total ongoing operations 218 275 343
Corporate 10 17 28
Divested operations 3 15
------ ------ ------
Total expenditures for property, plant &
equipment $ 228 $ 295 $ 386
====== ====== ======
Depreciation of property, plant & equipment
Fluid Power $ 91 $ 96 $ 97
Industrial & Commercial Controls 70 72 74
Automotive 69 66 65
Truck 54 56 57
------ ------ ------
Total ongoing operations 284 290 293
Corporate 22 23 21
Divested operations 14
------ ------ ------
Total depreciation of property, plant &
equipment $ 306 $ 313 $ 328
====== ====== ======
F-31
Geographic Region Information
Ongoing operations
--------------------------
Long-
Net Operating lived
sales profit assets
------ ------ ------
2002
United States $5,605 $ 483 $1,338
Canada 185 15 13
Europe 1,110 65 351
Latin America 403 45 160
Pacific Region 358 43 93
Eliminations (452)
------ ------ ------
$7,209 $ 651 $1,955
====== ====== ======
2001
United States $5,677 $ 414 $1,419
Canada 177 11 15
Europe 1,108 (5) 322
Latin America 406 37 203
Pacific Region 310 19 91
Eliminations (464)
------ ------ ------
$7,214 $ 476 $2,050
====== ====== ======
2000
United States $6,483 $ 679 $1,532
Canada 182 15 14
Europe 1,232 46 352
Latin America 412 47 193
Pacific Region 253 20 79
Eliminations (576)
------ ------ ------
$7,986 $ 807 $2,170
====== ====== ======
Net sales and operating profit are attributed to geographical regions based
upon the location of the selling unit.
Long-lived assets consist of property, plant and equipment-net.
Operating profit was reduced by unusual items as follows:
2002 2001 2000
---- ---- ----
United States $ 49 $ 67 $ 42
Europe 10 37 4
Latin America 2 1
Pacific Region 1
------ ------ ------
$ 59 $ 107 $ 47
====== ====== ======
F-32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
- --------------------------------------------------------------------------
Dollars in millions, except for per share data (per share data assume dilution)
Overview
- --------
While global economic conditions remained difficult in 2002, presenting a
challenging operating environment, Eaton posted significantly improved results,
with each business segment reporting solid performance during the year. During
2002, Eaton made significant progress towards key corporate goals of 1)
out-growing end markets, 2) resizing the Company to compete effectively and
profitably in the depressed market and 3) improving the strength of the balance
sheet.
Worldwide net sales were $7,209 in 2002. Although 1% lower than 2001, sales
reflected levels that outperformed a number of the Company's end markets. Net
income was $281 in 2002 ($3.92 per Common Share), up 66% from $169 in 2001
($2.39 per share). The increase was primarily due to the result of the benefits
of restructuring actions taken in 2002 and prior years. Before unusual items in
both years, operating earnings were $315 in 2002 ($4.40 per share), up 35% from
$233 in 2001 ($3.30 per share). Unusual items reported in both years included
restructuring charges, other unusual charges and gains on sales of businesses.
Eaton's results in 2002 were aided by actions taken in 2002 and earlier
years to comprehensively restructure operations. With these actions, the Company
incurred restructuring and other unusual charges of $72 in 2002 ($.66 per Common
Share) and $129 in 2001 ($1.21 per share), and delivered $130 of savings in
2002. These savings helped the Company to post significantly higher earnings
despite end markets showing yet another year of decline. In addition, 2002
results were favorably impacted by $.88 per Common Share due to the adoption of
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets", which ceased the amortization of goodwill and certain
intangible assets. These positive effects on income were partially offset by
additional pension expense and other postretirement benefit expense in 2002 of
$.52 per share. The Company also reported gains on sales of businesses of $.18
per share in 2002 compared to $.30 per share in 2001.
Throughout 2002, Eaton continued to focus on strengthening the balance
sheet. Cash flow from operations in 2002 was an all-time high of $900, and cash
flow after capital expenditures and cash dividends (free cash flow) for the year
was $549. As a result, total debt was reduced by $352 during the year and cash
and short-term investments increased by $117. The net debt to total capital
ratio at the end of 2002 was 41.9%, down from 46.2% at year-end 2001. This ratio
would have dropped to 38.2% but for the recognition of a $386 reduction of
Shareholders' Equity related to the recognition of a minimum pension liability
for certain pension plans at the end of 2002.
F-33
2002 Compared to 2001
- ---------------------
Results of Operations
- ---------------------
Sales of $7,209 for 2002 were 1% below 2001. After excluding the impact of
the divestitures of the Navy Controls business in the third quarter of 2002 and
the Vehicle Switch/Electronics Division (VS/ED) in the first quarter of 2001,
sales increased by 1%. Sales of the Fluid Power segment were $2,456 in 2002, 2%
below 2001, while sales of the Industrial & Commercial Controls segment of
$1,993 were down 9% from 2001, due to weakness in end markets served by these
segments. The Automotive segment reported sales of $1,594 in 2002, 8% higher
than 2001, reflecting the continued strong performance of the North American and
European automobile markets. Truck segment sales rose to $1,166, 13% above 2001,
spurred by purchases of heavy-trucks in North America in advance of new engine
emission requirements.
Sales in the United States increased to $5,605 in 2002, 1% above 2001 after
excluding the impact of the divestitures of businesses in 2002 and 2001,
primarily the result of continued strong performance in the Automotive segment
and the mid-year surge in the Truck segment. Sales in international markets were
$2,056 in 2002, only slightly above 2001. Sales in 2002 of $1,110 in Europe,
$403 in Latin America and $185 in Canada were all flat compared to 2001, as
these economies remained weak. Sales in the Pacific region increased to $358,
15% higher than 2001, primarily due to improved performance of Fluid Power,
Automotive and Truck operations in this region.
As the weak economic conditions of 2001 continued into 2002, Eaton
undertook additional restructuring actions to further reduce fixed operating
costs across its business segments and certain corporate functions. During 2002,
$62 of operational restructuring charges were recorded, including $26 for Fluid
Power, $16 for Industrial & Commercial Controls and $16 for Truck. These
compared to similar restructuring charges of $119 in 2001. In addition, unusual
corporate charges of $10 in each of 2002 and 2001 were recorded which related to
non-operating activities. On an after-tax basis, these restructuring and unusual
charges reduced net income for 2002 by $47 ($.66 per Common Share) and for 2001
by $86 ($1.21 per share). The operational restructuring charges are included in
the Statements of Consolidated Income in Income from Operations and reduced
Operating Profit of the related business segment. The corporate restructuring
charges are included in the Statements of Consolidated Income in Income from
Operations and the other corporate charges are included in Other Expense-Net.
All of the corporate restructuring and other corporate charges are included in
Business Segment Information in Corporate & Other-Net.
Results for 2002 were favorably impacted by the adoption of SFAS No. 142,
which ceased the amortization of goodwill and indefinite life intangible assets
recorded in connection with current and previous business acquisitions. This
accounting change increased pretax income for 2002 by $73 ($63 after- tax, or
$.88 per Common Share) compared to 2001. Income for 2002 was reduced by $57 ($37
after-tax, or $.52 per share) compared to 2001 due to increased pension expense
and other postretirement benefit expense which reflected the decline in the
market value of equity investments in Eaton's pension fund, coupled with lower
discount rates associated with pension and other postretirement benefit
liabilities.
F-34
As displayed in the Statements of Consolidated Income, despite slightly
lower sales, income from Operations of $517 in 2002 increased $169 over 2001,
rising to 7.2% of sales from 4.8% of sales in 2001. These increases were
primarily attributable to the benefits of the aggressive restructuring actions
described above, which generated $130 of savings in 2002. The increases also
reflected lower restructuring charges recorded in 2002 compared to 2001 and
reduced amortization expense in 2002 related to the change in accounting for
goodwill and indefinite life intangible assets described above. Offsetting these
positive effects on income was increased pension expense and other
postretirement benefit expense in 2002, as described above.
In the third quarter of 2002, Eaton sold the Navy Controls business, which
resulted in a pretax gain of $18 ($13 after-tax, or $.18 per Common Share).
During 2001, VS/ED, the Air Conditioning and Refrigeration business and certain
assets of Automotive and Truck businesses were sold. The sales of businesses in
2001 resulted in a net pretax gain of $61 ($22 after-tax, or $.30 per share).
The gains for both years are reported as a separate line item in the Statements
of Consolidated Income and Business Segment Information. In Business Segment
Information, the operating results of VS/ED are included in divested operations.
The effective income tax rate for 2002 was 29.5% compared to 39.4% for
2001. The higher rate in 2001 was primarily the result of the tax effect of
book/tax basis differences related to businesses sold in the first quarter of
2001 and the amortization of non-deductible goodwill in 2001. Excluding the
negative tax consequences related to the sales of businesses and non-deductible
goodwill in 2001, the effective tax rate for 2001 was 28.2% compared to 29.5% in
2002.
Before restructuring charges, other unusual charges and gains on the sales
of businesses, operating earnings were $315 in 2002 ($4.40 per Common Share),
35% above 2001 on a similar basis. These improvements were primarily the result
of the factors described above. Net income for 2002, including unusual charges
and gains on sales of businesses, was $281 ($3.92 per share), 66% higher
compared to $169 in 2001 ($2.39 per share).
Business Segments
- -----------------
Fluid Power
- -----------
Sales of Eaton's largest business segment, Fluid Power, were $2,456 in
2002, 2% below one year earlier. Fluid Power end markets showed no growth
compared to 2001, with North American fluid power industry shipments down about
2%, commercial aerospace markets off about 17%, and defense aerospace markets up
by 27%. The expected significant decline in the commercial aerospace market
started in the second quarter of 2002, while traditional mobile and industrial
hydraulics markets showed little improvement in 2002. Offsetting these declines
was strength in the military aerospace markets.
F-35
Operating profits before restructuring charges were $213 in 2002, 4% higher
than $205 posted in 2001. These profits represented a return on sales of 8.7% in
2002, up from 8.2% in 2001. In spite of general weakness in end markets, profits
in 2002 were higher than 2001, primarily the result of the benefits of
aggressive restructuring actions taken to resize this business in prior periods.
Restructuring charges recognized in 2002 were $26 compared to $22 in 2001.
Profits after restructuring charges were $187 in 2002, up from $183 in 2001.
In the fourth quarter of 2002, two acquisitions were completed in this
segment. The Company purchased the Boston Weatherhead business of Dana
Corporation for $130. This business, which had 2001 sales of $207, manufactures
hose, tubing, and fluid connectors for fluid power systems primarily for the
industrial distribution, mobile off-highway and heavy-duty truck markets. In
addition, the aerospace circuit breaker business of Mechanical Products was
purchased during the fourth quarter.
During the second quarter of 2002, Eaton purchased the remaining 40%
interest in its hydraulics systems joint venture company, Jining Eaton
Hydraulics Company, Ltd. (JEHYCO), located in Jining, China. JEHYCO is the
Company's fourth wholly-owned business in China.
In 2002, Eaton announced a multi-year contract with Lockheed Martin to
supply the wing fluid distribution package on the supersonic multi-role Joint
Strike Fighter, the F-35, which represents Eaton's second major contract for
this aircraft. The award is for the system design and development phase of the
program, which is expected to total 14 aircraft and generate an estimated $3 of
revenue over the next two years. Based on the projected manufacture of 3,000
aircraft and additional foreign military sales over the planned lifetime of the
F-35, this award has the potential of generating revenue for Eaton of $1 billion
over the 35 year life of the program. The Company also announced it had been
selected to receive $84 in business as a result of the U.S. Air Force's decision
to purchase an additional 60 C-17 cargo aircraft in 2004 through 2007.
During 2002, the Company also announced a multi-year contract with Airbus
to provide products for hydraulic fluid conveyance in the new Airbus 380, the
world's largest commercial aircraft. The contract has potential revenue of $70
over the next 20 years. This was the second contract awarded to Eaton for the
A380, with the combined contracts expected to generate revenues of approximately
$270 over the next 20 years. Additionally, during 2002, Eaton was awarded a
multi-year contract by BMW to provide fluid hose assemblies for two major
automobile production models. This contract is expected to have revenues in
excess of $150 over the next six years.
Industrial & Commercial Controls
- --------------------------------
In the Industrial & Commercial Controls segment, sales for 2002 were
$1,993, down 9% from 2001, but down only 7% after adjusting for the impact of
selling the Navy Controls business at the start of the third quarter. End
markets for the electrical business weakened during the year, with an estimated
9% decline in the North American markets for this business compared to 2001. The
long-cycle, large-project portion of this business, which is tied to commercial
construction, continued to soften during the year.
F-36
Operating profits before restructuring charges were $165 in 2002, down from
$193 in 2001. These profits represented a return on sales of 8.3% in 2002
compared to 8.8% in 2001. Profits declined 15% from 2001, but were down 12%
after excluding Navy Controls which was sold in mid-2002. The decline in profits
was primarily the result of declining sales volume due to weak market conditions
in most of the sectors this segment serves and the effects of product mix.
Restructuring charges recognized in 2002 were $16 compared to $30 in 2001.
Profits after restructuring charges were $149 in 2002 compared to $163 in 2001.
In January 2003, Eaton completed the acquisition of the electrical business
of Delta plc for $215. This business, which had 2001 sales of $379, includes
major electrical brands such as MEM(R), Holec(TM), Bill(TM), Home
Automation(TM), Elek(TM) and Tabula(TM). The Delta business represents a
significant addition to the capabilities and geographic footprint of the
Industrial & Commercial Controls business. Additionally, in early January 2003
the acquisition of the power systems business of Commonwealth Sprague Capacitor
was completed. This business will add to offerings in the areas of power quality
and energy management.
During the second quarter of 2002, Eaton announced the formation of its new
Performance Power Solutions organization, created to expand the Company's
position in the power quality and assurance market, as well as to create a new
business relationship with Johnson Controls. This business expansion is expected
to result in $300 of new business revenue over the next four years.
Automotive
- ----------
The Automotive segment posted sales of $1,594 in 2002, 8% above 2001.
Compared to 2001, NAFTA automotive production was up 6% to 16.7 million units,
while European production decreased 2% to 18.0 million units. The Automotive
segment continued its strong performance with sales growth that considerably
outpaced its end markets. The heavy investments Eaton has made in new product
development over the last several years are delivering strong results and
broadening opportunities, as this segment has been able to accelerate the pace
of new product introductions to gain market share.
Operating profits before restructuring charges were $226 in 2002, up 16%
from $194 in 2001. The segment produced a return on sales of 14.2% in 2002, up
from 13.1% in 2001. The increases in profits and margins were primarily the
result of the increase in sales during 2002.
In 2002, the Company announced the acquisition, from McLaren Performance
Technologies, of the technology, trademarks, and engineering assets related to
the Gerodisc(TM) product line. The addition of this product line to Eaton's
existing products broadens the product range sold to the light-duty automotive
differential market. During the year, Eaton also increased its investment to 49%
in Cyltec, an associate company that manufactures cylinder heads for the light
vehicle market in North America. In late 2002, Eaton won a contract from the
Chrysler Group to provide electronic differentials for the front and rear axles
of a future vehicle platform.
F-37
Further progress was made in growing Eaton's supercharger business in 2002.
In Brazil, the smallest supercharger ever produced on a commercial basis was
launched for use on the new Ford Fiesta, and delivery began of a high-efficiency
supercharger for use with the new M-271 engine program of Mercedes. The Company
is providing superchargers, intake and exhaust valves, roller rocker arms and
lash adjusters for the M-271 program.
In the first quarter of 2002, Eaton announced the receipt of a contract
from General Motors Corporation's Tier One mirror suppliers to provide memory
glass and power-folding mirror actuators for a wide range of pick-up trucks and
sport utility vehicles.
Truck
- -----
The Truck segment posted sales of $1,166 in 2002, a 13% increase over 2001.
Sales in the North American heavy-duty truck market were higher in the second
and third quarters of 2002, spurred by purchases of heavy-duty trucks in North
America in advance of new engine emission requirements. NAFTA heavy-duty truck
production was up 24% in 2002 to 181,000 units, NAFTA medium-duty truck
production was flat, European truck production was down 6%, and South American
production decreased by 12%.
Operating profits before restructuring charges were $106 in 2002 compared
to a loss of $9 in 2001. These profits represented a return on sales of 9.1% in
2002. The positive impact of the extensive restructuring actions in this segment
over the last two years can be seen in the $115 of increased profit before
restructuring costs in 2002 on increased sales of $137. Restructuring charges
recognized in 2002 were $16 compared to $55 in 2001. Profits after restructuring
charges were $90 in 2002 compared to a loss of $64 in 2001.
During 2002, Eaton announced two new contracts in South America with Volvo
and AGCO to supply transmissions for heavy-duty trucks and farm tractors. These
contracts are expected to generate more than $190 of sales over the next eight
years.
Corporate Income (Expense)
- --------------------------
Results for 2002 were impacted favorably by the adoption of SFAS No. 142,
which ceased the amortization of goodwill and indefinite life intangible assets
recorded in connection with current and previous business acquisitions. This
accounting change resulted in a $73 reduction in amortization expense in 2002.
Net interest expense of $104 in 2002 decreased by $38 compared to 2001. The
decrease was primarily related to the reduction in debt of $352 from the end of
2001 to the end of 2002, as well as a reduction of interest rates in 2002.
Corporate and other expense-net was $143 in 2002 compared to $29 in 2001.
The increase was primarily the result of increased pension expense and other
postretirement benefit expense of $57 in 2002 compared to 2001. This increase
was due to the effect of the decline in the market value of equity investments
in Eaton's pension fund, coupled with lower discount rates associated with
pension and other postretirement benefit liabilities. The increase in corporate
and other expense-net also reflected other expenses including profits owed to
minority interests in subsidiaries, foreign currency, environmental and legal,
as well as other corporate office accruals.
F-38
Changes in Financial Condition During 2002
- ------------------------------------------
Eaton's financial position further strengthened during 2002. Net working
capital of $723 at the end of 2002 was virtually unchanged from year-end 2001
(the current ratio was 1.4 at both year-ends). Eaton continued to generate
strong cash flow from operating activities, which is the primary source of funds
to finance the needs of the Company.
Operating activities generated cash of $900 in 2002, an all-time record and
in excess of the strong cash flow generation of $765 in 2001. Further progress
was made in reducing operating capital, resulting in a lowering of the number of
inventory days-on-hand by six days, a decrease in accounts receivable days
outstanding of three days, and reduction in capital expenditures. Capital
expenditures for 2002 were $228, $67 lower than 2001 and just over 3% of sales.
As a result, the Company was able to complete with cash the acquisitions of
Boston Weatherhead and the aerospace circuit breaker business of Mechanical
Products in November 2002 while still reducing debt by $352 during 2002 and
increasing cash and short-term investments by $117 at the end of 2002.
Total debt of $2,088 at the end of 2002 decreased $352 from the end of
2001. In addition to the contribution from strong operating cash flow, debt was
paid down from the proceeds from the sale of Navy Controls. As a result of lower
debt and increased cash and short-term investments, the net debt to capital
ratio was reduced to 41.9% at the end of 2002 from 46.2% at year-end 2001. This
ratio would have dropped to 38.2% but for a $386 reduction of Shareholders'
Equity related to the recognition of a minimum pension liability for certain
pension plans at the end of 2002. The Company has credit facilities of $900, of
which $500 expire in May 2003 and $400 in April 2005.
In 2002, Eaton issued $300 of 5.75% Notes due 2012. The net proceeds from
the Notes were used to reduce outstanding commercial paper and repay a portion
of more expensive indebtedness incurred in connection with the 1999 acquisition
of Aeroquip-Vickers, Inc. During 2002, the Company also reached an agreement
with the Internal Revenue Service relating to the treatment of its broad-based
company-owned life insurance plans for the years 1993 through 1998. Pursuant to
the agreement, the Company terminated its remaining broad-based company-owned
life insurance plans. The settlement of this issue resulted in no material
effect on Eaton's financial position, net income or cash flows.
Eaton is in compliance with all covenants and other requirements set forth
in its credit agreements and indentures, and it is not reasonably likely that
this condition would change in the foreseeable future. The Company does not have
any rating downgrade triggers that would accelerate the maturity dates of its
debt.
At the end of 2002, Shareholders' Equity was reduced by a non-cash
after-tax charge of $386 related to the recognition of a minimum liability for
certain pension plans. This charge is further described in "Retirement Benefit
Plans" in the Notes to the Consolidated Financial Statements. The charge did not
impact net income, and will be reversible should the pension plans again become
overfunded at the end of 2003. Pension funding requirements are not currently
affected by the recording of this non-cash charge.
Cash dividends paid were $123 in 2002. Dividends per Common Share of $1.76
in 2002 were the same as in 2001. Eaton has paid dividends on Common Shares each
year since 1923.
F-39
Outlook for 2003
- ----------------
The modest recovery Eaton had anticipated in its end markets beginning in
the fourth quarter of 2002 was delayed due to the slow and uneven pace of North
American economic recovery. As the Company surveys its end markets, only
marginal growth is foreseen in the first half of 2003, with stronger growth
expected in the second half. For the year as a whole, Eaton anticipates growth
in its end markets of approximately 1 to 2%. As in the past year, it expects to
outgrow end markets by approximately 2 to 3%.
The Company does not anticipate a recovery in the traditional mobile and
industrial hydraulics markets until the second half of 2003. The decline in the
commercial aerospace market has occurred as expected. Eaton believes that the
commercial aerospace markets are near bottom, but may not recover significantly
until 2004. Military aerospace markets remain strong and are expected to improve
further over the course of 2003.
Eaton expects that the electrical distribution equipment market will begin
to recover in 2003, but not until the fourth quarter. The residential market was
strong in 2002, but is expected to weaken slightly during 2003.
NAFTA automobile production is forecasted to be 15.9 million units in 2003
and 16.1 million units in Europe. The Company expects that North American
heavy-truck production during 2003 could approach 190,000 units, with volumes
lower in the first quarter and strengthening during the balance of the year.
The Company expects to record additional growth during 2003 from the
recently completed acquisitions of the Boston Weatherhead fluid power hose and
fittings business, the electrical division of Delta plc, the aerospace circuit
breaker business of Mechanical Products, and the power systems business of
Commonwealth Sprague Capacitor. Eaton anticipates these acquisitions could add
approximately $500 to 2003 revenues.
Restructuring expenses for 2003 are expected to be approximately $50,
evenly spread over the year. These charges relate substantially to the
integration of the recently acquired Boston Weatherhead fluid power business and
the electrical business of Delta plc.
Capital expenditures for 2003 are forecasted to be $335 and will be funded
primarily by cash flow from operations.
Due to the decline in stock market valuations during 2002 and the reduced
general level of interest rates, certain key assumptions used to calculate
pension and other postretirement benefit expense for 2003 will be adjusted,
including the lowering of the assumption used for the return on pension plan
assets from 10.00% to 8.75% and the discount rate from 7.25% to 6.75%. These
changes in assumptions are expected to result in an increase of approximately
$72 in pension expense and other postretirement benefit expense in 2003.
Before restructuring charges, Eaton projects 2003 operating earnings per
Common Share to be between $5.00 and $5.25. In 2003, the Company expects
restructuring charges to be approximately $.50 per share, resulting in a
projection of net income after restructuring charges of between $4.50 and $4.75
per share. As a result of the continuing soft market conditions, Eaton will
continue to exercise tight control over all expenditures. The Company
anticipates that it should be significantly cash flow positive again in 2003.
F-40
Significant Accounting Changes in 2003
- --------------------------------------
In 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". SFAS No. 146 addresses the reporting of
expenses related to exit and disposal activities, including business
restructurings, initiated after 2002. This Statement does not alter the
accounting for exit or disposal activities associated with acquired businesses.
The Statement will require an evaluation of the facts and circumstances in
determining the proper accounting recognition of expenses related to each exit
or disposal activity. It is expected the Statement will spread out the reporting
of these expenses, but not alter the related cash flows.
Critical Accounting Policies
- ----------------------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires Eaton's management
to make estimates and use assumptions in certain circumstances that affect
amounts reported in the accompanying consolidated financial statements. In
preparing these financial statements, management has made their best estimates
and judgments of certain amounts included in the financial statements, giving
due consideration to materiality. For any estimate or assumption there may be
other reasonable estimates or assumptions that could have been used. However,
the Company believes that given the current facts and circumstances, it is
unlikely that applying such other estimates and assumptions would have caused
materially different amounts to have been reported, except for pension and other
postretirement benefit plans for which several different reasonable assumptions
could be used for the valuation of the plans, as described below. Application of
these accounting policies involves the exercise of judgment and use of
assumptions as to future uncertainties and, as a result, actual results could
differ from estimates used.
Revenue Recognition
- -------------------
Substantially all of Eaton's revenues are recognized when products are
shipped to unaffiliated customers and title has transferred.
Allowance for Uncollectible Accounts Receivable
- -----------------------------------------------
Accounts receivable have been reduced by an allowance for amounts that may
become uncollectible in the future. This estimated allowance is based primarily
on management's evaluation of the financial condition of the customer.
Allowance for Obsolete and Excess Inventory
- -------------------------------------------
Inventories are valued at the lower of cost or market value and have been
reduced by an allowance for excess and obsolete inventories. The estimated
allowance is based on management's review of inventories on hand, compared to
estimated future usage and sales.
F-41
Impairment of Long-Lived Assets
- -------------------------------
As a result of the adoption of SFAS No. 142 in 2002, goodwill and
indefinite life intangible assets must be reviewed at least annually for
impairment, in accordance with the specified methodology. Further, goodwill,
intangible and other long-lived assets are reviewed for impairment whenever
events or changes in circumstances indicate the carrying amount may not be
recoverable. Goodwill and other intangible assets totaled $2,420 at the end of
2002 and represented 34% of total assets. These assets resulted primarily from
the $1,100 acquisition of the electrical distribution and controls business unit
of Westinghouse in 1994, and the $1,600 acquisition of Aeroquip-Vickers in 1999.
These businesses have a long history of operating success and profitability and
hold significant market positions in the majority of their product lines. Their
products are not subject to rapid technological or functional obsolescence,
which should result in continuous strong demand for products for many years and
accordingly support the book values of the goodwill and intangible assets
related to these businesses.
Deferred Income Tax Assets
- ---------------------------
Deferred income tax assets and liabilities have been recorded for the
differences between the financial accounting and income tax basis of assets and
liabilities. Recorded deferred income tax assets and liabilities are described
in detail in "Income Taxes" in the Notes to the Consolidated Financial
Statements. Significant factors considered by management in the determination of
the probability of the realization of deferred tax assets include historical
operating results, expectations of future earnings and taxable income, and the
extended period of time over which postretirement health care liabilities will
be paid.
Pension and Other Postretirement Benefit Plans
- ----------------------------------------------
The measurement of liabilities related to pension plans and other
postretirement benefit plans is based on management's assumptions related to
future events including interest rates, return on pension plan assets, rate of
compensation increases, and health care cost trend rates. Actual pension plan
asset performance will either reduce or increase unamortized pension losses,
which ultimately affects net income. A one-percentage point change in the
assumed rate of return on pension plan assets is estimated to have a $22 effect
on pension expense. Likewise, a one-percentage point increase in the discount
rate is estimated to reduce pension expense by $20. Information related to
changes in key assumptions used to recognize expense for other postretirement
benefit plans is found in "Retirement Benefit Plans" in the Notes to the
Consolidated Financial Statements.
For 2003, certain key assumptions used to calculate pension and other
postretirement benefit expense have been adjusted, including the lowering of
both the assumed return on pension plan assets from 10.00% to 8.75% and the
discount rate from 7.25% to 6.75%. These changes are expected to result in
increased pension and other postretirement benefit expense of approximately $72
in 2003 compared to 2002.
F-42
Protection of the Environment
- -----------------------------
Eaton's operations involve the use and disposal of certain substances
regulated under environmental protection laws. On an ongoing, regular basis,
certain processes continue to be modified in order to reduce the impact on the
environment, including the reduction or elimination of certain chemicals used
in, and wastes generated from, operations. Liabilities related to environmental
matters are further discussed in "Protection of the Environment" in the Notes to
the Consolidated Financial Statements.
Contingencies
- -------------
The Company is subject to various investigations, claims, legal and
administrative proceedings, covering a wide range of matters that arise in the
ordinary course of business activities. Any liability that may result from these
proceedings is not expected to have a material adverse effect on Eaton's
financial position, net income or cash flows.
Stock Options Granted to Employees
- ----------------------------------
In December 2002, Statement of Financial Accounting Standards (SFAS) No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure", was
issued by the Financial Accounting Standards Board. SFAS No. 148 amends SFAS No.
123, "Accounting for Stock-Based Compensation", to provide alternative methods
of transition when a company voluntarily changes to the fair value based method
of recognizing expense in the income statement for stock-based employee
compensation, including stock options granted to employees. As allowed by SFAS
No. 123, Eaton has adopted the disclosure-only provisions of the Standard and
does not recognize expense for stock options granted to employees.
Off-Balance Sheet Arrangements
- ------------------------------
Eaton does not have off-balance sheet arrangements, financings or other
relationships with unconsolidated entities or other persons known as "special
purpose entities" (SPEs). In the ordinary course of business, Eaton leases
certain real properties, primarily sales and office facilities, and equipment,
as described in "Lease Commitments" in the Notes to the Consolidated Financial
Statements. Transactions with related parties are in the ordinary course of
business, are conducted on an arm's-length basis, and are not material to
Eaton's financial position, net income or cash flows.
Eaton uses straightforward, non-leveraged, financial instruments for which
quoted market prices are readily available from a number of independent
services, to manage exposure to fluctuations in foreign currencies, interest
rates and commodity prices.
F-43
Contractual Obligations Related to Long-term Debt, Leases and Related Risk
Disclosure
- --------------------------------------------------------------------------
Eaton is subject to various financial risks attributable to operating in a
global economy. Systems to measure and assure that these exposures are
comprehensively evaluated have been developed so that appropriate and timely
action can be taken to reduce risk, if necessary. Management performs a periodic
oversight review of exposures. Derivative financial instruments are utilized on
a discrete basis to manage exposures in the foreign exchange, interest and
commodity markets only after approval by senior management. The counterparties
used in these transactions have been diversified in order to minimize the impact
of any potential credit loss in the event of nonperformance by the
counterparties. Derivative activities are described in greater detail in "Debt
and Other Financial Instruments" in the Notes to the Consolidated Financial
Statements.
Eaton is subject to interest rate risk as it relates to long-term debt. The
table below presents principal cash flows and related weighted-average interest
rates by expected maturity dates of long-term debt and capital leases, excluding
foreign currency principal swaps and immaterial long-term debt of certain
international operations.
2002
Expected maturity date
-------------------------------------------- Fair
2003 2004 2005 2006 2007 After Total value
---- ---- ---- ---- ---- ----- ----- -----
Long-term debt, including
current portion
Fixed rate (US$) $250 $ 15 $186 $ 50 $1,013 $1,514 $1,656
Average interest rate 7.0% 6.4% 8.5% 7.0% 7.0% 7.2%
Fixed rate (Yen in 2006
and Euro in 2007) $ 42 $209 $251 $270
Average interest rate 1.6% 6.0% 5.3%
Variable rate debt (US$) $150 $ 30 $180 $180
Average interest rate 2.6% 1.4% 2.4%
2001
Expected maturity date
-------------------------------------------- Fair
2002 2003 2004 2005 2006 After Total value
---- ---- ---- ---- ---- ----- ----- -----
Long-term debt, including
current portion
Fixed rate (US$) $125 $250 $ 15 $186 $762 $1,338 $1,451
Average interest rate 7.0% 7.0% 6.4% 8.5% 7.5% 7.5%
Fixed rate (Yen in 2006
and Euro in 2007) $ 38 $177 $215 $232
Average interest rate 1.6% 6.0% 5.2%
Variable rate debt (US$ $380 $400 $780 $780
Average interest rate 3.0% 3.0% 3.0%
By the end of 2002, approximately 43% of Eaton's long-term debt was swapped
to floating interest rates. Additional information related to long-term debt and
related interest rate swaps can be found in "Debt and Other Financial
Instruments" in the Notes to the Consolidated Financial Statements.
F-44
Minimum rental commitments for 2003 under noncancelable operating leases,
which expire at various dates and in most cases contain renewal options, are $83
and decline substantially thereafter.
Forward-Looking Statements
- --------------------------
This Annual Report to Shareholders contains forward-looking statements
concerning 2003 net income per Common Share, operating earnings per share,
worldwide markets for Eaton products, volumes from new business awards and
relationships (including long-term contracts) which are not necessarily spread
evenly throughout the award periods, expenses and benefits of restructuring
programs, capital expenditures, pension and other postretirement benefit expense
and compliance with credit agreements. These statements are subject to various
risks and uncertainties, many of which are outside the Company's control and,
therefore, should be used with caution. The following factors could cause actual
results to differ materially from those in the forward-looking statements:
unanticipated changes in the markets for the Company's business segments;
failure to implement restructuring plans; unanticipated downturns in business
relationships with customers or sales to these customers, including sales
pursuant to new long-term contracts where volumes and the timing of sales can
vary materially from expectations and from year to year; competitive pressures
on sales and pricing; increase in the cost of material and other production
costs, or unexpected costs that cannot be recouped in product pricing; the
introduction of competing technologies; unexpected technical or marketing
difficulties; unexpected claims, charges or dispute resolutions; and
unanticipated further deterioration of economic and financial conditions in the
United States and around the world. Eaton does not assume any obligation to
update these forward-looking statements.
2001 Compared to 2000 - Continuing Operations
- ---------------------------------------------
Results of Operations
- ---------------------
Net sales of continuing operations of $7,299 in 2001 decreased 12% from
2000. Excluding the impact on sales from the divestiture of the VS/ED in 2001,
sales from ongoing operations declined 10% for the year. Sales of the Fluid
Power segment were $2,507 in 2001, 4% below 2000, while sales of the Industrial
& Commercial Controls segment of $2,199 were down 9% from 2000. The Automotive
segment reported sales of $1,479 in 2001, which were down only 2% from 2000.
Truck segment sales fell to $1,029 in 2001, 29% below 2000, representing the
largest segment decline across the Company.
Net sales in the United States and Canada decreased 12% in 2001 to $5,854,
primarily the result of weak economic conditions. In 2001, sales in Europe fell
10% to $1,108, as the European economy weakened as well. Sales in the United
States and Europe also were lower due to the divestiture in the first quarter of
2001 of VS/ED, which had sales of $323 in 2000. Sales in Latin America were
$406, down 1% from the prior year. Sales in the Pacific region increased 23% to
$310, primarily due to the acquisition of the remaining 50% interest in Sumitomo
Eaton Hydraulics Company (now named Eaton Fluid Power Ltd).
F-45
In response to the weakening global business environment in early 2001, and
the anticipated delay in recovery of the economy and Eaton's end markets until
the second half of 2002, the Company took restructuring actions in 2001 to help
maintain a competitive advantage in the current economic environment and reduce
structural costs across its businesses. Operational restructuring charges
totaled $119 in 2001, including $55 related to the Truck business, $30 for the
Industrial & Commercial Controls business, and $22 for actions to continue the
integration of the former Aeroquip-Vickers operations and other recent
acquisitions within Fluid Power. Restructuring charges in 2001 for reductions in
corporate staff and other actions were $12. A charge of $10 was also recorded in
2001 related to an arbitration award in connection with a contractual dispute
over supply arrangements associated with a subsidiary of Eaton. The arbitration
award resulted from a legal action initiated in February 1999 against Vickers,
Inc. (now named Eaton Hydraulics Inc.), part of Aeroquip-Vickers, Inc., which
was acquired by Eaton in April 1999.
All restructuring charges and other unusual pretax charges totaled $129 in
2001 ($86 after-tax, or $1.21 per Common Share), compared to similar pretax
charges of $52 in 2000 ($34 after-tax, or $.47 per share). Unusual charges for
2000 included operational restructuring charges of $47 related to the Fluid
Power business segment and $5 for actions to restructure corporate staff. The
operational restructuring charges in 2001 and 2000 are included in the
Statements of Consolidated Income in Income from Operations and reduced
operating profit of the related business segment. The corporate charges are
included in the Statements of Consolidated Income in Income from Operations,
except for $11 in 2001 included in Other Income-Net that primarily related to
the arbitration award discussed above. In Business Segment Information, all
corporate charges are included in Corporate & Other-Net.
As displayed in the Statements of Consolidated Income, Income from
Operations in 2001 of $348 declined 46% from $649 in 2000. The decline was the
result of the difficult operating conditions in most of Eaton's businesses in
2001, especially the Truck segment, coupled with the increased levels of
restructuring charges recorded in 2001.
During 2001, Eaton sold businesses resulting in a net pretax gain of $61
($22 after-tax, or $.30 per Common Share). In the first quarter, VS/ED, which
had sales of $323 in 2000, was divested along with certain assets of the Truck
segment. In the third quarter, the Air Conditioning & Refrigeration business,
which had sales of $75 in 2000, was sold along with certain assets of the
Automotive segment. These gains are reported as a separate line item in the
Statements of Consolidated Income and Business Segment Information. In Business
Segment Information, the operating results of VS/ED are included in Divested
Operations.
Income in 2000 was increased by a net pretax gain on the sales of corporate
assets of $22 ($14 after-tax, or $.19 per Common Share). These gains were
included in the Statements of Consolidated Income in Other Income-Net and in
Business Segment Information in Corporate and Other-Net.
Before restructuring and the other unusual charges and gains on the sales
of businesses, operating earnings were $233 in 2001 ($3.30 per Common Share),
down 39% from $383 in 2000 ($5.28 per share). The decline was the result of the
difficult operating conditions in most of Eaton's businesses in 2001, especially
in the Truck segment. Income from continuing operations, including unusual
charges and gains on sales of businesses, was $169 in 2001 ($2.39 per share),
down 53% from $363 in 2000 ($5.00 per share).
F-46
Business Segments
- -----------------
Fluid Power
- -----------
Eaton's largest business segment, Fluid Power, reported sales of $2,507 in
2001, 4% below 2000, due primarily to weak markets for mobile and industrial
hydraulic products. This result compared favorably to an 11% decline in Fluid
Power's markets, with North American fluid power industry shipments off about
17%, and aerospace shipments that were flat compared to 2000. Sales for the
Aerospace business were up 9% during 2001. However, the anticipated weakening of
this business, resulting from the September 11th terrorist attacks, began to be
felt during the fourth quarter.
Operating profits before restructuring charges were $205 in 2001, down from
$282 in 2000. These profits represented a return on sales of 8.2% in 2001
compared to 10.8% in 2000. The decrease in profit was primarily attributable to
weak market conditions, which resulted in a significant decrease in sales
volumes during 2001. In response to these weak market conditions, this segment
accelerated the integration of Aeroquip-Vickers and other recent acquisitions.
The elimination of 600 positions announced in April 2001 was expanded to 1,000
positions in the third quarter and was completed before year-end. Restructuring
charges recognized in 2001 were $22 compared to $47 in 2000. Profits after
restructuring charges were $183 in 2001, down from $235 in 2000.
In the first quarter of 2001, Eaton completed the purchase of the remaining
50% interest in Sumitomo Eaton Hydraulics Company (now named Eaton Fluid Power
Ltd.), the former joint venture with Sumitomo Heavy Industries Ltd. located in
Kyoto, Japan. This acquisition had annualized sales of $76 in the Pacific
region.
Industrial & Commercial Controls
- --------------------------------
Industrial & Commercial Controls sales of $2,199 in 2001 were down 9% from
2000. Excluding divestitures, sales were off about 7%, compared to an estimated
19% decline in North American markets. This segment outperformed its markets due
to share growth, the continued growth of the Cutler-Hammer Engineering Services
and Systems (C-H ESS) business and increased participation in power quality
markets. End markets for this segment weakened significantly during 2001 due to
prolonged weakness in the industrial segment of the economy, with particular
weakness in the short-cycle distributor flow goods business, which typically
includes higher margin products. The large-project business also showed weakness
late in 2001.
Operating profits before restructuring charges were $193 in 2001, down from
$251 in 2000. These profits represented a return on sales of 8.8% in 2001
compared to 10.4% in 2000. Weak markets in the industrial and commercial sectors
and distributor businesses, as well as the effects of product mix and
restructuring charges, were responsible for the decreased profits in 2001. In
response to weakening market conditions in this business, restructuring actions
were implemented, including the elimination of 887 positions within the
organization. Restructuring charges recognized in 2001 were $30. Profits after
restructuring charges were $163 in 2001, down from $251 in 2000.
F-47
In the first quarter of 2001, the Company announced it had formed a 50-50
joint venture with Hager Electro SA, creating Eletromar Ltda. This operation
manufactures International Electrical Code residential circuit breakers in
Brazil for the South American marketplace.
Automotive
- ----------
Sales for the Automotive segment of $1,479 in 2001 were down 2% from 2000.
This compared to a 10% decrease in NAFTA automotive production and flat European
automotive production. Despite difficult North American markets and gradual
weakening of markets in Europe, this segment realized the benefit of market
share gains.
Operating profits were $194 in 2001, down 9% from $214 in 2000. These
profits represented a return on sales of 13.1% in 2001 compared to 14.2% in
2000. These results reflected the reduced level of sales in 2001 and were
achieved in spite of difficult market conditions and increased engineering and
research and development costs associated with new product launches for model
years 2002-2004.
In 2001, the Company announced the acquisition of the European portion of
the vehicle mirror actuator business of Donnelley Corporation, located in
Manorhamilton, Ireland. A portion of Eaton's existing mirror actuator business
was relocated to the new facility in Ireland and that operation is expected to
reach sales levels of $50 over the next two to three years.
Truck
- -----
Due to extraordinarily depressed industry conditions, sales of the Truck
segment were $1,029 in 2001, 29% below 2000. NAFTA heavy truck production for
the year was down 42% to 146,000 units, NAFTA medium-duty truck production was
down 21%, European truck production was down 9% and South American production
was up 7%.
Operating losses before restructuring charges were $9 in 2001 compared to
profits of $107 in 2000. The decrease in profit was primarily attributable to
the significant decrease in sales volumes during 2001, the result of very weak
market conditions. This segment completed restructuring actions during 2001
related to the European medium-duty and heavy-duty truck businesses. After
restructuring charges of $55 in 2001, operating losses were $64 in 2001 compared
to profits of $107 in 2000.
During 2001, Eaton acquired the commercial clutch manufacturing assets of
Transmisiones TSP, S.A. de C.V. This business was relocated to the new Truck
facility in San Luis Potosi, Mexico, when that plant became operational in 2002.
Corporate Income (Expense)
- -------------------------
Net interest expense was $142 in 2001, down from $177 in 2000. The decrease
was primarily related to the $564 reduction of debt in 2001 from cash flow from
operations and proceeds from the sales of businesses, as well as reductions in
interest rates during 2001.
Corporate & other-net expense of $29 in 2001 compared to income of $9 in
2000. The decline was due to a $22 pretax gain recorded in 2000 on the sales of
corporate assets and a charge of $10 recorded in 2001 related to an arbitration
award, both of which are discussed above.
F-48
QUARTERLY DATA
- --------------
(Unaudited)
Quarter ended in 2002 Quarter ended in 2001
-------------------------------------- --------------------------------------
Dec. 31 Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31
------- -------- ------- ------- ------- -------- ------- -------
(Millions except for per share data)
Net sales $1,775 $1,830 $1,881 $1,723 $1,695 $1,750 $1,871 $1,983
Gross margin 469 514 517 437 415 424 471 486
Percent of sales 26% 28% 27% 25% 24% 24% 25% 25%
Income before income taxes 92 132 127 48 39 61 74 104
Net income $ 67 $ 93 $ 88 $ 33 $ 30 $ 40 $ 49 $ 50
Net income per Common Share
Assuming dilution $ .94 $ 1.30 $ 1.21 $ .47 $ .42 $ .57 $ .69 $ .72
Basic .95 1.32 1.24 .48 .42 .58 .70 .73
Cash dividends paid per Common Share $ .44 $ .44 $ .44 $ .44 $ .44 $ .44 $ .44 $ .44
Market price per Common Share
High $80.30 $73.94 $87.11 $83.98 $76.00 $76.90 $81.43 $74.97
Low 59.10 59.83 69.06 65.90 58.34 55.12 66.16 63.75
A reconciliation of net income to
operating earnings follows:
Net income $ 67 $ 93 $ 88 $ 33 $ 30 $ 40 $ 49 $ 50
Excluding (after-tax)
Unusual charges 2 10 2 33 17 22 17 30
Gains on sales of businesses (13) (15) (7)
------ ------ ------ ------ ------ ------ ------ ------
Operating earnings $ 69 $ 90 $ 90 $ 66 $ 47 $ 47 $ 66 $ 73
====== ====== ====== ====== ====== ====== ====== ======
Net income per Common Share assuming
dilution $ .94 $ 1.30 $ 1.21 $ .47 $ .42 $ .57 $ .69 $ .72
Per share impact of unusual items .04 (.04) .03 .46 .23 .09 .25 .33
------ ------ ------ ------ ------ ------ ------ ------
Operating earnings per Common Share $ .98 $ 1.26 $ 1.24 $ .93 $ .65 $ .66 $ .94 $ 1.05
====== ====== ====== ====== ====== ====== ====== ======
F-49
Seven-Year Consolidated Financial Summary
- -----------------------------------------
2002 2001 2000 1999 1998 1997 1996
---- ---- ---- ---- --- ---- ----
(Millions except for per share data)
Continuing operations
Net sales $7,209 $7,299 $8,309 $8,005 $6,358 $7,104 $6,515
Income before income taxes 399 278 552 943 616 730 428
Income after income taxes 281 169 363 603 430 526 305
Percent of net sales 3.9% 2.3% 4.4% 7.5% 6.7% 7.4% 4.7%
Extraordinary item - redemption of debentures (54)
Income (loss) from discontinued operations 90 14 (81) (62) 44
------ ------ ------ ------ ------ ------ ------
Net income $ 281 $ 169 $ 453 $ 617 $ 349 $ 410 $ 349
====== ====== ====== ====== ====== ====== ======
Net income per Common Share assuming dilution
Continuing operations $ 3.92 $ 2.39 $ 5.00 $ 8.17 $ 5.91 $ 6.72 $ 3.89
Extraordinary item (.69)
Discontinued operations 1.24 .19 (1.11) (.79) .57
------ ------ ------ ------ ------ ------ ------
$ 3.92 $ 2.39 $ 6.24 $ 8.36 $ 4.80 $ 5.24 $ 4.46
====== ====== ====== ====== ====== ====== ======
Average number of Common Shares outstanding 71.7 70.5 72.6 73.7 72.7 78.2 78.2
Net income per Common Share basic
Continuing operations $ 3.98 $ 2.43 $ 5.06 $ 8.31 $ 6.02 $ 6.85 $ 3.93
Extraordinary item (.71)
Discontinued operations 1.25 .20 (1.13) (.80) .57
------ ------ ------ ------ ------ ------ ------
$ 3.98 $ 2.43 $ 6.31 $ 8.51 $ 4.89 $ 5.34 $ 4.50
====== ====== ====== ====== ====== ====== ======
Average number of Common Shares outstanding 70.6 69.4 71.8 72.5 71.4 76.8 77.4
Cash dividends paid per Common Share $ 1.76 $ 1.76 $ 1.76 $ 1.76 $ 1.76 $ 1.72 $ 1.60
- ----------------------------------------------------------------------------------------------------------
Total assets $7,138 $7,646 $8,180 $8,342 $5,570 $5,497 $5,290
Long-term debt 1,887 2,252 2,447 1,915 1,191 1,272 1,062
Total debt 2,088 2,440 3,004 2,885 1,524 1,376 1,092
Shareholders' equity 2,302 2,475 2,410 2,624 2,057 2,071 2,160
Shareholders' equity per Common Share $32.61 $35.61 $35.29 $35.44 $28.69 $27.72 $28.00
Common Shares outstanding 70.6 69.5 68.3 74.0 71.7 74.7 77.1
- ----------------------------------------------------------------------------------------------------------
A reconciliation of income from continuing
operations to operating earnings of
continuing operations follows:
Income from continuing operations $ 281 $ 169 $ 363 $ 603 $ 430 $ 526 $ 305
Excluding (after-tax)
Unusual charges 47 86 34 20 44 15 31
Gains on sales of businesses (13) (22) (198) (28) (69)
Gains on sales of corporate assets (14)
------ ------ ------ ------ ------ ------ ------
Operating earnings from continuing
operations $ 315 $ 233 $ 383 $ 425 $ 446 $ 472 $ 336
====== ====== ====== ====== ====== ====== ======
Income from continuing operations
per Common Share assuming dilution $ 3.92 $ 2.39 $ 5.00 $ 8.17 $ 5.91 $ 6.72 $ 3.89
Per share impact of unusual items .48 .91 .28 (2.41) .23 (.69) .40
------ ------ ------ ------ ------ ------ ------
Operating earnings per Common Share of
continuing operations $ 4.40 $ 3.30 $ 5.28 $ 5.76 $ 6.14 $ 6.03 $ 4.29
====== ====== ====== ====== ====== ====== ======
F-50
Eaton Corporation
2002 Annual Report on Form 10-K
Exhibit Index
Exhibits
3(a) Amended Articles of Incorporation (amended and restated as of
April 27, 1994) - Filed in conjunction with this Form 10-K
3(b) Amended Regulations (amended and restated as of April 26,
2000)- Incorporated by reference to the Form 10-Q for the six
months ended June 30, 2000
4(a) Instruments defining rights of security holders, including
indentures (Pursuant to Regulation S-K Item 601(b)(4), the
Company agrees to furnish to the Commission, upon request, a
copy of the instruments defining the rights of holders of long-
term debt)
4(b) Rights Agreement (Dated as of June 28, 1995) - Filed in
conjunction with this Form 10-K
10 Material contracts - Each of the following is either a
management contract or a compensatory plan or arrangement:
(a) Deferred Incentive Compensation Plan (amended and restated as
of March 31, 2000) - Incorporated by reference to the Form
10-K for the year ended December 31, 2000
(b) Executive Strategic Incentive Plan I (Amended and Restated as
of January 1, 2001) - Filed in conjunction with this
Form 10-K
(c) Group Replacement Insurance Plan (GRIP), effective as of
June 1, 1992 - Incorporated by reference to the Form 10-K for
the year ended December 31, 1992
(d) 1991 Stock Option Plan - Filed in conjunction with this Form
10-K
(e) 1995 Stock Plan - Filed in conjunction with this Form 10-K
(f) Incentive Compensation Deferral Plan (amended and restated as
of October 1, 1997) - Incorporated by reference to the Form
10-K for the year ended December 31, 2000
(g) Form of Change of Control Agreement entered into with
officers of Eaton Corporation - Filed in conjunction with
this Form 10-K
(h) Form of Indemnification Agreement entered into with officers
of Eaton Corporation - Filed in conjunction with this Form
10-K
(i) Limited Eaton Service Supplemental Retirement Income Plan
(amended and restated as of January 1, 2003) - Filed in
conjunction with this Form 10-K
(j) Supplemental Benefits Plan (amended and restated as of
January 1, 1989) (which provides supplemental retirement
benefits) - Filed in conjunction with this Form 10-K
(k) Excess Benefits Plan (Amended and Restated Effective
January 1, 1989) (with respect to Section 415 limitations of
the Internal Revenue Code) - Filed in conjunction with this
Form 10-K
(l) Executive Incentive Compensation Plan - Incorporated by
reference to the Form 10-K for the year ended December 31,
2000
(m) Plan for the Deferred Payment of Directors' Fees (Originally
adopted in 1985 and amended effective as of September 24,
1996 and January 28, 1998) - Filed in conjunction with this
Form 10-K
(n) Plan for the Deferred Payment of Directors' Fees (Originally
adopted in 1980 and amended and restated in 1989 and 1996) -
Filed in conjunction with this Form 10-K
(o) 1996 Non-Employee Director Fee Deferral Plan (amended and
restated as of October 22, 2002) - Filed in conjunction with
this Form 10-K
(p) Trust Agreement - Outside Directors (dated December 6, 1996)
- Filed in conjunction with this Form 10-K
(q) Trust Agreement - Officers and Employees (dated December 6,
1996) - Filed in conjunction with this Form 10-K
(r) 1998 Stock Plan - Incorporated by reference to the definitive
Proxy Statement dated March 13, 1998
(s) 2002 Stock Plan - Incorporated by reference to the definitive
Proxy Statement dated March 15, 2002
(t) Executive Strategic Incentive Plan II (Effective as of
January 1, 2001) - Filed in conjunction with this Form 10-K
12 Ratio of Earnings to Fixed Charges - Filed in conjunction with this
Form 10-K
21 Subsidiaries of Eaton Corporation - Filed in conjunction with this
Form 10-K
23 Consent of Independent Auditors - Filed in conjunction with this
Form 10-K
24 Power of Attorney - Filed in conjunction with this Form 10-K