Summary of EATON CORP - Yahoo! Finance

ITEM 2. MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS
Millions of dollars unless indicated otherwise (per share data assume dilution)
OVERVIEW OF EATON
Eaton Corporation is a diversified power management company with 2007 sales of $13 billion. Eaton is a global technology leader in electrical systems for power quality, distribution and control; hydraulics components, systems and services for industrial and mobile equipment; aerospace fuel, hydraulics and pneumatic systems for commercial and military use; and truck and automotive drivetrain and powertrain systems for performance, fuel economy and safety. Eaton has 82,000 employees and sells products to customers in more than 150 countries. The principal markets for the Electrical segment are industrial, non-residential and residential construction, commercial, government, institutional, and telecommunications customers. These customers are generally concentrated in North America, Europe and Asia/Pacific; however, sales are made globally. Sales are made directly and indirectly through distributors and manufacturers representatives to these customers. The principal markets for the Hydraulics segment are original equipment manufacturers and after-market customers of off-highway and industrial equipment as well as equipment and systems used in oil and gas, fine chemicals, mining, metal forming, and food and beverage applications. These manufacturers and other customers are located globally, and these products are sold and serviced through a variety of channels. The principal markets for the Aerospace segment are manufacturers of commercial and military aircraft and related after-market customers. These manufacturers and other customers are located globally, and these products are sold and serviced through a variety of channels. The principal markets for the Truck and Automotive segments are original equipment manufacturers and after-market customers of heavy-, medium-, and light-duty trucks and passenger cars. These manufacturers and other customers are located globally, and most sales of these products are made directly to these customers.
HIGHLIGHTS OF RESULTS FOR 2008
In the third quarter of 2008, Eaton posted sales that grew 25% over the third quarter of 2007 and were a third quarter record. Net income and net income per Common Share grew 22% and 9% in the third quarter of 2008 over the third quarter of 2007, respectively. Results for the third quarter of 2008 improved over the third quarter of 2007 despite the negative effect of the turmoil in the world credit markets on Eaton's end markets. The growth in financial results in the third quarter of 2008 was due in part to Eaton's improved business and geographic balance which has allowed Eaton to grow despite downturns in certain end markets. Sales and operating profits for the Electrical, Hydraulics, and Aerospace business segments all increased in the third quarter of 2008 compared to the third quarter of 2007. Sales of the Truck segment increased in the third quarter of 2008 compared to the third quarter of 2007 and operating profit in 2008 was even with the third quarter of 2007. Sales, operating profit and return on sales for the Electrical segment in the third quarter of 2008 were all-time quarterly records, and sales and operating profit for the Hydraulics and Aerospace segments were third quarter records.

                                        Three months ended September 30                            Nine months ended September 30
                                  2008                 2007             Increase             2008                2007             Increase
Continuing operations
Net sales                     $      4,114         $      3,298                25 %      $     11,889         $     9,659                23 %
Gross profit                         1,150                  917                25 %             3,324               2,705                23 %
Percent of net sales                  28.0 %               27.8 %                                28.0 %              28.0 %
Income before income
taxes                                  354                  263                35 %               994                 782                27 %
Income after income
taxes                         $        315         $        238                32 %      $        892         $       707                26 %
Income from discontinued
operations                                                   20                                     3                  31

Net income                    $        315         $        258                22 %      $        895         $       738                21 %


Net income per Common
Share assuming dilution
Continuing operations         $       1.87         $       1.59                18 %      $       5.55         $      4.71                18 %
Discontinued operations                                     .12                                   .02                 .20

                              $       1.87         $       1.71                 9 %      $       5.57         $      4.91                13 %

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Sales growth of 25% in the third quarter of 2008 over the third quarter of 2007 consisted of 19% from acquisitions of businesses within the last year, 4% from organic growth, and 2% from foreign exchange. Acquisitions of businesses included The Moeller Group, acquired in April 2008; Phoenixtec, acquired in February 2008; and the MGE small systems UPS business, acquired in October 2007, all of which are included in the Electrical segment. These acquisitions further expanded the proportion of Eaton's sales outside of the United States. Organic growth included 2% from growth in end markets and 2% from outgrowing end markets.
The increase in sales for the third quarter of 2008 over the third quarter of 2007 was primarily due to the acquisitions of businesses and growing end markets for the Electrical, Hydraulics, Aerospace, and Truck segments. These improvements in end markets were partially offset by weakness in end markets for the Automotive segment. Sales in the first nine months of 2008 increased 23% over the first nine months of 2007 primarily due to the same factors as in the third quarter of 2008, and also reflected sales of the Argo-Tech aerospace business, acquired in March 2007.
Gross profit increased 25% in the third quarter of 2008 over the third quarter of 2007. This increase was primarily due to sales growth of 25%, the benefits of integrating acquired businesses, and continued productivity improvements driven by the Eaton Business System (EBS). These increases in gross profit were partially offset by the impact of rising prices for raw materials, supplies and other commodities. The 23% increase in gross profit for the first nine months of 2008 over the first nine months of 2007 was primarily due to the same factors as in the third quarter of 2008.
Net income in the third quarter of 2008 increased 22% over the third quarter of 2007. The increase was primarily due to higher sales and the other factors that affected gross profit discussed above, partially offset by increases in selling, administrative, research and development expenses. In addition, a $20 after-tax gain on the sale of the Mirror Controls business was included in income from discontinued operations in the third quarter of 2007. Net income per Common Share in the third quarter of 2008 increased 9% over the third quarter of 2007 due to the factors that affected net income discussed above, partially offset by the effect of the sale of 18.678 million Common Shares in a public offering in April and May 2008. The increases of 21% in net income and 13% in net income per share for the first nine months of 2008 over the first nine months of 2007 were primarily due to the same factors as in the third quarter of 2008. In 2008, Eaton acquired certain businesses in separate transactions. The Statements of Consolidated Income include the results of these businesses from the effective dates of acquisition. A summary of these transactions follows:

                                                Date of           Business
Acquired business                             acquisition         segment       Annual sales
Engine Valves Business of Kirloskar          July 31, 2008       Automotive      $5 for 2007
Oil Engines Ltd.
An India-based designer, manufacturer
and distributor of intake and exhaust
valves for diesel and gasoline engines

The Moeller Group                            April 4, 2008       Electrical     €1.02 billion
A Germany-based supplier of electrical                                            for 2007
components for commercial and
residential building applications and
industrial controls for industrial
equipment applications

Balmen Electronic, S.L.                     March 31, 2008       Electrical      $6 for 2007
A Spain-based distributor and service
provider of uninterruptible power
supply (UPS) systems

Phoenixtec Power Company Ltd.              February 26, 2008     Electrical     $515 for 2007
A Taiwan-based manufacturer of single
and three-phase uninterruptible power
supply (UPS) Systems

On October 2, 2008 Eaton acquired Integ Holdings Limited, the parent company of Integrated Hydraulics Ltd., a U.K.-based manufacturer of screw-in cartridge valves, custom-engineered hydraulic valves and manifold systems. The company employs approximately 290 people and will be reported as part of the Hydraulics business segment.

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In February 2008, Eaton borrowed $250 under a 364-day $3.0 billion revolving credit agreement to partially finance the acquisition of Phoenixtec. In April 2008, Eaton borrowed €1.33 billion under the revolving credit agreement to finance the acquisition of Moeller. In order to refinance debt that was issued to partially fund these acquisitions, Eaton sold 18.678 million of its Common Shares in a public offering in April and May 2008, resulting in net cash proceeds of $1.522 billion. In May 2008, Eaton issued $300 of 4.9% notes due in 2013 and $450 of 5.6% notes due in 2018. The cash proceeds from the sale of the Common Shares and from the issuance of the notes were used to repay borrowings incurred to fund the acquisitions of Moeller and Phoenixtec, and to repay commercial paper issued under the backstop provided by the $3.0 billion revolving credit agreement. Subsequently, in May 2008 Eaton terminated the $3.0 billion revolving credit agreement.
Total debt of $4,362 at September 30, 2008 increased $945 from $3,417 at year-end 2007. The increase in total debt included the issuance of $750 of long-term notes and $956 of commercial paper and other borrowings, partially offset by the repayment of $792 of notes, commercial paper and other debt. The increase in total debt largely resulted from funding the acquisitions of Moeller, Phoenixtec, and other businesses in 2008 for $2,707, offset by cash proceeds of $1,522 from the sale of 18.678 million Common Shares in the second quarter of 2008, the issuance of $750 of long-term notes, and from other borrowings to fund working capital and other requirements. These actions allowed Eaton to finish the third quarter of 2008 with net-debt-to-capital ratios about the same as those prior to completing the acquisitions of Moeller and Phoenixtec. The net-debt-to-capital ratio was 35.8% at September 30, 2008 compared to 34.9% at year-end 2007, reflecting the combined effect during 2008 of the $945 increase in total debt, the $183 decrease in cash and short-term investments, and the $1,807 increase in Shareholders' equity, which resulted principally from the sale of Common Shares in the second quarter and from net income of $895 for the first nine months of 2008.
Net cash provided by operating activities in the first nine months of 2008 was $792 compared to $733 in the first nine months of 2007, an increase of $59. The increase was primarily due to higher net income of $157 and a decrease in contributions to pension plans of $67, partially offset by a net increase of $179 in working capital funding. Cash and short-term investments totaled $463 at September 30, 2008, down $183 from $646 at year-end 2007.
Net working capital of $1,085 at September 30, 2008 compared to $1,108 at year-end 2007, or a net reduction of $23. The change in net working capital was primarily due to the $637 increase in accounts receivable and the $312 increase in inventories in the first nine months of 2008, partially offset by the $271 increase in short-term debt and the $333 increase in accounts payable and certain other working capital accounts, resulting from the acquisitions of Moeller and Phoenixtec and higher levels of sales and operations. The net increase in these working capital accounts was partially offset by the $185 increase in current portion of long-term debt, and cash and short-term investments that decreased $183. The current ratio was 1.24 at September 30, 2008 and 1.30 at year-end 2007.
In light of its strong results and future prospects, on January 21, 2008 Eaton increased the quarterly dividend on its Common Shares by 16%, from $.43 per share to $.50 per share, effective for the February 2008 dividend. This is the fourth dividend increase within the last three years, reflecting Eaton's philosophy of growing its dividend in line with its long-term growth in earnings.
As of mid-October 2008, Eaton anticipates overall end market growth in the fourth quarter of 2008 to be flat with the prior year, a reduction from its previous expectation, as a result of the impact of the turmoil in world credit markets on Eaton's end markets. Eaton anticipates net income per Common Share in the fourth quarter of 2008 to be between $1.55 and $1.65 per share, after acquisition integration charges of $.15 per share. For the full year of 2008, due to the reduction in expectations for end market growth, Eaton expects earnings per share for 2008 to be between $7.10 and $7.20 per share, after acquisition integration charges of $.35 per share.

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RESULTS OF OPERATIONS - 2008 COMPARED TO 2007

Three months ended September 30 Nine months ended September 30 2008 2007 Increase 2008 2007 Increase Continuing operations
Net sales $ 4,114 $ 3,298 25 % $ 11,889 $ 9,659 23 % Gross profit 1,150 917 25 % 3,324 2,705 23 % Percent of net sales 28.0 % 27.8 % 28.0 % 28.0 % Income before income
taxes 354 263 35 % 994 782 27 % Income after income
taxes $ 315 $ 238 32 % $ 892 $ 707 26 % Income from discontinued
operations 20 3 31

Net income $ 315 $ 258 22 % $ 895 $ 738 21 %

Net income per Common
Share assuming dilution
Continuing operations $ 1.87 $ 1.59 18 % $ 5.55 $ 4.71 18 % Discontinued operations .12 .02 .20

$ 1.87 $ 1.71 9 % $ 5.57 $ 4.91 13 %

OTHER RESULTS OF OPERATIONS
In 2008 and 2007, Eaton incurred charges related to the integration of acquired
businesses. These charges, which consisted of plant consolidations and
integration, were recorded as expense as incurred. A summary of these charges
follows:

                                  Three months ended           Nine months ended
                                     September 30                 September 30
                                 2008            2007          2008           2007
           Electrical          $      14       $       4     $      24       $    8
           Hydraulics                  1               2             4            9
           Aerospace                   4              11            17           27
           Automotive                  1               1             3            1
           Corporate                   1                             3

           Pretax charges      $      21       $      18     $      51       $   45

           After-tax charges   $      14       $      11     $      34       $   29
           Per Common Share    $     .08       $     .08     $     .21       $  .20

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Charges in 2008 related to the integration of primarily the following acquisitions: in the Electrical segment, Moeller, Phoenixtec, the MGE small systems UPS business, and Senyuan; in the Hydraulics segment, Ronningen-Petter, Synflex and Hayward; in the Aerospace segment, Argo-Tech, PerkinElmer and Cobham; and in the Automotive segment, Saturn.
Charges in 2007 related to the integration of primarily the following acquisitions: in the Electrical segment, Senyuan and Powerware; in the Hydraulics segment, Synflex, Hayward and Walterscheid; and in the Aerospace segment, PerkinElmer and Cobham.
The acquisition integration charges were included in the Statements of Consolidated Income in Cost of products sold or Selling & administrative expense, as appropriate. In Business Segment Information, the charges reduced Operating profit of the related business segment.
The effective income tax rates for continuing operations for the third quarter and the first nine months of 2008 were 11.0% and 10.3%, respectively, compared to 9.4% and 9.5% for the same periods in 2007.
Net income in the third quarter of 2008 increased 22% over the third quarter of 2007. The increase was primarily due to higher sales and the other factors that affected gross profit discussed above, partially offset by increases in selling, administrative, research and development expenses. In addition, a $20 after-tax gain on the sale of the Mirror Controls business was included in income from discontinued operations in the third quarter of 2007. Net income per Common Share in the third quarter of 2008 increased 9% over the third quarter of 2007 due to the factors that affected net income discussed above, partially offset by the effect of the sale of 18.678 million Common Shares in a public offering in April and May 2008. The increases of 21% in net income and 13% in net income per share for the first nine months of 2008 over the first nine months of 2007 were primarily due to the same factors as in the third quarter of 2008.

RESULTS BY BUSINESS SEGMENT
Electrical

                                        Three months ended September 30                            Nine months ended September 30
                                  2008                 2007             Increase            2008                2007              Increase
Net sales                     $      1,941         $      1,221                59 %      $     5,184         $     3,463                 50 %
Operating profit                       259                  156                66 %              669                 415                 61 %
Operating margin                      13.3 %               12.8 %                               12.9 %              12.0 %

Sales of the Electrical segment reached record levels in the third quarter of 2008. The 59% increase in sales over the third quarter of 2007 consisted of 51% from acquisitions of businesses within the past 12 months, primarily Moeller, Phoenixtec and the MGE small systems UPS business, and 8% from organic growth. End markets for the Electrical segment grew about 4% during the third quarter of 2008 compared to the third quarter of 2007. U.S. markets grew 3% in the third quarter of 2008 and non-U.S. markets grew 4% in the quarter. Sales for the first nine months of 2008 increased 50% over the first nine months of 2007 primarily due to the same factors as in the third quarter of 2008. Despite current economic difficulties, the global electrical distribution and control markets and electrical power quality markets have held up well, although there are early indications that markets are beginning to slow. As a result, Eaton expects end market growth in the Electrical segment in the fourth quarter of 2008 to be closer to 2%.
Operating profit rose 66% in the third quarter of 2008 over the third quarter of 2007, and operating margin rose to 13.3% both of which were records for this segment. The increase in operating profit was largely due to growth in sales, results of acquired businesses, and continued productivity improvements. Operating profit was reduced by acquisition integration charges of $14 in the third quarter of 2008 compared to charges of $4 in the third quarter of 2007, which reduced the operating margin by 0.8% and 0.3% in 2008 and 2007, respectively. Acquisition integration charges in 2008 primarily related to Moeller, Phoenixtec, the MGE small systems UPS business, and Senyuan. Charges in 2007 related to Senyuan and Powerware. The incremental operating margin for the third quarter of 2008 (the increase in operating profit compared to the increase in sales) was 14%. The operating margin for acquired businesses for the third quarter of 2008 was 15%.
Operating profit for the first nine months of 2008 increased 61% over the first nine months of 2007 primarily due to the same factors as in the third quarter of 2008. Operating profit was reduced by acquisition integration charges of $24 in the first nine months of 2008 compared to charges of $8 in the first nine months of 2007, which reduced operating margin by 0.5% and 0.2% in 2008 and 2007, respectively.

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On April 4, 2008, Eaton acquired The Moeller Group, a Germany-based business which is a leading supplier of electrical components for commercial and residential building applications and industrial controls for industrial equipment applications. This business had sales of €1.02 billion for 2007. On March 31, 2008, Eaton acquired Balmen Electronic, S.L., a Spain-based distributor and service provider of uninterruptible power supply (UPS) systems. This business had sales of $6 for 2007.
On February 26, 2008, Eaton acquired Phoenixtec Power Company Ltd., a Taiwan-based manufacturer of single- and three-phase uninterruptible power supply (UPS) systems. This business had sales of $515 for 2007.

Hydraulics

                                       Three months ended September 30                            Nine months ended September 30
                                 2008                2007              Increase            2008                2007              Increase
Net sales                     $       638         $       597                  7 %      $     1,990         $     1,790                 11 %
Operating profit                       71                  61                 16 %              241                 195                 24 %
Operating margin                     11.1 %              10.2 %                                12.1 %              10.9 %

Sales of the Hydraulics segment in the third quarter of 2008 increased 7% over the third quarter of 2007 and were a new third quarter record. The 7% increase in sales consisted of 4% from organic growth and 3% from foreign exchange. Global hydraulics markets grew 3% in the third quarter of 2008 compared to the third quarter of 2007 with U.S. markets up 3% and non-U.S. markets up just under 4%. Sales for the first nine months of 2008 increased 11% over the first nine months of 2007 primarily due to the same factors as in the third quarter of 2008. Eaton anticipates that the rate of growth in global hydraulics markets in the fourth quarter of 2008 will be lower than in the third quarter, but still remain positive.
Operating profit rose 16% in the third quarter of 2008 over the third quarter of 2007, and operating margin increased to 11.1%. The increase in operating profit was due to growth in sales, benefits of integrating acquired businesses, and an overall improvement in operating efficiencies. Operating profit was reduced by acquisition integration charges of $1 in the third quarter of 2008 compared to charges of $2 in the third quarter of 2007, which reduced the operating margin by 0.2% and 0.3% in 2008 and 2007, respectively. Acquisition integration charges in 2008 primarily related to Ronningen-Petter, Synflex and Hayward. Charges in 2007 largely related to Synflex, Hayward and Walterscheid. The incremental operating margin for the third quarter of 2008 was 24%.
Operating profit for the first nine months of 2008 increased 24% over the first nine months of 2007 primarily due to the same factors as in the third quarter of 2008. Operating profit was reduced by acquisition integration charges of $4 in the first nine months of 2008 compared to charges of $9 in the first nine months of 2007, which reduced operating margin by 0.2% and 0.5% in 2008 and 2007, respectively.
On October 2, 2008 Eaton acquired Integ Holdings Limited, the parent company of Integrated Hydraulics Ltd., a U.K.-based manufacturer of screw-in cartridge valves, custom-engineered hydraulic valves and manifold systems. The company employs approximately 290 people.

Aerospace
. . .