-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, W0MxC0h89KrjFsMx5W2gUCGYEbFPMZbzuyg0oiDmarHAivLhh4503YFf59XGEtWT 7htVtNJ5p6bDlh95PMfttA== 0000031277-98-000002.txt : 19980326 0000031277-98-000002.hdr.sgml : 19980326 ACCESSION NUMBER: 0000031277-98-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980325 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: EATON CORP CENTRAL INDEX KEY: 0000031277 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRONIC & OTHER ELECTRICAL EQUIPMENT (NO COMPUTER EQUIP) [3600] IRS NUMBER: 340196300 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-01396 FILM NUMBER: 98572901 BUSINESS ADDRESS: STREET 1: EATON CTR STREET 2: 1111 SUPERIOR AVE CITY: CLEVELAND STATE: OH ZIP: 44114-2584 BUSINESS PHONE: 2165235000 FORMER COMPANY: FORMER CONFORMED NAME: EATON YALE & TOWNE INC DATE OF NAME CHANGE: 19710822 10-K 1 1997 FORM 10-K 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, 1997 Commission file number 1-1396 Eaton Corporation - ---------------------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 34-0196300 - ---------------------------------------------------------------- (State of incorporation) (I.R.S. Employer Identification No.) Eaton Center, Cleveland, Ohio 44114-2584 - ---------------------------------------------------------------- (Address of principal executive offices) (Zip code) (216) 523-5000 - ---------------------------------------------------------------- (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. X The aggregate market value of voting stock held by non-affiliates of the registrant as of January 31, 1998 was $6.4 billion. As of January 31, 1998, there were 71,807,322 Common Shares outstand- ing. Page 2 Documents Incorporated By Reference Portions of the Proxy Statement for the 1998 annual shareholders' meeting are incorporated by reference into Part III. Part I Item 1. Business Eaton Corporation (Eaton or Company), incorporated in 1916, is a global manufacturer of highly engineered products which serve industrial, vehicle, construction, commercial and semiconductor markets. Principal products include electrical power distribution and control equipment, truck drivetrain systems, engine components, hydraulic products, ion implanters and a wide variety of controls. Worldwide sales in 1997 reached $7.6 billion. At December 31, 1997, the Company had 49,000 employees. On August 4, 1997, the Company purchased Fusion Systems Corporation (Fusion) for $293 million, before a reduction for cash acquired of $90 million. Fusion, which had sales of $85 million in 1996, manufactures front-end process equipment for the semiconductor industry. On September 2, 1997, the Company purchased Dana Corporation's Spicer Clutch business for $180 million. Spicer Clutch, which had sales of $200 million in 1996, is a leader in the development of medium- and heavy-duty truck clutches and vibration dampers. The acquisitions of Fusion and Spicer Clutch 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. The purchase price allocation for Fusion included $85 million for purchased in-process research and development which was determined through an independent valuation. This amount was expensed at the date of acquisition because technological feasibility had not been established and no alternative commercial use had been identified. Therefore, 1997 includes the write-off of $85 million for purchased in-process research and development, with no income tax benefit, or $1.11 per Common Share. On October 1, 1997, the Company sold the majority of the stock of AIL Systems Inc. which represented the Company's Defense Systems business segment (the Company continues to hold a minor interest in AIL). On December 1, 1997, the Company sold its worldwide Appliance Controls business for $310 million. The sale of these businesses resulted in pretax gains of $91 million ($69 million aftertax, or $.90 per Common Share). On January 2, 1998, the Company also completed the sale of the Axle and Brake business. The proceeds from these divestitures were used to repurchase Common Shares under the Company's share repurchase program, which reduced the number of Common Shares outstanding to approximately 72 million at the end of January 1998. Information regarding principal products, net sales, operating profit and identifiable assets by business segment and geographic region, presented in "Business Segment and Geographic Region Information" on pages 40 to 44 of this report. Additional Page 3 information regarding Eaton's business segments and business in general is presented below. Electrical and Electronic Controls Patents and Trademarks - Eaton owns, controls or is licensed under many patents related to this business segment. The EATON, EATON (logomark), CH CONTROL, CHALLENGER, COMMANDER, CUTLER- HAMMER, GEMINI, DURANT, HEINEMANN, IKU (and design), LECTRON, L/P (and design) and PANELMATE trademarks are used in connection with marketing products included in this business segment. 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 business segment are price, geographic coverage, service and product performance. The number of competitors varies with respect to the different products. Eaton occupies a strong competitive position in this business segment and, with respect to many products, is considered among the market leaders. Major Customers - Approximately 10% of net sales in 1997 of the Electrical and Electronic Controls segment were made to WESCO Distribution, Inc. Also, approximately 6% of net sales in 1997 of this segment were made to divisions and subsidiaries of Ford Motor Company, which is a major customer of the Vehicle Components segment. Vehicle Components Patents and Trademarks - Eaton owns, controls or is licensed under many patents related to this business segment. Although the Company emphasizes the EATON and EATON (logomark) trademark in marketing many products within this business segment, it also markets under a number of other trademarks, including CHAR-LYNN, DILL, FULLER, ROADRANGER and SOLO. Seasonal Fluctuations - Sales of truck, passenger car and light duty components, and off-highway vehicle components are generally reduced in the third quarter of each year as a result of preparations by vehicle manufacturers for the upcoming model year and temporary shut-downs for taking physical inventories. Competition - Principal methods of competition in this business segment are price, service and product performance. Eaton occupies a strong competitive position in relation to many competitors in this business segment and, with respect to many products, is considered among the market leaders. Major Customers - Approximately 15% of net sales in 1997 of the Vehicle Components segment were made to divisions and subsidiaries of Ford Motor Company. Also, approximately 43% of net sales in 1997 of this segment were made to divisions and subsidiaries of six other large original equipment manufacturers of trucks, passenger cars, and light-duty and off-highway vehicles generally concentrated in North America. 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 Page 4 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. Information Concerning Eaton's Business in General Raw Materials - Principal raw materials used are iron, steel, copper, aluminum, brass, insulating materials, silver, rubber and plastic. 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 trucks, passenger cars 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 dates listed. Using this criterion, total backlog at December 31, 1997 and 1996 (in billions) was approximately $1.3 and $1, respectively. 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 1997, 1996 and 1995 (in millions) were $319, $267 and $227, respectively. Over the past five years, the Company has invested approximately $1.2 billion in research and development with significant increases in the past three years. Protection of the Environment - Operations of the Company involve the use and disposal of certain substances regulated under environmental protection laws. The Company continues to modify, on an ongoing, regular basis, certain processes 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 competitive position of the Company. Eaton's estimated capital expenditures for environmental control facilities are not expected to be material for 1998 and 1999. Information regarding the Company's liabilities related to environmental matters, is presented in "Protection of the Environment" on pages 29 and 30 of this report. Item 2. Properties Eaton's world headquarters is located in Cleveland, Ohio. The Company maintains manufacturing facilities at 145 locations in 28 countries. The Company is a lessee under a number of operating leases for certain real properties and equipment, none of which Page 5 are material to the Company's operations. Eaton's principal research facilities are located in Southfield, Michigan, Milwaukee, Wisconsin, and Willoughby Hills, Ohio. 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 None required to be reported. Item 4. Submission of Matters to a Vote of Security Holders None. Part II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 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 high and low market price per Common Share for each quarter in 1997 and 1996, is presented in "Quarterly Data" on page 38 and 39 of this report. At December 31, 1997, there were 13,669 holders of record of the Company's Common Shares. Additionally, 22,448 employees were shareholders through participation in the Company's Share Purchase and Investment Plan. Item 6. Selected Financial Data Information regarding selected financial data is presented in the "Five-Year Consolidated Financial Summary" on page 56 of this report. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations "Management's Discussion and Analysis of Financial Condition and Results of Operations" is included on pages 46 through 55 of this report. Item 7A. Disclosure of Qualitative and Quantitative Information about Market Risk Information regarding market risk is included on pages 51 and 52 of this report. Item 8. Financial Statements and Supplementary Data The consolidated financial statements, financial review and the report of independent auditors is presented on pages 15 through 44 of this report. Page 6 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Part III Item 10. Directors and Executive Officers of the Registrant Information contained on pages 5 through 7 in the definitive Proxy Statement dated March 13, 1998, with respect to directors, is incorporated by reference. A listing of Eaton's officers, their ages and their current positions and offices, as of January 31, 1998 follows:
Name Age Position (Date elected to position) - ------------------- ---- ----------------------------------- Stephen R. Hardis 62 Chairman and Chief Executive Officer (January 1, 1996 and September 1, 1995, respectively); Director Alexander M. Cutler 46 President and Chief Operating Officer (September 1, 1995); Director Adrian T. Dillon 44 Executive Vice President - Chief Financial and Planning Officer (September 1, 1995) Gerald L. Gherlein 59 Executive Vice President and General Counsel (September 4, 1991) Brian R. Bachman 52 Senior Vice President - Semiconductor and Specialty Systems (January 1, 1996) Robert J. McCloskey 58 Senior Vice President - Controls and Hydraulics (September 1, 1995) Thomas W. O'Boyle 55 Senior Vice President - Truck Components (September 1, 1995) Larry M. Oman 56 Senior Vice President - Automotive Components (September 1, 1995) David M. Wathen 45 Senior Vice President - Cutler-Hammer (October 9, 1997) Susan J. Cook 50 Vice President - Human Resources (January 16, 1995) Patrick X. Donovan 62 Vice President - International (April 27, 1988) Earl R. Franklin 54 Secretary and Associate General Counsel (September 1, 1991) John W. Hushen 62 Vice President - Corporate Affairs (August 1, 1991) Stanley V. Jaskolski 59 Vice President - Technical Management (October 1, 1990) Joseph J. Mikelonis 47 Vice President - Taxes (May 1, 1996) William T. Muir 55 Vice President - Manufacturing Technologies (April 1, 1989) Derek R. Mumford 56 Vice President - Information Technologies (April 1, 1992) Robert E. Parmenter 45 Vice President and Treasurer (January 1, 1997) Billie K. Rawot 46 Vice President and Controller (March 1, 1991)
Page 7 All of the officers listed above have served in various capacities with Eaton over the past five years, except for Susan J. Cook, Brian R. Bachman, and David M. Wathen. For the two years prior to joining Eaton, Ms. Cook was Vice President- Human Resources at Tandem Computers, Inc. Prior to joining Tandem Computers, Inc. in 1988, Ms. Cook had a seventeen-year career in human resources at IBM Corporation. For the three years prior to joining Eaton, Mr. Bachman was Vice President and General Manager for the Standard Products Business Group of Philips Semiconductor. Earlier in his career, he was President of the General Semiconductor Industry Unit of Square D Corporation. Prior to joining Eaton, Mr. Wathen was a senior executive with Allied Signal, Inc. Prior to joining Allied Signal, Inc. in 1996, Mr. Wathen spent seven years with Emerson Electric Company and twelve years with General Electric. 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 Information contained on pages 10 through 19 in the definitive Proxy Statement dated March 13, 1998, with respect to executive compensation, is incorporated by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management Information contained on pages 22 through 24 of the definitive Proxy Statement dated March 13, 1998, with respect to security ownership of certain beneficial owners and management, is incorporated by reference. Item 13. Certain Relationships and Related Transactions None required to be reported. Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) (1) The following consolidated financial statements and financial review, included in Item 8, are filed as a separate section of this report: Consolidated Balance Sheets - December 31, 1997 and 1996 - Page 16 and 17 Statements of Consolidated Income - Years ended December 31, 1997, 1996 and 1995 - Page 18 Page 8 Statements of Consolidated Cash Flows - Years ended December 31, 1997, 1996 and 1995 - Page 19 Statements of Consolidated Shareholders' Equity - Years ended December 31, 1997, 1996 and 1995 - Page 20 Financial Review - Pages 21 through 44 Summarized financial information for Eaton ETN Offshore Ltd. - Page 45 (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 May 19, 1994) - Incorporated by reference to the Form 8-K Report dated May 19, 1994 3(b) Amended Regulations (amended and restated as of April 27, 1988) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1994 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) Eaton Corporation Rights Agreement dated June 28, 1995 - Incorporated by reference to the Form 8-K Report dated June 28, 1995 10 Material contracts The following are either a management contract or a compensatory plan or arrangement: (a) Deferred Incentive Compensation Plan (amended and restated as of September 24, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 Page 9 (b) Executive Strategic Incentive Plan (amended and restated as of June 21, 1994 and July 25, 1995) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (c) Group Replacement Insurance Plan (GRIP), effective as of June 1, 1992 - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1992 (d) 1991 Stock Option Plan - Incorporated by reference to the definitive Proxy Statement dated March 18, 1991 (e) 1995 Stock Option Plan - Incorporated by reference to the definitive Proxy Statement dated March 17, 1995 (f) Incentive Compensation Deferral Plan (amended and restated as of September 24, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (g) Strategic Incentive and Option Plan (amended and restated as of September 24, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (h) Form of "Change in Control" Agreement entered into with officers of Eaton Corporation as of November 1, 1996 - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (i) The following are incorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1990: (i) Limited Eaton Service Supplemental Retirement Income Plan (amended and restated as of January 1, 1989) (ii) Amendments to the 1980 and 1986 Stock Option Plans (iii) Eaton Corporation Supplemental Benefits Plan (amended and restated as of January 1, 1989) (which provides supplemental retirement benefits) Page 10 (iv) Eaton Corporation Excess Benefits Plan (amended and restated as of January 1, 1989) (with respect to Section 415 limitations of the Internal Revenue Code) (j) Executive Incentive Compensation Plan, effective January 1, 1995 - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (k) Plan for the Deferred Payment of Directors' Fees (amended and restated as of September 24, 1996 and amended effective as of January 1, 1997) (filed as a separate section of this report) (l) Plan for the Deferred Payment of Directors' Fees (originally adopted in 1980 and amended effective February 25, 1997) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (m) 1996 Non-Employee Director Fee Deferral Plan (amended effective as of January 1, 1997 and February 25, 1997) (filed as a separate section of this report) (n) Eaton Corporation Trust Agreement - Outside Directors (dated December 6, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (o) Eaton Corporation Trust Agreement - Officers and Employees (dated December 6, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (p) Eaton Corporation Retirement Plan for Non-Employee Directors (amended and restated January 1, 1996) (filed as a separate section of this report) 21 Subsidiaries of Eaton Corporation (filed as a separate section of this report) 23 Consent of Independent Auditors (filed as a separate section of this report) 24 Power of Attorney (filed as a separate section of this report) Page 11 27 Financial Data Schedule (filed as a separate section of this report) (b) Reports on Form 8-K There were no reports on Form 8-K filed during the fourth quarter of 1997. (c) Exhibits Certain exhibits required by this portion of Item 14 are filed as a separate section of this report. (d) Financial Statement Schedules None required to be filed Page 12 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 20, 1998 /s/ Adrian T. Dillon --------------------- Adrian T. Dillon Executive Vice President and Chief Financial and Planning Officer; Principal Financial 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 20, 1998 Signature Title - ----------------------- ---------------------------------------- * - ----------------------- Stephen R. Hardis Chairman and Chief Executive Officer; Principal Executive Officer; Director * - ----------------------- Alexander M. Cutler President and Chief Operating Officer; Director * - ----------------------- Billie K. Rawot Vice President and Controller; Principal Accounting Officer * - ----------------------- Neil A. Armstrong Director * - ----------------------- Phyllis B. Davis Director Page 13 * - ----------------------- Ernie Green Director * - ----------------------- Ned C. Lautenbach Director * - ----------------------- John R. Miller Director * - ----------------------- Furman C. Moseley Director * - ----------------------- Victor A. Pelson Director * - ----------------------- A. William Reynolds Director * - ----------------------- Gary L. Tooker Director *By /s/ Adrian T. Dillon -------------------------------------- Adrian T. Dillon, Attorney-in-Fact for the officers and directors signing in the capacities indicated Page 14 Eaton Corporation 1997 Annual Report on Form 10-K Items 6, 7, 8 & Item 14(c) Report of Independent Auditors Consolidated Financial Statements and Financial Review Summary Financial Information for Eaton ETN Offshore Ltd. Management's Discussion and Analysis of Financial Condition and Results of Operations Five-Year Consolidated Financial Summary Certain Exhibits Page 15 REPORT OF INDEPENDENT AUDITORS - ------------------------------ To the Shareholders Eaton Corporation We have audited the accompanying consolidated balance sheets of Eaton Corporation and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the summary financial information of Eaton ETN Offshore Ltd. listed in Item 14(a). These financial statements and summary financial information are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and summary financial information based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Eaton Corporation at December 31, 1997 and 1996, and the consolidated results of its operations and cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related summary financial information, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Cleveland, Ohio January 19, 1998 Page 16 Eaton Corporation
Consolidated Balance Sheets December 31 --------------- (Millions) 1997 1996 ---- ---- ASSETS Current assets Cash $ 53 $ 22 Short-term investments 37 38 Accounts receivable 958 985 Inventories 734 729 Deferred income taxes 163 165 Other current assets 110 78 ------ ------ 2,055 2,017 Property, plant and equipment Land and buildings 622 700 Machinery and equipment 2,738 2,796 ------ ------ 3,360 3,496 Accumulated depreciation (1,601) (1,704) ------ ------ 1,759 1,792 Excess of cost over net assets of businesses acquired 966 968 Other assets 685 530 ------ ------ $5,465 $5,307 ====== ====== The Financial Review on pages 21 to 44 is an integral part of the consolidated financial statements.
Page 17 Eaton Corporation
Consolidated Balance Sheets December 31 ------------- (Millions) 1997 1996 ---- ---- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Short-term debt $ 81 $ 10 Current portion of long-term debt 23 20 Accounts payable 519 512 Accrued compensation 180 181 Accrued income and other taxes 76 97 Other current liabilities 478 410 ------ ------ 1,357 1,230 Long-term debt 1,272 1,062 Postretirement benefits other than pensions 553 585 Other liabilities 212 270 Shareholders' equity Common Shares (74.7 in 1997 and 77.1 in 1996) 37 39 Capital in excess of par value 844 830 Retained earnings 1,376 1,402 Foreign currency translation adjustments (139) (68) Shares in trust Employee Stock Ownership Plan (20) (36) Deferred compensation plans (27) (7) ------ ------ 2,071 2,160 ------ ------ $5,465 $5,307 ====== ====== The Financial Review on pages 21 to 44 is an integral part of the consolidated financial statements.
Page 18 Eaton Corporation
Statements of Consolidated Income Year ended December 31 ----------------------- (Millions except for per share data) 1997 1996 1995 ---- ---- ---- Net sales $7,563 $6,961 $6,822 Costs and expenses Cost of products sold 5,456 5,171 5,028 Selling and administrative 1,088 995 927 Research and development 319 267 227 Purchased in-process research and development 85 ------ ----- ----- 6,948 6,433 6,182 ------ ----- ----- Income from operations 615 528 640 Other income (expense) Interest expense (86) (85) (86) Interest income 7 6 6 Gain on sales of businesses 91 Other income--net 41 36 32 ------ ----- ----- 53 (43) (48) ------ ----- ----- Income before income taxes and extraordinary item 668 485 592 Income taxes 204 136 193 ------ ----- ----- Income before extraordinary item 464 349 399 Extraordinary item (54) ------ ----- ----- Net income $ 410 $ 349 $ 399 ====== ===== ====== Per Common Share Income before extraordinary item $ 6.05 $ 4.50 $ 5.13 Extraordinary item (.71) ------ ----- ----- Net income $ 5.34 $ 4.50 $ 5.13 ====== ===== ===== Per Common Share-assuming dilution Income before extraordinary item $ 5.93 $ 4.46 $ 5.08 Extraordinary item (.69) ------ ----- ----- Net income $ 5.24 $ 4.46 $ 5.08 ====== ===== ===== Cash dividends paid per Common Share $ 1.72 $ 1.60 $ 1.50 The Financial Review on pages 21 to 44 is an integral part of the consolidated financial statements.
Page 19 Eaton Corporation
Statements of Consolidated Cash Flows Year Ended December 31 ---------------------- (Millions) 1997 1996 1995 ---- ---- ---- Net cash provided by operating activities Income before extraordinary item $464 $349 $399 Adjustments to reconcile to net cash provided by operating activities Depreciation 285 270 238 Amortization 57 50 43 Deferred income taxes, long-term liabilities, and other non-cash items in income 17 (9) 42 Write-off of purchased in-process research and development 85 Gain on sales of businesses (91) Changes in operating assets and liabilities, excluding acquisitions and sales of businesses Accounts receivable (106) (32) (20) Inventories (53) 36 (30) Accounts payable and other accruals 140 42 (10) Other--net (35) (15) ---- ---- ---- 763 706 647 Net cash used in investing activities Acquisitions of businesses, less cash acquired (387) (151) (143) Sales of businesses 329 11 Expenditures for property, plant and equipment (438) (347) (399) Other--net (35) (7) 24 ---- ---- ---- (531) (505) (507) Net cash used in financing activities Borrowings with original maturities of more than three months Proceeds 425 169 368 Payments (570) (148) (251) Borrowings with original maturities of less than three months--net 356 (87) (73) Proceeds from exercise of stock options 36 18 11 Cash dividends paid (133) (124) (117) Purchase of Common Shares (315) (63) (40) ---- ---- ---- (201) (235) (102) ---- ---- ---- Total increase (decrease) in cash 31 (34) 38 Cash at beginning of year 22 56 18 ---- ---- ---- Cash at end of year $ 53 $ 22 $ 56 ==== ==== ==== The Financial Review on pages 21 to 44 is an integral part of the consolidated financial statements.
Page 20 Eaton Corporation
Statements of Consolidated Shareholders' Equity Shares in trust Foreign ------------------ Total Common Shares Capital in currency Deferred share- ------------- excess of Retained translation compensa- holders' Shares Amount par value earnings adjustments ESOP tion plans equity ------ ------ --------- -------- ----------- ---- ----------- -------- (Millions) Balance at January 1, 1995 78.0 $39 $806 $ 988 ($ 71) ($82) $1,680 Net income 399 399 Cash dividends paid, net of Employee Stock Ownership Plan (ESOP) tax benefit (116) (116) Issuance of shares under employee benefit plans, including tax benefit .4 14 (1) 13 Net unrealized loss on available-for-sale securities (6) (6) Purchase of shares (.8) (8) (32) (40) Shares allocated to employees 29 29 Net translation adjustments 16 16 ---- --- ---- ------ ---- ---- --- ------ Balance at December 31, 1995 77.6 39 812 1,232 (55) (53) 1,975 Net income 349 349 Cash dividends paid, net of ESOP tax benefit (123) (123) Issuance of shares under employee benefit plans, including tax benefit .5 23 (1) 22 Net unrealized loss on available-for-sale securities (4) (4) Purchase of shares (1.1) (12) (51) (63) Shares allocated to employees 17 17 Issuance of shares to trust .1 7 ($ 7) Net translation adjustments (13) (13) ---- --- ---- ------ ---- ---- --- ------ Balance at December 31, 1996 77.1 39 830 1,402 (68) (36) (7) 2,160 Net income 410 410 Cash dividends paid, net of ESOP tax benefit (132) (132) Issuance of shares under employee benefit plans, including tax benefit .9 47 (2) 45 Put option obligation, net (18) (18) Net unrealized loss on available-for-sale securities (10) (10) Purchase of shares (3.7) (2) (40) (292) (334) Shares allocated to employees 16 16 Issuance of shares to trust .2 20 (20) Net translation adjustments (71) (71) Other .2 5 5 ---- --- ---- ------ ---- ---- --- ------ Balance at December 31, 1997 74.7 $37 $844 $1,376 ($139) ($20) ($27) $2,071 ==== === ==== ====== ==== ==== === ====== The Financial Review on pages 21 to 44 is an integral part of the consolidated financial statements.
Page 21 FINANCIAL REVIEW - ---------------- ACCOUNTING POLICIES - ------------------- Consolidation - ------------- The consolidated financial statements include accounts of the Company and all majority-owned subsidiaries. The equity method of accounting is used for investments in associate companies and joint ventures where the Company has a 20% to 50% ownership interest. Foreign Currency Translation - ---------------------------- The functional currency for principally 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 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 forty years and machinery and equipment over principally three to ten years. Identified intangible assets primarily consist of patents, trademarks and tradenames, which are amortized over a range of five to forty years. Excess of cost over net assets of businesses acquired is amortized over a range of ten to forty years. Excess of cost over net assets of businesses acquired and certain other long-lived assets are reviewed for impairment losses whenever events or changes in circumstances indicate the carrying amount may not be recovered through future net cash flows generated by the assets. Financial Instruments - --------------------- The Company selectively uses straightforward, nonleveraged financial instruments as part of foreign exchange and interest rate risk management programs. The Company does not buy and sell financial instruments solely for trading purposes, except for nominal amounts authorized under limited, controlled circumstances. Credit loss has never been experienced, and is not anticipated, as the counterparties to various financial instruments are major international financial institutions with strong credit ratings and due to control over the limit of positions entered into with any one party. Although financial instruments are an integral part of the Company's risk management Page 22 programs, their incremental effect on financial condition and results of operations is not material. The Company and its subsidiaries, operating in Canada, Europe, Latin America and the Pacific Region, are exposed to fluctuations in foreign currencies in the normal course of business. The Company seeks to reduce exposure to foreign currency fluctuations through the use of foreign currency forward exchange contracts and options. Gains or losses on those financial instruments which hedge net investments in subsidiaries outside the United States are recorded in shareholders' equity. Gains or losses on those financial instruments which hedge specific transactions are recognized in net income, offsetting the underlying foreign currency transaction gains or losses. Cash premiums and discounts related to these financial instruments are amortized to other income--net over the life of the respective agreement. In the normal course of business, the Company's operations are also exposed to fluctuations in interest rates. The Company seeks to reduce the cost of and exposure to interest rate fluctuations through the use of interest rate swaps and caps. Gains or losses on interest rate swaps are included in interest expense since they hedge interest on debt. Cash premiums related to interest rate caps are amortized to interest expense over the life of the respective agreement. Options for Common Shares - ------------------------- The Company applies the intrinsic value based method to account for stock options granted to employees to purchase Common Shares. 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 Common Shares. Revenue Recognition - ------------------- Substantially all revenues are recognized when products are shipped to unaffiliated customers. Estimates - --------- Preparation of financial statements in conformity with generally accepted accounting principles 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. Page 23 SALES AND ACQUISITIONS OF BUSINESSES AND WRITE-OFF OF PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT - ---------------------------------------------------------------- On August 4, 1997, the Company purchased Fusion Systems Corporation (Fusion) for $293 million, before a reduction for cash acquired of $90 million. Fusion, which had sales of $85 million in 1996, manufactures front-end process equipment for the semiconductor industry. On September 2, 1997, the Company purchased Dana Corporation's Spicer Clutch business for $180 million. Spicer Clutch, which had sales of $200 million in 1996, is a leader in the development of medium- and heavy-duty truck clutches and vibration dampers. On April 16, 1996, the Company purchased CAPCO Automotive Products Corporation for $135 million. CAPCO, a Brazilian manufacturer of transmissions for light- and medium-duty trucks and transaxle components for passenger cars, had sales of $176 million in 1995. The acquisitions of Fusion, Spicer Clutch, and CAPCO 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. The purchase price allocation for Fusion included $85 million for purchased in-process research and development which was determined through an independent valuation. This amount was expensed at the date of acquisition because technological feasibility had not been established and no alternative commercial use had been identified. Therefore, the third quarter of 1997 includes the write-off of $85 million for purchased in-process research and development, with no income tax benefit, or $1.11 per Common Share. On October 1, 1997, the Company sold the majority of the stock of AIL Systems Inc. which represented the Company's Defense Systems business segment (the Company continues to hold a minor interest in AIL). On December 1, 1997, the Company sold its worldwide Appliance Controls business for $310 million. The sale of these businesses resulted in pretax gains of $91 million ($69 million aftertax, or $.90 per Common Share). During 1997, 1996 and 1995, the Company also acquired and sold other smaller operations. DEBT AND OTHER FINANCIAL INSTRUMENTS - ------------------------------------ The Company's subsidiaries outside the United States have lines of credit, primarily short-term, aggregating $138 million from various banks worldwide. At December 31, 1997, the Company had $81 million outstanding under these lines of credit. The weighted average interest rate on short-term debt, excluding immaterial amounts for highly inflationary countries, at December 31, 1997 and 1996 was 7.1% and 7.2%, respectively. Page 24 Long-term debt at December 31, excluding the current portion, follows (in millions):
1997 1996 ---- ---- 6-3/8% notes due 1999 (effective interest rate 4.8%) $ 100 $ 100 9% notes due 2001 100 100 8% debentures due 2006 86 86 8.9% debentures due 2006 100 100 7% debentures due 2011, net of unamor- tized discount of $90 million in 1996 (effective interest rate 14.6%) 110 8.1% debentures due 2022 100 100 7-5/8% debentures due 2024 (effective interest rate 7.1%) 100 100 6-1/2% debentures due 2025 (due 2005 at option of debenture holders) 150 150 Unsecured notes (5.6% to 6.6%) 500 150 Other (effective interest rate 9.5%) 36 66 ------ ------ $1,272 $1,062 ====== ======
The Company has a $250 million revolving line of credit, which expires in 1998, and a $500 million revolving credit agreement, which expires in 2000. These lines of credit provide funds for working capital and general corporate purposes. The unsecured notes are classified as long-term debt because the Company intends, and has the ability under the $500 million revolving credit agreement, to refinance these notes on a long-term basis. In 1997, the Company completed the termination of, and settled for cash, a $100 million 9% interest rate swap expiring in 2000. The combined $6.8 million pretax loss on the termination of the swap ($3.1 million related to 1996) is being amortized to interest expense through 2000 when the swap was originally scheduled to mature. The Company has interest rate swap agreements that effectively convert interest expense on $115 million of United States dollar fixed-rate debt to a fixed rate of 3.2% as to $50 million, and to floating rates at December 31, 1997 of 2.5% (based on the swap agreement) as to $25 million and 5.8% (based on the Amsterdam Interbank Offered Rate plus 1.89%) as to the remaining $40 million. In 1995, the Company entered into an agreement that expires in 1999 which effectively converts $40 million of United States dollar debt into Dutch Guilder denominated debt. This agreement was designated as a hedge of the Company's net investment in a Netherlands subsidiary. Aggregate mandatory sinking fund requirements and annual maturities of long-term debt are as follows (in millions): 1998, $23; 1999, $107; 2000, $502; 2001, $102; and 2002, $2. Page 25 Interest capitalized as part of acquisition or construction of major fixed assets (in millions) was $12 in 1997, $8 in 1996 and $10 in 1995. Interest paid (in millions) was $97 in 1997, and $96 in 1996 and 1995. Financial instruments outstanding at December 31 are as follows (in millions):
1997 1996 -------------------------- ------------------------- Notional Carrying Fair Notional Carrying Fair amount amount value amount amount value -------- -------- ----- -------- -------- ----- Cash and short-term investments $ 90 $ 90 $ 60 $ 60 Marketable equity investments 5 5 22 22 Marketable debt securities 62 62 44 44 Short-term debt (81) (81) (10) (10) Long-term debt, current portion of long-term debt and foreign currency principal swaps (1,295)(1,373) (1,082)(1,206) Put options (1) Foreign currency forward exchange contracts and options $112 (27) (27) $ 23 (10) (8) Interest rate swaps Fixed to floating 66 1 127 1 Floating to fixed 9 64 (5) Fixed to fixed 90 1 90 2 (2) Interest rate caps sold (50) (1) (1)
The fair values of short-term investments, marketable equity investments and debt securities, short-term and long-term debt, put options, and interest rate swaps and caps are principally based on quoted market prices. The fair value of foreign currency forward exchange contracts and options, which primarily mature in 1998, and foreign currency principal and interest rate swaps are estimated based on quoted market prices of comparable contracts, adjusted through interpolation where necessary for maturity differences. EXTRAORDINARY ITEM - ------------------ On December 30, 1997, the Company redeemed the $200 million of 7% debentures due 2011. The aftertax extraordinary loss on this redemption, including the write-off of debt issue costs, was $54 million, or $.71 per Common Share ($88 million before income taxes). Page 26 PENSION PLANS - ------------- The Company has non-contributory defined benefit pension plans covering the majority of employees. Plans covering salaried and certain hourly employees provide benefits that are generally based on years of service and final average compensation. Benefits for other hourly employees are generally based on years of service. Company policy is to fund at least the minimum amount required by applicable regulations. In the event of a change in control of the Company, excess pension plan assets of North American operations may be dedicated to funding of health and welfare benefits for employees and retirees. The components of pension expense for the years ended December 31 follow (in millions):
1997 1996 1995 ---- ---- ---- Service cost - benefits earned during year $ (64) $ (58) $ (51) Interest cost on projected benefit obligation (111) (105) (104) Actual return on assets 375 350 347 Net amortization and deferral (211) (200) (214) ----- ----- ----- $ (11) $ (13) $ (22) Curtailment loss (1) Settlement gain 68 6 6 ----- ----- ----- $ 56 $ (7) $ (16) ===== ===== =====
In 1997, the curtailment loss and settlement gain relate primarily to the sales of AIL Systems Inc. and the Appliance Controls business. Page 27 The pension asset (liability), by funded status of the plan, at December 31 follows (in millions):
1997 1996 --------------- --------------- Over- Under- Over- Under- funded funded funded funded ------ ------ ------ ------ Accumulated pension benefit obligation Vested $1,127 $ 178 $1,186 $ 177 Nonvested 91 8 94 7 ------ ------ ------ ------ 1,218 186 1,280 184 Value of future salary projections 134 25 152 14 ------ ------ ------ ------ Total projected pension benefit obligation 1,352 211 1,432 198 Fair value of plan assets 1,931 89 1,852 92 ------ ------ ------ ------ Plan assets in excess of (less than) projected benefit obligation 579 (122) 420 (106) Unamortized Initial net asset (7) (4) (14) (5) Net (gain) loss (431) 36 (326) 12 Prior service cost 18 14 15 16 Adjustment to recognize minimum liability (8) (11) ------ ------ ------ ------ $ 159 $ (84) $ 95 $ (94) ====== ====== ====== ======
Actuarial assumptions used in the calculation of the pension asset (liability) are as follows: 1997 1996 1995 ---- ---- ---- Discount rate 7.00% 7.25% 7.25% Compensation growth rate 4.50% 4.70% 4.70% Long-term rate of return on plan assets 10% 10% 9.50% Plan assets are invested in equity and fixed income securities and other instruments. Underfunded plans are associated principally with operations outside the United States. The changes in assumed rates at the end of 1997 had the effect of increasing the accumulated pension benefit obligation by $29 million with an offsetting increase in the unamortized net loss. This change will not have a material effect on future expense. Page 28 POSTRETIREMENT BENEFIT PLANS OTHER THAN PENSIONS - ------------------------------------------------ Generally, United States employees become eligible for postretirement benefits other than pensions, primarily health care and life insurance, upon retirement. These benefits are payable for life, although the Company retains the right to modify or terminate the plans providing these benefits. The plans are contributory, with retiree contributions adjusted annually, and contain other cost-sharing features, including deductibles and co-payments. Certain plans limit the annual amount of the Company's future contributions towards employees' postretirement health care benefits. Company policy is to pay claims as they are incurred since, unlike pensions, there is no effective method to obtain a tax deduction for prefunding of these benefits under existing United States income tax regulations. Expense for postretirement benefits other than pensions for the years ended December 31 follows (in millions):
1997 1996 1995 ---- ---- ---- Service cost - benefits earned during year $(13) $(12) $(12) Interest cost on projected benefit obligation (49) (47) (49) Amortization 3 5 8 ---- ---- ---- $(59) $(54) $(53) Curtailment gain 16 Settlement loss (12) ---- ---- ---- $(55) $(54) $(53) ==== ==== ====
The curtailment gain and settlement loss relate primarily to the sales of AIL Systems Inc. and the Appliance Controls business. The liability for postretirement benefit plans other than pensions at December 31 follows (in millions):
1997 1996 ---- ---- Accumulated postretirement benefit obligation Retirees $470 $465 Eligible plan participants 90 58 Non-eligible plan participants 177 182 Unamortized Prior service cost 29 53 Net loss (184) (138) ---- ---- $582 $620 ==== ====
Actuarial assumptions used in the calculation of the liability for postretirement benefits other than pensions are as follows:
Page 29 1997 1996 1995 ---- ---- ---- Discount rate 7.00% 7.25% 7.25% Projected health care cost trend rate 8% 9% 10% Ultimate trend rate 4.75% 5% 5% Year ultimate trend rate is achieved 2002 2001 2001
The changes in assumed rates had the effect of increasing the accumulated postretirement benefit obligation (APBO) by $13 million with an offsetting increase in the unamortized net loss. These changes will have an immaterial effect on future expense. An increase of 1% in assumed health care cost trend rates would increase the accumulated postretirement benefit obligation as of December 31, 1997 by $37 million and the net periodic cost for 1997 by $3 million. PROTECTION OF THE ENVIRONMENT - ----------------------------- The Company has several policies in place 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, the Company has, at each of its facilities, a person responsible for environmental, health and safety (EHS) matters. The Company routinely reviews EHS performance at each of its facilities; and, the Company continuously strives to minimize the generation of hazardous waste at its facilities. As a result of past operations, the Company is involved in remedial response and voluntary environmental cleanup activities 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 many sites, the determination of the extent of contamination, the length of time that remediation may require, the complexity of environmental regulations, and the continuing advancement of remediation technology. Taking these factors into account, the Company has estimated (without discounting) costs of remediation, which will be incurred over a period of several years. The Company accrues an amount equal to the best estimates of these costs when it is probable that a liability has been incurred. At December 31, 1997 and 1996, the balance sheet included an accrual for these costs (in millions) of $33 and $35, respectively. The Company has rights of recovery from non-affiliated parties as to a portion of these costs with regard to several of the sites. The accrual for 1997 was reduced due to the settlement of liability at certain sites, new cost-sharing agreements, and regulatory guidance and activity affecting estimated remediation costs. Page 30 Based upon the Company's analysis and subject to the difficulty in estimating these future costs, the Company expects that any sum it may be required to pay in connection with environmental matters is not reasonably likely to exceed the accrual by an amount that would have a material adverse effect on its financial condition or results of operations or liquidity. All of these estimates are forward-looking statements and, given the inherent uncertainties in evaluating environmental exposures, actual results can differ from these estimates. SHAREHOLDERS' EQUITY - -------------------- There are 300 million Common Shares authorized ($.50 par value per share). At December 31, 1997, there were 5.1 million Common Shares held in treasury and 13,669 holders of record of Common Shares. Additionally, 22,448 employees were shareholders through participation in the Share Purchase and Investment Plan. In the second half of 1997, the Company sold written put options on 400,000 Common Shares. Options on 150,000 Common Shares expired unexercised in 1997. In December 1997, the Company purchased 50,000 shares at $90 per Common Share as a result of an option exercise. The remaining 200,000 options expire in the first half of 1998 at strike prices of $90.00 and $94.66 per Common Share. Stock options have been granted to certain employees, under various plans, to purchase the Company's Common Shares at prices equal to fair market value as of date of grant. Historically, the majority of these options vest ratably during the three-year period following the date of grant and expire ten years from date of grant. In January 1997, 1.9 million special performance- vested stock options were granted at an option price of $71.81. These options become fully exercisable ten days before the expiration of their ten-year term. Accelerated vesting of these options is linked to the Company's success in achieving net income and Common Share price targets. Half of the options became exercisable during 1997 when the Company achieved the initial share price target of $85 per Common Share. The remaining options become exercisable if the Company earns $8 per Common Share during any twelve month period prior to the end of the year 2000. If the earnings target is not met by the end of 2000, the unmet target for each subsequent year will increase at a compound annual rate of 10%. Page 31 A summary of stock option activity follows (shares in millions):
1997 1996 1995 -------------- -------------- -------------- Average Average Average price price price per per per share Shares share Shares share Shares ------- ------ ------- ------ ----- ------ Outstanding, January 1 $44.32 5.0 $41.12 4.6 $37.94 4.0 Granted 73.07 2.8 53.10 1.1 48.60 1.1 Exercised 43.49 (.9) 33.57 (.6) 28.94 (.4) Canceled 59.85 (.1) 51.79 (.1) 50.58 (.1) --- --- --- Outstanding, December 31 $55.85 6.8 $44.32 5.0 $41.12 4.6 === === === Exercisable, December 31 4.5 3.7 3.3 Reserved for future grants, December 31 1.5 4.2 5.2
The following table summarizes information about stock options outstanding at December 31, 1997:
Weighted- average Weighted- remaining average Number contractual exercise Range of exercise prices outstanding life price - ------------------------ ----------- ----------- ------- $24.15 - $39.99 1.7 3.6 $32.86 $40.00 - $49.99 .8 7.1 48.56 $50.00 - $69.99 1.6 7.3 55.09 $70.00 - $100.91 2.7 9.1 73.12
The following table summarizes information about stock options that are exercisable at December 31, 1997:
Weighted- average Number exercise Range of exercise prices exercisable price - ------------------------ ----------- --------- $24.15 - $39.99 1.7 $32.86 $40.00 - $49.99 .6 48.56 $50.00 - $69.99 1.2 55.75 $70.00 - $100.91 1.0 71.98
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standard (SFAS) No. 123, 'Accounting for Stock-Based Compensation.' If the Company accounted for its stock options under the fair value method of SFAS No. 123, the Company's net income (in millions) and net income per Common Share would have been as indicated below:
Page 32 1997 1996 1995 ---- ---- ---- Net income $ 390 $ 343 $ 395 Net income per Common Share $5.08 $4.43 $5.07 Net income per Common Share-assuming dilution $4.99 $4.38 $5.02
The fair value of each option grant in 1997, 1996, and 1995 was estimated using the Black-Scholes option pricing model with the following assumptions:
1997 1996 1995 ---- ---- ---- Dividend yield 3% 3% 3% Expected volatility 22% 23% 24% Risk-free interest rate 6.0% to 6.7% 5.3% to 6.3% 6.7% to 7.8% Expected option life 4 to 6 years 4 years 4 years Weighted-average fair value of options granted during the year $16.84 $10.27 $11.50
The Company sponsors a Share Purchase and Investment Plan (SPIP) for United States operations under which eligible participating employees may choose to contribute up to 15% of their base pay to the SPIP. The Company matches employee contributions up to 6% of a participant's base pay as limited by United States income tax regulations. The matching contribution, which is determined each quarter based on net income per Common Share, ranges from 25% to 100% of a participant's contribution and is invested in the Company's Common Shares. In 1989, the Company prefunded, through 1999, a portion of anticipated matching contributions to the SPIP by creating an Employee Stock Ownership Plan (ESOP) under the SPIP and selling 5 million Common Shares for $150 million to the ESOP. The shares held by the ESOP which have not yet been allocated to employee accounts are included in shareholders' equity as "Shares in Trust-ESOP" and the notes payable of the ESOP, which are guaranteed by the Company, are included in long-term debt. Unallocated shares in the ESOP are released at historical cost based on the ratio of the annual principal payment on the notes payable compared to the original principal amount of the notes payable and allocated to employee accounts. Cash dividends paid on shares in the ESOP are charged against retained earnings and, along with Company contributions, are used to repay the principal and interest due on the notes payable. Unallocated shares in the ESOP, which are considered outstanding for purposes of computing net income per Common Share, at the end of 1997 and 1996 (in millions) were .8 and 1.2, respectively. Compensation expense related to the SPIP match, including the effect of shares released by the ESOP at historical cost, (in millions) was $6 in 1997, $10 in 1996 and $17 in 1995. Page 33 The Company has plans which permit eligible employees and directors to defer a portion of their compensation. The Company has deposited $65 million of marketable securities and Common Shares into a trust to fund a portion of these liabilities. The marketable securities are included in other assets and the shares, with a fair value of $27 million, are included in shareholders' equity. PREFERRED SHARE PURCHASE RIGHTS - ------------------------------- In June 1995, the Company declared a dividend of one Preferred Share Purchase Right (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 the Company's Common Shares. The Company is authorized to reduce the 20% 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 (Preferred Share), (2) to purchase for $250, that number of the Company'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. INCOME TAXES - ------------ Income before income taxes for the years ended December 31 follows (in millions):
1997 1996 1995 ---- ---- ---- United States $457 $385 $471 Non-United States 211 100 121 ---- ---- ---- $668 $485 $592 ==== ==== ====
Page 34 Income taxes for the years ended December 31 follows (in millions):
1997 1996 1995 ---- ---- ---- Current United States Federal $ 99 $ 81 $109 State and local 14 21 24 Non-United States 42 34 59 ---- ---- ---- 155 136 192 Deferred United States Reduction of valuation allowance for deferred income tax assets (11) Other Federal 20 (5) 26 State and local 5 1 Non-United States Reduction of valuation allowance for deferred income tax assets (4) Operating loss carryforwards 15 11 (4) Other 13 (6) (11) ---- ---- ---- 49 0 1 ---- ---- ---- $204 $136 $193 ==== ==== ====
Reconciliations of income taxes at the United States Federal statutory rate to the effective income tax rate for the years ended December 31 follow (in millions):
1997 ------------- 1996 1995 Amount Rate Rate Rate ------ ---- ---- ---- Income taxes at the United States statutory rate $234 35.0% 35.0% 35.0% Write-off of purchased in-process research and development 30 4.5 State and local income taxes 20 2.9 2.9 3.1 Possessions credit related to Puerto Rican operations (38) (5.7) (7.2) (5.4) Current and prior years' credit for increasing research activities (22) (3.3) (.6) Book/tax basis difference related to sales of businesses (13) (1.9) Reduction of valuation allowance for deferred income tax assets (4) (.6) (1.8) Adjustment of worldwide tax liabilities (1) (.2) .9 2.0 Foreign source income 1 .2 (2.6) 1.5 Other--net (3) (.4) (.2) (1.8) ---- ----- ----- ----- $204 30.5% 28.2% 32.6% ==== ===== ===== =====
Page 35 Significant components of current and long-term deferred income taxes at December 31 follow (in millions):
Current Long-term Long-term assets assets liabilities ------- --------- ----------- 1997 Accruals and other adjustments Employee benefits $ 45 $225 $(11) Depreciation and amortization (189) (12) Other 109 49 Operating loss carryforwards of non-United States subsidiaries 58 Other items 9 15 12 Valuation allowance (52) ---- ---- ---- $163 $106 $(11) ==== ==== ==== 1996 Accruals and other adjustments Employee benefits $ 57 $241 $ (5) Depreciation and amortization (190) (10) Other 102 43 Operating loss carryforwards of non-United States subsidiaries 79 Other items 6 32 4 Valuation allowance (56) ---- ---- ---- $165 $149 $(11) ==== ==== ====
At December 31, 1997, certain non-United States subsidiaries had operating loss carryforwards aggregating $165 million. Carryforwards of $134 million have no expiration dates and the balance expires at various dates from 1998 through 2005. The Company has manufacturing facilities in Puerto Rico which operate under tax relief and other incentives that will no longer be available after 2005. No provision has been made for income taxes on undistributed earnings of consolidated non-United States subsidiaries of $521 million at December 31, 1997, since the earnings retained have been reinvested by the subsidiaries. If distributed, such remitted earnings would be subject to withholding taxes but substantially free of United States income taxes. Worldwide income tax payments in 1997, 1996 and 1995 (in millions) were $163, $154 and $166, respectively. Page 36 OTHER INFORMATION - ----------------- Accounts Receivable - ------------------- Accounts receivable are net of an allowance for doubtful accounts (in millions) of $15 at the end of 1997 and 1996, respectively. Inventories - ----------- The components of inventories at December 31 follow (in millions):
1997 1996 ---- ---- Raw materials $258 $270 Work in process 330 312 Finished goods 235 240 ---- ---- Gross inventories at FIFO 823 822 Excess of current cost over LIFO cost (89) (93) ---- ---- Net inventories $734 $729 ==== ====
Gross inventories accounted for using the LIFO method (in millions) were $422 and $431 at the end of 1997 and 1996, respectively. Excess of Cost Over Net Assets of Businesses Acquired - ----------------------------------------------------- Accumulated amortization of excess of cost over net assets of businesses acquired (in millions) was $148 and $162 at the end of 1997 and 1996, respectively. Investments in Life Insurance - ----------------------------- The Company has company-owned life insurance policies insuring the lives of a portion of active United States employees. The policies accumulate asset values to meet future liabilities including the payment of employee benefits such as health care. At December 31, 1997 and 1996, the investment in the policies included in other assets (in millions) was $13 and $11, net of policy loans of $346 and $347, respectively. Net life insurance expense (in millions) of $8 in 1997, $9 in 1996 and $7 in 1995, including interest expense of $33, $35 and $27 in 1997, 1996 and 1995, respectively, is included in selling and administrative expense. Lease Commitments - ----------------- Minimum rental commitments for 1998 under noncancelable operating leases, which expire at various dates and in most cases contain renewal options, are $59 million and decline substantially thereafter. Rental expense in 1997, 1996 and 1995 (in millions) was $78, $71 and $67, respectively. Page 37 Net Income per Common Share - --------------------------- The Company adopted SFAS No. 128, 'Earnings Per Share', at the end of 1997. The calculation of net income per Common Share and net income per Common Share-assuming dilution follows:
(millions except per share data) 1997 1996 1995 ---- ---- ---- Net income per Common Share Net income $ 410 $ 349 $ 399 Average number of Common Shares outstanding 76.8 77.4 77.8 Net income per Common Share $5.34 $4.50 $5.13 ===== ===== ===== Net income per Common Share- assuming dilution Net income $ 410 $ 349 $ 399 Average number of Common Shares outstanding 76.8 77.4 77.8 Dilutive effect of stock options 1.4 .8 .8 ----- ----- ----- Total average number of Common Shares outstanding 78.2 78.2 78.6 ----- ----- ----- Net income per Common Share- assuming dilution $5.24 $4.46 $5.08 ===== ===== =====
Options to purchase 920,000 shares of Common Shares were outstanding at the end of 1995 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. Recently Issued Accounting Pronouncements - ----------------------------------------- In June 1997, SFAS No. 130, 'Reporting Comprehensive Income', was issued. SFAS No. 130 establishes new standards for reporting comprehensive income and its components; however, the adoption of SFAS No. 130 will have no effect on net income or shareholders' equity. The Company must adopt SFAS No. 130 in the first quarter of fiscal year 1998. The Company expects that comprehensive income will not differ materially from net income, except for foreign currency translation adjustments included in comprehensive income, the effect of which could be material depending on future changes in foreign exchange rates. In June 1997, SFAS No. 131, 'Disclosures about Segments of an Enterprise and Related Information', was issued. SFAS No. 131 changes the standards for reporting financial results by operating segments and related products and services, geographic areas, and major customers. The Company must adopt the standard no later than year-end 1998. Page 38 QUARTERLY DATA - -------------- (Unaudited)
Quarter ended (Millions except for ---------------------------------- per share data) Dec. 31 Sept. 30 June 30 Mar. 31 ------- -------- ------- ------- 1997 Net sales $1,934 $1,931 $1,909 $1,789 Gross margin 546 541 538 482 Percent of sales 28% 28% 28% 27% Income before extraordinary item $ 183 $ 54 $ 126 $ 101 Extraordinary item (54) ---------------------------------- Net income $ 129 $ 54 $ 126 $ 101 ================================== Per Common Share Income before extraordinary item $ 2.41 $ .70 $ 1.64 $ 1.31 Extraordinary item (.71) ---------------------------------- Net income $ 1.70 $ .70 $ 1.64 $ 1.31 ================================== Cash dividends paid $ .44 $ .44 $ .44 $ .40 Market price High 103-3/8 95-15/16 89-7/8 75-1/8 Low 85-1/2 81-7/8 67-1/2 67-1/4 Per Common Share-assuming dilution Income before extraordinary item $ 2.35 $ .69 $ 1.61 $ 1.29 Extraordinary item (.69) ---------------------------------- Net income $ 1.66 $ .69 $ 1.61 $ 1.29 ================================== 1996 Net sales $1,724 $1,719 $1,782 $1,736 Gross margin 426 436 472 456 Percent of sales 25% 25% 26% 26% Net income 66 85 103 95 Per Common Share Net income $ .85 $ 1.11 $ 1.32 $ 1.23 Cash dividends paid .40 .40 .40 .40 Market price High 70-7/8 61-1/4 62-3/8 61-7/8 Low 57-3/4 53 56-7/8 50-3/8 Per Common Share-assuming dilution Net income $ .84 $ 1.09 $ 1.31 $ 1.22
Page 39 Income in the fourth quarter of 1997 was increased by pretax gains of $91 million related to the sales of AIL Systems Inc. and the Appliance Controls business ($69 million aftertax, or $.90 per Common Share). Income in the fourth quarter of 1997 was reduced by pretax restructuring charges of $24 million ($15 million aftertax, or $.19 per Common Share). Net income in the fourth quarter of 1997 was reduced by a $54 million aftertax extraordinary loss for the redemption of debentures, or $.71 per Common Share. Net income in the third quarter of 1997 was reduced by an $85 million write-off of purchased in-process research and development, with no income tax benefit, or $1.11 per Common Share. Income in 1996 was reduced by pretax restructuring charges of $50 million ($32 million aftertax, or $.41 per Common Share). Of these restructuring charges, $29 million was recorded in the fourth quarter of 1996 and the remaining $21 million was recorded evenly throughout the first nine months of 1996. In the fourth quarter of 1996, the effective income tax rate for full year 1996 was adjusted to 28.2% from 29.9%. This adjustment reduced income tax expense for the fourth quarter by $7 million, which relates to the first nine months of 1996. In the third quarter of 1996, the estimated effective income tax rate for full year 1996 was adjusted to 29.9% from 31.6%. This adjustment reduced income tax expense for the third quarter by $5 million, which relates to the first half of 1996. Page 40 BUSINESS SEGMENT AND GEOGRAPHIC REGION INFORMATION - -------------------------------------------------- Eaton is a global manufacturer of highly engineered products which serve the industrial, vehicle, construction, commercial and semiconductor markets with operations located in 28 countries. The major classes of products included in each business segment and other information follows. Electrical and Electronic Controls - ---------------------------------- Industrial and Commercial Controls - Electromechanical and electronic controls including motor starters, contactors, overloads and electric drives; programmable controllers, counters, man/machine interface panels and pushbuttons; photoelectric, proximity, temperature and pressure sensors; residential, molded case, hydraulic, air and vacuum circuit breakers; loadcenters; safety switches; lighting control systems; panelboards; switchboards; switchgear components; switchgear; dry type transformers; protective relays and metering; surge suppressors; busway; meter centers; crane controls; portable tool switches; commercial switches; relays; vacuum interrupters; illuminated pushbuttons and panels; annunciator panels; electrically actuated valves and actuators; pressure transducers and switches; and Navy motor control and power conversion systems. Automotive and Appliance Controls - Electromechanical and electronic controls including convenience, stalk and concealed switches; knock sensors; climate control components; speed controls; water valves; thermostats; temperature and humidity sensors; transmission valves; speed sensitive steering systems; tone generators and chimes; lighting controls; emission control valves; collision warning systems; remote keyless entry systems and remote actuated solenoids. On December 1, 1997, the Company sold the Appliance Controls business which had sales of $418 million and $432 million in 1997 and 1996, respectively. The following products represent those included in the Appliance Controls business: timers, pressure switches, range controls, gas valves, and infinite switches. Specialty Controls - Ion implanters; photostabilizers; ozone and plasma ashers; thermal processing systems; flat panel display equipment; plastic and steel spring fasteners; retainer rings; clamps; golf grips; industrial rubber products; industrial clutches and brakes. The markets for these products are industrial, construction, commercial, automotive, appliance, aerospace and government customers concentrated principally 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. Page 41 Vehicle Components - ------------------ Truck Components - Heavy-, medium- and light-duty mechanical and automatic transmissions; power take-offs; engine valves; valve lifters; leaf springs; viscous fan drives; fans and fan shrouds; power steering pumps; fleet management systems and advanced drivetrain controls. On January 2, 1998, the Company completed the sale of the Axle and Brake business, which had sales of $659 million and $542 million in 1997 and 1996, respectively. This business manufactured components for commercial trucks, primarily heavy- and medium-duty, and construction of off-highway equipment. Products manufactured by this business include heavy- and medium- duty clutches; drive, trailer, and steering axles; brakes; anti- lock brake systems; locking differentials; tire pressure control systems and tire valves. Passenger Car and Light Duty Components - Engine valves; hydraulic valve lifters; viscous fan drives; fans and fan shrouds; locking differentials; limited slip differentials; viscous converter clutches; transaxle components; superchargers; tire valves; refrigeration charge and relief valves. Off-Highway Vehicle Components - Mechanical and automatic transmissions; drive and steering axles; specialty axle products; brakes; engine valves; hydraulic valve lifters; gear and piston pumps and motors; transaxles and steering systems; geroters; control valves and cylinders; forgings; central tire inflation systems and tire valves. The principal market for these products is original equipment manufacturers of heavy-, medium- and light-duty trucks, passenger cars and off-highway vehicles. These original equipment manufacturers are generally concentrated in North America, however, sales are made on a global basis. Most sales of these products are made directly to such manufacturers. Defense Systems - --------------- Strategic countermeasures; tactical jamming systems; electronic intelligence; electronic support measures and radar surveillance. On October 1, 1997, the Company sold the majority of AIL Systems Inc., which represented the Defense Systems business segment (the Company continues to hold a minor interest in AIL). Other Information - ----------------- Identifiable assets for each segment and geographic region represent those assets used in operations, including excess of cost over net assets of businesses acquired, and exclude general corporate assets, which consist principally of short-term investments, deferred income taxes, investments in associate companies and joint ventures, property and other assets. Page 42 Net sales to divisions and subsidiaries of one customer, primarily from the Vehicle Components business segment (in millions), were $766 in 1997, $739 in 1996 and $740 in 1995 (10% of sales in 1997 and 11% of sales in 1996 and 1995). Sales from the Company's United States operations to customers in foreign countries, primarily Canada, (in millions) were $791 in 1997, $743 in 1996 and $709 in 1995 (10% of sales in 1997, 11% in 1996, and 10% in 1995). Page 43 Geographic Region Information
Identi- Operating fiable (Millions) Net sales profit assets --------- --------- ------- 1997 United States $5,946 $ 516 $3,631 Canada 293 28 106 Europe 1,112 104 662 Latin America 532 34 435 Pacific Region 158 1 122 Eliminations (478) (104) ------ ------ ------ $7,563 $ 683 $4,852 ====== ====== ====== 1996 United States $5,440 $ 505 $3,399 Canada 297 23 108 Europe 1,113 84 752 Latin America 366 (31) 368 Pacific Region 148 18 136 Eliminations (403) (94) ------ ------ ------ $6,961 $ 599 $4,669 ====== ====== ====== 1995 United States $5,390 $ 571 $3,369 Canada 282 24 109 Europe 1,153 79 807 Latin America 266 4 151 Pacific Region 136 23 90 Eliminations (405) (99) ------ ------ ------ $6,822 $ 701 $4,427 ====== ====== ======
Operating profit in 1997 was reduced by restructuring charges (in millions) of $4 in the United States, $12 in Europe, $5 in Canada, $1 in Latin America, and $2 in the Pacific Rim. Operating profit for the United States in 1997 was reduced by an $85 million write-off of purchased in-process research and development. Operating profit in 1996 was reduced by restructuring charges (in millions) of $28 in the United States, $9 in Europe and $13 in Latin America. Geographic region information (table above) does not include results of associate companies and joint ventures in which the Company holds a 20%-50% ownership interest and which had total sales as follows (in millions):
1997 1996 1995 ---- ---- ---- United States $ 21 $ 13 $ 21 Europe 14 14 13 Latin America 31 16 20 Pacific Region 258 326 347 ---- ---- ---- $324 $369 $401 ==== ==== ====
Page 44 Business Segment Information
(Millions) 1997 1996 1995 ---- ---- ---- Net sales by classes of similar products Electrical and Electronic Controls Industrial and Commercial Controls $2,251 $2,096 $1,975 Automotive and Appliance Controls 1,125 1,144 1,062 Specialty Controls 656 634 574 ------ ------ ----- 4,032 3,874 3,611 Vehicle Components Truck Components 2,104 1,766 1,965 Passenger Car and Light Duty Components 808 734 669 Off-Highway Vehicle Components 548 475 458 ------ ------ ----- 3,460 2,975 3,092 Defense Systems 71 112 119 ------ ------ ----- $7,563 $6,961 $6,822 ====== ====== ====== Operating profit Electrical and Electronic Controls Before write-off of purchased in-process research and development $ 321 $ 309 $ 285 Write-off of purchased in-process research and development (85) Vehicle Components 449 286 414 Defense Systems (2) 4 2 ------ ------ ------ 683 599 701 Interest expense (86) (85) (86) Interest income 7 6 6 Gain on sales of businesses 91 General corporate expenses--net (27) (35) (29) ------ ------ ------ Income before income taxes and extraordinary item $ 668 $ 485 $ 592 ====== ====== ====== Identifiable assets Electrical and Electronic Controls $2,813 $2,888 $2,869 Vehicle Components 2,039 1,677 1,463 Defense Systems 104 95 ------ ------ ------ 4,852 4,669 4,427 General corporate assets 613 638 626 ------ ------ ------ Total assets $5,465 $5,307 $5,053 ====== ====== ====== Capital expenditures Electrical and Electronic Controls $ 217 $ 183 $ 174 Vehicle Components 203 145 203 Defense Systems 3 6 4 Corporate 15 13 18 ------ ------ ------ $ 438 $ 347 $ 399 ====== ====== ====== Depreciation and amortization Electrical and Electronic Controls $ 167 $ 153 $ 134 Vehicle Components 152 141 118 Defense Systems 7 10 13 Corporate 16 16 16 ------ ------ ------ $ 342 $ 320 $ 281 ====== ====== ======
Operating profit in 1997 was reduced by restructuring charges (in millions) of $18 for the Electrical and Electronic Controls segment and $6 for the Vehicle Components segment. Operating profit in 1996 was reduced by restructuring charges (in millions) of $16 for the Electrical and Electronic Controls segment and $34 for the Vehicle Components segment. Page 45 Summary Financial Information for Eaton ETN Offshore Ltd. - --------------------------------------------------------- Eaton ETN Offshore Ltd. (Eaton Offshore), a wholly-owned subsidiary of Eaton, was incorporated by Eaton in 1990 under the laws of Ontario, Canada, primarily for the purpose of raising funds through the offering of debt securities in the United States and making these funds available to Eaton or its subsidiaries. Eaton Offshore owns the common stock of a number of Eaton's subsidiaries which are engaged principally in the manufacture and/or sale of electrical and electronic controls, truck transmissions, fasteners, leaf spring assemblies and engine components. Effective January 31, 1994, Eaton Offshore, through its subsidiaries, acquired certain of the Canadian and Brazilian operations of the former Distribution and Control Business Unit (DCBU) of Westinghouse Electric Corporation. On June 30, 1994 and on April 1, 1995, majority ownership of certain other assets of DCBU and another subsidiary were transferred to a subsidiary of Eaton Offshore from Eaton. Effective January 1, 1996, majority ownership of certain German subsidiaries was transferred to other subsidiaries of Eaton. Summary financial information for Eaton Offshore and its consolidated subsidiaries for the years ended December 31 follows (in millions):
1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Income statement data Net sales $725 $602 $614 $494 $295 Gross margin 149 94 99 87 42 Net income 33 23 28 20 13 Balance sheet data Current assets $375 $304 $300 $237 $160 Noncurrent assets 196 146 152 122 109 Net intercompany receivables/(payables) (160) (53) (47) (4) (15) Current liabilities 120 90 98 83 50 Noncurrent liabilities 80 100 108 107 114
Page 46 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW - -------- For Eaton Corporation, 1997 proved to be a watershed year. The Company reported all-time record sales, earnings and earnings per share. Favorable market conditions, the benefits of restructuring actions taken in prior years, and the extraordinary efforts of the Company's employees worldwide all contributed to these outstanding results. During 1997, the Company's businesses performed well virtually across the board and notable progress was made to build an enterprise capable of higher sustainable earnings growth in the years ahead. This performance was achieved while spending at an accelerated pace on new product development and international expansion. To help achieve growth in future years, the Company completed a number of strategic repositioning moves. In the second half of the year, the Company completed acquisitions of Fusion Systems Corporation and Dana Corporation's worldwide Spicer Clutch business, which will build upon and extend the considerable strengths of the Semiconductor Equipment and Truck Components businesses, respectively. Also in the second half of the year, the Company sold AIL Systems Inc., which represented the Company's Defense Systems business segment, and the Appliance Controls business. On January 2, 1998, the Company completed the sale of the worldwide Axle and Brake business to Dana Corporation. Looking forward, the combination of these strategic moves is believed by management to have increased the Company's inherent earnings growth rate by about 10 percent. In the latter part of 1997, the economic climate in Asia worsened considerably. Poor regulation and currency management skills by certain governments in the region contributed to local currency devaluations and bank failures. This crisis was the primary cause of the decrease in operating profit for the Company's Pacific Region. However, as of December 31, 1997, these effects were not material to operations or financial results for the Company as a whole. 1997 COMPARED TO 1996 - --------------------- NET SALES - --------- Worldwide sales in 1997 exceeded $7 billion for the first time in the Company's history, 9% above 1996. Sales for North America showed improvement; however, sales in Europe were flat. In Latin America, sales increased 45% in 1997 over 1996 despite economic weakness in Mexico, Brazil and Argentina. The Company is now achieving the full strategic benefits of the April 1996 acquisition of CAPCO Automotive Products Corporation, which contributed to the sales increase in Latin America. Despite the continued recession in Japan and the crisis in Asia, sales in the Pacific Region rose 7% in 1997 over 1996. Page 47 Electrical and Electronic Controls, the Company's largest business segment, continued its growth trend by achieving record sales in 1997, increasing 4% in 1997 over 1996. This segment represents 53% of total sales. Activity in most markets remained firm, and the semiconductor equipment market began to rebound in the second half of 1997 after a difficult 1996. Aided by continued strength in Cutler-Hammer's market position, strong construction markets, and a booming commercial aircraft market, Industrial and Commercial Controls also achieved record sales in 1997, increasing 7% over 1996 results. Cutler-Hammer is now enjoying the full benefit of the synergies anticipated from the 1994 acquisition of Westinghouse's Distribution and Control Business Unit. Sales of the Company's Automotive and Appliance Controls businesses were off 2% from one year ago. Sales volumes were up while the strength of the U.S. dollar versus major European currencies reduced sales by 5%. Sales were lowered an additional 3% compared to 1996 as a result of the sale of the Company's Appliance Controls business on December 1, 1997 to Siebe plc. The net increase in volume compares favorably with about a 3% year-to-year increase in automotive production in North America and Europe. Specialty Controls, which includes the Company's Semiconductor Equipment Operations, reported record sales, increasing 3% in 1997 over 1996. During the third quarter of 1997, the Company acquired Fusion Systems Corporation, a leading supplier of front- end process equipment to the semiconductor industry. Excluding Fusion, Specialty Controls sales trailed 1996 results by 2%. While second half 1997 industry orders were somewhat stronger than anticipated, it is too early to determine the impact of the Asian economic crisis on our customers' demand for front-end processing equipment. Vehicle Components segment sales reached a record level, increasing 16% in 1997 over 1996. Truck Components, Passenger Car and Light Duty Components, and Off-Highway Vehicle Components all experienced record sales in 1997. After a difficult 1996, the 1997 success of this segment demonstrates that the Company's managers met the full challenge to achieve performance excellence. Truck Components achieved record sales, increasing 19% in 1997 over 1996. CAPCO, the Brazilian medium-duty transmission manufacturer acquired in 1996, accounted for $54 million of the $338 million increase in sales in 1997. With CAPCO's increase in sales and the favorable impact of new business awards from automotive manufacturers, the Company is now achieving the full strategic benefits of this important acquisition. The Company's Spicer Clutch unit, which was acquired from Dana Corporation in the third quarter of 1997, also contributed $68 million in sales in 1997. Excluding Spicer Clutch, sales were also at record levels, increasing 15% above one year ago. North American factory sales of Class 8 trucks rose about 13% in 1997 to 216,000 Page 48 and, based on current backlogs and the pace of orders, 1998 production is expected to rise another 5% to 10%. The European market was also up last year, though a more modest 6%, and the Company expects the pace of improvement to continue in 1998. The effects of the current austerity plan in Brazil make that market more problematic after a 30% market rise in 1997. Passenger Car and Light Duty Components experienced record sales in 1997, rising 10% over 1996. CAPCO contributed approximately $26 million of the $74 million increase in sales in 1997. The increase in volume was ahead of the increase in automotive production in North America, Europe, and Latin America. This trend can be attributed to continued penetration of selected automotive products, and greater participation in Latin American markets. Continuing demand from the North American hydraulics market enabled Off-Highway Vehicle Components also to report record sales in 1997, rising 15% over 1996. CAPCO contributed $20 million of the $73 million increase in sales. Higher levels of new product introductions for the Company's worldwide agricultural and construction equipment customers also contributed to the increase in sales. The Company's sales gains in 1997 were double the pace of the hydraulics industry, a result attributable to a faster pace of new product introductions for the Company's worldwide agricultural and construction equipment customers. OPERATING RESULTS - ----------------- Gross margin increased to 28% of net sales in 1997 from 26% in 1996 as a result of increased sales volumes across most lines of business, acquisitions and divestitures of businesses, and the benefits realized from recent restructurings. Income from operations, before a one-time charge, increased 33% in 1997 from 1996. The Company took a one-time charge of $85 million against third quarter, 1997 after-tax earnings to write- off the purchased in-process research and development associated with the recent acquisition of Fusion Systems Corporation. Operating profit for the Electrical and Electronic Controls segment continued to be strong, reaching $339 million before restructuring charges of $18 million and the write-off of purchased in-process research and development of $85 million, 4% ahead of 1996 results on a comparable basis. The Company is now achieving the performance expected from the 1994 acquisition of Westinghouse's Distribution and Control Business Unit. Operating profit for the Vehicle Components segment reached a record level of $455 million before $6 million of restructuring charges, 42% ahead of 1996 results on a comparable basis. All of the business units included in this segment demonstrated excellent performance throughout 1997. The increase in operating profit was primarily attributable to the exceptional performance by CAPCO where the year-over-year profits improved by more than $39 million. Operating profit as a percentage of sales also Page 49 increased from 10% in 1996 to 13% in 1997. This was accomplished through higher sales volume, the acquisition of the Spicer Clutch business in 1997, and benefits realized from restructuring efforts in the Truck Components business unit. During the fourth quarter of 1997, the Company reported one-time pretax gains of $91 million ($69 million aftertax) related to the December 1, 1997 sale of the Appliance Controls business and the October 1, 1997 sale of AIL Systems Inc. These gains were offset by a $54 million aftertax charge related to the redemption of the 7% debentures due April 1, 2011, and by a $15 million aftertax charge related to restructuring actions recorded in the fourth quarter of 1997. The 1997 restructuring charges principally relate to work force reductions composed of salaries and benefits and realignment among several businesses. These restructuring charges are intended to help the Company to continue the trend of earnings growth in future years. An analysis of changes in income taxes and the effective income tax rate is presented under 'Income Taxes' in the Financial Review. The Company's goal is to build an enterprise capable of higher sustainable earnings growth, emphasizing the development of new products, increased expansion into global markets, and acquisition of businesses and product lines to complement the Company's existing operations. To enhance the existing product portfolio as well as develop the products of tomorrow, the Company spent a record $319 million in 1997 on research and development, 19% above 1996. Over the past five years, the Company has spent approximately $1.2 billion on research and development. The Company continues to be active in pursuing growth in the world's developing markets. Recent examples of this expansion are the formation of Cutler-Hammer de Argentina, a 75% owned joint venture with Electro Integral de Sudamerica to manufacture and distribute electrical equipment in the Mercosur countries, the formation of a 51% owned joint venture with JC Corporation to manufacture automotive controls in Korea, and the establishment of a wholly-owned enterprise, Eaton Truck and Bus Components (Shanghai) Company, Limited, to manufacture heavy truck transmissions for Chinese and other Asia/Pacific markets. The Company also plans to build a new $70 million plant in Brazil to expand production of light-duty transmissions for a major automotive customer. CHANGES IN FINANCIAL CONDITION - ------------------------------ The Company remains in a strong financial position and has resources available in the form of working capital, lines of credit and funds provided by operations for continued reinvestment in existing operations, strategic acquisitions and managing the capital structure. Net working capital was $698 million at year-end 1997 compared to $787 million at year-end 1996 and the current ratio was 1.5 compared to 1.6 at those dates, respectively. Page 50 Accounts receivable days sales outstanding improved by 6 days in December 1997 which was the Company's third best December in the past fifteen years. The inventory turnover rate and days of inventory on-hand in 1997 showed improvement over 1996. The Fusion Systems and Spicer Clutch acquisitions resulted in an increase in excess of cost over net assets of businesses acquired from the prior year. However, this increase was offset by the write-off of the amounts related to the sale of AIL Systems Inc. and the Appliance Controls business. The Company's total debt increased by 26% to $1.4 billion in 1997. This increase in debt was primarily a result of acquisitions of businesses and the repurchase of Common Shares. As discussed under 'Debt and Other Financial Instruments' in the Financial Review, the Company has a $250 million one-year revolving line of credit and a $500 million long-term revolving credit agreement, which supports the Company's outstanding commercial paper. Reflecting the Company's ongoing investment program under long- range goals to achieve improvements in product quality, manufacturing productivity and business growth, capital expenditures for 1997 reached a record $438 million, 26% above 1996. Over the past five years, the Company has spent nearly $1.7 billion in capital expenditures intended to increase productivity, reduce costs and, selectively, to add capacity. In order to enhance product quality through technology improvements and to help achieve long-term growth prospects, capital spending in 1998 is anticipated to increase above the 1997 level. Management believes it is more likely than not that deferred income tax assets of $269 million as of December 31, 1997 will be realized through the reduction of future taxable income. Significant factors considered by management in the determination of the probability of realization of deferred tax assets include historical operating results, expectations of future earnings and the extended period of time over which the postretirement health care liability will be paid. The Company is subject to various inherent financial risks attributable to operating in a global economy. Derivative financial instruments are utilized to manage exposures in interest and foreign exchange markets. The Company has developed systems to measure and assure that these exposures are evaluated comprehensively so that appropriate and timely action can be taken to reduce risk, if necessary. Monitoring of exposures and the evaluation of risks includes approval of derivative activities on a discrete basis by senior management. Monthly, senior management performs an oversight and review of exposures and derivative activities. The Company diversifies the counterparties used in these transactions in order to minimize the impact of any potential credit loss in the event of nonperformance by the counterparties. Although derivatives are an integral part of the Company's risk management programs, their incremental effect on financial condition and results of operations is not material. Derivative activities are described Page 51 in greater detail under 'Debt and Other Financial Instruments' in the Financial Review. Operations of the Company involve the use and disposal of certain substances regulated under environmental protection laws. The Company continues to modify, on an ongoing, regular basis, certain processes in order to reduce the impact on the environment, including the reduction or elimination of certain chemicals used in and wastes generated from operations. The Company's liabilities related to environmental matters are further discussed under 'Protection of the Environment' in the Financial Review. Cash dividends paid in 1997 were a record $133 million and represented 32% of net income. Per share dividends in 1997 rose 8% from the previous year, following a 7% increase from the year before. The Company has paid dividends on Common Shares annually since 1923. In 1995, to avoid the dilution of earnings per share resulting from the exercise of stock options, the Board of Directors authorized the purchase of up to five million outstanding Common Shares over a five year period with a maximum of 1.5 million shares to be purchased in one year. Additionally, in September 1997, to avoid further dilution resulting from the sales of AIL Systems Inc. and the Appliance Controls and Axle and Brake businesses, the Board of Directors authorized the Company to spend up to an additional $500 million over a period of up to five years to purchase Common Shares. In January 1998, the Company completed the $500 million program by repurchasing 2.8 million shares for $256 million. This reduced the number of shares outstanding to approximately 72 million at the end of January 1998. During 1997, the Company returned $334 million to shareholders through share repurchases as 3.7 million shares were repurchased for an average price of $90 per share. Since the initiation of the programs, 8.4 million shares have been repurchased at an average price of $83 per share. The Company continues to generate substantial cash from operations which continues to be the primary source of funds to finance operating needs including record investments in research and development. The Company's emphasis on asset management generated record operating cash flow of $763 million in 1997, compared with the previous record in 1996. Cash flow from operations, supplemented by commercial paper borrowings, was used to fund business acquisitions, capital expenditures, repayment of debt, the record level of cash dividends and the repurchases of Common Shares. MARKET RISK DISCLOSURE - ---------------------- The Company is subject to interest rate risk as it relates to long-term debt. The following table presents principal cash flows and related weighted-average interest rates by expected maturity dates of the Company's long term-debt excluding foreign currency principal swaps. Page 52 December 31, 1997 ($ in millions)
Expected Maturity Date ----------------------------------------------------------- 1998 1999 2000 2001 2002 Thereafter Total Fair Value ---- ---- ---- ---- ---- ---------- ----- ---------- Long-term debt, including current portion Fixed rate (US$) $ 19 $107 $ 2 $102 $ 2 $587 $819 $899 Average interest rate 7.9% 6.5% 7.8% 9.1% 12.5% 7.8% Fixed rate (Won) $ 2 2 2 Average interest rate 18.2% Fixed rate (Zloty) $ 2 2 2 Average interest rate 26.3% Commercial Paper (US$) $500 500 500 Average interest rate 5.8%
See 'Changes in Financial Condition' in the Management's Discussion and Analysis of Financial Condition and Results of Operations for details on the Company's primary market risks, and the objectives and strategies used to manage these risks. Also, see 'Financial Instruments' under Accounting Policies in the notes to the consolidated financial statements for additional information on market risks. YEAR 2000 - --------- Computer software that uses two digits rather than four to identify the applicable year may be unable to interpret appropriately the calendar Year 2000, and thus could cause disruption of normal business activities. The Company uses software in various aspects of its business, including manufacturing, product development and many administrative functions, and much of this software will be unable to interpret the calendar Year 2000 appropriately unless it is modified or replaced. The Company is addressing this Year 2000 issue with a corporate- wide initiative led by the Company's Vice President-Information Technologies and involving coordinators for each Company location. The initiative includes the identification of affected software, the development of a plan for correcting that software in the most effective manner, the implementation of that plan and the monitoring of its implementation. The program also includes communications with the Company's significant suppliers and customers to determine the extent to which the Company's systems are vulnerable to any failures by them to address the Year 2000 issue. In most instances, the Company will replace older software with new programs and systems, which will significantly upgrade the existing software as well as appropriately interpret the calendar Year 2000 and beyond. Although the timing of these replacements is influenced by the Year 2000 issue, in most instances they will involve capital expenditures that would have occurred in the normal course of business in any event. The Page 53 Company expects that most of the modifications and replacements will be in place before the end of 1998. Given the information available at this time, management currently anticipates that the amount that the Company will spend to modify or replace software in order to remediate the Year 2000 issue should not have a material adverse effect on the Company's liquidity or results of operations, and that those costs should not cause reported financial information not to be indicative of future operating results or future financial condition. Specific factors which might cause a material difference include the availability and cost of trained personnel and the ability to locate all computer codes requiring correction. FORWARD-LOOKING STATEMENTS - -------------------------- The Company has included in this Annual Report expectations for 1998, an outlook concerning the Asian situation, certain anticipated effects of strategic moves, market expectations, and expectations for capital spending. Actual results could differ materially from these forward-looking statements since they inherently are subject to risks and uncertainties. Important factors which could cause such a difference include: continuity of business relationships with and purchases by major customers, product mix, competitive pressure on sales and pricing, increases in material and other production costs which cannot be recouped in product pricing, costs associated with correcting the Year 2000 issue, difficulties in introducing new products as well as global economic and market conditions. 1996 COMPARED TO 1995 - --------------------- NET SALES - --------- Worldwide sales in 1996 reached nearly $7 billion for the first time in the Company's history, slightly above 1995. During 1996, the Company benefited from the diversity of its product lines as well as from its global markets as the highest sales growth occurred in international markets. In 1996, sales for North America, which includes the United States and Canada, and Europe were flat compared to 1995. Despite the continued recession in Japan, sales in the Pacific Region rose 9% in 1996 over 1995, due in part to the acquisition of the Emwest electrical switchgear and controls business in May 1995. In Latin America, sales increased 38% in 1996 over 1995 despite economic weakness in Mexico, Brazil and Argentina. The increase in Latin America was attributable to the acquisition of CAPCO Automotive Products Corporation. On April 16, 1996, the Company purchased CAPCO, a Brazilian manufacturer of transmissions for light- and medium-duty trucks and transaxle components for passenger cars, for $135 million. Electrical and Electronic Controls, the Company's largest segment, continued to experience growth in sales in 1996 as sales Page 54 increased 7% in 1996 over 1995, which more than doubled from just three years ago. Activity in the markets served by this segment was more mixed in the second half of 1996 than earlier in the year. Aided by continued strength in Cutler-Hammer's electrical power distribution equipment business, Industrial and Commercial Controls sales rose 6% in 1996 over 1995. New program launches in the North American automotive controls business and the acquisition of the IKU Group in May 1995 contributed to the Automotive and Appliance Controls' 8% sales increase in 1996 over 1995. Specialty Controls sales increased 10% in 1996 over 1995 in spite of the sharp downturn in the worldwide market for semiconductor capital equipment in the second half of 1996. Sales of semiconductor equipment stabilized in the second half of 1996 at 23% below first half levels. Vehicle Components segment sales decreased 4% in 1996 from 1995. The acquisition of CAPCO affected prior year results comparisons. Excluding the effects of CAPCO, 1996 sales for this segment were $2.88 billion, 7% below 1995. Truck Components sales decreased 10% in 1996 from 1995. Excluding the effects of CAPCO, Truck Components sales declined 13% from the prior year's level. This reduction was primarily the result of the softening of the North American heavy-duty truck market from the record levels experienced in the prior two years. Passenger Car and Light Duty Components experienced record sales in 1996, rising 10% over 1995, despite flat passenger car production in North America and Europe. This better-than-market performance was attributed to selected market share penetration and the continued trend towards multivalve engines. Continued demand for hydraulic components from the agricultural, construction and industrial markets enabled Off-Highway Vehicle Components to report record sales in 1996, rising 4% over 1995, despite generally flat market activity. OPERATING RESULTS - ----------------- Income from operations declined 17% in 1996 from 1995. This reduction was primarily attributable to lower sales of Truck Components, offset by increased sales of Electrical and Electronic Controls, which historically have had a lower gross margin. The decrease also resulted from increased costs associated with various major growth programs designed to accelerate the Company's sustainable growth rate in the years ahead. During 1996, the Company spent $37 million more than in 1995 on these major growth programs. Income from operations in 1996 was also markedly affected by $50 million of restructuring charges. These restructuring charges principally related to workforce reductions. Several business Page 55 units took these charges in order to bring the Company's performance back to targeted levels. Operating profit for the Electrical and Electronic Controls segment continued to be strong and improved 8% in 1996 over 1995. Restructuring charges of $16 million reduced operating profit. The improvement in operating profit was primarily attributable to improved sales volumes and added contributions from acquired businesses. Operating profit for the Vehicle Components segment decreased 31% in 1996 from 1995. Excluding the effects of the April 1996 acquisition of CAPCO, 1996 operating profit was $302 million, a decrease of 27% from 1995. Operating results in this segment varied sharply by business unit and geographic region. Despite the disappointing results, most of the business units included in the segment demonstrated excellent performance throughout 1996. The reduction in operating profit was primarily attributable to lower sales volumes of Truck Components. The segment's operating results were below the Company's expectations given its earlier projection for a 22% downturn in the North American heavy-duty truck market in 1996 from 1995. Vehicle Components operating profit for 1996 also was reduced by $34 million of restructuring charges, which included $15 million to continue the restructuring of the North American axle/brake business unit for the purpose of bringing these business units to acceptable levels of profitability. Of these restructuring charges, $19 million was recorded in the fourth quarter of 1996, principally related to the segment's Latin American and European operations. Page 56 Eaton Corporation
Five-Year Consolidated Financial Summary For the year 1997 1996 1995 1994 1993 (Millions except for per share data) -------------------------------------------- Net sales $7,563 $6,961 $6,822 $6,052 $4,401 Income before income taxes and extraordinary item 668 485 592 488 262 Income before extraordinary item $ 464 $ 349 $ 399 $ 333 $ 180 Extraordinary item (54) (7) -------------------------------------------- Net income $ 410 $ 349 $ 399 $ 333 $ 173 ============================================ Per Common Share Income before extraordinary item $ 6.05 $ 4.50 $ 5.13 $ 4.40 $ 2.57 Extraordinary item (.71) (.10) -------------------------------------------- Net income $ 5.34 $ 4.50 $ 5.13 $ 4.40 $ 2.47 ============================================ Per Common Share-assuming dilution Income before extraordinary item $ 5.93 $ 4.46 $ 5.08 $ 4.35 $ 2.55 Extraordinary item (.69) (.10) -------------------------------------------- Net income $ 5.24 $ 4.46 $ 5.08 $ 4.35 $ 2.45 ============================================ Cash dividends paid per Common Share $ 1.72 $ 1.60 $ 1.50 $ 1.20 $ 1.15 Capital expenditures $ 438 $ 347 $ 399 $ 267 $ 227 Research and development expense 319 267 227 213 154 At the year-end Total assets $5,465 $5,307 $5,053 $4,682 $3,268 Working capital 698 787 822 744 679 Long-term debt 1,272 1,062 1,084 1,053 649 Shareholders' equity 2,071 2,160 1,975 1,680 1,105 Shareholders' equity per Common Share $27.72 $28.00 $25.45 $21.54 $15.50
Income in 1997 was increased by pretax gains of $91 million related to the sales of AIL Systems Inc., and the Appliance Controls business ($69 million aftertax, or $.90 per Common Share). Income in 1997 and 1996 was reduced by pretax restructuring charges of $24 million ($15 million aftertax, or $.19 per Common Share) and $50 million ($32 million aftertax, or $.41 per Common Share), respectively. Net income in 1997 was reduced by an $85 million write-off of purchased in-process research and development, with no income tax benefit, or $1.11 per Common Share. Net income in 1997 was reduced by a $54 million aftertax extra- ordinary loss for the redemption of debentures, or $.71 per Common Share. Results reflect the acquisition of Distribution and Control Business Unit (DCBU) of Westinghouse Electric Corporation on January 31, 1994. Income in 1993 was reduced by a $55 million acquisition integration charge related to the purchase of DCBU ($34 million aftertax, or $.49 per Common Share). Net income in 1993 was reduced by a $7 million aftertax extra- ordinary loss for the redemption of debentures, or $.10 per Common Share. Page 1 Eaton Corporation 1997 Annual Report on Form 10-K Item 14 (c) Listing of Exhibits Filed 3(a) Amended Articles of Incorporation (amended and restated as of May 19, 1994) - Incorporated by reference to the Form 8-K Report dated May 19, 1994 3(b) Amended Regulations (amended and restated as of April 27, 1988) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1994 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) Eaton Corporation Rights Agreement dated June 28, 1995 - Incorporated by reference to the Form 8-K Report dated June 28, 1995 10 Material contracts The following are either a management contract or a compensatory plan or arrangement: (a) Deferred Incentive Compensation Plan (amended and restated as of September 24, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (b) Executive Strategic Incentive Plan (amended and restated as of June 21, 1994 and July 25, 1995) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (c) Group Replacement Insurance Plan (GRIP), effective as of June 1, 1992 - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1992 (d) 1991 Stock Option Plan - Incorporated by reference to the definitive Proxy Statement dated March 18, 1991 (e) 1995 Stock Option Plan - Incorporated by reference to the definitive Proxy Statement dated March 17, 1995 (f) Incentive Compensation Deferral Plan (amended and restated as of September 24, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (g) Strategic Incentive and Option Plan (amended and restated as of September 24, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (h) Form of "Change in Control" Agreement entered into with officers of Eaton Corporation as of November 1, 1996 - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 Page 2 (i) The following are incorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1990: (i) Limited Eaton Service Supplemental Retirement Income Plan (amended and restated as of January 1, 1989) (ii) Amendments to the 1980 and 1986 Stock Option Plans (iii) Eaton Corporation Supplemental Benefits Plan (amended and restated as of January 1, 1989) (which provides supplemental retirement benefits) (iv) Eaton Corporation Excess Benefits Plan (amended and restated as of January 1, 1989) (with respect to Section 415 limitations of the Internal Revenue Code) (j) Executive Incentive Compensation Plan, effective January 1, 1995 - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (k) Plan for the Deferred Payment of Directors' Fees (filed as a separate section of this report) (l) Plan for the Deferred Payment of Directors' Fees (originally adopted in 1980 and amended effective February 25, 1997) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (m) 1996 Non-Employee Director Fee Deferral Plan (filed as a separate section of this report) (n) Eaton Corporation Trust Agreement - Outside Directors (dated December 6, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (o) Eaton Corporation Trust Agreement - Officers and Employees (dated December 6, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (p) Eaton Corporation Retirement Plan for Non-Employee Directors (filed as a separate section of this report) 21 Subsidiaries of Eaton Corporation (filed as a separate section of this report) 23 Consent of Independent Auditors (filed as a separate section of this report) 24 Power of Attorney (filed as a separate section of this report) 27 Financial Data Schedule (filed as a separate section of this report) Page 1 Eaton Corporation 1997 Annual Report on Form 10-K Item 14 (c) Exhibit 10 (k) Plan for Deferred Payment of Directors' Fees (amended and restated as of September 24, 1996 and amended effective as of January 1, 1997 ARTICLE I ESTABLISHMENT OF PLAN 1.01 "Establishment of Plan and Effective Date": Eaton Corporation (the "Company") has established this Plan for the Deferred Payment of Directors' Fees (the "Plan") effective as of October 23, 1985. This Amendment and Restatement of the Plan shall be effective as of September 24, 1996. 1.02 "Statement of Purpose": It is the purpose of the Plan to attract and retain qualified persons to serve as Directors of the Company by enabling such Directors to defer some or all fees which may be payable to them for future services as a member of the Board of Directors of the Company or as chairman or a member of any committee of the Board. Page 2 ARTICLE II DEFINITIONS When used herein the following terms shall have the meanings indicated unless a different meaning is clearly required by the context: 2.01 "Board": The Board of Directors of Eaton Corporation. 2.02 "Change in Control of the Company": For purposes of the Plan, a "Change in Control of the Company" shall be deemed to have occurred if (i) a tender offer shall be made and consummated for the ownership of securities of the Company representing 25% or more of the combined voting power of the Company's then outstanding voting securities, (ii) the Company shall be merged or consolidated with another corporation and as a result of such merger or consolidation less than 75% of the outstanding voting securities of the surviving or resulting corporation shall be owned in the aggregate by the former shareholders of the Company, other than affiliates (within the meaning of the Securities Exchange Act of 1934 (the "Exchange Act")) of any party to such merger or consolidation, as the same shall have existed immediately prior to such merger or consolidation, (iii) the Company shall sell substantially all of its assets to another corporation which is not a wholly-owned subsidiary of the Company, (iv) any "person" (as such term is used in Sections 3(a)(9) and 13(d)(3) of the Exchange Act) is or becomes the beneficial owner, directly or indirectly, of securities of the Company representing 25% or more of the combined voting power of the Company's then outstanding securities, or (v) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board cease for any reason to constitute at least a majority thereof unless the election, or the nomination for election by the Company's shareholders, of each new Director was approved by a vote of at least two-thirds of the Directors then still in office who were Directors at the beginning of the period. For purposes of the Plan, ownership of voting securities shall take into account and include ownership as determined by applying the provisions of Rule 13d-3(d)(1)(i) of the Exchange Act (as then in effect). 2.03 "Committee": The Corporate Compensation Committee of the Company which shall have full power and authority to administer and interpret, in its sole discretion, the provisions of the Plan. Page 3 2.04 "Company": Eaton Corporation and its corporate successors. 2.05 "Compensation": The total annual fees paid to a Participant for services as a Director of the Company including the annual retainer fee, Board meeting attendance fees, additional annual retainer fees paid to Board Committee chairmen and any other fees paid by the Company for services as a Director of the Company. 2.06 "Deferral Plans": The Company's plan of the same name as this Plan and this Plan. 2.07 "Deferred Account Balance": At any particular date, the total of all Compensation deferred under the Plan and earnings credited thereto less the amount of any deferred Compensation previously paid to the Participant. 2.08 "Deferred Compensation Agreement": The written agreement between the Company and a Participant substantially in the form attached hereto as Exhibit A and made a part hereof. 2.09 "Designated Beneficiary": One or more beneficiaries, as designated by a Participant in a written form filed with the Vice President and Secretary of the Company and approved by the Committee, to whom payments otherwise due to or for the benefit of the Participant hereunder shall be made in the event of his death prior to the commencement of benefit payments hereunder or the complete payment of such benefit. In the event no such written designation is made by a Participant or if such Designated Beneficiary shall not be in existence at the time of the Participant's death or if such Designated Beneficiary predeceases the Participant, the Participant shall be deemed to have designated his estate as the Designated Beneficiary. 2.10 "Failure to Pay": The circumstances described in either (i) or (ii) have occurred: (i) Any Participant shall have notified the Company and the Trustee in writing that the Company shall have failed to pay to the Participant, when due, either directly or by direction to the trustee of any trust holding assets for the payment of benefits pursuant to the Plan, at least 75% of any and all amounts which the Participant was entitled to receive at any time in accordance with the terms of the Plan, and that such amounts remain unpaid. Such notice must set forth the amount, if any, which was paid to the Participant, and the amount Page 4 which the Participant believes he or she was entitled to receive under the Plan. The failure to make such payment shall have continued for a period of 30 days after receipt of such notice by the Company, and during such 30-day period the Company shall have failed to prove, by clear and convincing evidence as determined by the Trustee in its sole and absolute discretion, that such amount was in fact paid or was not due and payable; or (ii) More than two Participants shall have notified the Company and the Trustee in writing that they have not been paid when due, either directly or by direction to the Trustee, amounts to which they are entitled under the Plan and that such amounts remain unpaid. Each such notice must set forth the amount, if any, which was paid to the Participant, and the amount which the Participant believes he or she was entitled to receive under the Plan. Within 15 days after receipt of each such notice, the Trustee shall determine, on a preliminary basis, whether any failure to pay such Participants has resulted in a failure to pay when due, directly or by direction, at least 75% of the aggregate amount due to all Participants under all the Deferral Plans in any two-year period, and that such amounts remain unpaid. If the Trustee determines that such a failure has occurred, then it shall so notify the Company and the Participants in writing within the same 15 day period. Within a period of 20 days after receipt of such notice from the Trustee, the Company shall have failed to prove by clear and convincing evidence, in the sole and absolute discretion of the Trustee, that such amount was paid or was not due and payable. 2.11 "Funded Amount": With respect to the account of any Participant, the value of any assets which have been placed in a grantor trust established by the Company to pay benefits with respect to that account, as determined at the time initial payments are to be made pursuant to the selections made by the Participants in accordance with Section 6.03 . 2.12 "Lump Sum Payment": The lump sum amount which is equal to the then present value of the payment, in fifteen annual payments commencing on the date of the lump sum payment, of the Participant's Deferred Account Balance plus a rate of return thereon equal to the rate or rates of interest specified in the Participant's Deferred Compensation Agreement throughout that fifteen year period, discounted with a rate of interest equal to "Moody's Corporate Bond Yield Average - Monthly Page 5 (Average Corporates)" most recently published by Moody's Investor Services, Inc., or any successor thereto, at the time of the calculation. 2.13 "Normal Retirement": Retirement as a Director of the Company at the Normal Retirement Date. 2.14 "Normal Retirement Date": The date a Participant retires from the Board of Directors after attaining the age of sixty-eight (68). 2.15 "Participant": A Director who is or hereafter becomes eligible to participate in the Plan and does participate by electing, in the manner specified herein, to defer Compensation pursuant to the Plan. 2.16 "Plan": This Plan for the Deferred Payment of Directors' Fees as contained herein which was originally effective as of October 23, 1985, and which has been amended from time to time thereafter. 2.17 "Regular Annuity Starting Date": The April 1st immediately following a Participant's Normal Retirement Date. 2.18 "Termination and Change in Control": The termination of the service as a Director of a Participant for any reason whatsoever prior to a Change in Control, upon a Change in Control or during the three-year period immediately following a Change in Control. 2.19 "Trustee": Shall mean the trustee of any trust which holds assets for the payment of the benefits provided by the Plan Page 6 ARTICLE III ELIGIBILITY AND PARTICIPATION 3.01 "Eligibility": Any Director of the Company who is separately compensated for his services on the Board and who is first elected to the Board prior to 1996 shall be eligible to participate under the Plan. Directors who serve as either an officer or an employee of the Company, or who are first elected after 1995, shall not be eligible to participate under the Plan. 3.02 "Manner of Election": (a) Any person wishing to commence participation in the Plan must file a signed copy of the Deferred Compensation Agreement in the form attached as Exhibit A with the Vice President and Secretary of the Company at Eaton Center, Cleveland, Ohio 44114. If the Company accepts the Election, an eligible Director shall become a Participant in the Plan as of December 1, 1985 for an Election filed in 1985 and as of the January 1st immediately following the date an Election is filed in any year after 1985 if such Election is filed prior to December 1 of such year. Upon the request of a Participant, the Committee may in its sole discretion approve the termination of future deferrals by such Participant. (b) The Board shall be vested with the authority to deny Participants the opportunity to defer future Compensation pursuant to the Plan for any reason if such denial is applied equitably to all Participants; provided, however, that the foregoing authority does not apply to any Participant's right to continue to defer the amount constituting his then existing Deferred Account Balance and any past and future earnings thereon, which amounts shall continue to be deferred and/or paid in accordance with the other terms and conditions of this Plan. 3.03 "Limits on Deferred Compensation": (a) Subject to required minimum and maximum annual limitations on the amount of Compensation which may be deferred equal to $5,000 and $30,000, respectively, a Participant may defer all or any portion of his future Compensation which is earned during a period of at least four (4) years (16 full calendar quarters) or for the Page 7 period to his Normal Retirement Date, if earlier, or for any period of time longer than four years which ends prior to his Normal Retirement Date. Future Compensation in excess of the $30,000 annual limitation may be deferred pursuant to the Company's Plan for Deferred Payment of Directors' Fees adopted as of June 1, 1980 (the "1980 Plan"), which plan continues to be effective. (b) Notwithstanding the annual limitations imposed under Section 3.03(a), an eligible Participant under the Plan may elect, in the manner specified in Section 3.02, prior to December 1, 1985, to have all or part of his Compensation which was deferred under the 1980 Plan to be held and distributed in accordance with the terms and conditions of the Plan. Page 8 ARTICLE IV RETIREMENT BENEFITS 4.01 "Normal Retirement Benefit": (a) The Normal Retirement Benefit is a level fifteen (15) year annuity payable to a Participant who has attained Normal Retirement in fifteen (15) equal annual installments commencing on the Participant's Regular Annuity Starting Date and continuing on the anniversary of that date each year thereafter until fifteen (15) annual payments have been made; (b) The Normal Retirement Benefit shall be calculated by reference to the Participant's total Compensation deferred under the Plan and the rate or rates of interest specified in his Deferred Compensation Agreement; provided, however, that the Committee may determine, in its sole discretion, to pay the Normal Retirement Benefit in a Lump Sum Payment. 4.02 "Early Termination Benefit": The Normal Retirement Benefit provided under the Plan is based on the assumption that each Participant will defer a specified amount of Compensation for a specified period of time of not less than (4) years or to his Normal Retirement Date, if earlier. In the event a Participant has not deferred Compensation in accordance with the terms and conditions of the Plan for at least four (4) years, resigns as a Director of the Company on a date which is before i) the end of the deferral period he elected or ii) his Normal Retirement Date, and iii) any Proposed Change in Control of the Company, then in lieu of the Normal Retirement Benefit described in Section 4.01(a) hereof, the Participant shall be entitled to receive an Early Termination Benefit either at age 68 or at the date of his termination as a Director, as determined by the Committee in its sole discretion. The Early Termination Benefit shall be equal to his Deferred Account Balance at the time of his termination as Director and shall be payable in a lump sum or in up to fifteen (15) equal annual installments, as determined by the Committee in its sole discretion. To the Early Termination Benefit payable to a Participant under this Section 4.02 shall be added interest at the rate specified in his Deferred Compensation Agreement, compounded annually, and credited on the unpaid deferred Compensation from the date of termination until the date paid by the Company. Page 9 4.03 "Entitlement to Normal Retirement Benefit After a Change in Control of the Company": Notwithstanding anything to the contrary herein, if within three years after a Change in Control of the Company any Participant who, before his Normal Retirement Date, is removed as a Director of the Company by a vote of the shareholders, resigns as a Director of the Company, completes his term of office as a Director of the Company and is not re-elected for the next successive term or is otherwise unable to defer additional Compensation for a full (4) years or until his Normal Retirement Date, whichever is earlier, because of any amendment, suspension or termination of the Plan, shall be entitled to receive the Normal Retirement Benefit payable as provided in Section 4.01(a) based upon his then existing Deferred Account Balance. Page 10 ARTICLE V SURVIVOR BENEFIT 5.01 "Survivor Benefit": Upon the occurrence of any of the following events, the Company shall pay to a Participant's Designated Beneficiary a benefit as defined in this ARTICLE V (herein referred to as a "Survivor Benefit"): (a) The death of a Participant while serving as a Director of the Company; or (b) The death of a Participant after becoming entitled to a Normal Retirement Benefit or an Early Termination Benefit but prior to commencement of payment of either such benefit. 5.02 "Amount of Survivor Benefit": The Survivor Benefit shall be an amount equal to the Participant's Deferred Account Balance at the date of his death together with interest thereon, compounded annually, from the date Compensation was deferred until the date it is completely paid by the Company (a "Deferral Period") at a rate equal to the prime rate announced by AmeriTrust Company National Association in Cleveland, Ohio (or any successor thereto) (hereinafter referred to as the "Prime Rate") from time to time during the Deferral Period. The Survivor Benefit shall be paid either in a lump sum or in up to fifteen (15) annual installments, as determined by the Committee in its sole discretion. 5.03 "Survivor Benefit After Commencement of Benefit Payments to the Participant": In the event a Participant who has begun to receive benefit installment payments under the Plan dies prior to full payment of his Normal Retirement Benefit or Early Termination Benefit, all remaining payments due hereunder shall be made to such Participant's Designated Beneficiary, either in a lump sum or in installments, in such amounts and over such periods, not exceeding the remaining period from the date of the Participant's death, as the Committee may direct in its sole discretion. Page 11 ARTICLE VI CERTAIN PAYMENTS TO PARTICIPANTS 6.01 "Termination and Change in Control": Notwithstanding anything herein to the contrary, upon the occurrence of a Termination and Change in Control, the Participants shall be entitled to receive from the Company the payments as provided in Section 6.03 . 6.02 "Failure to Pay": Notwithstanding anything herein to the contrary, upon the occurrence of a Failure to Pay, each Participant covered by the situation described in clause (i) of the definition of Failure to Pay, or each of the Participants in the event of a situation described in clause (ii) of that definition, as the case may be, shall be entitled to receive from the Company the payments as provided in Section 6.03. 6.03 "Payment Requirement": No later than the first to occur of (i) six months following the date hereof for any current Participant, (ii) a Termination and Change in Control or a Failure to Pay for any current Participant or (iii) the date upon which any person who is not a current Participant upon the date hereof becomes a Participant, each Participant shall select one of the payment alternatives set forth below with respect to that portion of the Participant's account equal to the full amount of the account minus the Funded Amount, and with respect to that portion of the account equal to the Funded Amount. The payment alternatives selected with respect to the two portions of the account need not be the same. The payment alternatives are as follows: (a) a Lump Sum Payment within 30 days following the Termination and Change in Control or Failure to Pay, as the case may be; (b) payment in monthly, quarterly, semiannual or annual payments, over a period not to exceed fifteen years, as selected by the Participant at the time provided in the first paragraph of this Section 6.03, commencing within 30 days following the Termination and Change in Control or Failure to Pay, as the case may be, which are substantially equal in amount, except that earnings attributable to periods following Termination and Change in Control or Failure to Pay at the rate or rates of interest specified in the Participant's Deferred Compensation Agreement shall be included with each payment. Page 12 Payment shall be made to each such Participant in accordance with his or her selected alternative as provided in Sections 6.01 and 6.02. Page 13 ARTICLE VII AMENDMENT AND TERMINATION 7.01 "Right to Amend and Terminate the Plan": The Company fully expects to continue the Plan but it reserves the right, at any time or from time to time, by action of the Board, to modify or amend the Plan, in whole or in part. In addition, the Company reserves the right by action of the Board to terminate the Plan, in whole or in part, at any time and for any reason, including, but not limited to, adverse changes in the federal tax laws. Notwithstanding anything herein to the contrary, no amendment, modification or termination of the Plan shall, without the consent of the Participant, alter this provision or impair any of the Participant's rights under the Plan with respect to benefits accrued prior to such amendment, modification or termination. 7.02 "Plan Termination Benefit": (a) In the event of the complete termination of the Plan, each Participant shall be entitled to receive an amount equal to his then Deferred Account Balance (other than amounts initially deferred under the l980 Plan which will continue to be held in accordance with the terms of the Plan) together with interest thereon at the Prime Rate in effect from time to time during such Deferral Period, compounded annually, and credited from the date of deferral until the date paid by the Company (hereinafter referred to as a "Plan Termination Benefit"). As determined by the Committee in its sole discretion, the Plan Termination Benefit shall be payable either in a lump sum or in up to fifteen (15) annual installments commencing at the time elected by the Participant in his Deferred Compensation Agreement prior to the Deferral Period. (b) In the event of a Participant's death prior to the complete payment of the benefits provided under this Section 8.02, all remaining payments due hereunder shall be made to the Participant's Designated Beneficiary in the same amount as was being received by the Participant. 7.03 "Right to Amend or Terminate the Plan After a Change in Control of the Company": Notwithstanding anything to the contrary herein, no amendment shall be made to the Plan after a Change in Control of the Company which would alter or impair this Section 7.03 or any rights Page 14 or obligations under the Plan in relation to any Participant without the prior written consent of the Participant; and in the event of complete termination of the Plan after a Change in Control of the Company, each Participant shall be entitled to receive his Normal Retirement Benefit, if greater than the Plan Termination Benefit, payable as provided in Section 4.01(a) based upon his then existing Deferred Account Balance. Page 15 ARTICLE VIII MISCELLANEOUS 8.01 "Non-Alienation of Benefits": Subject to any federal statute to the contrary, no right or benefit under the Plan shall be subject to anticipation, alienation, sale, assignment, pledge, encumbrance, or charge, and any attempt to anticipate, alienate, sell, assign, pledge, encumber, or charge any right or benefit under the Plan shall be void. No right or benefit hereunder shall in any manner be liable for or subject to the debts, contracts, liabilities, or torts of the person entitled to such benefits. If a Participant or his Designated Beneficiary (if entitled to benefits under the Plan) shall become bankrupt, or attempt to anticipate, alienate, sell, assign, pledge, encumber, or charge any right hereunder, then such right or benefit shall, in the discretion of the Committee, cease and terminate, and in such event, the Company may hold or apply the same or any part thereof for the benefit of the Participant or his spouse, children, or other dependents, or any of them, in such manner and in such amounts and proportions as the Committee may deem proper. 8.02 "No Trust Created": The obligations of the Company to make payments hereunder shall constitute a liability of the Company to the Participant. Such payments shall be made from the general funds of the Company, and the Company shall not be required to establish or maintain any special or separate fund, or purchase or acquire life insurance on a Participant's life, or otherwise to segregate assets to assure that such payments shall be made, and neither a Participant nor Designated Beneficiary shall have any interest in any particular asset of the Company by reason of its obligations hereunder. Nothing contained in the Plan shall create or be construed as creating a trust of any kind or any other fiduciary relationship between the Company and a Participant or any other person. 8.03 "No Employment Agreement": The Plan shall not be deemed to constitute a contract of employment between the Company and a Participant. Neither shall the execution of the Plan nor any action taken by the Company pursuant to the Plan be held or construed to confer on a Participant any legal right to be continued as Director of the Company, in an executive position or in any other capacity with the Company whatsoever; nor shall any provision herein restrict the right of any Participant to resign as a Director. Page 16 8.04 "Binding Effect": Obligations incurred by the Company pursuant to the Plan shall be binding upon and inure to the benefit of the Company, its successors and assigns, and the Participant or his Designated Beneficiary. 8.05 "Claims for Benefits": Each Participant or Designated Beneficiary must claim any benefit to which he may be entitled under this Plan by filing a written notification with the Vice President and Secretary of the Company. The Committee shall make all determinations with respect to such claims for benefits. If a claim is denied by the Committee, it must be denied within a reasonable period of time in a written notice stating the following: (a) The specific reason for the denial. (b) The specific reference to the Plan provision on which the denial is based. (c) A description of additional information necessary for the claimant to present his claim, if any, and an explanation of why such information is necessary. (d) An explanation of the Plan's claims review procedure. The claimant may have a review of the denial by the Committee by filing a written notice with the Vice President and Secretary of the Company within sixty (60) days after the notice of the denial of his claim. The written decision by the Committee with respect to the review must be given within one hundred and twenty (120) days after receipt of the written request. 8.06 "Entire Plan": This document and any amendments hereto contain all the terms and provisions of the Plan and shall constitute the entire Plan, any other alleged terms or provisions being of no effect. Page 17 ARTICLE IX CONSTRUCTION 9.01 "Governing Law": The Plan shall be construed and governed in accordance with the law of the State of Ohio. 9.02 "Gender": The masculine gender, where appearing in the Plan, shall be deemed to include the feminine gender, and the singular may include the plural, unless the context clearly indicates to the contrary. 9.03 "Headings, etc.": The cover page of the Plan, the Table of Contents and all headings used in this Plan are for convenience of reference only and are not part of the substance of the Plan. Page 18 Exhibit A DEFERRED COMPENSATION AGREEMENT THIS AGREEMENT is made this day of , 199_ , between EATON CORPORATION (hereinafter the "Company"), an Ohio corporation, and , a non-employee Director of the Company (hereinafter called "Participant"). WHEREAS, the Board of Directors of the Company has approved a Plan for the Deferred Payment of Directors' Fees (the "Plan") for the purpose of attracting and retaining qualified persons to serve as Directors of the Company; WHEREAS, the Plan provides that a Director becomes a participant under the Plan upon the execution and delivery by him of a Deferred Compensation Agreement, in the form of this Agreement, to the Administrative Committee under the Plan, and the acceptance of such agreement by the Company; NOW, THEREFORE, in consideration of the mutual agreements herein contained, the Company and the Participant hereby agree as follows: 1. Participation. This Agreement is made to evidence the Participant's participation in the Plan, to set forth the amount of the Participant's Compensation to be deferred thereunder and to establish the interest rates to be used to calculate the Participant's Normal Retirement Benefit and his Early Termination Benefit under the Plan. 2. The Plan Controls. The Plan (and all its provisions), as it now exists and as it may be amended hereafter, is incorporated herein and made a part of this Agreement, and the provisions of the Plan, as it may be amended from time to time, shall control the terms and conditions of this Agreement and anything contained herein which is inconsistent with the Plan, as so amended, shall be of no force or effect. 3. Definitions. When used herein, the terms which are defined in the Plan shall have the meanings given them in the Plan. 4. No Interest Created. Neither the Participant nor his Designated Beneficiary shall have any interest in any specific asset of the Company, including policies of insurance. The Participant and his Designated Beneficiary shall have only the right to receive the benefits provided under the Plan. Page 19 5. Deferrals. Pursuant to ARTICLE III of the Plan, the Participant hereby elects to defer the receipt of, and the Company hereby elects to defer the payment of, future Compensation in the amount of_________________ Dollars ($_______________________ ) for each calendar year during the period of________________________ to ____________________. 6. Normal Retirement Benefit Interest Rate. The Participant's Normal Retirement Benefit shall be determined by crediting interest to the Participant's total Compensation deferred under the Plan (including amounts transferred from the Company's Plan for the Deferred Payment of Directors' Fees established as of June 1, 1980) at the rate of ____ % compounded annually from the date of deferral until paid by the Company. 7. Early Termination Benefit Interest Rate. In accordance with ARTICLE IV of the Plan, interest shall be credited to the Early Termination Benefit at a rate equal to ____%, compounded annually. 8. Disposition In the Event of Plan Termination. In the event the Company determines to terminate the Plan, the Participant hereby elects to have his Plan Termination Benefit (other than amounts transferred from the 1980 Plan) distributed as indicated by the Participant below: (The Participant should check only one of the boxes below and sign his initials in the opposite blank). _________________________ I hereby elect to have payment of the Plan Termination initials________________ Benefit commence within a reasonable period of time after the Plan termination date; or _________________________ I hereby elect to have the Plan Termination Benefit be initials ________________ retained by the Company, credited with interest during the Deferral Period, compounded annually, at the Prime Rate and paid commencing upon the earlier to occur of my Normal Retirement or my resignation from the Board of Directors of the Company. The Company shall determine in its sole discretion whether the Plan Termination Benefit shall be paid in a lump sum or in up to fifteen (15) annual installments. 9. Entire Agreement. This Agreement contains the Page 20 entire agreement and understanding by and between the Company and the Participant, and no representations, promises, agreements, or understandings, written or oral, not contained herein shall be of any force or effect. Page 1 Eaton Corporation 1997 Annual Report on Form 10-K Item 14 (c) Exhibit 10 (m) 1996 Non-Employee Director Fee Deferral Plan (amended effective as of January 1, 1997 and February 25, 1997) I. Purpose The 1996 Non-Employee Director Fee Deferral Plan (the "Plan") enables each Director of Eaton Corporation ("Eaton" or the "Company") who is not employed by the Company to defer receipt of fees that may be payable to him or her for future services as a member of the Board of Directors of the Company (the "Board") or as chairman or as a member of any committee of the Board. The purpose of the Plan is to help attract and retain highly qualified individuals to serve as members of the Company's Board of Directors and as members of committees thereof. II. Eligibility All members of the Board who are not employed by the Company are eligible to participate in the Plan with respect to amounts earned as fees for services as a member of the Board or as chairman or a member of any committee of the Board. III. Definitions The terms used herein shall have the following meanings: Account - A bookkeeping account established by Eaton for a Participant to which may be credited Deferred Fees and earnings or losses thereon. Agreement - A written agreement between Eaton and a Participant deferring the receipt of Fees and indicating the term of the deferral. Beneficiary - The person or entity designated in writing executed and delivered by the Participant to the Committee. If that person or entity is not living or in existence at the time any unpaid balance of Deferred Fees becomes due after the death of a Participant, the term "Beneficiary" shall mean the Participant's estate or legal representative or any person, trust or organization designated in such Participant's will. Board - The Board of Directors of Eaton Corporation. Change in Control of Eaton - Shall be deemed to occur if Page 2 (i) a tender offer shall be consummated for 25% or more of the combined voting power of Eaton's then outstanding voting securities, (ii) Eaton shall be merged or consolidated with another corporation and as a result less than 75% of the outstanding voting securities of the resulting corporation shall be owned by the former shareholders of Eaton, other than affiliates (within the meaning of the Securities Exchange Act of 1934 (the "Exchange Act")) of any party to such merger or consolidation, as the same shall have existed immediately prior to such merger or consolidation, (iii) Eaton shall sell substantially all of its assets to another corporation that is not a wholly owned subsidiary of Eaton, (iv) any "person" (as such term is used in Sections 3(a)(9) and 13(d)(3) of the Exchange Act) is or becomes the beneficial owner, directly or indirectly, of 25% or more of the combined voting power of Eaton's then outstanding securities; or (v) during any period of two consecutive years, individuals who at the beginning of that period constitute the Board cease to constitute at least a majority thereof unless the election, or the nomination for election by Eaton's shareholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. For purposes of this Plan, ownership of voting securities shall take into account and include ownership as determined by applying the provisions of Rule 13d-3(d)(l)(i) of the Exchange Act (as then in effect). Committee - The Compensation and Organization Committee of the Board or such other committee as the Board may from time to time designate for purposes of administration of the Plan. Common Share Retirement Deferred Fees - Retirement Deferred Fees that are converted into share units in accordance with Article VI. Deferral Plans - This Plan and any other prior plan sponsored by the Company pursuant to which Fees may be deferred. Deferred Fees - That portion of Fees deferred pursuant to the Plan. Eaton - Eaton Corporation, an Ohio corporation, and its subsidiaries and successors and assigns. Eaton Common Shares - The common shares of Eaton Corporation with a par value of 504 each. Failure to Pay - The circumstances described in either (i) or (ii) have occurred: Page 3 (i) Any Participant shall have notified the Company and the Trustee in writing that the Company shall have failed to pay to the Participant, when due, either directly or by direction to the trustee of any trust holding assets for the payment of benefits pursuant to the Plan, at least 75% of any and all amounts which the Participant was entitled to receive at any time in accordance with the terms of the Plan, and that such amounts remain unpaid. Such notice must set forth the amount, if any, which was paid to the Participant by the Company, and the amount which the Participant believes he or she was entitled to receive under the Plan. The failure to make such payment shall have continued for a period of 30 days after receipt of such notice by the Company, and during such 30-day period the Company shall have failed to prove, by clear and convincing evidence as determined by the Trustee in its sole and absolute discretion, that such amount was in fact paid or was not due and payable; or (ii) More than two Participants shall have notified the Company and the Trustee in writing that they have not been paid when due, either directly or by direction to the Trustee, amounts to which they are entitled under the Plan and that such amounts remain unpaid. Each such notice must set forth the amount, if any, which was paid to the Participant, and the amount which the Participant believes he or she was entitled to receive under the Plan. Within 15 days after receipt of each such notice, the Trustee shall determine, on a preliminary basis, whether any failure to pay such Participants has resulted in a failure to pay when due, directly or by direction, at least 75% of the aggregate amount due to all Participants under all the Deferral Plans in any two-year period, and that such amounts remain unpaid. If the Trustee determines that such a failure has occurred, then it shall so notify the Company and the Participants in writing within the same 15 day period. Within a period of 20 days after receipt of such notice from the Trustee, the Company shall have failed to prove by clear and convincing evidence, in the sole and absolute discretion of the Trustee, that such amounts were paid or were not due and payable. Fees - Any amount payable to a Participant for services as a member of the Board or as chairman or a member of any committee of the Board. Funded Amount - With respect to the Account of any Participant, the value of any assets which have been placed in a grantor trust established by the Company to pay benefits with respect to that Account, as determined at the time initial payments are to be made pursuant to the selections made by the Page 4 Participants in accordance with Section 10.03. Interest Rate Retirement Deferred Fees - Retirement Deferred Fees that are credited with Treasury Note Based Interest in accordance with Article VII. Participant - A member of the Board who is not an employee of Eaton and who elects to defer receipt of Fees. Periodic Installments - Monthly, quarterly, semiannual or annual payments, over a period not to exceed fifteen years, as determined by the Committee in its sole discretion, which are substantially equal in amount, or, in the case of Common Share Retirement Deferred Fees, substantially equal in the number of share units being valued and paid or the number of Eaton Common Shares being distributed, except that earnings attributable to periods following Retirement or Termination of Service as a Director shall be included with each payment. Plan - This 1996 Non-Employee Director Fee Deferral Plan pursuant to which Fees may be deferred for later payment. Retirement - The Termination of Service as a Director of a Participant who is age 55 or older and who has at least ten years of service as a member of the Board, who is age 68 or older, or who is approved by the Committee to qualify as a retirement. Retirement Deferred Fees - That portion of Fees deferred for payment at Retirement, at one year following Retirement, or in Periodic Installments commencing after Retirement. Short-Term Deferred Fees - That portion of Fees deferred for payment as determined by the Committee in accordance with Article V. Termination and Change in Control - The Termination of Service as a Director of a Participant for any reason whatsoever prior to a Change in Control if there is a subsequent Change in Control or the Termination of Service as a Director of a Participant for any reason whatsoever during the three-year period immediately following a Change in Control. Termination of Service as a Director - The time when a Participant shall no longer be a member of the Board, whether by reason of retirement, death, voluntary resignation, divestiture, removal (with or without cause), or disability. Treasury Bill Interest Equivalent - A rate of interest equal to the quarterly average yield of 13-week U.S. Government Treasury Bills. Page 5 Treasury Note Based Interest - A rate of interest equal to the average yield of 10-year U.S. Government Treasury Notes plus 300 basis points. Trustee - The trustee of any trust which holds assets for the payment of the benefits provided by the Plan. Page 6 IV. Election to Defer Section 4.01 Deferral Options. For each calendar year commencing with 1997, a Participant may elect to defer the receipt of all or part of his or her Fees as Short-Term Deferred Fees or Retirement Deferred Fees. Once a Participant has made an effective election, he or she may not thereafter change that election or change any allocation between Short-Term Deferred Fees or Retirement Deferred Fees. Section 4.02 Amount Deferred. Not less than 10% of Fees payable for any calendar year may be deferred under the Plan. If a Participant elects to allocate a portion of Fees to both Short- Term Deferred Fees and Retirement Deferred Fees, the amount allocated to each shall be not less than 10% of the Fees payable for any calendar year. Section 4.03 Election Deadline. To be in effect, a Participant's election must be completed, signed and filed with the Committee on or before such date as is necessary to defer inclusion of the Fees in the Director's gross income for Federal income tax purposes. Section 4.04 Transfers. Notwithstanding anything herein to the contrary, a Participant may elect to have held and distributed in accordance with the terms and conditions of the Plan all or part of his or her compensation which was deferred under the 1980 Plan for Deferred Payment of Directors? Fees, and any such election with respect to amounts to be held and distributed as Retirement Deferred Fees for any Participant in payment status upon the effective date of such election may be held only as Interest Rate Deferred Fees if to do otherwise would be administratively impractical. V. Short-Term Deferred Fees If elected by a Participant, payment of the amount of Fees allocated to Short-Term Deferred Fees will be deferred. Short- Term Deferred Fees shall be credited to the Participant on the date such amount would have been distributed to him or her if there had been no valid deferral election by establishing an Account in the Participant?s name. Treasury Bill Interest Equivalents shall be credited quarterly to the Participant's Short-Term Deferred Fees Account until such compensation is paid to the Participant. Short-Term Deferred Fees, together with credited Treasury Bill Interest Equivalents, shall be paid to the Participant in a lump sum or in not more than five annual installments as determined by the Committee. Page 7 VI. Retirement Deferred Fees Section 6.01 Duration. If elected by a Participant, payment of the amount of Fees allocated to Retirement Deferred Fees will be deferred to Retirement or to one year after Retirement, but subject to Committee discretion as to date of payment as provided herein. Retirement Deferred Fees shall be credited to the Participant on the date such amount would have been distributed to him or her if there had been no valid deferral election by establishing an Account in the Participant's name. Section 6.02 Common Share Retirement Deferred Fees. Between 50% and 100%, as elected by the Participant, of the amount allocated to Retirement Deferred Fees shall be credited to Common Share Retirement Deferred Fees, and the balance shall be credited to Interest Rate Retirement Deferred Fees. Common Share Retirement Deferred Fees shall be converted into a number of share units based upon the average of the mean prices for Eaton Common Shares for the twenty trading days of the New York Stock Exchange during which Eaton Common Shares were traded immediately preceding the end of the calendar quarter in which the Fees to be deferred were earned. For purposes of the Plan, "mean price" shall be the mean of the highest and lowest selling prices for Eaton Common Shares quoted on the New York Stock Exchange List of Composite Transactions on the relevant trading day. On each Eaton Common Share dividend payment date, dividend equivalents equal to the actual Eaton Common Share dividends paid shall be credited to the share units in the Participant's Account, and shall in turn be converted into share units utilizing the mean price for Eaton Common Shares on the dividend payment date. Upon payment of Common Share Retirement Deferred Fees in Eaton Common Shares, the share units standing to the Participant's credit shall be converted to the same number of Eaton Common Shares for distribution to the Participant. Upon payment of Common Share Retirement Deferred Fees in cash, including any installment thereof in the case of Periodic Installments, the share units required to make the cash payment shall be converted to an amount equal to the greater of: (a) the product of the average of the mean prices for an Eaton Common Share for the last twenty trading days of the New York Stock Exchange during which Eaton Common Shares were traded in the month immediately preceding the month in which the date of payment occurs, multiplied by the number of share units then credited to the Participant's Account, or (b) if a Change in Control of Eaton shall have occurred at any time within thirty- six months immediately preceding the payment, the product of the number of share units credited to the Participant's Account at the time of payment multiplied by the highest of (i) the highest Page 8 price paid for an Eaton Common Share in any tender offer in connection with the Change in Control of Eaton; (ii) the price received for an Eaton Common Share in any merger, consolidation or similar event in connection with the Change in Control of Eaton; or (iii) the highest price paid for an Eaton Common Share as reported in any Schedule 13D within the sixty-day period immediately preceding the Change in Control of Eaton. Section 6.03 Interest Rate Retirement Deferred Fees. Retirement Deferred Fees not credited to Common Share Retirement Deferred Fees shall be credited to Interest Rate Retirement Deferred Fees. Interest Rate Retirement Deferred Fees shall be credited to the Interest Rate Retirement Deferred Fees Account, which shall earn Treasury Note Based Interest, compounded quarterly, until paid. Section 6.04 Periodic Installments. Upon the death of a Participant who has commenced receiving Periodic Installments, the entire remaining amount of his or her Retirement Deferred Fees shall be distributed to the Participant's Beneficiary. Such distributions may be made either in a lump sum or in installments in such amounts and over such periods, not exceeding the remaining number of annual installments from the date of death of the Participant, as the Committee may direct in its sole discretion. Section 6.05 Termination of Service as a Director. The Retirement Deferred Fees Account of a Participant whose Termination of Service as a Director occurs for reasons other than Retirement shall be distributed in a lump sum or in Periodic Installments, as the Committee may determine in its sole discretion. The lump sum payment shall be made, or the Periodic Installments shall commence, when the Committee may determine in its sole discretion, no later than February 1 of the calendar year immediately after the calendar year that includes the earliest of: (i) the Participant's death, (ii) the Participant's attainment of age 55 if he or she was credited with at least 10 years of service for Eaton (or an affiliate of Eaton), (iii) the Participant's attainment of age 68, or (iv) the fifth anniversary of the Participant's Termination of Service as a Director. Earnings shall be credited on undistributed Retirement Deferred Fees Accounts, and annual installment payments shall be adjusted to reflect such additional earnings, based on the remaining number of installment payments to be distributed and based on Treasury Note Based Interest, computed quarterly. Page 9 VII. Amendment and Termination Eaton fully expects to continue the Plan but it reserves the right, except as otherwise provided herein, at any time by action of the Board, to modify, amend or terminate the Plan for any reason, including adverse changes in the federal tax laws. Notwithstanding the foregoing, upon the occurrence of a Change in Control of Eaton, no amendment, modification or termination of the Plan shall, without the consent of any particular Participant, alter or impair any rights or obligations under the Plan with respect to that Participant. VIII. Administration The Plan shall be administered by the Committee. The Committee shall interpret the provisions of the Plan where necessary and may adopt procedures for the administration of the Plan which are consistent with the provisions of the Plan and any rules adopted by the Committee. After Retirement or other Termination of Service as a Director, the Committee shall determine in its sole discretion (i) whether Retirement Deferred Fees shall be paid in a lump sum or in Periodic Installments, (ii) the date on which a lump sum payment will be made or Periodic Installments will commence, which in the case of Retirement shall be not later than one year following the date to which the deferral was made, and in the case of Termination of Service as a Director for reasons other than Retirement shall be in accordance with Section 6.05, (iii) whether to change the Periodic Installments or the number of years over which they are to be paid, and (iv) whether Common Share Retirement Deferred Fees will be paid in cash or in Eaton Common Shares. In making these determinations, the Committee may consider the wishes and needs of the Participant or his or her Beneficiary. Each Participant or Beneficiary must claim any benefit to which such Beneficiary may be entitled under the Plan by a written notification to the Committee. If a claim is denied, it must be denied within a reasonable period of time in a written notice stating the specific reasons for the denial. The claimant may have a review of the denial by the Committee by filing a written notice with the Committee within sixty days after the notice of the denial of his or her claim. The written decision by the Committee with respect to the review must be given within 120 days after receipt of the written request. The determinations of the Committee shall be final and conclusive. Page 10 IX. Termination and Change in Control - Failure to Pay Section 9.01 Termination and Change in Control. Notwithstanding anything herein to the contrary, upon the occurrence of a Termination and Change in Control, the Participants shall be entitled to receive from the Company the payments as provided in Section 9.03. Section 9.02 Failure to Pay. Notwithstanding anything herein to the contrary, upon the occurrence of a Failure to Pay, each Participant covered by the situation described in clause (i) of the definition of Failure to Pay, or each of the Participants in the event of a situation described in clause (ii) of that definition, as the case may be, shall be entitled to receive from the Company the payments as provided in Section 9.03. Section 9.03 Payment Requirement. No later than (i) the first to occur of six months following the date hereof, a Termination and Change in Control or a Failure to Pay for any person who is a Participant upon such event or (ii) the date upon which any person who is not subject to clause (i) becomes a Participant, each Participant shall select one of the payment alternatives set forth below with respect to that portion of the Participant's Account equal to the full amount of the Account minus the Funded Amount, and with respect to that portion of the Account equal to the Funded Amount. The payment alternatives selected with respect to the two portions of the Account need not be the same. The payment alternatives are as follows: (a) a Lump Sum Payment within 30 days following the Termination and Change in Control or Failure to Pay, as the case may be; (b) payment in monthly, quarterly, semiannual or annual payments, over a period not to exceed fifteen years, as selected by the Participant at the time provided in the first paragraph of this Section 9.03, commencing within 30 days following the Termination and Change in Control or Failure to Pay, as the case may be, which are substantially equal in amount or in the number of share units being valued and paid or in the number of Eaton Common Shares being distributed, except that earnings attributable to periods following Termination and Change in Control or Failure to Pay shall be included with each payment. Payment of such amounts shall be made to each such Participant in accordance with his or her selected alternative as provided in Section 9.01 and 9.02. Page 11 X. Miscellaneous Section 10.01 Adjustments. In the event of a reorganization, merger, consolidation, reclassification, recapitalization, combination or exchange of shares, stock split, stock dividend, rights offering or similar event affecting shares of the Company, the Committee shall equitably adjust the number of share units previously allocated to the Accounts of Participants as Common Share Retirement Deferred Fees. Section 10.02 Designation of Beneficiaries. Each Participant shall have the right, by written instruction to the Committee, on a form supplied by the Committee, to designate one or more primary and contingent Beneficiaries (and the proportion to be paid to each, if more than one is designated) to receive his or her Account balance upon his or her death. Any such designation shall be revocable by the Participant. Section 10.03 Committee Actions. All actions of the Committee hereunder may be taken with or without a meeting. If taken without a meeting, the action shall be in writing and signed by a majority of the members of the Committee and if taken with a meeting, a majority of the Committee shall constitute a quorum for any such action. Section 10.04 Assignment. No benefit under the Plan shall be subject to anticipation, alienation, sale, transfer or encumbrance, and any attempt to do so shall be void. No benefit hereunder shall in any manner be liable for the debts, contracts, or liabilities of the person entitled to such benefits. If a Participant or Beneficiary shall become bankrupt, or attempt to anticipate, alienate, sell, transfer or encumber any benefit hereunder, then such benefit shall, in the discretion of the Committee, cease and terminate, and the Committee may hold or apply the same for the benefit of the Participant or his or her spouse, children, or other dependents, or any of them, in such manner and in such amounts and proportions as the Committee may deem proper. During a Participant's lifetime, rights hereunder are exercisable only by the Participant or the Participant's guardian or legal representative. Notwithstanding the foregoing, nothing in this Section shall prohibit the transfer of any benefit by will or by the laws of descent and distribution or (if permitted by applicable regulations under Section 16(b) of the Securities Exchange Act) pursuant to a qualified domestic relations order, as defined under the Internal Revenue Code and the Employee Retirement Income Security Act. Page 12 Section 10.05 No Funding Required. The obligations of Eaton to make payments shall be a liability of Eaton to the Participant. Eaton shall not be required to maintain any separate fund or reserve, or purchase or acquire life insurance on a Participant's life, or otherwise segregate assets to assure that any particular asset of Eaton is available to make such payments by reason of Eaton's obligations hereunder. Nothing contained in the Plan shall be construed as creating a trust or other fiduciary relationship between Eaton and a Participant or any other person. Section 10.06 No Contract for Services. The Plan shall not be deemed to constitute a contract for services between Eaton and a Participant. Neither the execution of the Plan nor any action taken by Eaton or the Committee pursuant to the Plan shall confer on a Participant any legal right to be continued as a member of the Board or in any other capacity with Eaton whatsoever. Section 10.07 Governing Law. The Plan shall be construed and governed in accordance with the law of the State of Ohio to the extent not covered by Federal law. Page 1 Eaton Corporation 1997 Annual Report on Form 10-K Item 14 (c) Exhibit 10 (p) Eaton Corporation Retirement Plan for Non-Employee Directors (amended and restated as of January 1, 1996) Eaton Corporation (the "Company") hereby amends and restates, effective as of January 1, 1996, the Eaton Corporation Retirement Plan for Non-Employee Directors ("the Plan"), which was originally adopted May 1, 1984. SECTION 1. Purpose of the Plan. The purpose of the Plan is to provide a retirement benefit to eligible non-employee Directors of the Company. SECTION 2. Effective Dates. The original effective date of the Plan was May 1, 1984. The effective date ("Effective Date") of this amendment and restatement of the Plan is January 1, 1996. SECTION 3. Eligibility. Any non-employee Director of the Company first elected to the Board of Directors of the Company ("the Board") prior to the Effective Date shall be eligible to receive a retirement benefit under the Plan if he or she ceases to be a Director for any reason after serving a minimum of one (1) year as a Director (a "Participant"). Any non-employee Director of the Company first elected to the Board on or after the Effective Date shall not be eligible to receive any benefit under the Plan. SECTION 4. (a) Amount of Retirement Income. The amount of annual retirement income payable pursuant to the Plan ("retirement income") to a Participant shall be equal to (i) the annual retainer payable to non-employee Directors for membership on the full Board in effect at the time a Participant ceases to be a Director multiplied by (ii) a fraction the numerator of which is the number of full years (which need not be consecutive) during which a Participant served as a Director up to five (5) and the denominator of which is the number five (5). (b) Payment Dates. The retirement income provided under this Section 4 shall commence on the first day of the month following the date a Participant ceases to be a Director and shall be payable annually on each anniversary of such date for the lesser of ten (10) years or the life of a Participant. Upon the death Page 2 of a Participant, all rights to receive any future payments of retirement income which would have been due under the Plan after the date of death shall immediately terminate and no amounts shall be due or payable to the deceased Participant, his or her estate, legal representatives, heirs or beneficiaries after the date of death. SECTION 5. Amendment to the Plan. Except as provided in Section 6 hereof, the Board reserves the right to interpret the terms and conditions of the Plan, to amend or modify the Plan, in whole or in part, or to terminate the Plan at any time. SECTION 6. Change in Control of the Company. No amendment to the Plan made after a Change in Control of the Company (as hereinafter defined) shall change this Section 6 or adversely affect the right of a Participant to receive the retirement income provided under Section 4 hereof in accordance with the terms and conditions of the Plan as then in effect. For purposes of the Plan, a "Change in Control of the Company" shall be deemed to have occurred if (i) a tender offer shall be made and consummated for the ownership of securities of the Company representing 25% or more of the combined voting power of the Company's then outstanding voting securities, (ii) the Company shall be merged or consolidated with another corporation and as a result of such merger or consolidation less than 75% of the outstanding voting securities of the surviving or resulting corporation shall be owned in the aggregate by the former shareholders of the Company, other than affiliates (within the meaning of the Securities Exchange Act of 1934 (the "Exchange Act")) of any party to such merger or consolidation, as the same shall have existed immediately prior to such merger or consolidation, (iii) the Company shall sell substantially all of its assets to another corporation which is not a wholly-owned subsidiary of the Company, (iv) any "person" (as such term is used in Sections 3(a)(9) and 13(d)(3) of the Exchange Act) is or becomes the beneficial owner, directly of indirectly, of securities of the Company representing 25% or more of the combined voting power of the Company's then outstanding securities, or (v) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board cease for any reason to constitute at least a majority thereof unless the election, or the nomination for election by the Company's shareholders, of each new Director was approved by a vote of at least two-thirds of the Directors then still in office who were Directors at the beginning of the period. For purposes of the Plan, ownership of voting securities shall take into account and include ownership as determined by applying the Page 3 provisions of Rule 13d-3(d)(1)(i) of the Exchange Act (as then in effect). SECTION 7. Assignment. Subject to any federal statute to the contrary, no right or benefit under the Plan shall be subject to anticipation, alienation, sale, assignment, pledge, encumbrance or charge, and any attempt to anticipate, alienate, sell, assign, pledge, encumber or charge any right or benefit under the Plan shall be void. No right or benefit hereunder shall in any manner be subject to the debts, contracts, liabilities or torts of the person entitled to such right or benefit. SECTION 8. General Creditor. A Participant has only the unsecured promise of the Company to pay the annual retirement income provided under the Plan. The right of a Participant to the assets of the Company are no greater than the rights of any other unsecured creditor of the Company. SECTION 9. No Employment Rights. Nothing contained in the Plan shall be construed as a right of a Participant to be continued as a Director, or as a contract of employment between the Company and a Participant. SECTION 10. Governing Law. The validity, interpretation and enforcement of the Plan shall be governed by the laws of the State of Ohio. Page 1 Eaton Corporation 1997 Annual Report on Form 10-K Item 14(c) Exhibit 21 Subsidiaries of Eaton Corporation Eaton is publicly held and has no parent corporation. Eaton's subsidiaries, the state or country in which each was organized, and the percentage of voting securities owned by Eaton or another Eaton subsidiary as of December 31, 1997 are as follows:
Percentage of voting securities owned (by Where Eaton unless otherwise Consolidated subsidiaries (A) organized indicated) - ------------------------------ ------------ ---------------------- Vorad Safety Systems, Inc. California 100% IVHS Technologies, Inc. CEEC Holdings Incorporated Delaware 100% CEEC Investments Incorporated CEEC Incorporated Delaware 100% Cutler-Hammer Inc. CEEC Investments Incorporated Delaware 100% CEEC Incorporated Challenger Electrical Equipment Corporation Delaware 100% CEEC Holdings Incorporated Challenger Pageland Inc. Delaware 100% Challenger Electrical Equipment Corporation Cutler-Hammer de Puerto Rico Inc. Delaware 100% Cutler-Hammer Inc. Cutler-Hammer Inc. Delaware 100% Eaton Administration Corporation Delaware 100% Eaton ESC Holding Company Delaware 100% Eaton International Corporation Delaware 100% Eaton Semiconductor Equipment Inc. Delaware 100% Eaton Truck Systems, Inc. Delaware 100% Eaton USEV Holding Company Delaware 100% Eaton VORAD Technologies, L.L.C. (Partnership) Delaware 50% Eaton Truck Systems, Inc. 50% Vorad Safety Systems, Inc. ERC Corporation Delaware 100% Eaton Leasing Corporation ERC II Corporation Delaware 100% Eaton Leasing Corporation Fusion Systems Corporation Delaware 100%
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High Temperature Engineering Corporation Delaware 100% IVHS Technologies, Inc. Delaware 70% Eaton Asia Investments Corporation Maryland 100% CAPCO Automotive Products Corporation Michigan 100% AIL Systems Holding Company Nevada 100% Cutler-Hammer de Puerto Rico Company (Partnership) Ohio 99% Cutler-Hammer de Puerto Rico Inc. 1% Cutler-Hammer Inc. Cutler-Hammer IDT, Inc. Ohio 100% Eaton Consulting Services Corporation Ohio 100% Eaton Leasing Corporation Ohio 100% Eaton Properties Corporation Ohio 100% Eaton Leasing Corporation Eaton Utah Corporation Ohio 100% Eaton Leasing Corporation Eaton Westlake Corporation Ohio 100% Eaton Leasing Corporation U.S. Engine Valve (Partnership) Ohio 5.607% 70% Eaton USEV Holding Company Cutler-Hammer de Argentina S.A. Argentina 75% Eaton Holding S.A. Eaton Holding S.A. Argentina 100% Eaton Controls Pty. Ltd. Australia 99.99996% Eaton International Corporation .00004% Eaton Pty. Ltd. Eaton Pty. Ltd. Australia 100% Eaton Foreign Sales Corporation Barbados 100%
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Eaton Holding Limited Barbados 100% Eaton Yale Ltd. Eaton Services Limited Barbados 100% Eaton Holding Limited Saturn Insurance Company Ltd. Bermuda Islands 100% Eaton Ltda. Brazil 65.12% Eaton Services Limited 34.88% Eaton International Corporation Eaton Truck Components Ltda. Brazil 21.135% 78.865%CAPCO Automotive Products Corporation Eaton Valvetrain Systems Ltda. Brazil 80% Eaton ETN Offshore Ltd. Canada 100% Common Shares - Eaton Corporation 100% Preferred Shares - Eaton International Corporation Eaton Yale Ltd. Canada 100% Eaton ETN Offshore Ltd. Tycor International Corporation Canada 100% Eaton Yale Ltd. Eaton Truck and Bus Components Company (Shanghai) Ltd. China 100% Eaton (China) Investments Co., Ltd. China 100% Eaton Asia Investments Corporation Jining Eaton Hydraulics Company Ltd. China 60% Suzhou Cutler-Hammer Electric Co., Ltd. China 75% Eaton Controles Industriales S.A. Costa Rica 97.53% Eaton International Corporation Eaton Controls d.o.o. Croatia 100% Eaton Technologies S.A. Cutler-Hammer, S.A. Dominican Republic 100% Cutler-Hammer Inc.
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Coupatan Immobiliere S.A. France 100% Eaton Technologies S.A. Eaton Automotive Controls Srl France 100% Eaton Technologies S.A. Eaton S.A. France 100% Eaton Technologies S.A. France 55% 45% Eaton International Corporation Eaton Automotive G.m.b.H. Germany 100% Eaton G.m.b.H. Eaton Controls G.m.b.H. & Co. K.G. (Partnership) Germany 99.5% Eaton Yale Ltd. .5% Eaton G.m.b.H. Eaton G.m.b.H. Germany 100% Eaton Technologies Limited Hong Kong 100% Eaton International Corporation Eaton Automotive Srl Italy 33% 67% Eaton Srl Eaton Engine Lifters Italy 100% Eaton Holding Limited Eaton Srl Italy 100% Eaton Holding International II B.V. Fusion Italia Srl Italy 100% Fusion Europe Ltd. Eaton Japan Co., Ltd. Japan 100% Fusion Semiconductor Japan KK Japan 100% Fusion Technology International Inc. Japan Fawick Company Limited Japan 50% Sumitomo Eaton Hydraulics Co., Ltd. Japan 50% Sumitomo Eaton Nova Corporation Japan 50% Cutler-Hammer Controls Sdn. Bhd.Malaysia 100% Eaton International Corporation Condura S. de R.L. de C.V. Mexico 99.999556% .000444% Eaton Holding International I B.V. Cutler-Hammer Mexicana, S.A. Mexico 100% Eaton International Corporation Eaton Controls, S. de R.L. de C.V. Mexico 99% 1% Eaton Holding International I B.V. Eaton Manufacturera S.A. de C.V. Mexico 90.603%
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Eaton Molded Products S. de R.L. de C.V. Mexico 99.9999985% .0000015% Eaton Holding International I B.V. Eaton Truck Components, S.A. de C.V. Mexico 99.995% .005%Eaton Holding International I B.V. Operaciones de Maquila de Juarez S de R.L. de C.V. Mexico 99.956%Cutler-Hammer Inc. .044%Eaton Holding International I B.V. Eaton s.a.m. Monaco 100% Eaton Automotive B.V. Netherlands 100% IKU Holding Montfoort B.V. Eaton B.V. Netherlands 100% Eaton C.V. (Partnership) Netherlands 99.9% Eaton Holding III Limited .1% Eaton International Corporation Eaton Holding International I B.V. Netherlands 100% Eaton Holding International II B.V. Netherlands 100% Eaton Holding International I B.V. IKU Holding Montfoort B.V. Netherlands 100% Eaton Holding B.V. Technisch Bureau Hoevelaken B.V.Netherlands 100% Eaton Holding B.V. Cutler-Hammer Asia Corporation Philippines 100% Eaton International Corporation Eaton Controls Spolka z o.o. Poland 100% Eaton Holding B.V. Eaton Automotive Spolka z o.o. Poland 100% Eaton Automotive Srl Cutler-Hammer Pte. Ltd. Singapore 100% Eaton International Corporation Eaton Services Pte. Ltd. Singapore 100% Eaton Semiconductor Equipment Inc.
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Eaton Truck Components (Pty) Limited South Africa 100% Eaton Limited (U.K.) Eaton J.C. Controls South Korea 51% Eaton International Corporation Eaton Limited South Korea 100% Eaton Semiconductor Limited South Korea 100% Eaton Semiconductor Equipment Inc. Fusion Pacific, Ltd. South Korea 100% Fusion Technology International Inc. Eaton Ros S.A. Spain 100% Eaton S.A. Eaton S.A. Spain 49.86% 50.14% Eaton B.V. Productos Eaton Livia S.A. Spain 100% Eaton S.A. Rheodata S.A. Switzerland 100% Rheodata Technologies S.A. Switzerland 100% Rheodata S.A. Eaton Limited Taiwan 19.42% 80.58% Eaton International Corporation Fusion Taiwan Inc. Taiwan 100% Fusion Technology International Inc. Modern Molded Products Limited Taiwan 50% Eaton International Corporation Eaton Technologies Limited Thailand 100% Rubberon Technology Corporation Limited Thailand 100% Eaton Financial Services Limited United Kingdom 100% Eaton Limited (U.K.) Eaton Holding Limited United Kingdom 100% Eaton Limited United Kingdom 100% Eaton Holding Limited Eaton Shared Services Limited United Kingdom 100% Eaton Holding Limited Fusion Europe Ltd. United Kingdom 100% Fusion Technology International Inc.
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Cutler-Hammer de Venezuela S.A. Venezuela 100% Eaton International Corporation Cutler-Hammer Electro Metalurgica C.A. Venezuela 100% Cutler-Hammer de Venezuela S.A.
(A) Other Eaton subsidiaries, most of which are inactive, are not listed above. If considered in the aggregate, they would not be material. Page 1 Eaton Corporation 1997 Annual Report on Form 10-K Item 14(c) Exhibit 23 Consent of Independent Auditors We consent to the incorporation by reference in the following Registration Statements and related Prospectuses of our report dated January 19, 1998, with respect to the consolidated financial statements of Eaton Corporation included in this Form 10-K for the year ended December 31, 1997:
Registration number Description Filing Date - ------------ ------------------------------------------ ----------------- 333-46861 Eaton Limited U.K. Savings-Related Share Option Scheme [1991] - Form S-8 Registration Statement February 25, 1998 333-40243 Eaton Corporation 172,489 Common Shares - Form S-3 Registration Statement February 20, 1998 333-45575 Eaton Limited U.K. Savings-Related Share Option Scheme [1991] - Form S-8 Registration Statement February 4, 1998 333-35697 Cutler-Hammer de Puerto Rico Company Retirement Savings Plan - Form S-8 Registration Statement September 16, 1997 333-35699 Eaton Savings Plan for Certain Cutler- Hammer Represented Employees - Form S-8 Registration Statement September 16, 1997 333-28869 Eaton 401(K) Savings Plan and Trust - Form S-8 Registration Statement June 10, 1997 333-28867 AIL Systems Inc. Employee Investment Plan - Form S-8 Registration Statement June 10, 1997 333-25693 Eaton Corporation Shareholder Dividend Reinvestment Plan - Form S-3 Registration Statement April 23, 1997 333-23539 Eaton Non-Employee Director Fee Deferral Plan - Form S-8 Registration Statement March 18, 1997 333-22597 Eaton Incentive Compensation Deferral Plan - Form S-8 Registration Statement March 13, 1997 333-13873 Eaton Corporation Investment Plan for Hourly Employees of the Hydraulics Division - Hutchinson Plant - Form S-8 Registration Statement October 10, 1996
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333-13869 Lincoln Plant Share Purchase and Investment Plan and Trust - Form S-8 Registration Statement October 10, 1996 333-13861 Eaton Corporation 401(k) Savings Plan for the Hourly Rate Employees at Airflex Division - Form S-8 Registration Statement October 10, 1996 333-13857 Eaton Wauwatosa Union Plan and Trust - Form S-8 Registration Statement October 10, 1996 333-13855 Eaton Winamac Hourly Investment Plan and Trust - Form S-8 Registration Statement October 10, 1996 333-03599 Eaton Corporation Share Purchase and Investment Plan - Form S-8 Registration Statement May 13, 1996 333-01365 Eaton Corporation Incentive Compensation Deferral Plan - Form S-3 Registration Statement March 1, 1996 33-64201 Eaton Corporation $120,837,500 of Debt Securities and Debt Warrants - Form S-3 Registration Statement November 14, 1995 33-63357 Lectron Products, Inc. Retirement Savings Plan - Form S-8 Registration Statement October 12, 1995 33-60907 Eaton 1995 Stock Plan - Form S-8 Registration Statement July 7, 1995 33-59459 Eaton Corporation 2,072,400 Common Shares - Form S-3 Registration Statement May 19, 1995 33-53521 Cutler-Hammer Inc. Savings Plan for Certain Hourly Employees - Form S-8 Registration Statement May 6, 1994 33-52333 Eaton Corporation $600,000,000 of Debt Securities, Debt Warrants, Common Shares and Preferred Shares - Form S-3 Registration Statement February 18, 1994 33-49779 Eaton Limited U.K. Savings-Related Share Option Scheme [1991] - Form S-8 Registation Statement July 16, 1993 33-49777 Eaton Corporation Share Purchase and Investment Plan - Form S-8 Registration Statement July 15, 1993 33-49393, Eaton Corporation Stock Option Plans - 33-12842, Form S-8 Registration Statement March 9, 1993 2-76349 & 2-58718
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33-15582 Eaton Limited U.K. Savings-Related Share Option Scheme - Form S-8 Registration Statement July 7, 1987 33-2688 Eaton Corporation Shareholder Dividend Reinvestment Plan (Including Post Effective Amendment No. 1 filed February 19, 1986) January 15, 1986 2-77090 Eaton Corporation Strategic Incentive and Option Plan - Form S-8 Registration Statement May 10, 1982
/s/ Ernst & Young LLP Cleveland, Ohio March 20, 1998 Page 1 Eaton Corporation 1997 Annual Report on Form 10-K Item 14(c) Exhibit 24 Power of Attorney KNOW ALL MEN BY THESE PRESENTS: That each person whose name is signed below has made, constituted and appointed, and by this instrument does make, constitute and appoint, Adrian T. Dillon, Billie K. Rawot or William J. Nowak his or her true and lawful attorney, for him or her and in his or her name, place and stead to subscribe, as attorney-in-fact, his or her signature as Director or Officer or both, as the case may be, of Eaton Corporation, an Ohio corporation, to the Annual Report on Form 10-K for the year ended December 31, 1997 pursuant to the Securities Exchange Act of 1934, and to any and all amendments to that Annual Report on Form 10-K, giving and granting unto each such attorney-in-fact full power and authority to do and perform every act and thing whatsoever necessary to be done in the premises, as fully as he or she might or could do if personally present, hereby ratifying and confirming all that each such attorney-in-fact shall lawfully do or cause to be done by virtue hereof. This Power of Attorney shall not apply to any Annual Report on Form 10-K or amendment thereto filed after December 31, 1998. IN WITNESS WHEREOF, this Power of Attorney has been signed this 25th day of February, 1998. /s/ Stephen R. Hardis /s/ Ned C. Lautenbach - ------------------------------ --------------------------- Stephen R. Hardis Ned C. Lautenbach Chairman and Chief Executive Director Officer; Principal Executive Officer; Director /s/ Alexander M. Cutler /s/ John R. Miller - ------------------------------ --------------------------- Alexander M. Cutler John R. Miller President and Chief Operating Director Officer; Director /s/ Adrian T. Dillon /s/ Furman C. Moseley - ------------------------------ --------------------------- Adrian T. Dillon Furman C. Moseley Executive Vice President; Director Chief Financial and Planning Officer; Principal Financial Officer /s/ Billie K. Rawot /s/ Victor A. Pelson - ------------------------------ --------------------------- Billie K. Rawot Victor A. Pelson Vice President and Controller; Director Principal Accounting Officer Page 2 /s/ Neil A. Armstrong /s/ A. William Reynolds - ------------------------------ --------------------------- Neil A. Armstrong A. William Reynolds Director Director /s/ Phyllis B. Davis /s/ Gary L. Tooker - ------------------------------ --------------------------- Phyllis B. Davis Gary L. Tooker Director Director /s/ Ernie Green - ----------------------------- Ernie Green Director EX-27.1 2
5 This schedule contains summary financial information extracted from the Consolidated Balance Sheets and the Statements of Consolidated Income and is qualified in its entirety by reference to such financial statements. 1,000,000 12-MOS 12-MOS 12-MOS DEC-31-1997 DEC-31-1996 DEC-31-1995 DEC-31-1997 DEC-31-1996 DEC-31-1995 53 22 56 37 38 28 973 1,000 947 15 15 15 734 729 735 2,055 2,017 1,967 3,360 3,496 3,214 1,601 1,704 1,561 5,465 5,307 5,053 1,357 1,230 1,145 1,272 1,062 1,084 0 0 0 0 0 0 37 39 39 2,034 2,121 1,936 5,465 5,307 5,053 7,563 6,691 6,822 7,563 6,691 6,822 5,456 5,171 5,028 6,948 6,433 6,182 (139) (42) (38) 0 0 0 86 85 86 668 485 592 204 136 193 464 349 399 0 0 0 (54) 0 0 0 0 0 410 349 399 5.34 4.50 5.13 5.24 4.46 5.08
EX-27.2 3
5 This schedule contains summary financial information extracted from the Consolidated Balance Sheets and the Statements of Consolidated Income and is qualified in its entirety by reference to such financial statements. 1,000,000 3-MOS 6-MOS 9-MOS DEC-31-1997 DEC-31-1997 DEC-31-1997 MAR-31-1997 JUN-30-1997 SEP-30-1997 25 23 24 43 29 70 1,095 1,135 1,160 14 15 16 723 744 785 2,133 2,165 2,310 3,475 3,517 3,638 1,732 1,755 1,801 5,359 5,400 5,845 1,208 1,228 1,343 1,121 1,055 1,387 0 0 0 0 0 0 39 39 39 2,151 2,235 2,196 5,359 5,400 5,845 1,789 3,698 5,629 1,789 3,698 5,629 1,307 2,678 4,068 1,639 3,361 5,189 (15) (30) (44) 0 0 0 20 40 62 145 327 422 44 100 141 101 227 281 0 0 0 0 0 0 0 0 0 101 227 281 1.31 2.94 3.65 1.29 2.90 3.58
EX-27.3 4
5 This schedule contains summary financial information extracted from the Consolidated Balance Sheets and the Statements of Consolidated Income and is qualified in its entirety by reference to such financial statements. 1,000,000 3-MOS 6-MOS 9-MOS DEC-31-1996 DEC-31-1996 DEC-31-1996 MAR-31-1996 JUN-30-1996 SEP-30-1996 3 8 25 23 21 31 1,100 1,107 1,070 14 14 14 739 735 736 2,079 2,102 2,088 3,231 3,319 3,398 1,594 1,633 1,690 5,130 5,255 5,277 1,161 1,154 1,162 1,071 1,143 1,125 0 0 0 0 0 0 39 39 39 2,007 2,065 2,092 5,130 5,255 5,277 1,736 3,518 5,237 1,736 3,518 5,237 1,280 2,590 3,873 1,583 3,207 4,801 (9) (22) (33) 0 0 0 21 43 64 141 290 405 46 92 122 95 198 283 0 0 0 0 0 0 0 0 0 95 198 283 1.23 2.55 3.66 1.22 2.52 3.63
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