-----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, AHgZWqS2fUbO5JDpqZpJFZQL84YIl7Be1n9Fr48o5Tr3sQZYKJmvh98ae3g80QVl R8iuOz1dhatIOLfeTUBPZg== 0000031277-98-000011.txt : 19981116 0000031277-98-000011.hdr.sgml : 19981116 ACCESSION NUMBER: 0000031277-98-000011 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981113 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-Q SEC ACT: SEC FILE NUMBER: 001-01396 FILM NUMBER: 98747015 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-Q 1 SEPT 30, 1998 FORM 10-Q Page 1 United States Securities and Exchange Commission Washington, D.C. 20549 Form 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the period ended September 30, 1998 ------------------ 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) 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 --- There were 71.4 million Common Shares outstanding as of September 30, 1998. Page 2 Part I - FINANCIAL INFORMATION Item 1. Financial Statements Eaton Corporation Condensed Consolidated Balance Sheets
Sept. 30, Dec. 31, (Millions) 1998 1997 ---- ---- ASSETS Current assets Cash $ 47 $ 53 Short-term investments 44 37 Accounts receivable 1,001 958 Inventories 687 734 Deferred income taxes and other current assets 282 273 ------ ------ 2,061 2,055 Property, plant and equipment 1,712 1,759 Excess of cost over net assets of businesses acquired 1,052 966 Deferred income taxes and other assets 668 685 ------ ------ $5,493 $5,465 ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Short-term debt and current portion of long-term debt $ 396 $ 104 Accounts payable and other current liabilities 1,186 1,253 ------ ------ 1,582 1,357 Long-term debt 1,194 1,272 Postretirement benefits other than pensions 550 553 Other liabilities 159 212 Shareholders' equity 2,008 2,071 ------ ------ $5,493 $5,465 ====== ======
See accompanying notes. Page 3 Eaton Corporation Statements of Consolidated Income
Three Months Ended Nine Months Ended September 30 September 30 ------------------ ----------------- (Millions except for per share data) 1998 1997 1998 1997 ---- ---- ---- ---- Net sales $1,620 $1,931 $5,019 $5,629 Costs and expenses Cost of products sold 1,192 1,390 3,599 4,068 Selling & administrative 247 272 774 801 Research & development 85 81 249 235 Purchased in-process research & development 85 85 ------ ------ ------ ------ 1,524 1,828 4,622 5,189 ------ ------ ------ ------ Income from operations 96 103 397 440 Other income (expense) Interest (expense) income - net (23) (20) (67) (57) Gain on sale of businesses 43 Other--net 6 12 22 39 ------ ------ ------ ------ (17) (8) (2) (18) ------ ------ ------ ------ Income before income taxes 79 95 395 422 Income taxes 21 41 118 141 ------ ------ ------ ------ Net income $ 58 $ 54 $ 277 $ 281 ====== ====== ====== ====== Net income per Common Share Assuming dilution $ .80 $ .69 $ 3.79 $ 3.58 Basic .82 .70 3.87 3.65 Average number of Common Shares outstanding Assuming dilution 72.3 78.7 73.0 78.4 Basic 71.1 77.1 71.5 77.1 Common Shares outstanding at end of period 71.4 77.1 71.4 77.1 Cash dividends paid per Common Share $ .44 $ .44 $ 1.32 $ 1.28
See accompanying notes. Page 4 Eaton Corporation Condensed Statements of Consolidated Cash Flows
Nine Months Ended September 30 ----------------- (Millions) 1998 1997 ---- ---- Net cash provided by operating activities Net income $ 277 $ 281 Adjustments to reconcile to net cash provided by operating activities Depreciation and amortization 245 250 Write-off of purchased in-process research and development 85 Gain on sale of businesses (43) Changes in operating assets and liabilities, excluding acquisitions and sales of businesses (157) (118) Other--net (26) (1) ------ ------ 296 497 Net cash used in investing activities Acquisitions of businesses, less cash acquired (107) (382) Sales of businesses 367 Expenditures for property, plant and equipment (271) (262) Net change in short-term investments (6) (34) Other--net (53) (25) ------ ------ (70) (703) Net cash (used in) provided by financing activities Borrowings with original maturities of more than three months Proceeds 1,174 394 Payments (795) (137) Borrowings with original maturities of less than three months--net (185) 82 Proceeds from exercise of stock options 17 25 Cash dividends paid (94) (99) Purchase of Common Shares (349) (57) ------ ------ (232) 208 ------ ------ (Decrease) increase in cash (6) 2 Cash at beginning of year 53 22 ------ ------ Cash at end of period $ 47 $ 24 ====== ======
See accompanying notes. Page 5 The following notes are included in accordance with the requirements of Regulation S-X and Form 10-Q: Preparation of Financial Statements - ----------------------------------- The condensed consolidated financial statements of Eaton Corporation (Eaton or the Company) are unaudited. However, in the opinion of management, all adjustments have been made which are necessary for a fair presentation of financial position, results of operations and cash flows for the stated periods. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's 1997 Annual Report on Form 10-K. The interim period results are not necessarily indicative of the results to be expected for the full year. Financial Presentation Changes - ------------------------------ Certain amounts for prior periods have been reclassified to conform to the current period presentation. Nonrecurring Charges - -------------------- Income in the third quarter of 1998 was reduced by pretax restructuring charges of $42 million ($27 million aftertax, or $.38 per Common Share-assuming dilution). These charges, which reduced operating profit of the Semiconductor Equipment business segment, related to workforce reductions, asset write- downs and other restructuring actions. Income in the first quarter of 1998 was reduced by nonrecurring pretax charges of $43 million ($28 million aftertax, or $.38 per Common Share-assuming dilution). The Company recorded $33 million of restructuring charges which reduced operating profit of the Automotive Components business segment by $8 million, the Industrial & Commercial Controls business segment by $15 million, and the Truck Components business segment by $10 million. These charges related to workforce reductions, asset write-downs and other restructuring actions. The Company also recorded a $10 million contribution to its charitable trust which is included in other expense. Sales of Businesses - ------------------- On January 2, 1998, the Company completed the sale of the Axle and Brake business to Dana Corporation. The sale of this business, and an adjustment related to a business sold in a prior period, resulted in a pretax gain of $43 million ($28 million aftertax, or $.38 per Common Share-assuming dilution) which was recorded in the first quarter of 1998. On April 1, 1998, the Company completed the sale of its automotive leaf spring business. The operating results of these businesses are reported in business segment information as divested operations Page 6 and prior periods have been reclassified to conform to the current period presentation. Acquisition of Fusion Systems Corporation and Write-off of Purchased In-Process Research & Development - ---------------------------------------------------------- On August 4, 1997, the Company purchased Fusion Systems Corporation for $293 million, before a reduction for cash acquired of $90 million. The acquisition was accounted for by the purchase method of accounting, and accordingly, the statements of income and the results of the Semiconductor Equipment business segment for the third quarter include the results of Fusion from the effective date of acquisition. The purchase price allocation 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 ($1.08 per Common Share-assuming dilution). Acquisition of Spicer Clutch - ----------------------------- On September 2, 1997, the Company completed the acquisition of Dana Corporation's worldwide Spicer Clutch business for $180 million. Clutch is a leader in the development of medium- and heavy-duty truck clutches and vibration dampers and had 1996 sales of $200 million. This acquisition was accounted for by the purchase method of accounting. Business Segment Reporting - -------------------------- As announced on April 2, 1998, the Company changed its business segment reporting in order to comply with Statement of Financial Accounting Standard (SFAS) No. 131, 'Disclosure about Segments of an Enterprise and Related Information'. This new rule changes the standards for reporting financial results by operating segments. Business segment information for 1997 has been reclassified to conform to the current year presentation. Comprehensive Income - -------------------- On January 1, 1998, the Company adopted SFAS No. 130, 'Reporting Comprehensive Income'. SFAS No. 130 establishes new standards for reporting comprehensive income and its components; however, the adoption of SFAS No. 130 has no impact on the Company's net income or shareholders' equity. For the Company, the principal difference between net income as historically reported in the statements of consolidated income and comprehensive income are foreign currency translation adjustments recorded in shareholders' equity. Comprehensive income (in millions) is as follows: Page 7 Three Months Ended September 30 ------------------ 1998 1997 ---- ---- Net income $ 58 $ 54 Foreign currency translation and other adjustments 23 (16) ---- ---- Comprehensive income $ 81 $ 38 ==== ==== Nine Months Ended September 30 ----------------- 1998 1997 ---- ---- Net income $277 $281 Foreign currency translation and other adjustments 37 (69) ---- ---- Comprehensive income $314 $212 ==== ==== Inventories - ----------- Sept. 30, Dec. 31, (Millions) 1998 1997 ---- ---- Raw materials $263 $258 Work-in-process and finished goods 497 565 ---- ---- Gross inventories at FIFO 760 823 Excess of current cost over LIFO cost (73) (89) ---- ---- Net inventories $687 $734 ==== ==== Net Income per Common Share - --------------------------- The calculation of net income per Common Share - assuming dilution and basic follows (millions except for per share data): Page 8 Three Months Ended September 30 ------------------ 1998 1997 ---- ---- Net income-assuming dilution and basic $ 58 $ 54 Average number of Common Shares outstanding-assuming dilution 72.3 78.7 Less dilutive effect of stock options 1.2 1.6 ---- ---- Average number of Common Shares outstanding-basic 71.1 77.1 ==== ==== Net income per Common Share Assuming dilution $ .80 $ .69 Basic $ .82 $ .70 Nine Months Ended September 30 ----------------- 1998 1997 ---- ---- Net income-assuming dilution and basic $ 277 $ 281 Average number of Common Shares outstanding-assuming dilution 73.0 78.4 Less dilutive effect of stock options 1.5 1.3 ---- ---- Average number of Common Shares outstanding-basic 71.5 77.1 ==== ==== Net income per Common Share Assuming dilution $3.79 $3.58 Basic $3.87 $3.65 Recently Issued Accounting Pronouncements - ----------------------------------------- In June 1998, SFAS No. 133, 'Accounting for Derivative Instruments and Hedging Activities', was issued. The Company must adopt the standard by the beginning of the first quarter of the year 2000. SFAS No. 133 will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The Company has not yet determined the effect of SFAS No. 133 on earnings and the financial position of the Company. Page 9 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 and engine components. On April 1, 1998, the division that manufactures leaf spring assemblies was sold. Summary financial information for Eaton Offshore and its consolidated subsidiaries is as follows (in millions): Nine Months Ended September 30 ------------------ 1998 1997 ---- ---- Income statement data Net sales $499 $543 Gross profit 118 119 Net income 44 52 Sept. 30, Dec. 31, 1998 1997 ---- ---- Balance sheet data Current assets $364 $375 Noncurrent assets 198 196 Net intercompany payables 107 160 Current liabilities 116 120 Noncurrent liabilities 115 107 Page 10 Eaton Corporation Business Segment Information
Three Months Ended Nine Months Ended September 30 September 30 ------------------ ----------------- (Millions) 1998 1997 1998 1997 ---- ---- ---- ---- Net sales Automotive Components $ 458 $ 429 $1,438 $1,348 Hydraulics & Other Components 145 145 465 442 Industrial & Commercial Controls 604 586 1,753 1,688 Semiconductor Equipment 48 131 220 316 Truck Components 365 303 1,112 830 ------ ------ ------ ------ Ongoing operations 1,620 1,594 4,988 4,624 Divested operations 337 31 1,005 ------ ------ ------ ------ Total net sales $1,620 $1,931 $5,019 $5,629 ====== ====== ====== ====== Operating profit Automotive Components $ 41 $ 48 $ 158 $ 175 Hydraulics & Other Components 19 27 78 84 Industrial & Commercial Controls 55 64 143 167 Semiconductor Equipment (71) 14 (93) 18 Truck Components 54 43 177 111 ------ ------ ------ ------ Ongoing operations 98 196 463 555 Divested operations 22 (1) 63 Amortization of intangible assets & excess of cost over net assets of businesses acquired (16) (13) (48) (33) Purchased in-process research & development (85) (85) Interest (expense) income - net (23) (20) (67) (57) Gain on sales of businesses 43 Other (expense) income - net 20 (5) 5 (21) ------ ------ ------ ------ Income before income taxes $ 79 $ 95 $ 395 $ 422 ====== ====== ====== ======
Page 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations - --------------------- Sales for the three months and nine months ended September 30, 1998 decreased 16% and 11%, respectively, from the comparable periods in 1997. The Company's 1997 strategic repositioning program of major divestitures and important acquisitions reduced year-to-date 1998 sales by about $800 (14%) million compared to one year ago. The Semiconductor Equipment business segment experienced a decline in sales while all other business segments experienced sales growth in the nine months ended September 30, 1998. Excluding the Semiconductor Equipment business segment, year-to-date 1998 sales from ongoing operations were 11% ahead of a year ago while operating margins were steady at 12% of sales. During the third quarter of 1998, the Company recorded a nonrecurring pretax charge of $42 million to restructure the Company's Semiconductor Equipment Operations (SEO). In last year's third quarter, the Company recorded a one-time charge of $85 million to write-off the purchased in-process research and development associated with the acquisition of Fusion Systems Corporation. During the first quarter of 1998, the Company recorded a one- time net pretax gain of $43 million, related principally to the January 2, 1998 sale of its worldwide Axle and Brake business to Dana Corporation. This gain was entirely offset by charges of $33 million related to restructuring actions and a $10 million contribution to the Company's charitable trust. Before nonrecurring charges in both periods, net income reached $85 million compared to last year's $139 million. Third quarter 1998 earnings per share before these charges were $1.18, down 33% from last year's $1.77 per fully diluted share. After nonrecurring charges in both periods, third quarter 1998 net income increased 7% and third quarter 1998 earnings per share were $.80, up 16% from last year's $.69 per fully diluted share. Net income for the nine months ended September 30, 1998 decreased 1% from the comparable period in 1997. The Company achieved a record earnings per share for the nine months ended September 30, 1998 of $3.79 compared to $3.58 for the same period in 1997. In the fourth quarter of 1998, the Company anticipates taking an additional $33 million of restructuring charges to bring costs back into better balance with likely 1999 physical volumes while still supporting the Company's ongoing growth initiatives. By the end of 1998, in just over a year, the Company will have invested more than $130 million in restructuring its businesses in order to improve its ability to achieve superior performance, whatever the economic climate may be. Page 12 Automotive Components - --------------------- Automotive Components sales in the third quarter and first nine months of 1998 were a record, increasing 7% from the comparable periods a year ago. Excluding the acquisitions of GT Products and Amtec S.p.A., sales during the quarter were up about 1% from a year ago compared to a 3% drop in North American light vehicle production, an 18% decline in South America, and a 5% increase in European production. Traditionally, sales for this segment in the third quarter are lower than in the second quarter as a result of preparations by vehicle manufacturers for the upcoming model year and their temporary shutdowns for the taking of annual physical inventories. Operating profit for the third quarter and first nine months of 1998 declined 15% and 10%, respectively, compared to the same periods in 1997. Beyond the impact of the General Motors strike, which reduced operating profits by about $7 million in the third quarter of 1998, the Company continues to struggle with product mix and strong European volumes. The Company recently won significant new contracts for the supercharger and automotive switch businesses. Increased spending on these programs has reduced margins near term, but should help ensure that this business segment continues to profitably outpace market growth in the years immediately ahead. Operating profit was also reduced by restructuring charges of $8 million recorded in the first quarter of 1998. During the third quarter of 1998, the Company acquired Amtec S.p.A., a privately owned Italian manufacturer of automotive cylinder heads. During the second quarter of 1998, the Company announced the formation of Shanghai Eaton Engine Components Company Ltd., a 55% owned joint venture with Shanghai Pudong Valve Factory and Asian Nittan Pte. Ltd. The venture manufactures and sells automotive and motorcycle engine valves and hydraulic valve lifters for the Chinese market. The Company also announced it had formed Eaton Shenglong Company Ltd., a 70% owned joint venture with Shenglong Group, which is producing viscous fan drives for the Chinese automotive market. During the first quarter of 1998, the Company acquired GT Products, a manufacturer of fuel system components that regulate fuel flow and vapor emissions in fuel tanks. On April 1, 1998, the Company concluded the previously announced sale of its automotive leaf spring business. Hydraulics & Other Components - ----------------------------- Hydraulics & Other Components sales in the third quarter of 1998 were essentially equal to last year's volume and consistent with the year-to-year change in North American mobile hydraulics shipments. Business slowed appreciably in the third quarter as the Company's customers reacted to the ongoing Asian crisis. Sales for the first nine months of 1998 increased Page 13 5% compared to the same period in 1997. Many of the agricultural equipment customers have scheduled lower fourth quarter production and the Company will be affected by that slowdown. Operating profits were down 30% and 7%, respectively, for the third quarter and first nine months of 1998 compared to the same periods in 1997. The operating efficiencies anticipated in the third quarter were not achieved, but investments made earlier this year are expected to produce better margins over the balance of 1998 and in 1999. Industrial & Commercial Controls - -------------------------------- Sales of Industrial & Commercial Controls reached a record in the third quarter of 1998, 3% ahead of one year ago compared to about a 2% increase in North American markets for distribution equipment and industrial controls markets. Sales increased 4% for the first nine months of 1998 compared to the same period in 1997. Operating profits for the third quarter and first nine months of 1998 declined 14% compared to the same periods in 1997 with Hurricane Georges responsible for about $4 million of the shortfall. Solid activity levels in electrical distribution equipment offset continued softness in industrial controls markets, but costs are still too high at present sales levels. The success of Cutler-Hammer's new Engineering Services and Systems Division, while incurring significant start-up costs, should help this segment to outpace market growth in the periods ahead. Operating profit was also reduced by restructuring charges of $15 million recorded in the first quarter of 1998. During the third quarter of 1998, the Company acquired Integrated Partial Discharge Diagnostics, Inc., a Minnetonka, Minnesota-based manufacturer of equipment that measures insulation deterioration within AC power equipment. Semiconductor Equipment - ----------------------- Semiconductor Equipment (SEO) sales in the third quarter and first nine months of 1998 fell 63% and 30%, respectively, compared to the same periods in 1997. Before a restructuring charge of $42 million, this business segment suffered an operating loss of $29 million for the third quarter of 1998 and $51 million for the first nine months of 1998 compared to operating profits of $14 million and $18 million in the comparable periods in 1997. During the third quarter of 1998, the Company recorded a nonrecurring pretax charge of $42 million to restructure this Page 14 business segment. The restructuring includes the layoff of an additional 475 employees from the SEO worldwide workforce, bringing to 1,050, or 42%, the number of employees laid off as a result of declining global markets for semiconductor equipment. The charge includes $10 million related to workforce reductions, $27 million for asset write-downs, and $5 million related to other restructuring actions. The Company also expects to record additional restructuring actions in the fourth quarter 1998 and in the first quarter of 1999 of approximately $4 million in each quarter. The Company has lowered 1998 sales and earnings expectations of the Semiconductor Equipment business segment. Given current orders and backlog, the Company now expects that sales will only reach $275 million in 1998, 40% below 1997 and the business segment will suffer an operating loss of approximately $80 million before the $42 million restructuring charge described above. The Company continues to search for the bottom of this market while pushing ahead with critical restructuring efforts. Assuming that volumes are no better in 1999 than this year, the Company would expect the restructuring efforts to produce break-even results next year. Truck Components - ---------------- Sales of Truck Components in the third quarter of 1998 were a record, 21% above last year's results. Operating profits also reached a record in the third quarter of 1998, 26% above last year. Sales and operating profit increased 34% and 59%, respectively, for the first nine months of 1998 compared to the same period in 1997. Heavy truck production is at record levels this year in both North America and Europe. The performance of the Clutch division, acquired from Dana Corporation in 1997, continues to exceed expectations. In general, the Company is taking advantage of sustained robust markets. Operating profit was reduced by restructuring charges of $10 million recorded in the first quarter of 1998. This business segment anticipates an additional $10 million restructuring charge in the fourth quarter of 1998, in part to begin restructuring its European business. European trucking deregulation, de- integration of OEMs, and the Euro will all transform the competitive landscape in Europe in the years ahead. This restructuring, building upon the recent acquisition of a Polish transmission manufacturer, is intended to ensure the Company achieves world class costs and productivity in all worldwide operations. During the third quarter of 1998, the Company acquired Fabryka Przekladni Samochodowych (FPS), a truck transmission manufacturer in Gdansk, Poland, with annual sales of about $20 million. This acquisition is an important step in a major initiative to improve the manufacturing cost structure of our European Truck operations. Also, construction of a $70 million Page 15 plant near Sao Paulo, Brazil to manufacture transaxles for GM's Corsa is on schedule and will begin production next year. Changes in Financial Condition - ------------------------------ The Company remains in a strong financial position at September 30, 1998; net working capital decreased from $698 million at the end of 1997 to $479 million at September 30, 1998 (the current ratio was 1.5 compared to 1.3 at each of those dates, respectively). Divested businesses and the increase in short-term debt were the primary causes of the reduction in working capital. Cash flow from operating activities, supplemented by proceeds from commercial paper borrowings and the sale of businesses, was used to fund capital expenditures, acquisitions of businesses, repayment of debt, cash dividends and the repurchase of Common Shares. During the second quarter of 1998, the Company terminated its existing credit agreements and entered into a new credit facility with a series of banks totaling $1 billion; $500 million with a five-year term and $500 million with a 364-day term. Year 2000 Readiness Disclosure - ------------------------------ 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 the business, including certain products, manufacturing, product development and many administrative functions. Much of this software may be unable to interpret the calendar Year 2000 appropriately unless it is modified or replaced. The Company has approached the Year 2000 issue with the creation of a corporate-wide initiative led by the Company's Vice President-Information Technologies and involving program managers from each business unit. The activities associated with the corporate-wide initiative include reviewing the Company's date-sensitive products and critical information technology (IT) and non-IT systems, such as those which interface with major customers, suppliers, and other third parties. The Company's Year 2000 compliance efforts encompass the following focus areas: Business Management Systems: This area includes information systems and applications relating to manufacturing, marketing, sales, purchasing, product development and design systems. These systems have been identified as very important to the support of the Company's operations and have been given the highest priority toward becoming Year 2000 compliant. Page 16 Enterprise Network Infrastructure: The Company utilizes one enterprise network throughout the organization which will be upgraded by the end of 1998 to become Year 2000 compliant. All personal/desktop computers and related software used throughout the Company will also be made compliant. Administrative Systems: This area includes systems associated with human resources, cash management and financial accounting and reporting. The Company operates a highly centralized systems environment in North America and throughout much of Europe and is working towards full compliance of these systems by mid-year 1999. Shop Floor Equipment and Facilities Infrastructure: The Company is auditing the machinery and equipment used both in manufacturing and in support operations at each location. This audit will establish Year 2000 readiness and measure the risk of non-compliance so as to determine the best remediation plan to be followed in avoiding potential disruptions in production. Software in Products: All of the Company's products which are currently marketed, and the vast majority of the products which have been marketed in the past, are either not date-sensitive or do not require remediation. With respect to certain previously-marketed products of the Semiconductor Equipment business segment and the Cutler-Hammer business, the Company is pursuing remediation programs that are consistent with its warranty requirements or is offering product upgrades or remediations. Supplier Assurance: To determine Year 2000 readiness, the Company undertook a supplier assurance program in 1997, which includes surveying its suppliers and evaluating their responses. Based on this evaluation and the criticality of the items or services provided by the suppliers, the Company is auditing their compliance and working with them towards assuring compliance or, if needed, the development of contingency plans. Customer Assurance: The Company is working with the Automotive Industry Action Group, various other trade organizations and customers to ensure that a common Year 2000 compliance approach is applied across those respective industries. Continuous interaction with these trade organizations is helping to identify the issues requiring attention and to develop appropriate solutions. The Company's Year 2000 program activities include the identification of affected hardware and software, the development of a plan for correcting those systems in the most effective manner, the execution of that plan and the monitoring of its success. Although the Company's various locations are at differing stages of readiness with respect to the various areas, the Company has substantially completed the Page 17 identification and plan development phases of the project. The Company is well underway in the execution phase and anticipates completing the majority of the program by mid-year 1999 although certain applications at certain business units may not be completed until late in 1999. Continuous review and testing is being conducted throughout all phases of the program to help ensure that the Company achieves and maintains compliance as the Year 2000 approaches. The program, as it relates to IT, involves a combination of hardware and software modifications, upgrades and replacements. In many instances, the Company will replace non-compliant systems with newer systems which will significantly improve functionality as well as appropriately interpret the calendar year 2000 and beyond. Although the timing of these actions may have been influenced by the Year 2000 issue, in virtually all instances they will involve capital expenditures that would have occurred in the normal course of business. As part of reengineering and other initiatives, the Company is also currently upgrading and replacing other systems to provide significantly enhanced functionality; however, these upgrades and replacements are unrelated to the Year 2000 issue. As part of the Company's Year 2000 program, detailed contingency plans are being formalized as the target date for completion approaches. Business disruption scenarios are currently being identified and appropriate strategies are being evaluated in the development of these various plans. The current estimate of total Year 2000 program costs is approximately $95 million. Approximately $70 million of those costs represent replacement costs of certain hardware and software which will provide significantly enhanced functionality over the systems that are currently being used. The remaining $25 million represents costs associated with modifying and upgrading existing systems. To date, approximately two thirds of the estimated costs have been incurred. Purchased hardware and software will be capitalized in accordance with normal Company policy while other remediation costs will be expensed as incurred. Cash flow related to these costs will be satisfied with funds from operations that are normally budgeted for procurement and maintenance of the Company's information systems and production and facilities equipment as well as operating cash flows. The Company requires regular project status reporting, and cost estimates will be revised as more refined estimates become available. The Company believes that it has an effective program in place to resolve the Year 2000 issue in a timely manner. However, satisfactory completion of the Company's program may not prevent business disruptions resulting from actions of the Company's critical suppliers and customers. Such disruptions would impair the Company's ability to obtain necessary materials for production or sell products to customers. If such a disruption occurred, the Company may experience lost or delayed sales and profits depending on the duration of the disruption. Key aspects of the Company's program are Page 18 addressing this uncertainty but its ability to be fully confident of conditions related to third parties is limited. Currently, the Company cannot reasonably estimate the amount of potential lost or delayed sales and profits. Euro - ---- On January 1, 1999, eleven of the fifteen member countries of the European Monetary Union (EMU) will begin a three-year transition phase during which a common currency called the Euro will be adopted as their legal currency. The Euro will then trade on currency exchanges and be available for non-cash transactions. During the transition period, public and private parties may pay for goods and services using either the Euro or the participating country's legacy currency on a "no compulsion, no prohibition" basis. The conversion rates between the existing legacy currencies and the Euro will be fixed on January 1, 1999. The legacy currencies will remain legal tender for cash transactions between January 1, 1999 and January 1, 2002 at which time all legacy currencies will be withdrawn from circulation and the new Euro denominated bills and coins will be used for cash transactions. The Company has several operations within the eleven participating countries that will be utilizing the Euro as their local currency in 1999. Additionally, the Company's operations in other European countries and elsewhere in the world will be conducting business transactions with customers and suppliers that will be denominated in the Euro. The Company has established Euro denominated bank accounts to accommodate Euro transactions. The Company's exposure to changes in foreign exchange rates may be reduced as a result of the Euro conversion. Conversely, changes in the value of the Euro in US Dollars may have a greater impact because there will be less diversity in the Company's exposure to foreign currencies. The Company has established a steering committee to review strategic and tactical areas arising from the Euro conversion. The Company has focused immediate efforts on aspects of the Euro conversion that require adjustment or compliance by January 1, 1999. These aspects include transacting business in the Euro, the competitive impact on product pricing and adjustments to billing systems to handle parallel currencies. The Company has determined that these systems have the capability to handle Euro transactions. Continuing analysis and development efforts by the steering committee and project teams at the business units will help ensure that the implementation of the Euro meets the timetable and regulations established by the EMU. Based on current estimates, the Company does not expect the costs incurred to address the Euro will have a material impact on the financial condition or results of operations. Page 19 Forward-Looking Statements - -------------------------- The forward-looking statements in this Form 10-Q relating to fourth quarter restructuring charges, the growth of the Automotive Components and the Industrial and Commercial Controls business segments, the slowdown of the Hydraulics and Other Components business segment, and the operating results of the Semiconductor Equipment business segment, should be used with caution. They are subject to various risks and uncertainties, many of which are outside the control of the Company. Important factors which could cause actual results to differ materially from those in the forward-looking statements include changes in global economic and financial conditions, labor strikes, the markets for the products to which the forward-looking statements relate, costs and disruptions associated with the Year 2000 issue and the impact of the conversion to the Euro currency. The Company assumes no obligation to update these forward-looking statements. Page 20 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits - See Exhibit Index attached. (b) Reports on Form 8-K. 1. On October 8, 1998, the Company filed a Current Report on Form 8-K concerning lowering 1998 expectation for sales and earnings of the Semiconductor Equipment Operations (SEO) and a $50 million charge to restructure SEO. Page 21 Signature Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Eaton Corporation ---------------------------- Registrant Date: November 12, 1998 /s/ Adrian T. Dillon ---------------------------- Adrian T. Dillon Executive Vice President - Chief Financial and Planning Officer; Principal Financial Officer Page 1 EATON CORPORATION EXHIBIT INDEX Regulation S-K, Item 601 - Exhibit Reference Number Exhibit - ------------------ ------- 4 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 of the Company and its subsidiaries. 27 Financial Data Schedule EX-27 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 9-MOS DEC-31-1998 SEP-30-1998 47 44 1,017 16 687 2,061 3,238 1,526 5,493 1,582 1,194 0 0 36 1,972 5,493 5,019 5,019 3,599 4,622 (65) 0 67 395 118 277 0 0 0 277 3.87 3.79
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