-----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, HcVhSKoItob2Unc10W8ljr7WXJZMQG1nUkFn1F8Zj0YzkAcCnyN70T6NnJW19BpD Gprlgpzx0iHBKykIsvuKGA== 0000031277-99-000012.txt : 19990512 0000031277-99-000012.hdr.sgml : 19990512 ACCESSION NUMBER: 0000031277-99-000012 CONFORMED SUBMISSION TYPE: 8-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19990510 ITEM INFORMATION: FILED AS OF DATE: 19990511 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: 8-K/A SEC ACT: SEC FILE NUMBER: 001-01396 FILM NUMBER: 99617149 BUSINESS ADDRESS: STREET 1: EATON CTR STREET 2: 1111 SUPERIOR AVE CITY: CLEVELAND STATE: OH ZIP: 44114-2584 BUSINESS PHONE: 2165235000 MAIL ADDRESS: STREET 1: 1111 SUPERIOR AVENUE CITY: CLEVELAND STATE: OH ZIP: 44114 FORMER COMPANY: FORMER CONFORMED NAME: EATON YALE & TOWNE INC DATE OF NAME CHANGE: 19710822 8-K/A 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Amended Form 8-K/A - #1 CURRENT REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Date of Report (Date of earliest event reported): April 22, 1999 EATON CORPORATION - -------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 1-1396 34-0196300 - ----------------- ------------ ------------------- (State or other (Commission (I.R.S. Employer jurisdiction of File Number) Identification No.) incorporation) Eaton Center Cleveland, Ohio 44114 - ---------------------------------------- ------------------- (Address of principal executive offices) (Zip Code) (216) 523-5000 ----------------------------- Registrant's telephone number, including area code Page 2 Item 2. Acquisition or Disposition of Assets ------------------------------------ On April 9, 1999, Eaton Corporation (Eaton) completed the acquisition of all of the outstanding common stock of Aeroquip- Vickers, Inc., for approximately $1.6 billion. Funds for the purchase price were primarily obtained through the issuance of commercial paper. The acquisition will be accounted for by the purchase method of accounting. Aeroquip is a global leader in the manufacture of products that include all pressure ranges of hose, fittings, adapters, couplings and other fluid connectors, plus precision molded and extruded plastic products. Vickers is a leading worldwide producer of hydraulic pumps, motors and cylinders; electronic and hydraulic controls; electric motors and drives; filtration products; and fluid- evaluation products and services. The two companies had combined sales of $2.1 billion for 1998. Page 3 Item 7. Financial Statements and Exhibits --------------------------------- Included in this report are 1) audited historical financial state- ments of Aeroquip-Vickers, Inc., 2) unaudited pro forma condensed financial statements reflecting Eaton's acquisition of Aeroquip- Vickers and 3) exhibit 23, consent of independent auditors. 1) FINANCIAL STATEMENTS FOR YEAR ENDED DECEMBER 31, 1998 FOR AEROQUIP-VICKERS, INC. REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Shareholders and Board of Directors Aeroquip-Vickers, Inc. We have audited the accompanying statement of financial position of Aeroquip-Vickers, Inc. and subsidiaries at December 31, 1998 and 1997 and the related statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed at Item 14(a)(2). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Aeroquip-Vickers, Inc. and subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 1 of Notes to Financial Statements, the Company changed its method of accounting for start-up activities in 1998. /s/ ERNST & YOUNG LLP Toledo, Ohio January 27, 1999 Page 4
STATEMENT OF INCOME Years ended December 31, 1998, 1997 and 1996 (In thousands, except per share data) 1998 1997 1996 -------- -------- -------- Net sales $2,149,474 $2,112,293 $2,032,915 Cost of products sold 1,619,905 1,554,668 1,520,736 ---------- ---------- ---------- MANUFACTURING INCOME 529,569 557,625 512,179 Selling and general administrative expenses 271,718 263,824 260,712 Engineering, research and development expenses 71,471 72,161 74,892 Special charge -- 30,000 -- ---------- ---------- ---------- OPERATING INCOME 186,380 191,640 176,575 Interest expense (27,013) (27,171) (25,813) Other income (expense) - net (11,830) (16,316) 2,659 ---------- ---------- ---------- INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE 147,537 148,153 153,421 Income taxes 47,200 47,300 50,700 ---------- ---------- ---------- INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 100,337 100,853 102,721 Cumulative effect of accounting change, net of income tax benefit of $1,549 (3,283) -- -- ---------- ---------- ---------- NET INCOME $ 97,054 $ 100,853 $ 102,721 ========== ========== ========== BASIC INCOME PER SHARE Before cumulative effect of accounting change $ 3.58 $ 3.60 $ 3.62 Cumulative effect of accounting change (.12) -- -- ---------- ---------- ---------- Basic net income per share $ 3.46 $ 3.60 $ 3.62 ========== ========== ========== DILUTED INCOME PER SHARE Before cumulative effect of accounting change $ 3.56 $ 3.51 $ 3.51 Cumulative effect of accounting change (.12) -- -- ---------- ---------- ---------- Diluted net income per share $ 3.44 $ 3.51 $ 3.51 ========== ========== ==========
The Notes to Financial Statements are an integral part of this statement. Page 5
STATEMENT OF FINANCIAL POSITION December 31, 1998 and 1997 (Dollars in thousands, except per share data) 1998 1997 ------------ ------------ ASSETS CURRENT ASSETS Cash and cash equivalents $ 17,310 $ 18,736 Receivables 341,825 348,822 Inventories 302,236 294,767 Other current assets 52,146 49,323 ----------- ----------- TOTAL CURRENT ASSETS 713,517 711,648 Plants and properties 1,119,557 993,002 Less accumulated depreciation 571,340 518,860 ----------- ----------- 548,217 474,142 Other assets 197,067 190,806 ----------- ----------- TOTAL ASSETS $ 1,458,801 $ 1,376,596 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Notes payable $ 101,829 $ 84,044 Accounts payable 113,698 111,800 Income taxes 27,167 30,496 Other accrued liabilities 197,726 212,800 Current maturities of long-term debt 1,035 1,857 ----------- ----------- TOTAL CURRENT LIABILITIES 441,455 440,997 Long-term debt 278,343 256,707 Postretirement benefits other than pensions 121,715 122,272 Other liabilities 48,469 46,421 SHAREHOLDERS' EQUITY Common stock - par value $5 a share Authorized - 100,000,000 shares Outstanding - 27,600,520 and 28,064,981 shares, respectively (after deducting 6,680,326 and 6,215,865 shares, respectively, in treasury) 138,003 140,325 Additional paid-in capital 47,841 41,288 Retained earnings 419,178 366,676 Accumulated other comprehensive income (loss) - currency translation adjustments (36,203) (38,090) ----------- ----------- TOTAL SHAREHOLDERS' EQUITY 568,819 510,199 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,458,801 $ 1,376,596 =========== ===========
The Notes to Financial Statements are an integral part of this statement. Page 6
STATEMENT OF CASH FLOWS Years ended December 31, 1998, 1997 and 1996 (In thousands) 1998 1997 1996 -------- -------- -------- OPERATING ACTIVITIES Net income $ 97,054 $ 100,853 $ 102,721 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of accounting change, net of income tax benefit 3,283 -- -- Special charge -- 30,000 -- Depreciation 70,661 66,562 68,684 Amortization 8,986 6,639 4,789 Gain on sales of affiliates -- -- (17,300) Dividends received from affiliates -- -- 9,932 Deferred income taxes 511 (467) 11,997 Changes in certain assets and liabilities, excluding effects from special charge, acquisitions and dispositions --Receivables 14,807 (31,073) (44,783) --Inventories 4,113 (47,215) 10,656 --Accounts payable (6,806) 19,018 (75) --Income taxes (4,654) 15,969 (15,929) --Other assets, payables and accruals (18,438) (9,354) (5,991) Restructuring payments - net 9,370 (16,666) 810 Other (1,404) 3,418 274 ---------- ---------- ---------- NET CASH PROVIDED BY OPERATING ACTIVITIES 177,483 137,684 125,785 INVESTING ACTIVITIES Capital expenditures (142,243) (139,811) (90,626) Businesses acquired (30,741) -- (42,540) Sales of businesses and affiliates -- 43,381 40,261 Other 1,532 1,561 1,483 ---------- ---------- ---------- NET CASH USED BY INVESTING ACTIVITIES (171,452) (94,869) (91,422) FINANCING ACTIVITIES Cash dividends (24,673) (22,465) (22,705) Increase (decrease) in notes payable 12,406 50,866 (1,444) Long-term borrowings 65,000 100,000 107,145 Repayments of long-term borrowings (44,301) (172,669) (77,465) Purchases of common stock (23,166) (21,590) (32,213) Stock issuance under stock plans 7,518 20,133 3,287 Other (773) (924) (2,440) ---------- ---------- ---------- NET CASH USED BY FINANCING ACTIVITIES (7,989) (46,649) (25,835) Effect of exchange rate changes on cash and cash equivalents 532 (1,364) (780) ---------- ---------- ---------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,426) (5,198) 7,748 Cash and cash equivalents at beginning of year 18,736 23,934 16,186 ---------- ---------- ---------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 17,310 $ 18,736 $ 23,934 ========== ========== ==========
The Notes to Financial Statements are an integral part of this statement. Page 7
STATEMENT OF SHAREHOLDERS' EQUITY Years ended December 31, 1998, 1997 and 1996 (Dollars in thousands, except per share data) Accumulated Other Comprehensive Income (Loss) - Additional Currency Common Paid-In Retained Translation Stock Capital Earnings Adjustments Total --------- --------- -------- ----------- -------- BALANCE AT JANUARY 1, 1996 $ 144,125 $ 17,933 $ 254,484 $ (15,670) $ 400,872 Net income 102,721 102,721 Other comprehensive income: Currency translation adjustments during the year 841 Reclassification of realized amounts to net income (6,387) (5,546) --------- Total comprehensive income 97,175 Cash dividends paid ($.80 share) (22,705) (22,705) Issuance of 108,990 shares, net of shares exchanged, under stock plans 545 2,742 3,287 Purchase of 1,022,100 treasury shares (5,111) (27,102) (32,213) --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 1996 139,559 20,675 307,398 (21,216) 446,416 Net income 100,853 100,853 Other comprehensive income: Currency translation adjustments during the year (19,144) Reclassification of realized amounts to net income 2,270 (16,874) --------- Total comprehensive income 83,979 Cash dividends paid ($.80 a share) (22,465) (22,465) Issuance of 578,054 shares, net of shares exchanged, under stock plans 2,891 17,242 20,133 Issuance of 70,950 shares upon conversion of long-term debt 355 3,371 3,726 Purchase of 496,100 treasury shares (2,480) (19,110) (21,590) --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 1997 140,325 41,288 366,676 (38,090) 510,199 Net income 97,054 97,054 Other comprehensive income: Currency translation adjustments during the year 2,014 Reclassification of realized amounts to net income (127) 1,887 --------- Total comprehensive income 98,941 Cash dividends paid ($.88 a share) (24,673) (24,673) Issuance of 193,039 shares, net of shares exchanged, under stock plans 965 6,553 7,518 Purchase of 657,500 treasury shares (3,287) (19,879) (23,166) --------- --------- --------- --------- --------- BALANCE AT DECEMBER 31, 1998 $ 138,003 $ 47,841 $ 419,178 $ (36,203) $ 568,819 ========= ========= ========= ========= =========
The Notes to Financial Statements are an integral part of this statement. Page 8 NOTES TO FINANCIAL STATEMENTS December 31, 1998 (Dollars in thousands, except per share data) NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its subsidiaries. Affiliated companies in which the Company's ownership is 20% to 50% are accounted for by the equity method. All significant intercompany transactions and accounts are eliminated upon consolidation. Use of Estimates: The preparation of financial statements in accordance with generally accepted accounting principles requires management to make certain estimates and exercise judgment affecting the reported amounts in the statements of income, financial position and cash flows, including disclosures in the Notes to Financial Statements. Actual results could differ from those estimates. Revenue Recognition: Revenue is recognized when products are shipped to customers. Cash Equivalents: Marketable securities that are highly liquid and have original maturities of three months or less are classified as cash equivalents. The carrying amount approximates fair value. Inventories: Inventories are stated at the lower of cost or market. Inventory costs for U.S. operations are determined principally by the last-in, first-out (LIFO) method. The remaining inventory costs are determined principally by the first-in, first-out (FIFO) method. Plants and Properties: Plants and properties are carried at cost. Depreciation is generally computed by the straight-line method over the estimated useful lives of the respective assets. In general, depreciation is provided at annual rates of 2.5% to 3% on buildings and 8% to 12% on equipment. Intangibles: Intangible assets are carried at cost less accumulated amortization and consist principally of goodwill. Goodwill represents the excess of cost over fair value of assets acquired, which is amortized over periods from 15 to 40 years using the straight-line method. Other intangibles include software and patents which are amortized over periods from five to 15 years using the straight-line method. The carrying amounts for goodwill and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that such carrying amounts may not be recoverable. For any long-lived assets that are determined to be impaired, a loss would be recognized for the difference between the carrying value and the fair value for assets to be held. Life Insurance: The Company's investment in corporate-owned life insurance is recorded net of policy loans. Net life insurance expense, including interest expense of $6,300, $10,800 and $9,150 on policy loans in 1998, 1997 and 1996, respectively, is included in Other income (expense) - net in the Statement of Income. Accounting Pronouncements: The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards Nos. 130, "Reporting Comprehensive Income," and 131, "Disclosures about Segments of an Enterprise and Related Information," in 1997. In 1998, the FASB issued Statements Nos. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," and 133, "Accounting for Derivative Instruments and Hedging Activities." Statement 130 requires that comprehensive income, which includes net income and other comprehensive income consisting of foreign currency Page 9 NOTES TO FINANCIAL STATEMENTS NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (Continued) items, minimum pension liability adjustments, and unrealized gains and losses on certain security investments, be reported as a total in the financial statements. Historically, the Company's only component of other comprehensive income has been foreign currency items. The Company adopted Statement 130 effective January 1, 1998, and reclassified financial statements for prior periods to reflect application of this Statement. Statement 131 requires that operating segment financial information be reported on a basis consistent with the Company's internal reporting that is used for evaluating segment performance and allocating resources. Statement 132 revises and standardizes disclosures about pensions and other postretirement benefit obligations and requires that information about changes in benefit obligations and fair values of plan assets be reported. Among other provisions, Statement 133 requires that all derivatives be recognized as assets or liabilities in the Statement of Financial Position and that those instruments be measured at fair value. The Company adopted Statement Nos. 131 and 132 in 1998, changing its reportable segments and providing the required disclosures for each of the statements. Prior-period segment information and pension and postretirement benefit obligation information were restated in accordance with the provisions of the statements. The adoption of Statement Nos. 130, 131 and 132 did not affect the Company's results of operations or consolidated financial position. Statement 133 will become effective for fiscal years beginning after June 15, 1999. Early application is permitted. The Company is currently evaluating the effect of the provisions of this Statement on its accounting and reporting policies, and has not determined when it will adopt the Statement. The Company does not expect that adoption of this Statement will have a material adverse effect on its consolidated financial position or results of operations. In 1998, The American Institute of Certified Public Accountants issued Statements of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," and 98-5, "Reporting on the Costs of Start-Up Activities." SOP 98-1 requires the capitalization of certain costs incurred after the date of adoption in connection with acquiring or developing software for internal use. The Company adopted SOP 98-1 in 1998, and since the Company's previous capitalization policy was similar to the requirements of SOP 98-1, the adoption of this standard did not have a material effect on the Company's consolidated financial position or results of operations. SOP 98-5 requires that the costs of start-up activities, including organization costs, be expensed as incurred and that initial application of this standard be reported as the cumulative effect of a change in accounting principle. The Company adopted SOP 98-5 in 1998, and recognized the cumulative effect of an accounting change of $4,832 ($3,283 after tax, or $.12 per share). The effect of this change in accounting was not material to income before cumulative effect of accounting change for the year ended December 31, 1998. Stock Options: The Company follows the intrinsic value method of accounting for stock options under Accounting Principles Board Opinion No. 25. When stock options are exercised, common stock is credited for the par value of shares issued; additional paid-in capital is credited for the consideration received in excess of par value and any related income tax benefits. Derivative Financial Instruments: The Company uses forward exchange contracts and option contracts to manage certain foreign exchange exposures. The Company enters into forward exchange contracts to hedge the effects of changes in exchange rates on certain recorded receivables and payables that are denominated in currencies other than the functional currencies of the originating locations. Forward exchange contracts are marked to market with changes in market value recorded in income as foreign exchange gains or Page 10 NOTES TO FINANCIAL STATEMENTS NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (Continued) losses, offsetting the losses or gains on the underlying transactions. The Company enters into option contracts to hedge certain anticipated transactions. These option contracts are designated as hedges of certain forecasted monthly purchases and sales transactions that are denominated in currencies other than the functional currencies of the originating locations, that other- wise would expose the Company to foreign currency exchange rate risk. Gains on option contracts are included in sales and cost of products sold when realized. Premiums on option contracts are deferred and amortized to cost of products sold on a straight-line basis over the life of the contracts. Forward exchange and option contracts are entered into with major commercial banks with high credit ratings. Forward exchange and option contracts are not held for trading or speculative purposes, and the Company is not a party to any leveraged derivatives. The terms of these contracts are generally one year or less. Page 11
NOTES TO FINANCIAL STATEMENTS NOTE 2 - INCOME PER SHARE Following is a reconciliation of income and average shares for purposes of calculating basic and diluted income per share: 1998 1997 1996 ---- ---- ---- Basic Income per Share - --------------------------- Income before cumulative effect of accounting change $ 100,337 $ 100,853 $ 102,721 Cumulative effect of accounting change (3,283) -- -- ---------- ---------- ---------- Net Income $ 97,054 $ 100,853 $ 102,721 ========== ========== ========== Average common shares outstanding 28,035,748 28,049,749 28,384,089 ========== ========== ========== Basic Income per Share Before cumulative effect of accounting change $ 3.58 $ 3.60 $ 3.62 Cumulative effect of accounting change (.12) -- -- ---------- ---------- ---------- Basic net income per share $ 3.46 $ 3.60 $ 3.62 ========== ========== ========== Diluted Income per Share - ------------------------- Income before cumulative effect of accounting change $ 100,337 $ 100,853 $102,721 After-tax equivalent of interest expense on 6% convertible debentures -- 2,192 3,720 ---------- ---------- ---------- Income for purpose of computing diluted income per share before cumulative effect of accounting change 100,337 103,045 106,441 Cumulative effect of accounting change (3,283) -- -- ---------- ---------- ---------- Income for purpose of computing diluted income per share $ 97,054 $ 103,045 $ 106,441 ========== ========== ========== Average common shares outstanding 28,035,748 28,049,749 28,384,089 Dilutive stock options 156,979 209,927 46,019 Assumed conversion of 6% convertible debentures -- 1,109,298 1,904,762 ---------- ---------- ---------- Average common shares for purpose of computing diluted income per share 28,192,727 29,368,974 30,334,870 ========== ========== ========== Diluted Income per Share Before cumulative effect of accounting change $ 3.56 $ 3.51 $ 3.51 Cumulative effect of accounting change (.12) -- -- ---------- ---------- ---------- Diluted net income per share $ 3.44 $ 3.51 $ 3.51 ========== ========== ==========
Options to purchase an average of 160,600 and 771,000 shares of common stock were outstanding during 1998 and 1996, respectively, that were not included in the computation of diluted income per share because the option exercise prices were greater than the average market price of common shares and, therefore, the effect would have been anti-dilutive. Page 12 NOTES TO FINANCIAL STATEMENTS NOTE 3 - SPECIAL CHARGE In 1997, the Company's Aeroquip segment exited its automotive interior plastics business and recorded a special charge of $30,000 ($18,500 net, or diluted net income per share of $.63). The special charge included a provision for severance payments of $6.3 million to terminate approximately 1,500 salaried and hourly employees, principally in Germany. The special charge also included lease termination costs amounting to $6.9 million; asset disposal costs, including environmental costs, amounting to $9.6 million; litigation costs amounting to $3 million; and other costs amounting to $4.2 million. The Company sold or closed eight facilities during 1997 that had combined sales of approximately $67,000 and $132,000 in 1997 and 1996, respectively. The planned actions to which this special charge related were substantially completed during 1997, and as of December 31, 1998, all costs had been incurred. NOTE 4 - ACQUISITIONS During 1998, the Company's Aeroquip segment acquired two companies and its Vickers segment acquired four companies for an aggregate purchase price of $30,741, including acquisition costs. In 1996, the Company's Vickers segment acquired two companies for an aggregate purchase price of $46,116, including acquisition costs. All of the above acquisitions were accounted for as purchases, and their operations were included in the Statement of Income from their respective acquisition dates. Had these acquisitions occurred as of the beginning of the respective years, the pro forma results of operations giving effect to the acquisitions would not be materially different from the net sales, net income and net income per share presented in the Statement of Income. NOTE 5 - GAIN ON SALE OF UNCONSOLIDATED AFFILIATES In 1996, the Company sold its 35% interest in Yokohama Aeroquip K.K. and its 49% interest in Aeroquip Mexicana S.A. The two transactions resulted in a net combined pretax gain of $17,300 ($5,000 net, or diluted net income per share of $.16). The combined p retax gain included a net translation gain of $6,387 previously deferred in accumulated other comprehensive income. NOTE 6 - INVENTORIES Inventory costs determined by the LIFO method accounted for approximately 58% and 61% of total inventories at December 31, 1998 and 1997, respectively. If all inventories valued by the LIFO method had been valued at current costs, these inventories would have been approximately $27,591 and $27,884 higher than reported at December 31, 1998 and 1997, respectively. NOTE 7 - DEBT
1998 1997 ------ ------ 7.875% senior debentures, due June 1, 2026 $100,000 $100,000 Medium term notes - interest rates from 6.40% to 7.58% - due at various dates from 2002 to 2018 165,000 100,000 9.55% senior sinking fund debentures -- 42,000 Industrial revenue bonds - interest rates from 5.8% to 7.625% - due at various dates to 2013 7,264 7,300 Other 7,114 9,264 -------- -------- 279,378 258,564 Less current maturities 1,035 1,857 -------- -------- $278,343 $256,707 ======== ========
Page 13 NOTES TO FINANCIAL STATEMENTS NOTE 7 - DEBT (Continued) In December 1997, the Company called its 9.55% senior sinking fund debentures for redemption on February 3, 1998. The debentures were due to mature in February 2018. Proceeds from additional borrowings under the Company's Medium Term Note program were used to redeem the debentures. The loss from redemption of the debentures amounting to approximately $2,500 was recorded in Other income (expense) - net in 1998. In June 1997, the Company called its 6% convertible subordinated debentures for redemption and recorded a loss of $1,487 in Other income (expense) - net. The debentures, which were due to mature in October 2002, were convertible into common shares of the Company at a conversion price of $52.50 per share. Prior to the redemption date, debentures in the amount of $3,726 were converted into 70,950 shares of common stock. In 1997, the Company established a Medium Term Note program. The remaining borrowing capacity at December 31, 1998, under provisions of a shelf registration statement designated for the Medium Term Note program was $185,000. Under terms of a revolving credit agreement, expiring August 31, 2001, with a consortium of U.S. and non-U.S. banks, the Company can borrow up to $175,000. Borrowings under the credit agreement bear interest at rates agreed to by the Company and lenders. The agreement is maintained to support the Company's commercial paper borrowings and, to the extent not so utilized, to provide domestic borrowings. The remaining borrowing capacity under this agreement at December 31, 1998, was $120,000. Covenants of the revolving credit agreement and certain other debt instruments require the Company to maintain certain financial ratios, including a limitation that the Company's debt-to-capitalization ratio (exclusive of the effects of the change in accounting for postretirement benefit obligations) not exceed a specified amount. At December 31, 1998, retained earnings of $255,000 were available for the payment of cash dividends and purchase of common stock. Maturities of long-term debt in 1999 and in the four succeeding years are $1,035, $355, $271, $25,188 and $97. Interest paid on short- and long-term debt during 1998, 1997 and 1996 amounted to $28,446, $27,664 and $27,392, respectively. The weighted-average interest rate of outstanding notes payable at December 31, 1998 and 1997, was 6.4% and 6.5%, respectively. NOTE 8 - CONTINGENCIES The Company or certain of its subsidiaries have been named parties to various lawsuits, claims and proceedings, including being named potentially responsible parties (PRP) for site investigation and cleanup costs under the Comprehensive Environmental Response, Compensation, and Liability Act (Superfund) or similar regulations with respect to certain sites, as well as other product liability, tort and contract claims and lawsuits which have arisen in the ordinary course of the Company's business. While the ultimate outcome of the various lawsuits, claims and proceedings, including PRP designations and other environmental matters, cannot now be predicted, the Company believes that any costs in excess of amounts provided, or covered by insurance as it relates to litigation, arising out of these matters will not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows. Page 14
NOTES TO FINANCIAL STATEMENTS NOTE 9 - INCOME TAXES The components of income before income taxes and cumulative effect of accounting change consist of the following: 1998 1997 1996 ------ ------ ------ U.S. $ 64,772 $ 84,300 $ 73,644 Non-U.S. 82,765 63,853 79,777 -------- -------- -------- $147,537 $148,153 $153,421 ======== ======== ======== Income tax expense consists of the following: 1998 1997 1996 ------ ------ ------ Current: U.S. federal $ 20,101 $ 23,231 $ 21,920 State and local 2,279 2,070 2,676 Non-U.S. 24,309 22,466 14,107 -------- -------- -------- 46,689 47,767 38,703 Deferred: U.S. federal 952 (136) 4,356 Non-U.S. (441) (331) 7,641 -------- -------- -------- 511 (467) 11,997 -------- -------- -------- $ 47,200 $ 47,300 $ 50,700 ======== ======== ======== Reconciliation of the statutory U.S. federal income tax rate to the effective income tax rate before cumulative effect of accounting change follows: 1998 1997 1996 ------ ------ ----- Statutory U.S. federal income tax rate 35.0% 35.0% 35.0% Increase (decrease) resulting from: State and local taxes, net of U.S. federal tax benefit .9 .9 1.1 Basis differences on affiliates sold -- -- 4.1 Research and development credit (2.9) (1.9) (2.6) Taxes in excess of (less than) the U.S. tax rate on non-U.S. earnings, including utilization of net operating loss carryforwards (1.0) 1.0 (3.2) Other -- (3.1) (1.4) ---- ---- ----- Effective income tax rate 32.0% 31.9% 33.0% ==== ==== =====
Page 15 NOTES TO FINANCIAL STATEMENTS NOTE 9 - INCOME TAXES (Continued) The effects of temporary differences and loss carryforwards giving rise to deferred tax assets and liabilities are as follows:
1998 1997 ------ ------ Gross Deferred Tax Assets: Postretirement benefits other than pensions $ 42,729 $ 42,704 Tax credits and loss carryforwards 14,943 8,668 Employee benefit accruals 15,088 14,289 Other 14,728 9,617 --------- --------- 87,488 75,278 Gross Deferred Tax Liabilities: Depreciation (38,067) (33,241) Other (8,741) (7,980) --------- --------- (46,808) (41,221) Valuation allowances (12,969) (6,816) --------- --------- Net deferred tax assets $ 27,711 $ 27,241 ========= ========= The components of net deferred tax assets are recorded in the Statement of Financial Position as follows: 1998 1997 ------ ------ Current assets $ 10,066 $ 3,679 Non-current assets 27,711 30,958 Non-current liabilities (10,066) (7,396) --------- --------- $ 27,711 $ 27,241 ========= =========
Valuation allowances increased $6,153 in 1998 and decreased $5,773 and $3,364 in 1997 and 1996, respectively. At December 31, 1998, the Company had net non-U.S. operating loss and foreign tax credit carryforwards of $20,700 and $8,200, respectively, for income tax purposes. Loss carryforwards of approximately $13,800 have no expiration dates. The remaining net operating loss and foreign tax credit carryforwards expire in years through 2008. Income tax expense for the years 1998, 1997 and 1996 was reduced by $1,190, $1,770 and $3,730, respectively, due to utilization of operating loss carryforwards. Non-U.S. operating loss carryforwards in the amount of $4,900 and $5,600 expired in 1998 and 1997, respectively, resulting in the loss of future tax benefits and a reduction in valuation allowances in the amount of $1,800 and $2,100, respectively. The Company does not provide deferred income taxes on undistributed earnings of certain of its non-U.S. subsidiaries which have been reinvested indefinitely. Undistributed earnings of non-U.S. subsidiaries for which U.S. income taxes have not been provided approximated $150,300 at December 31, 1998. Should these earnings be remitted, certain countries would impose withholding taxes that would be available for use as credits against any U.S. federal income tax liability, subject to certain limitations. It is not practical to estimate the amount of tax that would be payable should the Company remit these earnings. Income taxes paid during 1998, 1997 and 1996 amounted to $51,343, $31,798 and $54,633, respectively. Page 16 NOTES TO FINANCIAL STATEMENTS NOTE 10 - LEASES The Company and its subsidiaries lease a variety of real property and equipment. Rent expense under operating leases amounted to approximately $22,554, $20,457 and $18,863 for 1998, 1997 and 1996, respectively. Future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 1998, are as follows:
1999 $ 19,499 2000 14,752 2001 12,232 2002 7,758 2003 6,893 Thereafter 11,526 -------- $ 72,660 ========
NOTE 11 - FINANCIAL INSTRUMENTS Fair value for long-term debt, including current maturities, at December 31, 1998 and 1997, was $292,000 and $269,000, respectively. Fair value for notes payable at December 31, 1998 and 1997, approximated the carrying amounts at those dates. At December 31, 1998, the Company had forward exchange contracts outstanding with notional amounts equivalent to $14,300. The carrying amount of these outstanding forward exchange contracts was $121. Fair value was approximately equal to the carrying amount. These forward exchange contracts will mature at various dates through April 1999. At December 31, 1997, the Company had forward exchange contracts outstanding with notional amounts equivalent to $12,800. The carrying amount of these outstanding forward exchange contracts was $227. Fair value was approximately equal to the carrying amount. These forward exchange contracts matured at various dates through April 1998. At December 31, 1998, the Company held option contracts maturing at various dates through November 1999, with notional amounts equivalent to $28,000. Fair value of these option contracts was approximately $204. At December 31, 1997, the Company held option contracts maturing at various dates through December 1998, with notional amounts equivalent to $61,600. Fair value of these option contracts was approximately $600. NOTE 12 - BENEFIT PLANS The Company sponsors trusteed defined-contribution pension plans as its primary source of retirement benefits for U.S. and certain non-U.S. employees. In addition, the Company sponsors trusteed defined-benefit pension plans that cover a limited number of U.S. employees. The Company also provides access to postretirement benefits under life insurance and health care plans for most retired U.S. employees. Various pension plans are also in effect for subsidiaries operating outside the U.S., including trusteed or insured, government-sponsored and unfunded plans. Page 17 NOTES TO FINANCIAL STATEMENTS NOTE 12 - BENEFIT PLANS (Continued) Following is a reconciliation of the changes in benefit obligations and fair values of plan assets for defined-benefit pension and postretirement benefit plans for the two-year period ended December 31, 1998, and a summary of funded status as of December 31, 1998 and 1997.
Pension Postretirement Plans Plans ---------------- ---------------- 1998 1997 1998 1997 ---- ---- ---- ---- CHANGE IN BENEFIT OBLIGATIONS Benefit obligations at beginning of year $ 160,600 $ 157,800 $ 102,600 $ 111,100 Service cost 2,400 2,200 1,700 1,700 Interest cost 11,500 11,300 7,400 8,100 Participant contributions 300 200 100 200 Plan amendments 300 1,600 -- -- Actuarial (gains) losses 16,000 1,700 (600) (10,700) Benefit payments (10,000) (9,500) (8,100) (7,800) Settlements (2,800) -- -- -- Exchange rate changes 1,700 (4,700) -- -- --------- --------- --------- --------- Benefit obligations at end of year $ 180,000 $ 160,600 $ 103,100 $ 102,600 ========= ========= ========= ========= CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year $ 181,400 $ 154,200 $ -- $ -- Actual return on plan assets 19,400 38,200 -- -- Employer contributions 1,000 900 8,000 7,600 Participant contributions 300 200 100 200 Benefit payments (10,000) (9,500) (8,100) (7,800) Settlements (1,700) -- -- -- Exchange rate changes 1,000 (2,600) -- -- --------- --------- --------- --------- Fair value of plan assets at end of year $ 191,400 $ 181,400 $ -- $ -- ========= ========= ========= ========= FUNDED STATUS Funded status at end of year $ 11,400 $ 20,800 $(103,100) $(102,600) Unrecognized gains (19,500) (33,700) (9,815) (9,172) Unrecognized transition obligations (1,500) 400 -- -- Unrecognized prior service cost (credit) 4,800 6,200 (8,800) (10,500) --------- --------- --------- --------- Accrued benefit cost $ (4,800) $ (6,300) $(121,715) $(122,272) ========= ========= ========= ========= AMOUNTS RECORDED IN THE STATEMENT OF FINANCIAL POSITION CONSIST OF: Prepaid benefit cost $ 24,400 $ 15,500 $ -- $ -- Accrued benefit cost (29,200) (21,800) (121,715) (122,272) --------- --------- --------- --------- Net amount recorded $ (4,800) $ (6,300) $(121,715) $(122,272) ========= ========= ========= =========
Page 18 NOTES TO FINANCIAL STATEMENTS NOTE 12 - BENEFIT PLANS (Continued) The aggregate accumulated benefit obligations and fair value of pension plan assets at the end of each year for plans that have an accumulated benefit obligation in excess of plan assets were as follows:
1998 1997 ------ ------ Projected benefit obligations $39,593 $35,039 Accumulated benefit obligations 37,456 33,358 Plan assets 15,570 14,228
Components of net periodic benefit cost for the defined-benefit pension and postretirement benefit plans, total contributions charged to pension expense for the defined-contribution plans, and pension expense for other non-U.S. pension plans are summarized below:
Pension Plans Postretirement Plans ------------------------------ ------------------------------ 1998 1997 1996 1998 1997 1996 ---- ---- ---- ---- ---- ---- COMPONENTS OF NET PERIODIC BENEFIT COST Service cost $ 2,400 $ 2,200 $ 2,400 $ 1,700 $ 1,700 $ 1,700 Interest cost 11,500 11,300 11,300 7,400 8,100 8,200 Expected return on plan assets (14,800) (13,700) (13,000) -- -- -- Amortization of (gains) losses (600) (200) (200) -- -- -- Amortization of transition obligation 200 200 300 -- -- -- Amortization of prior service cost 700 500 400 (1,600) (1,700) (1,700) -------- -------- -------- -------- -------- -------- Net periodic benefit cost (income) of defined benefit plans (600) 300 1,200 7,500 8,100 8,200 Defined contribution plans 38,700 42,000 37,000 -- -- -- Other non-U.S. pension plans 1,100 1,000 1,200 -- -- -- -------- -------- -------- -------- -------- -------- Totals $ 39,200 $ 43,300 $ 39,400 $ 7,500 $ 8,100 $ 8,200 ======== ======== ======== ======== ======== ========
The Company's health care plans are contributory. In general, most participants meeting eligibility requirements and retiring after January 1, 1995, share in the cost of postretirement health care benefits by paying, in the form of a premium, the excess, if any, of the average of the Company's annual per-capita claims cost in the previous year over the amount of the Company's contribution as stated in the plans. Following are the weighted-average assumptions used in determining the Company's benefit obligations and net periodic benefit cost. The measurement date for these plans was principally September 30. Page 19
NOTES TO FINANCIAL STATEMENTS NOTE 12 - BENEFIT PLANS (Continued) Pension Benefits Postretirement Benefits ------------------------------ ------------------------- 1998 1997 1996 1998 1997 1996 ---- ---- ---- ---- ---- ---- Discount rate: U.S. 7.0% 7.5% 7.5% 7.0% 7.5% 7.5% Non-U.S. 6.4 7.2 7.5 Expected return on plan assets 9.5 10.0 10.0 Rate of compensation increase 4.0 4.0 4.0 Projected health care cost trend rates: Under age 65 7.95 8.6 9.1 Over age 65 5.95 6.4 6.7 Ultimate 5.0 5.25 5.25 Year ultimate health care cost trend rate is achieved 2008 2008 2008 The projected health care cost trend rates listed above for under and over age 65 participants represent assumed increases in per capita cost of covered health care benefits for 1999, 1998 and 1997, respectively. For future years, the rates are assumed to decrease gradually and remain at the ultimate trend rate thereafter. Because the amount of the Company's annual contribution to retiree health care costs is limited, changes to the assumed health care cost trend rates do not have a significant effect on the amounts reported for the health care plans. Following are the effects of a one-percentage- point change in the assumed health care cost trend rates.
One-Percentage- One-Percentage- Point Increase Point Decrease ---------------- --------------- Effect on total 1998 service and interest cost components of net periodic post-retirement health care benefit cost $ 331 $ (308) Effect on the health care component of the accumulated postretirement benefit obligation as of September 30, 1998 4,430 (4,121)
NOTE 13 - CAPITAL STOCK AND EMPLOYEE STOCK OPTIONS The Company has rights outstanding as set forth in a Rights Agreement, whereby holders of common stock have one right for each share of common stock outstanding. When exercisable, each right entitles its holder to buy one one-hundredth of a new preferred share for $150. The Company has 4,000,000 shares of serial preferred stock authorized, of which no shares were outstanding at December 31, 1998 or 1997. In the absence of further Board of Directors action, the rights generally will become exercisable and allow the holder to acquire the Company's common stock at a discounted price if a person or group acquires 20% or more of the outstanding shares of the Company's common stock. Rights held by persons who exceed the 20% threshold will be void. Under certain circumstances, the rights will entitle the holder to buy shares in an acquiring entity at a discounted price. The Agreement also includes an exchange option that, in general, after the rights become exercisable, allows the Board of Directors to, at its option, effect an exchange of part or all of the rights, other than rights that have become void, for shares of the Company's common stock. Under this option, the Company would issue one share of its common stock for each right, subject to adjustment in certain Page 20 NOTES TO FINANCIAL STATEMENTS NOTE 13 - CAPITAL STOCK AND EMPLOYEE STOCK OPTIONS (Continued) circumstances. The Company may, at its option, redeem all rights for $.01 per right, generally at any time prior to the rights becoming exercisable. The rights will expire on February 7, 2009, unless earlier redeemed, exchanged or amended by the Board of Directors. In 1998, the Company's shareholders approved the 1998 Stock Incentive Plan (the Plan) which permits the issuance of stock options, stock appreciation rights (SARs), performance awards and restricted stock awards to selected salaried employees as approved by the Organization and Compensation Committee of the Board of Directors. The number of shares of common stock that may be issued or transferred under the Plan may not exceed 1,772,299 shares (1,700,000 shares as designated in the Plan, plus 72,299 remaining shares available for grant under terms of the prior plan). Among other considerations, options may be granted to selected employees to purchase common stock at prices not less than 100% of the fair market value on the date of grant. Options expire 10 years after date of grant. Options granted under the Plan become exercisable ratably over a three-year period commencing one year following date of grant. Options that expire, terminate or are canceled without exercise are available for the grant of new awards. Performance awards may be granted to selected employees to receive future payments contingent on continuous service with the Company and achievement of pre-established goals. In January 1998 and 1997, 16,925 and 44,314 shares of common stock, respectively, were distributed to participants as performance awards under provisions of a plan that was discontinued in 1998. At December 31, 1998, there were no outstanding SARs, performance awards or restricted s tock awards. Also in 1998, the Company's shareholders approved the Non-Employee Directors' Stock Award Plan (Directors' Plan). The Directors' Plan provides, among other considerations, that upon election or re- election to the Board, each eligible director will receive a stock option covering 1,200 common shares and a stock award covering 200 common shares. Stock options are granted to purchase common stock at the fair market value of the Company's common stock on the date of grant. Stock options are exercisable ratably over a three-year period commencing one year following date of grant and expire 10 years after date of grant. Stock awards vest and become payable on the first anniversary following date of grant. The Company accounts for stock options in accordance with Accounting Principles Board Opinion No. 25 and related interpretations. As a result, no compensation expense for stock options has been recognized in the financial statements because such options were granted at market value at date of grant. However, pro forma information regarding net income and net income per share is required by Statement of Financial Accounting Standards No. 123, and has been determined for disclosure purposes as if the Company had accounted for stock options under the fair value method as prescribed by that Statement. The fair values of the Company's stock options were estimated as of the dates of grant using the Black-Scholes option pricing model with the following assumptions:
1998 1997 1996 ------ ------- ------- Risk-free interest rates 5.49% 5.8% 6.52% Expected dividend yields 1.7% 1.9% 2.3% Expected stock price volatility .330 .323 .319 Weighted-average expected option life 5 years 5 years 6 years
Page 21 NOTES TO FINANCIAL STATEMENTS NOTE 13 - CAPITAL STOCK AND EMPLOYEE STOCK OPTIONS (Continued) For purposes of pro forma disclosures, the estimated fair values of stock options are amortized to expense over the options' vesting periods. The estimated fair value per share of options granted during 1998, 1997 and 1996 was $16.86, $13.43 and $11.36, respectively. Pro forma income and income per share before cumulative effect of accounting change are as follows:
1998 1997 1996 ------- ------- ------- Income before cumulative effect of accounting change As reported $100,337 $100,853 $102,721 Pro forma 98,248 99,505 101,293 Diluted income per share before cumulative effect of accounting change As reported 3.56 3.51 3.51 Pro forma 3.48 3.46 3.46
Options outstanding at December 31, 1998, with a range of exercise prices from $22.50 to $33.75 had a weighted-average remaining contractual life of approximately 6.4 years and options with a range of exercise prices from $42.13 to $60.31 had a weighted-average remaining contractual life of approximately nine years. At December 31, 1998, the Company had 2,787,331 shares of common stock reserved for issuance in connection with stock options. The following table summarizes employee stock option activity:
1998 1997 1996 ------------------------ --------------------- ---------------------- Weighted- Weighted- Weighted- Average Average Average Option Exercise Option Exercise Option Exercise Shares Price Shares Price Shares Price ------------------------ --------------------- ---------------------- Outstanding at January 1 1,129,911 $ 35.44 1,405,950 $ 31.30 1,164,980 $ 30.67 Granted 353,500 51.73 342,000 42.13 349,000 33.02 Exercised (195,713) 32.57 (592,041) 29.52 (86,030) 29.18 Forfeited (80,158) 42.24 (16,998) 34.77 (4,500) 33.58 Canceled (11,335) 30.96 (9,000) 33.44 (17,500) 33.52 Outstanding at December 31 1,196,205 40.30 1,129,911 35.44 1,405,950 31.30 Exercisable at December 31 587,190 34.31 587,754 32.38 1,059,950 30.74 Available for future awards at December 31 1,491,126 58,133 391,060
In addition to the above, 9,800 options and stock awards were granted to directors in 1998 under the Directors' Plan at a weighted-average exercise price of $60.31. All options granted were outstanding at December 31, 1998, and none were exercisable at that date. 90,200 options are available for future awards at December 31, 1998. Page 22 NOTES TO FINANCIAL STATEMENTS NOTE 14 - BUSINESS SEGMENTS The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information," which was adopted in 1998. Statement 131 requires that segment financial information be reported on a basis consistent with the Company's internal reporting used for evaluating segment performance and allocating resources. Accordingly, in 1998, the Company changed its business segments, which were previously based on markets served, from Industrial, Automotive and Aerospace to Aeroquip and Vickers. These segments reflect the way the Company is organized and managed and how performance is measured. The Company evaluates performance and allocates resources based on operating income before allocation of corporate costs. Corporate costs represent the total of corporate headquarters costs. Although Aeroquip and Vickers serve many of the same customers and markets, they are managed separately because of significantly different product technologies and manufacturing processes and the differing dynamics required to serve their customers. Amounts for prior years have been restated to conform to the current year presentation. The Aeroquip segment designs, manufactures and distributes fluid connectors and plastic products. Fluid connectors include all pressure ranges of hose and hose assemblies; fittings, adapters, couplings and swivels; automotive air conditioning, power steering, and oil and transmission cooler components and assemblies; tube fittings and assemblies; refrigeration/air conditioning connectors; clamps and V-band couplings; fuel-handling products; noise-reduction products; chemical containment products; and electronic fluid system products. Aeroquip plastic products include molded, extruded and co-extruded plastic products. The Aeroquip segment serves original equipment and aftermarket customers in industrial markets located principally in the U.S., Europe, Asia-Pacific and Brazil; original equipment and aftermarket customers in aerospace and defense markets located principally in the U.S. and Europe; and automobile, light truck, sport utility and van manufacturers in automotive markets located principally in the U.S. and Europe. The Vickers segment designs, manufactures and distributes power and motion control products. Vickers products include hydraulic, electrohydraulic, pneumatic and electronic control devices; piston and vane pumps and motors; open architecture machine controls; hydraulic and pneumatic cylinders; hydraulic power packages; electric motors and drives; fuel pumps; electric motorpumps and generator packages; electrohydraulic and electromechanical actuators; sensors and monitoring devices; hydraulic and lubrication filtration; and fluid-evaluation products and services. The Vickers segment serves original equipment and aftermarket customers in industrial markets located principally in the U.S., Europe, Asia-Pacific and Brazil, and original equipment and aftermarket customers in aerospace and defense markets located principally in the U.S. and Europe. The accounting policies for the reportable segments are the same as those described in Note 1 - Significant Accounting Policies. Intersegment sales are not significant. Page 23 NOTES TO FINANCIAL STATEMENTS NOTE 14 - BUSINESS SEGMENTS (Continued) The following information relates to business segments:
Reconciling Amounts- Corporate and Eliminations Aeroquip Vickers Net Totals ---------- --------- -------------------- ---------- 1998 - ----- Net sales $1,071,608 $1,077,866 $ -- $2,149,474 Depreciation and amortization 35,284 42,017 2,346 79,647 Segment income 124,295 90,407 -- 214,702 (A) Investments in unconsolidated affiliates 1,585 -- -- 1,585 Segment assets 581,553 795,070 82,178 1,458,801 Capital expenditures 73,554 64,833 3,856 142,243 Expenditures for businesses acquired 11,762 18,979 -- 30,741 ========== ========== ========== ========== 1997 - ----- Net sales $1,065,188 $1,047,105 $ -- $2,112,293 Depreciation and amortization 35,139 35,625 2,437 73,201 Segment income 89,458 132,599 -- 222,057 (A) Investments in unconsolidated affiliates 945 637 -- 1,582 Segment assets 535,701 771,650 69,245 1,376,596 Capital expenditures 66,195 70,315 3,301 139,811 ========== ========== ========== ========== 1996 - ----- Net sales $1,099,914 $ 933,001 $ -- $2,032,915 Depreciation and amortization 39,314 31,499 2,660 73,473 Segment income 96,184 110,571 -- 206,755 (A) Investments in unconsolidated affiliates 1,041 1,152 -- 2,193 Segment assets 570,300 667,381 51,806 1,289,487 Capital expenditures 50,893 38,356 1,377 90,626 Expenditures for businesses acquired -- 42,540 -- 42,540 ========== ========== ========== ========== Note A - See following reconcilement of total segment income to income before income taxes and cumulative effect of accounting change. Page 24 NOTES TO FINANCIAL STATEMENTS NOTE 14 - BUSINESS SEGMENTS (Continued) Following is a reconciliation of total segment income to income before income taxes and cumulative effect of accounting change:
1998 1997 1996 ---- ---- ---- Segment income $ 214,702 $ 222,057 $ 206,755 Less unallocated corporate costs 28,322 30,417 30,180 ---------- ---------- ---------- Consolidated operating income 186,380 191,640 176,575 Interest expense (27,013) (27,171) (25,813) Other income (expense) - net (11,830) (16,316) 2,659 ---------- ---------- ---------- Income before income taxes and cumulative effect of accounting change $ 147,537 $ 148,153 $ 153,421 ========== ========== ========== Following are net sales by product groupings: Power and Motion Control $1,077,866 $1,047,105 $ 933,001 Fluid Connectors 929,022 858,769 824,388 Plastics 142,586 206,419 275,526 ---------- ---------- ---------- $2,149,474 $2,112,293 $2,032,915 ========== ========== ==========
Page 25 NOTES TO FINANCIAL STATEMENTS NOTE 14 - BUSINESS SEGMENTS (Continued) Following are net sales to external customers and plants and properties by geographic area. Net sales are reported based on the geographic location from which the sales originated. Amounts reported for plants and properties are based on the country where located.
Plants and Net Sales Properties --------- ---------- 1998 - ----- United States $1,394,277 $ 410,699 Europe United Kingdom 271,660 60,768 Germany 226,786 36,040 Other Europe 140,257 17,977 ---------- ---------- Total Europe 638,703 114,785 Other 116,494 22,733 ---------- ---------- Totals $2,149,474 $ 548,217 ========== ========== 1997 - ----- United States $1,356,334 $ 362,776 Europe United Kingdom 245,965 52,653 Germany 252,627 26,859 Other Europe 125,548 12,693 ---------- ---------- Total Europe 624,140 92,205 Other 131,819 19,161 ---------- ---------- Totals $2,112,293 $ 474,142 ========== ========== 1996 - ----- United States $1,291,875 $ 330,368 Europe United Kingdom 238,590 47,754 Germany 270,254 33,063 Other Europe 117,567 10,361 ---------- ---------- Total Europe 626,411 91,178 Other 114,629 15,937 ---------- ---------- Totals $2,032,915 $ 437,483 ========== ==========
Page 26 NOTES TO FINANCIAL STATEMENTS NOTE 15 - OTHER INFORMATION
1998 1997 ---------- ---------- RECEIVABLES Receivables $ 356,664 $ 363,523 Less allowance for doubtful accounts 14,839 14,701 --------- --------- $ 341,825 $ 348,822 INVENTORIES ========= ========= In-process and finished products $ 231,842 $ 239,800 Raw materials and manufacturing supplies 70,394 54,967 --------- --------- $ 302,236 $ 294,767 ========= ========= OTHER CURRENT ASSETS Deferred income taxes $ 10,066 $ 3,679 Prepaid expenses and other current assets 42,080 45,644 --------- --------- $ 52,146 $ 49,323 ========= ========= PLANTS AND PROPERTIES - AT COST Land and improvements $ 22,634 $ 21,458 Buildings 223,405 198,882 Machinery and equipment 801,692 694,572 Construction in progress 71,826 78,090 --------- --------- $1,119,557 $ 993,002 ========= ========= OTHER ASSETS Goodwill, net of accumulated amortization of $17,045 and $13,077 in 1998 and 1997, respectively $ 124,890 $ 111,905 Deferred income taxes 27,711 30,958 Receivables, deposits and other assets 44,466 47,943 --------- --------- $ 197,067 $ 190,806 ========= ========= NOTES PAYABLE Commercial paper $ 55,096 $ 36,177 Short-term notes payable to banks 46,733 47,867 --------- --------- $ 101,829 $ 84,044 ========= ========= OTHER ACCRUED LIABILITIES Employees' compensation and amounts withheld therefrom $ 106,502 $ 117,107 Taxes, other than income taxes 7,309 10,177 Other accrued liabilities 83,915 85,516 --------- --------- $ 197,726 $ 212,800 ========= =========
Page 27 NOTES TO FINANCIAL STATEMENTS NOTE 16 - SUBSEQUENT EVENT (Unaudited) On February 1, 1999, Eaton Corporation and Aeroquip-Vickers, Inc. announced that the companies had entered into an "Agreement and Plan of Merger" whereby Eaton Corporation would acquire all of the outstanding shares of Aeroquip-Vickers, Inc. for $58 per share in cash. The Boards of Directors of both companies have approved the transaction, which is subject to normal closing conditions and the approval of Aeroquip-Vickers shareholders. The transaction is expected to be completed in April 1999. QUARTERLY RESULTS OF OPERATIONS (Unaudited) The following is a summary of the quarterly results of operations for the years ended December 31, 1998 and 1997.
1998 ----------------------------------------------------------------------- Three Months Ended ----------------------------------------------------------- Year Ended Mar 31 Jun 30 Sep 30 Dec 31 Dec 31 ------- ------- ------- ------- ---------- (In thousands, except per share data) Net sales $ 547,055 $ 574,314 $ 508,974 $ 519,131 $2,149,474 Manufacturing income 144,232 151,575 123,821 109,941 529,569 Income before cumulative effect of accounting change 31,173 37,841 23,931 7,392 100,337 Cumulative effect of accounting change (3,283) -- -- -- (3,283) Net income 27,890 37,841 23,931 7,392 97,054 Basic income per share before cumulative effect of accounting change 1.11 1.34 .85 .27 3.58 Cumulative effect of accounting change (.12) -- -- -- (.12) Basic net income per share .99 1.34 .85 .27 3.46 Diluted income per share before cumulative effect of accounting change 1.10 1.33 .85 .27 3.56 Cumulative effect of accounting change (.12) -- -- -- (.12) Diluted net income per share .98 1.33 .85 .27 3.44 Average shares outstanding Basic 28,119 28,199 28,166 27,669 28,036 Diluted 28,336 28,454 28,302 27,674 28,193
Page 28 QUARTERLY RESULTS OF OPERATIONS (Unaudited) (Continued)
1997 ------------------------------------------------------------------- Three Months Ended ------------------------------------------------------- Year Ended Mar 31 Jun 30 Sep 30 Dec 31 Dec 31 ------- ------- ------- ------- ---------- (In thousands, except per share data) Net sales $ 538,426 $ 556,278 $ 494,777 $ 522,812 $2,112,293 Manufacturing income 132,475 147,037 134,406 143,707 557,625 Net income 5,694 33,630 30,104 31,425 100,853 Net income per share Basic .20 1.20 1.07 1.12 3.60 Diluted .20 1.15 1.05 1.11 3.51 Average shares outstanding Basic 27,974 27,948 28,153 28,150 28,050 Diluted 28,116 30,020 29,036 28,372 29,369
(a) The 1998 fourth quarter includes non-recurring charges (principally incurred severance costs) of $5 million, $3.1 million net (diluted net income per share of $.11). (b) In 1997, the Company redeemed its outstanding 6% convertible debentures, which were common stock equivalents. For purposes of computing diluted net income per share in 1997, the assumed conversion of the convertible debentures was included in average shares outstanding as follows: 1,904,762 shares in the 1997 second quarter, 627,667 shares in the 1997 third quarter and 1,109,298 shares for the year. (c) The 1997 first quarter included a special charge of $30 million, $18.5 million net (diluted net income per share of $.66 [$.63 for the year]) to exit Aeroquip's automotive interior plastics business. (d) In the 1997 third quarter, the annual effective income tax rate was reduced. The cumulative year-to-date adjustment increased third-quarter net income by $1.3 million (diluted net income per share of $.05). (e) The 1997 fourth quarter included income amounting to $4.3 million, $2.6 million net (diluted net income per share of $.09) from recovery of previously incurred development and pre-production costs with a Vickers aerospace customer arising from the termination of a component design and production supply contract, reduced by a charge of $2.6 million, $1.6 million net (diluted net income per share of $.05) to recognize a product liability claim from an Aeroquip industrial customer for a unique product that is no longer manufactured. Page 29 Item 14(a)(2) Schedule II - Valuation and Qualifying Accounts Aeroquip-Vickers, Inc. [CAPTION] - ----------------------------------------------------------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E - ---------------------------------------------------------------------------------------------------------------------------- ADDITIONS BALANCE AT (1) (2) BALANCE DESCRIPTION BEGINNING CHARGED TO COSTS CHARGED TO OTHER DEDUCTIONS AT END OF OF PERIOD AND EXPENSES ACCOUNTS-DESCRIBE DESCRIBE PERIOD - ----------------------------------------------------------------------------------------------------------------------------- (In Thousands) YEAR ENDED DECEMBER 31, 1998 Deducted from asset accounts: Allowance for doubtful accounts $ 14,701 $ 4,770 $ - $ 4,632 -A $ 14,839 Deferred tax valuation allowance 6,816 7,927 - (1,810)-B 12,969 36 -C
Note A - Doubtful accounts charged off, net of recoveries Note B - Effect of expiration of operating loss carryforward Note C - Currency translation adjustments
- ---------------------------------------------------------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E - ---------------------------------------------------------------------------------------------------------------------------- ADDITIONS BALANCE AT (1) (2) BALANCE DESCRIPTION BEGINNING CHARGED TO COSTS CHARGED TO OTHER DEDUCTIONS AT END OF OF PERIOD AND EXPENSES ACCOUNTS-DESCRIBE DESCRIBE PERIOD - ---------------------------------------------------------------------------------------------------------------------------- (In Thousands) YEAR ENDED DECEMBER 31, 1997 Deducted from asset accounts: Allowance for doubtful accounts $ 16,032 $ 1,485 $ - $ (2,816)-A $ 14,701 Deferred tax valuation allowance 12,589 (1,767) - (2,064)-B 6,816 (1,942)-C
Note A - Doubtful accounts charged off, net of recoveries Note B - Effect of expiration of operating loss carryforward Note C - Currency translation adjustments
- ---------------------------------------------------------------------------------------------------------------------------- COL. A COL. B COL. C COL. D COL. E - ---------------------------------------------------------------------------------------------------------------------------- ADDITIONS BALANCE AT (1) (2) BALANCE DESCRIPTION BEGINNING CHARGED TO COSTS CHARGED TO OTHER DEDUCTIONS AT END OF OF PERIOD AND EXPENSES ACCOUNTS-DESCRIBE DESCRIBE PERIOD - ---------------------------------------------------------------------------------------------------------------------------- (In Thousands) YEAR ENDED DECEMBER 31, 1996 Deducted from asset accounts: Allowance for doubtful accounts $ 13,241 $ 3,899 $ - $ (1,108)-A $ 16,032 Deferred tax valuation allowance 15,953 (3,853) - 489 -B 12,589
Note A - Doubtful accounts charged off, net of recoveries Note B - Currency translation adjustments Page 30 2) EATON CORPORATION UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS The following unaudited pro forma combined condensed financial statements have been prepared by Eaton's management. These financial statements reflect Eaton's acquisition of Aeroquip- Vickers, Inc. (A-V), and combine, for the indicated date or period, the historical consolidated financial statements of Eaton and A-V, using the purchase method of accounting. The unaudited pro forma combined condensed balance sheet reflects adjustments as if the acquisition had occurred on December 31, 1998. The unaudited pro forma combined statement of income reflects adjustments as if the acquisition had occurred at the beginning of 1998. The pro forma financial statements include preliminary estimates and assumptions which Eaton's management believes are reasonable. However, the pro forma results do not include any anticipated cost savings or other effects of the planned integration of Eaton and A-V. Therefore, the pro forma results are not necessarily indicative of the results which would have occurred if the business combination had been in effect on the dates indicated, or which may result in the future. Page 31 The pro forma financial statements have been prepared using the following facts and assumptions: - - Eaton acquires the common stock and common stock equivalents of A-V in exchange for a total cash payment of $1.623 billion. - - Eaton borrows $1.623 billion to finance the acquisition. - - The assets acquired and liabilities assumed of A-V are recorded at estimated fair values as determined by Eaton's management based on information currently available and on current tentative assumptions as to the future operations of A-V. Eaton will be obtaining independent appraisals of the fair values of the acquired property, plant and equipment, and identified intangible assets, and their remaining useful lives. Eaton will also be reviewing and determining the fair values of the other assets acquired and liabilities assumed. Accordingly, the allocation of the purchase price to the acquired assets and liabilities of A-V is subject to revision as a result of the final determination of appraised and other fair values. As a result of the acquisition of A-V, Eaton will incur costs to 1) exit and consolidate activities at A-V and Eaton locations, 2) involuntarily terminate and relocate employees of A-V and Eaton and 3) integrate operating locations and other activities of A-V and Eaton (integration costs). Generally accepted accounting principles require that the A-V integration costs be reflected as assumed liabilities in the allocation of the purchase price of A-V to the net assets of A-V acquired. These same accounting rules require that Eaton integration costs be recorded as expense as incurred subsequent to the acquisition date. As a result, Eaton integration costs are not reflected in the pro forma financial statements. The unaudited pro forma combined condensed balance sheet includes an adjustment to record 1) a current liability of $19 million for the estimated transaction costs related to the acquisition of A-V and 2) assumed liabilities of $64 million for estimated A-V integration costs based on Eaton's preliminary integration plan ($30 million as a current liability and $34 million as a long-term liability). As noted in public statements regarding the acquisition of A-V, Eaton has put in place a series of integration teams who are charged with formalizing the integration plans and restructuring opportunities for each of the A-V businesses. As Eaton is approaching this effort with the intent of minimizing disruption of the ongoing businesses and the external parties with whom they regularly interface, Eaton is determined to fully understand the major issues before proceeding with definitive action. Accordingly, at this juncture, the preliminary integration plan cannot yet be discussed with a great deal of specificity. In general terms, Eaton will be focusing on three key areas of integration: 1) manufacturing process and supply chain rationalization, including plant closings, 2) elimination of redundant administrative overhead and support activities, including the consolidation of administrative functions currently performed at A-V's world headquarters in Maumee, Ohio, and 3) restructuring and repositioning of the sales/marketing and research and development organizations to eliminate redundancies in these activities. Based on the preliminary integration plan, it is expected that A-V integration costs will approximate $33 million for employee severance and relocation, $28 million for manufacturing relocation and plant closings, and $3 million of other related costs. It is expected that a large portion of the actions currently being planned will be implemented within the next one to two years. All aspects of Eaton's preliminary integration plan will be re- examined after the acquisition date. As a result, the estimated assumed liabilities of $64 million for A-V integration costs will be adjusted accordingly. Major unresolved issues in the evaluation of the integration plan include capacity of existing and acquired facilities to accomodate new manufacturing and administrative processes and also the appropriate positioning of the sales/marketing and research and development organizations to best serve customer needs. Adjustments of the $64 million of assumed liabilities related to estimated A-V integration costs will be included in the allocation of the aggregate purchase price of A-V, if the adjustment is determined within the purchase price allocation period (normally no longer than one year after the date of the acquisition). Adjustments of these estimated liabilities that are determined after the end of the purchase price allocation period will be 1) recorded as a reduction of net income, if the ultimate amount of the liability exceeds the estimate, or 2) recorded as a reduction of the excess of the purchase price of A-V over the net assets of A-V acquired, if the ultimate amount of the liability is below the estimate. The pro forma results do not reflect the planned sale of Eaton's Engineered Fasteners and Fluid Power Divisions announced on March 25, 1999. For 1998, Engineered Fasteners and Fluid Power reported net sales of $94 million and $189 million, respectively, and total assets at February 28, 1999 of $40 million and $94 million, respectively. Proceeds from the sales of these businesses will be used to reduce the number of Common Shares that Eaton plans to sell in the future to refinance the $1.623 billion cost of the acquisition of A-V. Sale of the Engineered Fasteners business will be handled by the investment banking firm of Bowles Hollowell Conner, a division of First Union Capital Markets Corp., while the Fluid Power transaction will be handled by Goldman, Sachs & Co. Although Eaton intends to complete the sales of these businesses in 1999, no buyer has yet been identified, and, as a result, Eaton will not speculate on the sales price it might receive for the businesses. The pro forma results do not reflect a $3 million aftertax expense recorded by A-V in 1998 for the cumulative effect of an accounting change to charge to income previously deferred start-up costs for new facilities. The pro forma financial statements should be read in conjunction with the historical consolidated financial statements, and related notes, of Eaton, incorporated by reference from its Amended 1998 Form 10-K filed on May 11, 1999, and of A-V included in this Form 8-K. Page 32 Unaudited Pro Forma Combined Condensed Balance Sheet December 31, 1998
(Millions of dollars) Historical Pro ---------------- forma Pro Aeroquip adjust- forma Eaton -Vickers ments combined ----- -------- ------ -------- ASSETS Current assets Cash $ 80 $ 18 $ 98 Short-term investments 42 42 Accounts receivable 885 342 1,227 Inventories 707 302 $ 28 2a 1,037 Deferred income taxes & other current assets 268 52 12 2b 2 2l 334 ----- ----- ----- ----- 1,982 714 42 2,738 Property, plant & equipment 1,837 548 82 2c 2,467 Identified intangible assets 214 289 2d 503 Excess of cost over net assets of businesses acquired 1,025 125 (125)2e 968 2n 1,993 Deferred income taxes & other assets 607 72 (5)2f 674 ----- ----- ----- ----- $5,665 $1,459 $1,251 $8,375 ===== ===== ===== ===== LIABILITIES & SHAREHOLDERS' EQUITY Current liabilities Short-term debt & current portion of long-term debt $ 333 $ 103 $ 923 (1) $1,359 Accounts payable & other current liabilities 1,183 338 49 2g (4)2h 1,566 ----- ----- ----- ----- 1,516 441 968 2,925 Long-term debt 1,191 278 700 (1) 22 2i 2,191 Postretirement benefits other than pensions 557 122 (19)2j 660 Deferred income taxes & other liabilities 344 49 34 2k 115 2l 542 Shareholders' equity A-V 569 (569)2m 0 Eaton 2,057 2,057 ----- ----- ----- ----- $5,665 $1,459 $1,251 $8,375 ===== ===== ===== ===== See accompanying notes.
Page 33 NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET The pro forma adjustments to give effect to Eaton's acquisition of A-V, and the estimated purchase price allocation at December 31, 1998, are as follows: 1) The borrowing by Eaton of $1.623 billion to finance the acquisition price. Of these borrowings, $700 million are classified on the balance sheet as long-term debt because Eaton has issued $200 million of notes payable due in 2000 and intends, and has the ability under a new $500 million five-year revolving credit agreement entered into during April 1999, to refinance this amount of debt on a long- term basis. 2) The allocation of the aggregate purchase price of A-V, and the recognition of the excess of the purchase price over the estimated fair value of net assets of A-V acquired, is a follows (in millions): Adjustments ----------- 2a Adjust acquired inventories to estimated fair value $ 28 2b Adjust acquired pension assets for certain overfunded pension plans to estimated fair value 12 2c Adjust acquired property, plant and equipment to estimated fair value 82 2d Record acquired identified intangible assets at estimated fair value 289 2e Eliminate the excess of cost over net assets acquired related to A-V's acquisitions of businesses in prior years (125) 2f Eliminate deferred financing costs of A-V (5) 2g Record estimated current liabilities of $30 million related to post-acquisition integration of A-V's locations, employees, and other costs, and $19 million of transaction costs related to the acquisition (49) 2h Adjust acquired pension liability for certain underfunded pension plans to estimated fair value 4 2i Adjust acquired long-term debt to reflect Eaton's current interest rates (22) 2j Adjust acquired liability for post- retirement benefits other than pensions to estimated fair value 19 2k Record estimated long-term liabilities related to post-acquisition integration of A-V's locations, employees, and other costs (34) 2l Record deferred income taxes for the above adjustments, except for adjustment 2e which is nontaxable, assuming a 35% income tax rate (113) 2m Eliminate shareholders' equity of A-V prior to pro forma adjustments 569 2n Record preliminary estimate of excess of cost over net assets of A-V acquired 968 ----- Purchase price $1,623 ===== Page 34 Unaudited Pro Forma Combined Statement of Income Year Ended December 31, 1998
(Millions of dollars except for per share amounts) Historical Pro ---------------- forma Pro Aeroquip adjust- forma Eaton -Vickers ments combined ----- -------- ----- -------- Net sales $6,625 $2,150 $8,775 Costs & expenses Cost of products sold 4,759 1,620 $ 32 1a 1 1b 8 1c (2)1d (5)1e 12 1f 24 1g 6,449 Selling & administrative 1,050 272 1,322 Research & development 334 72 (32)1a 374 ----- ----- ----- ----- 6,143 1,964 38 8,145 ----- ----- ----- ----- Income from operations 482 186 (38) 630 Other income (expense) Interest expense-net (88) (27) (99)1h 1 1i (213) Gain on sale of businesses 43 43 Other-net 48 (12) 36 ----- ----- ----- ----- 3 (39) (98) (134) ----- ----- ----- ----- Income before income taxes 485 147 (136) 496 Income taxes 136 47 (41)1j 142 ----- ----- ----- ----- Net income $ 349 $ 100 $ (95) $ 354 ===== ===== ===== ===== Net income per Common Share (1k) - Assuming dilution $ 4.80 $ 4.87 Basic 4.89 4.96 Average number of Common Shares outstanding (in millions) - Assuming dilution 72.7 72.7 Basic 71.4 71.4 See accompanying notes.
Page 35 NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME The pro forma adjustments to give effect to Eaton's acquisition of A-V, and the estimated purchase price allocation for the year ended December 31, 1998, are as follows (in millions): 1a Reclassify engineering expenses of A-V to cost of products sold to be consistent with Eaton's accounting policy 1b Adjust expense for acquired pensions and postretirement benefits other than pensions of A-V to reflect Eaton's current actuarial assumptions 1c Depreciate the write-up of acquired property, plant and equipment to estimated fair value over 10 years 1d Eliminate amortization of certain costs, principally start-up activities, deferred by A-V 1e Eliminate amortization of the excess of cost over net assets acquired related to A-V's acquisitions of businesses in prior years 1f Amortize the estimated fair value of acquired identified intangible assets over 25 years 1g Amortize the excess of the purchase price of A-V over the estimated fair value of net assets acquired over 40 years 1h Record additional interest expense related to $1.623 billion increase in debt to fund the acquisition (assumed interest rate 6.1%) 1i Amortize adjustment of acquired long-term debt to reflect Eaton's current interest rates 1j Record the income tax effect of the above adjustments, except for adjustments 1e and 1g which are nontaxable, assuming a 35% income tax rate 1k Pro forma net income per Common Share is computed by dividing net income by the average number of Common Shares outstanding. Page 36 Exhibit 23 Consent of Independent Auditors We consent to the use of our report dated January 27, 1999, with respect to the consolidated financial statements and schedule of Aeroquip-Vickers, Inc. and subsidiaries included in the Current Report on Form 8-K/A dated April 22, 1999, as amended, of Eaton Corporation. /s/ Ernst & Young, LLP Toledo, Ohio May 10, 1999 Page 37 Signature Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. Eaton Corporation ----------------- /s/ Billie K. Rawot ----------------------------- Billie K. Rawot Vice President and Controller Principal Accounting Officer Date: May 10, 1999 -----END PRIVACY-ENHANCED MESSAGE-----