-----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, DMcBVKh1uwJ+2fVvxB2dQBbqu1dmvG1fH+3m1DtsCL0RXahkK6CbgE4a2DRWonSj jfhyK78uFHMfFakBjQNlAA== 0000950152-01-500132.txt : 20010308 0000950152-01-500132.hdr.sgml : 20010308 ACCESSION NUMBER: 0000950152-01-500132 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010306 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-K405 SEC ACT: SEC FILE NUMBER: 002-25786 FILM NUMBER: 1561655 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 STREET 2: EATON CENTER CITY: CLEVELAND STATE: OH ZIP: 44114 FORMER COMPANY: FORMER CONFORMED NAME: EATON YALE & TOWNE INC DATE OF NAME CHANGE: 19710822 10-K405 1 l86847ae10-k405.txt EATON CORPORATION 10-K405 1 United States Securities and Exchange Commission Washington, D.C. 20549 Form 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the year ended December 31, 2000 Commission file number 1-1396 Eaton Corporation - ------------------------------------------------------------------ (Exact name of registrant as specified in its charter) Ohio 34-0196300 - ------------------------------------------------------------------ (State of incorporation) (I.R.S. Employer Identification No.) Eaton Center, Cleveland, Ohio 44114-2584 - ------------------------------------------------------------------ (Address of principal executive offices) (Zip code) (216) 523-5000 - ------------------------------------------------------------------ (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered - ------------------------------ ---------------------------- Common Shares ($.50 par value) The New York Stock Exchange The Chicago Stock Exchange The Pacific Stock Exchange The London Stock Exchange Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months and (2) has been subject to such filing requirements for the past ninety days. Yes X --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X --- The aggregate market value of voting stock held by non-affiliates of the registrant as of January 31, 2001 was $4.7 billion. As of January 31, 2001, there were 68,450,766 Common Shares outstanding. 2 Page 2 Documents Incorporate By Reference Eaton Corporation (Eaton or Company) submits all required reports to the Securities and Exchange Commission (Commission), including financial statements, notes to financial statements and other financial information, through the Commission's Electronic Data Gathering, Analysis and Retrieval (EDGAR) system. In order to minimize cost and duplication of information provided to shareholders, the Company has not reproduced in this document the Annual Report on Form 10-K filed with the Commission, but instead, has elected to provide certain financial information in Parts I and II of Form 10-K through incorporation by reference to the 2000 Annual Report to shareholders. Portions of the Proxy Statement for the 2001 annual shareholders' meeting are incorporated by reference into Part III. Part I Item 1. Business Eaton Corporation (Eaton or Company), incorporated in 1916, is a global diversified industrial manufacturer. Eaton is a leader in fluid power systems, electrical power quality and controls, automotive air management and fuel economy, and intelligent truck components for fuel economy and safety. Worldwide sales in 2000 reached $8.3 billion. Headquartered in Cleveland, Ohio, the Company has 59,000 employees and 195 manufacturing sites in 24 countries on six continents. The internet address for Eaton is http://www.eaton.com. On June 30, 2000, Eaton's semiconductor equipment operations were reorganized into a wholly-owned subsidiary, Axcelis Technologies, Inc. In July, Axcelis completed an initial public offering for 17.6% of its common stock, and on December 29, 2000 Eaton distributed its remaining interest in Axcelis to Eaton shareholders as a dividend (spin-off). Accordingly, the consolidated financial statements have been restated to display Axcelis as a discontinued operation. Business Segment Information Information regarding principal products, net sales, operating profit and long-lived assets by business segment and geographic region, is presented in "Business Segment and Geographic Region Information" on pages 45 through 50 of this report. Additional information regarding Eaton's segments and business in general is presented below. 3 Page 3 Automotive Patents and Trademarks - Eaton owns, controls, or is licensed under many patents related to this segment. While the EATON and EATON (logomark) trademarks are emphasized in marketing many products within this segment, the Company also markets under a number of other trademarks including EATONITE, DILL, IKU, ULV, SUPERCHARGER (& DESIGN), DYNA-TRAXX, INTELLI-TRAXX. Seasonal Fluctuations - Sales of the Automotive segment are generally reduced in the third quarter of each year as a result of preparations by vehicle manufacturers for the upcoming model year and temporary shut-downs for taking physical inventories. Competition - Principal methods of competition in this segment are price, service and product performance. Eaton occupies a strong competitive position in relation to many competitors in this segment and, with respect to many products, is considered among the market leaders. Significant Customers - Approximately 45% of this segment's net sales in 2000 were made to divisions and subsidiaries of three large original equipment manufacturers of vehicles, generally concentrated in North America and Europe. Eaton has been conducting business with each of these companies for many years. Sales to these companies include a number of different products and different models or types of the same product, sales of which are not dependent upon one another. With respect to many of the products sold, various divisions and subsidiaries of each of the companies are in the nature of separate customers, and sales to one division or subsidiary are not dependent upon sales to other divisions or subsidiaries. One of these customers is also a significant customer of the Truck segment. Fluid Power Patents and Trademarks - Eaton owns, controls, or is licensed under many patents related to this segment. The EATON, EATON (logomark), CHAR-LYNN, Q-AMP, GEROLER, ORBIT, ORBITROL, VICKERS, TEDECO, STERER, ILLUMINATER, LUBRICLONE, LEVELMASTER, EEMCO, TELLITE, AEROQUIP, "FLYING A" LOGO, AEROQUIP EXPRESS, BENCHMARK, BRUISER, AQP, HI-PAC, STC, MATCHMATE, MATCHMATE BLUE, MATCHMATE ICE, STARTLITE, EPSILON, RYNGLOK, AIRFLEX, FAWICK, and GOLF PRIDE trademarks are used in connection with marketing products included in this segment. Competition - Principal methods of competition in this segment are price, geographic coverage, service and product performance. Eaton occupies a strong competitive position in relation to many competitors in this segment and, with respect to many products, is considered among the market leaders. 4 Page 4 Significant Customers - Approximately 6% of this segment's net sales in 2000 were made to one manufacturer of vehicles in Europe, which is not a significant customer of any other segment. Industrial & Commercial Controls Patents and Trademarks - Eaton owns, controls, or is licensed under many patents related to this segment. The EATON, EATON (logomark), CUTLER-HAMMER, CH (EMBLEM), C-HESS, SERIES C (& DESIGN), DE-ION, DURANT, CHALLENGER, FACTORYMATE, PANELMATE, POW-R-WAY, POW-R-LINE, POW-R-QUICK, POW-R-DESIGNER, ADVANTAGE, ADVANTAGE PLUS, ADVANTAGE (& DESIGN), ADVANCED POWER CENTER, MAGNUM, MAGNUM DS, DS, OPTIM, TRI-PAC, IMPACC, and HEINEMANN are some of the more significant trademarks used in connection with marketing products included in this segment. In addition, the Company has the right to use the WESTINGHOUSE trademark in marketing certain products until 2004. Competition - Principal methods of competition in this segment are price, geographic coverage, service and product performance. Eaton occupies a strong competitive position in relation to many competitors in this segment and, with respect to many products, is considered among the market leaders. Significant Customers - Approximately 20% of this segment's net sales in 2000 were made to one customer located in the United States, which is not a significant customer of any other segment. Truck Patents and Trademarks- Eaton owns, controls, or is licensed under many patents related to this segment. The EATON, EATON (logomark), FULLER, ROADRANGER, AutoShift, VORAD, SmartCruise, EASY-PEDAL , SOLO, ANGLE SPRING, LIGHTNING and TOP 2 trademarks are used in connection with marketing products included in this segment. Competition - Principal methods of competition in this segment are price, service and product performance. Eaton occupies a strong competitive position in relation to many competitors in this segment and, with respect to many products, is considered among the market leaders. Significant Customers- Approximately 62% of this segment's net sales in 2000 were made to divisions and subsidiaries of four original equipment manufacturers of heavy-, medium-, and light-duty trucks and off-highway vehicles, generally concentrated in North America and Europe. One of these customers is also a significant customer of the Automotive segment. Information Concerning Eaton's Business in General Patents - Eaton's policy is to file applications and obtain patents for its new products including product modifications and 5 Page 5 improvements. While patents generally expire 20 years after the patent application filing date, new patents are issued to Eaton on a regular basis. While in the aggregate Eaton's patents are considered important in the operation of its businesses, the loss or expiration of any one patent would not materially affect Eaton as a whole. Employees - Eaton has 5,571 United States employees who are subject to a total of 18 different collective bargaining agreements and are represented by the following unions: IAM, UAW, PACE, IBEW, USW, IUE, MPWU, and BSEA. Raw Materials - Principal raw materials used are iron, steel, copper, aluminum, brass, insulating materials, silver, rubber and plastic. Materials are purchased in various forms, such as pig iron, metal sheets and strips, forging billets, bar stock and plastic pellets. Raw materials, as well as parts and other components, are purchased from many suppliers and, under normal circumstances, the Company has no difficulty obtaining them. Order Backlog - Since a significant portion of open orders placed with Eaton by original equipment manufacturers of cars, trucks and off-highway vehicles are historically subject to month-to-month releases by customers during each model year, such orders are not considered technically firm. In measuring backlog of orders, the Company includes only the amount of such orders released by such customers as of the dates listed. Using this criterion, total backlog at December 31, 2000 and 1999 (in billions) was approximately $1.4 and $1.5, respectively. Backlog should not be relied upon as being indicative of results of operations for future periods. Research and Development - Research and development expenses for new products and improvement of existing products in 2000, 1999 and 1998 (in millions) were $269, $262 and $252, respectively. Over the past five years, the Company has invested approximately $1.3 billion in research and development. Protection of the Environment - Operations of the Company involve the use and disposal of certain substances regulated under environmental protection laws. The Company continues to modify, on an ongoing, regular basis, certain processes in order to reduce the impact on the environment, including the reduction or elimination of certain chemicals used in and wastes generated from operations. Compliance with Federal, State and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, is not expected to have a material adverse effect upon earnings or the competitive position of the Company. Eaton's estimated capital expenditures for environmental control facilities are not expected to be material for 2001 and 2002. Information regarding the Company's liabilities related to environmental 6 Page 6 matters, presented in "Protection of the Environment" on pages 35 and 36 of this report. Item 2. Properties Eaton's world headquarters is located in Cleveland, Ohio. The Company maintains manufacturing facilities at 195 locations in 24 countries. The Company is a lessee under a number of operating leases for certain real properties and equipment, none of which are material to the Company's operations. Eaton's principal research facilities are located in Southfield, Michigan, and Milwaukee, Wisconsin. In addition, certain divisions conduct research in their own facilities. Management believes that the manufacturing facilities are adequate for operations, and such facilities are maintained in good condition. Item 3. Legal Proceedings None required to be reported. Item 4. Submission of Matters to a Vote of Security Holders None. Part II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters The Company's Common Shares are listed for trading on the New York, Chicago, Pacific and London stock exchanges. Information regarding cash dividends paid and the high and low market price per Common Share for each quarter in 2000 and 1999, is presented in "Quarterly Data" on pages 66 and 67 of this report. At December 31, 2000, there were 11,847 holders of record of the Company's Common Shares. Additionally, approximately 28,000 current and former employees were shareholders through participation in the Eaton Share Purchase and Investment Plan. Item 6. Selected Financial Data Information regarding selected financial data, is presented in the "Five-Year Consolidated Financial Summary" on pages 68 and 69 of this report. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations "Management's Discussion and Analysis of Financial Condition and Results of Operations", is presented on pages 51 through 65 of this report. 7 Page 7 Item 7A. Quantitative and Qualitative Disclosure About Market Risk Information regarding market risk, is presented on pages 62 and 63 of this report. Item 8. Financial Statements and Supplementary Data The consolidated financial statements, financial review and the report of independent auditors, is presented on pages 17 through 50 of this report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Part III Item 10. Directors and Executive Officers of the Registrant Information contained in the definitive Proxy Statement to be filed on or about March 16, 2001, with respect to directors, is incorporated by reference. A listing of Eaton's officers, their ages, positions and offices held over the past five years, as of January 31, 2001, follows: Name Age Position (Date elected to position) - --------------------- ---- ---------------------------------------------- Alexander M. Cutler 49 Chairman and Chief Executive Officer; President (August 1, 2000 - present) President and Chief Operating Officer (September 1, 1995 - July 31,2000) Director (1993 - present) Adrian T. Dillon 47 Executive Vice President - Chief Financial and Planning Officer (April 23, 1997 - present) Vice President - Chief Financial and Planning Officer (1995-1997) Craig Arnold 40 Senior Vice President and Group Executive - Fluid Power(October 25, 2000 - present) Corporate Vice President of General Electric and President of GE Lighting Service Ltd. (1999-2000) Corporate Vice President and President of GE Plastics, Greater China (1998- 1999) 8 Page 8 Corporate Vice President and President of GE Appliances, Asia (1997-1998) Managing Director of Structured Products Europe at GE Plastics(1995- 1997) Stephen M. Buente 50 Senior Vice President and Group Executive - Automotive (August 21, 2000 - present) Operations Vice President - Automotive Controls (1999-2000) Operations Vice President - Engine Components (1995-1999) Randy W. Carson 50 Senior Vice President and Group Executive - Cutler-Hammer (January 1, 2000 - present) Vice President - Growth Initiatives (February 24, 1999 - December 31, 1999) Senior Vice President at Rockwell Automation (1992-1998) Thomas W. O'Boyle 58 Senior Vice President and Group Executive - Truck Components (September 1, 1995 - present) Kristen M. Bihary 47 Vice President - Communications (July 28, 1999 - present) Vice President - External Affairs, Internal and Marketing Communications at Shell Chemical Company (1998-1999) Vice President - Public Affairs at Varity Corporation (1995-1998) Donald H. Bullock 41 Vice President - Information Technologies (August 1, 2000 - present) Director of Finance Reengineering (1998-2000) Principal at CSC Index (1992-1998) Susan J. Cook 53 Vice President - Human Resources (January 16, 1995 - present) Earl R. Franklin 57 Secretary and Associate General Counsel (September 1, 1991 - present) J. Robert Horst 57 Vice President and General Counsel (January 1, 2000 - present) Deputy General Counsel (1998-1999) Associate General Counsel (1991-1998) 9 Page 9 Stanley V. Jaskolski 62 Vice President - Technical Management (October 1, 1990 - present) John S. Mitchell 44 Vice President - Taxes (November 22, 1999 - present) Vice President - Taxes at The Limited, Inc. (1997-1999) Director of Taxes at The Limited, Inc. (1987-1997) Robert E. Parmenter 48 Vice President and Treasurer (January 1, 1997 - present) Assistant Treasurer (1994-1996) Billie K. Rawot 49 Vice President and Controller (March 1, 1991 - present) Ken D. Semelsberger 39 Vice President - Strategic Planning (April 28, 1999 - present) Director - Corporate Development and Planning (1998-1999) Director - Strategic Planning (1995-1998) There are no family relationships among the officers listed, and there are no arrangements or understandings pursuant to which any of them were elected as officers. All officers hold office for one year and until their successors are elected and qualified, unless otherwise specified by the Board of Directors; provided, however, that any officer is subject to removal with or without cause, at any time, by a vote of a majority of the Board of Directors. Item 11. Executive Compensation Information contained in the definitive Proxy Statement to be filed on or about March 16, 2001, with respect to executive compensation, is incorporated by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management Information contained in the definitive Proxy Statement to be filed on or about March 16, 2001, with respect to security ownership of certain beneficial owners and management, is incorporated by reference. Item 13. Certain Relationships and Related Transactions None required to be reported. 10 Page 10 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) (1) (i) The following consolidated financial statements and financial review, included in Item 8, are filed as a separate section of this report. Report of Independent Auditors - Page Consolidated Balance Sheets - December 31, 2000 and 1999 - Pages 18 and 19 Statements of Consolidated Income - Years ended December 31, 2000, 1999 and 1998 - Page 20 Statements of Consolidated Cash Flows - Years ended December 31, 2000, 1999 and 1998 - Page 21 Statements of Consolidated Shareholders' Equity - Years ended December 31, 2000, 1999 and 1998 - Page 22 (2) All schedules for which provision is made in Regulation S-X of the Securities and Exchange Commission, are not required under the related instructions or areinapplicable and, therefore, have been omitted. (3) Exhibits 3(a) Amended Articles of Incorporation (amended and restated as of April 27, 1994) - Incorporated by reference to the Form 8-K Report dated May 19, 1994 3(b) Amended Regulations (amended and restated as of April 26, 2000) - Incorporated by reference to Form 10-Q for the six months ended June 30, 2000 4(a) Instruments defining rights of security holders, including indentures (Pursuant to Regulation S-K Item 601(b)(4), the Company agrees to furnish to the Commission, upon request, a copy of the instruments defining the rights of holders of long-term debt) 4(b) Eaton Corporation Rights Agreement dated June 28, 1995 - Incorporated by reference to the Form 8-K Report dated June 28, 1995 11 Page 11 10 Material contracts The following are either a management contract or a compensatory plan or arrangement: (a) Deferred Incentive Compensation Plan (amended and restated as of March 31, 2000)(filed as a separate section of this report) (b) Executive Strategic Incentive Plan (amended and restated as of June 21, 1994, July 25, 1995, April 21, 1998 and April 1, 1999)(filed as a separate section of this report) (c) Group Replacement Insurance Plan (GRIP), effective as of June 1, 1992 - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1992 (d) 1991 Stock Option Plan - Incorporated by reference to the definitive Proxy Statement dated March 18, 1991 (e) 1995 Stock Plan - Incorporated by reference to the definitive Proxy Statement dated March 17, 1995 (f) Incentive Compensation Deferral Plan (amended and restated as of October 1, 1997)(filed as a separate section of this report) (g) Strategic Incentive and Option Plan (amended and restated as of September 24, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (h) Form of "Change of Control" Agreement entered into with officers of Eaton Corporation as of November 1, 1996 - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (i) The following are incorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1990: 12 Page 12 (i) Limited Eaton Service Supplemental Retirement Income Plan (amended and restated as of January 1, 1989) (ii) Amendments to the 1980 and 1986 Stock Option Plans (iii) Eaton Corporation Supplemental Benefits Plan (amended and restated as of January 1, 1989) (which provides supplemental retirement benefits) (iv) Eaton Corporation Excess Benefits Plan (amended and restated as of January 1, 1989) (with respect to Section 415 limitations of the Internal Revenue Code) (j) Executive Incentive Compensation Plan (filed as a separate section of this report) (k) Plan for the Deferred Payment of Directors' Fees (amended and restated as of September 24, 1996 and amended effective as of January 1, 1997) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1997 (l) Plan for the Deferred Payment of Directors' Fees (originally adopted in 1980 and amended effective February 25, 1997) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (m) 1996 Non-Employee Director Fee Deferral Plan (amended effective January 1, 1997 and February 25, 1997) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1997 (n) Eaton Corporation Trust Agreement - Outside Directors (dated December 6, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 13 Page 13 (o) Eaton Corporation Trust Agreement - Officers and Employees (dated December 6, 1996) - Incorporated by reference to the Annual Report on Form 10-K for the year ended December 31, 1996 (p) Eaton Corporation Retirement Plan for Non- Employee Directors (amended and restated January 1, 1996) - Incorporated by Reference to the Annual Report filed on Form 10-K for the year ended December 31, 1997 (q) 1998 Stock Plan - Incorporated by reference to the definitive Proxy Statement dated March 13, 1998 12 Ratio of Earnings to Fixed Charges (filed as a separate section of this report) 21 Subsidiaries of Eaton Corporation (filed as a separate section of this report) 22 Consent of Independent Auditors (filed as a separate section of this report) 23 Power of Attorney (filed as a separate section of this report) (b) Reports on Form 8-K On November 30, 2000, the Company filed a Current Report on Form 8-K regarding the suspension of its $500 million Common Share repurchase program and the prospects for the North American vehicle market for fourth quarter 2000 and the first quarter of 2001. On December 11, 2000, the Company filed a Current Report on Form 8-K announcing the spin-off of Axcelis Technologies, Inc. On January 12, 2001, the Company filed a Current Report on Form 8-K announcing an expected charge of $55 million to restructure its Truck business in 2001. On January 22, 2001, the Company filed a Current Report on Form 8-K regarding the fourth quarter 2000 earnings release. 14 Page 14 On January 31, 2001, the Company filed a Current Report on Form 8-K regarding financial data restated for discontinued operations. The restated data includes Comparative Financial Summaries, Balance Sheets, Income Statements, and Business Segment Information for 1996-2000 and quarterly information for 2000 and 1999. (c) Exhibits Certain exhibits required by this portion of Item 14 are filed as a separate section of this report. (d) Financial Statement Schedules None required to be filed. 15 Page 15 Signatures Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Eaton Corporation ------------------------------ Registrant Date: March 5, 2001 /s/ Adrian T. Dillon ------------------------------ Adrian T. Dillon Executive Vice President-- Chief Financial and Planning Officer; Principal Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. DATE: March 5, 2001 Signature Title - ------------------------------------- ------------------------------------- * - ------------------------------------- Alexander M. Cutler Chairman and Chief Executive Officer; President; Director * - ------------------------------------- Billie K. Rawot Vice President and Controller; Principal Accounting Officer * - ------------------------------------- Michael J. Critelli Director * - ------------------------------------- Ernie Green Director * - ------------------------------------- Ned C. Lautenbach Director * - ------------------------------------- Deborah L. McCoy Director * - ------------------------------------- John R. Miller Director 16 Page 16 * - ------------------------------------- Victor A. Pelson Director * - ------------------------------------- A. William Reynolds Director * - ------------------------------------- Gary L. Tooker Director *By /s/ Adrian T. Dillon --------------------------------------- Adrian T. Dillon, Attorney-in-Fact for the officers and directors signing in the capacities indicated 17 Page 17 Eaton Corporation 2000 Annual Report on Form 10-K Items 6, 7, 7A, 8 & Item 14(c) REPORT OF INDEPENDENT AUDITORS To the Shareholders Eaton Corporation We have audited the consolidated balance sheets of Eaton Corporation as of December 31, 2000 and 1999, and the related statements of consolidated income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Eaton Corporation at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Cleveland, Ohio January 19, 2001 18 Page 18 Eaton Corporation Consolidated Balance Sheets December 31 ----------------- (Millions) 2000 1999 ---- ---- ASSETS Current assets Cash $ 82 $ 79 Short-term investments 44 83 Accounts receivable 1,219 1,165 Inventories 872 876 Deferred income taxes 147 161 Other current assets 207 188 ------ ------ 2,571 2,552 Property, plant & equipment Land & buildings 792 728 Machinery & equipment 3,255 3,116 ------ ------ 4,047 3,844 Accumulated depreciation (1,773) (1,550) ------ ------ 2,274 2,294 Goodwill 2,026 1,853 Other intangible assets 556 598 Deferred income taxes & other assets 753 714 Net assets of discontinued operations 331 ------ ------ $8,180 $8,342 ====== ====== The Financial Review on pages 23 to 50 is an integral part of the consolidated financial statements. 19 Page 19 Eaton Corporation Consolidated Balance Sheets December 31 ----------------- (Millions) 2000 1999 ---- ---- LIABILITIES & SHAREHOLDERS' EQUITY Current liabilities Short-term debt $ 447 $ 958 Current portion of long-term debt 110 12 Accounts payable 485 487 Accrued compensation 199 277 Accrued income & other taxes 191 255 Other current liabilities 675 579 ------ ------ 2,107 2,568 Long-term debt 2,447 1,915 Postretirement benefits other than pensions 679 666 Deferred income taxes & other liabilities 537 569 Shareholders' equity Common Shares (68.3 in 2000 and 74.0 in 1999) 34 37 Capital in excess of par value 1,266 1,041 Retained earnings 1,410 1,804 Accumulated other comprehensive income (loss) (267) (220) Shares in trust - deferred compensation plans (33) (38) ------ ------ 2,410 2,624 ------ ------ $8,180 $8,342 ====== ====== The Financial Review on pages 23 to 50 is an integral part of the consolidated financial statements. 20 Page 20 Eaton Corporation Statements of Consolidated Income Year ended December 31 ---------------------- (Millions except for per share data) 2000 1999 1998 ---- ---- ---- Net sales $8,309 $8,005 $6,358 Costs & expenses Cost of products sold 6,092 5,792 4,528 Selling & administrative 1,299 1,248 974 Research & development 269 262 252 ------ ------ ------ 7,660 7,302 5,754 ------ ------ ------ Income from operations 649 703 604 Other income (expense) Interest expense - net (177) (152) (88) Gain on sales of businesses 340 43 Other - net 80 52 57 ------ ------ ------ (97) 240 12 ------ ------ ------ Income from continuing operations before income taxes 552 943 616 Income taxes 189 340 186 ------ ------ ------ Income from continuing operations 363 603 430 Income (loss) from discontinued operations 90 14 (81) ------ ------ ------ Net income $ 453 $ 617 $ 349 ====== ====== ====== Net income per Common Share-assuming dilution Continuing operations $ 5.00 $ 8.17 $ 5.91 Discontinued operations 1.24 .19 (1.11) ------ ------ ------ $ 6.24 $ 8.36 $ 4.80 ====== ====== ====== Average number of Common Shares outstanding 72.6 73.7 72.7 Net income per Common Share-basic Continuing operations $ 5.06 $ 8.31 $ 6.02 Discontinued operations 1.25 .20 (1.13) ------ ------ ------ $ 6.31 $ 8.51 $ 4.89 ====== ====== ====== Average number of Common Shares outstanding 71.8 72.5 71.4 Cash dividends paid per Common Share $ 1.76 $ 1.76 $ 1.76 The Financial Review on pages 23 to 50 is an integral part of the consolidated financial statements. 21 Page 21 Eaton Corporation Statements of Consolidated Cash Flows Year ended December 31 ----------------------- (Millions) 2000 1999 1998 ---- ---- ---- Net cash provided by operating activities of continuing operations Income from continuing operations $ 363 $ 603 $ 430 Adjustments to reconcile to net cash provided by operating activities Depreciation & amortization 364 332 254 Amortization of goodwill & other intangible assets 98 89 58 Deferred income taxes 44 52 106 Gain on sales of businesses & corporate assets (22) (340) (43) Other non-cash items in income (20) (34) Changes in operating assets & liabilities, excluding acquisitions & sales of businesses Accounts receivable (39) (59) (63) Inventories (13) 17 (55) Accounts payable & other accruals (139) (33) (26) Accrued income & other taxes (86) 67 5 Other - net (31) (20) (9) ------ ------ ------ 519 708 623 Net cash used in investing activities of continuing operations Expenditures for property, plant & equipment (386) (480) (468) Acquisitions of businesses, less cash acquired (115) (1,602) (117) Proceeds from initial public offering of subsidiary 349 Sales of businesses & corporate assets 122 544 375 Other - net 6 (83) (56) ------ ------ ------ (24) (1,621) (266) Net cash (used in) provided by financing activities of continuing operations Borrowings with original maturities of more than three months Proceeds 1,555 1,917 1,409 Payments (1,560) (1,517) (982) Borrowings with original maturities of less than three months - net 150 519 (303) Cash dividends paid (127) (128) (126) Purchase of Common Shares (417) (5) (349) Sale of Common Shares 147 Other - net 11 25 17 ------ ------ ------ (388) 958 (334) ------ ------ ------ Cash provided by continuing operations 107 45 23 Net cash (used in) provided by discontinued operations (104) (43) 2 ------ ------ ------ Total increase in cash 3 2 25 Cash at beginning of year 79 77 52 ------ ------ ------ Cash at end of year $ 82 $ 79 $ 77 ====== ====== ====== The Financial Review on pages 23 to 50 is an integral part of the consolidated financial statements. 22 Page 22 Eaton Corporation Statements of Consolidated Shareholders' Equity
Shares in trust Accumulated ------------------ Total Common Shares Capital in other Deferred share- --------------- excess of Retained comprehensive compensa- holders' (Millions) Shares Dollars par value earnings income (loss) ESOP tion plans equity ------ ------- ---------- -------- ------------- ---- ----------- -------- Balance at January 1, 1998 74.7 $37 $ 844 $1,385 $(148) $(20) $(27) $2,071 Net income 349 349 Other comprehensive income 38 38 ------ Total comprehensive income 387 Cash dividends paid, net of ESOP tax benefit (126) (126) Issuance of shares under employee benefit plans, including tax benefit .5 25 (1) 14 38 Put option obligation, net 16 16 Purchase of shares (3.7) (1) (42) (286) (329) Issuance of shares to trust, net .2 10 (10) 0 ---- --- ------ ------ ----- ---- ---- ------ Balance at December 31, 1998 71.7 36 853 1,321 (110) (6) (37) 2,057 Net income 617 617 Other comprehensive income (loss) (110) (110) ------ Total comprehensive income 507 Cash dividends paid, net of ESOP tax benefit (128) (128) Issuance of shares under employee benefit plans, including tax benefit .8 49 (1) 6 54 Put option obligation, net (7) (7) Sale of shares 1.6 1 146 147 Purchase of shares (.1) (5) (1) (6) ---- --- ------ ------ ----- ---- ---- ------ Balance at December 31, 1999 74.0 37 1,041 1,804 (220) 0 (38) 2,624 Net income 453 453 Other comprehensive income (loss) (47) (47) ------ Total comprehensive income 406 Cash dividends paid (127) (127) Issuance of shares under employee benefit plans, including tax benefit .3 57 (1) 56 Put option obligation, net 7 7 Purchase of shares (6.0) (3) (112) (302) (417) Issuance of shares 5 5 Initial public offering and spin-off of subsidiary 272 (416) (144) Other - net 1 (1) 0 ---- --- ------ ------ ----- ---- ---- ------ Balance at December 31, 2000 68.3 $34 $1,266 $1,410 $(267) $ 0 $(33) $2,410 ==== === ====== ====== ===== ==== ==== ======
The Financial Review on pages 23 to 50 is an integral part of the consolidated financial statements. 23 Page 23 FINANCIAL REVIEW All references to net income per Common Share assume dilution, unless otherwise indicated. ACCOUNTING POLICIES Consolidation The consolidated financial statements include accounts of the Company and all majority-owned subsidiaries. The equity method of accounting is used for investments in associate companies and joint ventures where the Company has a 20% to 50% ownership interest. Foreign Currency Translation The functional currency for principally all subsidiaries outside the United States is the local currency. Financial statements for these subsidiaries are translated into United States dollars at year-end exchange rates as to assets and liabilities and weighted-average exchange rates as to revenues and expenses. The resulting translation adjustments are recorded in shareholders' equity in accumulated other comprehensive income (loss). Inventories Inventories are carried at lower of cost or market. Inventories in the United States are generally accounted for using the last-in, first-out (LIFO) method. Remaining United States and all other inventories are accounted for using the first-in, first-out (FIFO) method. Depreciation and Amortization Depreciation and amortization are computed by the straight-line method for financial statement purposes. Cost of buildings is depreciated over forty years and machinery and equipment over principally three to ten years. Goodwill and intangible assets, primarily consisting of patents, trademarks, tradenames are amortized over a range of five to forty years. Software is amortized over its estimated useful life, generally three to five years, but not to exceed five years. Goodwill and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount may not be recoverable. Events or circumstances that would result in an impairment review primarily include operations reporting losses or a 24 Page 24 significant change in the use of an asset. The asset would be considered impaired when the future net undiscounted cash flows generated by the asset are less than its carrying value. An impairment loss would be recognized based on the amount by which the carrying value of the asset exceeds its fair value. Financial Instruments The Company selectively uses straightforward, nonleveraged financial instruments as part of foreign exchange and interest rate risk management programs. Financial instruments are not bought and sold solely for trading purposes except for nominal amounts authorized under limited, controlled circumstances. Credit loss has never been experienced, and is not anticipated, as the counterparties to various financial instruments are major international financial institutions with strong credit ratings and due to control over the limit of positions entered into with any one party. Although financial instruments are an integral part of the Company's risk management programs, their incremental effect on financial condition and results of operations is not material. The Company and its subsidiaries are exposed to fluctuations in foreign currencies in the normal course of business. Foreign currency forward exchange contracts and other instruments are used to reduce exposure to foreign currency fluctuations. Accrued gains or losses on those financial instruments which hedge net investments in subsidiaries outside the United States are recorded in shareholders' equity. Gains or losses on those financial instruments which hedge specific transactions are deferred and subsequently recognized in net income when the gains or losses on the hedged foreign currency transaction are recognized in net income. Cash premiums and discounts related to these financial instruments are amortized to other income-net over the life of the respective agreement. In the normal course of business the Company's operations are also exposed to fluctuations in interest rates. Interest rate swaps, forward interest rate agreements and other instruments are used to reduce the cost of, and exposure to, interest rate fluctuations. Accrued gains or losses on interest rate swaps and other instruments are included in interest expense since they hedge interest on debt. Gains and losses on forward interest rate agreements are deferred and subsequently recognized in net income when interest expense on the hedged debt is recognized in net income. Cash premiums related to these financial instruments are amortized to interest expense over the life of the respective agreement. 25 Page 25 Statement of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, requires all derivative instruments to be recognized on the balance sheet at fair value. The standard must be adopted by the Company effective January 1, 2001. Adoption will not have a material effect on the consolidated results of operations or financial position of the Company. Options for Common Shares The Company applies the intrinsic value based method described in Accounting Principles Board Opinion No. 25 to account for stock options granted to employees to purchase Common Shares. Under this method, no compensation expense is recognized on the grant date, since on that date the option price equals the market price of the underlying Common Shares. Revenue Recognition Substantially all revenues are recognized when products are shipped to unaffiliated customers. In December 1999, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition". SAB 101 clarifies the SEC staff's views on application of generally accepted accounting principles to revenue recognition. The Company has concluded its revenue recognition policy continues to be appropriate and in accordance with generally accepted accounting principles and SAB 101. The Company's accounting policy with respect to shipping and handling costs billed to the customer is to include the amounts billed in net sales and the related costs in cost of products sold. Estimates Preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and notes. Actual results could differ from these estimates. Financial Presentation Changes Certain amounts for prior years have been reclassified to conform to the current year presentation. 26 Page 26 DISCONTINUED OPERATIONS On June 30, 2000, the Company's semiconductor equipment operations were reorganized into a wholly-owned subsidiary, Axcelis Technologies, Inc. (Axcelis). In July 2000, Axcelis completed an initial public offering (IPO) for the sale of 17,050,000 shares of common stock at $22 per share. The proceeds from the IPO, net of an underwriting discount and other offering expenses, were $349 million and, together with cash from other sources available to Axcelis, were used to pay a $300 million dividend to Eaton. On December 29, 2000 Eaton distributed its remaining interest in Axcelis to Eaton shareholders as a dividend (spin-off). The distribution was tax-free to Eaton and its shareholders for United States income tax purposes. The $272 million gain on the IPO was recorded as a direct increase to shareholders' equity. The spin-off was recorded as a $416 million direct reduction of shareholders' equity. The consolidated financial statements have been restated to present the semiconductor equipment operations as a discontinued operation. Results reported separately by Axcelis are reported on a stand-alone basis and differ from results of discontinued operations. Operating results of discontinued operations are summarized as follows (in millions): 2000 1999 1998 ---- ---- ---- Net sales $ 679 $ 397 $ 267 Income (loss) before income taxes $ 132 $ 20 $(131) Income taxes (benefit) 42 6 (50) ----- ----- ----- Net income (loss) $ 90 $ 14 $ (81) ===== ===== ===== ACQUISITIONS OF BUSINESSES The Company acquired businesses for a combined net cash purchase price (in millions) of $115 in 2000, $1,602 in 1999 and $117 in 1998. All acquisitions were accounted for by the purchase method of accounting and, accordingly, the Statements of Consolidated Income include the results of the acquired businesses from the effective dates of acquisition. In September 2000, the industrial cylinder business of International Motion Control Incorporated was acquired for $75 million. This business, which had 1999 sales of $63 million, manufactures industrial cylinders which are primarily used by machine and equipment builders to transfer and apply fluid power. The operating results of this business are reported in Business Segment Information in Fluid Power. 27 Page 27 In April 1999, the Company acquired Aeroquip-Vickers, Inc. The operating results are reported in Business Segment Information in Fluid Power. The assets acquired and liabilities assumed in the acquisition of Aeroquip-Vickers were recorded at estimated fair values as determined by Eaton's management. The Company obtained independent appraisals of the fair values of the acquired property, plant and equipment, and identified intangible assets, and their remaining useful lives and has completed the review and determination of the fair values of the other assets acquired and the liabilities assumed. A summary of the assets acquired and liabilities assumed in the acquisition follows (in millions): Recorded fair values Assets acquired $1,724 Liabilities assumed (1,217) Goodwill (amortized by the straight-line method over forty years) 1,116 ------ Purchase price 1,623 Less cash acquired & liability for outstanding shares (30) ------ Net cash paid $1,593 ====== As a result of the acquisition of Aeroquip-Vickers, Eaton incurred acquisition integration costs for the incremental expenditures to exit and consolidate activities at Aeroquip-Vickers locations, to involuntarily terminate Aeroquip-Vickers employees and to integrate operating locations and other activities of Aeroquip-Vickers with Eaton. Acquisition integration costs, which are not associated with the generation of future revenues and have no future economic benefit, have been reflected as assumed liabilities in the purchase price allocation. The components of the acquisition integration liabilities are as follows (in millions of dollars): Workforce reductions Plant -------------------- consolidation Employees Dollars & other Total --------- ------- -------------- ----- 1999 470 $ 31 $ 1 $ 32 Utilized in 1999 (460) (28) (1) (29) ----- --- --- --- Balance at December 31, 1999 10 3 0 3 2000 2,075 72 10 82 Utilized in 2000 (1,060) (33) (3) (36) ----- --- --- --- Balance remaining at December 31, 2000 1,025 $ 42 $ 7 $ 49 ===== === === === 28 Page 28 The acquisition integration liabilities for Aeroquip-Vickers were based on Eaton's integration plan which focuses on: 1) manufacturing process and supply chain rationalization, including plant closings, 2) elimination of redundant administrative overhead and support activities, and 3) restructuring and repositioning of the sales/marketing and research and development organizations to eliminate redundancies. Workforce reductions primarily related to plant closings and consolidations, for which decisions were finalized in the first quarter of 2000. Adjustments to these liabilities 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 goodwill, if the ultimate amount of the liability is below the estimate. SALES OF BUSINESSES & CORPORATE ASSETS The Company sold businesses, product lines and certain corporate assets for aggregate cash proceeds (in millions) of $122 in 2000, $544 in 1999 and $375 in 1998. The sale of certain corporate assets and product lines in 2000 resulted in a pretax gain of $22 million ($14 million after-tax or $.19 per Common Share). Divestitures in 1999 included the sale of the Engineered Fasteners division in August and the Fluid Power division in October. The sales of these businesses, and adjustments related to businesses sold in prior periods, resulted in a pretax gain of $340 million ($198 million after-tax, or $2.68 per Common Share). In December, substantially all of Vickers Electronic Systems was sold, which was acquired in the acquisition of Aeroquip-Vickers, resulting in no gain or loss. Divestitures in 1998 included the sale of the Axle and Brake business in January and the automotive leaf spring business in April. The sales of these businesses, and adjustments related to businesses sold in prior periods, resulted in a pretax gain of $43 million ($28 million after-tax, or $.38 per Common Share). The operating results of businesses sold in 1999 and 1998 are reported in Business Segment Information as Divested Operations. 29 Page 29 UNUSUAL CHARGES During 2000 and 1999, in connection with the integration of Aeroquip-Vickers, Eaton incurred various costs, primarily plant consolidation and other expenses, including outside consulting fees, travel expenses and the relocation of inventory and equipment. In accordance with generally accepted accounting principles, these acquisition integration costs, which are associated with the generation of future revenues and have future economic benefit, were recorded as expense. Acquisition integration expenses related to Aeroquip-Vickers, and restructuring charges in 2000, 1999, and 1998 related to other business segments, are included in the Statements of Consolidated Income in Income from Operations and reduced operating profit of the related segment and are described below. 2000 Charges Income from continuing operations in 2000 was reduced by charges of $52 million ($34 million after-tax, or $.47 per Common Share), which included $47 million associated with the integration of Aeroquip-Vickers and $5 million of corporate related charges. Integration charges consisted of $46 million of plant consolidation and other expenses and $1 million for workforce reductions. The workforce reduction charges consist of severance and other related employee benefits and include the expected termination of approximately 110 employees, primarily manufacturing personnel. 1999 Charges Income from continuing operations in 1999 was reduced by charges of $30 million ($20 million after-tax, or $.27 per Common Share), which included $23 million associated with the integration of Aeroquip-Vickers as discussed above and $7 million of restructuring charges related to the Truck segment. Integration charges of $23 million related to the acquisition of Aeroquip-Vickers included $21 million for plant consolidation and other expenses. In addition, a $2 million liability for workforce reductions, severance and other related employee benefits, was recorded and included the expected termination of 70 employees, primarily manufacturing personnel. As part of the ongoing effort to restructure European operations in the Truck segment, a restructuring liability of $7 million was recorded. The Company is completing the closure of a manufacturing facility in Aycliffe, United Kingdom and consolidating production into an existing facility 30 Page 30 in Poland. This charge related to workforce reductions, severance and other related employee benefits, for the expected termination of 190 employees, primarily manufacturing personnel. 1998 Charges Income from continuing operations in 1998 was reduced by charges of $68 million ($44 million after-tax, or $.61 per Common Share) which included $58 million to restructure certain business segments and $10 million for a contribution to the Company's charitable trust. Restructuring charges of $58 million primarily related to workforce reductions, inventory write-downs, and other costs in the Automotive, Industrial and Commercial Controls, and Truck segments. The charges included $33 million for workforce reductions, primarily severance and other related employee benefits, for the expected termination of 2,525 employees, mainly manufacturing personnel. Certain plants in these segments were closed and production was consolidated into other existing facilities. Restructuring Liabilities Movement of the various components of restructuring liabilities of continuing operations are as follows (in millions of dollars): Inventory & Plant Workforce other asset consolidation Employees reductions write-downs & other Total --------- ---------- ----------- ------------- ----- 1998 2,525 $ 33 $ 16 $ 9 $ 58 Utilized in 1998 (600) (5) (16) (6) (27) ----- ---- ---- ---- ---- Balance remaining at December 31, 1998 1,925 28 0 3 31 1999 260 9 0 0 9 Utilized in 1999 (1,825) (22) 0 (2) (24) ----- ---- ---- ---- ---- Balance remaining at December 31, 1999 360 15 0 1 16 2000 0 0 0 0 0 Utilized in 2000 (180) (7) 0 (1) (8) ----- ---- ---- ---- ---- Balance remaining at December 31, 2000 180 $ 8 $ 0 $ 0 $ 8 ===== ==== ==== ==== ==== DEBT AND OTHER FINANCIAL INSTRUMENTS At December 31, 2000, short-term debt was $447 million, of which $368 million related to United States operations. Credit facilities of $600 million, which mature April 2001, 31 Page 31 are available to support this short-term debt. Subsidiaries outside the United States have lines of credit, primarily short-term, aggregating $128 million from various banks worldwide. At December 31, 2000, $79 million was outstanding under these lines of credit. Long-term debt at December 31, excluding the current portion, follows (in millions): 2000 1999 ---- ---- 6.95% notes due 2004 $ 250 $ 250 8% debentures due 2006 86 86 8.9% debentures due 2006 100 100 6% Euro 200 million notes due 2007 186 8.1% debentures due 2022 100 100 7-5/8% debentures due 2024 66 94 6-1/2% debentures due 2025 (due 2005 at option of debenture holders) 145 150 7.875% debentures due 2026 82 82 7.65% debentures due 2029 200 200 6.4% to 7.6% medium-term notes due at various dates ranging from 2002 to 2018 257 167 Commercial paper 900 500 Other 75 186 ------ ------ $2,447 $1,915 ====== ====== The Company has a multi-year credit facility of $900 million, $500 million of which expires in 2003 and $400 million expires in 2005. Commercial paper of $900 million is classified as long-term debt because the Company intends, and has the ability under this agreement, to refinance these notes on a long-term basis. In March 2000, the Company entered into a seven-year Euro 200 million interest rate swap to convert the 6% Euro 200 million notes from a fixed-rate to a floating-rate based upon the six-month Euro Interbank Offered Rate (4.8% at December 31, 2000). In 1999, the Company entered into a five-year $100 million interest rate swap and a thirty-year $150 million interest rate swap. These swaps effectively convert a portion of the 6.95% notes and the 7.65% debentures to floating rates based on the six-month London Interbank Offered Rate (6.2% at December 31, 2000). In 1999, the Company entered into an agreement expiring in May 2002, which effectively converts $50 million of United States dollar floating-rate debt into Japanese Yen 32 Page 32 denominated debt with interest payable at a floating-rate (.849% at December 31, 2000). In 1999, the Company also entered into an agreement expiring in October 2001, which effectively converts $50 million of United States dollar floating-rate debt into Euro denominated debt based on the three-month Euro Interbank Offered Rate (4.9% at December 31, 2000). The weighted-average interest rate on short-term borrowings, including commercial paper classified in long-term debt, was 6.5% and 6.2% at December 31, 2000 and 1999, respectively. Aggregate mandatory sinking fund requirements and annual maturities of long-term debt are as follows (in millions): 2001, $110; 2002, $131; 2003, $504; 2004, $255; and 2005, $415. Interest capitalized as part of the acquisition or construction of major fixed assets (in millions) was $22 in 2000, $21 in 1999 and $16 in 1998. Interest paid (in millions) was $205 in 2000, $163 in 1999 and $102 in 1998. The carrying values of cash, short-term investments and short-term debt in the Consolidated Balance Sheet approximate their estimated fair values. The estimated fair values of other financial instruments outstanding at December 31 are as follows (in millions): 2000 1999 ------------------------- -------------------------- Notional Carrying Fair Notional Carrying Fair amount amount value amount amount value -------- ------- ----- -------- -------- ----- Marketable debt securities $ 48 $ 48 $ 63 $ 63 Long-term debt, current portion of long-term debt & foreign currency principal swaps (2,557) (2,621) (1,927) (1,963) Foreign currency forward exchange contracts $ 271 6 7 $ 20 Interest rate swaps Fixed to floating 436 20 250 (7) Fixed to fixed 75 1 (1) Floating to floating 100 50 (1) The estimated fair values of financial instruments are principally based on quoted market prices. The fair value of foreign currency forward exchange contracts, which primarily mature in 2001, and foreign currency principal and interest rate swaps are estimated based on quoted market prices of comparable contracts, adjusted through interpolation where necessary for maturity differences. 33 Page 33 RETIREMENT BENEFIT PLANS The Company has defined benefit pension plans and other postretirement benefit plans, primarily health care and life insurance. In the event of a change in control of the Company, excess pension plan assets of North American operations may be dedicated to funding of health and welfare benefits of employees and retirees. Components of plan obligations and assets and the recorded asset (liability) of continuing operations at December 31 are as follows (in millions): Other postretirement Pension benefits benefits ---------------- -------------- 2000 1999 2000 1999 ---- ---- ---- ---- Benefit obligation at beginning of year $(1,754) $(1,600) $(835) $(767) Service cost (63) (67) (16) (15) Interest cost (119) (108) (60) (54) Effect of divestitures 2 25 3 13 Effect of acquisitions (179) (106) Actuarial (loss) gain (7) 40 19 36 Benefits paid 160 146 67 60 Effect of translation 29 3 Other (10) (14) (5) (2) ------- ------- ----- ----- Benefit obligation at end of year $(1,762) $(1,754) $(827) $(835) ------- ------- ----- ----- Fair value of plan assets at beginning of year $ 2,386 $ 2,004 Actual return on plan assets (24) 341 Employer contributions 28 20 $ 65 $ 58 Effect of divestitures (26) Effect of acquisitions 192 Benefits paid (160) (146) (67) (60) Effect of translation (24) (1) Other 3 2 2 2 ------- ------- ----- ----- Fair value of plan assets at end of year $ 2,209 $ 2,386 $ 0 $ 0 ------- ------- ----- ----- Pension plan assets in excess of benefit obligations $ 447 $ 632 Obligations with no plan assets $(827) $(835) Unamortized Net (gain) loss (213) (469) 128 156 Prior service cost 35 36 (9) (15) Other (12) (14) ------- ------- ----- ----- Recorded asset (liability) $ 257 $ 185 $(708) $(694) ======= ======= ===== ===== 34 Page 34 The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets (in millions) were $281, $247 and $136, respectively, as of December 31, 2000, and $146, $136 and $23, respectively, as of December 31, 1999. The components of net periodic benefit income (cost) of continuing operations for the years ended December 31 are as follows (in millions): Pension benefits ------------------------- 2000 1999 1998 ---- ---- ---- Service cost $(63) $(67) $(57) Interest cost (119) (108) (98) Expected return on plan assets 200 179 158 Other 6 (3) (4) ---- ---- ---- 24 1 (1) Curtailment (loss) gain (2) (5) 8 Settlement gain 18 18 41 ---- ---- ---- $ 40 $ 14 $ 48 ==== ==== ==== Other postretirement benefits ----------------------------- 2000 1999 1998 ---- ---- ---- Service cost $(16) $(15) $(12) Interest cost (60) (54) (49) Net amortization (3) (2) ---- ---- ---- (76) (72) (63) Curtailment gain 1 1 1 Settlement loss (4) (5) ---- ---- ---- $(75) $(75) $(67) ==== ==== ==== The curtailment and settlement gains and losses reflect the sales of the Engineered Fasteners and Fluid Power divisions in 1999 and the Axle and Brake business in 1998. 35 Page 35 Actuarial assumptions used in the calculation of the recorded asset (liability) are as follows: 2000 1999 ---- ---- Discount rate 7.75% 7.50% Return on pension plan assets 10.00% 10.00% Rate of compensation increase 4.75% 4.50% Projected health care cost trend rate 5.25% 6.00% Ultimate health care trend rate 5.50% 5.25% Year ultimate health care trend rate is achieved 2001 2001 Assumed health care cost trend rates have a significant effect on the amounts reported for other postretirement benefits. A one-percentage-point change in the assumed health care cost trend rate would have the following effects (in millions): 1% Increase 1% Decrease ----------- ----------- 2000 benefit cost $ 3 $ (2) Recorded liability at December 31, 2000 32 (29) The Company also has various defined-contribution benefit plans, primarily consisting of the Eaton Share Purchase and Investment Plan and the Aeroquip-Vickers Savings and Profit Sharing Plan. Total contributions related to these plans charged to expense were (in millions) $75 in 2000, $34 in 1999 and $9 in 1998. PROTECTION OF THE ENVIRONMENT The Company has established policies to ensure that its operations are conducted in keeping with good corporate citizenship and with a positive commitment to the protection of the natural and workplace environments. For example, each manufacturing facility has a person responsible for environmental, health and safety (EHS) matters. All of the Company's manufacturing facilities are becoming certified under ISO 14001, an international standard for environmental management systems. The Company routinely reviews EHS performance at each of its facilities and continuously strives to improve pollution prevention at its facilities. As a result of past operations, the Company is involved in remedial response and voluntary environmental remediation at a number of sites, including certain currently-owned or formerly-owned plants. The Company has also been named a potentially responsible party (PRP) under the Federal Superfund law at a number of waste disposal sites. 36 Page 36 A number of factors affect the cost of environmental remediation, including the number of parties involved at a particular site, the determination of the extent of contamination, the length of time the remediation may require, the complexity of environmental regulations, and the continuing advancement of remediation technology. Taking these factors into account, the Company has estimated (without discounting) costs of remediation, which will be incurred over a period of several years. The Company accrues an amount consistent with the estimates of these costs when it is probable that a liability has been incurred. At December 31, 2000 and 1999, the Consolidated Balance Sheet included a liability for these costs (in millions) of $58 and $52, respectively. With regard to some of the matters included in the liability, the Company has rights of recovery from non-affiliated parties for a portion of these estimated costs. Based upon the Company's analysis and subject to the difficulty in estimating these future costs, the Company expects that any sum it may be required to pay in connection with environmental matters is not reasonably likely to exceed the liability by an amount that would have a material adverse effect on its financial condition, results of operations, or liquidity. All of these estimates are forward-looking statements and, given the inherent uncertainties in evaluating environmental exposures, actual results can differ from these estimates. SHAREHOLDERS' EQUITY There are 300 million Common Shares authorized ($.50 par value per share). At December 31, 2000, there were 11,847 holders of record of Common Shares. Additionally, approximately 28,000 current and former employees were shareholders through participation in the Eaton Share Purchase and Investment Plan (SPIP), and the Aeroquip-Vickers Savings & Profit Sharing Plan. The Company has plans which permit eligible employees and directors to defer a portion of their compensation. The Company has deposited $61 million of marketable securities and its Common Shares into a trust to fund a portion of these liabilities. The marketable securities are included in other assets and the Common Shares are included in shareholders' equity. Stock Options Stock options have been granted to certain employees, under various plans, to purchase Common Shares at prices equal to fair market value as of date of grant. Historically, the 37 Page 37 majority of these options vest ratably during the three-year period following the date of grant and expire ten years from the date of grant. During 1998 and 1997, the Company granted special performance-vested stock options with a ten-year vesting term in lieu of more standard employee stock options. These options have a provision for accelerated vesting when the Company achieves certain net income and Common Share price targets. If the targets are not achieved, these options become exercisable ten days before the expiration of their ten-year term. As of December 31, 2000, 2.5 million special performance-vested stock options were outstanding of which 1.0 million were exercisable. As a result of the spin-off of Axcelis on December 29, 2000, all outstanding stock options were adjusted to reflect the effect of the spin-off. Outstanding options were adjusted so that the intrinsic values of the options after the spin-off were equivalent to the intrinsic values of the options immediately before the spin-off (intrinsic value represents the difference between market value and option price on a per share basis extended by the number of shares). The intrinsic value was maintained by a combination of a reduction of the exercise price relative to the market price of Eaton Common Shares subsequent to the spin-off and an increase in the number of shares underlying the outstanding options. A summary of stock option activity follows (shares in millions): 2000 1999 1998 --------------- --------------- ---------------- Average Average Average price price price per per per share Shares share Shares share Shares ------- ------ ------- ------ ------ ------ Outstanding, January 1 $65.89 8.7 $61.46 7.5 $55.85 6.8 Granted 71.90 1.5 74.53 2.2 87.81 1.2 Exercised 33.76 (.3) 44.95 (.8) 43.40 (.4) Canceled 83.05 (.6) 75.12 (.2) 71.11 (.1) ---- --- --- Options outstanding at December 29, before spin-off of Axcelis $66.89 9.3 Cancellation of options of Axcelis employees 72.39 (.5) Adjustment for spin-off of Axcelis 1.4 ---- --- --- Outstanding, December 31 $57.30 10.2 $65.89 8.7 $61.46 7.5 ==== === === Exercisable, December 31 $51.51 5.8 $55.39 4.6 $51.91 4.8 Reserved for future grants, December 31 2.0 2.4 4.4 38 Page 38 The following table summarizes information about stock options outstanding at December 31, 2000 after the spin-off of Axcelis (shares in millions): Weighted- Weighted- average average remaining exercise Range of exercise Number contractual price per prices per share outstanding life (years) share - --------------------------------------------------------------------- $20.79 - $29.99 .5 .9 $27.21 $30.00 - $39.99 .5 2.1 33.88 $40.00 - $49.99 2.2 4.1 45.64 $50.00 - $59.99 .1 8.6 57.44 $60.00 - $69.99 5.6 7.5 61.70 $70.00 - $79.99 1.1 7.3 75.67 $80.00 - $88.41 .2 8.3 86.55 The following table summarizes information about stock options that are exercisable at December 31, 2000 after the spin-off of Axcelis (shares in millions): Weighted- average exercise Range of exercise prices Number price per per share exercisable share - ----------------------------------------------------- $20.79 - $29.99 .5 $27.21 $30.00 - $39.99 .5 33.88 $40.00 - $49.99 2.2 45.64 $50.00 - $59.99 .1 55.52 $60.00 - $69.99 2.1 61.86 $70.00 - $79.99 .3 76.01 $80.00 - $88.41 .1 87.73 The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standard (SFAS) No. 123, "Accounting for Stock-Based Compensation". If the Company accounted for its stock options under the fair value method of SFAS No. 123, net income (in millions) and net income per Common Share would have been as indicated below: 39 Page 39 2000 1999 1998 ---- ---- ---- Net income As reported $ 453 $ 617 $ 349 Assuming fair value method 435 602 338 Net income per Common Share-assuming dilution As reported $6.24 $8.36 $4.80 Assuming fair value method 5.99 8.16 4.65 Net income per Common Share-basic As reported $6.31 $8.51 $4.89 Assuming fair value method 6.06 8.30 4.73 The fair value of each option grant was estimated using the Black-Scholes option pricing model with the following assumptions: 2000 1999 1998 ---- ---- ---- Dividend yield 3% 3% 3% Expected volatility 23% 21% 22% Risk-free interest rate 6% to 6.8% 4.7% to 6.1% 5.5% to 5.7% Expected option life in years 4 or 5 4 or 5 4, 5 or 6 Weighted-average per share fair value of options granted during the year $15.47 $12.99 $18.73 Preferred Share Purchase Rights In 1995, the Company declared a dividend of one Preferred Share Purchase Right for each outstanding Common Share. The Rights become exercisable only if a person or group acquires, or offers to acquire, 20% or more of the Company's Common Shares. The Company is authorized to reduce the 20% threshold for triggering the Rights to not less than 10%. The Rights expire on July 12, 2005, unless redeemed earlier at one cent per Right. When the Rights become exercisable, the holder of each Right, other than the acquiring person, is entitled (1) to purchase for $250, one one-hundredth of a Series C Preferred Share, (2) to purchase for $250, that number of the Company's Common Shares or common stock of the acquiring person having a market value of twice that price, or (3) at the option of the Company, to exchange each Right for one Common Share or one one-hundredth of a Preferred Share. Comprehensive Income The components of accumulated other comprehensive income (loss) as reported in the Statement of Consolidated Shareholders' Equity are as follows (in millions): 40 Page 40 Unrealized Foreign gain (loss) currency on available translation for sale adjustments securities Total ----------- ---------- ----- Balance at January 1, 1998 $(139) $(9) $(148) 1998 adjustment, net of income taxes (2) 6 4 Recognition in income of adjustment related to divested businesses 34 34 ----- --- ----- Balance at December 31, 1998 (107) (3) (110) 1999 adjustment, net of income taxes (116) 3 (113) Recognition in income of adjustment related to divested businesses 3 3 ----- --- ----- Balance at December 31, 1999 (220) 0 (220) 2000 adjustment, net of income taxes (47) (4) (51) Adjustment for spin-off of Axcelis 4 4 ----- --- ----- Balance at December 31, 2000 $(263) $(4) $(267) ===== === ===== INCOME TAXES For financial statement reporting purposes, income from continuing operations before income taxes (in millions), based on the geographical location of the operation to which such earnings are attributable, is summarized below. Certain foreign operations are branches of Eaton Corporation and are, therefore, subject to United States as well as foreign income tax regulations. As a result, pretax income by location and the components of income tax expense by taxing jurisdiction are not directly related. 2000 1999 1998 ---- ---- ---- United States $417 $773 $588 Non-United States 135 173 62 Write-off of foreign currency translation adjustments related to divested businesses (3) (34) ---- ---- ---- $552 $943 $616 ==== ==== ==== Income tax expense of continuing operations for the years ended December 31 follows (in millions): 41 Page 41 2000 1999 1998 ---- ---- ---- Current United States Federal $ 85 $223 $ 22 State & local 19 13 15 Non-United States 51 51 41 ---- ---- ---- 155 287 78 Deferred United States Federal 28 30 102 Non-United States Change in valuation allowance (8) Operating loss carryforwards 2 17 (1) Other 12 6 7 ---- ---- ---- 34 53 108 ---- ---- ---- $189 $340 $186 ==== ==== ==== Reconciliations of income taxes of continuing operations at the United States Federal statutory rate to the effective income tax rate for the years ended December 31 follow (in millions): 2000 1999 1998 ---- ---- ---- Income taxes at the United States statutory rate 35.0% 35.0% 35.0% State & local income taxes 2.7 .6 1.8 Amortization of goodwill & intangible assets 2.6 1.3 1.1 Adjustment of worldwide tax liabilities 5.0 1.3 .3 Possessions credit related to Puerto Rican operations (8.4) (3.2) (6.5) Credit for increasing research activities (3.2) (.9) (1.5) Effective income tax rate differential related to: Sales of businesses 2.5 1.7 Foreign source income 1.2 1.5 .3 Earnings of consolidated subsidiaries and associate companies outside the United States (3.5) (2.2) (.4) Other--net 2.8 .2 (1.6) ---- ---- ---- 34.2% 36.1% 30.2% ==== ==== ==== 42 Page 42 Significant components of current and long-term deferred income taxes of continuing operations at December 31 follow (in millions): Current Long-term Long-term assets assets liabilities ------- --------- ----------- 2000 Accruals & other adjustments Employee benefits $ 59 $ 195 Depreciation & amortization $ (8) (451) Other 81 65 Operating loss carryforwards 3 47 3 Other items 7 14 26 Valuation allowance (3) (47) (27) ---- ---- ----- $147 $ 6 $(189) ==== ==== ===== 1999 Accruals & other adjustments Employee benefits $ 51 $ 2 $ 205 Depreciation & amortization (5) (431) Other 101 28 Operating loss carryforwards 57 3 Other items 9 16 (4) Valuation allowance (56) ---- ---- ----- $161 $ 14 $(199) ==== ==== ===== At December 31, 2000, certain non-United States subsidiaries had operating loss carryforwards aggregating $146 million. Carryforwards of $99 million have no expiration dates and the balance expires at various dates from 2001 through 2010. The Company has manufacturing facilities in Puerto Rico which operate under United States tax law incentives that will no longer be available after 2005. No provision has been made for income taxes on undistributed earnings of consolidated non-United States subsidiaries of $701 million at December 31, 2000, since the earnings retained have been reinvested by the subsidiaries. If distributed, such remitted earnings would be subject to withholding taxes but substantially free of United States income taxes. Worldwide income tax payments (in millions) were $210 in 2000, $169 in 1999 and $30 in 1998. 43 Page 43 The Internal Revenue Service (IRS) has asserted the Company owes additional taxes and interest for 1993 relating to the treatment of transactions involving company-owned life insurance. A similar issue exists for 1994-1998. The Company strongly disagrees with the IRS and is vigorously contesting the matter. Management believes resolution of this matter will not have a material adverse effect on the Company's results of operations, financial condition and cash flows. OTHER INFORMATION Assets Accounts receivable are net of an allowance for doubtful accounts of $24 million at the end of 2000 and $23 million at the end of 1999. The components of inventories at December 31 follow (in millions): 2000 1999 ---- ---- Raw materials $ 310 $ 287 Work in process 290 332 Finished goods 311 295 ----- ----- Gross inventories at FIFO 911 914 Excess of current cost over LIFO cost (39) (38) ----- ----- Net inventories $ 872 $ 876 ===== ===== Gross inventories accounted for using the LIFO method (in millions) were $568 at the end of 2000 and $555 at the end of 1999. Accumulated amortization of goodwill and intangible assets (in millions) was $277 and $159 at the end of 2000 and $230 and $126 at the end of 1999, respectively. The Company has company-owned life insurance policies insuring the lives of a portion of active United States employees. The policies accumulate asset values to meet future liabilities including the payment of employee benefits such as health care. At December 31, 2000 and 1999, the investment in the policies included in other assets (in millions) was $33 and $53, net of policy loans of $405 and $397, respectively. Net life insurance expense (in millions) of $6 in 2000, $8 in 1999 and $7 in 1998, including interest expense of $35 in 2000, $32 in 1999 and $33 in 1998, is included in selling and administrative expense. 44 Page 44 Lease Commitments Minimum rental commitments for 2001 under noncancelable operating leases, which expire at various dates and in most cases contain renewal options, are $76 million and decline substantially thereafter. Rental expense (in millions) was $118 in 2000, $108 in 1999 and $85 in 1998. Net Income per Common Share The calculation of net income per Common Share-assuming dilution and basic follows: (Millions except for per share data) 2000 1999 1998 ---- ---- ---- Net income $ 453 $ 617 $ 349 ===== ===== ===== Average number of Common Shares outstanding - assuming dilution 72.6 73.7 72.7 Less dilutive effect of stock options .8 1.2 1.3 ----- ----- ----- Average number of Common Shares outstanding - basic 71.8 72.5 71.4 ===== ===== ===== Net income per Common Share Assuming dilution Continuing operations $5.00 $8.17 $5.91 Discontinued operations 1.24 .19 (1.11) ----- ----- ----- $6.24 $8.36 $4.80 ===== ===== ===== Net income per Common Share Basic Continuing operations $5.06 $8.31 $6.02 Discontinued operations 1.25 .20 (1.13) ----- ----- ----- $6.31 $8.51 $4.89 ===== ===== ===== Employee stock options to purchase 6.0 million Common Shares in 2000, 1.5 million in 1999 and 3.7 million in 1998 were outstanding but were not included in the computation of net income per Common Share-assuming dilution, since they would have had an antidilutive effect on earnings per share. 45 Page 45 BUSINESS SEGMENT AND GEOGRAPHIC REGION INFORMATION The Company is a global manufacturer of highly engineered products, which serve the industrial, vehicle, construction, commercial and aerospace markets with 59,000 employees and 195 manufacturing sites in 24 countries around the world. The Company's segments are based on the way that management aggregates products and business units for making operating decisions and assessing performance. Major products included in each segment and other information follows. Automotive Valve train systems, intake and exhaust valves, lash compensation lifters and lash adjusters, cylinder heads, superchargers, limited slip and locking differentials, transmission dampers, precision gear forgings, air control valves, climate controls, convenience switches (for power windows, door locks, mirrors, lights, etc.), engine sensors, mirror actuators, transmission controls, keyless entry systems, daytime running lamps, speed-sensitive steering systems, on-board vapor recovery valves, check valves, fuel level sensors and pressure control valves Fluid Power All pressure ranges of hose, fittings, adapters, couplings and other fluid power connectors; hydraulic pumps, motors, valves, cylinders, power steering units, transaxles and transmissions; electronic and hydraulic controls; electric motors and drives; filtration products and fluid-evaluation products and services; aerospace products and systems - hydraulic and electrohydraulic pumps, motors, electric motor pumps, hydraulic motor driven generators and integrated system packages, hydraulic and electromechanical actuators, flap and slat systems, nose wheel steering systems, cockpit controls, power and load management systems, sensors, fluid debris monitoring products, illuminated displays, integrated displays and panels, relays and valves; clutches and brakes for industrial machines; golf grips and precision molded and extruded plastic products Industrial and Commercial Controls To control and protect electric motors -- drives, contactors, starters, and other motor control products; for position sensing -- a wide range of sensors; to control machine logic -- automation personal computers and programmable logic controllers; to permit human interface with machines -- a full range of operator interface hardware and software; to manage distribution of electricity in homes, businesses and 46 Page 46 industrial facilities -- vacuum interrupters, a wide range of circuit breakers and a variety of power distribution and control assemblies and components; to support customer power and control system requirements -- engineering systems and diagnostic and support services; for commercial and military applications -- thermal circuit breakers and power control and conversion equipment Truck Heavy-, medium-, and light-duty mechanical transmissions, heavy-duty automated transmissions, heavy- and medium-duty clutches, traction control systems, transfer boxes, power take-off units, splitter boxes, gearshift mechanisms, transmissions for off-highway construction equipment, intelligent cruise control systems, collision warning systems and transportation logistics management systems Other Information The principal markets for Automotive, Fluid Power, and Truck are original equipment manufacturers and after-market customers of heavy-, medium-, and light-duty trucks, passenger cars, off-highway vehicles, industrial equipment and aerospace products and systems. These original equipment manufacturers are generally concentrated in North America and Europe; however, sales are made globally. Most sales of these products are made directly to such manufacturers. The principal markets for Industrial and Commercial Controls are industrial, construction, commercial, automotive and government customers. These customers are generally concentrated in North America; however, sales are made globally. Sales are made directly by the Company and indirectly through distributors and manufacturers' representatives to such customers. No single customer represented more than 10% of net sales of continuing operations in 2000, 1999 or 1998. Sales from ongoing United States and Canadian continuing operations to customers in foreign countries (in millions) were $599 in 2000, $625 in 1999 and $744 in 1998 (7% of sales in 2000, 8% in 1999 and 12% in 1998). The accounting policies of the segments are generally the same as the policies described under "Accounting Policies" in the Financial Review, except that inventories and related cost of products sold of the segments are accounted for using the FIFO method and the segment results only reflect the service cost component related to pensions and other postretirement benefits. Intersegment sales and transfers 47 Page 47 are accounted for at the same prices as if the sales and transfers were made to third parties. Identifiable assets exclude general corporate assets, which principally consist of short-term investments, deferred income taxes, certain accounts receivable, certain property, plant and equipment, and certain other assets. 48 Page 48 Business Segment Information (Millions) 2000 1999 1998 ---- ---- ---- Net sales Automotive $1,825 $1,857 $1,741 Fluid Power 2,607 2,036 681 Industrial & Commercial Controls 2,421 2,274 2,145 Truck 1,456 1,630 1,478 ------ ------ ------ Total ongoing operations 8,309 7,797 6,045 Divested operations 208 313 ------ ------ ------ Total net sales $8,309 $8,005 $6,358 ====== ====== ====== Operating profit Automotive $ 225 $ 236 $ 198 Fluid Power 235 177 117 Industrial & Commercial Controls 251 181 140 Truck 107 235 201 ------ ------ ------ Total ongoing operations 818 829 656 Divested operations 44 49 Amortization of goodwill & other intangible assets (98) (89) (58) Interest expense - net (177) (152) (88) Gain on sales of businesses 340 43 Corporate & other - net 9 (29) 14 ------ ------ ------ Income from continuing operations before income taxes $ 552 $ 943 $ 616 ====== ====== ====== Income from continuing operations before income taxes was reduced by unusual items as follows (in millions): Automotive $ 12 Fluid Power $ 47 $ 21 1 Industrial & Commercial Controls 28 Truck 7 17 Corporate 5 2 10 49 Page 49 (Millions) 2000 1999 1998 ---- ---- ---- Identifiable assets Automotive $1,056 $1,020 $1,012 Fluid Power 1,518 1,504 359 Industrial & Commercial Controls 1,099 1,109 1,090 Truck 710 767 725 ------ ------ ------ Total ongoing operations 4,383 4,400 3,186 Goodwill 2,026 1,853 970 Other intangible assets 556 598 182 Corporate 1,215 1,160 834 Divested operations 125 Net assets of discontinued operations 331 273 ------ ------ ------ Total assets $8,180 $8,342 $5,570 ====== ====== ====== Expenditures for property, plant & equipment Automotive $ 111 $ 123 $ 115 Fluid Power 95 118 43 Industrial & Commercial Controls 71 76 144 Truck 81 120 126 ------ ------ ------ Total ongoing operations 358 437 428 Corporate 28 34 26 Divested operations 9 14 ------ ------ ------ Total expenditures for property, plant & equipment $ 386 $ 480 $ 468 ====== ====== ====== Depreciation of property, plant & equipment Automotive $ 79 $ 81 $ 80 Fluid Power 97 78 24 Industrial & Commercial Controls 74 73 64 Truck 57 51 52 ------ ------ ------ Total ongoing operations 307 283 220 Corporate 21 26 18 Divested operations 7 10 ------ ------ ------ Total depreciation of property, plant & equipment $ 328 $ 316 $ 248 ====== ====== ====== 50 Page 50 Geographic Region Information Ongoing operations -------------------------- Long- Net Operating lived (Millions) sales profit assets* ----- --------- ------ 2000 United States $6,672 $ 688 $1,550 Canada 182 15 14 Europe 1,364 47 412 Latin America 421 48 217 Pacific Region 254 20 81 Eliminations (584) ------ ------ ------ $8,309 $ 818 $2,274 ====== ====== ====== 1999 United States $6,310 $ 721 $1,598 Canada 172 12 11 Europe 1,294 66 398 Latin America 365 29 206 Pacific Region 213 1 81 Eliminations (557) ------ ------ ------ $7,797 $ 829 $2,294 ====== ====== ====== 1998 United States $4,902 $ 571 $1,148 Canada 159 11 9 Europe 841 58 275 Latin America 411 23 223 Pacific Region 123 (7) 50 Eliminations (391) ------ ------ ------ $6,045 $ 656 $1,705 ====== ====== ====== *Long-lived assets consist of property, plant, and equipment - net. Operating profit was reduced by unusual items as follows (in millions): 2000 1999 1998 ---- ---- ---- United States $ 42 $ 21 $ 42 Europe 4 7 7 Latin America 1 1 Pacific Region 8 51 Page 51 Management's Discussion and Analysis of Financial Condition and Results of Operations All references to net income per Common Share assume dilution. Overview of Operating Results for 2000 - -------------------------------------- Worldwide net sales of continuing operations reached a record $8.309 billion in 2000, 4% ahead of 1999. Income from continuing operations was $363 million in 2000 ($5.00 per Common Share), down from $603 million in 1999 ($8.17 per share). Excluding unusual items in both years, income from continuing operations was $383 million in 2000 ($5.28 per share), down from $425 million in 1999 ($5.76 per share). Unusual items included acquisition integration and restructuring charges, and gains on sales of businesses and corporate assets reported in both years. Total net income was $453 million, or $6.24 per share in 2000 compared to $617 million, or $8.36 per share in 1999. Eaton's semiconductor equipment operations were reorganized into a wholly-owned subsidiary, Axcelis Technologies, Inc. on June 30, 2000. In July, Axcelis completed an initial public offering for 17.6% of its common stock, and on December 29th Eaton distributed its remaining interest in Axcelis to Eaton shareholders. Accordingly, the consolidated financial statements have been restated to present the semiconductor equipment operations as a discontinued operation. For 2000, net sales of discontinued operations were $679 million, up 71% from 1999. Income from discontinued operations rose to $90 million in 2000, up sharply from $14 million in 1999. Sales and net income per share before unusual items for continuing and discontinued operations combined were new records in 2000. Income from continuing and discontinued operations before unusual items reached $473 million, or $6.52 per Common share, on combined sales of $8.988 billion. Comparable 1999 earnings were $439 million, or $5.95 per share, on combined sales of $8.402 billion. These results were achieved despite the increasingly challenging economic environment experienced in the second half of 2000. For the first time, the Company reported record annual earnings per share before unusual items despite a severe downturn in the North American heavy truck market. The Company's diversification strategy paid off in 2000, with notable performances by the Industrial & Commercial Controls and Fluid Power segments offsetting results reflective of the extraordinarily difficult conditions in the Truck segment. Additionally, the continuing recovery of markets for semiconductor capital equipment and benefits of the restructuring of this business initiated in the second half of 1998 benefited the results of discontinued operations. 52 Page 52 2000 Compared to 1999 - Continuing Operations - --------------------------------------------- Results of Operations - --------------------- Net sales of continuing operations were $8.309 billion in 2000, an increase of 4% over 1999. The increase in sales was primarily the result of the acquisition of Aeroquip-Vickers, Inc. in the second quarter of 1999, which more than offset sales decreases of $208 million related to businesses sold in 1999. The acquisition of Aeroquip-Vickers was the primary driver of the 28% increase in sales of the Fluid Power segment to $2.607 billion in 2000, compared to 1999. Sales of the Industrial & Commercial Controls segment rose 6.5% to $2.421 billion in 2000 over 1999, in line with overall growth in underlying markets that were paced by strong non-residential building in North America. However, these increases in sales were largely offset by extraordinarily difficult conditions in markets for truck components that caused sales of the Truck segment to fall 11% to $1.456 billion compared to 1999. Preliminary data for class 8 trucks in the NAFTA region show that production fell from 333,000 units in 1999 to 252,000 in 2000, a decline of about 25%. As an industry leader in truck components, the Truck segment was adversely affected by extraordinary volatility in this market and was unable to reduce resources at the same pace as orders dropped. Sales of the Automotive segment were $1.825 billion in 2000, down $32 million from 1999, reflecting flat year-over-year light vehicle production in North America and in Europe, and helped by sales from introductions of new products. Net sales in the United States and Canada in 2000 increased to $6.854 billion, 6% over 1999, primarily the result of the acquisition of Aeroquip-Vickers and the strong performance of certain of the Company's North American markets. In Europe, sales rose 5% to $1.364 billion, reflecting solid European economic performance with a 1% gain in light vehicle production, an 8% rise in medium and heavy truck production, and a 5% increase in industrial production during 2000. Sales in Latin America rose 15% to $421 million, primarily due to the Latin American economic rebound with 4% economic growth in the region. In the Pacific Region, sales increased 19% in 2000 to $254 million, a reflection of that area's continuing recovery from the economic crisis that occurred in Asia in 1998. As a result of the increases in sales at international operations, related operating profits increased 20% to $130 million. As displayed in the Statement of Consolidated Income, continuing operations reported Income from Operations of $649 million in 2000 (7.8% of sales), down from $703 million in 1999 (8.8% of sales). These results reflect the benefit of Eaton's diversification, with excellent performances by the Industrial 53 Page 53 & Commercial Controls and Fluid Power segments offsetting extremely difficult conditions in the Truck segment. Income from Operations in 2000 was reduced by restructuring charges of $52 million ($34 million after-tax, or $.47 per Common Share) compared to similar charges of $30 million in 1999 ($20 million after-tax, or $.27 per share). The restructuring charges in 2000 and 1999 were primarily associated with the integration of Aeroquip-Vickers, and also included $7 million in 1999 for the restructuring of certain European operations of the Truck segment. These charges reduced operating profit of the Fluid Power segment, except for the $7 million charge in 1999 mentioned previously which reduced operating profit of the Truck segment, and charges related to general corporate ($5 million for 2000 and $2 million for 1999). Income in 2000 included a net gain on the sales of corporate assets of $22 million ($14 million after-tax, or $.19 per Common Share). In 1999, the divestitures of the Engineered Fasteners and Fluid Power divisions resulted in a pretax gain of $340 million ($198 million after-tax, or $2.68 per share). These gains were included in the Statements of Consolidated Income in Other income-net and in Business Segment Information below business segment operating profit. Income from continuing operations was $363 million in 2000 ($5.00 per Common Share), down from $603 million in 1999 ($8.17 per share). Excluding unusual items in both years, earnings were $383 million in 2000 ($5.28 per share), down from $425 million in 1999 ($5.76 per share). The benefits of the Company's diversification were also reflected in cash earnings per share (earnings per share before non-cash amortization of acquisition-related goodwill and other intangibles). Excluding unusual items in both years, cash earnings per share of continuing operations in 2000 were $6.37, compared to $6.74 in 1999. Cash earnings per share have been included because it is commonly used by financial analysts as one measure of operating performance. Cash earnings per share are not determined using generally accepted accounting principles and, therefore, are not necessarily comparable to other companies. Cash earnings per share should not be considered in isolation or as a substitute for, or more meaningful than, measures of performance determined in accordance with generally accepted accounting principles. 54 Page 54 Business Segments - ----------------- Automotive - ---------- Automotive segment sales were $1.825 billion in 2000, 2% below 1999, in large part because of the weak Euro exchange rate. A 2% increase in volume compared favorably with trends in Eaton's light vehicle markets, including a 2% drop in production in the NAFTA region, a 1% increase in Europe, and a 19% rise in South American output. The above-market volume performance was largely related to new product introductions. Operating profit in 2000 was $225 million (12.3% of net sales), down $11 million from $236 million (12.7% of sales) in 1999. During 2000, Eaton began an expansion of its supercharger capacity in Brazil and announced it would divest its Vehicle Switch/Electronics Division, which had 2000 sales of $323 million, because the business no longer fit its longer-term strategic objectives. Fluid Power - ----------- Fluid Power sales were $2.607 billion in 2000, up 28% over 1999. The increase resulted primarily from the acquisition of Aeroquip-Vickers in the second quarter of 1999 and other acquisitions in 2000. This increase in sales was offset to some extent by a weaker Euro's impact on sales. The change in sales was also affected by a 3% increase in North American fluid power markets and a 9% decline in aerospace markets. Operating profit in 2000 was $235 million compared to $177 million in 1999. Before acquisition integration charges of $47 million in 2000 and $21 million in 1999, operating profit was $282 million (10.8% of net sales), up 42% from $198 million (9.7% of sales) in 1999. In the context of soft industry conditions and the on-going integration of Aeroquip-Vickers, the segment performed reasonably well. The most difficult aspects of the manufacturing integration of this acquisition have been completed. Overall, the acquisition added about 70 cents to earnings per share in 2000. During 2000, Eaton announced it agreed to purchase Sumitomo Heavy Industries, Ltd.'s 50% interest in Sumitomo Eaton Hydraulics Company, Ltd. (SEHYCO), the two companies' Japanese hydraulic products joint venture. During the year, Eaton also completed three other acquisitions; the industrial cylinder business of International Motion Control Incorporated, Frederick Duffield PTY Ltd., an Australian-based manufacturer of metal hydraulic fittings and adapters, and the clamps, flanges, seals and flexible joint business of Honeywell International. The Company remains cautious about the prospects for fluid power markets in 2001, given the current stagnant trend in 55 Page 55 industry orders, however aerospace markets should be at least 10% above 2000. Volumes should exceed market trends due to the three acquisitions completed over the course of 2000, and the addition of SEHYCO, which is expected to close during the first quarter of 2001. Profits in 2001 should also benefit from the expected additional 25 cents per share accretion generated by completion of the Aeroquip-Vickers integration. Industrial & Commercial Controls - -------------------------------- Industrial & Commercial Controls sales and profits in 2000 were at record levels. Sales of $2.421 billion were 7% ahead of 1999, consistent with the increase in North American shipments of distribution equipment and industrial controls. Operating profit of $251 million (10.4% of net sales) was 39% higher than 1999 operating profit of $181 million (8.0% of sales). Fourth quarter Cutler-Hammer orders were up 6% with disproportionate strength in distribution equipment offsetting weakness in industrial controls. CHESS, the engineering services business, was in the black during the fourth quarter of 2000, the first full quarter of profitability. While volume growth in 2001 is expected to be moderate compared to 2000, Eaton expects another record year from Industrial & Commercial Controls in 2001. At the end of 2000, the power tool switch product line, with annual sales of about $40 million, was sold. Truck - ----- Truck segment sales in 2000 were $1.456 billion, 11% below 1999. This compares to a 25% decline in NAFTA production of class 8 trucks, a 5% drop in NAFTA medium-duty truck production, an 8% rise in European medium and heavy truck output and a 30% increase in South American commercial vehicle production. This segment reported operating profits of $107 million in 2000 compared to profits of $242 million in 1999, before restructuring charges of $7 million in 1999. The North American heavy truck industry suffered a 25% drop during 2000, with the entire production decline occurring in the second half of the year. This decline was unprecedented, especially during a period of generally favorable macroeconomic conditions. As an industry leader, Eaton was fully affected by this extraordinary volatility, and was unable to reduce resources at the same pace as orders dropped. This segment continues to win new business on a global scale. However, the Company has determined that the costs of serving demanding customer needs in the context of unprecedented volatility have become unacceptably high. As a result, in January 2001, the Company announced its plan to restructure the Truck segment in 56 Page 56 order to begin to evolve to a business model that is less vertically integrated, takes better advantage of its global presence, and focuses on those areas where it brings distinctive value to the marketplace. Eaton expects to take a $55 million charge during 2001 to restructure this business, with about $40 million recognized in the first quarter of 2001 and the balance of the expense recognized over the remainder of the year. Recurring annual savings from the restructuring are anticipated to reach $40 million, with a payback period of approximately 18 months. The result is expected to be a more flexible, more profitable organization that is less affected by the inevitable ups and downs of this dynamic, growth market, and can better serve the needs of its customers, suppliers, employees and owners. During 2000, the Company announced a multi-year, $250 million agreement to supply medium-duty truck transmission components to DaimlerChrysler AG in Brazil from Eaton's facility in Mogi Mirim, Brazil. Non-operating Income (Expense) - ----------------------------- Amortization of goodwill and other intangible assets was $98 million in 2000, up $9 million from $89 million in 1999. The increase was largely attributable to the recognition of a full year of amortization related to the acquisition of Aeroquip-Vickers, compared to nine months in 1999. Net interest expense was $177 million in 2000 compared to $152 million in 1999. The increase was largely due to the recognition of a full-year of interest for borrowings required to finance the acquisition of Aeroquip-Vickers in the second quarter of 1999. Corporate and other expenses netted to income of $9 million in 2000 compared to net expense of $29 million in 1999, or a net change of $38 million. The change was primarily related to a $22 million gain on the sale of corporate assets recorded in 2000. Changes in Financial Condition - ------------------------------ Eaton continues to generate substantial cash from operating activities, the primary source of funds to finance the needs of the Company. Continuing operations generated operating cash flow of $519 million in 2000 compared to $708 million in 1999. Spending in 2000 included higher income tax payments related to taxes payable for gains on businesses sold in 1999 and increased expenditures related to the integration of Aeroquip-Vickers. 57 Page 57 Net working capital was $464 million at the end of 2000 with a current ratio of 1.2. The primary cause of the increase in working capital was the $413 million net reduction of short-term debt and current portion of long-term debt. This reduction reflected the reclassification of $400 million of short-term debt to long-term debt, the result of a new $400 million long-term credit facility entered into during 2000. Total debt was $3.004 billion at the end of 2000, up $119 million from $2.885 billion at the end of 1999. The increase reflected the use of $417 million of cash in 2000 to repurchase Common Shares, offset by a $300 million dividend received from Axcelis. Axcelis paid the dividend to Eaton using proceeds received from the initial public offering of its common stock in July 2000 and other cash resources available to it. In March 2000, Eaton sold Euro 200 million of 6% notes due 2007 and in August 2000, issued $100 million of 7.05% medium-term notes due 2002. Net proceeds from the sale of the notes were used to refinance outstanding commercial paper and short-term notes. As discussed under "Debt and Other Financial Instruments" in the Financial Review, the Company's domestic multi-year credit facilities were $900 million at the end of 2000, of which $500 million expires in 2003 and $400 million expires in 2005. These credit facilities support outstanding commercial paper of $1.275 billion at the end of 2000 of which $900 million was classified as long-term debt, up from $500 million at the end of 1999 because of the new $400 million facility entered into in 2000. Cash dividends paid in 2000 were $127 million and represented 27.9% of net income. Annual per share dividends of $1.76 in 2000 were consistent with 1999. Eaton has paid dividends on Common Shares annually since 1923. In January 2000, to avoid the dilution of earnings per share resulting from the exercise of stock options, Eaton's Board of Directors authorized the purchase of up to $500 million of Common Shares over a five-year period. This authorization replaced the expiring five million share repurchase program authorized in 1994. In July 2000, the Board of Directors authorized the repurchase of an additional $500 million of Common Shares. The Company intended to purchase these shares in the open market and, market conditions permitting, expected to complete these repurchases by year-end 2000. In light of softening general economic conditions, and in order to strengthen its balance sheet, in January 2001, Eaton announced that it was suspending purchases under the July program. During 2000, under both programs described above, 6 million shares were repurchased for $417 million. 58 Page 58 Emphasis continues to be focused on the ongoing physical capital investment program designed to enhance product quality, manufacturing productivity and business growth, reduce costs and, selectively, to add capacity. Capital expenditures for 2000 were $386 million. Capital spending in 2001 is expected to continue at the level reached in 2000. Goodwill and other intangible assets totaled $2.582 billion at the end of 2000 and represented 32% of total assets. The majority of these assets resulted from the $1.1 billion acquisition in 1994 of the electrical distribution and controls business unit of Westinghouse, and the $1.6 billion acquisition in 1999 of Aeroquip-Vickers. Goodwill for these businesses is amortized over 40 years since these businesses have a long history of operating success and profitability, which Eaton expects to continue. Each business holds a significant market position in the majority of their product lines and their products are well accepted by customers, which should continue in the future. These products are not subject to rapid technological or functional obsolescence, which should result in continuous strong demand for products for many years. The integration of these businesses and product lines into Eaton has created permanent value through the streamlining of product lines, manufacturing capacity and organization structure. This should enable the combined businesses to obtain synergy of complementary product offerings, operations and technical expertise for many years to come. The Company records deferred income tax assets and liabilities for the differences between the financial accounting and income tax basis of assets and liabilities. Recorded deferred income tax assets and liabilities are described in detail under "Income Taxes" in the Financial Review. Deferred tax assets are expected to be realized through the reduction of future taxable income. Significant factors considered by management in the determination of the probability of realization of deferred tax assets include historical operating results, expectations of future earnings and taxable income and the extended period of time over which the postretirement health care liability will be paid. Eaton is subject to various inherent financial risks attributable to operating in a global economy. Systems to measure and assure that these exposures are comprehensively evaluated have been developed so that appropriate and timely action can be taken to reduce risk, if necessary. Monitoring of exposures and the evaluation of risks includes approval of derivative activities on a discrete basis by senior management. Management performs a monthly oversight review of exposures and derivative activities. Derivative financial instruments are utilized to manage exposures in both the interest and foreign exchange markets. The counterparties used in these transactions 59 Page 59 have been diversified in order to minimize the impact of any potential credit loss in the event of nonperformance by the counterparties. Although derivatives are an integral part of risk management programs, their incremental effect on financial condition and results of operations is not material. Derivative activities are described in greater detail under "Debt and Other Financial Instruments" in the Financial Review. Operations of the Company involve the use and disposal of certain substances regulated under environmental protection laws. On an ongoing, regular basis, certain processes continue to be modified in order to reduce the impact on the environment, including the reduction or elimination of certain chemicals used in and wastes generated from operations. Liabilities related to environmental matters are further discussed under "Protection of the Environment" in the Financial Review. 1999 Compared to 1998 - Continuing Operations - --------------------------------------------- 1999 proved to be a very eventful and significant year with Eaton reporting record sales, net income and net income per Common Share. While the most significant contribution to the increase in sales was the addition of Aeroquip-Vickers, increases were registered by all businesses. Each of Eaton's four business segments, Automotive, Fluid Power, Industrial and Commercial Controls, and Truck, reported record sales in 1999. On April 9, 1999, Eaton acquired Aeroquip-Vickers, Inc., the largest acquisition in the Company's history. Aeroquip-Vickers had 1998 sales of $2.1 billion. This significant acquisition, as discussed under "Acquisitions of Businesses" in the Financial Review, built upon and extended Eaton's already strong position in mobile and industrial hydraulics. Aeroquip-Vickers is a global leader in industrial hydraulics that fundamentally complements Eaton's existing strengths in mobile hydraulics to position the combined business as a world leader in serving both mobile and industrial hydraulics customers. Aeroquip-Vickers also complements Eaton's existing global hydraulics market strengths with a significant complementary product line contribution of hoses and couplings that serve mobile, industrial, aerospace and automotive customers. Together, Eaton and Aeroquip-Vickers created an aerospace and hydraulics business and a systems capability across all hydraulics applications. Results of Operations - --------------------- Worldwide sales of continuing operations reached a record $8.005 billion in 1999, 26% ahead of 1998. The increase in sales in 1999 was primarily attributable to the acquisition of Aeroquip-Vickers. Sales in the United States and Canada 60 Page 60 increased 28% to $6.482 billion and rose 54% in Europe to $1.294 billion. In Latin America, sales decreased 11% to $365 million as this region continued to struggle with economic weaknesses in Mexico, Brazil, and Argentina. Sales in the Pacific Region increased 73% in 1999 to $213 million, reflecting a partial recovery from the economic crisis that occurred in Asia in 1998. As displayed in the Statement of Consolidated Income, continuing operations reported Income from Operations of $703 million in 1999, an increase of 16% over 1998. Income from continuing operations, including the gain on sales of businesses and restructuring charges, of $603 million in 1999 increased 40% from 1998 and 1999 earnings per share were $8.17, 38% above 1998. The improved performance in 1999 was primarily the result of the acquisition of Aeroquip-Vickers, robust conditions in the Truck, Automotive, and Industrial and Commercial Controls markets, and the benefits of 1998's restructuring actions. Although conditions in the Fluid Power business remained very weak, excellent progress was made in the integration of Aeroquip-Vickers. During 1999, the Aeroquip and Vickers businesses added about $.27 to earnings per share before unusual charges. In 1999, the divestitures of the Engineered Fasteners and Fluid Power divisions resulted in the recognition of a pretax gain of $340 million ($198 million after-tax, or $2.68 per Common Share). The Engineered Fasteners and Fluid Power divisions had 1998 sales of $94 million and $189 million, respectively. Unusual charges of $30 million were recorded in 1999 ($20 million after-tax, or $.27 per share). These charges were associated with the integration of Aeroquip-Vickers and the restructuring of certain European operations in the Truck segment. In 1998, a pretax gain of $43 million ($28 million after-tax, or $.38 per Common Share) was recognized related to business divestitures, net of adjustments related to businesses sold in prior periods. During 1998, unusual pretax charges of $68 million were recorded ($44 million after-tax, or $.61 per share), which included $58 million to restructure operations within certain business segments and $10 million for a contribution to Eaton's charitable trust. The restructuring charges principally related to workforce reductions, inventory and other asset write-downs, plant closing and other costs. 61 Page 61 Business Segments - ----------------- Automotive - ---------- The Automotive segment achieved record sales of $1.857 billion in 1999, 7% above 1998. This increase compared to increases of 9% in North American light vehicle production and 2% in European output and a 20% decrease in South American output. This above-market performance was attributable to penetration gains across certain product lines. Operating profit reached a record $236 million, an increase of 19% over 1998. This record performance was primarily due to increased sales and benefits of 1998's restructuring initiatives. Before restructuring charges of $12 million in 1998, operating profit in 1999 was 12% ahead of 1998. Fluid Power - ----------- The Fluid Power segment achieved record sales of $2.036 billion in 1999, well above 1998 sales of $681 million. The increase in sales was primarily due to the acquisition of Aeroquip-Vickers. Aeroquip's fluid conveyance business also finished 1999 on a strong note. Operating profits reached a record $177 million in 1999, an increase of 51% from 1998. During 1999, operating profits were reduced by charges of $21 million related to the integration of Aeroquip-Vickers. Before unusual charges in both years, operating profit in 1999 was 68% ahead of 1998. Industrial & Commercial Controls - -------------------------------- Sales of Industrial and Commercial Controls reached a record $2.274 billion in 1999, 6% ahead of 1998 and exceeding the 3% rise in the North American market for electrical distribution equipment and industrial controls. Sales growth was attributable to strong residential and commercial construction markets, new multi-product "solutions" packaging, and a sharp increase in shipments in the Navy Controls business. The new Engineering Services business unit whose sales nearly tripled from the previous year boosted results in 1999. Operating profits of $181 million in 1999 were also a record, 29% above 1998. This increase was the result of increased sales and benefits of 1998's restructuring initiatives partially offset by the costs of building the new Engineering Services business unit. Before 1998 restructuring charges of $28 million, operating profit in 1999 was 8% ahead 1998. Truck - ----- Truck segment sales in 1999 reached a record $1.630 billion, increasing 10% over 1998. This sales growth compared with a 62 Page 62 20% rise in NAFTA class 8 factory sales, flat European commercial truck production, and a decline of 25% in South American truck output. The Company took advantage of boom conditions in North American truck markets and worked hard to meet the challenge of surging demand. Operating profits reached a record of $235 million in 1999, 17% ahead of 1998. Before restructuring charges in both years, operating profits were 11% ahead of last year. These improved results were primarily due to increased sales offset by operating inefficiencies stemming from unprecedented demand. In 1999, a restructuring charge of $7 million was recorded related to the announced closure of the Aycliffe, United Kingdom medium-duty transmission plant. This closure was a part of 1998's $150 million cost-out program. Non-operating Income (Expense) - ----------------------------- Amortization of goodwill and other intangible assets of $89 million in 1999 increased by $31 million over 1998. This increase was largely attributable to the acquisition of Aeroquip-Vickers. Net interest expense of $152 million in 1999 increased by $64 million over 1998. The increase was primarily due to borrowings required to finance the acquisition of Aeroquip-Vickers. As previously discussed, a gain on the sales of businesses of $340 million was recorded in 1999 compared to $43 million in 1998. Corporate and other expenses of $29 million in 1999 increased by $43 million over 1998. The year-to-year change was related primarily to incentive compensation and deferred compensation accruals. A $24 million increase in incentive compensation accruals related to the record performance in 1999 compared to the disappointing operating results experienced in 1998, resulting in higher compensation expense. A $19 million increase in deferred compensation accruals was due to an increase in the stock price during 1999 from the year-end level of 1998, which drove an increase in the accrual in 1999. Market Risk Disclosure - ---------------------- Eaton is subject to interest rate risk as it relates to long-term debt. The table below presents principal cash flows (in millions) and related weighted-average interest rates by expected maturity dates of long-term debt, excluding foreign currency principal swaps and immaterial long-term debt of certain international operations. 63 Page 63 December 31, 2000 Expected maturity date ------------------------------------------------ 2001 2002 2003 2004 2005 Thereafter Total Fair value ---- ---- ---- ---- ---- ---------- ------ ------ Long-term debt, including current portion Fixed rate (US$) $100 $126 $253 $ 15 $1,135 $1,629 $1,693 Average interest rate 9.0% 7.0% 6.9% 6.4% 7.4% 6.9% Commercial paper (US$) $500 400 900 900 Average interest rate 6.4% 6.4% 6.4% December 31, 1999 Expected maturity date ------------------------------------------------ 2000 2001 2002 2003 2004 Thereafter Total Fair value ---- ---- ---- ---- ---- ---------- ------ ------ Long-term debt, including current portion Fixed rate (US$) $ 10 $102 $ 27 $254 $1,008 $1,401 $1,443 Average interest rate 12.5% 9.0% 6.6% 6.9% 7.6% 7.5% Commercial paper (US$) $500 500 500 Average interest rate 6.1% 6.1% See "Changes in Financial Condition" in Management's Discussion and Analysis of Financial Condition and Results of Operations for details on the Company's primary market risks, and the objectives and strategies used to manage these risks. Also, see "Financial Instruments" under Accounting Policies in the Financial Review for additional information on market risks. Euro - ---- On January 1, 1999, eleven of the fifteen member countries of the European Union (EU) began a three-year transition phase during which the Euro was adopted as their common legal currency. The Euro is traded on currency exchanges and is 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 64 Page 64 and the Euro were fixed on January 1, 1999. The legacy currencies will remain legal tender for cash transactions between January 1, 1999 and June 30, 2002 by which date all legacy currencies will have been 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 have adopted the Euro as the legal currency of the country. These operations and operations in other European countries and elsewhere in the world are conducting business transactions with customers and suppliers denominated in the Euro. Euro denominated bank accounts have been established to accommodate Euro transactions. Exposure to changes in European foreign exchange rates has reduced as a result of the Euro conversion. The Company has established a steering committee to review strategic and tactical areas arising from the Euro conversion. Their efforts focused on those aspects of the Euro conversion required to conduct Euro-denominated business transactions beginning in 1999. Those aspects included transacting business in the Euro, the competitive impact on product pricing and adjustments to billing systems to handle parallel currencies. Systems are in place which are capable of transacting business in Euro's during the transitional period until December 31, 2001. Continuing analysis and development efforts by the steering committee and project teams at the business units continue to ensure that the full implementation, systems upgrades, policy and procedural changes for Euro functionality are adopted in line with the timetable and regulations established by the EU by January 1, 2002. 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. Forward-Looking Statements - -------------------------- This Annual Report to Shareholders contains forward-looking statements concerning earnings per share in 2001, the sale of its Vehicle Switch/Electronics Division, sales volume and profits in the Fluid Power segment, volume growth in the Industrial & Commercial Controls segment, expected restructuring charge, recurring annual savings from restructuring and future prospects for the Truck segment, the Company's capital spending in 2001, synergy related to the integration of Aeroquip-Vickers Inc., an agreement to supply medium-duty truck transmission components to Daimler Chrysler AG in Brazil and the realization of tax assets through the reduction of future taxable income. These statements are subject to various risks and uncertainties, many of which are 65 Page 65 outside the Company's control. The following factors could cause actual results to differ materially from those in the forward-looking statements: difficulties in negotiating the sale of the Vehicle Switch/Electronics Division, unanticipated costs or impediments in implementing the restructuring of the Truck business and the operations of that business thereafter, unanticipated changes in the heavy- and medium-duty truck markets, the fluid power markets or the industrial and commercial controls markets, a significant downturn in the economy or in business relationships with customers or unanticipated reductions in their purchases from the Company, competitive pressure on sales and pricing, increases in the cost of material and other production costs that cannot be recouped in product pricing and deterioration of economic conditions in the United States and around the world. Eaton does not assume any obligation to update these forward-looking statements. 66 Page 66 Quarterly Data - -------------- (Unaudited)
Quarter ended 2000 Quarter ended 1999 (Millions except for per share data) -------------------------------------- -------------------------------------- Dec. 31 Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31 ------- -------- ------- ------- ------- -------- ------- ------- Continuing operations Net sales $1,948 $2,008 $2,169 $2,184 $2,081 $2,118 $2,202 $1,604 Gross margin 493 516 605 603 549 575 618 471 Percent of sales 25% 26% 28% 28% 26% 27% 28% 29% Income before income taxes 85 105 186 176 354 274 177 138 Income after income taxes $ 58 $ 69 $ 123 $ 113 $ 215 $ 175 $ 118 $ 95 Income (loss) from discontinued operations 26 24 22 18 9 9 7 (11) ------ ------ ------ ------ ------ ------ ------ ------ Net income $ 84 $ 93 $ 145 $ 131 $ 224 $ 184 $ 125 $ 84 ====== ====== ====== ====== ====== ====== ====== ====== Net income per Common Share - assuming dilution Continuing operations $ .83 $ .95 $ 1.66 $ 1.52 $ 2.86 $ 2.34 $ 1.62 $ 1.32 Discontinued operations .37 .33 .30 .25 .12 .12 .09 (.15) ------ ------ ------ ------ ------ ------ ------ ------ $ 1.20 $ 1.28 $ 1.96 $ 1.77 $ 2.98 $ 2.46 $ 1.71 $ 1.17 ====== ====== ====== ====== ====== ====== ====== ====== Net income per Common Share - basic Continuing operations $ .84 $ .96 $ 1.69 $ 1.55 $ 2.91 $ 2.39 $ 1.65 $ 1.33 Discontinued operations .37 .33 .30 .25 .13 .13 .09 (.15) ------ ------ ------ ------ ------ ------ ------ ------ $ 1.21 $ 1.29 $ 1.99 $ 1.80 $ 3.04 $ 2.52 $ 1.74 $ 1.18 ====== ====== ====== ====== ====== ====== ====== ====== Cash dividends paid per Common Share $ .44 $ .44 $ .44 $ .44 $ .44 $ .44 $ .44 $ .44 Market price per Common Share High $76.31 $73.81 $86.56 $81.44 $89.13 $103.50 $94.69 $ 74 Low 57.50 58.94 66.25 60.13 67.50 85.38 71.69 62
67 Page 67 Reconciliation of income from continuing operations to operating earnings of continuing operations follows: Income from continuing operations $ 58 $ 69 $ 123 $ 113 $ 215 $ 175 $ 118 $ 95 Excluding (after-tax) Unusual charges 14 8 7 5 12 5 2 Gain of sales of businesses (117) (81) Gain on sales of corporate assets (7) (7) ------ ------ ------ ------ ------ ------ ------ ------ Operating earnings from continuing operations $ 72 $ 77 $ 123 $ 111 $ 110 $ 99 $ 120 $ 95 ====== ====== ====== ====== ====== ====== ====== ====== Income from continuing operations per Common Share - assuming dilution $ .83 $ .95 $ 1.66 $ 1.52 $ 2.86 $ 2.34 $ 1.62 $ 1.32 Per share impact of unusual items .20 .12 (.01) (.02) (1.39) (1.01) .03 ------ ------ ------ ------ ------ ------ ------ ------ Operating earnings per Common Share Continuing operations 1.03 1.07 1.65 1.50 1.47 1.33 1.65 1.32 Discontinued operations .37 .33 .30 .25 .12 .12 .09 (.15) ------ ------ ------ ------ ------ ------ ------ ------ $ 1.40 $ 1.40 $ 1.95 $ 1.75 $ 1.59 1.45 $ 1.74 $ 1.17 ====== ====== ====== ====== ====== ====== ====== ====== Cash operating earnings per Common Share Continuing operations $ 1.31 $ 1.34 $ 1.92 $ 1.77 $ 1.72 $ 1.61 $ 1.94 $ 1.48 Discontinued operations .40 .35 .33 .28 .15 .15 .12 (.13) ------ ------ ------ ------ ------ ------ ------ ------ $ 1.71 $ 1.69 $ 2.25 $ 2.05 $ 1.87 $ 1.76 $ 2.06 $ 1.35 ====== ====== ====== ====== ====== ====== ====== ======
Cash earnings per Common Share represent income per Common Share excluding unusual items, before amortization expense for goodwill and other intangible assets. 68 Page 68 Eaton Corporation Five-Year Consolidated Financial Summary
For the year 2000 1999 1998 1997 1996 - -------------------------------------------------------------------------------------------------------- (Millions except for per share data) Continuing operations Net sales $8,309 $8,005 $6,358 $7,104 $6,515 Income before income taxes 552 943 616 730 428 Income after income taxes $ 363 $ 603 $ 430 $ 526 $ 305 Percent of net sales 4.4% 7.5% 6.7% 7.4% 4.7% Extraordinary item - redemption of debentures (54) Income(loss) from discontinued operations 90 14 (81) (62) 44 ------ ------ ------ ------ ------ Net income $ 453 $ 617 $ 349 $ 410 $ 349 ====== ====== ====== ====== ====== Net income per Common Share - assuming dilution Continuing operations $ 5.00 $ 8.17 $ 5.91 $ 6.72 $ 3.89 Extraordinary item (.69) Discontinued operations 1.24 .19 (1.11) (.79) .57 ------ ------ ------ ------ ------ $ 6.24 $ 8.36 $ 4.80 $ 5.24 $ 4.46 ====== ====== ====== ====== ====== Average number of Common Shares outstanding 72.6 73.7 72.7 78.2 78.2 Net income per Common Share - basic Continuing operations $ 5.06 $ 8.31 $ 6.02 $ 6.85 $ 3.93 Extraordinary item (.71) Discontinued operations 1.25 .20 (1.13) (.80) .57 ------ ------ ------ ------ ------ $ 6.31 $ 8.51 $ 4.89 $ 5.34 $ 4.50 ====== ====== ====== ====== ====== Average number of Common Shares outstanding 71.8 72.5 71.4 76.8 77.4 Cash dividends paid per Common Share $ 1.76 $ 1.76 $ 1.76 $ 1.72 $ 1.60
69 Page 69 Market price per Common Share High $ 86.56 $103.50 $ 99.63 $103.38 $ 70.88 Low 57.50 62 57.50 67.25 50.38 At the year-end - ----------------------------------------------------------------------------------------------------- Total assets $8,180 $8,342 $5,570 $5,497 $5,290 Long-term debt 2,447 1,915 1,191 1,272 1,062 Total debt 3,004 2,885 1,524 1,376 1,092 Shareholders' equity 2,410 2,624 2,057 2,071 2,160 Shareholders' equity per Common Share $35.29 $35.44 $28.69 $27.72 $28.00 Common Shares outstanding 68.3 74.0 71.7 74.7 77.1 - ----------------------------------------------------------------------------------------------------- For the year - ----------------------------------------------------------------------------------------------------- Reconciliation of income from continuing operations to operating earnings of continuing operations follows: Income from continuing operations $ 363 $ 603 $ 430 $ 472 $ 305 Excluding (after-tax) Unusual charges 34 20 44 69 31 Gain of sales of businesses (198) (28) (69) Gain on sales of corporate assets (14) ------ ------ ------ ------ ------ Operating earnings from continuing operations $ 383 $ 425 $ 446 $ 472 $ 336 ====== ====== ====== ====== ====== Income from continuing operations per Common Share - assuming dilution $ 5.00 $ 8.17 $ 5.91 $ 6.03 $ 3.89 Per share impact of unusual items .28 (2.41) .23 .40 ------ ------ ------ ------ ------ Operating earnings per Common Share Continuing operations 5.28 5.76 6.14 6.03 4.29 Discontinued operations 1.24 .19 (.73) .30 .58 ------ ------ ------ ------ ------ $ 6.52 $ 5.95 $ 5.41 $ 6.33 $ 4.87 ====== ====== ====== ====== ======
70 Cash earnings per Common Share excluding unusual items - assuming dilution Continuing operations $ 6.37 $ 6.74 $ 6.75 $ 6.55 $ 4.77 Discontinued operations 1.35 .30 (.63) .31 .58 ------ ------ ------ ------ ------ $ 7.72 $ 7.04 $ 6.12 $ 6.86 $ 5.35 ====== ====== ====== ====== ======
Cash earnings per Common Share represent income per Common Share excluding unusual items, before amortization expense for goodwill and other intangible assets. 71 Page 70 Eaton Corporation 2000 Annual Report on Form 10-K Item 14(c) Exhibit 10(a) Deferred Incentive Compensation Plan (amended and restated as of March 31, 2000) I. PURPOSE ------- The purpose of the Deferred Incentive Compensation Plan is to promote the greater success of Eaton Corporation and its subsidiaries by providing a means to defer Incentive Compensation for key employees whose level and nature of position enable them to affect significantly the profitability, competitiveness and growth of Eaton. II. CONCEPT ------- The Plan is based on the concept that the deferral of Incentive Compensation for later payment to a Participant, including the later payment during Retirement, will provide a benefit to each Participant and an incentive to improve the profitability, competitiveness and growth of Eaton. III. DEFINITIONS ----------- Unless otherwise required by the context, the terms used herein shall have the meanings as set forth below: ACCOUNT: The account established by Eaton for each Participant to which may be credited his or her Deferred Incentive Compensation, Dividend Equivalents, Treasury Bill Interest Equivalents and Fixed Rate Interest Equivalents. BENEFICIARY: The person or entity (including a trust or the estate of the Participant) designated in a written document executed by the Participant and delivered to the Committee. If at the time when any unpaid balance of Deferred Incentive Compensation shall be or become due at or after the death of a Participant, there shall not be any living person or any entity in existence so designated, the term "Beneficiary" shall mean the Participant's estate. BOARD: The Board of Directors of Eaton. CAUSE: For the purposes of this Plan, Eaton shall have "Cause" to terminate the Participant's employment hereunder upon (i) the willful and continued failure by the Participant to substantially perform the Participant's duties with Eaton (other than any such failure resulting 72 Page 71 from the Participant's incapacity due to physical or mental illness), after a demand for substantial performance is delivered to the Participant by the Board which specifically identifies the manner in which the Board believes that the Participant has not substantially performed the Participant's duties, or (ii) the willful engaging by the Participant in gross misconduct materially and demonstrably injurious to Eaton. For purposes of this definition, no act, or failure to act, on the Participant's part shall be considered "willful" unless done, or omitted to be done, by the Participant not in good faith and without reasonable belief that the Participant's action or omission was in the best interest of Eaton. Notwithstanding the foregoing, the Participant's employment shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to the Participant a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice to the Participant and an opportunity for the Participant, together with the Participant's counsel, to be heard before the Board), finding that in the good faith opinion of the Board the Participant was guilty of conduct set forth above in clauses (i) or (ii) of this definition and specifying the particulars thereof in detail. CHANGE IN CONTROL OF EATON: For purposes of this Plan, a "Change in Control of Eaton" shall be deemed to have occurred if (i) a tender offer shall be made and consummated for the ownership of securities of Eaton representing 25% or more of the combined voting power of Eaton's then outstanding voting securities, (ii) Eaton shall be merged or consolidated with another corporation and as a result of such merger or consolidation less than 75% of the outstanding voting securities of the surviving or resulting corporation shall be owned in the aggregate by the former shareholders of Eaton, other than affiliates (within the meaning of the Securities Exchange Act of 1934 (the "Exchange Act")) of any party to such merger or consolidation, as the same shall have existed immediately prior to such merger or consolidation, (iii) Eaton shall sell substantially all of its assets to another corporation which is not a wholly owned subsidiary of Eaton, (iv) any "person" (as such term is used in Sections 3(a)(9) and 13(d)(3) of the Exchange Act) is or becomes the beneficial owner, directly or indirectly, of securities of Eaton representing 25% or more of the combined voting power of Eaton's then outstanding securities; or (v) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board cease for any reason to constitute at least a majority thereof unless the 73 Page 72 election, or the nomination for election by Eaton's shareholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were Directors at the beginning of the period. For purposes of this Plan, ownership of voting securities shall take into account and include ownership as determined by applying the provisions of Rule 13d-3(d)(1)(i) of the Exchange Act (as then in effect). COMMITTEE: The Corporate Compensation Committee of Management of Eaton. COMPENSATION COMMITTEE OF THE BOARD: The Compensation Committee of the Board of Directors of Eaton. CONTINGENT SHARE UNITS: Units credited to a Participant's Account which are equivalent in value to the market value of Eaton Common Shares. DEFERRAL PLANS: Shall mean the Incentive Compensation Deferral Plan, the Strategic Incentive and Option Plan and this Plan. DEFERRED INCENTIVE COMPENSATION: That portion of Incentive Compensation which has been deferred pursuant to the Plan and any Dividend Equivalents, Treasury Bill Interest Equivalents, Fixed Rate Interest Equivalents and Contingent Share Units which are attributable thereto. DEFERRED INCENTIVE COMPENSATION AGREEMENT: The written agreement between Eaton and a Participant pursuant to which Incentive Compensation is deferred under the Plan. DISABILITY: If, as a result of the Participant's incapacity due to physical or mental illness, the Participant shall have been absent from the Participant's duties with Eaton on a full-time basis for 180 consecutive business days and within thirty (30) days after written Notice of Termination the Participant shall not have returned to the full-time performance of the Participant's duties, any termination of the Participant's employment by Eaton shall be for "Disability." DIVIDEND EQUIVALENT: An amount equal to the per share dividends paid on Eaton Common Shares. EATON: Eaton Corporation, an Ohio corporation, and its subsidiaries and successors and assigns. EATON COMMON SHARES: The common shares of Eaton. 74 Page 73 EXECUTIVE INCENTIVE COMPENSATION PLAN: An incentive compensation plan approved (a) by the Board of Directors of Eaton for participation in this Plan and whose participants are designated by the Committee on an annual basis or (b) by the Management Compensation Committee (comprised solely of officers of the Company) and whose participants do not include any officers of the Company. FAILURE TO PAY: Shall mean that the circumstances described in either (i) or (ii) have occurred: (i) Any Participant shall have notified Eaton and the Trustee in writing that Eaton shall have failed to pay to the Participant, when due, either directly or by direction to the trustee of any trust holding assets for the payment of benefits pursuant to the Plan, at least 75% of any and all amounts which the Participant was entitled to receive at any time in accordance with the terms of the Plan, and that such amounts remain unpaid. Such notice must set forth the amount, if any, which was paid to the Participant, and the amount which the Participant believes he or she was entitled to receive under the Plan. The failure to make such payment shall have continued for a period of 30 days after receipt of such notice by Eaton, and during such 30-day period Eaton shall have failed to prove, by clear and convincing evidence as determined by the Trustee in its sole and absolute discretion, that such amount was in fact paid or was not due and payable; or (ii) More than two Plan Participants shall have notified Eaton and the Trustee in writing that they have not been paid when due, either directly or by direction to the Trustee, amounts to which they are entitled under the Plan and that such amounts remain unpaid. Each such notice must set forth the amount, if any, which was paid to the Participant, and the amount which the Participant believes he or she was entitled to receive under the Plan. Within 15 days after receipt of each such notice, the Trustee shall determine, on a preliminary basis, whether any failure to pay such Participants has resulted in a failure to pay when due, directly or by direction, at least 75% of the aggregate amount due to all Participants under all the Deferral Plans in any two-year period, and that such amounts remain unpaid. If the Trustee determines that such a failure has occurred, then it shall so notify Eaton and the Participants in writing within the same 15 day period. Within a period of 20 days after receipt of such notice from the Trustee, Eaton shall have failed to prove by clear and convincing evidence, in the sole and 75 Page 74 absolute discretion of the Trustee, that such amount was paid or was not due and payable. FIXED RATE INTEREST EQUIVALENT: With respect to any Participant, the rate of interest as specified in the Deferred Incentive Compensation Agreement between such Participant and Eaton. FUNDED AMOUNT: With respect to the Account of any Participant, the value of any assets which have been placed in a grantor trust established by the Company to pay benefits with respect to that Plan Account, as determined at the time initial payments are to be made pursuant to the selections made by the Participants in accordance with Section 9.03. GOOD REASON: For purposes of this Plan, any Termination of Employment by a Participant under the following circumstances shall be for "Good Reason": (i) without the Participant's express written consent, the assignment to the Participant of any duties inconsistent with the Participant's positions, duties, responsibilities and status with Eaton immediately prior to a Change in Control of Eaton, or a change in the Participant's reporting responsibilities, titles or offices as in effect immediately prior to a Change in Control of Eaton, or any removal of the Participant from or any failure to re-elect the Participant to any of such positions, except in connection with the termination of the Participant's employment for Cause, Disability or as a result of the Participant's death; (ii) a reduction by Eaton in the Participant's base salary as in effect immediately prior to the Change in Control of Eaton or as the same may be increased from time to time; or the failure by Eaton to increase such base salary each year after a Change in Control of Eaton by an amount which at least equals, on a percentage basis, the average annual percentage merit increase in the Participant's base salary during the five (5) full calendar years immediately preceding a Change in Control of Eaton; (iii) a failure by Eaton to continue the Participant's participation in Eaton's Executive Incentive Compensation Plan (the "I.C. Plan"), Deferred Incentive Compensation Plan (the "Deferred I.C. Plan"), Limited Eaton Service Supplemental Retirement Income Plan (the "Limited Service Plan"), the Executive Strategic Incentive Plan (the "ESIP Plan") and the Supplemental 76 Page 75 Benefit Plan established by the Board as a result of the limitations on pension benefits imposed by Section 415 of the Internal Revenue Code (the "Supplemental Plan"), as each plan may be modified from time to time but substantially in the form presently in effect, on at least the basis as in effect immediately prior to the Change in Control of Eaton or to pay the Participant any amounts earned under such plans in accordance with the terms of such plans. (iv) the relocation of Eaton's principal executive offices to a location outside Cuyahoga County, Ohio or any county adjoining Cuyahoga County, Ohio, or Eaton's requiring the Participant to be based anywhere other than Eaton's principal executive offices or the location where the Participant is based immediately prior to the Change in Control of Eaton except for required travel on Eaton's business to an extent substantially consistent with the Participant's business travel obligations in effect immediately prior to the Change in Control of Eaton, or, in the event the Participant consents to any such relocation of Eaton's principal executive offices, the failure by Eaton to pay (or reimburse the Participant for) all reasonable moving expenses incurred by the Participant relating to a change of the Participant's principal residence in connection with such relocation and to indemnify the Participant against any loss (defined as the difference between the actual sale price of such residence and the higher of (a) the Participant's aggregate investment in such residence or (b) the fair market value of such residence as determined by any real estate appraiser designated by the Participant and reasonably satisfactory to Eaton) realized in the sale of the Participant's principal residence in connection with any such change of residence; (v) the failure by Eaton to continue to effect any benefit or compensation plan (including but not limited to the plans described under paragraph (p)(iii) above), pension plan, life insurance plan, health and accident plan or disability plan in which the Participant is participating at the time of a Change in Control of Eaton (or plans providing the Participant with substantially similar benefits), the taking of any action by Eaton which would adversely affect the Participant's participation in or materially reduce the Participant's benefits under any of such plans or deprive the Participant of any material fringe or personal benefit enjoyed by the Participant at the time of the Change in Control of Eaton, or the failure by 77 Page 76 Eaton to provide the Participant with the number of paid vacation days to which the Participant is then entitled on the basis of years of service with Eaton in accordance with Eaton's normal vacation policy in effect immediately prior to the Change in Control of Eaton; (vi) the failure of Eaton to obtain the assumption of this Plan by any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the assets of Eaton, by agreement in form and substance satisfactory to the Participant, to expressly assume this Plan and the obligations of Eaton hereunder; or (vii) any purported termination of the Participant's employment which is not effected pursuant to a Notice of Termination satisfying the requirements of a Notice of Termination as herein defined (and, if applicable, the definition of "Cause" as herein defined); and for purposes of this Plan, no such purported termination shall be effective. INCENTIVE COMPENSATION: The full amount of the annual Incentive Compensation awarded to a Participant under the Executive Incentive Compensation Plan. INCENTIVE YEAR: An incentive year as defined under the provisions of the Executive Incentive Compensation Plan. LUMP SUM PAYMENT: Means an amount (payable in cash or Eaton Common Shares, or a combination thereof) equal to the total of the following amounts calculated as of the date of the payment: (i) The amount, if any, of the Participant's Periodic Compensation then credited to his Account and accrued and unpaid Treasury Bill Interest Equivalents thereon; plus (ii) The amount, if any, of the Participant's unpaid Type A Retirement Compensation calculated in accordance with Section 6.04 of the Plan and assuming for purposes of the conversion calculation that a Change in Control of Eaton has occurred within the relevant time period so that Section 6.04(b) is applicable; plus (iii) The amount, if any, payable as a lump sum in relation to Type B Retirement Compensation, calculated in accordance with Section 6.10(a)(ii) of the Plan, assuming that the Type B Retirement Compensation would be credited with Fixed 78 Page 77 Rate Interest Equivalents from the date of the Lump Sum Payment until paid over the fifteen-year period following the date of such Lump Sum Payment. In the event that a Participant or a Participant's Designated Beneficiary has begun to receive benefit installment payments under the Plan prior to the date of the Lump Sum Payment, the amount of such Lump Sum shall be equal to the present value of the remaining annual payments which otherwise would have been made calculated as described in this Section. MEAN PRICE: The mean between the highest and lowest quoted selling price of an Eaton Common Share on the New York Stock Exchange List of Composite Transactions. NORMAL RETIREMENT DATE: The date a Participant attains age sixty-five (65). NOTICE OF TERMINATION: Any termination of the Participant's employment by Eaton for Cause or Disability or by the Participant for Good Reason shall be communicated by written Notice of Termination to the Participant or Eaton, respectively. For purposes of this Plan, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Plan relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Participant's employment under the provision so indicated. PARTICIPANT: An employee of Eaton in a key position receiving benefits under the Executive Incentive Compensation Plan and participating under the Plan. PERIODIC COMPENSATION: That portion of a Participant's Incentive Compensation which is deferred under the Plan for payment over a period of five (5) years. PERIODIC INSTALLMENTS: Equal monthly, quarterly, semiannual or annual payments, over a period not to exceed 15 years, as determined by the Committee in its sole discretion. PLAN: The Deferred Incentive Compensation Plan pursuant to which all or a portion of Incentive Compensation may be deferred for later payment to a participant, as amended and restated as of January 1, 1989, and as subsequently amended on March 31, 2000 to provide for distributions of Type A Retirement Compensation first commencing after March 31, 2000 shall be made in Eaton Common Shares (except as otherwise provided in Section 6.04). 79 Page 78 RETIREMENT: The Termination of Employment of a Participant who is age fifty-five (55) or older and who has at least ten (10) years of service with Eaton or who is age sixty-five (65) or older or under circumstances making him eligible to receive pension payments under a pension plan sponsored by Eaton commencing within sixty (60) days of the date of such Termination of Employment. RETIREMENT COMPENSATION: That portion of Incentive Compensation deferred under the Plan for payment to a Participant upon his or her Retirement which either shall be Type A Retirement Compensation or Type B Retirement Compensation as selected by the Participant in accordance with Section 4.01. TERMINATION AND CHANGE IN CONTROL: Shall mean the termination of the employment of a Participant for any reason whatsoever prior to a Change in Control, upon a subsequent Change in Control or termination of the employment of a Participant for any reason whatsoever during the three-year period immediately following a Change in Control. TERMINATION OF EMPLOYMENT: The time when a Participant shall no longer be employed by Eaton whether by reason of Retirement, death, voluntary resignation (with or without Good Reason), divestiture or closing of a business unit, plant or facility, discharge (with or without Cause), or such disability that, under the then current employment practices of Eaton, the employment of the Participant is deemed to have been terminated. TREASURY BILL INTEREST EQUIVALENT: A rate of interest equal to the quarterly average yield of 13-week U.S. Government Treasury Bills. TRUSTEE: Shall mean the trustee of any trust which holds assets for the payment of the benefits provided by the Plan. TYPE A RETIREMENT COMPENSATION: As defined in Section 6.01. TYPE B RETIREMENT COMPENSATION: As defined in Section 6.01. 80 Page 79 IV. ELECTION TO DEFER ----------------- SECTION 4.01. With respect to Incentive Compensation for each Incentive Year commencing in or after 1986, the Participant shall be given the opportunity to elect, by signing and delivering to the Committee a Deferred Incentive Compensation Agreement, the manner and extent to which the Participant's Incentive Compensation awarded in respect to such Incentive Year shall be deferred under the Plan, the allocation between Periodic Compensation and Retirement Compensation and, with respect to the latter, the allocation between Type A Retirement Compensation and Type B Retirement Compensation. SECTION 4.02. Not less than 10% of Incentive Compensation awarded for any Incentive Year may be deferred under the Plan. SECTION 4.03. If a Participant elects to allocate a portion of Incentive Compensation to both Periodic Compensation and Retirement Compensation, the amount allocated to each form of Compensation shall be not less than 10% of the Incentive Compensation awarded for any Incentive Year. SECTION 4.04. To be in effect for an Incentive Year, a Participant's election pursuant to Section 4.01 must be completed on or before June 15 of such Incentive Year; PROVIDED, HOWEVER, that in order to select Type B Retirement Compensation such election must be completed on or before December 2 of the immediately preceding Incentive Year. Only Participants who have elected to allocate Deferred Incentive Compensation to Retirement Compensation for the Incentive Year commencing in 1985 (under the Plan as in effect prior to the October 23, 1985 amendment and restatement thereof) shall be entitled to allocate all or part of such Deferred Incentive Compensation to Type B Retirement Compensation. SECTION 4.05. Once a Participant has made an effective election under Section 4.01 with respect to the deferral and allocation of his or her Incentive Compensation, he or she may not thereafter change that election or change the allocation between Periodic Compensation and Retirement Compensation or between Type A Retirement Compensation and Type B Retirement Compensation. 81 Page 80 V. PERIODIC COMPENSATION --------------------- SECTION 5.01. There shall be computed and credited quarterly to the Participant's Account Treasury Bill Interest Equivalents on all unpaid Periodic Compensation. SECTION 5.02. Commencing in January of the second year following the Incentive Year for which the Periodic Compensation was credited to the Participant, the Periodic Compensation shall be paid to the Participant in five (5) equal annual installments; and, with each such installment, there shall be paid to the Participant all Treasury Bill Interest Equivalents credited to the Participant and then unpaid. SECTION 5.03. Upon Termination of Employment, any unpaid Periodic Compensation and any unpaid Treasury Bill Interest Equivalents credited thereon shall be paid to the Participant, or his or her Beneficiary, as the case may be, pursuant to the schedule for payment described in Section 5.02. VI. RETIREMENT COMPENSATION ----------------------- A. General. -------- SECTION 6.01. The amount of Deferred Incentive Compensation allocated to Retirement Compensation shall correspond with the portion of the Incentive Compensation award elected by the Participant pursuant to Section 4.01. Such amount may be allocated between Type A Retirement Compensation and, subject to Sections 6.08 and 6.09, Type B Retirement Compensation. Amounts allocated as Type A Retirement Compensation shall be converted into a number of Contingent Share Units on such date or dates as shall correspond with the determination and transfer of Incentive Compensation (it being understood that such transfer may be the payment date of such Incentive Compensation). The amounts allocated as Type A Retirement Compensation shall be converted into a number of Contingent Share Units based upon the average of the Mean Prices for Eaton Common Shares for the twenty trading days of the New York Stock Exchange during which Eaton Common Shares were traded immediately following the end of the Incentive Year in which the Incentive Compensation so allocated was earned. Amounts allocated as Type B Retirement Compensation shall not be converted into Contingent Share Units, but instead shall be credited with Fixed Rate Interest Equivalents, compounded annually, until paid. 82 Page 81 Retirement Compensation which the Participant elects to have converted into Contingent Share Units is referred to herein as "Type A Retirement Compensation" and Retirement Compensation to be credited with Fixed Rate Interest Equivalents is referred to herein as "Type B Retirement Compensation." B. Provisions Regarding Type A Retirement Compensation. ---------------------------------------------------- SECTION 6.02. On each dividend payment date for Eaton Common Shares, Dividend Equivalents shall be credited to the Participant's Account with respect to all Contingent Share Units then credited to such Account and shall be converted into an appropriate number of Contingent Share Units utilizing the procedures set forth in Section 6.01 but at the Mean Price on said dividend payment date. SECTION 6.03. In determining the number of Contingent Share Units to be credited to a Participant, whether by reason of the conversion of Retirement Compensation to Contingent Share Units or by reason of the conversion of Dividend Equivalents to Contingent Share Units, such number may be expressed in fractions of a Contingent Share Unit computed to the nearest tenth. The number of Contingent Share Units credited to a Participant shall be appropriately adjusted to reflect any change in the capitalization of Eaton resulting from a stock dividend, stock split, reorganization, merger, consolidation, recapitalization, combination, exchange of shares or any other similar events. SECTION 6.04. Upon Retirement or other Termination of Employment of the Participant or upon any other distribution of Type A Retirement Compensation, (x) all Contingent Share Units standing to his or her credit shall be converted to an equal number of Eaton Common Shares and (y) his or her account shall be credited with an additional amount equal to the amount, if any, by which the amount determined under Subsection 6.04(a) exceeds the greater of the amounts determined under Subsections 6.04(b) and (c): (a) the total of all Incentive Compensation allocated to Type A Retirement Compensation, as determined prior to conversion to Contingent Share Units pursuant to Section 6.01 hereof, and Treasury Bill Interest Equivalents, compounded quarterly, in respect to such Incentive Compensation for the period from the date of allocation to the date of Retirement or other Termination of Employment or distribution. (b) the product of the average of the Mean Prices for an Eaton Common Share for the twenty (20) trading days of the New York Stock Exchange during which Eaton Common Shares 83 Page 82 were traded immediately preceding the date of Retirement or other Termination of Employment or distribution multiplied by the number of Contingent Share Units then credited to the Participant's Account. (c) if a Change in Control of Eaton shall have occurred at any time within the period of thirty-six (36) months immediately preceding the Participant's Retirement or other Termination of Employment, the product of the highest of the following: (i) the highest price paid for an Eaton Common Share in any tender offer in connection with the Change in Control; (ii) the price received for an Eaton Common Share in any merger, consolidation or similar event in connection with the Change in Control; or (iii) the highest price paid for an Eaton Common Share as reported in any Schedule 13D within the sixty (60) day period immediately preceding the Change in Control; multiplied by the number of Contingent Share Units credited to the Participant's Account at the time of his or her Retirement or other Termination of Employment or distribution. The additional amount, if any, so determined shall be converted to Eaton Common Shares based on the average of the Mean Prices for Eaton Common Shares on the date of such determination which shall be credited to the Participant's Account and held for later distribution as set forth in Section 6.05. SECTION 6.05. Upon Retirement or other Termination of Employment of a Participant or upon any other distribution of Type A Retirement Compensation, and after the conversion of Contingent Share Units to Eaton Common Shares and the calculation of the additional amount, if any, to be credited to the Participant's Account as set forth in Section 6.04, the Committee shall determine in its sole discretion the method of distribution of such Eaton Common Shares and the additional amount, if any, whether in a lump sum, to be paid within one year after Retirement or other Termination of Employment or upon the date of any of other distribution of such Compensation, or Periodic Installments; PROVIDED, HOWEVER, that in making such determination the Committee may consider the wishes and needs of the Participant or his or her Beneficiary, as the case may be, with respect to the payment of Type A Retirement Compensation. 84 Page 83 SECTION 6.06. There shall be computed on a quarterly basis and credited to the Participant's Account Dividend Equivalents on the unpaid amount of Type A Retirement Compensation determined pursuant to Section 6.04 until such Compensation is paid by Eaton. All credited Dividend Equivalents shall be converted to Eaton Common Shares using the method set forth in Section 6.04 but based on a date which is as near to the distribution date as is administratively practical. SECTION 6.07. Commencing at such time as the Committee shall determine, but not later than one (1) year following Retirement or other Termination of Employment, the Eaton Common Shares credited to the Participant's Account in accordance with Section 6.04 shall be distributed to the Participant or his Beneficiary, as the case may be, in accordance with the schedule for distribution determined under Section 6.05 and, with each Periodic Installment, there shall be paid all Dividend Equivalents credited to the Participant and then unpaid. C. Provisions Regarding Type B Retirement Compensation. ---------------------------------------------------- SECTION 6.08. A Participant may defer as Type B Retirement Compensation all or any portion of his or her future Incentive Compensation which is earned during a period of four (4) consecutive Incentive Years or for the period to his or her Normal Retirement Date, if earlier; PROVIDED, HOWEVER, that with respect to any Incentive Year, the amount of Incentive Compensation a Participant may defer as Type B Retirement Compensation must be at least $5,000 and no greater than the maximum amount for such Incentive Year specified in such Participant's Deferred Incentive Compensation Agreement; PROVIDED, FURTHER, that any Incentive Compensation in excess of such annual maximum limitation may be deferred as either Periodic Compensation or Type A Retirement Compensation. SECTION 6.09. Notwithstanding anything herein to the contrary, Eaton shall be entitled to deny Participants the opportunity to elect to defer future Incentive Compensation as Type B Retirement Compensation for any reason if such Incentive Compensation is not then subject to an effective deferral election; PROVIDED, HOWEVER, that any such denial by Eaton of the opportunity to elect deferrals shall apply to all Participants equally. SECTION 6.10. (a) Following Retirement, all Type B Retirement Compensation then credited to a Participant's Account, 85 Page 84 together with Fixed Rate Interest Equivalents earned during the period of deferral, shall be paid to the Participant or his or her Beneficiary in fifteen (15) equal annual installments commencing on the first day of February following the year in which the Participant attains age 65; PROVIDED, HOWEVER, that after consideration of the wishes and needs of the Participant or his or her Beneficiary, the Committee may determine in its sole discretion (i) to commence payment of the installments to any Participant at an earlier date following Retirement; (ii) to pay to any Participant the Type B Retirement Compensation in a lump sum within one year following Retirement; or (iii) to pay Type B Retirement Compensation in a lump sum upon any Termination of Employment by reason of divestiture or closing of a business unit, subsidiary, plant or facility or to provide that such Type B Retirement Compensation shall be paid commencing on a date which is subsequent to such Termination of Employment but not later than the Participant's Normal Retirement Date. For purposes of the payments under the foregoing clauses (ii) and (iii), the amount of such lump sum shall be equal to the then present value of the fifteen (15) annual payments which otherwise would have been made as calculated using an interest rate equal to "Moody's Corporate Bond Yield Average - Monthly (Average Corporates)" most recently published by Moody's Investor Services, Inc. (or any successor thereto) at the time of the calculation. (b) The rate of each Participant's Fixed Rate Interest Equivalent, as set forth in his or her Deferred Incentive Compensation Agreement, is based on the assumption that the Participant will defer a specified amount of Incentive Compensation for four (4) consecutive years or to his or her Retirement, if earlier. Notwithstanding any provisions hereof to the contrary, upon a Participant's Termination of Employment, other than for Retirement and except as provided in Section 6.10(c), all Type B Retirement Compensation then credited to his or her Account shall be credited only with Treasury Bill Interest Equivalents, compounded quarterly, for the actual period of deferral until paid in lieu of the Fixed Rate Interest Equivalents otherwise credited to Type B Retirement Compensation; PROVIDED, HOWEVER, that the Committee may determine in its sole discretion that all Type B Retirement Compensation credited to a Participant's Account shall continue to be credited with Fixed Rate Interest Equivalents until paid. Upon such Termination of Employment, payment of the amounts 86 Page 85 credited to a Participant's Account shall be made as determined by the Committee (i) in Periodic Installments commencing within one year following such Termination of Employment or at such other date not later than first February following the Participant's Normal Retirement Date as determined by the Committee, or (ii) in a lump sum within one year following such Termination of Employment or at such other date not later than the first February following the Participant's Normal Retirement Date as determined by the Committee. (c) Notwithstanding anything in Section 6.10(b) to the contrary, (i) if a Participant's Termination of Employment occurs within five (5) years after a Change in Control of Eaton and such Termination of Employment is by Eaton without Cause or by the Participant for Good Reason or for Retirement, all Type B Retirement Compensation then credited to the Participant's Account shall be credited with the Fixed Rate Interest Equivalents and held under the Plan as elected by the Participant in his or her Deferred Incentive Compensation Agreement; (ii) if within five (5) years after a Change in Control of Eaton a Participant is not permitted to complete the deferral of Incentive Compensation until the Participant's Retirement because of any amendment or termination of the Plan, all Type B Retirement Compensation then credited to the Participant's Account shall be credited with the Fixed Rate Interest Equivalents and held under the Plan as elected by the Participant in his or her Deferred Incentive Compensation Agreement; or (iii) if a Participant's Termination of Employment is caused by any divestiture or closing of a business unit, subsidiary, plant or facility, the Compensation Committee of the Board may determine in its sole discretion that all Type B Retirement Compensation then credited to the Participant's Account shall be credited with the Fixed Rate Interest Equivalents until paid as provided under Section 6.10(a). VII. AMENDMENT AND TERMINATION ------------------------- SECTION 7.01. Eaton fully expects to continue the Plan but it reserves the right, except as otherwise provided herein, at any time or from time to time, by action of the Compensation Committee of the Board, to modify or amend the Plan, in whole or in part, or to terminate the Plan, in whole or in part, at any time and for any reason, including, but not limited to, adverse changes in the federal tax laws; PROVIDED, HOWEVER, that no amendment may be made to the 87 Page 86 provisions of the Plan which comply with Rule l6b-3(c)(2)(ii)(A) of the Securities Exchange Act of 1934, as amended, more than once every six months, other than to comport with changes in the Internal Revenue Code, the Employee Retirement Income Security Act, or the rules thereunder. SECTION 7.02. In the event of any termination of the Plan which results in the Participants being unable to have any future Incentive Compensation allocated as Type B Retirement Compensation, the amount of all Type B Retirement Compensation credited to a Participant's Account at the date of such Plan termination shall be converted to Type A Retirement Compensation, effective retroactively to the date such Retirement Compensation was allocated pursuant to Section 6.01, and either shall be paid to the Participant or continue to be held under the Plan as elected by the Participant in his or her Deferred Incentive Compensation Agreement, except for 1985 Incentive Compensation, if any, deferred as Type B Retirement Compensation which shall continue to be held under the Plan. Notwithstanding the foregoing, in the event of a termination of the Plan within five (5) years after a Change in Control of Eaton, all Type B Retirement Compensation then credited to a Participant's Account together with Fixed Rate Interest Equivalents earned during the period of deferral shall not be converted to Type A Retirement Compensation but shall be held under the Plan as elected by the Participant in his or her Deferred Incentive Compensation Agreement. No amendment to, or termination of, the Plan after a Change in Control of Eaton shall modify this provision or any provision hereof relating to a Change in Control of Eaton or the rights of a Participant in effect under the Plan immediately prior to such Change in Control of Eaton. Notwithstanding anything herein to the contrary, no amendment, modification or termination of the Plan shall, without the consent of the Participant, alter or impair this provision or any of the Participant's rights under the Plan with respect to benefits accrued prior to such amendment, modification or termination. VIII. ADMINISTRATION -------------- SECTION 8.01. The Plan shall be administered by the Committee in accordance with rules of general application for the administration of the Plan as the Committee may, from time to time, adopt. The Committee shall interpret the provisions of the Plan where necessary and may adopt procedures for the administration of the Plan which are consistent with the provisions of the Plan and the rules adopted by the Committee. 88 Page 87 SECTION 8.02. Each Participant or Beneficiary must claim any benefit to which he or she may be entitled under the Plan by a written notification to the Committee. If a claim is denied, it must be denied within a reasonable period of time in a written notice stating the specific reasons for the denial. The claimant may have a review of the denial by the Committee by filing a written notice with the Committee within sixty (60) days after the notice of the denial of his or her claim. The written decision by the Committee with respect to the review must be given within one hundred and twenty (120) days after receipt of the written request. IX. PAYMENTS TO PARTICIPANTS ------------------------ SECTION 9.01. Notwithstanding anything herein to the contrary, upon the occurrence of a Termination and Change in Control, the Participants shall be entitled to receive from the Company the payments as provided in Section 9.03 . SECTION 9.02. Notwithstanding anything herein to the contrary, upon the occurrence of a Failure to Pay, each Participant covered by the situation described in clause (i) of the definition of Failure to Pay, or each of the Participants in the event of a situation described in clause (ii) of that definition, as the case may be, shall be entitled to receive from the Company the payments as provided in Section 9.03. SECTION 9.03. No later than the first to occur of (i) one year following the date hereof for any current Participant, (ii) a Termination and Change in Control or a Failure to Pay for any current Participant or (iii) the date upon which any person who is not a current Participant upon the date hereof becomes a Participant, each Participant shall select one of the payment alternatives set forth below with respect to that portion of the Participant's Plan Account equal to the full amount of the Account minus the Funded Amount, and with respect to that portion of the Account equal to the Funded Amount. The payment alternatives selected with respect to the two portions of the Account need not be the same. The payment alternatives are as follows: 89 Page 88 (a) a lump sum payment within 30 days following the Termination and Change in Control or Failure to Pay, as the case may be; (b) payment in monthly, quarterly, semiannual or annual payments, over a period not to exceed fifteen years, as selected by the Participant at the time provided in the first paragraph of this Section 9.03, commencing within 30 days following the Termination and Change in Control or Failure to Pay, as the case may be, which are substantially equal in amount or in the number of share units being valued and paid, except that earnings attributable to periods following Termination and Change in Control or Failure to Pay shall be included with each payment. Payment shall be made to each such Participant in accordance with his or her selected alternative as provided in Sections 9.01 and 9.02. X. MISCELLANEOUS ------------- SECTION 10.01. Each Participant shall have the right, by written instruction to the Committee, on a form supplied by the Committee, to designate one or more primary and contingent beneficiaries (and the proportion to be paid to each, if more than one is designated) to receive his or her Deferred Incentive Compensation upon his or her death. Any such designation shall be revocable by the Participant. SECTION 10.02. The Committee may, in its sole discretion, change the amount of the Periodic Installments or the number of years over which the Periodic Installments are to be paid or permit the payment of any Deferred Incentive Compensation at any date or dates which may be earlier than the payment date or dates provided under the Plan. The Committee may consider the needs and desires of the participant or beneficiary in making this decision. The determination of the Committee shall be final and conclusive upon Eaton, the Participant and the Beneficiary. Any Type B Retirement Compensation paid pursuant to this Section 10.02 to a Participant who would then be eligible to terminate his or her employment for Retirement shall be credited with the Fixed Rate Interest Equivalent on the amount so paid. Any Type B Retirement Compensation paid to a Participant who is not then eligible to terminate his or her employment for Retirement shall be credited only with the Treasury Bill Interest Equivalent. SECTION 10.03. All payments under the Plan shall be subject to such taxes (federal, state or local) as may be due thereon and the determination by the Committee as to 90 Page 89 withholding with respect thereto shall be binding upon the Participant and his or her Beneficiary. SECTION 10.04. If any Participant under the Plan is a member of the Committee, he or she shall not participate as a member of the Committee in any determination under the Plan relating to his or her Deferred Incentive Compensation. SECTION 10.05. All action of the Committee hereunder may be taken with or without a meeting. If taken without a meeting, the action shall be in writing and signed by a majority of the members of the Committee and if taken with a meeting, a majority of the Committee shall constitute a quorum for any such action. SECTION 10.06. Subject to any federal statute to the contrary, no right or benefit under the Plan shall be subject to anticipation, alienation, sale, assignment, pledge, encumbrance, or charge, and any attempt to anticipate, alienate, sell, assign, pledge, encumber, or charge any right or benefit under the Plan shall be void. No right or benefit hereunder shall in any manner be liable for or subject to the debts, contracts, liabilities, or torts of the person entitled to such benefits. If the Participant or Beneficiary shall become bankrupt, or attempt to anticipate, alienate, sell, assign, pledge, encumber, or charge any right hereunder, then such right or benefit shall, in the discretion of the Company, cease and terminate, and in such event, the Company may hold or apply the same or any part thereof for the benefit of the Participant or his or her spouse, children, or other dependents, or any of them, in such manner and in such amounts and proportions as the Company may deem proper. SECTION 10.07. The obligations of Eaton to make payments hereunder shall constitute a liability of Eaton to the Participant. Eaton may, but shall not be required to, establish or maintain any special or separate fund, or purchase or acquire life insurance on a Participant's life, or otherwise to segregate assets to assure that such payments shall be made. SECTION 10.08. The Plan shall not be deemed to constitute a contract of employment between Eaton and a Participant. Neither shall the execution of this Plan nor any action taken by Eaton pursuant to this Plan be held or construed to confer on a Participant any legal right to be continued as an employee of Eaton, in an executive position or in any other capacity with Eaton whatsoever. 91 Page 90 SECTION 10.09. Obligations incurred by Eaton pursuant to this Plan shall be binding upon and inure to the benefit of Eaton, its successors and assigns, and the Participant or his or her Beneficiary. SECTION 10.10. This Plan shall be construed and governed in accordance with the law of the State of Ohio. SECTION 10.11. The masculine gender, where appearing in the Plan, shall be deemed to include the feminine gender, and the singular may include the plural, unless the context clearly indicates to the contrary. SECTION 10.12. All headings used in the Plan are for convenience of reference only and are not part of the substance of the Plan. 92 Page 91 Eaton Corporation 2000 Annual Report on Form 10-K Item 14(c) Exhibit 10(b) Executive Strategic Incentive Plan (amended and restated as of June 21, 1994, July 25, 1995, April 21, 1998 and April 1, 1999) 1. PURPOSE ------- The purpose of the Executive Strategic Incentive Plan (the "Plan") is to promote the growth and profitability of Eaton Corporation (the "Company") through the granting of incentives intended to motivate executives of the Company to achieve demanding long-term corporate objectives and to attract and retain executives of outstanding ability. 2. ADMINISTRATION -------------- Except as otherwise expressly provided herein, the Plan shall be administered by the Compensation and Organization Committee (the "Committee") of the Company's Board of Directors which shall consist of at least three directors of the Company selected by the Board. Except as otherwise expressly provided herein, the Committee shall have complete authority to: (i) interpret all provisions of the Plan consistent with law; (ii) designate the executives to participate under the Plan; (iii) determine the incentive targets and performance objectives applicable to participants; (iv) adopt, amend and rescind general and special rules and regulations for the Plan's administration; and (v) make all other determinations necessary or advisable for the administration of the Plan. 3. ELIGIBILITY ----------- Any executive of the Company designated by the Committee in its sole discretion shall be eligible to participate in the Plan. 4. INCENTIVE TARGETS ----------------- (A) Establishment of Incentive Amounts Individual Incentive Amounts for each participant with respect to each Plan Award Period (as defined below) shall be determined by multiplying the Incentive Percentages adopted by the Committee which are applicable to such participant, and which may not exceed 120%, by 93 Page 92 the amount of such participant's actual weighted average year-end salary range midpoint for the Award Period. In the event that during any Award Period a participant's salary grade changes to a grade for which a different Incentive Percentage would be applicable, such different Incentive Percentage shall be applicable to such participant with respect to the portion of any Award Period remaining after such salary grade change. With respect to Award Periods beginning on or after January 1, 1998, participant incentive targets will be expressed in the form of Performance Share Units which will be determined by the Committee by: (a) first estimating the Individual Incentive Amount for each participant with respect to each Award Period by multiplying the Incentive Percentage adopted by the Committee which is applicable to such participant, by the amount of such participant's estimated weighted average salary range midpoint for the Award Period and, (b) then dividing such Individual Incentive Amount by the average of the mean prices for the Company's common shares for the first twenty(20) trading days of each Award Period. At the end of each Award Period the estimated Individual Incentive Amount used for each participant (and the resulting number of Performance Share Units) shall be adjusted to reflect the participant's actual weighted average year-end salary range midpoint for such Award Period. In all cases, such amount shall be rounded up to the nearest 50 whole units. For purposes of the Plan, "mean price" shall be the mean of the highest and lowest selling prices for Company common shares quoted on the New York Stock Exchange List of Composite Transactions on the relevant trading day. Notwithstanding the foregoing, the Committee may, in its sole discretion, use a different method for establishing incentive targets for participants under the Plan. (B) Award Periods Each Award Period shall be the four-calendar year period commencing as of the first day of the calendar year in which the performance objectives are established for the Award Period as described in Section 4(C). A new Award Period shall commence as of the first day of each calendar year, unless otherwise specified by the Committee. (C) Establishment of Company Performance Objectives As soon as practicable at the beginning of each Award Period, threshold, target, and maximum Company performance objectives for such Award Period shall be established by the Committee. The performance objectives 94 Page 93 shall be based upon cash flow return on gross capital ("CFROGC") except that, for Award Periods commencing on or after January 1, 1998, unless otherwise determined by the Committee in its sole discretion, performance objectives will be established using a CFROGC/EPS Growth Performance Matrix which shall use the Company's average cash flow return on gross capital for such period along one axis and the Company's cumulative earnings per share for such period along the second axis. Within sixty (60) days after the performance objectives have been established by the Committee, each participant will be provided with written notice of his or her established objectives. In its sole discretion, the Committee may modify previously established performance objectives as a result of any change in conditions, the occurrence of any events or other factors which make such objectives unsuitable. Notwithstanding the foregoing, after a Change in Control (as hereinafter defined), neither the Committee nor the Board shall have the authority to modify performance objectives in any manner which could prove detrimental to the interests of the Plan's participants. (D) Determination of Payments As promptly as practicable after the end of each Award Period, the Committee shall fix the level of attainment of the Company's performance for the Award Period and approve award payments under the Plan which shall not exceed: (i) 50% of the participant's Incentive Amount upon attainment of the threshold performance objective; (ii) 100% of the participant's Incentive Amounts upon attainment of the target performance objective; and (iii) 200% of the participant's Incentive Amount upon attainment of the maximum performance objective; provided, however, that if the Company's performance does not place it within the top 25%, using equivalent measurements of performance, of a group of peer companies selected by the Committee in its sole discretion, an award payment equal to 150% of the participant's Incentive Amount shall instead be paid upon the attainment of maximum performance. Payments ranging from 50% to 200% of the Incentive Amounts will be determined by the Committee in respect of an Award Period for the attainment of performance objectives between either threshold and target or target and maximum. Such amounts, if any, shall be paid to the participant in cash within ninety (90) days after the end of each Award Period, unless the participant made an irrevocable election to defer all or part of the amount of his or her award payment pursuant to any long term incentive 95 Page 94 compensation deferral plan adopted by the Company and made available for amounts earned hereunder. Notwithstanding the foregoing, for Award Periods beginning on or after January 1, 1998, Final Individual Performance Share Unit Awards shall be determined by the Committee by: (a) determining the CFROGC/EPS Growth Matrix Performance Percentage applicable for the Award Period; (b) multiplying such percentage by the number of Performance Share Units credited to the participant and (c) further multiplying the result by an Individual Performance Rating which will be a whole percentage between zero and 150% established by the Committee in its sole discretion after considering the recommendations of Company management. The Final Individual Performance Share Unit Award shall be distributed to participants in the form of whole Company common shares (except that, to the extent necessary to satisfy federal, state or local tax withholding obligations, Performance Share Units may be converted to cash at a market value of Company common shares determined by the Committee), unless the participant has made an irrevocable election to defer all or part of the amount of his or her award pursuant to any long term incentive compensation deferral plan adopted by the Committee or the Company. 5. PRORATA PAYMENTS ---------------- A participant must be employed by the Company or one of its subsidiaries at the end of an Award Period in order to be entitled to a payment in respect to such Award Period; provided, however, that a payment, prorated for the participant's length of service during the Award Period, may be authorized by the Committee, in its sole discretion, in the event the employment of a participant terminates before the end of an Award Period due to death, permanent disability, normal or early retirement, closure or divestiture of an Eaton facility or any other reason. Notwithstanding the foregoing, upon any termination of the Plan by the Committee during the term of any Award Period, payments to all participants will be made, prorated for each participant's length of service during the Award Period prior to the date of Plan termination. 6. OTHER PROVISIONS ---------------- (A) Adjustments upon Certain Changes In the event of changes to the structure or corporate organization of the Company's businesses which affect the participants and/or the performance prospects of the Company, the Committee may make appropriate adjustments 96 Page 95 to individual participant Incentive Targets or to the established performance objectives for incomplete Award Periods. Adjustments under this Section 6 shall be made by the Committee, whose determination as to what adjustments shall be made, and the extent thereof, shall be final, binding and conclusive. Notwithstanding the foregoing, after a Change in Control, neither the Committee nor the Board shall have the authority to change established Performance Objectives in any manner which could prove detrimental to the interests of the participant. (B) Change in Control Defined For purposes of the Plan, a Change in Control shall be deemed to have occurred if: (i) a tender offer shall be made and consummated for the ownership of 25% or more of the outstanding voting securities of the Company, (ii) the Company shall be merged or consolidated with another Corporation and as a result of such merger or consolidation less than 75% of the outstanding voting securities of the surviving or resulting corporation shall be owned in the aggregate by the former shareholders of the Company as the same shall have existed immediately prior to such merger or consolidation, (iii) the Company shall sell substantially all of its assets to another corporation which is not a wholly-owned subsidiary of the Company, (iv) a "person" within the meaning of Section 3(a)(9) or of Section 13(d)(3) of the Securities Exchange Act of 1934 (as in effect on the effective date of the Plan) shall acquire 25% or more of the outstanding voting securities of the Company (whether directly, indirectly, beneficially or of record). For purposes of the Plan, ownership of voting securities shall take into account and shall include ownership as determined by applying the provisions of Rule 13d-3(d)(1)(I) under the Securities Exchange Act of 1934 (as in effect on the effective date of the Plan), or (v) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board cease for any reason 97 Page 96 to constitute at least a majority thereof unless the election, or nomination for election by the Company's shareholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. (C) Non-Transferability No right to payment under the Plan shall be subject to debts, contract liabilities, engagements or torts of the participant, nor to transfer, anticipation, alienation, sale, assignment, pledge or encumbrance by the participant except by will or the law of descent and distribution or pursuant to a qualified domestic relations order. (D) Compliance with Law and Approval of Regulatory Bodies No payment shall be made under the Plan except in compliance with all applicable federal and state laws and regulations including, without limitation, compliance with tax requirements. (E) No Right to Employment Neither the adoption of the Plan nor its operation, nor any document describing or referring to the Plan, or any part thereof, shall confer upon any participant under the Plan any right to continue in the employ of the Company or any subsidiary, or shall in any way affect the right and power of the Company or any subsidiary to terminate the employment of any participant under the Plan at any time with or without assigning a reason therefore, to the same extent as the Company might have done if the Plan had not been adopted. (F) Interpretation of the Plan Headings are given to the sections of the Plan solely as a convenience to facilitate reference; such headings, numbering and paragraphing shall not in any case be deemed in any way material or relevant to the construction of the Plan or any provisions thereof. The use of the masculine gender shall also include within its meaning the feminine. The use of the singular shall also include within its meaning the plural and vice versa. (G) Amendment and Termination The Committee may at any time suspend, amend or terminate the Plan. Notwithstanding the foregoing, upon the 98 Page 97 occurrence of a Change in Control, no amendment, suspension or termination of the Plan shall, without the consent of the participant, alter or impair any rights or obligations under the Plan with respect to such participant. (H) Effective Dates of the Plan The Plan was adopted by the Board on April 24, 1991 but the effective date of the Plan shall be January 1, 1991. The Plan was amended and restated as of June 21, 1994, July 25, 1995, April 21, 1998 and April 1, 1999. 99 Page 98 Eaton Corporation 2000 Annual Report on Form 10-K Item 14(c) Exhibit 10(f) Incentive Compensation Deferral Plan (amended and restated as of October 1, 1997) I. Purpose The Incentive Compensation Deferral Plan (the "Plan") enables employees who contribute significantly to the success of Eaton Corporation (the "Company") to defer receipt of awards earned under incentive compensation plans and certain other compensation. The purpose of the Plan is to help attract and retain highly qualified individuals, to provide an incentive to those individuals to improve the profitability, competitiveness and growth of the Company, and to help align their interests with those of the shareholders. II. Eligibility All elected officers of the Company are eligible to participate in the Plan with respect to i) amounts earned under the Executive Strategic Incentive Plan or any other Eaton incentive plan made available for deferral hereunder by the Committee; and ii) any amount paid as a Recruitment Bonus. Such other executives as determined by the Committee shall also be eligible to participate in the Plan with respect to any amounts earned under any Eaton incentive compensation plan made available for deferral hereunder by the Committee, including the Senior Operations Managers Plan, and any amount paid as a Recruitment Bonus. III. Definitions The terms used herein shall have the following meanings: Account--A bookkeeping account established by Eaton for a Participant to which may be credited Deferred Incentive Compensation and earnings or losses thereon. Agreement--A written agreement between Eaton and a Participant deferring the receipt of Incentive Compensation and indicating the term of the deferral. Beneficiary--The person or entity designated in writing by the Participant and delivered to the Committee. If that person or entity is not living or in existence at the time any unpaid 100 Page 99 balance of Deferred Incentive Compensation becomes due after the death of a Participant, the term "Beneficiary" shall mean the Participant's estate or legal representative or any person, trust or organization designated in such Participant's will. Board--The Board of Directors of Eaton Corporation. Change in Control of Eaton--Shall be deemed to occur if (i) a tender offer shall be consummated for 25% or more of the combined voting power of Eaton's then outstanding voting securities, (ii) Eaton shall be merged or consolidated with another corporation and as a result less than 75% of the outstanding voting securities of the resulting corporation shall be owned by the former shareholders of Eaton, other than affiliates (within the meaning of the Securities Exchange Act of 1934 (the "Exchange Act")) of any party to such merger or consolidation, as the same shall have existed immediately prior to such merger or consolidation, (iii) Eaton shall sell substantially all of its assets to another corporation which is not a wholly owned subsidiary of Eaton, (iv) any "person" (as such term is used in Sections 3(a)(9) and 13(d)(3) of the Exchange Act) is or becomes the beneficial owner, directly or indirectly, of 25% or more of the combined voting power of Eaton's then outstanding securities; or (v) during any period of two consecutive years, individuals who at the beginning of that period constitute the Board cease to constitute at least a majority thereof unless the election, or the nomination for election by Eaton's shareholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. For purposes of this Plan, ownership of voting securities shall take into account and include ownership as determined by applying the provisions of Rule 13d-3(d)(l)(i) of the Exchange Act (as then in effect). Committee--The Compensation and Organization Committee of the Board. Common Share Retirement Compensation--Retirement Compensation which is converted into share units in accordance with Article VII. Deferred Incentive Compensation--That portion of Incentive Compensation deferred pursuant to the Plan. Eaton--Eaton Corporation, an Ohio corporation, and its subsidiaries and successors and assigns. 101 Page 100 Eaton Common Shares--The common shares of Eaton Corporation with a par value of $.50 each. Incentive Compensation--Any payment awarded to a Participant under any Incentive Compensation Plan or paid as a Recruitment Bonus. Incentive Compensation Plan--Any incentive compensation plan approved by either the Board or its Compensation Committee. Interest Rate Retirement Compensation--Retirement Compensation which is credited with Treasury Note Based Interest in accordance with Article VII. Participant--An employee of Eaton who elects to defer receiving benefits under an Incentive Compensation Plan designated by the Committee as eligible for deferral hereunder or any Recruitment Bonus. Periodic Installments--Monthly, quarterly, semiannual or annual payments, over a period not to exceed fifteen years, as determined by the Committee in its sole discretion, which are substantially equal in amount, or, in the case of Common Share Retirement Compensation, substantially equal in the number of share units being valued and paid or the number of Eaton Common Shares being distributed, except that earnings attributable to periods following Retirement or Termination of Employment shall be included with each payment. Plan--This Incentive Compensation Deferral Plan pursuant to which Incentive Compensation may be deferred for later payment. Proposed Change in Control--The first to occur of any of the following events (including the expiration of the periods specified therein): (i) twenty (20) days after the commencement of a tender offer shall be made for the ownership of securities of Eaton representing 25% or more of the combined voting power of Eaton's then outstanding voting securities (unless such tender offer shall have been withdrawn); (ii) twenty (20) days after the commencement of solicitation of proxies or consents for a merger or consolidation with another corporation and as a result of such merger or consolidation less than 75%, in the Committee's view, of the outstanding voting securities of the surviving or resulting corporation would be 102 Page 101 owned in the aggregate by the former shareholders of Eaton, other than the party and any affiliates (within the meaning of the Exchange Act) of any party, to such merger or consolidation, as the same shall have existed immediately prior to such merger or consolidation; (iii) upon the date that Eaton shall have entered into an agreement to sell substantially all of its assets to another corporation which is not a wholly owned subsidiary of Eaton; (iv) within twenty (20) days after any "person" (as such term is used in Sections 3(a)(9) and 13(d)(3) of the Exchange Act) becomes the beneficial owner, directly or indirectly, of securities of Eaton representing 15% or more of the combined voting power of Eaton's then outstanding securities; or (v) upon the date that individuals who, at the beginning of any period of two consecutive years, constitute the Board, cease for any reason to constitute at least 76% thereof, unless the election, or the nomination for election by Eaton's shareholders, of each new director was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of the period. For purposes of this definition, ownership of voting securities shall take into account and include ownership as determined by applying the provisions of Rule 13d-3(d)(1)(i) of the Exchange Act (as then in effect). Recruitment Bonus--Any amount offered by the Company in order to recruit new executives. Retirement--The Termination of Employment of a Participant who is age fifty-five or older and who has at least ten years of service with Eaton, who is age sixty-five or older or who is eligible to receive pension payments under a pension plan sponsored by Eaton commencing within sixty days of the date of such Termination of Employment, or who is approved by the Committee to qualify as a retirement. Retirement Compensation--That portion of Incentive Compensation deferred for payment at Retirement, at one year following Retirement, or in Periodic Installments commencing after Retirement. 103 Page 102 Short-Term Compensation--That portion of Incentive Compensation deferred for payment as determined by the Committee in accordance with Article V. Termination of Employment--The time when a Participant shall no longer be employed by Eaton, whether by reason of retirement, death, voluntary resignation, divestiture, discharge (with or without cause), or such disability that, under the then current employment practices of Eaton, the employment of the Participant is deemed to have been terminated. Treasury Bill Interest Equivalent--A rate of interest equal to the quarterly average yield of 13-week U.S. Government Treasury Bills. Treasury Note Based Interest--A rate of interest equal to the average yield of 10-year U.S. Government Treasury Notes plus 300 basis points. Variable-Term Compensation--That portion of Incentive Compensation deferred for payment to a Participant until such time as it is determined by the Committee in its sole discretion that such compensation can be paid in whole or in part without exceeding the deduction limit imposed by Section 162(m) of the Internal Revenue Code or without being subject to that section. IV. Election to Defer Section 4.01 Deferral Options For each award period ending during or after 1994 (an "Award Period") with respect to any plan eligible for the deferral of Incentive Compensation hereunder, or with respect to any Recruitment Bonus offered by the Company after October 1, 1997, the Participant may elect to defer the receipt of all or part of his or her Incentive Compensation as Short-Term Compensation, Variable-Term Compensation or Retirement Compensation. Once a Participant has made an effective election, he or she may not thereafter change that election or change any allocation between Short-Term Compensation, Variable-Term Compensation or Retirement Compensation. Section 4.02 Amount Deferred Between 10% and 100% of any Recruitment Bonus may be deferred under the Plan and not less than 10% of Incentive Compensation awarded for any Award Period may be deferred under the Plan, 104 Page 103 except that Variable-Term Compensation may be less than 10% of the Incentive Compensation awarded for any Award Period. If a Participant elects to allocate a portion of Incentive Compensation to both Short-Term Compensation and Retirement Compensation, the amount allocated to each shall be not less than 10% of the Incentive Compensation awarded for any Award Period. Section 4.03 Election Deadline To be in effect for an Award Period, a Participant's election must be completed, signed and filed with the Committee on or before such date as is necessary to defer an award for Federal income tax purposes. Elections to defer a Recruitment Bonus must be completed, signed and filed with the Committee prior to the Participant's acceptance of employment with the Company. V. Short-Term Compensation If elected by a Participant, payment of the amount of Incentive Compensation allocated to Short-Term Compensation will be deferred. Treasury Bill Interest Equivalents shall be credited quarterly to the Participant's Short-Term Compensation Account until such compensation is paid to the Participant. Short-Term Compensation, together with credited Treasury Bill Interest Equivalents, shall be paid to the Participant in a lump sum or in not more than five annual installments as determined by the Committee. VI. Variable-Term Compensation Section 6.01 Amount and Duration Variable-Term Compensation is a response to amendments to the Internal Revenue Code which limit the deductibility of individual annual compensation in excess of $1 million. Only those Participants whose total taxable compensation is likely to exceed that amount will be offered the opportunity to select Variable-Term Compensation. If elected by a Participant, the amount of Incentive Compensation allocated to Variable-Term Compensation will be the amount (if any) determined by the Committee in its sole discretion which, when added to other compensation of the Participant, exceeds the deductible compensation limit imposed by Internal Revenue Code Section 162(m). Amounts allocated as Variable-Term Compensation shall be credited to the Account of the Participant on the date such amounts would have been paid if there had been no valid 105 Page 104 deferral election. Variable-Term Compensation will be deferred until such time as the Committee, in its sole discretion, shall determine that it, together with the earnings thereon, can be paid in whole or in part without exceeding the limit imposed by Section 162(m). Section 6.02 Earnings The Variable-Term Compensation Account shall be credited with Treasury Note Based Interest, compounded quarterly until paid. VII. Retirement Compensation Section 7.01 Duration If elected by a Participant, payment of the amount of Incentive Compensation allocated to Retirement Compensation will be deferred to Retirement or to one year after Retirement, but subject to Committee discretion as to date of payment as provided herein. Retirement Compensation shall be credited to the Participant on the date such amount would have been distributed to him or her if there had been no valid deferral election by establishing an Account in the Participant's name. Section 7.02 Common Share Retirement Compensation Between fifty percent and one hundred percent, as elected by the Participant, of the amount allocated to Retirement Compensation shall be credited to Common Share Retirement Compensation, and the balance shall be credited to Interest Rate Retirement Compensation. Common Share Retirement Compensation shall be converted into a number of share units based upon the average of the mean prices for Eaton Common Shares for the twenty trading days of the New York Stock Exchange during which Eaton Common Shares were traded immediately following the end of the incentive period in which the Incentive Compensation to be deferred was earned. On each Eaton Common Share dividend payment date, dividend equivalents equal to the actual Eaton Common Share dividends paid shall be credited to the share units in the Participant's Account, and shall in turn be converted into share units utilizing the mean Eaton Common Share price on the dividend payment date. The maximum, cumulative number of share units that may be allocated to all Participants is 2 million. 106 Page 105 Allocations to Common Share Retirement Compensation are subject to approval of the Plan by the Company's shareholders and to the share unit limitation provided above. If that approval is not obtained, or if that limitation would be exceeded, then those allocations shall instead be made to Interest Rate Retirement Compensation. Upon payment of Common Share Retirement Compensation in Eaton Common Shares, the share units standing to the Participant's credit shall be converted to the same number of Eaton Common Shares for distribution to the Participant. Upon payment of Common Share Retirement Compensation in cash, including any installment thereof in the case of Periodic Installments, the share units required to make the cash payment shall be converted to an amount equal to the greater of: (a) the product of the average of the mean prices for an Eaton Common Share for the last twenty trading days of the New York Stock Exchange during which Eaton Common Shares were traded in the month immediately preceding the month in which the date of payment occurs, multiplied by the number of share units then credited to the Participant's Account, or (b) if a Change in Control of Eaton shall have occurred at any time within thirty-six months immediately preceding the payment, the product of the number of share units credited to the Participant's Account at the time of payment multiplied by the highest of (i) the highest price paid for an Eaton Common Share in any tender offer in connection with the Change in Control of Eaton; (ii) the price received for an Eaton Common Share in any merger, consolidation or similar event in connection with the Change in Control of Eaton; or (iii) the highest price paid for an Eaton Common Share as reported in any Schedule 13D within the sixty-day period immediately preceding the Change in Control of Eaton. Section 7.03 Interest Rate Retirement Compensation Retirement Compensation not credited to Common Share Retirement Compensation shall be credited to Interest Rate Retirement Compensation. Interest Rate Retirement Compensation shall be credited to the Interest Rate Retirement Compensation Account, which shall earn Treasury Note Based Interest, compounded quarterly, until paid. Section 7.04 Periodic Installments Upon the death of a Participant who has commenced receiving Periodic Installments, the entire remaining amount of his or her Retirement Compensation shall be distributed to the Participant's Beneficiary. Such distributions may be made either in a lump sum or in installments in such amounts and over such periods, not exceeding the remaining number of annual installments from the date 107 Page 106 of death of the Participant, as the Committee may direct in its sole discretion. Section 7.05 Termination of Employment The Retirement Compensation Account of a Participant whose employment terminates for reasons other than Retirement shall be distributed in a lump sum or in Periodic Installments, as the Committee may determine in its sole discretion. The lump sum payment shall be made, or the Periodic Installments shall commence, as the Committee may determine in its sole discretion, no later than the February 1 of the calendar year immediately after the calendar year that includes the earliest of: (i) the Participant's death, (ii) the Participant's attainment of age 55 if he or she was credited with at least 10 years of service for Eaton (or an affiliate of Eaton), (iii) the Participant's attainment of age 65, or (iv) the fifth anniversary of the Participant's termination of employment. Earnings shall be credited on undistributed Retirement Compensation Accounts, and annual installment payments shall be adjusted to reflect such additional earnings, based on the remaining number of installment payments to be distributed and based on Treasury Note Based Interest, computed quarterly. VIII. Amendment and Termination Eaton fully expects to continue the Plan but it reserves the right, except as otherwise provided herein, at any time by action of the Committee, to modify, amend or terminate the Plan for any reason, including adverse changes in the federal tax laws. Notwithstanding the foregoing, (a) no amendment or modification of the provisions of the Plan permitting officers to receive awards or setting the formula that determines the amount, price and timing of awards, shall be made more than once every six months (or at more frequent intervals if permitted by applicable governmental regulations); and (b) upon the occurrence of a Change in Control of Eaton, no amendment, modification or termination of the Plan shall, without the consent of the Participant, alter or impair any rights or obligations under the Plan with respect to such Participant. IX. Administration The Plan shall be administered by the Committee. The Committee shall interpret the provisions of the Plan where necessary and may adopt procedures for the administration of the Plan which are consistent with the provisions of the Plan and any rules adopted by the Committee. After Retirement or other Termination of Employment, the Committee shall determine in its sole discretion (i) whether Retirement 108 Page 107 Compensation shall be paid in a lump sum or in Periodic Installments, (ii) the date on which a lump sum payment will be made or Periodic Installments will commence, which in the case of Retirement shall be not later than one year following the date to which the deferral was made, and in the case of Termination of Employment for reasons other than Retirement shall be in accordance with Section 7.05, (iii) whether to change the Periodic Installments or the number of years over which they are to be paid, and (iv) whether Common Share Retirement Compensation will be paid in cash or in Eaton Common Shares. In making these determinations, the Committee may consider the wishes and needs of the Participant or his or her Beneficiary. Each Participant or Beneficiary must claim any benefit to which such Beneficiary may be entitled under the Plan by a written notification to the Committee. If a claim is denied, it must be denied within a reasonable period of time in a written notice stating the specific reasons for the denial. The claimant may have a review of the denial by the Committee by filing a written notice with the Committee within sixty days after the notice of the denial of his or her claim. The written decision by the Committee with respect to the review must be given within one hundred twenty days after receipt of the written request. The determinations of the Committee shall be final and conclusive. X. Automatic Lump Sum Payment Except as provided below, upon the date of a Proposed Change in Control, Eaton shall make an immediate lump sum payment of the Account balances, including all earnings to that date, to each Participant or his or her Beneficiary. At any time prior to a Proposed Change in Control, the Committee may decide that the Lump Sum Payment shall not be made, upon a Proposed Change in Control, because any such payment is not then advisable, in the Committee's judgment, in order to protect the benefits of the Participants under the Plan. If the Committee makes such a decision, it may thereafter (i) take no further action, in which case the Lump Sum Payments will not be made, (ii) reconsider such decision and decide at a later date (which may be subsequent to a Proposed Change in Control) to terminate the Plan and make Lump Sum Payments, (iii) provide funding for the Plan benefits by depositing funds in trust for such purpose or (iv) take no action to protect the Plan benefits. XI. Miscellaneous Section 11.01 Adjustments In the event of a reorganization, merger, consolidation, reclassification, recapitalization, combination or exchange of shares, stock split, stock dividend, rights offering or similar 109 Page 108 event affecting shares of the Company, the Committee shall equitably adjust the limitation on the number and class of share units which may be allocated to Participants as Common Share Retirement Compensation, and the number of share units previously allocated to their Accounts. Section 11.02 Designation of Beneficiaries Each Participant shall have the right, by written instruction to the Committee, on a form supplied by the Committee, to designate one or more primary and contingent Beneficiaries (and the proportion to be paid to each, if more than one is designated) to receive his or her Account balance upon his or her death. Any such designation shall be revocable by the Participant. Section 11.03 Committee Actions All actions of the Committee hereunder may be taken with or without a meeting. If taken without a meeting, the action shall be in writing and signed by a majority of the members of the Committee and if taken with a meeting, a majority of the Committee shall constitute a quorum for any such action. The determination by the Committee as to the withholding of taxes shall be binding upon the Participants and their Beneficiaries. Section 11.04 Assignment No benefit under the Plan shall be subject to anticipation, alienation, sale, transfer or encumbrance, and any attempt to do so shall be void. No benefit hereunder shall in any manner be liable for the debts, contracts, or liabilities of the person entitled to such benefits. If the Participant or Beneficiary shall become bankrupt, or attempt to anticipate, alienate, sell, transfer or encumber any benefit hereunder, then such benefit shall, in the discretion of the Committee, cease and terminate, and the Committee may hold or apply the same for the benefit of the Participant or his or her spouse, children, or other dependents, or any of them, in such manner and in such amounts and proportions as the Committee may deem proper. During a Participant's lifetime, rights hereunder are exercisable only by the Participant or that person's guardian or legal representative. Notwithstanding the foregoing, nothing in this Section shall prohibit the transfer of any benefit by will or by the laws of descent and distribution or (if permitted by applicable regulations under Section 16(b) of the Securities Exchange Act) pursuant to a qualified domestic relations order, as defined under the Internal Revenue Code and the Employee Retirement Income Security Act. 110 Page 109 Section 11.05 No Funding Required The obligations of Eaton to make payments shall be a liability of Eaton to the Participant. Eaton shall not be required to maintain any separate fund or reserve, or purchase or acquire life insurance on a Participant's life, or otherwise segregate assets to assure that any particular asset of Eaton is available to make such payments by reason of Eaton's obligations hereunder. Nothing contained in the Plan shall be construed as creating a trust or other fiduciary relationship between Eaton and a Participant or any other person. Section 11.06 No Employment Contract The Plan shall not be deemed to constitute a contract of employment between Eaton and a Participant. Neither shall the execution of the Plan nor any action taken by Eaton or the Committee pursuant to the Plan confer on a Participant any legal right to be continued in any other capacity with Eaton whatsoever. Section 11.07 Governing Law The Plan shall be construed and governed in accordance with the law of the State of Ohio to the extent not covered by Federal law. Section 11.08 Effective Date The Plan was originally adopted by the Board on June 22, 1994 and was amended by the Committee and restated effective as of October 1, 1997. 111 Page 110 Eaton Corporation 2000 Annual Report on Form 10-K Item 14(c) Exhibit 10(j) Executive Incentive Compensation Plan I. Purpose The purpose of the Plan is to provide an annual incentive compensation opportunity for eligible employees in executive, administrative, professional, technical, or advisory positions whose actions are considered to have a significant impact on corporate performance. II. Administration The Plan is adopted by the Board of Directors of Eaton Corporation and may be amended, modified or discontinued as the Board,in its sole discretion, may deem necessary. The Plan is administered by the Management Compensation Committee (the "Committee"), which shall consist of the Chief Executive Officer and up to four officers designated by the Chief Executive Officer. The Committee shall have complete authority to interpret all provisions of the Plan consistent with the law. III. Concept The Plan is based on the concept that those individuals in positions that have an opportunity to significantly affect company results should have a significant portion of their total compensation at risk and linked to business and individual results. IV. Eligibility Any salaried employee of the Corporation or any of its subsidiaries (including any subsidiary acquired after adoption of this Plan) who in the judgment of the Commit- tee meets the criteria described in Article I may be selected for participation in the Plan. The Committee will have final authority for designating participants in the Plan, but may delegate this authority, as it deems advisable. An employee may be designated as a participant on the first of any month following the approval of the Committee or its designee. 112 Page 111 V. Calculation of Incentive Compensation Payments Plan participants will be placed into one of three (3) Incentive Compensation Programs within the overall Plan. These three Programs are: Operations Program - which will include participants who are assigned to operating units. Corporate Staff Program - which will include participants who are members of corporate staff functional departments. Executive Management Program - which will include senior elected officers. The total Corporate Incentive Pool will be created by multiplying participants' salary grade midpoints by target Percentage Incentive Factors appropriate for their respective levels of responsibility. The aggregate pool amount will then be multiplied by the Corporate Performance Factor to determine the Initial Adjusted Corporate Incentive Pool. The Corporate Performance Factor raises or lowers the Initial Corporate Incentive Pool based on Eaton's performance as measured by Cash Flow Return on Gross Capital (CFR). A philosophical cornerstone of the Plan is the belief that consistently high CFR performance will result in increases in shareholder value. The Compensation and Organization Committee of the Board will establish the Corporate Performance Factor Schedule. This schedule will define the threshold, target, and maximum CFR goals and pool adjustment levels for the designated year. This process determines the maximum amount of the Initial Adjusted Corporate Incentive Pool but is not linked to the incentive distribution process. The Compensation and Organization Committee of the Board of Directors, in its sole discretion, will determine the Final Adjusted Corporate Incentive Pool by multiplying the Initial Adjusted Corporate Incentive Pool by a Corporate Performance Incentive Pool Modifier which can affect the initial incentive pool by as much as plus or minus twenty (20%) percent. In applying the Corporate Performance Incentive Pool Modifier, the Committee will take into consideration such other performance factors as it deems appropriate which may include, but are not limited to: performance versus Profit Plan goals; performance versus that reported for Eaton's peer companies and progress toward the execution of the corporation's growth strategies. The process of allocating the incentive funds is based upon performance ratings. In the Operations Program, each appropriate operating unit will be given a rating on a scale from zero (0) 113 Page 112 to 150. Participants in each program will be given individual ratings based on the same scale. These ratings will be established by a senior officer, subject to final review and approval by the Chief Executive Officer, and will be based primarily upon the success of the unit and/or individual in meeting pre-established objectives. If is intended that the ratings process should allow maximum flexibility for the recognition of unanticipated challenges and opportunities, which may not have been contemplated at the time the original objectives were established. While it is not necessary that the entire Final Adjusted Corporate Incentive Pool be allocated to participants, the total of all awards made to participants throughout the Corporation cannot be greater than the sum of the pools of all three programs. Excepted from this provision are the awards made to designated employees by the Compensation and Organization Committee of the Board of Directors, which shall be calculated in a manner consistent with the Plan, but which shall be paid from the Corporation's General Funds rather than the Corporate Incentive Pool. At the sole discretion of the Chief Executive Officer, money not distributed from one program may be reallocated to another program. VI. Other Provisions The Plan provides for a Special Award Fund which will allow the Compensation and Organization Committee of the Board of Directors, on an exception basis, to award special payments to individual participants who, in that Committee's judgment, have made extraordinary contributions to the Corporation in a year when there would normally be no incentive compensation payment due to below threshold corporate performance. The maximum amount of such awards is defined in Article X of this Plan. Note: When assigning individual ratings a specific effort is made to reward extraordinary job performance. To accomplish this senior officers are expected to allocate ratings above 100 based on clearly demonstrated and exceptional job performance, leadership and initiative. The remainder of that business unit and/or department incentive pool will be allocated, again by job performance, to the remaining participants. As a natural consequence of this process the individual rating will generally average 100. However, because the Plan is designed to reward exceptional performance with ratings well above 100, fully competent performers can expect individual ratings that may average below 100. 114 Page 113 VII. Payment Incentive compensation will be paid in the year subsequent to the year in which it is earned at the earliest feasible date following the determination of final corporate performance and the calculation of individual incentive payments. VIII. Service for Part of Year A participant must be employed by the Company or one of its subsidiaries at the end of an Award Period in order to be entitled to a payment in respect to such Award Period; provided, however, that a payment, prorated for the participant's months of participation during the Award Period, may be authorized by the Committee, in its sole discretion, in the event the employment of a participant terminates before the end of an Award Period due to death, permanent disability, normal or early retirement, closure or divestiture of an Eaton facility or any other reason. IX. Accounting Provisions Awards paid out under the provisions of the Plan to participants in the Operations Program will be accrued for and charged to the appropriate units. Awards to participants in the Executive Management and Corporate Staff Programs will be accrued for and charged as a corporate administrative expense. X. Definitions of Special Terms INCENTIVE POTENTIAL - The amount derived from multiplying a participant's midpoint by the target percentage incentive factor appropriate for the position's level of responsibility. This calculation is made prior to any adjustment for corporate, group or individual results. INITIAL ADJUSTED CORPORATE INCENTIVE POOL - The sum of the Incentive Potential for all participants in each of the three programs multiplied by the Corporate Performance Factor. FINAL ADJUSTED CORPORATE INCENTIVE POOL - The result obtained by multiplying the Initial Adjusted Corporate Incentive Pool by the Corporate Performance Modifier as described in Section V. CORPORATE PERFORMANCE FACTOR - Adjustment percentages which raise or lower the Corporate Incentive Pool based on Eaton's performance. The following schedule will be applied to the 2000 incentive pool adjustment. 115 Page 114 Corporate Performance CFR Factor 14.75% Threshold 40% 20.30% Target 100% 21.40% Maximum 200% CASH FLOW RETURN ON GROSS CAPITAL - Net income plus depreciation, goodwill amortization and after-tax net interest divided by capital plus accumulated depreciation multiplying a participant's midpoint by the target percentage minus goodwill and short-term investments. SPECIAL AWARD FUND - An amount not greater than twenty (20%) percent of the sum of the Corporate Incentive Pool. The Compensation and Organization Committee of the Board of Directors will have sole authority to grant up to the maximum of this Fund to recognize extraordinary contributions to the Corporation in a year when the CFR threshold was not met and the Plan did not generate payments for participants. MIDPOINT - The midpoint of the base salary range for each participant's level of responsibility that is effective as of July 1st of each new incentive year. PERCENTAGE INCENTIVE FACTOR SCHEDULE - A schedule outlining the percentage to be applied against the midpoint of the base salary range of each level of participant in order to determine the participant's Incentive Potential. The incentive factor will vary according to level of responsibility and may be changed from time to time to reflect the competitive practices for companies comparable to Eaton. The schedule will be established by the Compensation Department subject to review and approval of the Compensation and Organization Committee of the Board of Directors. 116 Page 115 Eaton Corporation 2000 Annual Report on Form 10-K Item 14(c) Exhibit 12 Ratio of Earnings to Fixed Charges
Year ended December 31 ----------------------------------------------------------------------- 2000 1999 1998 1997 1996 -------------- ------------- ------------- ------------- -------------- Income from continuing operations Before income taxes & extraordinary item $ 552 $ 943 $ 616 $ 730 $ 428 Adjustments Minority interests in Consolidated subsidiaries 8 2 (2) 1 1 Income of equity investees (1) (1) (1) (3) (4) Interest expensed 182 159 93 86 85 Amortization of debt issue costs 1 1 1 Estimated portion of rent expense Representing interest 39 36 28 25 23 Amortization of capitalized interest 10 8 7 8 8 Distributed income of equity Investees 1 1 2 3 -------------- ------------- ------------- ------------- -------------- Adjusted income from continuing Operations before income taxes & extraordinary item $ 792 $1,147 $ 742 $ 850 $ 545 ============== ============= ============= ============= ============== Fixed Charges Interest expensed $ 182 $ 159 $ 93 $ 86 $ 85 Interest capitalized 22 21 16 12 8 Amortization of debt issue costs 1 1 1 Estimated portion of rent expense Representing interest 39 36 28 25 23 -------------- ------------- ------------- ------------- -------------- Total fixed charges $ 244 $ 216 $ 137 $ 124 $ 117 ============== ============= ============= ============= ============== Ratio of earnings to fixed charges 3.25 5.31 5.42 6.85 4.66
117 Page 116 Eaton Corporation 2000 Annual Report on Form 10-K Item 14(c) Exhibit 21 Subsidiaries of Eaton Corporation Eaton is publicly held and has no parent corporation. Eaton's subsidiaries, the state or country in which each was organized, and the percentage of voting securities owned by Eaton or another Eaton subsidiary as of December 31, 2000 are as follows:
Percentage of voting securities Consolidated Where owned (by Eaton unless subsidiaries (A) Organized otherwise indicated) - ------------------------------------------------------------------------------------------------------------------------ Vorad Safety Systems, Inc. California 100% IVHS Technologies, Inc. Aeroquip International Inc. Delaware 77% Eaton Aeroquip Inc. 23% Vickers International Inc. Cutler-Hammer de Puerto Rico Inc. Delaware 100% Cutler-Hammer Inc. Cutler-Hammer Inc. Delaware 100% Integrated Partial Discharge Delaware 100% Cutler-Hammer Inc. Diagnostics, Inc. (IPDD) Eaton Administration Corporation Delaware 100% Eaton Aerospace LLC Delaware 100% Eaton Hydraulics Inc. Eaton ESC Holding Company Delaware 100% Eaton International Corporation Delaware 100% Eaton Truck Systems, Inc. Delaware 100% Eaton USEV Holding Company Delaware 100%
118 Page 117 Eaton VORAD Technologies, L.L.C. Delaware 93.3% Eaton Truck Systems, Inc. (Partnership) 6.7% Vorad Safety Systems, Inc. ERC Corporation Delaware 100% Eaton Leasing Corporation ERC II Corporation Delaware 100% Eaton Leasing Corporation IVHS Technologies, Inc. Delaware 69.8% M.C. Aerospace Corporation Delaware 100% Eddot Company Modern Molded Products, Inc. Delaware 100% Kate Patrick Mfg. Inc. Delaware 100% Modern Molded Products, Inc. Kelmac Grip, L.P. Delaware 92% Modern Molded Products, Inc. 8% Kate Patrick Mgf. Inc. Eaton Hydraulics Inc. Delaware 100% Eaton Aeroquip Inc. Vickers International Inc. Delaware 100% Eaton Aeroquip Inc. Eaton Asia Investments Corporation Maryland 100% Eaton Aeroquip Inc. Michigan 100% Aeroquip-Vickers Inc. Aeroquip Inoac Company (Partnership) Michigan 51% Eaton Aeroquip Inc. CAPCO Automotive Products Corporation Michigan 100% Eddot Company Michigan 100% Eaton Hydraulics Inc.
119 Page 118 G.T. Products, Inc. Michigan 100% Aeroquip-Vickers, Inc. Ohio 100% Cutler-Hammer IDT, Inc. Ohio 100% Eaton Consulting Services Corporation Ohio 100% Eaton Leasing Corporation Ohio 100% Eaton MDH Co. Inc. Ohio 100% Eaton MDH Limited Partnership Ohio 1% 99% Eaton MDH Co. Inc. Eaton Properties Corporation Ohio 100% Eaton Leasing Corporation Eaton Utah Corporation Ohio 100% Eaton Leasing Corporation U.S. Engine Valve (Partnership) Ohio 5.607% 70% Eaton USEV Holding Company Summa Manufacturing Corporation Tennessee 100% Eaton Hydraulics Inc. Eaton S.A. Argentina 100% Vickers Systems Pty. Ltd. Australia 100% Vickers International Inc. Cutler-Hammer Controls Pty. Ltd. Australia 99.99996% Eaton International Corporation .00004% Eaton Pty. Ltd. Eaton Finance Pty. Ltd. Australia 100% Eaton International Corporation Eaton Finance G.P. Australia 99.834% Eaton Finance Pty. Ltd. .166% Eaton Specialty Controls Pty. Ltd.
120 Page 119 Eaton Pty. Ltd. Australia 100% Eaton Specialty Controls Pty. Ltd. Australia 99.9996% .0004% Eaton International Corporation Eaton Holding G.m.b.H. Austria 100% Eaton International Corporation A-VIC Limited Barbados 100% Aeroquip International Inc. Aeroquip Ltd. Barbados 100% Aeroquip-Vickers Canada Inc. Aeroquip-Vickers Assurance Ltd. Barbados 100% Aeroquip-Vickers Inc. Eaton Foreign Sales Corporation Barbados 100% Eaton Holding Limited Barbados 100% Eaton Yale Ltd. Eaton Services Limited Barbados 100% Eaton Holding Limited Saturn Insurance Company Ltd. Bermuda Islands 100% Aeroquip do Brasil S.A. Brazil 99.5% Aeroquip-Vickers International Inc. Eaton Ltda. Brazil 65.0428% Eaton Services Limited 34.9572% Eaton International Corporation Eaton Truck Components Ltda. Brazil 21.135% 78.865% CAPCO Automotive Products Corporation Vickers do Brasil Ltda. Brazil 100% Vickers International Inc. Aeroquip-Vickers Inc. Canada 100% Aeroquip International Inc.
121 Page 120 Eaton ETN Offshore Ltd. Canada 100% Common Shares - Eaton Corporation 100% Preferred Shares - Eaton International Corporation Eaton Yale Ltd. Canada 100% Eaton ETN Offshore Ltd. Electrotechnique GFTL, Inc. Canada 100% Eaton Yale Ltd. Eaton Holding I Limited Cayman Islands 100% Eaton Holding III Limited Eaton Holding II Limited Cayman Islands 100% Eaton Holding III Limited Eaton Holding III Limited Cayman Islands 100% Eaton Holding G.m.b.H. Eaton Hydraulics (Shanghai)Co., Ltd. China 100% Eaton China Investment Co., Ltd. Eaton Truck and Bus Components Company China 100% Eaton China Investment Co., Ltd. (Shanghai) Ltd. Eaton China Investments Co., China 100% Eaton Asia Investments Ltd. Corporation Jining Eaton Hydraulics Company Ltd. China 60% Shanghai Eaton Engine Components China 69.42% Eaton China Investment Co., Ltd. Company, Ltd. Cutler-Hammer (Suzhou) Electric Co., China 100% Ltd. Vickers Hydraulic Systems (China) Co., China 100% Vickers International Inc. Ltd. Eaton Controles Costa Rica 100% Eaton
122 Page 121 Industriales S.A. International Corporation Cutler-Hammer, S.A. Dominican Republic 100% Cutler-Hammer Inc. Aeroquip-Vickers S.A. France 61% Aeroquip International Inc. 39% Vickers International Inc. Eaton Automotive Controls Srl France 100% Eaton Technologies S.A. Eaton S.A. France 100% Eaton Technologies S.A. France 55% 45% Eaton International Corporation Aeroquip Wolfsburg G.m.b.H. & Co. KG Germany 100% Aeroquip-Vickers International (Partnership) G.m.b.H. Aeroquip Wolfsburg Verwaltungs G.m.b.H. Germany 100% Aeroquip International Inc. Aeroquip-Vickers International G.m.b.H. Germany 94.9% Eaton Holding G.m.b.H. 5.1% Eaton Aeroquip Inc. Eaton Automotive G.m.b.H. Germany 100% Eaton G.m.b.H. Eaton Controls G.m.b.H. & Co. K.G. Germany 99.33% Eaton Yale Ltd. (Canada) (Partnership) .67% Eaton G.m.b.H. Eaton G.m.b.H. Germany .1% 99.9% Eaton Holding G.m.b.H Eaton Holding G.m.b.H. Germany 100% Eaton B.V. Eaton Limited Hong Kong 100% Eaton International Corporation
123 Page 122 Vickers Systems Limited Hong Kong 99.995% Vickers International Inc. .005% Vickers System Inc. Eaton Industries Private Ltd. India .01% 99.99% Eaton International Corporation Vickers Systems International Ltd. India 51% Vickers, Incorporated Aeroquip-Vickers S.p.A. Italy 99.88% Eaton Srl .06% Aeroquip Corporation Eaton Automotive Srl Italy 100% Eaton Srl Eaton Srl Italy 100% Eaton B.V. Hydroline Srl Italy 100% Aeroquip-Vickers SpA Eaton Japan Co., Ltd. Japan 100% Japan Fawick Company Limited Japan 50% Sumitomo Eaton Hydraulics Co., Ltd. Japan 50% Vickers Systems Sdn. Bhd. Malaysia 100% Vickers International Inc. Cutler-Hammer Controls Sdn. Bhd. Malaysia 100% Eaton International Corporation Aeroquip de Mexico S.A. de C.V. Mexico 99.8% Controladora Aeroquip-Vickers de Mexico S.A. de C.V. .2% Aeroquip International Inc. Aeroquip S.A. de C.V. Mexico 99.998% Controladora Aeroquip-Vickers de Mexico S.A. de C.V.
124 Page 123 .002% Eaton Aeroquip Inc. Aeroquip Servicios S.A. de C.V. Mexico 99.998% Aeroquip International Inc. .002% Eaton Aeroquip Inc. Condura S. de R.L. de C.V. Mexico 99.999556% .000444% Eaton Controls S. de R.L. de C.V. Controladora Aeroquip-Vickers de Mexico 99.8% Aeroquip International Inc. Mexico S.A. de C.V. .2% Aeroquip-Vickers Inc. Cutler-Hammer Mexicana, S.A. Mexico 100% Eaton International Corporation Eaton Controls, S. de R.L. de C.V. Mexico 99% 1% Condura S. de R.L. de C.V. Eaton Molded Products S. de R.L. de Mexico 99.9999985% C.V. .0000015% Condura S. de R.L. de C.V. Eaton Truck Components, S. de R.L. de Mexico 99.995% C.V. .005% Condura S. de R.L. de C.V. Operaciones de Maquila de Juarez S. de Mexico 99.956% Cutler-Hammer Inc. R.L. de C.V. .044% Condura S de. R.L. de C.V. Eaton s.a.m. Monaco 100% Eaton Automotive B.V. Netherlands 100% IKU Holding Montfoort B.V. Eaton B.V. Netherlands 100% Eaton Holding International I B.V. Eaton C.V. (Partnership) Netherlands 99.9% Eaton Holding III Limited .1% Eaton International Corporation Eaton Holding B.V. Netherlands 100% Eaton B.V.
125 Page 124 Eaton Holding International I B.V. Netherlands 100% Aeroquip International Inc. Eaton International B.V. Netherlands 100% IKU Holding Montfoort B.V. Netherlands 100% Eaton Holding B.V. Eaton Finance B.V. Netherlands 100% Eaton B.V. Hydrowa B.V. Netherlands 100% Eaton Holding B.V. Eaton Finance N.V. Netherlands Antilles 45% 55% Eaton International Inc. Vickers Systems Limited New Zealand 100% Vickers International Inc. Aeroquip-Vickers International Inc. Panama 100% Aeroquip A.G. Cutler-Hammer Asia Corporation Philippines 100% Eaton International Corporation Eaton Automotive Spolka z o.o. Poland 100% Eaton Automotive Srl Eaton Controls Spolka z o.o. Poland 100% Eaton Holding B.V. Eaton Truck Components S.A. Poland 99.51% Eaton B.V. Aeroquip Singapore Pte. Limited Singapore 100% Aeroquip International Inc. Aeroquip-Vickers Pte. Ltd. Singapore 100% Vickers International Inc. Cutler-Hammer Pte. Ltd. Singapore 100% Eaton International Corporation Vickers Systems Asia Pacific Pte. Ltd. Singapore 100% Vickers International Inc.
126 Page 125 Aeroquip South Africa (Pty.) Ltd. South Africa 100% Aeroquip International Inc. Eaton Truck Components (Pty) Limited South Africa 100% Eaton Limited Vickers Systems Korea Ltd. South Korea 100% Vickers International Inc. Eaton Automotive Controls Limited South Korea 100% Eaton International Corporation Eaton Limited South Korea 100% Aeroquip Iberica S.A. Spain 100% Aeroquip International Inc. Eaton S.A. Spain 49.86% 50.14% Eaton International B.V. Eaton Ros S.A. Spain 100% Eaton S.A. Productos Eaton Livia S.A. Spain 48% Eaton S.A. 52% Eaton International B.V. Vickers Systems AB Sweden 100% Vickers International Inc. Aeroquip A.G. Switzerland 100% Aeroquip International Inc. Eaton SA Switzerland 100% Eaton Limited Taiwan 19.4% 80.6% Eaton International Corporation Modern Molded Products Limited Taiwan 100% Eaton International Corporation Vickers Systems Ltd. Taiwan 99.996% Vickers International Inc. .001% Aeroquip-Vickers Inc.
127 Page 126 .001% Aeroquip Corporation .001% Vickers, Incorporated Eaton Technologies Limited Thailand 100% Rubberon Technology Corporation Limited Thailand 100% Aeroquip-Vickers Limited United Kingdom 100% Eaton Holding Ltd. Cutler-Hammer Europa Pension Trustees United Kingdom 50% Eaton Limited Ltd. 50% Eaton Financial Services Limited Eaton Financial Services Limited United Kingdom 100% Eaton Limited Eaton Holding Limited United Kingdom 100% Eaton B.V. Eaton Limited United Kingdom 100% Eaton Holding Limited Eaton Shared Services Limited United Kingdom 100% Eaton Holding Limited Aeroquip-Vickers Export Trading Company U.S. Virgin Islands 100% Aeroquip-Vickers Inc. Cutler-Hammer de Venezuela S.A. Venezuela 100% Eaton International Corporation
(A) Other Eaton subsidiaries, many inactive, are not listed above. If considered in the aggregate, they would not be material. 128 Page 127 Eaton Corporation 2000 Annual Report on Form 10-K Item 14(c) Exhibit 23 Consent of Independent Auditors We consent to the incorporation by reference in the following Registration Statements and related Prospectuses of our report dated January 19, 2001, with respect to the consolidated financial statements of Eaton Corporation included in this Form 10-K for the year ended December 31, 2000:
Registration Number Description Filing Date - ------------------------------------------------------------------------------------------------------------------------ 333-43876 Eaton Corporation 401(k) Savings Plan - Form S-8 August 16, 2000 Registration Statement - 500,000 Shares 333-35946 Deferred Incentive Compensation Plan - Form S-8 May 1, 2000 Registration Statement - 375,000 Shares 333-86391 Aeroquip-Vickers Savings and Profit Sharing Plan - Form September 2, 1999 S-8 Registration Statement 333-86389 Eaton Corporation Executive Strategic Incentive Plan - September 2, 1999 Form S-8 Registration Statement 333-77245 Eaton Corporation 401(k) Savings Plan - Form S-8 April 28, 1999 Registration Statement 333-77243 Eaton Corporation Share Purchase and Investment Plan - April 28, 1999 Form S-8 Registration Statement 333-74355 Eaton Corporation $1,400,000,000 of Debt Securities, Debt March 12, 1999 Warrants, Common Shares and Preferred Shares - Form S-3 Registration Statement (Including Post Effective Amendment No. 1 filed on April 23, 1999 and Amendment No. 2 filed on May 11, 1999) 333-62375 Eaton Corporation 1998 Stock Plan - Form S-8 Registration August 27, 1998 Statement
129 Page 128 333-62373 Eaton Holding Limited U.K. Savings-Related Share Option August 27, 1998 Scheme [1998] - Form S-8 Registration Statement 333-46861 Eaton Limited U.K. Savings-Related Share Option Scheme February 25, 1998 [1991] - Form S-8 Registration Statement 333-45575 Eaton Limited U.K. Savings-Related Share Option Scheme February 4, 1998 [1991] - Form S-8 Registration Statement 333-35697 Cutler-Hammer de Puerto Rico Company Retirement Savings September 16, 1997 Plan - Form S-8 Registration Statement 333-28869 Eaton 401(k) Savings Plan and Trust - Form S-8 June 10, 1997 Registration Statement 333-25693 Eaton Corporation Shareholder Dividend Reinvestment Plan - April 23, 1997 Form S-3 Registration Statement 333-23539 Eaton Non-Employee Director Fee Deferral Plan - Form S-8 March 18, 1997 Registration Statement 333-22597 Eaton Incentive Compensation Deferral Plan - Form S-8 March 13, 1997 Registration Statement 333-13873 Eaton Corporation Investment Plan for Hourly Employees of October 10, 1996 the Hydraulics Division - Hutchinson Plant - Form S-8 Registration Statement 333-13869 Lincoln Plant Share Purchase and Investment Plan and Trust October 10, 1996 - Form S-8 Registration Statement 333-13861 Eaton Corporation 401(k) Savings Plan for the Hourly Rate October 10, 1996 Employees at Airflex Division - Form S-8 Registration Statement
130 Page 129 333-13855 Eaton Winamac Hourly Investment Plan and Trust - Form S-8 October 10, 1996 Registration Statement 333-03599 Eaton Corporation Share Purchase and Investment Plan - May 13, 1996 Form S-8 Registration Statement 333-01365 Eaton Corporation Incentive Compensation Deferral Plan - March 1, 1996 Form S-3 Registration Statement 33-64201 Eaton Corporation $120,837,500 of Debt Securities and Debt November 14, 1995 Warrants - Form S-3 Registration Statement 33-60907 Eaton 1995 Stock Plan - Form S-8 Registration Statement July 7, 1995 33-52333 Eaton Corporation $600,000,000 of Debt Securities, Debt February 18, 1994 Warrants, Common Shares and Preferred Shares - Form S-3 Registration Statement 33-49779 Eaton Limited U.K. Savings-Related Share Option Scheme July 16, 1993 [1991] - Form S-8 Registration Statement 33-49393 & Eaton Corporation Stock Option Plans - Form S-8 March 9, 1993 33-12842 Registration Statement 33-15582 Eaton Limited U.K. Savings-Related Share Option Scheme - July 7, 1987 Form S-8 Registration Statement
/s/ Ernst & Young LLP Cleveland, Ohio March 5, 2001 131 Page 130 Eaton Corporation 2000 Annual Report on Form 10-K Item 14(c) Exhibit 24 Power of Attorney KNOW ALL MEN BY THESE PRESENTS: That each person whose name is signed below has made, constituted and appointed, and by this instrument does make, constitute and appoint, Adrian T. Dillon, Billie K. Rawot or William J. Nowak his or her true and lawful attorney, for him or her and in his or her name, place and stead to subscribe, as attorney-in-fact, his or her signature as Director or Officer or both, as the case may be, of Eaton Corporation, an Ohio corporation, to its Annual Report on Form 10-K for the year ended December 31, 2000 pursuant to the Securities Exchange Act of 1934, and to any and all amendments to that Annual Report, hereby giving and granting unto each such attorney-in-fact full power and authority to do and perform every act and thing whatsoever necessary to be done in the premises, as fully as he or she might or could do if personally present, hereby ratifying and confirming all that each such attorney-in-fact shall lawfully do or cause to be done by virtue hereof. This Power of Attorney shall not apply to any Annual Report on Form 10-K or amendment thereto filed after December 31, 2001. IN WITNESS WHEREOF, this Power of Attorney has been signed this 27th day of February, 2001. /s/ Alexander M. Cutler /s/ Deborah L. McCoy - ---------------------------------------------------------- ----------------------------------------------------------------- Alexander M. Cutler Deborah L. McCoy Chairman and Chief Executive Director Officer; President; Director /s/ Adrian T. Dillon /s/ John R. Miller - ---------------------------------------------------------- ----------------------------------------------------------------- Adrian T. Dillon John R. Miller Executive Vice President--Chief Director Financial and Planning Officer; Principal Financial Officer /s/ Billie K. Rawot /s/ Victor A. Pelson - ---------------------------------------------------------- ----------------------------------------------------------------- Billie K. Rawot Victor A. Pelson Vice President and Controller; Director Principal Accounting Officer /s/ A. William Reynolds /s/ Michael J. Critelli ----------------------------------------------------------------- - ---------------------------------------------------------- A. William Reynolds Michael J. Critelli Director /s/ Ernie Green - ---------------------------------------------------------- Ernie Green
132 Page 131 Director Director /s/ Ned C. Lautenbach /s/ Gary L. Tooker - ---------------------------------------------------------- ----------------------------------------------------------------- Ned C. Lautenbach Gary L. Tooker Director Director
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