ETN 06.30.2011 10-Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2011
Commission file number 1-1396
EATON CORPORATION
(Exact name of registrant as specified in its charter)

Ohio
 
34-0196300
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification Number)
 
 
 
Eaton Center, Cleveland, Ohio
 
44114-2584
(Address of principal executive offices)
 
(Zip Code)
 
 
 
(216) 523-5000
 
 
 
 
 
 
(Registrant's telephone number, including area code)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Not applicable
 
 
 
 
 
 
(Former name, former address and former fiscal year if changed since last report)
 
 
 
 
 
 
 
 
 

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 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
 
Accelerated filer o
 
       Non-accelerated filer o
 
Smaller reporting company o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ
There were 341.1 million Common Shares outstanding as of June 30, 2011.
 

Table of Contents

TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
EX-101 INSTANCE DOCUMENT
 
EX-101 SCHEMA DOCUMENT
 
EX-101 CALCULATION LINKBASE DOCUMENT
 
EX-101 LABELS LINKBASE DOCUMENT
 
EX-101 PRESENTATION LINKBASE DOCUMENT
 
EX-101 DEFINITION LINKBASE DOCUMENT
 



Table of Contents

PART 1 — FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS.

EATON CORPORATION
CONSOLIDATED STATEMENTS OF INCOME

 
Three months ended
June 30
 
Six months ended
June 30
(In millions except for per share data)
2011
 
2010
 
2011
 
2010
Net sales
$
4,090

 
$
3,378

 
$
7,893

 
$
6,481

 
 
 
 
 
 
 
 
Cost of products sold
2,862

 
2,387

 
5,544

 
4,588

Selling and administrative expense
698

 
604

 
1,363

 
1,191

Research and development expense
107

 
103

 
212

 
204

Interest expense-net
31

 
34

 
63

 
69

Other income-net
(4
)
 
(1
)
 
(20
)
 
(9
)
Income before income taxes
396

 
251

 
731

 
438

Income tax expense
58

 
22

 
107

 
53

Net income
338

 
229

 
624

 
385

Less net income for noncontrolling interests
(2
)
 
(3
)
 
(1
)
 
(4
)
Net income attributable to Eaton common shareholders
$
336

 
$
226

 
$
623

 
$
381

 
 
 
 
 
 
 
 
Net income per common share
 
 
 
 
 
 
 
Diluted
$
0.97

 
$
0.66

 
$
1.80

 
$
1.12

Basic
0.99

 
0.67

 
1.83

 
1.14

 
 
 
 
 
 
 
 
Weighted-average number of common shares outstanding
 
 
 
 
 
 
 
Diluted
345.7

 
340.4

 
345.7

 
339.8

Basic
340.9

 
334.7

 
340.5

 
334.5

 
 
 
 
 
 
 
 
Cash dividends paid per common share
$
0.34

 
$
0.25

 
$
0.68

 
$
0.50


Net income per common share, weighted-average number of common shares outstanding and cash dividends paid per common share have been restated to give effect to the two-for-one stock split. See Note 1 for additional information.
The accompanying notes are an integral part of these condensed consolidated financial statements.

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Table of Contents

EATON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions)
June 30,
2011
 
December 31,
2010
Assets
 
 
 
Current assets
 
 
 
Cash
$
282

 
$
333

Short-term investments
601

 
838

Accounts receivable-net
2,625

 
2,239

Inventory
1,766

 
1,564

Other current assets
643

 
532

Total current assets
5,917

 
5,506

 
 
 
 
Property, plant and equipment-net
2,589

 
2,477

 
 
 
 
Other noncurrent assets

 

Goodwill
5,723

 
5,454

Other intangible assets
2,360

 
2,272

Deferred income taxes
961

 
1,001

Other assets
571

 
542

Total assets
$
18,121

 
$
17,252

 
 
 
 
Liabilities and shareholders’ equity
 
 
 
Current liabilities
 
 
 
Short-term debt
$
101

 
$
72

Current portion of long-term debt
16

 
4

Accounts payable
1,534

 
1,408

Accrued compensation
367

 
465

Other current liabilities
1,385

 
1,284

Total current liabilities
3,403

 
3,233

 
 
 
 
Noncurrent liabilities
 
 
 
Long-term debt
3,650

 
3,382

Pension liabilities
1,222

 
1,429

Other postretirement benefits liabilities
639

 
743

Deferred income taxes
499

 
487

Other noncurrent liabilities
521

 
575

Total noncurrent liabilities
6,531

 
6,616

 
 
 
 
Shareholders’ equity
 
 
 
Eaton shareholders’ equity
8,152

 
7,362

Noncontrolling interests
35

 
41

Total equity
8,187

 
7,403

Total liabilities and equity
$
18,121

 
$
17,252


The accompanying notes are an integral part of these condensed consolidated financial statements.

3

Table of Contents

EATON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 
Six months ended
June 30
(In millions)
2011
 
2010
Operating activities
 
 
 
Net income
$
624

 
$
385

Adjustments to reconcile to net cash provided by operating activities
 
 
 
Depreciation and amortization
280

 
277

Contributions to pension plans
(309
)
 
(349
)
Contributions to other postretirement benefits plans
(132
)
 
(39
)
Changes in working capital
(472
)
 
(121
)
Other-net
56

 
154

Net cash provided by operating activities
47

 
307

 
 
 
 
Investing activities
 
 
 
Cash paid for acquisitions of businesses
(212
)
 

Capital expenditures for property, plant and equipment
(221
)
 
(101
)
Sales (purchases) of short-term investments-net
251

 
(121
)
Other-net
7

 
6

Net cash used in investing activities
(175
)
 
(216
)
 
 
 
 
Financing activities
 
 
 
Borrowings with original maturities of more than three months
 
 
 
Proceeds
307

 
55

Payments
(17
)
 
(27
)
Borrowings (payments) with original maturities of less than three months-net
   (primarily commercial paper)
18

 
(48
)
Cash dividends paid
(232
)
 
(168
)
Exercise of employee stock options
62

 
36

Repurchase of shares
(68
)
 

Other-net
(5
)
 
2

Net cash provided by (used in) financing activities
65

 
(150
)
 
 
 
 
Effect of foreign exchange rate changes on cash
12

 
(32
)
Total decrease in cash
(51
)
 
(91
)
Cash at the beginning of the period
333

 
340

Cash at the end of the period
$
282

 
$
249


The accompanying notes are an integral part of these condensed consolidated financial statements.

4

Table of Contents

EATON CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Amounts are in millions unless indicated otherwise (per share data assume dilution).

Note 1.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Eaton Corporation (Eaton or Company) have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting of normal recurring accruals) have been made that are necessary for a fair presentation of the condensed consolidated financial statements for the interim periods.
This Form 10-Q should be read in conjunction with the consolidated financial statements and related notes included in Eaton’s 2010 Form 10-K. The interim period results are not necessarily indicative of the results to be expected for the full year. Management has evaluated subsequent events through the date this Form 10-Q was filed with the SEC.
On January 27, 2011, Eaton’s Board of Directors announced a two-for-one stock split of the Company’s common shares effective in the form of a 100% stock dividend. The record date for the stock split was February 7, 2011, and the additional shares were distributed on February 28, 2011. Accordingly, all per share amounts, weighted-average shares outstanding, and equity-based compensation presented in the condensed consolidated financial statements and notes have been adjusted retroactively to reflect the stock split.
Certain prior year amounts have been reclassified to conform to the current year presentation.

Note 2.
ACQUISITIONS OF BUSINESSES
In 2011 and 2010, Eaton acquired businesses and entered into a joint venture in separate transactions. The Consolidated Statements of Income include the results of these businesses from the dates of the transactions or formation. These transactions are summarized below:
Acquired business
 
Date of
transaction
 
Business
segment
 
Annual sales
ACTOM Low Voltage
 
June 30,
2011
 
Electrical
Rest of World
 
$65 for the
year ended
May 31,
2011
A South Africa manufacturer and supplier of motor control components, engineered electrical distribution systems and uninterruptible power supply (UPS) systems.
 
 
 
 
 
 
 
 
 
 
 
 
 
C.I. ESI de Colombia S.A.
 
June 2,
2011
 
Electrical
Americas
 
$8 for 2010
A Colombia-based distributor of industrial electrical equipment and engineering services in the Colombian market, focused on oil and gas, mining, and industrial and commercial construction.
 
 
 
 
 
 
 
 
 
 
Internormen Technology Group
 
May 12,
2011
 
Hydraulics
 
$55 for 2010
A Germany-based manufacturer of hydraulic filtration and instrumentation with sales and distribution subsidiaries in China, the United States, India and Brazil.
 
 
 
 
 
 
 
 
 
 
Eaton-SAMC (Shanghai) Aircraft Conveyance System Manufacturing Co., Ltd.
 
March 8,
2011
 
Aerospace
 
New joint venture
A 49%-owned joint venture in China focusing on the design, development, manufacturing and support of fuel and hydraulic conveyance systems for the global civil aviation market.
 
 
 
 
 
 
 
 
 
 
Tuthill Coupling Group
 
January 1,
2011
 
Hydraulics
 
$35 for the
year ended
November 30,
2010
A United States and France-based manufacturer of pneumatic and hydraulic quick coupling solutions and leak-free connectors used in industrial, construction, mining, defense, energy and power applications.
 
 
 
 
 
 
 
 
 
 
 
 
 
Chloride Phoenixtec Electronics
 
October 12,
2010
 
Electrical
Rest of World
 
$25 for the
year ended
September 30,
2010
A China manufacturer of UPS systems. Eaton acquired the remaining shares to increase its ownership from 50% to 100%.
 
 
 
 
 
 

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Table of Contents

Acquired business
 
Date of
transaction
 
Business
segment
 
Annual sales
CopperLogic, Inc.
 
October 1,
2010
 
Electrical
Americas
 
$35 for the
year ended
September 30,
2010
A United States-based manufacturer of electrical and electromechanical systems.
 
 
 
 
 
 
 
 
 
 
 
 
 
Wright Line Holding, Inc.
 
August 25,
2010
 
Electrical
Americas
 
$101 for the
year ended
June 30,
2010
A United States provider of customized enclosures, rack systems, and air-flow management systems to store, power, and secure mission-critical IT data center electronics.
 
 
 
 
 
 
 
 
 
 
 
 
 
EMC Engineers, Inc.
 
July 15,
2010
 
Electrical
Americas
 
$24 for 2009
A United States energy engineering and energy services company that delivers energy efficiency solutions for a wide range of governmental, educational, commercial and industrial facilities.
 
 
 
On June 30, 2011, Eaton reached an agreement to acquire E. Begerow GmbH & Co. KG, a Germany-based system provider of advanced liquid filtration solutions. This business develops and produces technologically innovative filter media and filtration systems for food and beverage, chemical, pharmaceutical and industrial applications and had sales of $84 in 2010. The terms of the agreement are subject to customary closing conditions. The acquisition is expected to close during the third quarter of 2011. This business will be included in the Hydraulics segment.

Note 3.
ACQUISITION INTEGRATION AND RESTRUCTURING CHARGES
Acquisition Integration Charges
Eaton incurs charges related to the integration of acquired businesses. A summary of these charges follows:
 
Three months ended
June 30
 
Six months ended
June 30
 
2011
 
2010
 
2011
 
2010
Business segment
 
 
 
 
 
 
 
Electrical Americas
$
1

 
$
1

 
$
4

 
$
2

Electrical Rest of World
1

 
7

 
1

 
14

Aerospace

 
1

 

 
2

Total integration charges before income taxes
$
2

 
$
9

 
$
5

 
$
18

After-tax integration charges
$
2

 
$
6

 
$
4

 
$
12

Per common share
$

 
$
0.02

 
$
0.01

 
$
0.03

Charges in 2011 were related primarily to CopperLogic, Wright Line Holding and EMC Engineers. Charges in 2010 were related primarily to Moeller and Phoenixtec. These charges were included in Cost of products sold or Selling and administrative expense, as appropriate. In Note 13. Business Segment Information, the charges reduced Operating profit of the related business segment.
Workforce Reduction and Plant Closing Liabilities
The following table summarizes the liabilities related to acquisition integration, plant closing charges, and other workforce reduction actions:
 
Workforce reductions
 
Plant closing and other
 
 
 
Employees
 
Dollars
 
 
Total
Balance at January 1, 2011
327

 
$
11

 
$
5

 
$
16

Liabilities recognized
64

 
1

 
4

 
5

Utilized
(151
)
 
(3
)
 
(7
)
 
(10
)
Balance at June 30, 2011
240

 
$
9

 
$
2

 
$
11


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Note 4.
GOODWILL
A summary of goodwill follows:
 
June 30,
2011
 
December 31,
2010
Electrical Americas
$
2,155

 
$
2,061

Electrical Rest of World
1,044

 
985

Hydraulics
1,112

 
1,007

Aerospace
1,045

 
1,037

Truck
153

 
151

Automotive
214

 
213

Total goodwill
$
5,723

 
$
5,454

The increase in goodwill in 2011 was due to foreign currency translation and businesses acquired during 2011. For additional information regarding acquired businesses, see Note 2.

Note 5.
DEBT
On June 16, 2011, Eaton completed the issuance of $300 floating rate senior unsecured Notes due June 16, 2014 (the Notes). The Notes bear interest annually at a floating rate, reset quarterly, equal to the three-month LIBOR rate for U.S. dollars plus 0.33% (33 basis points). Interest is payable quarterly in arrears beginning on September 16, 2011. The Notes contain a provision which requires the Company to make an offer to purchase all or any part of the Notes at a purchase price of 101% of the principal amount plus accrued and unpaid interest if certain change of control events occur. The Notes are subject to customary non-financial covenants.
Eaton completed the refinancing of a $500, five-year revolving credit facility in June 2011 (the facility). This refinancing maintains long-term revolving credit facilities at a total of $1.5 billion. The revolving credit facility is used to support commercial paper borrowings. The facility will expire June 16, 2016, replacing a $500 facility that had been set to expire on September 1, 2011.

Note 6.
RETIREMENT BENEFITS PLANS
The components of retirement benefits expense follow:
 
Three months ended June 30
 
United States
pension benefit expense
 
Non-United States
pension benefit expense
 
Other postretirement
benefits expense
 
2011
 
2010
 
2011
 
2010
 
2011
 
2010
Service cost
$
23

 
$
20

 
$
12

 
$
10

 
$
4

 
$
4

Interest cost
33

 
33

 
20

 
17

 
10

 
12

Expected return on plan assets
(41
)
 
(39
)
 
(18
)
 
(16
)
 

 

Amortization
19

 
13

 
3

 
2

 
3

 
2

 
34

 
27

 
17

 
13

 
17

 
18

Settlement loss
4

 
4

 
3

 

 

 

Total expense
$
38

 
$
31

 
$
20

 
$
13

 
$
17

 
$
18


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Table of Contents

 
Six months ended June 30
 
United States
pension benefit expense
 
Non-United States
pension benefit expense
 
Other postretirement
benefits expense
 
2011
 
2010
 
2011
 
2010
 
2011
 
2010
Service cost
$
46

 
$
40

 
$
25

 
$
19

 
$
8

 
$
8

Interest cost
66

 
66

 
40

 
34

 
20

 
23

Expected return on plan assets
(82
)
 
(78
)
 
(36
)
 
(31
)
 

 

Amortization
38

 
26

 
6

 
4

 
6

 
5

 
68

 
54

 
35

 
26

 
34

 
36

Settlement loss
7

 
9

 
3

 

 

 

Total expense
$
75

 
$
63

 
$
38

 
$
26

 
$
34

 
$
36

During the second quarter of 2011, Eaton contributed $100 into a Voluntary Employee Benefit Association trust for the pre-funding of postretirement Medicare Part D prescription drug benefits for the Company's eligible United States employees and retirees. The contribution was made as part of the Company's strategy to improve the funding of its pension and postretirement obligations. As part of that strategy, in the first quarter of 2011, the Company contributed $250 to its United States qualified pension plans.

Note 7.
LEGAL CONTINGENCIES
In December 2010, a Brazilian court held that a judgment obtained by a Brazilian company, Raysul, against another Brazilian company, Saturnia, which was sold by Eaton in 2006, could be enforced against Eaton Ltda. This judgment is based on an alleged violation of an agency agreement between Raysul and Saturnia. At June 30, 2011, the Company has a total accrual of 65 Brazilian Reais related to this matter, comprised of 60 Brazilian Reais recognized in the fourth quarter of 2010 ($39 based on current exchange rates) with an additional 5 Brazilian Reais recognized in 2011 ($3 based on current exchange rates) due to subsequent accruals for interest and inflation. The Company expects that any sum it may be required to pay in connection with this matter will not exceed the amount of the recorded liability. In 2010, Eaton filed motions for clarification with the Brazilian court of appeals which were denied on April 6, 2011. On July 1, 2011, Eaton Ltda. filed an appeal of this decision to the Superior Court of Justice in Brasilia.
On October 5, 2006, ZF Meritor LLC and Meritor Transmission Corporation (collectively, Meritor) filed an action against Eaton in the United States District Court for Delaware. The action sought damages, which would be trebled under United States antitrust laws, as well as injunctive relief and costs. The suit alleged that Eaton engaged in anti-competitive conduct against Meritor in the sale of heavy-duty truck transmissions in North America. Following a four week trial on liability only, on October 8, 2009, the jury returned a verdict in favor of Meritor. Eaton firmly believes that it competes fairly and honestly for business in the marketplace, and that at no time did it act in an anti-competitive manner. During an earlier stage in the case, the judge concluded that damage estimates contained in a report filed by Meritor were not based on reliable data and the report was specifically excluded from the case. On November 3, 2009, Eaton filed a motion for judgment as a matter of law and to set aside the verdict. That motion was denied on March 10, 2011. On March 14, 2011, Eaton filed a motion for entry of final judgment of liability, zero damages and no injunctive relief. On June 9, 2011, that motion was denied. On July 8, 2011, Eaton filed a motion for interlocutory appeal. Accordingly, an estimate of any potential loss related to this action cannot be made at this time.
Eaton is subject to a broad range of claims, administrative and legal proceedings such as lawsuits that relate to contractual allegations, tax audits, patent infringement, personal injuries (including asbestos claims), antitrust matters and employment-related matters. Although it is not possible to predict with certainty the outcome or cost of these matters, the Company believes they will not have a material adverse effect on the consolidated financial statements.

Note 8.
INCOME TAXES
The effective income tax rate for the second quarter of 2011 was 14.7% compared to 9.0% for the second quarter of 2010 and 14.6% for the first six months of 2011 compared to 12.2% for the first six months of 2010. Higher effective tax rates in both the second quarter and first six months of 2011 were primarily attributable to greater levels of income in high tax jurisdictions, particularly in the United States, due to improved economic conditions.

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Table of Contents

Note 9.
EQUITY
Eaton has a common share repurchase plan that authorizes the repurchase of 10 million common shares. The shares are expected to be repurchased over time, depending on market conditions, the market price of the Company’s common shares, the Company’s capital levels and other considerations. During the first six months of 2011, 1.3 million common shares were repurchased in the open market at a total cost of $68. No common shares were repurchased in the open market in the first six months of 2010.
The changes in Shareholders’ equity follow:
 
Eaton
shareholders’
equity
 
Noncontrolling
interests
 
Total
equity
Balance at December 31, 2010
$
7,362

 
$
41

 
$
7,403

 
 
 
 
 
 
Net income
623

 
1

 
624

Other comprehensive income
368

 

 
368

Total comprehensive income
991

 
1

 
992

Cash dividends paid
(232
)
 
(7
)
 
(239
)
Issuance of shares under equity-based compensation plans-net
99

 

 
99

Repurchase of shares
(68
)
 

 
(68
)
Balance at June 30, 2011
$
8,152

 
$
35

 
$
8,187

Comprehensive Income (Loss)
Comprehensive income (loss) consists primarily of net income, foreign currency translation and related hedging instruments, changes in unrecognized costs of pension and other postretirement benefits, and changes in the effective portion of open derivative contracts designated as cash flow hedges. The following table summarizes the components of Comprehensive income (loss):
 
Three months ended
June 30
 
Six months ended
June 30
 
2011
 
2010
 
2011
 
2010
Net income
$
338

 
$
229

 
$
624

 
$
385

 
 
 
 
 
 
 
 
Foreign currency translation and related hedging instruments
121

 
(307
)
 
338

 
(483
)
Pensions and other postretirement benefits
19

 
28

 
35

 
47

Cash flow hedges
(4
)
 
(5
)
 
(5
)
 
(9
)
Other comprehensive income (loss)
136

 
(284
)
 
368

 
(445
)
Total comprehensive income (loss)
474

 
(55
)
 
992

 
(60
)
Adjustment for comprehensive income attributable to noncontrolling interests
(1
)
 
(3
)
 
(1
)
 
(4
)
Total Comprehensive income (loss) attributable to Eaton common shareholders
$
473

 
$
(58
)
 
$
991

 
$
(64
)

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Table of Contents

Net Income per Common Share
A summary of the calculation of net income per common share attributable to common shareholders follows:
 
Three months ended
June 30
 
Six months ended
June 30
(Shares in millions)
2011
 
2010
 
2011
 
2010
Net income attributable to Eaton common shareholders
$
336

 
$
226

 
$
623

 
$
381

 
 
 
 
 
 
 
 
Weighted-average number of common shares outstanding-diluted
345.7

 
340.4

 
345.7

 
339.8

Less dilutive effect of stock options and restricted stock awards
4.8

 
5.7

 
5.2

 
5.3

Weighted-average number of common shares outstanding-basic
340.9

 
334.7

 
340.5

 
334.5

 
 
 
 
 
 
 
 
Net income per common share
 
 
 
 
 
 
 
Diluted
$
0.97

 
$
0.66

 
$
1.80

 
$
1.12

Basic
0.99

 
0.67

 
1.83

 
1.14

For the second quarter and first six months of 2011, 0.7 million stock options, respectively, were excluded from the calculation of diluted net income per common share because the exercise price of the options exceeded the average market price of the common shares during the period and their effect, accordingly, would have been antidilutive. For the second quarter and first six months of 2010, 7.2 million stock options, respectively, were excluded from the calculation of diluted net income per common share because the exercise price of the options exceeded the average market price of the common shares during the period and their effect, accordingly, would have been antidilutive.

Note 10.
FAIR VALUE MEASUREMENTS
Fair value is measured based on an exit price, representing the amount that would be received to sell an asset or paid to satisfy a liability in an orderly transaction between market participants. Fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, a fair value hierarchy is established, which categorizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
A summary of financial instruments recognized at fair value, and the fair value measurements used, follows:
 
Total
 
Quoted prices
in active
markets for
identical assets
(Level 1)
 
Other
observable
inputs
(Level 2)
 
Unobservable
inputs
(Level 3)
June 30, 2011
 
 
 
 
 
 
 
Cash
$
282

 
$
282

 
$

 
$

Short-term investments
601

 
601

 

 

Net derivative contracts
61

 

 
61

 

Long-term debt converted to floating interest rates by
   interest rate swaps
44

 

 
44

 

 
 
 
 
 
 
 
 
December 31, 2010
 
 
 
 
 
 
 
Cash
$
333

 
$
333

 
$

 
$

Short-term investments
838

 
838

 

 

Net derivative contracts
69

 

 
69

 

Long-term debt converted to floating interest rates by
   interest rate swaps
42

 

 
42

 


10

Table of Contents

Eaton values its financial instruments using an industry standard market approach, in which prices and other relevant information is generated by market transactions involving identical or comparable assets or liabilities. No financial instruments were recognized using unobservable inputs.
Other Fair Value Measurements
Long-term debt and the current portion of long-term debt had a carrying value of $3,666 and fair value of $4,091 at June 30, 2011 compared to $3,386 and $3,787, respectively, at December 31, 2010.

Note 11.
DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
In the normal course of business, Eaton is exposed to certain risks related to fluctuations in interest rates, foreign currency exchange rates and commodity prices. The Company uses various derivative and non-derivative financial instruments, primarily interest rate swaps, foreign currency forward exchange contracts, foreign currency swaps and, to a lesser extent, commodity contracts, to manage risks from these market fluctuations. The instruments used by Eaton are straightforward, non-leveraged instruments. The counterparties to these instruments are financial institutions with strong credit ratings. Eaton maintains control over the size of positions entered into with any one counterparty and regularly monitors the credit rating of these institutions. Such instruments are not purchased and sold for trading purposes.
Derivative financial instruments are accounted for at fair value and recognized as assets or liabilities in the Condensed Consolidated Balance Sheets. Accounting for the gain or loss resulting from the change in the fair value of the derivative financial instrument depends on whether it has been designated, and is effective, as part of a hedging relationship and, if so, as to the nature of the hedging activity. Eaton formally documents all relationships between derivative financial instruments accounted for as hedges and the hedged item, as well as its risk-management objective and strategy for undertaking the hedge transaction. This process includes linking all derivative financial instruments to a recognized asset or liability, specific firm commitment, forecasted transaction, or net investment in a foreign operation. These financial instruments can be designated as:
Hedges of the change in the fair value of a recognized fixed-rate asset or liability, or the firm commitment to acquire such an asset or liability (a fair value hedge); for these hedges, the gain or loss from the derivative financial instrument, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in income during the period of change in fair value.
Hedges of the variable cash flows of a recognized variable-rate asset or liability, or the forecasted acquisition of such an asset or liability (a cash flow hedge); for these hedges, the effective portion of the gain or loss from the derivative financial instrument is recognized in Accumulated other comprehensive income (loss) and reclassified to income in the same period when the gain or loss on the hedged item is included in income.
Hedges of the foreign currency exposure related to a net investment in a foreign operation (a net investment hedge); for these hedges, the effective portion of the gain or loss from the derivative financial instrument is recognized in Accumulated other comprehensive income (loss) and reclassified to income in the same period when the gain or loss related to the net investment in the foreign operation is included in income.
The gain or loss from a derivative financial instrument designated as a hedge that is effective is classified in the same line of the Consolidated Statements of Income as the offsetting loss or gain on the hedged item. The change in fair value of a derivative financial instrument that is not effective as a hedge is immediately recognized in income.
For derivatives that are not designated as a hedge, any gain or loss is immediately recognized in income. The majority of derivatives used in this manner relate to risks resulting from assets or liabilities denominated in a foreign currency and certain commodity contracts that arise in the normal course of business.


11

Table of Contents

Derivative Financial Statement Impacts
The fair value of derivative financial instruments recognized in the Condensed Consolidated Balance Sheets follows:
 
Notional
amount
 
Other
 current
assets
 
Other
long-term
assets
 
Other
current
liabilities
 
Type of
hedge
 
Term
June 30, 2011
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedges
 
 
 
 
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
540

 
$

 
$
44

 
$

 
Fair value
 
2 to 23 years
Foreign currency exchange contracts
361

 
5

 

 
6

 
Cash flow
 
12 to 36 months
Commodity contracts
47

 
2

 

 

 
Cash flow
 
12 months
Total
 
 
$
7

 
$
44

 
$
6

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedges
 
 
 
 
 
 
 
 
 
 
 
Foreign currency exchange contracts
$
3,586

 
$
41

 
 
 
$
28

 
 
 
12 months
Commodity contracts
128

 
3

 
 
 

 
 
 
12 months
Total
 
 
$
44

 
 
 
$
28

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2010
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as hedges
 
 
 
 
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
540

 
$

 
$
42

 
$

 
Fair value
 
2 to 23 years
Foreign currency exchange contracts
227

 
4

 

 
5

 
Cash flow
 
12 to 36 months
Commodity contracts
39

 
8

 

 

 
Cash flow
 
12 months
Cross currency swaps
75

 
2

 

 

 
Net investment
 
12 months
Total
 
 
$
14

 
$
42

 
$
5

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedges
 
 
 
 
 
 
 
 
 
 
 
Foreign currency exchange contracts
$
2,777

 
$
20

 
 
 
$
19

 
 
 
12 months
Commodity contracts
102

 
17

 
 
 

 
 
 
12 months
Total
 
 
$
37

 
 
 
$
19

 
 
 
 
The foreign currency exchange contracts shown in the table above as derivatives not designated as hedges are primarily contracts entered into to manage foreign currency volatility or exposure on intercompany sales and loans. While Eaton does not elect hedge accounting treatment for these derivatives, Eaton targets managing 100% of the intercompany balance sheet exposure to minimize the effect of currency volatility related to the movement of goods and services in the normal course of its operations. This activity represents the great majority of these foreign currency exchange contracts.


12

Table of Contents

Amounts recognized in Accumulated other comprehensive income (loss) follow:
 
Three months ended June 30
 
2011
 
2010
 
Gain (loss)
recognized in
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
reclassified
from
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
recognized in
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
reclassified
from
Accumulated
other
comprehensive
income (loss)
Derivatives designated as cash flow hedges
 
 
 
 
 
 
 
Foreign currency exchange contracts
$

 
$

 
$
2

 
$

Commodity contracts
(1
)
 
3

 
(4
)
 
3

Derivatives designated as net investment hedges
 
 
 
 
 
 
 
Cross currency swaps
1

 

 
4

 

Total
$

 
$
3

 
$
2

 
$
3

 
Six months ended June 30
 
2011
 
2010
 
Gain (loss)
recognized in
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
reclassified
from
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
recognized in
Accumulated
other
comprehensive
income (loss)
 
Gain (loss)
reclassified
from
Accumulated
other
comprehensive
income (loss)
Derivatives designated as cash flow hedges
 
 
 
 
 
 
 
Foreign currency exchange contracts
$
1

 
$

 
$
(1
)
 
$

Commodity contracts
(1
)
 
5

 
(3
)
 
5

Derivatives designated as net investment hedges
 
 
 
 
 
 
 
Cross currency swaps
1

 

 
4

 

Total
$
1

 
$
5

 
$

 
$
5

Gains and losses reclassified from Accumulated other comprehensive income (loss) to the Consolidated Statements of Income were recognized in Cost of products sold.
Amounts recognized in net income follow:
 
Three months ended
June 30
 
Six months ended
June 30
 
2011
 
2010
 
2011
 
2010
Derivatives designated as fair value hedges
 
 
 
 
 
 
 
Fixed-to-floating interest rate swaps
$
8

 
$
32

 
$
2

 
$
36

Related long-term debt converted to floating interest
   rates by interest rate swaps
(8
)
 
(32
)
 
(2
)
 
(36
)
 
$

 
$

 
$

 
$

Gains and losses described above were recognized in Interest expense.

13

Table of Contents

Note 12.
INVENTORY
The components of inventory follow:
 
June 30,
2011
 
December 31,
2010
Raw materials
$
721

 
$
651

Work-in-process
255

 
229

Finished goods
915

 
800

Inventory at FIFO
1,891

 
1,680

Excess of FIFO over LIFO cost
(125
)
 
(116
)
Total inventory
$
1,766

 
$
1,564


Note 13.
BUSINESS SEGMENT INFORMATION
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision maker, or decision making group, in deciding how to allocate resources to an individual segment and in assessing performance. Eaton’s operating segments are Electrical Americas, Electrical Rest of World, Hydraulics, Aerospace, Truck and Automotive. For additional information regarding Eaton’s business segments, see Note 14 to the Consolidated Financial Statements contained in the 2010 Form 10-K.


14

Table of Contents

EATON CORPORATION
BUSINESS SEGMENT INFORMATION

 
Three months ended
June 30
 
Six months ended
June 30
 
2011
 
2010
 
2011
 
2010
Net sales
 
 
 
 
 
 
 
Electrical Americas
$
1,033

 
$
894

 
$
1,997

 
$
1,696

Electrical Rest of World
787

 
665

 
1,530

 
1,273

Hydraulics
728

 
568

 
1,413

 
1,058

Aerospace
409

 
370

 
798

 
746

Truck
673

 
492

 
1,249

 
945

Automotive
460

 
389

 
906

 
763

Total net sales
$
4,090

 
$
3,378

 
$
7,893

 
$
6,481

 
 
 
 
 
 
 
 
Segment operating profit
 
 
 
 
 
 
 
Electrical Americas
$
144

 
$
120

 
$
276

 
$
225

Electrical Rest of World
77

 
60

 
147

 
102

Hydraulics
120

 
77

 
226

 
131

Aerospace
50

 
48

 
95

 
97

Truck
120

 
59

 
210

 
105

Automotive
55

 
39

 
105

 
81

Total segment operating profit
566

 
403

 
1,059

 
741

 
 
 
 
 
 
 
 
Corporate
 
 
 
 
 
 
 
Amortization of intangible assets
(48
)
 
(43
)
 
(96
)
 
(88
)
Interest expense-net
(31
)
 
(34
)
 
(63
)
 
(69
)
Pension and other postretirement benefits expense
(37
)
 
(29
)
 
(70
)
 
(61
)
Other corporate expense-net
(54
)
 
(46
)
 
(99
)
 
(85
)
Income before income taxes
396

 
251

 
731

 
438

Income tax expense
58

 
22

 
107

 
53

Net income
338

 
229

 
624

 
385

Less net income for noncontrolling interests
(2
)
 
(3
)
 
(1
)
 
(4
)
Net income attributable to Eaton common shareholders
$
336

 
$
226

 
$
623

 
$
381



15

Table of Contents

ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Amounts are in millions of dollars or shares unless indicated otherwise (per share data assume dilution).

TWO-FOR-ONE STOCK SPLIT
On January 27, 2011, Eaton’s Board of Directors announced a two-for-one split of the Company’s common shares effective in the form of a 100% stock dividend. The record date for the stock split was February 7, 2011, and the additional shares were distributed on February 28, 2011. Accordingly, all share and per share data have been adjusted retroactively to reflect the stock split.

COMPANY OVERVIEW
Eaton Corporation is a diversified power management company with 2010 sales of $13.7 billion. The Company is a global technology leader in electrical components and systems for power quality, distribution and control; hydraulics components, systems and services for industrial and mobile equipment; aerospace fuel, hydraulics and pneumatic systems for commercial and military use; and truck and automotive drivetrain and powertrain systems for performance, fuel economy and safety. Eaton has approximately 73,000 employees in over 50 countries, and sells products to customers in more than 150 countries.
Eaton acquired certain businesses that affect comparability on a year over year basis. The Consolidated Statements of Income include the results of these businesses from the dates of the transactions or formation. For a list of business acquisitions and joint ventures impacting the comparative periods, see Note 2 to the Condensed Consolidated Financial Statements.
A summary of Eaton’s Net sales, Net income attributable to Eaton common shareholders, and Net income per common share-diluted follows:
 
Three months ended
June 30
 
Six months ended
June 30
 
2011
 
2010
 
2011
 
2010
Net sales
$
4,090

 
$
3,378

 
$
7,893

 
$
6,481

Net income attributable to Eaton common shareholders
336

 
226

 
623

 
381

Net income per common share-diluted
$
0.97

 
$
0.66

 
$
1.80

 
$
1.12


RESULTS OF OPERATIONS
The following discussion of Consolidated Financial Results and Business Segment Results of Operations includes certain non-GAAP financial measures. These financial measures include operating earnings, operating earnings per common share, and operating profit before acquisition integration charges for each business segment, each of which excludes amounts that differ from the most directly comparable measure calculated in accordance with generally accepted accounting principles (GAAP). A reconciliation of each of these financial measures to the most directly comparable GAAP measure is included in the table below and in the discussion of the operating results of each business segment. Management believes that these financial measures are useful to investors because they exclude transactions of an unusual nature, allowing investors to more easily compare Eaton’s financial performance period to period. Management uses this information in monitoring and evaluating the on-going performance of Eaton and each business segment.

16

Table of Contents

Consolidated Financial Results
 
Three months ended
June 30
 
 
 
Six months ended
June 30
 
 
 
2011
 
2010
 
Increase
 
2011
 
2010
 
Increase
Net sales
$
4,090

 
$
3,378

 
21
%
 
$
7,893

 
$
6,481

 
22
%
Gross profit
1,228

 
991

 
24
%
 
2,349

 
1,893

 
24
%
Percent of net sales
30.0
%
 
29.3
%
 
 
 
29.8
%
 
29.2
%
 
 
Income before income taxes
396

 
251

 
58
%
 
731

 
438

 
67
%
Net income
$
338

 
$
229

 
48
%
 
$
624

 
$
385

 
62
%
Less net income for noncontrolling interests
(2
)
 
(3
)
 
 
 
(1
)
 
(4
)
 
 
Net income attributable to Eaton common shareholders
336

 
226

 
49
%
 
623

 
381

 
64
%
Excluding acquisition integration charges (after-tax)
2

 
6

 
 
 
4

 
12

 
 
Operating earnings
$
338

 
$
232

 
46
%
 
$
627

 
$
393

 
60
%
 
 
 
 
 
 
 
 
 
 
 
 
Net income per common share-diluted
$
0.97

 
$
0.66

 
47
%
 
$
1.80

 
$
1.12

 
61
%
Excluding per share impact of acquisition integration charges
   (after-tax)

 
0.02

 
 
 
0.01

 
0.03

 
 
Operating earnings per common share
$
0.97

 
$
0.68

 
43
%
 
$
1.81

 
$
1.15

 
57
%
Net Sales
Net sales in the second quarter of 2011 increased by 21% compared to the second quarter of 2010. The sales increase was due to 14% from higher core sales, an increase of 6% from the favorable impact of foreign exchange, and an increase of 1% from acquisitions of businesses. End markets increased 12% in the second quarter of 2011 compared to the same period in 2010. Net sales in the first six months of 2011 increased by 22% compared to the first six months of 2010. The sales increase was due to 16% from higher core sales, an increase of 4% from the favorable impact of foreign exchange, and an increase of 2% from acquisitions of businesses. The increase in core sales in both the second quarter and first six months of 2011 reflects the continuing global expansion of the Company's markets and global economic recovery from the depressed levels of 2009. Eaton now anticipates its end markets for all of 2011 will grow by 11%.
Gross Profit
Gross profit increased by 24% in the second quarter of 2011 compared to the second quarter of 2010, improving to 30.0% of net sales, up 0.7 percentage points from the second quarter of 2010. Gross profit increased by 24% in the first six months of 2011 compared to the first six months of 2010, improving to 29.8% of net sales, up 0.6 percentage points from the first six months of 2010. The increase in the gross profit margin in both the second quarter and first six months of 2011 was primarily due to higher sales volumes and the benefits of substantial changes in the Company’s cost structure implemented in the past two years, partially offset by higher raw materials and commodity costs.
Income Taxes
The effective income tax rate for the second quarter of 2011 was 14.7% compared to 9.0% for the second quarter of 2010 and 14.6% for the first six months of 2011 compared to 12.2% for the first six months of 2010. Higher effective tax rates in both the second quarter and first six months of 2011 were primarily attributable to greater levels of income in high tax jurisdictions, particularly in the United States, due to improved economic conditions.
Net Income
Net income attributable to Eaton common shareholders of $336 in the second quarter of 2011 increased 49% compared to net income of $226 in the second quarter of 2010, and Net income per common share of $0.97 in the second quarter of 2011 increased 47% over Net income per common share of $0.66 in the second quarter of 2010. Net income attributable to Eaton common shareholders of $623 in the first six months of 2011 increased 64% compared to net income of $381 in the first six months of 2010, and Net income per common share of $1.80 in the first six months of 2011 increased 61% over Net income per common share of $1.12 in the first six months of 2010. The increase in both the second quarter and first six months of 2011 was primarily due to higher sales and the factors noted above that affected gross profit.

17

Table of Contents

Business Segment Results of Operations
The following is a discussion of net sales, operating profit and operating profit margin by business segment which includes a discussion of operating profit and operating profit margin before acquisition integration charges. For additional information related to integration charges see Note 3 to the Condensed Consolidated Financial Statements. For additional information related to acquired businesses see Note 2 to the Condensed Consolidated Financial Statements.
Electrical Americas
 
Three months ended
June 30
 
 
 
Six months ended
June 30
 
 
 
2011
 
2010
 
Increase
 
2011
 
2010
 
Increase
Net sales
$
1,033

 
$
894

 
16
%
 
$
1,997

 
$
1,696

 
18
%
 
 
 
 
 
 
 
 
 
 
 
 
Operating profit
144

 
120

 
20
%
 
276

 
225

 
23
%
Operating margin
13.9
%
 
13.4
%
 
 
 
13.8
%
 
13.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquisition integration charges
$
1

 
$
1

 
 
 
$
4

 
$
2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Before acquisition integration charges
 
 
 
 
 
 
 
 
 
 
 
Operating profit
$
145

 
$
121

 
20
%
 
$
280

 
$
227

 
23
%
Operating margin
14.0
%
 
13.5
%
 
 
 
14.0
%
 
13.4
%
 
 
Net sales increased 16% in the second quarter of 2011 compared to the second quarter of 2010 due to an increase of 11% in core sales, an increase of 4% from the acquisitions of businesses, and an increase of 1% from the favorable impact of foreign exchange. End markets increased 10% in the second quarter of 2011 compared to the same period in 2010. Net sales increased 18% in the first six months of 2011 compared to the first six months of 2010 due to an increase of 13% in core sales, an increase of 4% from the acquisitions of businesses, and an increase of 1% from the favorable impact of foreign exchange. The increase in net sales in both the second quarter and first six months of 2011 was due to particularly strong growth in the industrial electrical markets.
Operating profit before acquisition integration charges in the second quarter of 2011 increased 20% from the second quarter of 2010. Operating profit before acquisition integration charges in the first six months of 2011 increased 23% from the first six months of 2010. The increase in both the second quarter and first six months of 2011 was largely due to higher net sales as noted above, partially offset by higher raw materials and commodity costs.
Electrical Rest of World
 
Three months ended
June 30
 
 
 
Six months ended
June 30
 
 
 
2011
 
2010
 
Increase
 
2011
 
2010
 
Increase
Net sales
$
787

 
$
665

 
18
%
 
$
1,530

 
$
1,273

 
20
%
 
 
 
 
 
 
 
 
 
 
 
 
Operating profit
77

 
60

 
28
%
 
147

 
102

 
44
%
Operating margin
9.8
%
 
9.0
%
 
 
 
9.6
%
 
8.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquisition integration charges
$
1

 
$
7

 
 
 
$
1

 
$
14

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Before acquisition integration charges
 
 
 
 
 
 
 
 
 
 
 
Operating profit
$
78

 
$
67

 
16
%
 
$
148

 
$
116

 
28
%
Operating margin
9.9
%
 
10.1
%
 
 
 
9.7
%
 
9.1
%
 
 

18

Table of Contents

Net sales increased 18% in the second quarter of 2011 compared to the second quarter of 2010 due to an increase of 13% from the favorable impact of foreign exchange and an increase in core sales of 5%. End markets grew 6% in the second quarter of 2011 compared to the second quarter of 2010, with growth of 6% in both European and Asian markets. Net sales increased 20% in the first six months of 2011 compared to the first six months of 2010 due to an increase in core sales of 11%, an increase of 8% from the favorable impact of foreign exchange, and an increase of 1% from the acquisition of a business.
Operating profit before acquisition integration charges in the second quarter of 2011 increased 16% from the second of 2010. Operating profit before acquisition integration charges in the first six months of 2011 increased 28% from the first six months of 2010. The increase in operating profit in both the second quarter and first six months of 2011 was primarily due to higher sales volumes, partially offset by higher raw materials and commodity costs.
Hydraulics
 
Three months ended
June 30
 
 
 
Six months ended
June 30
 
 
 
2011
 
2010
 
Increase
 
2011
 
2010
 
Increase
Net sales
$
728

 
$
568

 
28
%
 
$
1,413

 
$
1,058

 
34
%
 
 
 
 
 
 
 
 
 
 
 
 
Operating profit
120

 
77

 
56
%
 
226

 
131

 
73
%
Operating margin
16.5
%
 
13.6
%
 
 
 
16.0
%
 
12.4
%
 
 
Net sales in the second quarter of 2011 increased 28% compared to the second quarter of 2010 due to higher core sales of 20%, an increase of 5% from the favorable impact of foreign exchange, and an increase of 3% from the acquisition of businesses. Global hydraulics markets grew 18% over the second quarter of 2010, of which U.S. markets grew 21% while markets outside the U.S. grew 16%. Net sales in the first six months of 2011 increased 34% compared to the first six months of 2010 due to higher core sales of 27%, an increase of 4% from the favorable impact of foreign exchange, and an increase of 3% from the acquisition of businesses.
Operating profit in the second quarter of 2011 increased 56% from the second quarter of 2010. Operating profit in the first six months of 2011 increased 73% from the first six months of 2010. The increase in operating profit in both the second quarter and first six months of 2011 was primarily due to higher sales volumes, partially offset by higher raw materials and commodity costs.
Aerospace
 
Three months ended
June 30
 
Increase
(decrease)
 
Six months ended
June 30
 
Increase
(decrease)
 
2011
 
2010
 
 
2011
 
2010
 
Net sales
$
409

 
$
370

 
11
%
 
$
798

 
$
746

 
7
 %
 
 
 
 
 
 
 
 
 
 
 
 
Operating profit
50

 
48

 
4
%
 
95

 
97

 
(2
)%
Operating margin
12.2
%
 
13.0
%
 
 
 
11.9
%
 
13.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquisition integration charges
$

 
$
1

 
 
 
$

 
$
2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Before acquisition integration charges
 
 
 
 
 
 
 
 
 
 
 
Operating profit
$
50

 
$
49

 
2
%
 
$
95

 
$
99

 
(4
)%
Operating margin
12.2
%
 
13.2
%
 
 
 
11.9
%
 
13.3
%
 
 
Net sales in the second quarter of 2011 increased 11% compared to the second quarter of 2010 due to higher core sales of 8% and an increase of 3% from the favorable impact of foreign exchange. End markets grew 4% in the second quarter of 2011 compared to the second quarter of 2010. Net sales in the first six months of 2011 increased 7% compared to the first six months of 2010 due to higher core sales of 5% and an increase of 2% from the favorable impact of foreign exchange. Growth in both the second quarter and first six months of 2011 was primarily driven by higher customer demand in commercial OEM markets and commercial aftermarkets.

19

Table of Contents

Operating profit before acquisition integration charges in the second quarter of 2011 increased 2% from the second quarter of 2010. Operating profit before acquisition integration charges in the first six months of 2011 decreased 4% from the first six months of 2010. Operating margin before acquisition integration charges decreased 1.0 percentage points from 13.2% in the second quarter of 2010 to 12.2% in the second quarter of 2011. Operating margin before acquisition integration charges decreased 1.4 percentage points from 13.3% in the first six months of 2010 to 11.9% in the first six months of 2011. The decrease was primarily due to increased expenses stemming from changes in scope, program delays, and execution of new customer programs.
Truck
 
Three months ended
June 30