Edgar Filing: EATON CORP

Large accelerated filer þ

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

(Do not check if a smaller reporting company)

ETN 06.30.2012 10-Q

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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, 2012

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 (or for such shorter period that the registrant was required to file such reports), 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

There were 337.6 million Common Shares outstanding as of June 30, 2012.

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TABLE OF CONTENTS
PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 1A. RISK FACTORS
ITEM 6. EXHIBITS
SIGNATURES
Exhibit Index
EX-12
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT

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PART I — 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)	2012		2011			2012		2011
Net sales	$	4,068	$	4,090		$	8,028	$	7,893

Cost of products sold	2,815		2,862			5,569		5,544
Selling and administrative expense	690		698			1,392		1,363
Research and development expense	106		107			211		212
Interest expense-net	30		31			58		63
Other expense (income)-net	8		(4		)	11		(20		)
Income before income taxes	419		396			787		731
Income tax expense	37		58			94		107
Net income	382		338			693		624
Less net income for noncontrolling interests	—		(2		)	—		(1		)
Net income attributable to Eaton common shareholders	$	382	$	336		$	693	$	623

Net income per common share
Diluted	$	1.12	$	0.97		$	2.04	$	1.80
Basic	1.13		0.99			2.06		1.83

Weighted-average number of common shares outstanding
Diluted	339.5		345.7			339.6		345.7
Basic	337.0		340.9			336.2		340.5

Cash dividends paid per common share	$	0.38	$	0.34		$	0.76	$	0.68

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

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EATON CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME



	Three months ended June 30						Six months ended June 30
(In millions)	2012			2011			2012			2011
Net income	$	382		$	338		$	693		$	624
Less net income for noncontrolling interests	—			(2		)	—			(1		)
Net income attributable to Eaton common shareholders	382			336			693			623

Other comprehensive (loss) income, net of tax
Foreign currency translation and related hedging instruments	(271		)	121			(99		)	338
Pensions and other postretirement benefits	33			19			71			35
Cash flow hedges	(4		)	(4		)	12			(5		)
Other comprehensive (loss) income	(242		)	136			(16		)	368
Adjustment for other comprehensive income for noncontrolling interests	—			1			—			—
Other comprehensive (loss) income attributable to Eaton common shareholders	(242		)	137			(16		)	368

Total comprehensive income attributable to Eaton common shareholders	$	140		$	473		$	677		$	991

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

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EATON CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS



(In millions)	June 30, 2012		December 31, 2011
Assets
Current assets
Cash	$	525	$	385
Short-term investments	652		699
Accounts receivable-net	2,683		2,444
Inventory	1,756		1,701
Other current assets	750		597
Total current assets	6,366		5,826

Property, plant and equipment-net	2,675		2,602

Other noncurrent assets
Goodwill	5,649		5,537
Other intangible assets	2,218		2,192
Deferred income taxes	1,024		1,134
Other assets	622		582
Total assets	$	18,554	$	17,873

Liabilities and shareholders’ equity
Current liabilities
Short-term debt	$	86	$	86
Current portion of long-term debt	609		321
Accounts payable	1,556		1,491
Accrued compensation	333		420
Other current liabilities	1,246		1,319
Total current liabilities	3,830		3,637

Noncurrent liabilities
Long-term debt	3,678		3,366
Pension liabilities	1,495		1,793
Other postretirement benefits liabilities	631		642
Deferred income taxes	416		442
Other noncurrent liabilities	546		501
Total noncurrent liabilities	6,766		6,744

Shareholders’ equity
Eaton shareholders’ equity	7,937		7,469
Noncontrolling interests	21		23
Total equity	7,958		7,492
Total liabilities and equity	$	18,554	$	17,873

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

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EATON CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



	Six months ended June 30
(In millions)	2012			2011
Operating activities
Net income	$	693		$	624
Adjustments to reconcile to net cash provided by operating activities
Depreciation and amortization	278			280
Contributions to pension plans	(355		)	(309		)
Contributions to other postretirement benefits plans	(35		)	(132		)
Changes in working capital	(444		)	(472		)
Other-net	234			56
Net cash provided by operating activities	371			47

Investing activities
Cash paid for acquisitions of businesses	(365		)	(212		)
Capital expenditures for property, plant and equipment	(231		)	(221		)
Sales of short-term investments-net	35			251
Other-net	(21		)	7
Net cash used in investing activities	(582		)	(175		)

Financing activities
Borrowings with original maturities of more than three months
Proceeds	600			307
Payments	(17		)	(17		)
(Payments) borrowings with original maturities of less than three months-net	(1		)	18
Cash dividends paid	(255		)	(232		)
Exercise of equity-based awards	44			62
Repurchase of shares	—			(68		)
Excess tax benefit from equity-based compensation	21			—
Other-net	(47		)	(5		)
Net cash provided by financing activities	345			65

Effect of foreign exchange rate changes on cash	6			12
Total increase (decrease) in cash	140			(51		)
Cash at the beginning of the period	385			333
Cash at the end of the period	$	525		$	282

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

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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 2011 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.


Note 2.	ACQUISITIONS OF BUSINESSES

In 2012 and 2011, 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 and the related annual sales prior to acquisition are summarized below:



Acquired businesses and joint venture	Date of transaction	Business segment	Annual sales
Polimer Kaucuk Sanayi ve Pazarlama A.S.	June 1, 2012	Hydraulics	$335 for 2011
A Turkish manufacturer of hydraulic and industrial hose for construction, mining, agriculture, oil and gas, manufacturing, food and beverage, and chemicals markets. This business sells its products under the SEL brand name.	June 1, 2012	Hydraulics	$335 for 2011

Gycom Electrical Low-Voltage Power Distribution, Control and Automation	June 1, 2012	Electrical Rest of World	$24 for 2011
A Swedish electrical low-voltage power distribution, control and automation components business.	June 1, 2012	Electrical Rest of World	$24 for 2011

E.A. Pedersen Company	December 29, 2011	Electrical Americas	$37 for 2011
A United States manufacturer of medium voltage switchgear, metal-clad switchgear, power control buildings and relay control panels primarily for the electrical utilities industry.	December 29, 2011	Electrical Americas	$37 for 2011

IE Power, Inc.	August 31, 2011	Electrical Americas	$5 for 2010
A Canadian provider of high power inverters for a variety of mission-critical applications including solar, wind and battery energy storage.	August 31, 2011	Electrical Americas	$5 for 2010

E. Begerow GmbH & Co. KG	August 15, 2011	Hydraulics	$84 for 2010
A German 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.


ACTOM Low Voltage	June 30, 2011	Electrical Rest of World	$65 for the year ended May 31, 2011
A South African manufacturer and supplier of motor control components, engineered electrical distribution systems and uninterruptible power supply (UPS) systems.

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Acquired businesses and joint venture	Date of transaction	Business segment	Annual sales
C.I. ESI de Colombia S.A.	June 2, 2011	Electrical Americas	$8 for 2010
A Colombian distributor of industrial electrical equipment and engineering services in the Colombian market, focused on oil and gas, mining, and industrial and commercial construction.	June 2, 2011	Electrical Americas	$8 for 2010

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.	May 12, 2011	Hydraulics	$55 for 2010

Eaton-SAMC (Shanghai) Aircraft Conveyance System Manufacturing Co., Ltd.	March 8, 2011	Aerospace	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.	March 8, 2011	Aerospace	Joint venture

Tuthill Coupling Group	January 1, 2011	Hydraulics	$35 for the year ended November 30, 2010
A United States based manufacturer of pneumatic and hydraulic quick coupling solutions and leak-free connectors used in industrial, construction, mining, defense, energy and power applications.

On April 5, 2012, Eaton reached an agreement to acquire substantially all the shares of Jeil Hydraulics Co., Ltd., a Korean manufacturer of hydraulic motors and valves with sales of $189 for 2011. The acquisition closed on July 6, 2012 and will be included in the Hydraulics segment.

On May 21, 2012, Eaton reached an agreement to acquire Cooper Industries plc (Cooper). Cooper is incorporated in Ireland and is a diversified global manufacturer of electrical components and tools with sales of $5.4 billion for 2011. At the close of the transaction, Eaton and Cooper will be combined under a newly created company (New Eaton), which is currently called Eaton Corporation Limited and is incorporated in Ireland. The total consideration to be received by Cooper shareholders in the transaction is comprised of both cash and equity and has a value of approximately $11.8 billion based on the closing share price of Eaton common stock of $42.40 on May 18, 2012. Based on the terms of the transaction agreement, the purchase consideration entitles the holder of each ordinary share of Cooper to receive from New Eaton $39.15 and 0.77479 of a New Eaton ordinary share. At the close of the transaction, the former shareholders of Eaton and Cooper are expected to own approximately 73% and 27% of New Eaton, respectively. The transaction is subject to respective shareholder approval, receipt of certain regulatory approvals and other customary conditions, and is expected to close in the second half of 2012.


Note 3.	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
	2012		2011		2012		2011
Business segment
Electrical Americas	$	2	$	1	$	3	$	4
Electrical Rest of World	3		1		4		1
Hydraulics	3		—		4		—
Total business segment integration charges before income taxes	8		2		11		5
Corporate	8		—		8		—
Total integration charges before income taxes	$	16	$	2	$	19	$	5
After-tax integration charges	$	10	$	2	$	12	$	4
Per common share	$	0.03	$	—	$	0.04	$	0.01

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Business segment charges in 2012 were related primarily to The Moeller Group, E. Begerow GmbH & Co. KG and Internormen Technology Group. Business segment charges in 2011 were related primarily to CopperLogic, Wright Line Holding and EMC Engineers. 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.

Corporate charges in 2012 were related primarily to pre-acquisition transaction costs associated with the planned acquisition of Cooper. These charges were included in Selling and administrative expense. In Note 13. Business Segment Information, the charges were included in Other corporate expense-net. See Note 2 for additional information about business acquisitions.


Note 4.	GOODWILL

A summary of goodwill follows:



	June 30, 2012		December 31, 2011
Electrical Americas	$	2,020	$	2,043
Electrical Rest of World	973		981
Hydraulics	1,259		1,116
Aerospace	1,041		1,040
Truck	149		150
Automotive	207		207
Total goodwill	$	5,649	$	5,537

The increase in goodwill in 2012 was primarily due to a business acquired during 2012. For additional information regarding acquired businesses, see Note 2.


Note 5.	DEBT

On May 21, 2012, Eaton secured a 364-day bridge facility totaling $6.75 billion related to financing the cash portion of the acquisition of Cooper. The bridge facility will be available in a single draw on the acquisition closing date. At the Company's discretion, the interest rate on the bridge facility may initially be set at either a LIBOR-based rate plus a margin of 1.25%, with increases in margin every 90 days to a maximum margin of 2.50%, or an Alternate Base Rate (ABR) plus the margin for LIBOR loans at any time minus 1.00%. The ABR is the highest of (a) Prime Rate (as published in the Wall Street Journal), (b) the Federal Funds rate plus 0.50%, and (c) one-month LIBOR plus 1.00%. The bridge facility allows for voluntary prepayment at any time without a premium or penalty. Upon the closing of the Cooper acquisition and shortly thereafter, the bridge facility will be guaranteed by certain subsidiaries of the Company and Cooper. The bridge facility contains customary events of default, the occurrence of which may accelerate the payment of interest and principal amounts outstanding. The bridge facility is subject to certain customary affirmative and negative covenants. At June 30, 2012, capitalized deferred financing fees totaled $39 and are being amortized over the estimated term of the bridge facility.

On June 14, 2012, Eaton refinanced a $500, three-year revolving credit facility and a $500, five-year revolving credit facility with a $750, three-year revolving credit facility and a $750, five-year revolving credit facility, respectively. These facilities increase long-term revolving credit facilities from $1.5 billion to $2.0 billion. The revolving credit facilities are used to support commercial paper borrowings. The three-year revolving credit facility will expire June 14, 2015, and the five-year revolving credit facility will expire June 14, 2017. There were no borrowings outstanding under Eaton's revolving credit facilities at June 30, 2012.

On June 28, 2012, Eaton received proceeds totaling $600 from the private issuance of $300, 3.47% notes due June 28, 2021 and $300, 3.68% notes due June 28, 2023 (collectively, the Notes). Interest is payable semi-annually. The Notes contain a change of control provision which requires the Company to make an offer to purchase all or any part of the Notes at a purchase price of 100% of the principal amount plus accrued and unpaid interest. The Notes are subject to certain customary covenants.

These financing activities were initiated to enhance the Company's capital structure prior to completing the acquisition of Cooper. See Note 2 for additional information about business acquisitions.

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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
	2012			2011			2012			2011			2012			2011
Service cost	$	29		$	23		$	12		$	12		$	4		$	4
Interest cost	33			33			19			20			10			10
Expected return on plan assets	(45		)	(41		)	(19		)	(18		)	(2		)	—
Amortization	29			19			4			3			3			3
	46			34			16			17			15			17
Settlement loss	5			4			—			3			—			—
Total expense	$	51		$	38		$	16		$	20		$	15		$	17



	Six months ended June 30
	United States pension benefit expense						Non-United States pension benefit expense						Other postretirement benefits expense
	2012			2011			2012			2011			2012			2011
Service cost	$	58		$	46		$	24		$	25		$	8		$	8
Interest cost	67			66			38			40			19			20
Expected return on plan assets	(90		)	(82		)	(38		)	(36		)	(3		)	—
Amortization	58			38			8			6			7			6
	93			68			32			35			31			34
Settlement loss	9			7			2			3			—			—
Total expense	$	102		$	75		$	34		$	38		$	31		$	34


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, 2012, the Company has a total accrual of 74 Brazilian Reais related to this matter ($37 based on current exchange rates), comprised of 60 Brazilian Reais recognized in the fourth quarter of 2010 ($30 based on current exchange rates) with an additional 14 Brazilian Reais recognized through June 30, 2012 ($7 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. Eaton Holding and Eaton Ltda. filed appeals on various issues to the Superior Court of Justice in Brasilia. On September 27, 2011, the Superior Court of Justice accepted two of the appeals and on November 21, 2011, Eaton's remaining appeal was accepted. These appeals will be heard in due course.

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. That motion was denied on June 9, 2011. On August 19, 2011, the Court entered final judgment of liability but awarded zero damages to plaintiffs. The Court also entered an injunction prohibiting Eaton from offering rebates or other incentives based on purchasing targets but stayed the injunction pending appeal. Eaton has appealed the liability finding and the injunction to the Third Circuit Court of Appeals. Meritor has cross-appealed the finding of zero damages. Accordingly, an estimate of any potential loss related to this action cannot be made at this time.

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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 2012 was 8.7% compared to 14.7% for the second quarter of 2011 and 11.9% for the first six months of 2012 compared to 14.6% for the first six months of 2011. The lower effective tax rate in the second quarter of 2012 was primarily attributable to a reduction in deferred tax liabilities in a European jurisdiction due to realization of a lower effective tax rate, and higher foreign tax credits, partially offset by the expiration of the U.S. Research and Experimentation tax credit as of December 31, 2011. The lower effective tax rate in the first six months of 2012 was attributable to the items noted above and the favorable impact of enhanced investment incentives in Europe.

At the end of the fourth quarter of 2011, the IRS issued a Notice for Eaton's 2005 and 2006 tax years. The Notice proposes assessments of $75 in additional taxes plus $52 in penalties related primarily to transfer pricing adjustments for products manufactured in the Company's facilities in Puerto Rico and the Dominican Republic and sold to affiliated companies located in the U.S., net of agreed credits and deductions. The Company has set its transfer prices for products sold between these affiliates at the same prices that the Company sells such products to third parties. The Notice was issued despite the IRS having previously recognized the validity of the Company's transfer pricing methodology by entering into two successive binding Advance Pricing Agreements (APAs) that approved and, in fact, required the application of the Company's transfer pricing methodology for the ten year period of 2001 through 2010. For the years 2001 through 2004, the IRS had previously accepted the transfer pricing methodology related to these APAs after a comprehensive review conducted in two separate audit cycles. On December 16, 2011, immediately prior to the Notice being issued, the IRS sent a letter stating that it was canceling the APAs.

The Company firmly believes that the proposed assessments are without merit. The Company also believes that it was in full compliance with the terms of the two APAs and that the IRS's unilateral attempt to retroactively cancel these two binding contracts is also without merit and represents a breach of the two contracts. On February 29, 2012, the Company filed a Petition with the U.S. Tax Court in which it asserted that the transfer pricing established in the two APA contracts meets the arms-length standard set by the U.S. income tax law, that the transfer pricing the Company has used is in full compliance with U.S. income tax laws, and accordingly, that the two APA contracts should be enforced in accordance with their terms. On June 11, 2012, the Company filed a motion for partial summary judgment with the U.S. Tax Court, asking the U.S. Tax Court to rule the APAs are “contracts” and that the IRS has the burden of proof to substantiate cancellation of the APAs. The Company believes that the ultimate resolution of this matter will not have a material impact on its consolidated financial statements.


Note 9.	EQUITY

The changes in Shareholders’ equity follow:



	Eaton shareholders’ equity			Noncontrolling interests			Total equity
Balance at December 31, 2011	$	7,469		$	23		$	7,492
Net income	693			—			693
Other comprehensive loss	(16		)	—			(16		)
Cash dividends paid	(255		)	(2		)	(257		)
Issuance of shares under equity-based compensation plans-net	46			—			46
Balance at June 30, 2012	$	7,937		$	21		$	7,958

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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)	2012		2011		2012		2011
Net income attributable to Eaton common shareholders	$	382	$	336	$	693	$	623

Weighted-average number of common shares outstanding-diluted	339.5		345.7		339.6		345.7
Less dilutive effect of stock options and restricted stock awards	2.5		4.8		3.4		5.2
Weighted-average number of common shares outstanding-basic	337.0		340.9		336.2		340.5

Net income per common share
Diluted	$	1.12	$	0.97	$	2.04	$	1.80
Basic	1.13		0.99		2.06		1.83

For the second quarter and first six months of 2012, 2.4 million and 1.7 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 2011, 0.5 million and 0.3 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, 2012
Cash	$	525	$	525	$	—	$	—
Short-term investments	652		652		—		—
Net derivative contracts	73		—		73		—
Long-term debt converted to floating interest rates by interest rate swaps - net	80		—		80		—

December 31, 2011
Cash	$	385	$	385	$	—	$	—
Short-term investments	699		699		—		—
Net derivative contracts	46		—		46		—
Long-term debt converted to floating interest rates by interest rate swaps - net	66		—		66		—

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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 $4,287 and fair value of $4,820 at June 30, 2012 compared to $3,687 and $4,273, respectively, at December 31, 2011. The fair value of debt is determined based on trade information in the financial markets of the Company's public debt and is considered a Level 2 fair value measurement.


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. Gains and losses associated with commodity hedge contracts are classified in Cost of products sold.

Eaton uses certain of its debt denominated in foreign currency to hedge portions of its net investments in foreign operations against foreign currency exposure (net investment hedges). Debt denominated in foreign currency and designated as non-derivative net investment hedging instruments was $126 at June 30, 2012 and $129 at December 31, 2011.

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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		Other long-term liabilities		Type of hedge	Term
June 30, 2012
Derivatives designated as hedges
Fixed-to-floating interest rate swaps	$	1,290	$	—	$	80	$	—	$	—	Fair value	1 to 22 years
Floating-to-fixed interest rate swaps	300		—		—		—		1		Cash flow	2 years
Foreign currency exchange contracts	417		5		—		3		—		Cash flow	12 to 36 months
Commodity contracts	41		—		—		4		—		Cash flow	12 months
Total			$	5	$	80	$	7	$	1

Derivatives not designated as hedges
Foreign currency exchange contracts	$	3,641	$	17			$	14				12 months
Commodity contracts	46		—				7					12 months
Total			$	17			$	21

December 31, 2011
Derivatives designated as hedges
Fixed-to-floating interest rate swaps	$	940	$	—	$	68	$	—	$	2	Fair value	1 to 22 years
Floating-to-fixed interest rate swaps	300		—		—		—		—		Cash flow	2 years
Foreign currency exchange contracts	308		4		—		9		—		Cash flow	12 to 36 months
Commodity contracts	47		—		—		7		—		Cash flow	12 months
Total			$	4	$	68	$	16	$	2

Derivatives not designated as hedges
Foreign currency exchange contracts	$	2,954	$	18			$	14				12 months
Commodity contracts	61		—				12					12 months
Total			$	18			$	26

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.

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Amounts recognized in Accumulated other comprehensive income (loss) follow:



	Three months ended June 30
	2012						2011
	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
Floating-to-fixed interest rate swaps	$	(1	)	$	(1	)	$	—		$	—
Foreign currency exchange contracts	(3		)	1			—			—
Commodity contracts	(4		)	(2		)	(1		)	3
Derivatives designated as net investment hedges
Cross currency swaps	—			—			1			—
Total	$	(8	)	$	(2	)	$	—		$	3



	Six months ended June 30
	2012						2011
	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
Floating-to-fixed interest rate swaps	$	(2	)	$	(1	)	$	—		$	—
Foreign currency exchange contracts	6			(1		)	1			—
Commodity contracts	—			(4		)	(1		)	5
Derivatives designated as net investment hedges
Cross currency swaps	—			—			1			—
Total	$	4		$	(6	)	$	1		$	5

Gains and losses reclassified from Accumulated other comprehensive income (loss) to the Consolidated Statements of Income were recognized in Cost of products sold or Interest expense-net, as appropriate.

Amounts recognized in net income follow:



	Three months ended June 30						Six months ended June 30
	2012			2011			2012			2011
Derivatives designated as fair value hedges
Fixed-to-floating interest rate swaps	$	24		$	8		$	14		$	2
Related long-term debt converted to floating interest rates by interest rate swaps	(24		)	(8		)	(14		)	(2		)
	$	—		$	—		$	—		$	—

Gains and losses described above were recognized in Interest expense-net.

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Note 12.	INVENTORY

The components of inventory follow:



	June 30, 2012			December 31, 2011
Raw materials	$	747		$	706
Work-in-process	279			272
Finished goods	883			867
Inventory at FIFO	1,909			1,845
Excess of FIFO over LIFO cost	(153		)	(144		)
Total inventory	$	1,756		$	1,701


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 2011 Form 10-K.

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EATON CORPORATION BUSINESS SEGMENT INFORMATION

	Three months ended June 30						Six months ended June 30
	2012			2011			2012			2011
Net sales
Electrical Americas	$	1,133		$	1,033		$	2,220		$	1,997
Electrical Rest of World	683			787			1,334			1,530
Hydraulics	769			728			1,504			1,413
Aerospace	436			409			866			798
Truck	625			673			1,256			1,249
Automotive	422			460			848			906
Total net sales	$	4,068		$	4,090		$	8,028		$	7,893

Segment operating profit
Electrical Americas	$	190		$	144		$	352		$	276
Electrical Rest of World	52			77			105			147
Hydraulics	123			120			232			226
Aerospace	59			50			119			95
Truck	120			120			236			210
Automotive	48			55			92			105
Total segment operating profit	592			566			1,136			1,059

Corporate
Amortization of intangible assets	(42		)	(48		)	(84		)	(96		)
Interest expense-net	(30		)	(31		)	(58		)	(63		)
Pension and other postretirement benefits expense	(39		)	(37		)	(80		)	(70		)
Other corporate expense-net	(62		)	(54		)	(127		)	(99		)
Income before income taxes	419			396			787			731
Income tax expense	37			58			94			107
Net income	382			338			693			624
Less net income for noncontrolling interests	—			(2		)	—			(1		)
Net income attributable to Eaton common shareholders	$	382		$	336		$	693		$	623

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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).

COMPANY OVERVIEW

Eaton Corporation is a diversified power management company with 2011 net sales of $16.0 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
	2012		2011		2012		2011
Net sales	$	4,068	$	4,090	$	8,028	$	7,893
Net income attributable to Eaton common shareholders	382		336		693		623
Net income per common share-diluted	$	1.12	$	0.97	$	2.04	$	1.80

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.

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Consolidated Financial Results



	Three months ended June 30						Increase (decrease)		Six months ended June 30						Increase (decrease)
	2012			2011			Increase (decrease)		2012			2011			Increase (decrease)
Net sales	$	4,068		$	4,090		(1	)%	$	8,028		$	7,893		2	%
Gross profit	1,253			1,228			2	%	2,459			2,349			5	%
Percent of net sales	30.8		%	30.0		%			30.6		%	29.8		%
Income before income taxes	419			396			6	%	787			731			8	%
Net income	$	382		$	338		13	%	$	693		$	624		11	%
Less net income for noncontrolling interests	—			(2		)			—			(1		)
Net income attributable to Eaton common shareholders	382			336			14	%	693			623			11	%
Excluding acquisition integration charges (after-tax)	10			2					12			4
Operating earnings	$	392		$	338		16	%	$	705		$	627		12	%

Net income per common share-diluted	$	1.12		$	0.97		15	%	$	2.04		$	1.80		13	%
Excluding per share impact of acquisition integration charges (after-tax)	0.03			—					0.04			0.01
Operating earnings per common share	$	1.15		$	0.97		19	%	$	2.08		$	1.81		15	%

Net Sales

Net sales in the second quarter of 2012 decreased 1% compared to the second quarter of 2011. The sales decrease was due to a decrease of 5% from the impact of foreign exchange, partially offset by an increase of 3% in core sales and 1% from acquisitions of businesses. End markets increased 3% in the second quarter of 2012 compared to the same period in 2011. Net sales in the first six months of 2012 increased 2% compared to the first six months of 2011. The sales increase was due to an increase of 4% in core sales and 1% from acquisitions of businesses, partially offset by a 3% decrease from the impact of foreign exchange. The increase in core sales in both the second quarter and first six months of 2012 reflects the modest growth of the Company's markets. Eaton now anticipates that its revenues will grow by 4% for all of 2012.

Gross Profit

Gross profit increased 2% in the second quarter of 2012 compared to the second quarter of 2011. Gross profit margin increased 0.8 percentage points from 30.0% in the second quarter of 2011 to 30.8% in the second quarter of 2012. Gross profit increased 5% in the first six months of 2012 compared to the first six months of 2011. Gross profit margin increased 0.8 percentage points from 29.8% for the first six months of 2012 to 30.6% for the first six months of 2012. The gross profit margin in both the second quarter and first six months of 2012 was positively impacted by strong incremental margins on sales volume growth.

Income Taxes

Net Income

Net income attributable to Eaton common shareholders of $382 in the second quarter of 2012 increased 14% compared to net income of $336 in the second quarter of 2011, and Net income per common share of $1.12 in the second quarter of 2012 increased 15% over Net income per common share of $0.97 in the second quarter of 2011. Net income attributable to Eaton common shareholders of $693 in the first six months of 2012 increased 11% compared to net income of $623 in the first six months of 2011, and Net income per common share of $2.04 in the first six months of 2012 increased 13% over Net income per common share of $1.80 in the first six months of 2011. The increase in both the second quarter and first six months of 2012 was primarily due to gross profit improvements and a lower effective tax rate in both the second quarter and first six months of 2012.

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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 acquired businesses and acquisition integration charges, see Note 2 and Note 3 to the Condensed Consolidated Financial Statements, respectively.

Electrical Americas



	Three months ended June 30								Six months ended June 30
	2012			2011			Increase		2012			2011			Increase
Net sales	$	1,133		$	1,033		10	%	$	2,220		$	1,997		11	%

Operating profit	190			144			32	%	352			276			28	%
Operating margin	16.8		%	13.9		%			15.9		%	13.8		%

Acquisition integration charges	$	2		$	1				$	3		$	4

Before acquisition integration charges
Operating profit	$	192		$	145		32	%	$	355		$	280		27	%
Operating margin	16.9		%	14.0		%			16.0		%	14.0		%

Net sales increased 10% in the second quarter of 2012 compared to the second quarter of 2011 due to an increase of 10% in core sales and an increase of 1% from the acquisition of businesses, partially offset by a 1% decrease from the impact of foreign exchange. End markets grew 8% in the second quarter of 2012 compared to the same period in 2011. Net sales increased 11% in the first six months of 2012 compared to the first six months of 2011 due to an increase of 11% in core sales and an increase of 1% from the acquisition of businesses, partially offset by a 1% decrease from the impact of foreign exchange. The increase in net sales in both the second quarter and first six months of 2012 was due to continued growth in markets served by the Electrical Americas segment, with particularly strong growth in residential and non-residential construction markets. Eaton now anticipates its Electrical Americas markets will grow by 8% for all of 2012.

Operating profit before acquisition integration charges in the second quarter of 2012 increased 32% from the second quarter of 2011. Operating margin before acquisition integration charges increased 2.9 percentage points from 14.0% in the second quarter of 2011 to 16.9% in the second quarter of 2012. Operating profit before acquisition integration charges in the first six months of 2012 increased 27% from the first six months of 2011. Operating margin before acquisition integration charges increased 2.0 percentage points from 14.0% for the first six months of 2011 to 16.0% for the first six months of 2012. The increase in operating margin in both the second quarter and first six months of 2012 was largely due to benefits from higher sales volumes.

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Electrical Rest of World



	Three months ended June 30						Decrease		Six months ended June 30						Decrease
	2012			2011			Decrease		2012			2011			Decrease
Net sales	$	683		$	787		(13	)%	$	1,334		$	1,530		(13	)%

Operating profit	52			77			(32	)%	105			147			(29	)%
Operating margin	7.6		%	9.8		%			7.9		%	9.6		%

Acquisition integration charges	$	3		$	1				$	4		$	1

Before acquisition integration charges
Operating profit	$	55		$	78		(29	)%	$	109		$	148		(26	)%
Operating margin	8.1		%	9.9		%			8.2		%	9.7		%

Net sales decreased 13% in the second quarter of 2012 compared to the second quarter of 2011 due to a decrease of 8% from the impact of foreign exchange and a decrease of 7% in core sales, partially offset by an increase of 2% from the acquisition of a business. End markets declined 3% in the second quarter of 2012 compared to the second quarter of 2011. Net sales decreased 13% in the first six months of 2012 compared to the first six months of 2011 due to a decrease in core sales of 10% and a decrease of 5% from the impact of foreign exchange, partially offset by an increase of 2% from the acquisition of a business. The decrease in net sales in both the second quarter and first six months of 2012 reflects the continued regional recession in Europe and weakness in the China market. Eaton now anticipates its Electrical Rest of World markets will decline 3% for all of 2012.

Operating profit before acquisition integration charges in the second quarter of 2012 decreased 29% from the second quarter of 2011. Operating margin before acquisition integration charges decreased 1.8 percentage points from 9.9% in the second quarter of 2011 to 8.1% in the second quarter of 2012. Operating profit before acquisition integration charges in the first six months of 2012 decreased 26% from the first six months of 2011. Operating margin before acquisition integration charges decreased 1.5 percentage points from 9.7% for the first six months of 2011 to 8.2% for the first six months of 2012. The decrease in operating margin in both the second quarter and first six months of 2012 was largely due to the factors impacting net sales as noted above.

Hydraulics



	Three months ended June 30								Six months ended June 30
	2012			2011			Increase		2012			2011			Increase
Net sales	$	769		$	728		6	%	$	1,504		$	1,413		6	%

Operating profit	123			120			3	%	232			226			3	%
Operating margin	16.0		%	16.5		%			15.4		%	16.0		%

Acquisition integration charges	$	3