Eaton Reports Fourth Quarter

Net income in both periods included charges related to acquisition integration. Before acquisition integration charges, operating earnings per share in the fourth quarter of 2006 were $1.66 compared to $1.43 per share in 2005, an increase of 16 percent. Operating earnings for the fourth quarter of 2006 were $251 million compared to $219 million in 2005, an increase of 15 percent. Excel 07 had no impact upon earnings in the fourth quarter.

Sales growth in the fourth quarter of 10 percent consisted of 4 percent from organic growth, 4 percent from acquisitions, and 2 percent from higher exchange rates. End markets in the fourth quarter grew by 4 percent.

Income tax for the fourth quarter was a credit of $2 million. Included in fourth quarter taxes was an income tax benefit of $32 million, which was part of the Excel 07 program, resulting from the resolution in the fourth quarter of international income tax items, as well as a tax benefit from the reenactment of the Research and Experimentation tax credit in December.

For the full year 2006, sales were $12.4 billion, 12 percent above 2005. Net income of $950 million increased 18 percent over 2005, and net income per share of $6.22 rose 19 percent. Operating earnings per share for 2006 of $6.39 rose 19 percent above 2005. Operating earnings in 2006 totaled $977 million versus $829 million in 2005, an increase of 18 percent.

Alexander M. Cutler, Eaton chairman and chief executive officer, said, “We had a strong fourth quarter, posting our nineteenth quarter in a row with year-over-year operating earnings per share growth of more than 10 percent. Equally significant is the balance of earnings in the quarter, with our Electrical and Fluid Power businesses representing 70 percent of our overall segment operating earnings.

“Looking at 2006 as a whole, we had a very solid year and are off to a good start on the goals we set for Eaton for the 2006 – 2010 time period,” said Cutler. “Our sales in 2006 grew 12 percent, operating earnings per share grew 19 percent, and our return on equity was 23 percent. In addition, we generated a record amount of cash, with operating cash flow in 2006 rising 25 percent, to more than $1.4 billion.

“As we survey our end markets in 2007, we anticipate our markets will decline by approximately 3 1/2 percent, primarily as a result of the expected dramatic decrease in the NAFTA heavy-duty truck market. This is roughly 1 1/2 percent lower growth in our markets than we expected a year ago, as we now see the slowdown in the overall manufacturing sector experienced in the second half of 2006 extending into the early portion of 2007,” said Cutler. “The significant restructuring undertaken in our Excel 07 program will offset much of the market decline. Our Excel 07 program incurred net costs of $154 million prior to tax settlements and divestiture gains. The earnings benefit in 2007 we now expect from the Excel 07 program is double the target we announced when we started the program in January of 2006. With our Excel 07 program behind us, we believe our operations are well positioned for the balance of the decade.

“We expect to outgrow our end markets in 2007 by approximately $200 million, and we also expect to record approximately $300 million of growth from the full-year impact of the six acquisitions we completed in 2006, and the two acquisitions we have signed but not yet completed,” said Cutler. “As a result, we anticipate our revenues in 2007 will be flat compared to 2006.”

In light of its strong results and future prospects, Eaton is taking the following actions:

• Increasing its quarterly dividend by 10 percent, from $.39 per share to $.43 per share

• Making a voluntary contribution of $150 million to its qualified pension plan in the United States

• Authorizing a new 10 million repurchase of common shares, replacing the 1.3 million shares remaining from the 10 million share repurchase authorization approved in April of 2005.

“We anticipate net income per share for the first quarter of 2007 to be $1.30 to $1.40, and for the full year to be $6.05 to $6.25. Operating earnings per share, which exclude charges to integrate our recent acquisitions and joint ventures, are anticipated to be $1.35 to $1.45 for the first quarter of 2007, and $6.30 to $6.50 for the full year.”

Business Segment Results

Fourth quarter sales for the Electrical segment were $1.1 billion, up 9 percent over 2005. Operating profits in the fourth quarter were $142 million. Operating profits before acquisition integration charges were $143 million, up 29 percent from results in 2005. Net Excel 07 costs in the fourth quarter were $12 million. In addition, fourth quarter operating margins were positively impacted by the sale of the Brazilian battery business acquired in the 2004 Powerware acquisition.

“End markets for our electrical business grew about 2 1/2 percent during the fourth quarter, reflecting a slowdown from the growth rate earlier in 2006,” said Cutler. “In 2007, we expect our markets to grow approximately 4 percent, with growth in the nonresidential markets offsetting a decline in the residential market. We expect operating margins to improve as a result of the additional volume, a reduced impact from commodity costs, and the benefits from the Excel 07 actions taken in 2006.

“We announced two small European acquisitions, the acquisitions of Schreder-Hazemeyer and the power protection business of Power Products, in the fourth quarter,” said Cutler. “These acquisitions expand our sales in new geographic areas.”

In the Fluid Power segment, fourth quarter sales were $985 million, 17 percent above the fourth quarter of 2005. Adjusted for acquisitions completed within the last year, sales grew 7 percent. Operating profits in the fourth quarter were $103 million. Operating profits before acquisition integration charges were $115 million, up 17 percent compared to a year earlier. Excel 07 resulted in a net savings of $1 million in the fourth quarter.

Fluid Power markets grew 6 percent compared to the same period in 2005, with global hydraulics shipments up 7 percent, commercial aerospace markets up 14 percent, defense aerospace markets up 2 percent, and European automotive production flat.

“Growth in the mobile and industrial hydraulics markets moderated slightly in the fourth quarter from the rates seen earlier in the year,” said Cutler. “For 2007, we anticipate that growth in the construction equipment markets will be lower than in 2006, while agricultural equipment markets are expected to grow for the first time in three years. Industrial markets are likely to post lower growth than in 2006. Growth in the commercial aerospace market is expected to be solid, while defense aerospace markets are expected to post modest growth. In total, we believe the Fluid Power markets will grow approximately 4 percent.

“We anticipate Fluid Power operating margins will improve in 2007 as a result of the additional volume, the increasing mix of aerospace revenues, and the benefits from the Excel 07 actions taken in 2006,” said Cutler.

“We reached agreement in December to acquire Argo-Tech,” said Cutler. “This acquisition will round out our aerospace fuel system capabilities and further strengthens the overall breadth of our rapidly-growing Aerospace business.”

The Truck segment posted sales of $620 million in the fourth quarter, up 13 percent compared to 2005. Operating profits in the quarter were $76 million, down 30 percent compared to the fourth quarter of 2005. Adjusting for the $27 million of net Excel 07 costs incurred in the fourth quarter, operating profits declined by 5 percent. Also contributing to the margin decline in the quarter was an adjustment to Brazilian inventories. The Excel 07 net costs and Brazilian inventory adjustment comprised the entire decline in year-to-year Truck segment operating margins.

NAFTA heavy-duty production was up 16 percent compared to 2005, NAFTA medium-duty production was up 20 percent, European truck production was flat, and Brazilian vehicle production was up 1 percent.

“Production of NAFTA heavy-duty trucks in 2006 totaled 378,000 units,” said Cutler. “We are maintaining our forecast that production in 2007 will be between 205,000 and 210,000 units.

“Our hybrid truck program made further progress during the quarter, with the receipt of the 2006 Environmental Innovation Award from the Ohio Environmental Council,” said Cutler.

The Automotive segment posted fourth quarter sales of $394 million, 6 percent lower than the comparable quarter of 2005. Operating profits were $34 million. Operating profits before acquisition integration charges were $36 million, 27 percent lower than the fourth quarter of 2005. Excel 07 net costs in the fourth quarter were neutral.

Automotive production in NAFTA declined by 8 percent compared to the fourth quarter of 2005, while European production was flat.

“Our Automotive segment margins in the fourth quarter were impacted by the reductions in production volumes in North America and the continued importation of engines by Asian producers,” said Cutler. “For 2007, we anticipate weaker production in NAFTA, with another year of flat production in Europe. However, we expect our margins to improve as a result of the substantial benefits from Excel 07.”