Eaton Second Quarter Report

Net income was $209 million compared to $161 million in 2004, an increase of 30 percent.

Net income in both periods included charges for restructuring activities related to the integration of acquisitions. Before these restructuring charges, operating earnings per share in the second quarter of 2005 were $1.40 versus $1.06 per share in 2004, an increase of 32 percent, and operating earnings for the second quarter of 2005 were $214 million compared to $166 million in 2004, an increase of 29 percent.

Alexander M. Cutler, Eaton chairman and chief executive officer, said, "We are very pleased with our second quarter results, which came in above our guidance. Sales growth in the quarter of 18 percent consisted of 9 percent from organic growth, 7 percent from acquisitions, and 2 percent from exchange rates. Our end markets grew by approximately 7 percent.

"In the second quarter, our segment operating margin before restructuring charges was 13.3 percent, a significant step up from the 12.6 percent margin in the first quarter, and a record for the second quarter," said Cutler. "Our operating cash flow for the quarter was $322 million.

"During the quarter, we repurchased $200 million of stock, and we also issued $200 million of long-term debt," said Cutler. "In addition, we were pleased that Standard & Poor's upgraded both our short-term and long-term debt ratings during the quarter.

"As we survey our end markets, we now anticipate growth in 2005 of between 4 to 5 percent," said Cutler. "Growth in nonresidential electrical markets in the U.S. is starting to accelerate, while the growth in the hydraulics markets has slowed.

"We anticipate net income per share for the third quarter of 2005 to be between $1.20 and $1.30. We are increasing our full-year guidance for net income per share by 10 cents, to between $5.00 and $5.20. Operating earnings per share, which exclude restructuring charges to integrate acquisitions, are anticipated to be between $1.25 and $1.35 in the third quarter of 2005, and we are increasing our full-year guidance for operating earnings per share by 10 cents, to between $5.20 and $5.40."

Business Segment Results

Second quarter sales of Eaton's largest segment, Electrical, were $924 million, up 33 percent over 2004. Excluding the impact of the Powerware acquisition, second quarter sales were up 11 percent compared to 2004. Operating profits in the second quarter were $87 million. Operating profits before restructuring charges were $94 million, up 47 percent from results in 2004.

"End markets for our electrical business grew about 5 percent during the second quarter. In addition, our operating margins expanded to 10.2 percent, compared to 9.0 percent in the first quarter," said Cutler. "We expect end market growth in the second half to be between 5 and 6 percent.

"During the quarter, we announced a new joint venture in China to manufacture medium voltage switchgear components," said Cutler. "Also, we were named for the second year in a row as Frost & Sullivan's Power Quality Company of the Year."

In the Fluid Power segment, second quarter sales were $842 million, 6 percent above the second quarter of 2004. Fluid Power markets grew 3 percent compared to the same period in 2004, with global fluid power industry shipments up an estimated 5 percent, commercial aerospace markets up 7 percent, defense aerospace markets flat, and European automotive production down 1 percent. Operating profits in the second quarter were $94 million. Operating profits before restructuring charges were $95 million, up 3 percent compared to a year earlier.

"Growth in the mobile and industrial hydraulics markets slowed during the first half of the year," said Cutler. "The commercial aerospace market is starting to accelerate, while defense aerospace is likely to be flat for the full year.

"We announced in early July the acquisition of the industrial filtration business of Hayward Industries," said Cutler. "This acquisition, which is expected to close by the end of the third quarter, provides a sizeable entry into the filtration market, an area that is a natural extension of our existing Fluid Power business and an area expected to enjoy significant growth over the next several years.

"During the quarter, we won several awards for the Boeing 787 and the Airbus A400," said Cutler. "The new awards for the 787 are expected to total revenues of $194 million, and the new awards on the A400 are expected to total revenues of $27 million. In addition, we were pre-selected for five subsystems on the very light jet program of Embraer, pending final contract approval."

The Truck segment posted sales of $596 million in the second quarter, up 37 percent compared to 2004, and recorded operating profits of $120 million, an increase of 54 percent from the second quarter of 2004. NAFTA heavy-duty production was up 39 percent compared to 2004, NAFTA medium-duty production was up 11 percent, European truck production was up 10 percent, and Brazilian vehicle production was up 13 percent.

"Second quarter production of NAFTA heavy-duty trucks totaled 88,000 units, about 11 percent more than in the first quarter of 2005," said Cutler. "As a result of the higher than expected NAFTA heavy-duty production in the first two quarters of 2005, we are raising our estimate of the 2005 market from 310,000 units to 320,000 units.

"We are delighted to continue our very positive momentum in the developing market for hybrid powertrains for medium duty trucks," said Cutler. "In early July, we were notified that the UK's Institute of Transport Management awarded Eaton the Global Environmental Company of the Year for our hybrid powertrain technology.

"We were also awarded a contract to supply medium-duty transmissions to Hyundai for the Korean market," said Cutler. "We anticipate annual volumes of $20 million, with production starting in 2007."

The Automotive segment posted second quarter sales of $472 million, 1 percent lower than the comparable quarter of 2004. Automotive production in both NAFTA and Europe was down 1 percent compared to the second quarter of 2004. Operating profits were $67 million, up 3 percent compared to a year earlier.

"The Automotive markets held up better than generally expected during the second quarter," said Cutler. "We are expecting that for 2005 as a whole the markets in NAFTA and Europe will be down approximately 2 percent.

"We completed the acquisition of Morestana during the quarter, which expands our manufacturing presence in Mexico," said Cutler. "We also made progress during the quarter on the construction of a significant new plant in Poland to expand our ability to serve European automotive customers."

"Last week, we announced we signed an agreement to purchase Tractech Holdings, a global manufacturer of specialized differentials and clutch components for the commercial vehicle markets," said Cutler. "This acquisition, which is expected to close in the third quarter, will allow us to extend our existing differential product capabilities into a wide range of markets beyond our traditional light vehicle applications."