Eaton Sandy

a Transformational Year

In times of economic uncertainty around the world, many people and organizations begin to hesitate and make themselves victims of forces they consider beyond their control. At Eaton, we have chosen instead to move forward with confidence and purpose—and to create our own growth.

To Our Shareholders:

Just two years ago, we celebrated our 100th anniversary, paying tribute to generations of employees whose relentless ingenuity and passionate spirit have made Eaton one of the world’s leading power management companies. Over that proud history, we demonstrated time and again that the only way to succeed is to maintain a bold course regardless of economic conditions, and to continuously transform our business to adapt to changing markets and customer needs.

During 2012, we sustained that strategy by acquiring Cooper Industries plc, a company with a heritage that is as rich as our own—and a history of accomplishments that dates back even further. The $13 billion acquisition—the largest we’ve ever accomplished—is a transformational milestone that expands the electrical solutions we can offer to customers, strengthens our capabilities in growing market segments (including oil and gas, mining, data centers and utilities) and increases our presence in key geographic regions.

I’m pleased to welcome Cooper’s shareholders and employees with this letter, and we’ve dedicated this year’s annual report to exploring the myriad opportunities that our combined businesses have already begun to pursue. Together, we truly do make a “powerful combination”—a combination that I’m confident will continue to transform our business in many ways for years to come.

Delivering strong returns in a soft economy

While 2012 began with great promise, global economies sputtered during the second half of the year, deflating many of our end markets. In fact, our end markets shrank by 5 percent during the fourth quarter—more than twice the decline we expected. Despite this weakness, we continued to post solid financial results and deliver strong returns to Eaton’s shareholders. Among the year’s financial and operating highlights (including one month of results from the Cooper acquisition, which we closed on November 30):

  • We posted record sales of $16.3 billion, up 2 percent from 2011.
  • Net income per share fell 12 percent to $3.46, due in large part to acquisition, integration and restructuring costs incurred during the year.
  • We generated $1.7 billion in cash from operations and increased our dividend by 12 percent.
  • We contributed $413 million to our pension plans, strengthening our balance sheet.
  • We completed five acquisitions: three new electrical businesses (Cooper, Rolec Comercial e Industrial S.A. and Gycom’s low-voltage power distribution business) and two new hydraulics businesses (Polimer Kauçuk Sanayi ve Pazarlama A.S., which manufactures hoses under the SEL brand, and Jeil Hydraulics Co. Ltd.).
Eaton 2000
Eaton 2012
Eaton 2012 Pro Forma
Together, these businesses will now generate more than 80 percent of our revenues.

Eaton is a significantly larger—and far different—company today than we were only 12 years ago, driven by the strong growth of our electrical, hydraulics and aerospace businesses and our rapid expansion around the world.

  • We strengthened our commitment to sustainability leadership by reducing our greenhouse gas emissions, waste to landfill and water consumption, while expanding our efforts to build better, safer and stronger workplaces and communities.
  • We launched a global “Zero Incident Safety Culture” to further engage our employees and to strengthen our safety process, reducing our number of severe injuries by 17 percent from the previous year.
  • Ninety-six percent of our workforce participated in our global employee survey, demonstrating continued strong employee engagement.

Our stock attained new record highs during 2012. For the year, the value of Eaton shares (including quarterly dividends) increased by 29 percent compared to gains of 10 percent for the Dow Jones industrial average, 16 percent for the S&P 500 and 17 percent for the Nasdaq composite index. Since 2000, Eaton stock has delivered a strong 14 percent compounded annual total shareholder return.

As part of our acquisition of Cooper, we reincorporated our company in Ireland. Eaton continues to trade on the New York Stock Exchange under the ticker symbol “ETN.”

Maintaining a balanced business strategy

Eaton is a significantly larger—and far different—company today than we were only 12 years ago, driven by the strong growth of our electrical, hydraulics and aerospace businesses. Since 2000, revenues from these businesses have nearly tripled, while revenues from our vehicle businesses are up just under 10 percent.

Our acquisition of Cooper accelerates that evolution, establishing Eaton as one of the world’s largest electrical companies. Renowned Cooper franchises such as Crouse-Hinds and Bussmann fortify our expertise and expand our powerhouse portfolio of electrical product lines that now includes Cutler-Hammer, Holec, Powerware, Moeller, Phoenixtec, McGraw-Edison, Kyle, Halo and many more.

As a result, we believe we’ve never been better positioned to focus our efforts on attractive growth opportunities while maintaining a strategically diversified mix of businesses. Going forward, we estimate:

  • Our electrical business will generate approximately 60 percent of our annual sales, compared to only 29 percent in 2000.
  • More than 80 percent of our annual sales will be generated by our combined electrical, hydraulics and aerospace businesses with the balance of our sales generated by our vehicle business.
  • Half of our revenues will be generated outside of the U.S.—compared to only 20 percent in 2000. (This projection is slightly lower than our 2011 and 2012 results because more of Cooper’s sales are currently U.S.-based.)

This diversification of our businesses—both across geographies and business cycles—continues to help us balance the variability and volatility that is inherent in managing a global industrial company. During 2012, for example, strong commercial and residential sales in the Americas enabled our electrical business to achieve record revenues and profits, despite weakness in European and Asia Pacific markets. Modest growth in our hydraulics and aerospace businesses helped offset declines in automotive and truck. (Read more in our operating highlights.)

To reflect the evolution of our company, we will begin reporting our financial results in 2013 using the following five business segments: electrical products, electrical systems and services, hydraulics, aerospace and vehicle.

2012

Operating highlights


Electrical

Electrical

Including one month of revenues from our acquisition of Cooper Industries, sales of our global electrical business grew by 8 percent in 2012 to $7.7 billion, a new record. Profits topped $1.1 billion, also a record. Sales and profits in the Americas achieved all-time highs with both the power distribution and power quality businesses showing equal strength at year-end. Electrical sales declined in the rest of the world but improved significantly during the second half of the year, in spite of continued weakness in European and Asia Pacific markets. Our new line of highly efficient mid-range uninterruptible power systems and our Power Xpert UX family of medium-voltage switchgear are just two examples of how we continued to expand our industry leadership. Our acquisition of Rolec Comercial e Industrial S.A. strengthens our capabilities in the mining sector and adds to our local presence in Chile and Peru. Our acquisition of Cooper was the capstone to an outstanding year.

Integrated solutions for large-scale projects—such as a $27 million contract to provide turnkey equipment design, electrical assemblies and engineering services for the Panama Canal expansion program—helped drive our growth during 2012. We also experienced strong demand for sustainable building solutions, including a $10 million contract to increase the energy efficiency of 15 Veterans Health Administration medical centers. Innovations in lean automation technology, combined with expanded distribution, boosted sales to global machine manufacturers. We expect that our acquisition of Cooper—with its exceptional strength in commercial, residential, industrial and utility end markets—will expand these and other growth opportunities in 2013 and beyond.

Hydraulics

Hydraulics

Our hydraulics business grew again in 2012, although slower than in recent years due to reduced infrastructure and construction spending. For the year, sales totaled $3.0 billion, up 4 percent compared to 2011. These results include two key acquisitions—Polimer Kauçuk (SEL), strengthening our industrial and specialty hose portfolio, and Korea’s Jeil Hydraulics, creating new opportunities in the construction equipment market.

Sales to Africa, Eastern Europe and Russia were strong and we continued to expand our business in agriculture, mining and energy markets, including Brazil’s oil and gas industry. New contracts in China included Guizhou Aviation Industry Group (cotton harvesting equipment), XCMG Group (construction machinery) and Wanda Group (entertainment). Sales of filtration products to the food and beverage market grew by double digits during the year; we also made gains in marine, pharmaceutical, blood fractionation and refinery markets.

Aerospace

Aerospace

We continued to expand our sales of safe, reliable and efficient power management solutions to global aerospace customers in 2012, with revenues growing by 4 percent during the year. New wins will secure future growth fueled by contracts with Boeing (major components and subsystems for the KC-46 tanker), COMAC (cargo-door actuation system for the C919 passenger aircraft), GE Aviation (debris monitoring components for the LEAP-X engine) and Embraer (hydraulic components and fuel-tank inerting for the KC-390 military transport aircraft).

During 2012, we celebrated our 50th year of supporting NASA missions, including supplying high-pressure seals for the Curiosity rover, which landed on Mars in August.

Vehicle

Vehicle

Sales for our truck business declined 13 percent during 2012 to $2.3 billion. However, we maintained strong margins—18.2 percent—as a result of reduced warranty claims, aggressive spending controls and lower commodity costs. Commercial vehicle buyers continue to drive demand for our fuel-efficient UltraShift PLUS automated transmissions, including new contracts in South America, South Africa, China and Brazil. Our automotive business posted sales of $1.6 billion, an 8 percent decline compared to the previous year.

Net of foreign exchange and divestitures, results were flat. European markets, which slumped to levels close to the lows of the last decade, erased gains in other parts of the world. Demand remains strong for Eaton technologies that boost fuel economy, including our superchargers (currently available or in development on about 75 vehicles), variable-valve lifts, hollow valves and cylinder-deactivation technology. We also won our first ELocker locking differential contract in Russia.


Our businesses are balanced through the economic cycle

Eaton businesses are balanced through the economic cycle

Creating our own growth in an uncertain environment

Global economies decelerated as we progressed through 2012, leading to another year of sub-par growth. We don’t expect that environment to change dramatically in 2013 as the Eurozone struggles with challenging fiscal and monetary decisions, the U.S. remains captive to the pressures of fiscal imbalance, and emerging nations—once the source of strong growth—continue their slow rebound.

As a result, our economic outlook for 2013 feels much like it did a year ago when I wrote in this same letter: “Faced with subtrend global economic growth, companies must create their own growth.” I’m confident that the actions our team took in 2012 have already put us solidly on that course:

  • We believe our acquisition of Cooper will add approximately $5.8 billion to our 2013 revenues. By 2016, we believe the Cooper acquisition will create $405 million in annual pre-tax operational synergies and an additional $160 million in annual after-tax synergies from cash management and resultant tax benefits.
  • Our acquisitions of Rolec, Gycom, Polimer Kauçuk (SEL) and Jeil will add another $200 million to our 2013 revenues and create new opportunities for us in attractive markets.
  • We have continued our aggressive investments in new products and technologies, and the steady stream of new products and services emanating from these investments continues to drive premium growth opportunities.
  • To respond to continuing soft market conditions, particularly in Europe, we restructured, consolidated or closed several of our manufacturing facilities, reducing future costs.

While the Cooper acquisition will demand significant management and financial resources for the next several years, I’m pleased to report that our integration plan is ahead of schedule, delivering faster than expected efficiencies in our supply chain and selling, general and administrative expenses. We’re also ahead of plan in terms of our cash flow generation and ability to repay debt. As a result, we believe the Cooper acquisition will be accretive to earnings in 2013, a full year ahead of our original projections. During our fourth quarter conference call, we issued guidance of $4.05 to $4.45 operating earnings per share for 2013, which would establish a new record for our company even in this challenging environment.

I want to salute our associates’ commitment to never standing still, even in the face of uncertainty. Their courage to continue to innovate, to adopt and explore new concepts, and to serve our customers in new ways is truly admirable. Not hesitating, always moving forward—their accomplishments each and every day are truly impressive. I have seen the same courageous commitment from the talented leaders and associates of Cooper Industries, creating a dynamic environment for growth.

While strong, our team’s collective pride in our enterprise is tempered by our recognition that we have so much more to improve and accomplish. Eaton’s transformation will continue, fueled by our values-based culture and our customers’ growing demand for safe, reliable, efficient and sustainable power management solutions. We live our values every day and are prepared to once again make this annual pledge to our shareholders: We are committed to Doing Business Right!

On behalf of our entire Eaton team, thank you for your continued support.

Alexander M. Cutler
Chairman and Chief Executive Officer