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

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

Not applicable

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

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 167.8 million Common Shares outstanding as of June 30, 2010.

 

 

PART 1 – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

EATON CORPORATION
STATEMENTS OF CONSOLIDATED INCOME

		Three months ended								Six months ended
		June 30								June 30
(Millions except for per share data)		2010				2009				2010				2009
Net sales		$	3,378			$	2,901			$	6,481			$	5,714
Cost of products sold			2,387				2,189				4,588				4,363
Selling & administrative expense			604				554				1,191				1,112
Research & development expense			103				95				204				193
Interest expense-net			34				41				69				78
Other (income) expense-net			(1	)			(8	)			(9	)			1
Income (loss) before income taxes			251				30				438				(33	)
Income tax expense (benefit)			22				(1	)			53				(12	)
Net income (loss)			229				31				385				(21	)
Adjustment of net income (loss) for noncontrolling interests			(3	)			(2	)			(4	)
Net income (loss) attributable to common shareholders		$	226			$	29			$	381			$	(21	)
Net income (loss) per common share — diluted		$	1.33			$	.17			$	2.24			$	(.13	)
Average number of common shares outstanding — diluted			170.2				167.6				169.9				166.2
Net income (loss) per common share — basic		$	1.35			$	.17			$	2.27			$	(.13	)
Average number of common shares outstanding — basic			167.4				166.9				167.2				166.2
Cash dividends paid per common share		$	.50			$	.50			$	1.00			$	1.00

See accompanying notes.

EATON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS

		June 30,				December 31,
(Millions)		2010				2009
Current assets
Cash		$	249			$	340
Short-term investments			538				433
Accounts receivable			2,126				1,899
Inventories			1,386				1,326
Deferred income taxes & other current assets			563				526
Total current assets			4,862				4,524
Property, plant & equipment-net			2,270				2,445
Goodwill			5,125				5,435
Other intangible assets			2,203				2,441
Deferred income taxes & other long-term assets			1,467				1,437
Total assets		$	15,927			$	16,282
Current liabilities
Short-term debt		$	93			$	113
Current portion of long-term debt			5				5
Accounts payable			1,229				1,057
Accrued compensation			350				256
Other current liabilities			1,321				1,258
Total current liabilities			2,998				2,689
Long-term debt			3,378				3,349
Pension liabilities			1,217				1,586
Other postretirement benefits liabilities			753				754
Deferred income taxes & other long-term liabilities			971				1,086
Equity
Eaton shareholders’ equity			6,570				6,777
Noncontrolling interests			40				41
Total equity			6,610				6,818
Total liabilities & equity		$	15,927			$	16,282

See accompanying notes.

EATON CORPORATION
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS

		Six months ended
		June 30
(Millions)		2010				2009
Net cash provided by (used in) operating activities
Net income (loss)		$	385			$	(21	)
Adjustments to reconcile to net cash provided by (used in) operating activities
Depreciation & amortization			277				281
Pension expense			89				174
Contributions to pension plans			(349	)			(125	)
Changes in working capital			(121	)			251
Other-net			26				(117	)
Net cash provided by operating activities			307				443
Net cash provided by (used in) investing activities
Expenditures for property, plant & equipment			(101	)			(96	)
Sales (purchases) of short-term investments-net			(121	)			(67	)
Other-net			6				(2	)
Net cash used in investing activities			(216	)			(165	)
Net cash provided by (used in) financing activities
Borrowings with original maturities of more than three months — proceeds			55				557
Borrowings with original maturities of more than three months — payments			(27	)			(315	)
Borrowings (payments) with original maturities of less than three months-net, primarily commercial paper			(48	)			(424	)
Cash dividends paid			(168	)			(167	)
Cash from exercise of employee stock options			36				9
Other-net			2				(3	)
Net cash used in financing activities			(150	)			(343	)
Effect of foreign exchange rate changes on cash			(32	)			25
Total decrease in cash			(91	)			(40	)
Cash at the beginning of the year			340				188
Cash at the end of the period		$	249			$	148

See accompanying notes.

EATON CORPORATION
NOTES TO THE SECOND QUARTER 2010 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Millions of dollars and shares unless indicated otherwise (per share data assume dilution)

PREPARATION OF FINANCIAL STATEMENTS

The accompanying unaudited condensed consolidated financial statements of Eaton Corporation (Eaton) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and notes 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 financial position, results of operations and cash flows for the stated periods. Management has evaluated subsequent events through the date the financial statements were filed with the SEC, noting no events that require adjustment of, or disclosure in, the consolidated financial statements for the period ended June 30, 2010, except as described in the “Acquisitions of Businesses” note below. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in Eaton’s 2009 Annual Report on Form 10-K. The interim period results are not necessarily indicative of the results to be expected for the full year.

ACQUISITIONS OF BUSINESSES

In 2009, Eaton acquired one business and entered into a joint venture. The Statements of Consolidated Income include the results of these businesses from the dates of the transactions. These transactions are summarized below:

		Date of		Business
Acquired business		acquisition		segment		Annual sales
Micro Innovation Holding AG		September 1, 2009		Electrical Rest of World		$33 for 2008
A Switzerland-based manufacturer of human machine interfaces, programmable logic controllers and input/output devices. Eaton acquired the remaining shares to increase its ownership from 50% to 100%.
SEG Middle East Power Solutions & Switchboard Manufacture LLC		July 2, 2009		Electrical Rest of World		$10 for 2008
A 49%-owned joint venture in Abu Dhabi that manufactures low voltage switchboards and control panels assemblies for use in the Middle East power generation and industrial markets.

Subsequent Events — Acquisitions of Businesses

On July 15, 2010, Eaton acquired EMC Engineers, Inc. Headquartered in Denver, Colorado, this business is an energy engineering and energy services company that delivers energy efficiency solutions for a wide range of governmental, educational, commercial and industrial facilities. The firm is a leader in retrofitting and modernizing mechanical, electrical and control systems, as well as energy modeling and analysis, facility commissioning, and energy savings performance contracting. This business had sales of $24 for 2009 and employs approximately 155 people.

On July 12, 2010, Eaton entered into a joint venture with Shanghai Aircraft Manufacturing Co., Ltd. (SAMC), a subsidiary of Commercial Aircraft Corporation of China (COMAC), to support the COMAC C919 single-aisle commercial aircraft program. The joint venture will be based in Shanghai and will focus on the design, development, manufacturing and support of fuel and hydraulic conveyance systems for the global civil aviation market. Total program value for C919 conveyance systems, including aftermarket opportunities, is estimated at $1.8 billion, based on an anticipated volume of 2,500 aircraft. Eaton will own a 49% interest in the joint venture.

ACQUISITION INTEGRATION, WORKFORCE REDUCTION & PLANT CLOSING CHARGES

Acquisition Integration Charges

In 2010 and 2009, Eaton incurred charges related to the integration of acquired businesses. These charges were recognized as expense as incurred. A summary of these charges follows:

		Three months ended								Six months ended
		June 30								June 30
		2010				2009				2010				2009
Electrical Americas		$	1			$	2			$	2			$	3
Electrical Rest of World			7				10				14				26
Hydraulics															1
Aerospace			1				3				2				5
Automotive															1
Pretax charges		$	9			$	15			$	18			$	36
After-tax charges		$	6			$	10			$	12			$	24
Per common share		$	.03			$	.06			$	.07			$	.14

Charges in 2010 were related primarily to Moeller and Phoenixtec. Charges in 2009 were related primarily to Integrated Hydraulics, Kirloskar, Moeller, Phoenixtec and Argo-Tech.

Workforce Reduction Charges

Eaton took significant actions in 2009 to reduce its workforce in response to the severe economic downturn. The reductions totaled approximately 17% of the full-time workforce. These actions resulted in the recognition of severance and pension and other postretirement benefits expense of $69 in the second quarter of 2009 and $134 in the first half of 2009.

Summary of Acquisition Integration, Workforce Reduction & Plant Closing Liabilities

A summary of liabilities related to acquisition integration, workforce reduction, and plant closing charges, follows:

										Plant
		Workforce reductions								closing				Total
		Employees				Dollars				& other				dollars
Balance at December 31, 2009			1,418			$	43			$	12			$	55
Liabilities recognized											18				18
Utilized			(886	)			(23	)			(20	)			(43	)
Balance at June 30, 2010			532			$	20			$	10			$	30

These charges were included in the Statements of Consolidated Income in Cost of products sold or Selling & administrative expense, as appropriate. In Business Segment Information, the charges reduced Operating profit of the related business segment.

RETIREMENT BENEFIT PLANS EXPENSE

The components of retirement benefit plans expense follow:

		Three months ended June 30
										Other
										postretirement
		Pension benefits								benefits
		2010				2009				2010				2009
Service cost		$	(30	)		$	(28	)		$	(4	)		$	(4	)
Interest cost			(50	)			(51	)			(12	)			(12	)
Expected return on plan assets			55				47
Amortization			(15	)			(9	)			(2	)
			(40	)			(41	)			(18	)			(16	)
Curtailment loss							(14	)
Settlement loss			(4	)			(51	)
		$	(44	)		$	(106	)		$	(18	)		$	(16	)

		Six months ended June 30
										Other
										postretirement
		Pension benefits								benefits
		2010				2009				2010				2009
Service cost		$	(59	)		$	(60	)		$	(8	)		$	(8	)
Interest cost			(100	)			(100	)			(23	)			(24	)
Expected return on plan assets			109				95
Amortization			(30	)			(22	)			(5	)			(1	)
			(80	)			(87	)			(36	)			(33	)
Curtailment loss							(18	)							(1	)
Settlement loss			(9	)			(69	)
		$	(89	)		$	(174	)		$	(36	)		$	(34	)

Due to limitations imposed by the Pension Protection Act on pension lump sum distributions, Eaton’s U.S. Qualified Pension Plan became restricted in 2009 from making 100% lump sum payments. As a result, the plan experienced a significant increase in lump sum payments in 2009 before the limitation went into effect. Total pension settlement expense was $51 in the second quarter of 2009 and $69 in the first half of 2009, most of which was attributable to the U.S. pension plans. A portion of the increase was attributable to the workforce reduction in 2009.

As a result of the workforce reduction in 2009, curtailment expense related to pension plans of $14 was recognized in the second quarter of 2009 and $18 in the first half of 2009. The curtailment expense included recognition of the change in the projected benefit obligation, as well as recognition of a portion of the unrecognized prior service cost.

These charges were primarily included in the Statements of Consolidated Income in Cost of products sold or Selling & administrative expense, as appropriate. In Business Segment Information, the charges were included in Pension & other postretirement benefits expense.

INCOME TAXES

During the second quarter and the first half of 2010, income tax expense of $22 and $53, respectively, was recognized (an effective tax rate of 9.0% in the second quarter and 12.2% in the first half of 2010) compared to income tax benefits of $1 and $12 in the second quarter and the first half of 2009, respectively (a tax benefit rate of 4.8% in the second quarter and 36.6% for the first half of 2009). Income tax expense for the first half of 2010 included a non-cash, one-time charge of $23 ($0.14 per common share) that was recognized in the first quarter of 2010 to reflect the impact of the Health Care Reform and Education Reconciliation Act on taxation associated with Medicare Part D. Without this one-time charge, income tax expense of $30 (an effective tax rate of 6.9%) would have been recognized in the first half of 2010. Income tax expense for the first half of 2010 also reflected a benefit associated with the successful resolution of international tax audit issues; the recognition of state and local income tax attributes involving tax loss carryforwards, tax credits and other temporary differences; the recognition of international tax incentives; and the recognition of other international tax benefits. Included as an offset to the aforementioned income tax benefits that lowered the effective income tax rate in the first half of 2010 was an adjustment totaling $29 that was recognized in the first quarter of 2010 related to an income tax audit of transfer prices for 2005 to 2009. After further analysis of the facts surrounding the income tax audit and related adjustments, the Company recognized a $7 reduction of income tax expense in the second quarter of 2010. The Company concluded that the effect of these adjustments was not material to the prior period financial statements, as well as the projected 2010 financial statements.

MERITOR LITIGATION

On October 5, 2006, ZF Meritor LLC and Meritor Transmission Corporation (collectively, Meritor) filed an action against Eaton in the U.S. District Court for Delaware. The action sought damages, which would be trebled under U.S. 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 is currently pending. Accordingly, an estimate of any potential loss related to this action cannot be made at this time.

COMPREHENSIVE INCOME (LOSS)

The components of comprehensive income (loss) follow:

		Three months ended								Six months ended
		June 30								June 30
		2010				2009				2010				2009
Net income (loss)		$	229			$	31			$	385			$	(21	)
Foreign currency translation & related hedging instruments			(307	)			399				(483	)			216
Cash flow hedges			(5	)			10				(9	)			33
Pensions & other postretirement benefits			28				214				47				239
Other comprehensive income (loss)			(284	)			623				(445	)			488
Total comprehensive income (loss)			(55	)			654				(60	)			467
Less comprehensive income (loss) attributable to noncontrolling interests			(3	)			(2	)			(4	)
Comprehensive income (loss) attributable to common shareholders		$	(58	)		$	652			$	(64	)		$	467

TOTAL EQUITY

The changes in Total equity follow:

		Eaton
		shareholders’				Noncontrolling				Total
		equity				interests				equity
Balance at December 31, 2009		$	6,777			$	41			$	6,818
Net income			381				4				385
Other comprehensive income (loss)			(445	)							(445	)
Total comprehensive income (loss)			(64	)			4				(60	)
Cash dividends paid			(168	)			(5	)			(173	)
Issuance of shares under employee benefit plans- net			25								25
Balance at June 30, 2010		$	6,570			$	40			$	6,610

		Eaton
		shareholders’				Noncontrolling				Total
		equity				interests				equity
Balance at December 31, 2008		$	6,317			$	48			$	6,365
Net (loss)			(21	)							(21	)
Other comprehensive income			488								488
Total comprehensive income			467								467
Cash dividends paid			(167	)			(4	)			(171	)
Issuance of shares under employee benefit plans- net			30								30
Balance at June 30, 2009		$	6,647			$	44			$	6,691

INVENTORIES

The components of inventories follow:

		June 30,				December 31,
		2010				2009
Raw materials		$	635			$	608
Work-in-process & finished goods			859				823
Inventories at FIFO			1,494				1,431
Excess of FIFO over LIFO cost			(108	)			(105	)
Total inventories		$	1,386			$	1,326

NET INCOME (LOSS) PER COMMON SHARE

A summary of the calculation of net income (loss) per common share attributable to common shareholders assuming dilution and basic follows:

		Three months ended								Six months ended
		June 30								June 30
(Shares in millions)		2010				2009				2010				2009
Net income (loss) attributable to common shareholders		$	226			$	29			$	381			$	(21	)
Average number of common shares outstanding — diluted			170.2				167.6				169.9				166.2
Less dilutive effect of stock options and restricted stock awards			2.8				.7				2.7
Average number of common shares outstanding — basic			167.4				166.9				167.2				166.2
Net income (loss) per common share — diluted		$	1.33			$	.17			$	2.24			$	(.13	)
Net income (loss) per common share — basic		$	1.35			$	.17			$	2.27			$	(.13	)

In the first half of 2010, 3.6 million stock options 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. This compares to 8.2 million antidilutive stock options for the same period in 2009.

FINANCIAL ASSETS & LIABILITIES RECOGNIZED AT FAIR VALUE

Financial instruments are categorized into a fair value hierarchy of three levels, based on the degree of subjectivity inherent in the valuation methodology as follows:

•		Level 1 — Quoted prices (unadjusted) for identical assets in active markets.
•		Level 2 — Quoted prices for similar assets in active markets, and inputs that are observable for the asset, either directly or indirectly, for substantially the full term of the financial instrument.
•		Level 3 — Unobservable prices or inputs.

A summary of financial instruments recognized at fair value and the fair value measurements used, follows:

		June 30, 2010
														Recognized
		Level 1				Level 2				Level 3				value
Cash		$	249											$	249
Short-term investments			538												538
Foreign currency forward exchange contracts						$	(4	)							(4	)
Commodity contracts							(9	)							(9	)
Fixed-to-floating interest rate swaps							65								65
Related long-term debt converted to floating interest rates by interest rate swaps							(65	)							(65	)
Total		$	787			$	(13	)		$				$	774

Level 2 financial instruments are valued using an industry standard market approach. No financial instruments were recognized using unobservable prices or inputs Level 3.

Long-term debt and current portion of long-term debt had a carrying value of $3,383 and fair value of $3,813 at June 30, 2010.

Assets of $2,129 related to defined benefit pension plans were also measured at fair value at June 30, 2010.

DISCLOSURES ABOUT DERIVATIVE FINANCIAL INSTRUMENTS & 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 derivative financial instruments used by Eaton are straightforward, non-leveraged instruments. The counterparties to these financial 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 derivative financial instruments are not purchased and sold for trading purposes.

Derivative financial instruments are measured at fair value and recognized as assets or liabilities in the Consolidated Balance Sheet. 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, on 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 Eaton shareholders’ equity 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 Eaton shareholders’ equity 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 as a hedge is included in the same line of the Statement of Consolidated 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 that arise in the normal course of business.

Information as to the fair value of derivative financial instruments recognized in the Consolidated Balance Sheet follows:

		Fair value at June 30, 2010
		Other								Other
		current				Other long-				current
		assets				term assets				liabilities
Derivatives designated as hedges
Fixed-to-floating interest rate swaps (fair value hedges)						$	65
Foreign currency exchange contracts (cash flow hedges)		$	4							$	3
Commodity contracts (cash flow hedges)											3
Total		$	4			$	65			$	6
Derivatives not designated as hedges
Foreign currency exchange contracts		$	21							$	26
Commodity contracts			1								7
Total		$	22							$	33

		Fair value at December 31, 2009
		Other								Other
		current				Other long-				current
		assets				term assets				liabilities
Derivatives designated as hedges
Fixed-to-floating interest rate swaps (fair value hedges)						$	29
Foreign currency exchange contracts (cash flow hedges)		$	6							$	4
Commodity contracts (cash flow hedges)			5
Total		$	11			$	29			$	4
Derivatives not designated as hedges
Foreign currency exchange contracts		$	17							$	31
Commodity contracts			3
Total		$	20							$	31

At June 30, 2010, the notional amount related to derivatives designated as hedges in the table above was $1,020, including $700 of fixed-to-floating interest rate swaps. This compares to $879 of notional value at December 31, 2009, including $700 of fixed-to-floating interest rate swaps.

Amounts recognized in net income follow:

		Three months ended June 30
		Gain (loss) recognized in net income
		2010				2009
Derivatives designated as fair value hedges
Fixed-to-floating interest rate swaps		$	32			$	(26	)
Related long-term debt converted to floating interest rates by interest rate swaps			(32	)			26

		Six months ended June 30
		Gain (loss) recognized in net income
		2010				2009
Derivatives designated as fair value hedges
Fixed-to-floating interest rate swaps		$	36			$	(45	)
Related long-term debt converted to floating interest rates by interest rate swaps			(36	)			45

The gains and losses described above were recognized in the Statements of Consolidated Income in Interest expense.

Amounts recognized in Eaton shareholder’s equity follow:

		Three months ended June 30
		2010								2009
		Gain (loss)				Gain (loss)				Gain (loss)				Gain (loss)
		recognized in				reclassified				recognized in				reclassified
		Eaton				from Eaton				Eaton				from Eaton
		shareholders’				shareholders’				shareholders’				shareholders’
		equity				equity				equity				equity
Derivatives designated as cash flow hedges
Foreign currency exchange contracts		$	5							$	7			$	(3	)
Commodity contracts			(3	)		$	1				7				(6	)
Total		$	2			$	1			$	14			$	(9	)

		Six months ended June 30
		2010								2009
		Gain (loss)				Gain (loss)				Gain (loss)				Gain (loss)
		recognized in				reclassified				recognized in				reclassified
		Eaton				from Eaton				Eaton				from Eaton
		shareholders’				shareholders’				shareholders’				shareholders’
		equity				equity				equity				equity
Derivatives designated as cash flow hedges
Foreign currency exchange contracts		$	1			$	(1	)		$	1			$	(7	)
Commodity contracts			(4	)			4				19				(16	)
Total		$	(3	)		$	3			$	20			$	(23	)

The gains and losses described above that were reclassified from Eaton shareholders’ equity to the Statements of Consolidated Income were recognized in Cost of products sold.

EATON CORPORATION
BUSINESS SEGMENT INFORMATION

		Three months ended								Six months ended
		June 30								June 30
		2010				2009				2010				2009
Net sales
Electrical Americas		$	894			$	881			$	1,696			$	1,740
Electrical Rest of World			665				595				1,273				1,139
Hydraulics			568				425				1,058				855
Aerospace			370				409				746				827
Truck			492				321				945				613
Automotive			389				270				763				540
Total net sales		$	3,378			$	2,901			$	6,481			$	5,714
Segment operating profit (loss)
Electrical Americas		$	120			$	144			$	225			$	250
Electrical Rest of World			60				16				102				10
Hydraulics			77				14				131				20
Aerospace			48				70				97				141
Truck			59				(3	)			105				(37	)
Automotive			39				(19	)			81				(65	)
Total segment operating profit			403				222				741				319
Corporate
Amortization of intangible assets			(43	)			(42	)			(88	)			(84	)
Interest expense-net			(34	)			(41	)			(69	)			(78	)
Pension & other postretirement benefits expense			(29	)			(92	)			(61	)			(139	)
Stock option expense			(2	)			(6	)			(7	)			(13	)
Other corporate expense–net			(44	)			(11	)			(78	)			(38	)
Income (loss) before income taxes			251				30				438				(33	)
Income tax expense (benefit)			22				(1	)			53				(12	)
Net income (loss)			229				31				385				(21	)
Adjustment of net income (loss) for noncontrolling interests			(3	)			(2	)			(4	)
Net income (loss) attributable to common shareholders		$	226			$	29			$	381			$	(21	)

Segment operating profit was reduced by acquisition integration charges as follows:
Electrical Americas		$	1			$	2			$	2			$	3
Electrical Rest of World			7				10				14				26
Hydraulics															1
Aerospace			1				3				2				5
Automotive															1
Total		$	9			$	15			$	18			$	36

ITEM 2. MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS.

EATON CORPORATION

Millions of dollars and shares unless indicated otherwise (per share data assume dilution)

Net income refers to net income attributable to Eaton common shareholders

OVERVIEW OF THE COMPANY

Eaton Corporation is a diversified power management company with 2009 sales of $11.9 billion. Eaton 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 70,000 employees and sells products to customers in more than 150 countries.

The principal markets for the Electrical Americas and Electrical Rest of World segments are industrial, institutional, government, utility, commercial, residential, information technology and original equipment manufacturers. These products are used wherever there is a demand for electrical power in commercial buildings, data centers, residences, apartment and office buildings, hospitals, factories and utilities. The segments share several common global customers, but a large number of customers are located regionally and sales are made directly and indirectly through distributors, resellers and manufacturers representatives.

The principal markets for the Hydraulics segment include oil and gas, renewable energy, marine, agriculture, construction, mining, forestry, utility, material handling, truck and bus, machine tools, molding, primary metals and power generation. Key manufacturers in these markets and other customers are located globally, and these products are sold and serviced through a variety of channels.

The principal markets for the Aerospace segment are manufacturers of commercial and military aircraft and related after-market customers. These manufacturers and customers are located globally, and products are sold and serviced through a variety of channels.

The principal markets for the Truck and Automotive segments are original equipment manufacturers and after-market customers of heavy-, medium- and light-duty trucks, SUVs, CUVs, or passenger cars. Customers are located globally, and most sales are made directly.

RECONCILIATION OF NON-GAAP FINANCIAL MEASURES

This Management’s Discussion & Analysis of Financial Condition & Results of Operations discloses operating earnings, operating earnings per common share, and operating profit (loss) 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 Summary of Results of Operations for 2010 and in Results by Business Segment. This Management’s Discussion & Analysis of Financial Condition & Results of Operations also discloses net income and net income per common share, and operating earnings and operating earnings per common share, before the non-cash, one-time income tax charge of $23 ($.14 per share) related to Medicare Part D, recognized in the first quarter of 2010, as discussed below. 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.

SUMMARY OF RESULTS OF OPERATIONS FOR 2010 COMPARED TO 2009

Eaton reported net sales of $3.4 billion in the second quarter of 2010 and $6.5 billion in the first half of 2010, increases of 16% and 13% over the second quarter and the first half of 2009, respectively. Net income of $226 in the second quarter of 2010 and $381 in the first half of 2010 increased significantly over net income of $29 in the second quarter of 2009 and a net loss of $(21) in the first half of 2009. Net income per common share was $1.33 in the second quarter of 2010 and $2.24 in the first half of 2010, which also increased significantly over net income per share of $.17 in the second quarter of 2009 and a net loss of ($.13) per share in the first half of 2009. The continued expansion in the global economy drove growth in most of the Company’s end markets and the Company’s newly reset cost structure allowed Eaton to realize strong incremental margins on the increase in sales in 2010. Additionally, net income for the second quarter and the first half of 2010 improved over similar periods in 2009 due to the absence in 2010 of severance and pension and other postretirement benefits expense of $69 in the second quarter of 2009 and $134 in the first half of 2009. Net income in the first half of 2010 included a non-cash, one-time income tax charge of $23 ($.14 per common share) that was recognized in the first quarter of 2010 related to Medicare Part D resulting from the new Health Care Reform and Education Reconciliation Act. Adjusting for this one-time income tax charge, net income in the first half of 2010 was $404, or $2.38 per share, compared to a net loss of $(21) in the first half of 2009, or ($.13) per share.

The following are highlights of results for 2010 compared to 2009:

		Three months ended June 30																Six months ended June 30
										Increase/				%												Increase/				%
		2010				2009				(Decrease)				Increase				2010				2009				(Decrease)				Increase
Net sales		$	3,378			$	2,901			$	477				16	%		$	6,481			$	5,714			$	767				13	%
Gross profit			991				712				279				39	%			1,893				1,351				542				40	%
Percent of net sales			29.3	%			24.5	%											29.2	%			23.7	%
Income (loss) before income taxes		$	251			$	30			$	221				737	%		$	438			$	(33	)		$	471
Income tax expense (benefit)			22				(1	)			23								53				(12	)			65
Net income (loss)			229				31				198				639	%			385				(21	)			406
Adjustment of net income (loss) for noncontrolling interests			(3	)			(2	)			(1	)							(4	)							(4	)
Net income (loss) attributable to common shareholders		$	226			$	29			$	197				679	%		$	381			$	(21	)		$	402
Net income (loss) per common share — diluted		$	1.33			$	.17			$	1.16				682	%		$	2.24			$	(.13	)		$	2.37
Average common shares outstanding — diluted (in millions)			170.2				167.6				2.6				1.6	%			169.9				166.2				3.7
Reconciliation of net income (loss) attributable to common shareholders to operating earnings
Net income (loss) attributable to common shareholders		$	226			$	29			$	197				679	%		$	381			$	(21	)		$	402
Excluding acquisition integration charges (after-tax)			6				10				(4	)							12				24				(12	)
Operating earnings		$	232			$	39			$	193				495	%		$	393			$	3			$	390
Net income (loss) per common share — diluted		$	1.33			$	.17			$	1.16				682	%		$	2.24			$	(.13	)		$	2.37
Per share impact of acquisition integration charges (after-tax)			.03				.06				(.03	)							.07				.14				(.07	)
Operating earnings per common share		$	1.36			$	.23			$	1.13				491	%		$	2.31			$	.01			$	2.30

Net sales in the second quarter of 2010 increased by 16% compared to the second quarter of 2009. The increase included 12% growth in end markets and 4% above-market growth, with no impact from foreign exchange.

Net sales in the first half of 2010 increased by 13% compared to the first half of 2009. The increase included 11% from core sales and 2% from foreign exchange.

Gross profit increased by 39% in the second quarter of 2010 compared to the second quarter of 2009, and improved to 29.3% of sales. The increase was primarily due to the increase in sales in the second quarter of 2010 and the Company’s newly reset cost structure, including savings associated with workforce reductions taken in 2009. The improvement in the second quarter of 2010 also reflected the absence of pretax charges of $69 for severance and pension and other postretirement benefits expense in the second quarter of 2009 resulting from work force reductions taken in 2009, a substantial portion of which were recognized in Cost of products sold.

Gross profit increased by 40% in the first half of 2010 compared to the first half of 2009, and improved to 29.2% of sales. The increase was primarily due to the same factors as in the second quarter of 2010. The improvement in the first half of 2010 also reflected the absence of pretax charges of $134 in the first half of 2009 resulting from the work force reductions taken in 2009, a substantial portion of which were recognized in Cost of products sold.

Net income of $226 in the second quarter of 2010, or $1.33 per common share, increased significantly compared to net income of $29 in the second quarter of 2009, or $.17 per share. The increases were primarily due to higher sales in 2010 and the factors that affected gross profit discussed above. Before the effect of acquisition integration charges, operating earnings were $232 in the second quarter of 2010, or $1.36 per share, significantly above operating earnings of $39 in the second quarter of 2009, or $.23 per share.

Net income of $381 in the first half of 2010, or $2.24 per common share, increased significantly over a net loss of $(21) in the first half of 2009, or $(.13) per share, primarily due to the same factors as in the second quarter of 2010. Net income in the first half of 2010 included a non-cash, one-time income tax charge of $23 ($.14 per common share) that was recognized in the first quarter of 2010 related to Medicare Part D resulting from the new Health Care Reform and Education Reconciliation Act. Adjusting for this one-time income tax charge, net income in the first half of 2010 was $404, or $2.38 per share, compared to a net loss of $(21) in the first half of 2009, or ($.13) per share. Before the effect of acquisition integration charges, operating earnings were $393 in the first half of 2010, or $2.31 per share, significantly above operating earnings of $3 in the first half of 2009, or $.01 per share. Adjusting for the non-cash, one-time income tax charge related to Medicare Part D, operating earnings in the first half of 2010 were $416, or $2.45 per share.

Net cash provided by operating activities was $307 in the first half of 2010, a decrease of $136 compared to net cash provided by operating activities of $443 in the first half of 2009. Operating cash flows in 2010 reflected higher net income in the first half of 2010 of $385, before adjusting for noncontrolling interests, compared to the net loss of ($21) in the first half of 2009. Cash provided by operating activities in the first half of 2010 was lowered by contributions to pension plans of $349 compared to $125 in the first half of 2009, and a use of cash of $121 resulting from an increase in funding of working capital in the first half of 2010 compared to a decrease of $251 in working capital in the first half of 2009. The increase in working capital funding in the first half of 2010, primarily accounts receivable and inventory, was due to higher levels of operations in 2010 resulting from the global economic recovery. Cash and short-term investments totaled $787 at June 30, 2010, an increase of $14 from $773 at December 31, 2009.

Total debt of $3,476 at June 30, 2010 increased by $9 from $3,467 at December 31, 2009. The increase was primarily due to an increase in long-term debt of $29, partially offset by a $20 reduction of short-term debt. Short-term debt was reduced through the use of cash generated from operations. The net-debt-to-capital ratio was 29.0% at June 30, 2010 compared to 28.4% at the end of 2009, reflecting the combined effect of the $9 increase in total debt and the $207 decrease in Eaton shareholders’ equity, partially offset by the $14 increase in cash and short-term investments. The decrease in equity primarily resulted from foreign currency translation adjustments of $483 and cash dividends paid of $168, partially offset by net income of $381.

Net working capital of $1,864 at June 30, 2010 increased by $29 from $1,835 at the end of 2009. The increase was primarily due to the net increase in cash and short-term investments, accounts receivable and inventory due to higher levels of operations resulting from the global economic recovery, partially offset by related increases in accounts payable and other current liabilities. Accounts receivable days outstanding declined 1 day from March 2010, and days of inventory on-hand also declined 1 day from March 2010. The current ratio was 1.6 at June 30, 2010 and 1.7 at year-end 2009.

As of mid-July, Eaton anticipates its overall end markets will grow 8% for all of 2010 compared to its earlier forecast of 6%. Although the debt problems in Europe are likely to slow the rate of growth in some European markets, and the rate of economic growth in China has moderated slightly, the Company anticipates solid global growth continuing during the second half of the year.

In light of Eaton’s strong results for the second quarter of 2010 and its improved outlook for the balance of the year, in mid-July the Company increased the quarterly dividend on its common shares by 16%, from $0.50 per share to $0.58 per share.

OTHER RESULTS OF OPERATIONS

In 2010 and 2009, Eaton incurred charges related to the integration of acquired businesses. These charges were recognized as expense as incurred. A summary of these charges follows:

		Three months ended								Six months ended
		June 30								June 30
		2010				2009				2010				2009
Electrical Americas		$	1			$	2			$	2			$	3
Electrical Rest of World			7				10				14				26
Hydraulics															1
Aerospace			1				3				2				5
Automotive															1
Pretax charges		$	9			$	15			$	18			$	36
After-tax charges		$	6			$	10			$	12			$	24
Per common share		$	.03			$	.06			$	.07			$	.14

Charges in 2010 were related primarily to Moeller and Phoenixtec. Charges in 2009 were related primarily to Integrated Hydraulics, Kirloskar, Moeller, Phoenixtec and Argo-Tech. The acquisition integration charges were included in the Statements of Consolidated Income in Cost of products sold or Selling & administrative expense, as appropriate. In Business Segment Information, the charges reduced Operating profit of the related business segment.

Eaton took significant actions in 2009 to reduce its workforce in response to the severe economic downturn. The reductions totaled approximately 17% of the full-time workforce. These actions resulted in the recognition of severance and pension and other postretirement benefits expense of $69 in the second quarter of 2009 and $134 in the first half of 2009. These charges were primarily

included in the Statements of Consolidated Income in Cost of products sold or Selling & administrative expense, as appropriate. In Business Segment Information, the charges reduced Operating profit of the related business segment.

Due to limitations imposed by the Pension Protection Act on pension lump sum distributions, Eaton’s U.S. Qualified Pension Plan became restricted in 2009 from making 100% lump sum payments. As a result, the plan experienced a significant increase in lump sum payments in 2009 before the limitation went into effect. Total pension settlement expense was $51 in the second quarter of 2009 and $69 in the first half of 2009, most of which was attributable to the U.S. pension plans. A portion of the increase was attributable to the workforce reduction in 2009. Additionally, as a result of the workforce reduction in 2009, curtailment expense related to pension plans of $14 was recognized in the second quarter of 2009 and $18 in the first half of 2009. The curtailment expense included recognition of the change in the projected benefit obligation, as well as recognition of a portion of the unrecognized prior service cost. These charges were primarily included in the Statements of Consolidated Income in Cost of products sold or Selling & administrative expense, as appropriate. In Business Segment Information, the charges were included in Pension & other postretirement benefits expense.

During the second quarter and the first half of 2010, income tax expense of $22 and $53, respectively, was recognized (an effective tax rate of 9.0% in the second quarter and 12.2% in the first half of 2010) compared to income tax benefits of $1 and $12 in the second quarter and the first half of 2009, respectively (a tax benefit rate of 4.8% in the second quarter and 36.6% in the first half of 2009). Income tax expense for the first half of 2010 included a non-cash, one-time charge of $23 ($0.14 per common share) that was recognized in the first quarter of 2010 to reflect the impact of the Health Care Reform and Education Reconciliation Act on taxation associated with Medicare Part D. Without this one-time charge, income tax expense of $30 (an effective tax rate of 6.9%) would have been recognized in the first half of 2010. Income tax expense for the first half of 2010 also reflected a benefit associated with the successful resolution of international tax audit issues; the recognition of state and local income tax attributes involving tax loss carryforwards, tax credits and other temporary differences; the recognition of international tax incentives; and the recognition of other international tax benefits. Included as an offset to the aforementioned income tax benefits that lowered the effective income tax rate in the first half of 2010 was an adjustment totaling $29 that was recognized in the first quarter of 2010 related to an income tax audit of transfer prices for 2005 to 2009. After further analysis of the facts surrounding the income tax audit and related adjustments, the Company recognized a $7 reduction of income tax expense in the second quarter of 2010.

RESULTS BY BUSINESS SEGMENT

Electrical Americas

		Three months ended June 30												Six months ended June 30
										Increase
		2010				2009				(Decrease)				2010				2009				Decrease
Net sales		$	894			$	881				1	%		$	1,696			$	1,740				(3	)%
Operating profit			120				144				(17	)%			225				250				(10	)%
Operating margin			13.4	%			16.3	%							13.3	%			14.4	%
Acquisition integration charges		$	1			$	2							$	2			$	3
Before acquisition integration charges
Operating profit			121				146				(17	)%			227				253				(10	)%
Operating margin			13.5	%			16.6	%							13.4	%			14.5	%

Sales of the Electrical Americas segment increased 1% in the second quarter of 2010 compared to the second quarter of 2009. The increase consisted of a 1% increase from foreign exchange, end markets that declined 2%, and 2% growth above end markets. Late-cycle non-residential markets declined 17% in the second quarter of 2010, while there was continued growth in early-cycle power quality and industrial controls businesses and the start of recovery in mid-cycle businesses.

Sales in the first half of 2010 decreased 3% compared to the first half of 2009. The reduction in sales included a decrease of 5% from core sales, partially offset by an increase of 2% from foreign exchange. The decline reflected end markets that were down in the first half of 2010 compared to the first half of 2009. Late-cycle non-residential end markets declined in the first half of 2010, partially offset by growth in the early-cycle power quality and industrial controls businesses. For all of 2010, Eaton anticipates end markets for this segment are likely to decline by 1%, as the recovery in early- and mid-cycle markets, and the benefits from stimulus programs, will have largely offset the decline in the non-residential market.

Operating profit in the second quarter of 2010 was $120. Excluding acquisition integration charges of $1 in the second quarter of 2010, operating profit was $121 and the operating margin was 13.5%. The decrease in operating profit before acquisition integration charges from the second quarter of 2009 was largely due to the cessation of temporary cost savings measures introduced in 2009 and changes in mix, partially offset by savings resulting from the workforce reductions taken in 2009.

Operating profit in the first half of 2010 was $225. Excluding acquisition integration charges of $2 in the first half of 2010, operating profit was $227 and the operating margin was 13.4%. The decrease in operating profit before acquisition integration charges from the first half of 2009 was primarily due to the same factors as in the second quarter of 2010.

On July 15, 2010, Eaton acquired EMC Engineers, Inc. Headquartered in Denver, Colorado, this business is an energy engineering and energy services company that delivers energy efficiency solutions for a wide range of governmental, educational, commercial and industrial facilities. The firm is a leader in retrofitting and modernizing mechanical, electrical and control systems, as well as energy modeling and analysis, facility commissioning, and energy savings performance contracting. This business had sales of $24 for 2009 and employs approximately 155 people.

In June 2010, Eaton won a contract to design and install a turnkey solar photovoltaic system at the New Mexico Veterans Affairs Health Care System. The scope of the $20 contract includes designing and installing a 3.2 megawatt photovoltaic system throughout the site.

In April 2010, Eaton won a contract to provide the U.S. Air Force’s Air Logistics Center with power reliability products and turnkey services. Over the five year life of the contract, revenues totaling up to $569 will be split between Eaton and one other supplier.

Electrical Rest of World

		Three months ended June 30												Six months ended June 30
		2010				2009				Increase				2010				2009				Increase
Net sales		$	665			$	595				12	%		$	1,273			$	1,139				12	%
Operating profit			60				16				275	%			102				10				920	%
Operating margin			9.0	%			2.7	%							8.0	%			0.9	%
Acquisition integration charges		$	7			$	10							$	14			$	26
Before acquisition integration charges
Operating profit			67				26				158	%			116				36				222	%
Operating margin			10.1	%			4.4	%							9.1	%			3.2	%

Sales of the Electrical Rest of World segment increased 12% in the second quarter of 2010 compared to the second quarter of 2009. The increase included 15% from core sales and 1% from acquisitions of businesses, partially offset by a 4% decrease from foreign exchange. End markets for this segment grew 6% in the second quarter of 2010 compared to the second quarter of 2009, with European electrical markets increasing 5% and Asian markets growing 8%.

Sales in the first half of 2010 increased 12% compared to the first half of 2009. The increase included 9% from core sales, 2% from foreign exchange, and 1% from acquisitions of businesses. For all of 2010, Eaton is maintaining its forecast that end markets for this segment will grow 6%.

Operating profit in the second quarter of 2010 was $60. Excluding acquisition integration charges of $7 in the second quarter of 2010, operating profit was $67 and the operating margin improved to 10.1%. The increase in operating profit before acquisition integration charges from the second quarter of 2009 was largely due to the increase in sales in the second quarter of 2010 and savings resulting from the workforce reductions taken in 2009, partially offset by the cessation of temporary cost savings measures introduced in 2009.

Operating profit in the first half of 2010 was $102. Excluding acquisition integration charges of $14 in the first half of 2010, operating profit was $116 and the operating margin improved to 9.1%. The increase in operating profit before acquisition integration charges from the first half of 2009 was primarily due to the same factors as in the second quarter of 2010.

Hydraulics

		Three months ended June 30												Six months ended June 30
		2010				2009				Increase				2010				2009				Increase
Net sales		$	568			$	425				34	%		$	1,058			$	855				24	%
Operating profit			77				14				450	%			131				20				555	%
Operating margin			13.6	%			3.3	%							12.4	%			2.3	%
Acquisition integration charges		$	0			$	0							$	0			$	1
Before acquisition integration charges
Operating profit			77				14				450	%			131				21				524	%
Operating margin			13.6	%			3.3	%							12.4	%			2.5	%