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EATON CORP PLC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

July 31, 2014

Amounts are in millions of dollars or shares unless indicated otherwise (per share data assume dilution).

COMPANY OVERVIEW Eaton Corporation plc (Eaton or the Company) is a power management company providing energy-efficient solutions that help its customers effectively manage electrical, hydraulic and mechanical power. With 2013 net sales of $22.0 billion, the Company is a global technology leader in electrical products, systems and services for power quality, distribution and control, power transmission, lighting and wiring products; 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 103,000 employees in over 60 countries and sells products to customers in more than 175 countries. Summary of Results of Operations During the second quarter of 2014, the Company's results of operations were impacted by the litigation settlements, partially offset by the gain on the divestiture of Eaton's Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses. Additional information on the litigation settlements and sale of businesses is presented in Note 6 and Note 2, respectively, to the Condensed Consolidated Financial Statements. A summary of Eaton's Net sales, Net income attributable to Eaton ordinary shareholders, and Net income per ordinary share-diluted follows: Three months ended Six months ended June 30 June 30 2014 2013 2014 2013 Net sales $ 5,767$ 5,602$ 11,259$ 10,912 Net income attributable to Eaton ordinary shareholders 171 494 610 872



Net income per ordinary share - diluted $ 0.36$ 1.04$ 1.27$ 1.83

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 ordinary share, and operating profit before acquisition integration charges for each business segment, as well as corporate expense, 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. For additional information on acquisition integration charges, see Note 3 to the Condensed Consolidated Financial Statements. 22



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Consolidated Financial Results

Three months ended



Six months ended

June 30 Increase June 30 Increase 2014 2013 (decrease) 2014 2013 (decrease) Net sales $ 5,767$ 5,602 3 % $ 11,259$ 10,912 3 % Gross profit 1,742 1,732 1 % 3,376 3,307 2 % Percent of net sales 30.2 % 30.9 % 30.0 % 30.3 % Income before income taxes 57 534 (89 )%

510 934 (45 )% Net income $ 172$ 497 (65 )% $ 613$ 877 (30 )% Less net income for noncontrolling interests (1 ) (3 ) (3 ) (5 ) Net income attributable to Eaton ordinary shareholders 171 494 (65 )% 610 872 (30 )% Excluding acquisition integration charges and transaction costs (after-tax) 23 25 67 47 Operating earnings $ 194$ 519 (63 )% $ 677$ 919 (26 )% Net income per ordinary share - diluted $ 0.36$ 1.04 (65 )% $ 1.27$ 1.83 (31 )% Excluding per share impact of acquisition integration charges and transaction costs (after-tax) 0.05 0.05 0.14 0.10 Operating earnings per ordinary share $ 0.41$ 1.09 (62 )% $ 1.41$ 1.93 (27 )% Net Sales Net sales in the second quarter and first six months of 2014 increased 3% compared to the second quarter and first six months of 2013 due to an increase in core sales. The increase in core sales is primarily due to modest growth in the Company's end markets. Eaton continues to anticipate its end markets will grow 3% for all of 2014. Gross Profit The gross profit margin decreased slightly for the second quarter and the first six months of 2014 from the second quarter and first six months of 2013, respectively. The decrease in gross profit margin was primarily due to certain restructuring activities Eaton undertook in April 2014 in an effort to gain efficiencies in the Vehicle, Hydraulics and Aerospace business segments. For additional information related to restructuring activities, see Note 3 to the Condensed Consolidated Financial Statements. Income Taxes The effective income tax rate for the second quarter and first six months of 2014 was a benefit of 203% and 20%, respectively, compared to expense of 7% and 6% for the second quarter and first six months of 2013, respectively. Excluding the litigation settlements and related legal costs, as well as the gain on the sale of Eaton's Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses, which represents a total pre-tax expense of $494 and occurred in the second quarter of 2014, the effective income tax rate was expense of 8% for the second quarter of 2014 compared to 7% for the second quarter of 2013 and 6% for the first six months of 2014 and 2013. See Note 6 and Note 2 for additional information about legal contingencies and the sale of businesses, respectively. Net Income Net income attributable to Eaton ordinary shareholders of $171 in the second quarter of 2014 decreased 65% compared to Net income attributable to Eaton ordinary shareholders of $494 in the second quarter of 2013. Net income per ordinary share of $0.36 in the second quarter of 2014 decreased 65% compared to Net income per ordinary share of $1.04 in the second quarter of 2013. Net income attributable to Eaton ordinary shareholders of $610 in the first six months of 2014 decreased 30% compared to Net income of $872 in the first six months of 2013. Net income per ordinary share of $1.27 in the first six months of 2014 decreased 31% from Net income per ordinary share of $1.83 in the first six months of 2013. The decrease in Net income attributable to Eaton ordinary shareholders and Net income per ordinary share in the second quarter and the first six months of 2014 was primarily due to the litigation settlements, partially offset by the sale of Eaton's Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses, as noted above. 23



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Business Segment Results of Operations The following is a discussion of Net sales, operating profit and operating margin by business segment, which includes a discussion of operating profit and operating profit margin before acquisition integration charges. For additional information related to acquisition integration charges, see Note 3 to the Condensed Consolidated Financial Statements. Electrical Products Three months ended Six months ended June 30 June 30 2014 2013 Increase 2014 2013 Increase Net sales $ 1,832$ 1,758 4 % $ 3,558$ 3,418 4 % Operating profit 300 272 10 % 550 513 7 % Operating margin 16.4 % 15.5 % 15.5 % 15.0 % Acquisition integration charges $ 12$ 12 $



41 $ 15

Before acquisition integration charges Operating profit $ 312$ 284 10 % $ 591$ 528 12 % Operating margin 17.0 % 16.2 % 16.6 % 15.4 % Net sales increased 4% in the second quarter and the first six months of 2014 compared to the second quarter and the first six months of 2013 due to an increase in core sales. Core sales growth in the second quarter and the first six months of 2014 was due to strength in North American markets. Eaton continues to anticipate its Electrical Products markets will grow 3% for all of 2014. Operating margin before acquisition integration charges increased from 16.2% in the second quarter of 2013 to 17.0% in the second quarter of 2014. Operating margin before acquisition integration charges increased from 15.4% in the first six months of 2013 to 16.6% in the first six months of 2014. The increase in operating margin in both the second quarter and first six months of 2014 was due to higher sales volumes, as noted above, and incremental synergies related to the acquisition of Cooper Industries plc. Electrical Systems and Services Three months ended



Six months ended

June 30 Increase June 30 Increase 2014 2013 (decrease) 2014 2013 (decrease) Net sales $ 1,628$ 1,624 - % $ 3,152$ 3,145 - % Operating profit 194 227 (15 )% 363 437 (17 )% Operating margin 11.9 % 14.0 % 11.5 % 13.9 % Acquisition integration charges $ 13$ 11 $



39 $ 16

Before acquisition integration charges Operating profit $ 207$ 238 (13 )% $ 402$ 453 (11 )% Operating margin 12.7 % 14.7 % 12.8 % 14.4 % Net sales increased slightly in the second quarter and first six months of 2014 from the second quarter and first six months of 2013, respectively, due to an increase in core sales of 1%, offset by a decrease of 1% from the impact of currency translation. Core sales growth in the second quarter and first six months of 2014 was primarily due to growth in North America and Europe. Eaton continues to anticipate its Electrical Systems and Services markets will grow 3% for all of 2014. Operating margin before acquisition integration charges decreased from 14.7% in the second quarter of 2013 to 12.7% in the second quarter of 2014. Operating margin before acquisition integration charges decreased from 14.4% in the first six months of 2013 to 12.8% in the first six months of 2014. The decrease in operating margin in the second quarter and first six months of 2014 was primarily due to higher logistics costs, unfavorable mix, and pricing pressures. 24



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Table of Contents Hydraulics Three months ended Six months ended June 30 Increase June 30 Increase 2014 2013 (decrease) 2014 2013 (decrease) Net sales $ 787$ 772 2 % $ 1,569$ 1,528 3 % Operating profit 94 104 (10 )% 202 182 11 % Operating margin 11.9 % 13.5 % 12.9 % 11.9 % Acquisition integration charges $ 5$ 8



$ 9$ 20

Before acquisition integration charges Operating profit $ 99$ 112 (12 )% $ 211$ 202 4 % Operating margin 12.6 % 14.5 % 13.4 % 13.2 % Net sales increased 2% in the second quarter of 2014 compared to the second quarter of 2013 due to an increase in core sales. Net sales increased 3% in the first six months of 2014 compared to the first six months of 2013 due to an increase in core sales of 4%, partially offset by a decrease of 1% from the impact of currency translation. The increase in core sales in the second quarter and first six months of 2014 was primarily due to strength in industrial applications, partially offset by weakness in the global agricultural equipment market and the China construction equipment market. Eaton now anticipates its Hydraulics markets will grow 1% for all of 2014. Operating margin before acquisition integration charges decreased from 14.5% in the second quarter of 2013 to 12.6% in the second quarter of 2014. Operating margin before acquisition integration charges increased from 13.2% in the first six months of 2013 to 13.4% in the first six months of 2014. The decrease in operating margin in the second quarter of 2014 was primarily due to certain restructuring activities Eaton undertook in April 2014 in an effort to gain efficiencies in the segment. The increase in operating margin in the first six months of 2014 was primarily due to higher sales volumes, as noted above, partially offset by the restructuring charges described above. Aerospace Three months ended Six months ended June 30 June 30 2014 2013 Increase 2014 2013 Increase Net sales $ 486$ 446 9 % $ 950$ 880 8 % Operating profit 69 67 3 % 131 129 2 % Operating margin 14.2 % 15.0 % 13.8 % 14.7 % Net sales increased 9% in the second quarter of 2014 compared to the second quarter of 2013 due to an increase in core sales of 10% and an increase of 2% from the impact of currency translation, partially offset by a decrease of 3% from the divestiture of Eaton's Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses. Net sales increased 8% in the first six months of 2014 compared to the first six months of 2013 due to an increase in core sales of 8% and an increase of 2% from the impact of currency translation, partially offset by a decrease of 2% from the divestiture of Eaton's Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses. The increase in core sales in the second quarter and first six months of 2014 was primarily due to continued strength in commercial OEM markets as well as growth in the commercial aftermarket. Eaton continues to anticipate its Aerospace markets will grow 3% for all of 2014. Operating margin decreased from 15.0% in the second quarter of 2013 to 14.2% in the second quarter of 2014. Operating margin decreased from 14.7% in the first six months of 2013 to 13.8% in the first six months of 2014. The decrease in operating margin in the second quarter and first six months of 2014 was primarily due to certain restructuring activities Eaton undertook in April 2014 in an effort to gain efficiencies in the segment. 25



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Vehicle Three months ended Six months ended June 30 Increase June 30 Increase 2014 2013 (decrease) 2014



2013 (decrease) Net sales $ 1,034$ 1,002 3 % $ 2,030$ 1,941 5 %

Operating profit 155 172 (10 )% 306 304 1 % Operating margin 15.0 % 17.2 %

15.1 %



15.7 %

Net sales increased 3% in the second quarter of 2014 compared to the second quarter of 2013 due to an increase in core sales. Net sales increased 5% in the first six months of 2014 compared to the first six months of 2013 due to an increase in core sales of 6%, partially offset by a decrease of 1% from the impact of currency translation. The increase in core sales in the second quarter and first six months of 2014 was primarily due to improved global demand, particularly in North American markets, partially offset by weakness in South American markets. Eaton continues to anticipate its Vehicle markets will grow 5% for all of 2014. Operating margin decreased from 17.2% in the second quarter of 2013 to 15.0% in the second quarter of 2014. Operating margin decreased from 15.7% in the first six months of 2013 to 15.1% in the first six months of 2014. The decrease in operating margin in the second quarter and first six months of 2014 was primarily due to certain restructuring activities Eaton undertook in April 2014 in an effort to gain efficiencies in the segment. Corporate Expense Three months ended Six months ended June 30 Increase June 30 Increase 2014 2013 (decrease) 2014 2013 (decrease) Litigation settlements $ 644 $ - NM $ 644 $ - NM Amortization of intangible assets 109 108 1 % 219 215 2 % Interest expense - net 55 71 (23 )% 117 146 (20 )% Pension and other postretirement benefits expense 32 43 (26 )% 83 81 2 % Inventory step-up adjustment - 1 NM - 34 NM Other corporate (income) expense - net (85 ) 85 (200 )% (21 ) 155 (114 )% Total corporate expense $ 755$ 308 145 % $ 1,042$ 631 65 % Total Corporate expense increased 145% from $308 in the second quarter of 2013 to $755 in the second quarter of 2014 and 65% from $631 in the first six months of 2013 to $1,042 in the first six months of 2014 primarily due to litigation settlements totaling $644, partially offset by a decrease in Other corporate (income) expense - net due to the divestiture of Eaton's Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses. For additional information on the litigation settlements and sale of businesses see Note 6 and Note 2, respectively, to the Condensed Consolidated Financial Statements. LIQUIDITY, CAPITAL RESOURCES AND CHANGES IN FINANCIAL CONDITION Financial Condition and Liquidity Eaton's objective is to finance its business through operating cash flow and an appropriate mix of equity and long-term and short-term debt. By diversifying its debt maturity structure, Eaton reduces liquidity risk. The Company maintains access to the commercial paper markets through a commercial paper program, which is supported by credit facilities in the aggregate principal amount of $2,000. There were no borrowings outstanding under these revolving credit facilities at June 30, 2014. Over the course of a year, cash, short-term investments and short-term debt may fluctuate in order to manage global liquidity. Eaton believes it has the operating flexibility, cash flow, cash and short-term investment balances, and access to capital markets in excess of the liquidity necessary to meet future operating needs of the business as well as scheduled payments of long-term debt. Eaton was in compliance with each of its debt covenants for all periods presented. 26



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Sources and Uses of Cash Flow Operating Cash Flow Net cash provided by operating activities was $645 in the first six months of 2014, a decrease of $64 compared to $709 in the first six months of 2013. Lower operating cash flow in the first six months of 2014 compared to the first six months of 2013 was primarily due to higher contributions to defined benefits plans. Investing Cash Flow Net cash provided by investing activities was $148 in the first six months of 2014, a decrease of $458 compared to $606 in the first six months of 2013. Investing cash flows in 2014 were primarily impacted by the absence of proceeds totaling $761 from the sale of Apex Tool Group, LLC in the first six months of 2013, partially offset by proceeds totaling $273 in the first six months in 2014, related to the sale of Eaton's Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions businesses in the second quarter of 2014. For additional information on the sale of businesses, see Note 2 to the Condensed Consolidated Financial Statements. Financing Cash Flow Net cash used in financing activities was $1,078 in the first six months of 2014, a decrease of $172 compared to $1,250 in the first six months of 2013. The lower use of cash was primarily due to a decrease in payments on debt borrowings from $977 in the first six months of 2013 to $576 in the first six months of 2014, related to financing the acquisition of Cooper Industries plc, partially offset by share repurchases totaling $99 during the first six months of 2014 and higher cash dividends. For additional information on business acquisitions and share repurchases, see Note 2 and Note 8, respectively, to the Condensed Consolidated Financial Statements. FORWARD-LOOKING STATEMENTS This Form 10-Q Report contains forward-looking statements. These statements may discuss goals, intentions and expectations as to future trends, plans, events, results of operations or financial condition, or state other information relating to Eaton, based on current beliefs of management as well as assumptions made by, and information currently available to, management. Forward-looking statements generally will be accompanied by words such as "anticipate," "believe," "could," "estimate," "expect," "forecast," "guidance," "intend," "may," "possible," "potential," "predict," "project" or other similar words, phrases or expressions. These statements should be used with caution and are subject to various risks and uncertainties, many of which are outside Eaton's control. The following factors could cause actual results to differ materially from those in the forward-looking statements: unanticipated changes in the markets for the Company's business segments; unanticipated downturns in business relationships with customers or their purchases from us; the availability of credit to customers and suppliers; competitive pressures on sales and pricing; increases in the cost of material and other production costs, or unexpected costs that cannot be recouped in product pricing; the introduction of competing technologies; unexpected technical or marketing difficulties; unexpected claims, charges, litigation or dispute resolutions; strikes or other labor unrest; the impact of acquisitions and divestitures; unanticipated difficulties integrating acquisitions; new laws and governmental regulations; interest rate changes; tax rate changes or exposure to additional income tax liability; stock market and currency fluctuations; and unanticipated deterioration of economic and financial conditions in the United States and around the world. Eaton does not assume any obligation to update these forward-looking statements.


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