Document OKGoNYbe8eOBoRENQBrqwjmM

Eaton Corporation financial Review The (air value of each option grant in 1997,1996, and 1995 was esti mated using the Black-Scholes option pricing model with the following assumptions: 1997 1996 1995 Oividend yield Expected volatility Risk-free Merest rale Expected option life Weighted-average fair value of options granted during the year 3* 22m 6.0% to 6.7m 4 to 6 years 3m 23m 5.3% to 6.3m 4 years 3m 24m 6.7% to 7.8m 4 years $16.84 $10.27 $11.50 The Company sponsors a Share Purchase and lnvestment Plan (SPIP) for United States operations under which eligible participating employees may choose to contribute up to 15% of their base pay. The Company matches employee contributions up to 6% of a participant's base pay as limited by United States income tax regulations. The matching contribution, which is determined each quarter based on net income per Common Share, ranges from 25% to 100% of a partici pant's contribution and is invested in the Company's Common Shares. In 1989. the Company prefunded, through 1999, a portion of antici pated matching contributions to the SPIP by creating an Employee Stock Ownership Plan (ESOP) under the SPIP and selling 5 million Com mon Shares for $150 million to the ESOP The shares held by the ESOP which have not yet been allocated to employee accounts are included ip'^^areholders' equity as "Shares in Trust-ESOP" and the notes payable i ESOP, which are guaranteed by the Company, are included in long term debt. Unallocated shares in the ESOP are released at historical cost based on the ratio of the annua) principal payment on the notes payable compared to the original principal amount of the notes payable and allocated to employee accounts. Cash dividends paid on shares in the ESOP are charged against retained earnings and, along with Company contributions, are used to repay the principal and interest due on the notes payable. Unallocated shares in the ESOP, which are considered outstanding for purposes of computing net income per Common Share, at the end of 1997 and 1996 (in millions) were .8 and f2, respectively. Compensation expense related to the SPIP match, including the effect of shares released by the ESOP at historical cost, (in millions) was $6 in 1997, $10 in 1996 and $17 in 1995. The Company has plans which permit eligible employees and directors to defer a portion of their compensation. The Company has deposited $65 million of marketable securities and Common Shares into a bust to fund a portion of these liabilities. The marketable securi ties are included in other assets and the shares, with a fair value of $27 million, are included in shareholders' equity. Preferred Share Purchase Rights In June 1995, the Company declared a dividend of one Preferred Share Purchase Right (Right) for each outstanding Common Share. The Rights become exercisable only it a person or group acquires, or offers to acquire, 20% or more of the Company's Common Shares. The Company is authorized to reduce the 20% threshold for triggering the Rights to not i^^han 10%. The Rights expire on July 12,2005, unless redeemed ^ jr at one cent per Right. When the Rights become exercisable, the holder of each Right, other than the acquiring person, is entitled (1) to purchase for $250, one one-hundredth of a Series C Preferred Share (Preferred Share), (2) to purchase for $250. that number of the Company's Common Shares or common stock of the acquiring person having a market value of twice that price, or (3) at the option of the Company, to exchange each Right lor one Common Share or one one-hundredth of a Preferred Share. Income Taxes Income before income taxes for the years ended December 31 follows On millions): 1997 1996 1995 United States Non-Untted States $457 211 $385 too $471 121 $668 $485 $592 Income taxes for the years ended December 31 follows. On millions): Current United States Federal State and local Non-Untted States Deferred United States Reduction of valuation allowance for deferred Income tax assets Other Federal State and local Non-Untted States Reduction of valuation alowancs for deferred Income tax assets Operating toes carryforwards Other 1997 1996 1995 $ 99 14 42 155 $ 81 21 34 136 $109 24 59 192 (It) 20 (5) 26 51 (4) 15 13 49 $204 11 (6) 0 $136 (4) (11) 1 $193 Reconciliations of income taxes at the United States Federal statu tory rate to the effective income tax rate for the years ended December 31 follow On millions): 1997 Atnogftt Rat. 1996 Rata 1995 Rata Income taxes at the United States statutory rate Write-off of purchased In-process research and development State and local Income taxes Possessions credit related to Puerto Rican operations Current and prior years' credit for Increasing research activities Book/lax basis difference related to sales of businesses Reduction of valuation allowance for deterred Income tax assets Adjustment of worldwide tax liabilities Foreign source income Other--net S 234 35.0M 35.0m 3S.0M 30 4.5 20 2.9 2.9 3.1 (38) (5.7) (7.2) (5.4) (22) (3.3) (.6) (13) (1.9) (4) (.6) (IB) (1) 1 (3) $204 C2) .2 (.4) 30.5M 9 (2-6) (.2) 26.2m 2.0 1.5 (1-8) 32.6m 28