Eaton Corp plc (ETN) FY 2021 MD&A

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

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 an intelligent power management company dedicated to improving the quality of life and protecting the environment for people everywhere. We are guided by our commitment to do business right, to operate sustainably and to help our customers manage power – today and well into the future. By capitalizing on the global growth trends of electrification and digitalization, we're accelerating the planet's transition to renewable energy, helping to solve the world's most urgent power management challenges, and doing what's best for our stakeholders and all of society.

Eaton’s businesses are well-positioned to take advantage of secular growth trends related to the energy transition from fossil fuels to renewables. We are responding to these trends by innovating solutions that transform the electrical power value chain, investing in electrical vehicle markets, increasing our focus on electrification, and employing digital technologies for power management. The Company’s innovations are expected to enable the integration of renewables and sustainability solutions, with new types of equipment, services, and software. These strategic focus areas are an important part of our response to climate change.

Founded in 1911, Eaton has been listed on the New York Stock Exchange for nearly a century. We reported revenues of $19.6 billion in 2021 and serve customers in more than 170 countries.

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Portfolio Changes

The Company continues to actively manage its portfolio of businesses to deliver on its strategic objectives. The Company is focused on deploying its capital toward businesses that provide opportunities for above-market growth, strong returns, and align with secular trends and its power management strategies. Over the last three years, Eaton has completed a number of transactions to strengthen its portfolio.

Additional information related to acquisitions and divestitures of businesses is presented in Note 2.

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Restructuring

In the second quarter of 2020, Eaton decided to undertake a multi-year restructuring program to reduce its cost structure and gain efficiencies in its business segments and at corporate in order to respond to declining market conditions brought on by the COVID-19 pandemic. Since the inception of the program, the Company has incurred charges of $292 million. These restructuring activities are expected to incur additional expenses of $28 million in 2022 primarily comprised of plant closing and other costs, resulting in total estimated charges of $320 million for the entire program. The projected mature year savings from these restructuring actions are expected to be $230 million when fully implemented in 2023. Additional information related to this restructuring is presented in Note 16.

Summary of Results of Operations

A summary of Eaton’s Net sales, Net income attributable to Eaton ordinary shareholders, and Net income per share attributable to Eaton ordinary shareholders - diluted is as follows:

During 2019, the Company’s results of operations were impacted by negative currency translation and weaker than expected growth in the Company’s end markets, particularly in the second half of 2019. Despite the declining market conditions and unfavorable impact of currency translation, the Company generated solid operating margins and Net income per ordinary share.

During 2020, the Company's results of operations were impacted by the COVID-19 pandemic. Organic sales were down 11% in 2020 primarily due to the impact from the COVID-19 pandemic. The divestitures of the Lighting and Automotive Fluid Conveyance businesses reduced sales, which was partially offset by growth from the acquisitions of Souriau-Sunbank Connection Technologies (Souriau-Sunbank) and Power Distribution, Inc.

During 2021, the Company's organic sales increased 10% as end-markets and regions served by our business segments have largely recovered from the negative impact of the COVID-19 pandemic. Our Electrical Global, Vehicle and eMobility business segments all realized organic growth greater than 10% during the year. This level of organic growth was achieved despite supply chain constraints limiting the availability of materials in select businesses, travel restrictions continuing to impact commercial aviation, and reduced production levels at our customers leading to historic low vehicle inventory. Additionally, over the past several years, Eaton has completed a number of transactions to add higher growth, better margin businesses to its portfolio. These portfolio updates, along with continued improvements in supply chains and recovery of the Aerospace and Vehicle markets from the pandemic, have the Company better aligned with secular growth trends and well positioned for expected further growth.

COVID-19

The Company has been impacted by the COVID-19 pandemic in select markets and industries. As a result, our businesses have been focused on cost control measures where appropriate to offset the volume declines we experienced in addition to executing on our multi-year restructuring program we decided to undertake in the second quarter of 2020. In 2021, the Company has seen broad-based strength in its end-markets and regions as our businesses have largely recovered from the negative impact of the COVID-19 pandemic. However as global economies recover, many of our businesses have been impacted by supply chain disruptions, inflation and labor shortages. Additionally, our Aerospace business segment continues to see some softness in demand due to the impact of continued travel restrictions on commercial aviation, particularly in international travel.

Eaton's products and support services are vital to hospitals, emergency services, military sites, utilities, public works, transportation, and shipping providers. In addition, data centers, retail outlets, airports, and governments, as well as the networks that support schools and remote workers, rely on the Company's products to serve their customers and communities. As a result, the Company's plants are generally not subject to extended shutdowns.

The Company continues to monitor the pandemic’s impact throughout the world, including guidance from governmental authorities and world health organizations. The Company’s actions to protect the safety and health of its workforce are aligned with its preventive health protocols and those of governmental authorities and health organizations including the Centers for Disease Controls (U.S.) and the World Health Organization.

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RESULTS OF OPERATIONS

Non-GAAP Financial Measures

The following discussion of Consolidated Financial Results includes certain non-GAAP financial measures. These financial measures include adjusted earnings and adjusted earnings per ordinary share, each of which differs from the most directly comparable measure calculated in accordance with generally accepted accounting principles (GAAP). A reconciliation of adjusted earnings and adjusted earnings per ordinary share to the most directly comparable GAAP measure is included in the Consolidated Financial Results table below. During the first quarter of 2021, the Company revised its definition of adjusted earnings to exclude intangible asset amortization expense and prior periods have been retrospectively adjusted to apply this change. Management believes that these financial measures are useful to investors because they exclude certain transactions, 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.

Acquisition and Divestiture Charges

Eaton incurs integration charges and transaction costs to acquire and integrate businesses, and transaction, separation and other costs to divest and exit businesses. Eaton also recognizes gains and losses on the sale of businesses. A summary of these Corporate items is as follows:

Acquisition integration, divestiture charges and transaction costs in 2021 are primarily related to the divestiture of the Hydraulics business, the acquisitions of Tripp Lite, Cobham Mission Systems, Souriau-Sunbank Connection Technologies, and Ulusoy Elektrik Imalat Taahhut ve Ticaret A.S., and other charges to acquire and exit businesses including certain indemnity claims associated with the sale of 50% interest in the commercial vehicle automated transmission business in 2017. Charges in 2020 are primarily related to the divestitures of the Hydraulics business and the Lighting business, the acquisitions of Souriau-Sunbank, Ulusoy Elektrik, and Power Distribution, Inc., and other charges to exit businesses. Charges in 2019 related to the divestiture of the Lighting business, the acquisitions of Ulusoy Elektrik, ISG, and Souriau-Sunbank, the loss on the sale of the Automotive Fluid Conveyance business, and other charges to exit businesses. These charges were included in Cost of products sold, Selling and administrative expense, Research and development expense, Interest expense - net, or Other expense - net. In Business Segment Information in Note 17, the charges were included in Other expense - net.

Intangible Asset Amortization Expense

Intangible asset amortization expense is as follows:

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Consolidated Financial Results

Net Sales

Organic sales increased 10% in 2021 due to broad-based strength in end-markets and regions as our business segments have largely recovered from the negative impact of the COVID-19 pandemic. This organic growth was achieved despite the supply chain constraints experienced by the Electrical Americas business segment, and customers of the Vehicle and eMobility business segments also experienced supply chain constraints leading to reduced production levels. Additionally, organic sales in the Aerospace business segment continued to be impacted by travel restrictions from the COVID-19 pandemic on commercial aviation. The decrease in organic sales in 2020 was primarily due to the impact from the COVID-19 pandemic, with lower sales in all business segments.

The acquisitions of Tripp Lite and Cobham Mission Systems increased sales in 2021, while the divestitures of the Hydraulics and Lighting businesses reduced sales.

Gross Profit

Gross profit margin increased from 30.5% in 2020 to 32.3% in 2021 primarily due to higher sales volumes and savings from restructuring actions. Organic sales volumes improved in the Electrical Americas, Electrical Global, and Vehicle business segments, and declined in the Aerospace business segment. Gross profit also improved due to the net impact of the acquisitions of Tripp Lite and Cobham Mission Systems and the divestiture of the Hydraulics business. Conversely, commodity and logistics inflation had an unfavorable impact on gross margin during 2021. Gross profit margin decreased from 33.0% in 2019 to 30.5% in 2020 primarily due to the impact from the COVID-19 pandemic, with lower sales in all business segments.

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Income Taxes

During 2021, income tax expense of $750 million was recognized (an effective tax rate of 25.9%) compared to income tax expense of $331 million in 2020 (an effective tax rate of 19.0%) and income tax expense of $378 million in 2019 (an effective tax rate of 14.6%). The increase in the effective tax rate from 19.0% in 2020 to 25.9% in 2021 was primarily due to the tax expense on the gain from the sale of the Hydraulics business in 2021 discussed in Note 2. The increase in the effective tax rate from 14.6% in 2019 to 19.0% in 2020 was primarily due to the tax expense on the gain from the sale of the Lighting business in 2020 discussed in Note 2, partially offset by a tax benefit on the restructuring charges discussed in Note 16. Additionally, see Note 11 for income tax rate reconciliations from Ireland's national statutory rate to the consolidated effective rate.

Net Income

Net income attributable to Eaton ordinary shareholders of $2,144 million in 2021 increased 52% compared to $1,410 million in 2020. Net income in 2021 and 2020 included after-tax gains of $197 million on the sale of the Hydraulics business and $91 million on the sale of the Lighting business, respectively. Excluding these gains, the increase in 2021 net income was primarily due to higher gross profit and lower restructuring program charges, partially offset by higher income tax expense, acquisition and divestiture charges, and intangible asset amortization expense. Net income attributable to Eaton ordinary shareholders of $1,410 million in 2020 decreased 36% compared to $2,211 million in 2019. Net income in 2020 included an after-tax gain of $91 million on the sale of the Lighting business. The decrease in 2020 net income was primarily due to lower sales volumes as a result of the COVID-19 pandemic.

Net income per ordinary share increased to $5.34 in 2021 compared to $3.49 in 2020. Net income per ordinary share in 2021 and 2020 included $0.49 and $0.22 from the sale of the Hydraulics and Lighting businesses, respectively. Excluding these gains, the increase in Net income per ordinary share in 2021 was due to higher Net income attributable to Eaton ordinary shareholders and the impact of the Company's share repurchases over the past two years. Net income per ordinary share decreased to $3.49 in 2020 compared to $5.25 in 2019. The decrease in Net income per ordinary share in 2020 was due to lower Net income attributable to Eaton ordinary shareholders, adjusted for the impact of the Company's share repurchases over the past few years.

Adjusted Earnings

Adjusted earnings of $2,659 million in 2021 increased 34% compared to Adjusted earnings of $1,985 million in 2020. The increase in Adjusted earnings in 2021 was primarily due to higher Net income attributable to Eaton ordinary shareholders, adjusted for acquisition and divestiture charges, restructuring program charges, and intangible asset amortization expense. Adjusted earnings of $1,985 million in 2020 decreased 26% compared to Adjusted Earnings of $2,668 million in 2019. The decrease in Adjusted earnings in 2020 was primarily due to lower Net income attributable to Eaton ordinary shareholders, adjusted for acquisition and divestiture charges, and restructuring program charges.

Adjusted earnings per ordinary share increased to $6.62 in 2021 compared to $4.91 in 2020. The increase in Adjusted earnings per ordinary share in 2021 was due to higher Adjusted earnings and the impact of the Company's share repurchases over the past two years. Adjusted earnings per ordinary share decreased to $4.91 in 2020 compared to $6.34 in 2019. The decrease in Adjusted earnings per ordinary share in 2020 was due to lower Adjusted earnings, adjusted for the impact of the Company's share repurchases over the past few years.

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Business Segment Results of Operations

The following is a discussion of Net sales, operating profit and operating profit margin by business segment.

Electrical Americas

The increase in organic sales in 2021 was primarily due to broad-based strength in end-markets as they have largely recovered from the COVID-19 pandemic with particular strength in residential and data centers, partially offset by weakness in sales to utilities. This organic growth was achieved despite the supply chain constraints experienced by the Electrical Americas business segment during 2021, which had a negative impact on Net sales. The decrease in organic sales in 2020 was primarily driven by the impact of the COVID-19 pandemic, partially offset by growth in residential, data center, and utility end-markets.

The operating margin increased from 20.2% in 2020 to 20.6% in 2021 primarily due to higher organic sales volumes, the favorable net impact of an acquisition and a divestiture, and savings from restructuring actions. Conversely, commodity and logistics inflation had an unfavorable impact on the operating margin. The operating margin increased from 18.9% in 2019 to 20.2% in 2020 primarily due to the favorable impact from the divestiture of the Lighting business and cost containment actions to counteract the impact of the COVID-19 pandemic, partially offset by lower volumes.

Electrical Global

The increase in organic sales in 2021 was primarily due to broad-based strength in end-markets as they have largely recovered from the COVID-19 pandemic. The decrease in organic sales in 2020 was primarily driven by the impact of the COVID-19 pandemic, with particular weakness in global oil and gas markets and industrial applications.

The operating margin increased from 15.9% in 2020 to 18.7% in 2021 primarily due to higher sales volumes and savings from restructuring actions, partially offset by commodity and logistics inflation. The operating margin decreased from 17.3% in 2019 to 15.9% in 2020 primarily due to lower sales volumes and unfavorable product mix, partially offset by cost containment actions to mitigate the impact of the COVID-19 pandemic.

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Hydraulics

On August 2, 2021, Eaton completed the sale of the Hydraulics business segment. As a result, net sales and operating profit for 2021 are not directly comparable to 2020, since 2021 only includes the results of the Hydraulics business through the date of the sale.

The decrease in organic sales in 2020 was primarily due to the impact from the COVID-19 pandemic, with weakness at both OEMs and distributors globally.

The operating margin increased from 8.8% in 2019 to 10.1% in 2020 primarily due to depreciation expense no longer being charged as a result of the business being classified as held for sale as discussed in Note 2 and cost containment actions to counteract the impact of the COVID-19 pandemic, partially offset by lower sales volumes.

Aerospace

The decrease in organic sales in 2021 was primarily due to the impact of continued travel restrictions from the COVID-19 pandemic on commercial aviation and weakness in military aftermarket. The decrease in organic sales in 2020 was primarily due to the impact of the COVID-19 pandemic on commercial aviation, partially offset by growth in military sales.

The operating margin increased from 18.6% in 2020 to 21.9% in 2021 primarily due to the acquisition of Cobham Mission Systems and savings from restructuring actions, partially offset by lower organic sales volumes. The operating margin decrease from 24.0% in 2019 to 18.6% in 2020 primarily due to lower sales volumes and the acquisition of Souriau-Sunbank, partially offset by cost containment actions to mitigate the impact of the COVID-19 pandemic.

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Vehicle

The increase in organic sales in 2021 was primarily due to strength in all regions compared to 2020 which was significantly impacted by plant shutdowns due to the COVID-19 pandemic. This organic growth was achieved despite the Vehicle business segment's organic sales being negatively impacted in 2021 as a result of its customers experiencing supply chain constraints leading to reduced production levels and historic low vehicle inventory. The decrease in organic sales in 2020 was driven by plant shutdowns in the second quarter of 2020, lower Class 8 OEM production, and weakness in light vehicle sales primarily due to the impact from the COVID-19 pandemic.

The operating margin increased from 11.5% in 2020 to 17.4% in 2021 primarily due to higher sales volumes and savings from restructuring actions, partially offset by commodity and logistics inflation. The operating margin decreased from 15.1% in 2019 to 11.5% in 2020 primarily due to lower sales volumes, partially offset by cost containment actions to mitigate the impact of the COVID-19 pandemic.

eMobility

The increase in organic sales in 2021 was primarily due to strength in North American and Asia Pacific regions compared to 2020 which was significantly impacted by plant shutdowns due to the COVID-19 pandemic. This organic growth was achieved despite the eMobility business segment's organic sales being negatively impacted in 2021 as a result of its customers experiencing supply chain constraints leading to reduced production levels. The decrease in organic sales in 2020 was primarily due to the impact from the COVID-19 pandemic, with particular weakness in the legacy internal combustion engine platforms.

The operating margin decreased from negative 2.7% in 2020 to negative 8.5% in 2021 primarily due to increased research and development costs and manufacturing start-up costs associated with new electric vehicle programs, and commodity and logistics inflation, partially offset by higher sales volumes. The operating margin decreased from 5.3% in 2019 to negative 2.7% in 2020 primarily due to lower sales volumes and increased research and development costs.

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Corporate Expense

Total corporate expense was $810 million in 2021 compared to Total corporate expense of $1,191 million in 2020. The decrease in Total corporate expense was primarily due to lower Other expense - net, lower Restructuring program charges, and the favorable impact of the freeze on the Company's United States pension plans, partially offset by higher Intangible asset amortization expense due to acquisitions of businesses. The decrease in Other expense - net is primarily due to the 2021 gain on sale of the Hydraulics business exceeding the 2020 gain on the sale of the Lighting business by $396 million. This decrease was partially offset by higher acquisition and divestiture charges and higher other corporate expenses due to the removal of the temporary cost containment actions taken during 2020 to mitigate the impact of the COVID-19 pandemic. Total corporate expense was $1,191 million in 2020 compared to Total Corporate expense of $1,120 million in 2019. The increase in Total corporate expense was primarily due to higher Restructuring program charges, partially offset by lower Other expense - net. The decrease in Other expense - net is primarily due to the 2020 gain on the sale of the Lighting business, partially offset by higher acquisition and divestiture charges.

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LIQUIDITY, CAPITAL RESOURCES, AND FINANCIAL CONDITION

Liquidity and Financial Condition

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.

On March 8, 2021, a subsidiary of Eaton issued Euro denominated notes (2021 Euro Notes) with a face value of €1,500 million ($1,798 million), in accordance with Regulation S promulgated under the Securities Act of 1933, as amended. The 2021 Euro Notes are comprised of two tranches of €900 million and €600 million, which mature in 2026 and 2030, respectively, with interest payable annually at a respective rate of 0.128% and 0.577%. The issuer received proceeds totaling €1,494 million ($1,790 million) from the issuance, net of financing costs and discounts.

On May 17, 2021, the Company entered into a $2,500 million 364-day revolving credit facility, which brought the Company’s total revolving credit facilities to $4,500 million. At June 30, 2021, the Company had access to the commercial paper markets through its $4,500 million commercial paper program, of which $3,372 million was outstanding including funds to finance the acquisition of Cobham Mission Systems discussed in Note 2. Eaton used the proceeds from the sale of the Hydraulics business, which was completed August 2, 2021, to reduce its outstanding commercial paper borrowings.

On September 22, 2021, the Company downsized the 364-day revolving credit facility from $2,500 million to $500 million, which reduced the Company's total revolving credit facilities to $2,500 million. In September 2021, the Company also downsized its commercial paper program to $2,500 million.

On October 4, 2021, the Company replaced its existing $500 million 364-day revolving credit facility, $750 million five-year revolving credit facility, $500 million four-year revolving credit facility, and $750 million five-year revolving credit facility, with a new $500 million 364-day revolving credit facility and a new $2,000 million five-year revolving credit facility that will expire on October 4, 2026. The revolving credit facilities totaling $2,500 million are used to support commercial paper borrowings and are fully and unconditionally guaranteed by Eaton and certain of its direct and indirect subsidiaries on an unsubordinated, unsecured basis. There were no borrowings outstanding under Eaton’s revolving credit facilities at December 31, 2021. The Company maintains access to the commercial paper markets through its $2,500 million commercial paper program, of which none was outstanding on December 31, 2021. In addition to the revolving credit facilities, the Company also had available lines of credit of $972 million from various banks primarily for the issuance of letters of credit, of which there was $335 million outstanding at December 31, 2021.

Eaton received proceeds of $1.4 billion from the sale of its Lighting business in 2020 and $3.1 billion from the sale of its Hydraulics business in 2021. The Company paid $4.45 billion to acquire Tripp Lite and Cobham Mission Systems in 2021.

Over the course of a year, cash, short-term investments, and short-term debt may fluctuate in order to manage global liquidity. As of December 31, 2021 and 2020, Eaton had cash of $297 million and $438 million, short-term investments of $271 million and $664 million, and short-term debt of $13 million and $1 million, respectively. Eaton believes it has the operating flexibility, cash flow, cash and short-term investment balances, availability under existing revolving credit facilities, and access to capital markets in excess of the liquidity necessary to meet future operating needs of the business, fund capital expenditures and acquisitions of businesses, as well as scheduled payments of long-term debt.

For additional information on financing transactions and debt, see Note 8.

Eaton’s credit facilities and indentures governing certain long-term debt contain various covenants, the violation of which would limit or preclude the use of the credit facilities for future borrowings, or might accelerate the maturity of the related outstanding borrowings covered by the indentures. At Eaton’s present credit rating level, the most restrictive financial covenant provides that the ratio of secured debt (or lease payments due under a sale and leaseback transaction) to adjusted consolidated net worth (or consolidated net tangible assets, in each case as defined in the relevant credit agreement or indenture) may not exceed 10%. Eaton's actual ratios are substantially below the required threshold. In addition, Eaton is in compliance with each of its debt covenants for all periods presented.

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Cash Flows

A summary of cash flows is as follows:

Operating Cash Flow

Net cash provided by operating activities decreased by $781 million in 2021 compared to 2020. The decrease in net cash provided by operating activities in 2021 was primarily due to higher working capital balances to support the Company’s organic growth as our business segments have largely recovered from the negative impact of the COVID-19 pandemic, taxes paid on the sale of the Hydraulics business, and a $200 million pension contribution to Eaton's U.S. qualified pension plan in 2021.

Net cash provided by operating activities decreased by $507 million in 2020 compared to 2019. The decrease in net cash provided by operating activities in 2020 was driven by lower net income, partially offset by lower working capital balances compared to 2019.

Investing Cash Flow

Net cash used in investing activities increased by $2,161 million in 2021 compared to 2020. The increase in the use of cash was primarily driven by cash paid in 2021 for business acquisitions of $4,500 million compared to cash paid in 2020 for business acquisitions of $200 million, partially offset by proceeds received in 2021 from the sale of Hydraulics business of $3,129 million compared to proceeds received in 2020 from the sale of the Lighting business of $1,408 million, and net sales of short-term investments of $379 million in 2021 compared to net purchases of $441 million in 2020. Capital expenditures were $575 million in 2021 compared to $389 million in 2020.

Net cash provided by investing activities increased by $2,263 million in 2020 compared to 2019. The increase in the source of cash was primarily driven by proceeds from the sale of the Lighting business and lower cash paid for business acquisitions, partially offset by net purchases of short-term investments of $441 million in 2020 compared to net purchases of $70 million in 2019. Capital expenditures were $389 million in 2020 compared to $587 million in 2019.

Financing Cash Flow

Net cash used in financing activities decreased by $2,723 million in 2021 compared to 2020. The decrease in the use of cash was primarily due to higher proceeds from borrowings of $1,798 million in 2021 compared to no proceeds from borrowings in 2020, lower share repurchases of $122 million in 2021 compared to $1,608 million in 2020, and net proceeds of short-term debt of $20 million in 2021 compared to net payments of $254 million in 2020, partially offset by higher payments on borrowings of $1,013 million in 2021 compared to $249 million in 2020.

Net cash used in financing activities increased by $1,764 million in 2020 compared to 2019. The increase in the use of cash was primarily due to no proceeds from borrowings in 2020 compared to $1,232 million in 2019 and higher share repurchases of $1,608 million in 2020 compared to $1,029 million in 2019.

Uses of Cash

Purchases of Goods and Services

The Company purchases goods and services in the normal course of business based on expected usage. For certain purchases, the Company enters into purchase obligations with various vendors, which include short-term and long-term commitments for purchases of raw materials, outstanding non-cancelable purchase orders, releases under blanket purchase orders, and commitments under ongoing service arrangements. As of December 31, 2021, the Company has purchase obligations to support the operation of its business similar to those included in historical cash flow trends.

Capital Expenditures

Capital expenditures were $575 million, $389 million, and $587 million in 2021, 2020 and 2019, respectively. Eaton expects approximately $650 million in capital expenditures in 2022.

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Dividends

Cash dividend payments were $1,219 million, $1,175 million, and $1,201 million for 2021, 2020 and 2019, respectively. On February 23, 2022, Eaton's Board of Directors declared a quarterly dividend of $0.81 per ordinary share, a 7% increase over the dividend paid in the fourth quarter of 2021. The dividend is payable on March 31, 2022 to shareholders of record on March 11, 2022. Payment of quarterly dividends in the future depends upon the Company’s ability to generate net income and operating cash flows, among other factors, and is subject to declaration by the Eaton Board of Directors. The Company intends to continue to pay quarterly dividends in 2022.

Share Repurchases

On February 27, 2019, the Board of Directors adopted a share repurchase program for share repurchases up to $5.0 billion of ordinary shares (2019 Program). Under the 2019 Program, the ordinary shares are expected to be repurchased over time, depending on market conditions, the market price of ordinary shares, capital levels, and other considerations. During 2021 and 2020, 0.9 million and 17.1 million ordinary shares, respectively, were repurchased under the 2019 Program in the open market at a total cost of $122 million and $1,608 million, respectively. The Company will continue to pursue share repurchases in 2022 depending on market conditions and capital levels. On February 23, 2022, the Board renewed the 2019 Program by providing authority for up to $5.0 billion in repurchases to be made during the three-year period commencing on that date (2022 Program).

Acquisition of Businesses

The Company paid cash of $4,500 million, $200 million, and $1,180 million to acquire businesses in 2021, 2020 and 2019, respectively. The Company will continue to focus on deploying its capital toward businesses that provide opportunities for higher growth and strong returns, and align with secular trends and its power management strategies.

Debt

The Company manages a number of short-term and long-term debt instruments, including commercial paper. For additional information on financing transactions and debt, see Note 8.

Leases

See Note 7 for maturities of lease liabilities.

Unrecognized Income Tax Benefits

At December 31, 2021, the gross unrecognized income tax benefits totaled $1,120 million and interest and penalties were $128 million. Eaton cannot predict with reasonable certainty the timing of cash settlements with the respective taxing authorities. For additional information about income taxes see Note 11.

Defined Benefits Plans

Pension Plans

During 2021, the fair value of plan assets in the Company’s employee pension plans increased $319 million to $5,919 million at December 31, 2021. The increase in plan assets was primarily due to strong returns on plan assets and the Company's contributions to the pension plans. At December 31, 2021, the net unfunded position of $678 million in pension liabilities consisted of $819 million in plans that have no funding requirements and $97 million in plans that require funding, partially offset by $59 million in the U.S. qualified pension plan that is overfunded and $179 million in all other plans that are overfunded.

Funding requirements are a major consideration in making contributions to Eaton’s pension plans. With respect to the Company’s pension plans worldwide, the Company intends to contribute annually not less than the minimum required by applicable law and regulations. In 2021, $343 million was contributed to the pension plans. The Company anticipates making $114 million of contributions to certain pension plans during 2022. The funded status of the Company’s pension plans at the end of 2022, and future contributions, will depend primarily on the actual return on assets during the year and the discount rate used to calculate certain benefits at the end of the year. For additional information about pension plans see Note 9.

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Supply Chain Finance Program

The Company negotiates payment terms directly with its suppliers for the purchase of goods and services. In addition, a third-party financial institution offers a voluntary supply chain finance (SCF) program that enables certain of the Company’s suppliers, at the supplier’s sole discretion, to sell receivables due from the Company to the financial institution on terms directly negotiated with the financial institution. If a supplier elects to participate in the SCF program, the supplier decides which invoices are sold to the financial institution and the Company has no economic interest in a supplier’s decision to sell an invoice. The SCF program does not have a significant impact on the Company’s liquidity as payments by the Company to participating suppliers are paid to the financial institution on the invoice due date, regardless of whether an individual invoice is sold by the supplier to the financial institution. The amounts due to the financial institution for suppliers that participate in the SCF program are included in Accounts payable on the Company’s Consolidated Balance Sheets, and the associated payments are included in operating activities on the Consolidated Statements of Cash Flows. At  December 31, 2021 and 2020, Accounts payable included $151 million and $15 million, respectively, payable to suppliers that have elected to participate in the SCF program.

Guaranteed Debt

Issuers, Guarantors and Guarantor Structure

Eaton Corporation has issued senior notes pursuant to indentures dated April 1, 1994 (the 1994 Indenture), November 20, 2012 (the 2012 Indenture) and September 15, 2017 (the 2017 Indenture). The senior notes of Eaton Corporation are registered under the Securities Act of 1933, as amended (the Registered Senior Notes). Eaton Corporation is also the issuer of one outstanding series of privately placed debt securities (the PPNs), and Eaton Capital Unlimited Company, another subsidiary of Eaton, is the issuer of four outstanding series of debt securities sold in offshore transactions under Regulation S promulgated under the Securities Act (the Eurobonds). The PPNs, the Eurobonds and the Registered Senior Notes (together, the Senior Notes) comprise substantially all of Eaton’s long-term indebtedness.

Substantially all of the Senior Notes, together with the credit facilities described above under Financial Condition and Liquidity (the Credit Facilities), are guaranteed by Eaton and 18 of its subsidiaries. Accordingly, they rank equally with each other. However, because these obligations are not secured, they would be effectively subordinated to any existing or future secured indebtedness of Eaton and its subsidiaries. As of December 31, 2021, Eaton has no material, long-term secured debt. The guaranteed Registered Senior Notes are also structurally subordinated to the liabilities of Eaton's subsidiaries that are not guarantors. Except as described below under Future Guarantors, Eaton is not obligated to cause its subsidiaries to guarantee the Registered Senior Notes.

The table set forth in Exhibit 22 filed with the 2020 Form 10-K filed on February 24, 2021, details the primary obligors and guarantors with respect to the guaranteed Registered Senior Notes.

Terms of Guarantees of Registered Securities

Payment of principal and interest on the Registered Senior Notes is guaranteed, on an unsecured, unsubordinated basis by the subsidiaries of Eaton set forth in the table referenced in Exhibit 22. Each guarantee is full and unconditional, and joint and several. Each guarantor's guarantee is an unsecured obligation that ranks equally with all its other unsecured and unsubordinated indebtedness. The obligations of each guarantor under its guarantee of the Registered Senior Notes is subject to a customary savings clause or similar provision designed to prevent such guarantee from constituting a fraudulent conveyance or otherwise legally impermissible or voidable obligation.

Generally, each guarantee of the Registered Senior Notes by a guarantor other than Eaton provides that it will be automatically and unconditionally released and discharged upon:

(a)the consummation of any transaction permitted under the applicable indenture resulting in such guarantor ceasing to be a subsidiary, such as a sale to a third party;

(b)such guarantee (so long as the guarantor is not obligated under any other U.S. debt obligations), becoming prohibited by any applicable law, rule or regulation or by any contractual obligation;

(c)such guarantee resulting in material adverse tax consequences to Eaton or any of its subsidiaries (so long as the applicable guarantor is not obligated under any other U.S. debt obligation); or

(d)such guarantor becoming a controlled foreign corporation within the meaning Section 957(a) of the Internal Revenue Code (a CFC), or an entity the material assets of which is limited to equity interests of a CFC.

Notwithstanding the foregoing, each guarantee by a direct or indirect parent of Eaton Corporation (other than Eaton) provides that it will be released only under the circumstances described in subparagraphs (b) and (c) above.

The guarantee of Eaton does not contain any release provisions.

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Future Guarantors

The 2012 and 2017 Indentures generally provide that, with certain limited exceptions, any subsidiary of Eaton must become a guarantor if it becomes obligated as borrower or guarantor under any series of debt securities or a syndicated credit facility. Further, any entity that becomes a direct or indirect parent entity of Eaton Corporation and holds any material assets, with certain limited exceptions, or owes any material liabilities must become a guarantor.

The 1994 Indenture does not contain provisions with respect to future guarantors.

Summarized Financial Information of Guarantors and Issuers

The financial information presented is that of Eaton Corporation and the Guarantors, which includes Eaton Corporation plc, on a combined basis and the financial information of non-issuer and non-guarantor subsidiaries has been excluded. Intercompany balances and transactions between Eaton Corporation and Guarantors have been eliminated, and amounts due from, amounts due to, and transactions with non-issuer and non-guarantor subsidiaries have been presented separately.

Credit Ratings

Eaton's debt has been assigned the following credit ratings:

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CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) in the United States requires management to make certain estimates and assumptions that may involve the exercise of significant judgment. For any estimate or assumption used, there may be other reasonable estimates or assumptions that could have been used. However, based on facts and circumstances inherent in developing estimates and assumptions, management believes it is unlikely that applying other such estimates and assumptions would have caused materially different amounts to have been reported. Actual results may differ from these estimates.

Revenue Recognition

Sales are recognized when control of promised goods or services are transferred to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. Control is transferred when the customer has the ability to direct the use of and obtain benefits from the goods or services. The majority of the Company’s sales agreements contain performance obligations satisfied at a point in time when control is transferred to the customer. Sales recognized over time are generally accounted for using an input measure to determine progress completed at the end of the period. Sales for service contracts generally are recognized as the services are provided. For agreements with multiple performance obligations, judgment is required to determine whether performance obligations specified in these agreements are distinct and should be accounted for as separate revenue transactions for recognition purposes. In these types of agreements, we generally allocate sales price to each distinct obligation based on the price of each item sold in separate transactions.

Due to the nature of the work required to be performed for obligations recognized over time, Eaton estimates total costs by contract. The estimate of total costs are subject to judgment. Estimated amounts are included in the recognized sales price to the extent it is not probable that a significant reversal of cumulative sales will occur. Additionally, contracts can be modified to account for changes in contract specifications, requirements or sale price. The effect of a contract modification on the sales price or adjustments to the measure of completion under the input method are recognized as adjustments to revenue on a cumulative catch-up basis.

Eaton records reductions to sales for returns, and customer and distributor incentives, primarily comprised of rebates, at the time of the initial sale. Rebates are estimated based on sales terms, historical experience, trend analysis, and projected market conditions in the various markets served. The rebate programs offered vary across businesses due to the numerous markets Eaton serves, but the most common incentives relate to amounts paid or credited to customers for achieving defined volume levels. Returns are estimated at the time of the sale primarily based on historical experience and recorded gross on the Consolidated Balance Sheet. See Note 3 for additional information.

Impairment of Goodwill and Other Long-Lived Assets

Goodwill

Goodwill is evaluated annually for impairment as of July 1 using either a quantitative or qualitative analysis. Goodwill is tested for impairment at the reporting unit level, and is based on the net assets for each reporting unit, including goodwill and intangible assets. The Company’s reporting units are equivalent to the reportable operating segments, except for the Aerospace segment which has two reporting units. Goodwill is assigned to each reporting unit, as this represents the lowest level that constitutes a business and is the level at which management regularly reviews the operating results. The Company performs a quantitative analysis using a discounted cash flow model and other valuation techniques, but may elect to perform a qualitative analysis.

Additionally, goodwill is evaluated for impairment whenever an event occurs or circumstances change that would indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Events or circumstances that may result in an impairment review include changes in macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, other relevant entity-specific events, specific events affecting the reporting unit or sustained decrease in share price.

The annual goodwill impairment test was performed using a qualitative analysis in 2021 and 2020, except for the eMobility reporting unit which used a quantitative analysis. A qualitative analysis is performed by assessing certain trends and factors, including projected market outlook and growth rates, forecasted and actual sales and operating profit margins, discount rates, industry data, and other relevant qualitative factors. These trends and factors are compared to, and based on, the assumptions used in the most recent quantitative analysis performed for each reporting unit. The results of the qualitative analyses did not indicate a need to perform quantitative analysis.

Goodwill impairment testing was also performed using quantitative analyses in 2020 for the Electrical Americas, Electrical Global, Hydraulics and Aerospace reporting units due to a reorganization of the Company’s businesses and in 2020 as a result of the Hydraulics business being classified as held for sale as discussed in Note 2. The Company used the relative fair value method to reallocate goodwill.

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Quantitative analyses were performed by estimating the fair value for each reporting unit using a discounted cash flow model. The model includes estimates of future cash flows, future growth rates, terminal value amounts, and the applicable weighted-average cost of capital used to discount those estimated cash flows. The future cash flows were based on the Company's long-term operating plan and a terminal value was used to estimate the reporting unit's cash flows beyond the period covered by the operating plan. The weighted-average cost of capital is an estimate of the overall after-tax rate of return required by equity and debt market holders of a business enterprise. These analyses require the exercise of judgments, including judgments about appropriate discount rates, perpetual growth rates, revenue growth, and margin assumptions. Sensitivity analyses were performed around certain of these assumptions in order to assess the reasonableness of the assumptions and the resulting estimated fair values.

Based on these analyses performed in 2021 and 2020, the fair value of Eaton's reporting units continue to substantially exceed their respective carrying amounts and thus, no impairment exists.

Indefinite Life Intangible Assets

Indefinite life intangible assets consist of certain trademarks. They are evaluated annually for impairment as of July 1 using either a quantitative or qualitative analysis to determine whether their fair values exceed their respective carrying amounts. Indefinite life intangible asset impairment testing for 2021 and 2020 was performed using a quantitative analysis. Determining the fair value of these assets requires significant judgment and the Company uses a royalty relief methodology similar to that employed when the associated assets were acquired, but using updated estimates of future sales, cash flows and profitability. Sensitivity analyses were performed around certain of these assumptions in order to assess the reasonableness of the assumptions and the resulting estimated fair values.

Additionally, indefinite life intangible assets are evaluated for impairment whenever an event occurs or circumstances change that would indicate that it is more likely than not that the asset is impaired. Events or circumstances that may result in an impairment review include changes in industry and market considerations, cost factors, financial performance, and other relevant entity-specific events that could affect inputs used to determine the respective fair values of the indefinite-lived intangible assets.

For 2021 and 2020, the fair value of indefinite lived intangible assets exceeded the respective carrying value.

For additional information about goodwill and other intangible assets see Note 6.

Acquisitions of Businesses

The acquisition of a business is accounted for using the acquisition method of accounting which requires assets and liabilities to be recognized at their fair values on the acquisition date. The initial fair value of assets acquired and liabilities assumed may be revised based on the final determination of fair value during the measurement period of 12 months from the acquisition date. The Company generally determines the fair value of intangible assets acquired using third-party valuations that are prepared using discounted cash flow models that rely on the Company's estimates. These estimates require judgement of future revenue growth rates, future margins, and the applicable weighted-average cost of capital used to discount those estimated cash flows. Sensitivity analyses were performed around certain of these assumptions in order to assess the reasonableness of the assumptions and the resulting estimated fair values. For additional information about the acquisitions of businesses see Note 2.

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Divestitures of Businesses

The Company records assets and liabilities of a business to be sold as held for sale in the Consolidated Balance Sheet when all the required criteria are met. The held for sale assets and liabilities are initially measured at the lesser of their carrying value or fair value less cost to sell, with any resulting loss being immediately recognized. In each subsequent reporting period until the business is sold, the Company continues to estimate the fair value less cost to sell of the business and recognizes any additional losses, or any gains to the extent losses were previously recorded on the held for sale assets and liabilities.

In the first quarter of 2020, the Company used the relative fair value method to allocate goodwill to the Hydraulics business. The fair value of the Hydraulics business was estimated based on a combination of the price paid to Eaton by Danfoss A/S and a discounted cash flow model. The model includes estimates of future cash flows, future growth rates, terminal value amounts, and the applicable weighted-average cost of capital used to discount those estimated cash flows. The weighted-average cost of capital is an estimate of the overall after-tax rate of return required by equity and debt market holders of a business enterprise. These analyses require the exercise of judgments, including judgments about appropriate discount rates, perpetual growth rates, revenue growth, and margin assumptions. For additional information about the divestitures of businesses see Note 2.

Recoverability of Deferred Income Tax Assets

Eaton is subject to the income tax laws in the jurisdictions in which it operates. In order to determine the income tax provision for financial statement purposes, Eaton must make significant estimates and judgments about its business operations in these jurisdictions. These estimates and judgments are also used in determining the deferred income tax assets and liabilities that have been recognized for differences between the financial statement and income tax basis of assets and liabilities, and income tax loss carryforwards and income tax credit carryforwards.

Management evaluates the realizability of deferred income tax assets for each jurisdiction in which it operates. If the Company experiences cumulative pre-tax income in a particular jurisdiction in a three-year period including the current and prior two years, management normally concludes that the deferred income tax assets will more likely than not be realizable and no valuation allowance is recognized, unless known or planned operating developments, or changes in tax laws, would lead management to conclude otherwise. However, if the Company experiences cumulative pre-tax losses in a particular jurisdiction in a three-year period including the current and prior two years, management then considers a series of factors in the determination of whether the deferred income tax assets can be realized. These factors include historical operating results, known or planned operating developments, the period of time over which certain temporary differences will reverse, consideration of the utilization of certain deferred income tax liabilities, tax law carryback capability in a particular country, prudent and feasible tax planning strategies, changes in tax laws, and estimates of future earnings and taxable income using the same assumptions as those used for the Company’s goodwill and other impairment testing. After evaluation of these factors, if the deferred income tax assets are expected to be realized within the tax carryforward period allowed for that specific country, management would conclude that no valuation allowance would be required. To the extent that the deferred income tax assets exceed the amount that is expected to be realized within the tax carryforward period for a particular jurisdiction, management would establish a valuation allowance. For additional information about income taxes see Note 11.

Unrecognized Income Tax Benefits

Eaton recognizes an income tax benefit from an uncertain tax position only if it is more likely than not that the benefit would be sustained upon examination by taxing authorities, based on the technical merits of the position. The Company evaluates and adjusts the amount of unrecognized income tax benefits based on changes in law, facts and circumstances. Eaton also estimates, where reasonably possible, the increase or decrease in the amount of unrecognized income tax benefits in the next 12 months.

The evaluation and determination of the amount of unrecognized income tax benefits related to uncertain tax positions is complex and involves both the exercise of judgement and the utilization of certain estimates and assumptions. Each tax position carries unique facts and circumstances that must be evaluated in light of current tax laws, regulations, and judicial decisions. Additionally, the ultimate resolution of the majority of Eaton’s unrecognized income tax benefits is dependent upon uncontrollable factors such as the timing of finalizing resolutions of audit disputes through reaching settlement agreements or concluding litigation, or changes in law.

Pension and Other Postretirement Benefits Plans

The measurement of liabilities related to pension plans and other postretirement benefits plans is based on assumptions related to future events including interest rates, return on plan assets, rate of compensation increases, and health care cost trend rates. Actual plan asset performance will either reduce or increase losses included in accumulated other comprehensive loss, which ultimately affects net income.

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The discount rate for United States plans was determined by discounting the expected future benefit payments using a theoretical zero-coupon spot yield curve derived from a universe of high-quality bonds as of the measurement date and solving for the single rate that would generate the same benefit obligation. Only corporate bonds with a rating of Aa, determined by averaging the ratings by Moody’s, Standard & Poor's, and Fitch, were included. Callable bonds that are not make-whole bonds and certain other non-comparable bonds were eliminated. Finally, a subset of bonds was selected by grouping the universe of bonds by duration and retaining 50% of the bonds that had the highest yields.

The discount rates for non-United States plans were determined by region and are based on high quality long-term corporate and government bonds. Consideration has been given to the duration of the liabilities in each plan when selecting the bonds to be used in determining the discount rate.

To estimate the service and interest cost components of net periodic benefit cost for the vast majority of its defined benefits pension and other postretirement benefits plans, the Company used a spot rate approach by applying the specific spot rates along the yield curve used to measure the benefit obligation at the beginning of the period to the relevant projected cash flows.

Key assumptions used to calculate pension and other postretirement benefits expense are adjusted at each year-end. A 1-percentage point change in the assumed rate of return on pension plan assets is estimated to have approximately a $54 million effect on pension expense. Likewise, a 1-percentage point change in the discount rate is estimated to have approximately a $48 million effect on pension expense. A 1-percentage point change in the assumed rate of return on other postretirement benefits assets is estimated to have less than $1 million effect on other postretirement benefits expense. A 1-percentage point change in the discount rate is estimated to have less than $1 million effect on expense for other postretirement benefits plans.

Additional information related to changes in key assumptions used to recognize expense for other postretirement benefits plans is found in Note 9.