<PAGE>

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

              Annual report pursuant to Section 13 or 15(d) of the
                         Securities Exchange Act of 1934

                      FOR THE YEAR ENDED DECEMBER 31, 2008

                          Commission file number 1-1396

                                EATON CORPORATION
             (Exact name of registrant as specified in its charter)

                Ohio                                      34-0196300
   (State or other jurisdiction of          (IRS Employer Identification Number)
    incorporation or organization)

             Eaton Center
            Cleveland, Ohio                              44114-2584
(Address of principal executive offices)                 (Zip code)

                                 (216) 523-5000
              (Registrant's telephone number, including area code)

           Securities registered pursuant to Section 12(b) of the Act:

<TABLE>
<CAPTION>
                                                  Name of each exchange on
           Title of each class                       which registered
----------------------------------------   -------------------------------------
<S>                                        <C>
      Common Share ($.50 par value)             The New York Stock Exchange
                                                The Chicago Stock Exchange
</TABLE>

Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [X]

Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. No [X]

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 ninety days. Yes [X]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

<PAGE>

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 [X]             Accelerated filer [ ]

Non-accelerated filer [ ]               Smaller reporting company [ ]
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). No [X]

The aggregate market value of Common Stock held by non-affiliates of the
registrant as of June 30, 2008 was $14.1 billion.

As of January 31, 2009, there were 165.2 million Common Shares outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2009 annual shareholders meeting are
incorporated by reference into Part III.


                                     Page 2

<PAGE>

                                     PART I

ITEM 1. BUSINESS

Eaton Corporation is a diversified power management company with 2008 sales of
$15.4 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 75,000 employees and sells products to customers
in more than 150 countries. For more information, visit www.eaton.com.

Eaton electronically files or furnishes reports pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 (Exchange Act) to the United States
Securities and Exchange Commission (SEC), including annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and proxy and
information statements, as well as any amendments to those reports. As soon as
reasonably practicable, these reports are available free of charge through the
Company's Internet web site at http://www.eaton.com. These filings are also
accessible on the SEC's Internet web site at http://www.sec.gov.

RECENT DEVELOPMENTS

In 2008, Eaton acquired certain businesses and entered into a joint venture in
separate transactions for combined net cash purchase prices of $2.807 billion.
The Statements of Consolidated Income include the results of these businesses
from the effective dates of acquisition. A summary of these transactions
follows:

<TABLE>
<CAPTION>
                                                                               Business
Acquired business and joint venture                      Date of acquisition   segment           Annual sales
------------------------------------------------------   -------------------   ----------   ----------------------
<S>                                                      <C>                   <C>          <C>
Integ Holding Limited                                         October 2,       Hydraulics       $52 for 2007
   A U.K.-based manufacturer of screw-in                         2008
   cartridge valves, custom-engineered hydraulic
   valves and manifold systems

Nittan Global Tech Co. Ltd.                                  Operational       Automotive          New joint
   A joint venture to manage the global design,               October 1,                            venture
   manufacture and supply of engine valves and                   2008
   valve actuation products to Japanese and Korean
   automobile and engine manufacturers. In
   addition, during the second half of 2008,
   several related manufacturing joint ventures
   were established.

Engine Valves Business of Kirloskar Oil Engines Ltd.        July 31, 2008      Automotive         $5 for 2007
   An India-based designer, manufacturer and
   distributor of intake and exhaust valves for diesel
   and gasoline engines

PK Electronics                                              July 31, 2008      Electrical         $9 for 2007
   A Belgium-based distributor and service provider
   of single phase and three-phase uninterruptible
   power supply (UPS) systems

The Moeller Group                                           April 4, 2008      Electrical      E1.02 billion for
   A Germany-based supplier of electrical                                                            2007
   components for commercial and residential
   building applications and industrial controls for
   industrial equipment applications

Balmen Electronic, S.L.                                       March 31,        Electrical        $6 for 2007
   A Spain-based distributor and service provider                2008
   of uninterruptible power supply (UPS) systems

Phoenixtec Power Company Ltd.                                February 26,      Electrical        $515 for 2007
   A Taiwan-based manufacturer of single and                     2008
   three-phase uninterruptible power supply (UPS)
   systems
</TABLE>


                                     Page 3

<PAGE>

BUSINESS SEGMENT INFORMATION

Information by business segment and geographic region regarding principal
products, principal markets, methods of distribution, net sales, operating
profit and assets is presented in "Business Segment & Geographic Region
Information" on pages 47 through 51. Additional information regarding Eaton's
segments and business is presented below.

ELECTRICAL

Seasonal Fluctuations - Sales of this segment are historically lower in the
first quarter and higher in the third and fourth quarters of a year.

Competition - Principal methods of competition in this segment are performance
of products and systems, technology, customer service and support, and price.
Eaton has a strong competitive position in relation to the many competitors in
this segment and, with respect to many products, is considered among the market
leaders.

HYDRAULICS

Seasonal Fluctuations - Sales of this segment are historically higher in the
first and second quarters and lower in the third and fourth quarters of the
year.

Competition - Principal methods of competition in this segment are product
performance, geographic coverage, service, and price. Eaton has a strong
competitive position in relation to the many competitors in this segment and,
with respect to many products, is considered among the market leaders.

AEROSPACE

Significant Customers - Approximately 10% of this segment's sales in 2008 were
made to one large manufacturer of aircraft.

Competition - Principal methods of competition in this segment are total cost of
ownership, product and system performance, quality, design engineering
capabilities and timely delivery. Eaton has a strong competitive position in
relation to the many competitors in this segment and, with respect to many
products and platforms, is considered among the market leaders.

TRUCK

Significant Customers - Approximately 35% of this segment's sales in 2008 were
made to two large manufacturers of heavy-, medium-, and light-duty trucks and
off-highway vehicles.

Competition - Principal methods of competition in this segment are product
performance, service, and price. Eaton has a strong competitive position in
relation to the many competitors in this segment and, with respect to many
products, is considered among the market leaders.

AUTOMOTIVE

Seasonal Fluctuations - Sales of this segment historically are lower in the
third quarter than in other quarters during the year as a result of the normal
seasonal pattern of automotive industry production.

Significant Customers - Approximately 27% of this segment's sales in 2008 were
made to two large manufacturers of vehicles.

Competition - Principal methods of competition in this segment are product
performance, service, and price. Eaton has a strong competitive position in
relation to the many competitors in this segment and, with respect to many
products, is considered among the market leaders.

INFORMATION CONCERNING EATON'S BUSINESS IN GENERAL

RAW MATERIALS - Eaton's major requirements for raw materials include iron,
steel, copper, nickel, aluminum, brass, silver, molybdenum, titanium, vanadium,
rubber, plastic and insulating materials. Materials are purchased in various
forms, such as extrusions, castings, powder metal, metal sheets and strips,
forging billets, bar stock and plastic pellets. Raw materials, as well as parts
and other components, are purchased from many suppliers and, under normal
circumstances, the Company had no difficulty obtaining them. In 2008, prices
increased for some basic metals purchased by Eaton through the third quarter,
with a dramatic drop during the last 60 days of 2008 due to the global economic
slow down. The Company maintained appropriate levels of inventory to guard
against basic metals shortages, and did not experience any general availability
constraints in 2008.


                                     Page 4

<PAGE>

PATENTS AND TRADEMARKS - Eaton views its name and mark as significant to its
business as a whole. Eaton's products are marketed with a portfolio of patents,
trademarks, licenses or other forms of intellectual property that expire at
various dates in the future. Eaton develops and acquires new intellectual
property on an ongoing basis and considers all of its intellectual property to
be valuable. Based on the broad scope of Eaton's product lines, management
believes that the loss or expiration of any single intellectual property right
would not have a material effect on the results of operations or financial
position of Eaton or its business segments. Eaton's policy is to file
applications and obtain patents for its new products including product
modifications and improvements.

ORDER BACKLOG - Since a significant portion of open orders placed with Eaton by
original equipment manufacturers of trucks, off-highway vehicles and passenger
cars are historically subject to month-to-month releases by customers during
each model year, these orders are not considered firm. In measuring backlog of
orders, the Company includes only the amount of these orders released by
customers as of the dates listed. Using this criterion, total backlog at
December 31, 2008 and 2007 was approximately $3.2 billion. Backlog should not be
relied upon as being indicative of results of operations for future periods.

RESEARCH AND DEVELOPMENT - Research and development expenses (in millions) for
new products and improvement of existing products in 2008, 2007 and 2006 were
$417, $335 and $315, respectively. Over the past five years, the Company has
invested approximately $1.6 billion in research and development.

PROTECTION OF THE ENVIRONMENT - Operations of the Company involve the use and
disposal of certain substances regulated under environmental protection laws.
Eaton continues to modify certain processes on an ongoing, regular basis in
order to reduce the impact on the environment, including the reduction or
elimination of certain chemicals used in, and wastes generated from, operations.
Compliance with Federal, State and local provisions which have been enacted or
adopted regulating the discharge of materials into the environment, or otherwise
relating to the protection of the environment, are not expected to have a
material adverse effect upon earnings or the competitive position of the
Company. Eaton's estimated capital expenditures for environmental control
facilities are not expected to be material for 2009 and 2010. Information
regarding the Company's liabilities related to environmental matters is
presented in "Protection of the Environment" on pages 39 and 40.

FOREIGN OPERATIONS - Financial information related to Eaton's foreign operations
is presented in "Business Segment & Geographic Information" on page 49.
Information regarding risks that may affect Eaton's foreign operations is
presented in Item 1A of this Form 10-K Report.

ITEM 1A. RISK FACTORS

Among the risks that could materially adversely affect Eaton's businesses,
financial condition or results of operations are the following:

DOWNTURNS IN THE GLOBAL END MARKETS THAT EATON SERVES OR DISRUPTIONS IN THE
GLOBAL CAPITAL MARKETS THAT EATON UTILIZES FOR FINANCING MAY HAVE AN ADVERSE
EFFECT ON EATON'S BUSINESS RESULTS OR FINANCIAL FLEXIBILITY.

The global economy is currently experiencing a period of substantial
uncertainty, the effects of which cannot be completely anticipated. One such
effect was a decline in certain of Eaton's end markets during the fourth quarter
of 2008. Eaton's end markets have continued to decline in the first quarter of
2009 and it is unclear when the end markets will begin to recover. Although
Eaton has not experienced any limitations in its access to the capital markets
to date, certain other companies have experienced limitations. It is possible
that the current world economic crisis could at some point result in some
limitations to Eaton's access to the capital markets.

Eaton's segment revenues, operating results and profitability have varied in the
past and may vary from quarter to quarter in the future. Profitability can be
negatively impacted by volatility in the end markets that Eaton serves. The
Company has undertaken measures to reduce the impact of this volatility through
diversification of markets it serves and expansion of geographic regions in
which it operates. Future downturns in any of the markets that Eaton serves
could adversely affect the Company's revenues, operating results and
profitability.

EATON'S OPERATING RESULTS DEPEND IN PART ON CONTINUED SUCCESSFUL RESEARCH,
DEVELOPMENT AND MARKETING OF NEW AND/OR IMPROVED PRODUCTS AND SERVICES, AND
THERE CAN BE NO ASSURANCE THAT EATON WILL CONTINUE TO SUCCESSFULLY INTRODUCE NEW
PRODUCTS AND SERVICES.


                                     Page 5

<PAGE>

The success of new and improved products and services depends on their initial
and continued acceptance by Eaton's customers. The Company's businesses are
affected, to varying degrees, by technological change and corresponding shifts
in customer demand, which could result in unpredictable product transitions or
shortened life cycles. Eaton may experience difficulties or delays in the
research, development, production or marketing of new products and services
which may prevent Eaton from recouping or realizing a return on the investments
required to bring new products and services to market. The end result could be a
negative impact on the Company's operating results.

EATON'S OPERATIONS DEPEND ON PRODUCTION FACILITIES THROUGHOUT THE WORLD, MANY OF
WHICH ARE LOCATED OUTSIDE THE UNITED STATES AND ARE SUBJECT TO GREATER RISKS OF
DISRUPTED PRODUCTION.

Eaton manages businesses with manufacturing facilities worldwide. In recent
years, the Company's operations outside the United States have increased
significantly in relative size in comparison to its total operations. The
Company's manufacturing facilities and operations could be disrupted by a
natural disaster, or labor strike, war, political unrest, terrorist activity or
public health concerns. Some of Eaton's non-United States manufacturing
facilities also may be more susceptible to economic and political upheaval than
Eaton's United States facilities. Any such disruption could cause delays in
shipments of products and the loss of sales and customers, and insurance
proceeds may not adequately compensate the Company for the losses.

EATON'S SUBSTANTIAL FOREIGN SALES SUBJECT IT TO ECONOMIC RISK AS EATON'S RESULTS
OF OPERATIONS MAY BE ADVERSELY AFFECTED BY CHANGES IN LOCAL GOVERNMENT
REGULATIONS AND POLICIES AND FOREIGN CURRENCY FLUCTUATIONS.

As noted above in Item 1 "Foreign Operations," a significant portion of Eaton's
sales are outside the United States, and the Company expects sales in foreign
markets to continue to represent a significant portion of its total sales.
Foreign sales and operations are subject to changes in local government
regulations and policies, including those related to tariffs and trade barriers,
investments, property ownership rights, taxation, exchange controls and
repatriation of earnings. Changes in the relative values of currencies occur
from time to time and could affect Eaton's operating results. While the Company
monitors exchange rate exposures and attempts to reduce these exposures through
hedging activities, these risks could adversely affect the Company's operating
results.

EATON USES A VARIETY OF RAW MATERIALS AND COMPONENTS IN ITS BUSINESSES, AND
SIGNIFICANT SHORTAGES OR PRICE INCREASES COULD INCREASE OPERATING COSTS AND
ADVERSELY IMPACT THE COMPETITIVE POSITIONS OF EATON'S PRODUCTS.

Eaton's major requirements for raw materials are described above in Item 1 "Raw
Materials." Significant shortages could affect the prices Eaton's affected
businesses are charged and the competitive position of their products and
services, all of which could adversely affect Eaton's results of operations.

EATON ENGAGES IN ACQUISITIONS AND JOINT VENTURES, AND MAY ENCOUNTER UNEXPECTED
DIFFICULTIES IDENTIFYING, PRICING OR INTEGRATING THOSE BUSINESSES.

Eaton seeks to grow, in part, through strategic acquisitions and joint ventures,
which are intended to complement or expand the Company's businesses, and expects
to continue to do so in the future. The success of this strategy will depend on
Eaton's ability to identify, price, finance and complete these transactions or
arrangements. Success will also depend on the Company's ability to integrate the
businesses acquired in these transactions and to develop satisfactory working
arrangements with the Company's strategic partners in the joint ventures. Eaton
may encounter unexpected difficulties in completing and integrating acquisitions
with Eaton's existing operations, and in managing strategic investments.
Furthermore, the Company may not realize the degree, or timing, of benefits
Eaton anticipated when it first entered into a transaction. Any of the foregoing
could adversely affect the Company's business and results of operations.

EATON MAY BE UNABLE TO ADEQUATELY PROTECT ITS INTELLECTUAL PROPERTY RIGHTS,
WHICH COULD AFFECT THE COMPANY'S ABILITY TO COMPETE.

Protecting Eaton's intellectual property rights is critical to its ability to
compete and succeed. The Company owns a large number of United States and
foreign patents and patent applications, as well as trademark and copyright
registrations that are necessary, and contribute significantly, to the
preservation of Eaton's competitive position in various markets. Although
management believes that the loss or expiration of any single intellectual
property right would not have a material effect on the results of operations or
financial position of Eaton or its business segments, there can be no assurance



                                     Page 6

<PAGE>

that any one, or more, of these patents and other intellectual property will not
be challenged, invalidated or circumvented by third parties. Eaton enters into
confidentiality and invention assignment agreements with the Company's
employees, and into non-disclosure agreements with Eaton's suppliers and
appropriate customers so as to limit access to and disclosure of the Company's
proprietary information. These measures may not suffice to deter
misappropriation or independent third party development of similar technologies.
Moreover, the protection provided to Eaton's intellectual property by the laws
and courts of foreign nations may not be as advantageous to Eaton as the
remedies available under United States law.

EATON IS SUBJECT TO LITIGATION AND ENVIRONMENTAL REGULATIONS THAT COULD
ADVERSELY IMPACT EATON'S BUSINESSES.

At any given time, Eaton may be subject to litigation, the disposition of which
may have a material adverse effect on the Company's businesses, financial
condition or results of operations. Information regarding the Company's current
legal proceedings is presented in "Protection of the Environment" and
"Contingencies" on pages 39 and 40.

EATON PARTICIPATES IN MARKETS THAT ARE COMPETITIVE AND EATON'S RESULTS COULD BE
ADVERSELY IMPACTED BY COMPETITORS' ACTIONS.

Eaton's businesses operate in competitive markets. The Company competes against
other global manufacturers and service providers on the basis of product
performance, quality and price, in addition to other factors. While Eaton's
product development and quality initiatives have been competitive strengths in
the past, actions by Eaton's competitors could lead to downward pressure on
prices and/or a decline in the Company's market share, either of which could
adversely affect Eaton's results.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Eaton's world headquarters is located in Cleveland, Ohio. The Company maintains
manufacturing facilities at 224 locations in 33 countries. The Company is a
lessee under a number of operating leases for certain real properties and
equipment, none of which is material to its operations. Management believes that
the existing manufacturing facilities are adequate for operations, and these
facilities are maintained in good condition.

ITEM 3. LEGAL PROCEEDINGS

Information regarding the Company's current legal proceedings is presented in
"Protection of the Environment" and "Contingencies" on pages 39 and 40.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding executive officers of the Company is presented in Item 10
of this Form 10-K Report.

                                     PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company's Common Shares are listed for trading on the New York and Chicago
stock exchanges. Information regarding cash dividends paid and the high and low
market price per Common Share for each quarter in 2008 and 2007 is presented in
"Quarterly Data" on page 74. At December 31, 2008, there were 8,548 holders of
record of the Company's Common Shares. Additionally, 19,987 current and former
employees were shareholders through participation in the Eaton Savings Plan
(ESP), Eaton Personal Investment Plan (EPIP), and the Eaton Electrical de Puerto
Rico Inc. Retirement Savings Plan.

Information regarding equity compensation plans required by Regulation S-K Item
201(d) is provided in Item 12 of this Form 10-K Report.


                                     Page 7

<PAGE>

ITEM 6. SELECTED FINANCIAL DATA

Information regarding selected financial data is presented in the "Ten-Year
Consolidated Financial Summary" on page 75.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

"Management's Discussion & Analysis of Financial Condition & Results of
Operations" is presented on pages 52 through 73.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information regarding market risk is presented in "Market Risk Disclosure" on
pages 66 and 67.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The report of the independent registered public accounting firm, consolidated
financial statements, and notes to consolidated financial statements are
presented on pages 16 through 51.

Information regarding selected quarterly financial information for 2008 and 2007
is presented in "Quarterly Data" on page 74.

ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures - Pursuant to SEC Rule 13a-15,
an evaluation was performed under the supervision and with the participation of
Eaton's management, including Alexander M. Cutler - Chairman and Chief Executive
Officer; President; and Richard H. Fearon - Vice Chairman and Chief Financial
and Planning Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based on that evaluation, Eaton's
management concluded that the Company's disclosure controls and procedures were
effective as of December 31, 2008.

Disclosure controls and procedures are designed to ensure that information
required to be disclosed in Company reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the SEC's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed in Company reports filed under
the Exchange Act is accumulated and communicated to management, including the
Company's Chief Executive Officer and Chief Financial Officer, to allow timely
decisions regarding required disclosure.

"Management's Report on Internal Control Over Financial Reporting" is presented
on page 19.

"Report of Independent Registered Public Accounting Firm" relating to internal
control over financial reporting is presented on page 18.

During the fourth quarter of 2008, there was no change in Eaton's internal
control over financial reporting that materially affected, or is reasonably
likely to materially affect, Eaton's internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

None.


                                     Page 8

<PAGE>

                                    PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information required with respect to the directors of the Company is set forth
under the caption "Election of Directors" in the Company's definitive Proxy
Statement to be filed on or about March 13, 2009, and is incorporated by
reference.

A listing of the Company's executive officers, their ages, positions and offices
held over the past five years, as of February 1, 2009, follows:

<TABLE>
<CAPTION>
Name                      Age   Position (Date elected to position)
----                      ---   ------------------------------------------------
<S>                       <C>   <C>
Alexander M. Cutler        57   Chairman and Chief Executive Officer; President
                                   (August 1, 2000 - present)
                                Director (September 22, 1993 - present)

Richard H. Fearon          52   Vice Chairman and Chief Financial and Planning
                                   Officer
                                   (April 24, 2002 - present)

Craig Arnold               48   Vice Chairman and Chief Operating Officer -
                                   Industrial Sector
                                   (February 1, 2009 - present)
                                Chief Executive Officer - Fluid Power Group
                                   (October 25, 2000 - January 31, 2009)

Thomas S. Gross            54   Vice Chairman and Chief Operating Officer -
                                   Electrical Sector
                                   (February 1, 2009 - present)
                                President - Power Quality and Control Business
                                   (April 1, 2008 - January 31, 2009)
                                Vice President and President Operations
                                   (October 24, 2007 - March 31, 2008)
                                Vice President  - Eaton Business System
                                   (July 23, 2003 - October 23, 2007)

Richard D. Holder          46   Executive Vice President - Eaton Business System
                                   (April 1, 2008 - present)
                                Vice President - Eaton Business System
                                   (May 1, 2006 - March 31, 2008)
                                Vice President and General Manager;
                                   Power Distribution and Assemblies Division;
                                   Electrical Group
                                   (August 1, 2004 - April 30, 2006)
                                Vice President, Supply Chain and Operational
                                   Excellence, Electrical Group
                                   (July 16, 2001 - July 31, 2004)

Susan J. Cook              61   Executive Vice President - Chief Human Resources
                                   Officer
                                   (January 16, 1995 - present)

Mark M. McGuire            51   Executive Vice President and General Counsel
                                   (December 1, 2005 - present)
                                Vice President and Deputy General Counsel,
                                   International Paper Company (2003 - 2005)

Thomas E. Moran            44   Senior Vice President and Secretary
                                   (October 1, 2008 - present)
                                Assistant Secretary and Managing Counsel, The
                                   Dow Chemical Company (2002-2008)

Billie K. Rawot            57   Senior Vice President and Controller
                                   (March 1, 1991 - present)
</TABLE>


                                     Page 9

<PAGE>

<TABLE>
<S>                       <C>   <C>
Kurt B. McMaken            39   Senior Vice President - Corporate Development
                                and Treasury
                                   (February 1, 2009 - present)
                                Vice President - Corporate Development and
                                   Planning
                                   (January 1, 2008 - January 31, 2009)
                                Director  - Corporate Planning
                                   (April 1, 2006 - December 31, 2007)
                                Director  - Corporate Development
                                   (October 1, 2004 - March 30, 2006)
                                Manager  - Corporate Development and Planning
                                   (October 1, 2002 - September 30, 2004)
</TABLE>

There are no family relationships among the officers listed, and there are no
arrangements or understandings pursuant to which any of them were elected as
officers. All officers hold office for one year and until their successors are
elected and qualified, unless otherwise specified by the Board of Directors;
provided, however, that any officer is subject to removal with or without cause,
at any time, by a vote of a majority of the Board of Directors.

Information required with respect to compliance with Section 16(a) of the
Exchange Act is set forth under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's definitive Proxy Statement to be filed on
or about March 13, 2009, and is incorporated by reference.

The Company has adopted a Code of Ethics, which applies to the Directors,
officers and employees worldwide. This document is available on the Company's
website at http://www.eaton.com.

There were no changes during fourth quarter 2008 to the procedures by which
security holders may recommend nominees to the Company's Board of Directors.

Information related to the Company's Audit Committee, and members of the
Committee that are financial experts, is set forth under the caption "Board
Committees - Audit Committee" in the Company's definitive Proxy Statement to be
filed on or about March 13, 2009, and is incorporated by reference.

ITEM 11. EXECUTIVE COMPENSATION

Information required with respect to executive compensation is set forth under
the caption "Executive Compensation" in the Company's definitive Proxy Statement
to be filed on or about March 13, 2009, and is incorporated by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

Information required with respect to securities authorized for issuance under
equity compensation plans is set forth under the caption "Equity Compensation
Plans" in the Company's definitive Proxy Statement to be filed on or about March
13, 2009, and is incorporated by reference.

Information required with respect to security ownership of certain beneficial
owners, is set forth under the caption "Share Ownership Tables" in the Company's
definitive Proxy Statement to be filed on or about March 13, 2009, and is
incorporated by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE

Information required with respect to certain relationships and related
transactions is set forth under the caption "Review of Related Person
Transactions" in the Company's definitive Proxy Statement to be filed on or
about March 13, 2009, and is incorporated by reference.

Information required with respect to director independence is set forth under
the caption "Director Independence" in the Company's definitive Proxy Statement
to be filed on or about March 13, 2009, and is incorporated by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information required with respect to principal accountant fees and services is
set forth under the caption "Audit Committee Report" in the Company's definitive
Proxy Statement to be filed on or about March 13, 2009, and is incorporated by
reference.


                                     Page 10

<PAGE>

                                     PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a) (1) The report of the independent registered public accounting firm,
consolidated financial statements and notes to consolidated financial
statements, included in the 2008 Annual Report to Shareholders are included in
Item 8 above:

     Report of Independent Registered Public Accounting Firm - Page 16

     Statements of Consolidated Income - Years ended December 31, 2008, 2007 and
     2006 - Page 20

     Consolidated Balance Sheets - December 31, 2008 and 2007 - Page 21

     Statements of Consolidated Cash Flows - Years ended December 31, 2008, 2007
     and 2006 - Page 22

     Statements of Consolidated Shareholders' Equity - Years ended December 31,
     2008, 2007 and 2006 - Pages 23 and 24

     Notes to Consolidated Financial Statements - Pages 25 through 51

     All other schedules for which provision is made in Regulation S-X of the
     SEC are not required under the related instructions or are inapplicable
     and, therefore, have been omitted.

(3)  Exhibits

     3(i) Amended Articles of Incorporation (amended and restated as of
          April 24, 2008) - Incorporated by reference to the Form 10-Q Report
          for the three months ended March 31, 2008

     3(ii) Amended Regulations (amended and restated as of April 23, 2008) -
          Incorporated by reference to the Form 10-Q Report for the three months
          ended March 31, 2008

     4(a) Pursuant to Regulation S-K Item 601(b) (4), the Company agrees to
          furnish to the SEC, upon request, a copy of the instruments defining
          the rights of holders of its other long-term debt

     10   Material contracts

          (a)  Tender Offer for all of the shares of Phoenixtec Power Company
               Ltd. announced on December 20, 2007 - Incorporated by reference
               to the Form 10-K Report for the year ended December 31, 2007

          (b)  Share Purchase Agreement between Green Beta S.a.r.l. and Eaton
               Corporation dated December 20, 2007 - Incorporated by reference
               to the Form 10-K Report for the year ended December 31, 2007

          (c)  Senior Executive Incentive Compensation Plan (effective January
               1, 2008) - Incorporated by reference to the definitive Proxy
               Statement dated March 14, 2008

          (d)  Executive Incentive Compensation Plan (effective January 1, 2005)
               - Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2005

          (e)  2005 Non-Employee Director Fee Deferral Plan (2008 restatement) -
               Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2007

          (f)  Deferred Incentive Compensation Plan II (2008 restatement) -
               Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2007


                                    Page 11

<PAGE>

          (g)  Excess Benefits Plan II (2008 restatement) - Incorporated by
               reference to the Form 10-K Report for the year ended December 31,
               2007

          (h)  Incentive Compensation Deferral Plan II (2008 restatement) -
               Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2007

          (i)  Limited Eaton Service Supplemental Retirement Income Plan II
               (2008 restatement) - Incorporated by reference to the Form 10-K
               Report for the year ended December 31, 2007

          (j)  Supplemental Benefits Plan II (2008 restatement) - Incorporated
               by reference to the Form 10-K Report for the year ended December
               31, 2007

          (k)  Form of Restricted Share Unit Agreement (2 year vesting) -
               Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2007

          (l)  Form of Restricted Share Unit Agreement (4 year vesting) -
               Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2007

          (m)  Form of Restricted Share Agreement (2 year vesting) -
               Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2007

          (n)  Form of Restricted Share Agreement (4 year vesting) -
               Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2007

          (o)  Form of Restricted Share Agreement (Non-Employee Directors) -
               Incorporated by Reference to the Form 8-K Report filed January
               28, 2009

          (p)  Form of Stock Option Agreement for Executives (2008) -
               Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2007

          (q)  Form of Stock Option Agreement for Executives - Incorporated by
               reference to the Form 10-K Report for the year ended December 31,
               2006

          (r)  Form of Stock Option Agreement for Non-Employee Directors (2008)
               - Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2007

          (s)  2002 Stock Plan - Incorporated by reference to the definitive
               Proxy Statement dated March 15, 2002

          (t)  2004 Stock Plan - Incorporated by reference to the definitive
               Proxy Statement dated March 19, 2004

          (u)  2008 Stock Plan - Incorporated by reference to the definitive
               Proxy Statement dated March 14, 2008

          (v)  Plan for the Deferred Payment of Directors' Fees (originally
               adopted in 1985 and amended effective September 24, 1996, January
               28, 1998, January 23, 2002, February 24, 2004, December 8, 2004
               and, in certain respects, January 1, 2005) - Incorporated by
               reference to the Form 10-K Report for the year ended December 31,
               2007

          (w)  1996 Non-Employee Director Fee Deferral Plan (amended and
               restated effective January 1, 2005) - Incorporated by reference
               to the Form 10-K Report for the year ended December 31, 2006

          (x)  Form of Change of Control Agreement entered into with officers of
               Eaton Corporation - Filed in conjunction with this Form 10-K
               Report

          (y)  Form of Indemnification Agreement entered into with officers of
               Eaton Corporation - Incorporated by reference to the Form 10-K
               Report for the year ended December 31, 2002


                                     Page 12

<PAGE>

          (z)  Form of Indemnification Agreement entered into with directors of
               Eaton Corporation - Incorporated by reference to the Form 8-K
               Report filed January 26, 2007

          (aa) Executive Strategic Incentive Plan (amended and restated January
               1, 2008) - Incorporated by reference to the definitive Proxy
               Statement dated March 14, 2008

          (bb) Executive Strategic Incentive Plan II (effective January 1, 2001)
               - Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2002

          (cc) Supplemental Executive Strategic Incentive Plan (effective as of
               June 25, 2008) - Filed in conjunction with this Form 10-K Report

          (dd) Deferred Incentive Compensation Plan (amended and restated March
               31, 2000) - Incorporated by reference to the Form 10-K Report for
               the year ended December 31, 2000

          (ee) 1998 Stock Plan - Incorporated by reference to the definitive
               Proxy Statement dated March 13, 1998

          (ff) Incentive Compensation Deferral Plan (amended and restated
               October 1, 1997) - Incorporated by reference to the Form 10-K
               Report for the year ended December 31, 2000

          (gg) Trust Agreement - Officers and Employees (dated December 6, 1996)
               - Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2002

          (hh) Trust Agreement - Non-employee Directors (dated December 6, 1996)
               - Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2002

          (ii) Group Replacement Insurance Plan (GRIP) (effective June 1, 1992)
               - Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 1992

          (jj) 1991 Stock Option Plan - Incorporated by reference to the Form
               10-K Report for the year ended December 31, 2002

          (kk) Excess Benefits Plan (amended and restated effective January 1,
               1989) - Incorporated by reference to the Form 10-K Report for the
               year ended December 31, 2002

          (ll) Supplemental Benefits Plan (amended and restated January 1, 1989)
               - Incorporated by reference to the Form 10-K Report for the year
               ended December 31, 2002

          (mm) Eaton Corporation Board of Directors Policy on Incentive
               Compensation, Stock Options and Other Equity Grants upon the
               Restatement of Financial Results - Incorporated by reference to
               the Form 10-K Report for the year ended December 31, 2007

     12   Ratio of Earnings to Fixed Charges - Filed in conjunction with this
          Form 10-K Report

     14   Code of Ethics - Incorporated by reference to the definitive Proxy
          Statement filed on March 14, 2008

     21   Subsidiaries of Eaton Corporation - Filed in conjunction with this
          Form 10-K Report

     23   Consent of Independent Registered Public Accounting Firm - Filed in
          conjunction with this Form 10-K Report


                                     Page 13

<PAGE>

     24   Power of Attorney - Filed in conjunction with this Form 10-K Report

     31.1 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act of
          2002, Section 302) - Filed in conjunction with this Form 10-K Report

     31.2 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act of
          2002, Section 302) - Filed in conjunction with this Form 10-K Report

     32.1 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act of
          2002, Section 906) - Filed in conjunction with this Form 10-K Report

     32.2 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act of
          2002, Section 906) - Filed in conjunction with this Form 10-K Report

(b)  Exhibits

     Certain exhibits required by this portion of Item 15 are filed as a
     separate section of this Form 10-K Report.


                                     Page 14

<PAGE>

                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

                                        Eaton Corporation
                                        Registrant


Date: February 27, 2009                 /s/ Richard H. Fearon
                                        ----------------------------------------
                                        Richard H. Fearon
                                        Vice Chairman and Chief Financial and
                                        Planning Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.

Date: February 27, 2009

<TABLE>
<CAPTION>
Signature                               Title
---------                               ----------------------------------------
<S>                                     <C>


*
-------------------------------------
Alexander M. Cutler                     Chairman and Chief Executive Officer;
                                        President; Principal Executive Officer;
                                        Director


*
-------------------------------------
Billie K. Rawot                         Senior Vice President and Controller;
                                        Principal Accounting Officer


*
-------------------------------------
Christopher M. Connor                   Director


*
-------------------------------------
Charles E. Golden                       Director


*
-------------------------------------
Arthur E. Johnson                       Director


*
-------------------------------------
Deborah L. McCoy                        Director


*
-------------------------------------
Gregory R. Page                         Director


-------------------------------------
Gary L. Tooker                          Director


*
-------------------------------------
Michael J. Critelli                     Director


*
-------------------------------------
Ernie Green                             Director


*
-------------------------------------
Ned C. Lautenbach                       Director


*
-------------------------------------
John R. Miller                          Director


*
-------------------------------------
Victor A. Pelson                        Director
</TABLE>


*By /s/ Richard H. Fearon
    ---------------------------------
    Richard H. Fearon,
    Attorney-in-Fact for the officers
    and directors signing in the
    capacities indicated


                                     Page 15
<PAGE>

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders
Eaton Corporation

We have audited the accompanying consolidated balance sheets of Eaton
Corporation as of December 31, 2008 and 2007, and the related statements of
consolidated income, shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 2008. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Eaton Corporation
at December 31, 2008 and 2007, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December 31,
2008, in conformity with United States generally accepted accounting principles.

As discussed in "Retirement Benefit Plans" in the Notes to the Consolidated
Financial Statements, in accordance with SFAS No. 158, Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statements No. 87, 88, 106, and 132(R), Eaton Corporation changed its method of
accounting for the funded status of its defined benefit pension and other
postretirement benefit plans in 2006 and, in 2008, changed its method of
accounting for the measurement date provisions of these plans.

We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), Eaton Corporation's internal control
over financial reporting as of December 31, 2008, based on criteria established
in Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated February 27, 2009
expressed an unqualified opinion thereon.


ERNST & YOUNG LLP

Cleveland, Ohio
February 27, 2009


                                    Page 16

<PAGE>

MANAGEMENT'S REPORT ON FINANCIAL STATEMENTS

We have prepared the accompanying consolidated financial statements and related
information of Eaton Corporation included herein for the three years ended
December 31, 2008. The primary responsibility for the integrity of the financial
information included in this annual report rests with management. The financial
information included in this annual report has been prepared in accordance with
accounting principles generally accepted in the United States based on our best
estimates and judgments and giving due consideration to materiality. The opinion
of Ernst & Young LLP, Eaton's independent registered public accounting firm, on
those financial statements is included herein.

Eaton has high standards of ethical business practices supported by the Eaton
Code of Ethics and corporate policies. Careful attention is given to selecting,
training and developing personnel, to ensure that management's objectives of
establishing and maintaining adequate internal controls and unbiased, uniform
reporting standards are attained. Our policies and procedures provide reasonable
assurance that operations are conducted in conformity with applicable laws and
with the Company's commitment to a high standard of business conduct.

The Board of Directors pursues its responsibility for the quality of Eaton's
financial reporting primarily through its Audit Committee, which is composed of
six independent directors. The Audit Committee meets regularly with management,
the internal auditors and the independent registered public accounting firm to
ensure that they are meeting their responsibilities and to discuss matters
concerning accounting, control, audits and financial reporting. The internal
auditors and independent registered public accounting firm have full and free
access to senior management and the Audit Committee.

ALEXANDER M. CUTLER   RICHARD H. FEARON              BILLIE K. RAWOT
Chairman and Chief    Vice Chairman and              Senior Vice President and
Executive Officer;    Chief Financial and Planning   Controller
President             Officer

February 27, 2009


                                    Page 17

<PAGE>

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders
Eaton Corporation

We have audited Eaton Corporation's internal control over financial reporting as
of December 31, 2008, based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria). Eaton Corporation's management is
responsible for maintaining effective internal control over financial reporting,
and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Management's Report on Internal Control
Over Financial Reporting. Our responsibility is to express an opinion on the
Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.

A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.

As indicated in the accompanying Management's Report on Internal Control Over
Financial Reporting, management's assessment of and conclusion on the
effectiveness of internal control over financial reporting did not include the
internal controls of certain entities that were acquired during 2008, which are
included in the 2008 consolidated financial statements of Eaton Corporation and
constituted approximately 7% of total assets as of December 31, 2008 and 10% of
net sales for the year then ended. Our audit of internal control over financial
reporting of Eaton Corporation also did not include an evaluation of the
internal control over financial reporting for these entities.

In our opinion, Eaton Corporation maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2008,
based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
Eaton Corporation as of December 31, 2008 and 2007, and the related statements
of consolidated income, shareholders' equity, and cash flows for each of the
three years in the period ended December 31, 2008 and our report dated February
27, 2009 expressed an unqualified opinion thereon.


ERNST & YOUNG LLP

Cleveland, Ohio
February 27, 2009


                                    Page 18

<PAGE>


MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of Eaton Corporation is responsible for establishing and
maintaining adequate internal control over financial reporting (as defined in
Exchange Act rules 13a-15(f)).

Under the supervision and with the participation of Eaton's management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of the effectiveness of the Company's internal control
over financial reporting as of December 31, 2008. Our evaluation of internal
control over financial reporting did not include the internal controls of
certain entities that were acquired during 2008, which are included in the 2008
consolidated financial statements and constituted approximately 7% of total
assets as of December 31, 2008 and 10% of net sales for the year then ended. In
conducting this evaluation, we used the framework set forth by the Committee of
Sponsoring Organizations of the Treadway Commission in Internal Control -
Integrated Framework. Based on this evaluation under the framework referred to
above, management concluded that the Company's internal control over financial
reporting was effective as of December 31, 2008.

The independent registered public accounting firm Ernst & Young LLP has issued
an audit report on the effectiveness of the Company's internal control over
financial reporting as of December 31, 2008. This report is included herein.

ALEXANDER M. CUTLER   RICHARD H. FEARON              BILLIE K. RAWOT
Chairman and Chief    Vice Chairman and              Senior Vice President and
Executive Officer;    Chief Financial and Planning   Controller
President             Officer

February 27, 2009


                                    Page 19

<PAGE>

STATEMENTS OF CONSOLIDATED INCOME

<TABLE>
<CAPTION>

                                                   Year ended December 31
                                                ---------------------------
(Millions except for per share data)              2008      2007     2006
------------------------------------            -------   -------   -------
<S>                                             <C>       <C>       <C>
NET SALES                                       $15,376   $13,033   $12,232
Cost of products sold                            11,191     9,382     8,949
Selling & administrative expense                  2,513     2,139     1,939
Research & development expense                      417       335       315
Interest expense-net                                157       147       105
Contribution to Eaton Charitable Fund                          16
Other (income) expense-net                          (30)      (27)      (45)
                                                -------   -------   -------
Income from continuing operations before
   income taxes                                   1,128     1,041       969
Income taxes                                         73        82        72
                                                -------   -------   -------
Income from continuing operations                 1,055       959       897
Income from discontinued operations                   3        35        53
                                                -------   -------   -------
NET INCOME                                      $ 1,058   $   994   $   950
                                                =======   =======   =======
NET INCOME PER COMMON SHARE ASSUMING DILUTION
   Continuing operations                        $  6.50   $  6.38   $  5.87
   Discontinued operations                          .02       .24       .35
                                                -------   -------   -------
                                                $  6.52   $  6.62   $  6.22
                                                =======   =======   =======
Average number of Common Shares outstanding
   assuming dilution                              162.3     150.3     152.9

NET INCOME PER COMMON SHARE BASIC
   Continuing operations                        $  6.58   $  6.51   $  5.97
   Discontinued operations                          .02       .24       .35
                                                -------   -------   -------
                                                $  6.60   $  6.75   $  6.32
                                                =======   =======   =======
Average number of Common Shares outstanding
   basic                                          160.2     147.3     150.2

CASH DIVIDENDS PAID PER COMMON SHARE            $  2.00   $  1.72   $  1.48

</TABLE>

The notes on pages 25 to 51 are an integral part of the consolidated financial
statements.


                                    Page 20

<PAGE>

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                   December 31
                                                --------   -------
(Millions)                                        2008       2007
----------                                      --------   -------
<S>                                             <C>        <C>
ASSETS
Current assets
   Cash                                         $    188   $   142
   Short-term investments                            342       504
   Accounts receivable                             2,295     2,208
   Inventories                                     1,554     1,483
   Deferred income taxes                             239       291
   Other current assets                              177       139
                                                --------   -------
                                                   4,795     4,767
                                                --------   -------
Property, plant & equipment-net
   Land & buildings                                1,425     1,175
   Machinery & equipment                           4,142     4,067
                                                --------   -------
                                                   5,567     5,242
   Accumulated depreciation                       (2,928)   (2,909)
                                                --------   -------
                                                   2,639     2,333
Goodwill                                           5,232     3,982
Other intangible assets                            2,518     1,557
Deferred income taxes                                971       498
Other assets                                         500       293
                                                --------   -------
                                                $ 16,655   $13,430
                                                ========  ========
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities
   Short-term debt                              $    812   $   825
   Current portion of long-term debt                 269       160
   Accounts payable                                1,121     1,170
   Accrued compensation                              297       355
   Other current liabilities                       1,246     1,149
                                                --------   -------
                                                   3,745     3,659
                                                --------   -------
Long-term debt                                     3,190     2,432
Pension liabilities                                1,650       681
Other postretirement liabilities                     703       772
Deferred income taxes                                543       224
Other liabilities                                    507       490
Shareholders' equity
   Common Shares (165.0 million outstanding
      in 2008 and 146.0 million in 2007)              82        73
   Capital in excess of par value                  3,879     2,290
   Retained earnings                               3,917     3,257
   Accumulated other comprehensive loss           (1,538)     (423)
   Deferred compensation plans                       (23)      (25)
                                                --------   -------
                                                   6,317     5,172
                                                --------   -------
                                                $ 16,655   $13,430
                                                ========  ========
</TABLE>

The notes on pages 25 to 51 are an integral part of the consolidated financial
statements.


                                    Page 21

<PAGE>

STATEMENTS OF CONSOLIDATED CASH FLOWS

<TABLE>
<CAPTION>
                                                   Year ended December 31
                                                ----------------------------
(Millions)                                        2008      2007       2006
----------                                      -------   --------   -------
<S>                                             <C>       <C>        <C>
NET CASH PROVIDED BY (USED IN) OPERATING
   ACTIVITIES
Net income                                      $ 1,058   $    994   $   950
Adjustments to reconcile to net cash provided
   by operating activities
   Depreciation & amortization                      592        469       434
   Deferred income taxes                           (225)       (51)       37
   Pension liabilities, net of contributions          5         26        79
   Gains on sales of businesses                     (19)       (46)      (56)
   Other long-term liabilities                      (40)       (25)      (45)
   Other non-cash items in income                    49         38        33
   Changes in working capital, excluding
      acquisitions & sales of businesses
      Accounts receivable                           128        (72)      (40)
      Inventories                                   118        (79)     (129)
      Accounts payable                             (208)        27       207
      Accrued income & other taxes                  (31)       (41)     (149)
      Other current liabilities                    (125)        11       136
      Other working capital accounts                (81)        10        43
   Cash received from termination of
      interest rate swaps                            85         19         1
   Other-net                                        110       (119)      (70)
                                                -------   --------   -------
                                                  1,416      1,161     1,431
                                                -------   --------   -------
NET CASH PROVIDED BY (USED IN) INVESTING
   ACTIVITIES
Expenditures for property, plant & equipment       (448)      (354)     (360)
Cash paid for acquisitions of businesses         (2,807)    (1,433)     (256)
Proceeds from sales of businesses                    25        119        65
Sales (purchases) of short-term investments-net     100        247      (418)
Other-net                                           (69)       (39)      (42)
                                                -------   --------   -------
                                                 (3,199)    (1,460)   (1,011)
                                                -------   --------   -------
NET CASH PROVIDED BY (USED IN) FINANCING
   ACTIVITIES
Borrowings with original maturities of more
   than three months
   Proceeds                                       1,656      1,652       706
   Payments                                        (984)      (979)     (617)
Borrowings with original maturities of less
   than three months-net, primarily
   commercial paper                                  (5)        62       (35)
Cash dividends paid                                (320)      (251)     (220)
Proceeds from issuance of Common Shares           1,522
Proceeds from exercise of employee stock
   options                                           47        141       108
Income tax benefit from exercise of employee
   stock options                                     13         42        28
Purchase of Common Shares                          (100)      (340)     (386)
                                                -------   --------   -------
                                                  1,829        327      (416)
                                                -------   --------   -------
Total increase in cash                               46         28         4
Cash at the beginning of the year                   142        114       110
                                                -------   --------   -------
Cash at the end of the year                     $   188   $    142   $   114
                                                =======   ========   =======
</TABLE>

The notes on pages 25 to 51 are an integral part of the consolidated financial
statements.


                                    Page 22
<PAGE>

STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                         Accumulated
                                               Common Shares    Capital in                  other          Deferred        Total
                                             ----------------    excess of   Retained   comprehensive   compensation   Shareholders'
(Millions)                                   Shares   Dollars    par value   earnings       loss            plans          equity
----------                                   ------   -------   ----------   --------   -------------   ------------   -------------
<S>                                          <C>      <C>       <C>          <C>        <C>             <C>            <C>
BALANCE AT JANUARY 1, 2006                    148.5     $74       $2,013      $2,376         $(649)          $(36)        $3,778
Net income                                                                       950                                         950
Foreign currency translation and related
   hedging instruments (including income
   tax benefits of $16)                                                                         95                            95
Deferred loss on cash flow hedges (net of
   income tax benefits of $3)                                                                   (5)                           (5)
Minimum pension liability (net of income
   tax benefits of $1)                                                                          (8)                           (8)
                                                                                                                          -------
Other comprehensive income                                                                                                    82
                                                                                                                          -------
Total comprehensive income                                                                                                 1,032
Adjustment to initially apply SFAS No. 158
   Pensions (net of income tax
   benefits of $85)                                                                           (163)                         (163)
   Other postretirement benefits (net of
   income tax benefits of $119)                                                               (119)                         (119)
Cash dividends paid                                                             (220)                                       (220)
Issuance of shares under employee benefit
   plans, including income tax benefits
   of $36                                       3.1       2          176          (2)                          13            189
Purchase of shares by trust                                                                                    (5)            (5)
Purchase of shares                             (5.3)     (3)         (75)       (308)                                       (386)
                                              -----     ---       ------      ------       -------           ----         -------
BALANCE AT DECEMBER 31, 2006                  146.3      73        2,114       2,796          (849)           (28)         4,106
Net income                                                                       994                                         994
Foreign currency translation and related
   hedging instruments (including income
   taxes of $14)                                                                               212                           212
Deferred loss on cash flow hedges (net of
   income tax benefits of $3)                                                                   (5)                           (5)
Pensions (net of income taxes of $101)                                                         214                           214
Other postretirement benefits (net of
   income taxes of $8)                                                                           5                             5
                                                                                                                          -------
Other comprehensive income                                                                                                   426
                                                                                                                          -------
Total comprehensive income                                                                                                 1,420
Cash dividends paid                                                             (251)                                       (251)
Issuance of shares under employee benefit
   plans, including income tax
   benefits of $51                              3.7       2          237          (5)                           8            242
Purchase of shares by trust                                                                                    (5)            (5)
Purchase of shares                             (4.0)     (2)         (61)       (277)                                       (340)
                                              -----     ---       ------      ------       -------           ----         -------
</TABLE>


                                     Page 23

<PAGE>

STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                         Accumulated
                                               Common Shares    Capital in                  other         Deferred         Total
                                             ----------------    excess of   Retained   comprehensive   compensation   Shareholders'
(Millions)                                   Shares   Dollars    par value   earnings       loss            plans          equity
----------                                   ------   -------   ----------   --------   -------------   ------------   -------------
<S>                                          <C>      <C>       <C>          <C>        <C>             <C>            <C>
BALANCE AT DECEMBER 31, 2007                  146.0      73        2,290       3,257          (423)           (25)         5,172
Net income                                                                     1,058                                       1,058
Foreign currency translation and related
   hedging instruments (including income
   tax benefits of $68)                                                                       (722)                         (722)
Deferred loss on cash flow hedges (net of
   income tax benefits of $12)                                                                 (23)                          (23)
Pensions (net of income tax benefits
   of $227)                                                                                   (419)                         (419)
Other postretirement benefits (net of
   income taxes of $31)                                                                         49                            49
                                                                                                                          -------
Other comprehensive loss                                                                                                  (1,115)
                                                                                                                          -------
Total comprehensive loss                                                                                                     (57)
Effects of changing measurement date under
   SFAS No. 158 (net of income tax
   benefits of $8)                                                               (11)                                        (11)
Cash dividends paid                                                             (320)                                       (320)
Issuance of shares under employee
   benefit plans, including income tax
   benefits of $16                              1.7       1          109          (1)                          5             114
Issuance of shares                             18.7       9        1,513                                                   1,522
Purchase of shares by trust                                                                                   (3)             (3)
Purchase of shares                             (1.4)     (1)         (33)        (66)                                       (100)
                                              -----     ---       ------      ------       -------          ----          -------
BALANCE AT DECEMBER 31, 2008                  165.0     $82       $3,879      $3,917       $(1,538)         $(23)         $ 6,317
                                              =====     ===       ======      ======       =======          ====          =======
</TABLE>

The notes on pages 25 to 51 are an integral part of the consolidated financial
statements.


                                     Page 24

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

DESCRIPTION OF COMPANY

Eaton Corporation is a diversified power management company and 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; truck and automotive drivetrain and
powertrain systems for performance, fuel economy and safety. Eaton has
approximately 75,000 employees and sells products to customers in more than 150
countries.

ACCOUNTING POLICIES

CONSOLIDATION & BASIS OF PRESENTATION

The consolidated financial statements include accounts of Eaton and all
subsidiaries and other controlled entities. The equity method of accounting is
used for investments in associate companies where the Company has a 20% to 50%
ownership interest. These associate companies are not material either
individually, or in the aggregate, to Eaton's financial position, results of
operations or cash flows.

Eaton does not have off-balance sheet arrangements or financings with
unconsolidated entities or other persons. In the ordinary course of business,
the Company leases certain real properties and equipment, as described in "Lease
Commitments" in the Notes below. Transactions with related parties are in the
ordinary course of business, are conducted on an arm's-length basis, and are not
material to Eaton's financial position, results of operations or cash flows.

REVENUE RECOGNITION

Sales are recognized when a sales agreement is in place, products have been
shipped to unaffiliated customers and title has transferred in accordance with
shipping terms (FOB shipping point, FOB destination or equivalent International
Commercial (INCO) Terms), the selling price is fixed and determinable and
collectability is reasonably assured, all significant related acts of
performance have been completed, and no other significant uncertainties exist.
Shipping and handling costs billed to customers are included in Net sales and
the related costs in Cost of products sold. Other revenues for service contracts
are generally recognized as the services are provided.

FOREIGN CURRENCY TRANSLATION

The functional currency for substantially all subsidiaries outside the United
States is the local currency. Financial statements for these subsidiaries are
translated into United States dollars at year-end exchange rates as to assets
and liabilities and weighted-average exchange rates as to revenues and expenses.
The resulting translation adjustments are recorded in Accumulated other
comprehensive income (loss) in Shareholders' equity. Gains and losses related to
foreign currency transactions are recorded in Other (income) expense-net in the
Statements of Consolidated Income.

INVENTORIES

Inventories are carried at lower of cost or market. Inventories in the United
States are generally accounted for using the last-in, first-out (LIFO) method.
Remaining United States and all other inventories are accounted for using the
first-in, first-out (FIFO) method. Cost components include raw materials,
purchased components, direct labor, indirect labor, utilities, depreciation,
inbound freight charges, purchasing and receiving costs, inspection costs,
warehousing costs, and costs of the distribution network.

DEPRECIATION & AMORTIZATION

Depreciation and amortization are computed by the straight-line method for
financial statement purposes. Cost of buildings is depreciated over principally
40 years and machinery and equipment over principally 3 to 10 years. At December
31, 2008, the weighted-average amortization periods for intangible assets
subject to amortization were 14 years for patents, 18 years for manufacturing


                                     Page 25

<PAGE>

technology and 20 years for customer relationships, primarily as a result of the
long life of aircraft platforms. Software is amortized over a range of 3 to 7
years.

Long-lived assets, except goodwill and indefinite life intangible assets as
described in the Notes below, are reviewed for impairment whenever events or
changes in circumstances indicate the carrying amount may not be recoverable.
Events or circumstances that would result in an impairment review include
operations reporting losses, a significant adverse change in the use of an
asset, the planned disposal or sale of the asset, a significant adverse change
in the business climate or legal factors related to the asset, or a significant
decrease in the estimated fair value of an asset. The asset would be considered
impaired when the estimated future net undiscounted cash flows generated by the
asset are less than its carrying value. An impairment loss would be recognized
based on the amount by which the carrying value of the asset exceeds its fair
value.

GOODWILL & INDEFINITE LIFE INTANGIBLE ASSETS

In accordance with Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets," Eaton does not amortize goodwill and
indefinite life intangible assets recorded in connection with business
acquisitions. Indefinite life intangible assets primarily consist of trademarks.

Goodwill is tested for impairment at the reporting unit level and is based on
the net assets for each unit including goodwill and intangible assets. The
Company completed annual impairment tests for goodwill and indefinite life
intangible assets as of July 1, 2008 as required by SFAS No. 142. In addition,
based on changes in the global economic environment in the second half of 2008,
goodwill and indefinite life intangible assets were also tested for impairment
in the fourth quarter of 2008. These tests confirmed that the fair value of the
Company's reporting units and indefinite life intangible assets exceed their
respective carrying values and that no impairment loss was required to be
recognized.

DERIVATIVE FINANCIAL INSTRUMENTS

In the normal course of business, Eaton is exposed to fluctuations in interest
rates, foreign currency exchange rates, and commodity prices. The Company uses
various financial instruments, primarily interest rate swaps, foreign currency
forward exchange contracts, foreign currency swaps and, to a lesser extent,
commodity swaps, to manage exposure to these market fluctuations.

Derivative financial instruments used by Eaton are straightforward,
non-leveraged instruments. The counterparties to these 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 solely for trading purposes, except for nominal amounts
authorized under limited, controlled circumstances.

All derivative financial instruments are recognized as either assets or
liabilities in the Consolidated Balance Sheet and are measured at fair value.
Accounting for the gain or loss resulting from the change in the financial
instrument's fair value depends on whether it has been designated, and is
effective, as a hedge and, if so, on the nature of the hedging activity.
Financial instruments can be designated as hedges of changes in the fair value
of a recognized fixed-rate asset or liability, or the firm commitment to acquire
such an asset or liability; as hedges of variable cash flows of a recognized
variable-rate asset or liability, or the forecasted acquisition of such an asset
or liability; or as hedges of foreign currency exposure from a net investment in
one of the Company's foreign operations. Gains and losses related to a hedge are
either recognized in income immediately to offset the gain or loss on the hedged
item or are deferred and reported as a component of Accumulated other
comprehensive income (loss) in Shareholders' equity and subsequently recognized
in net income when the hedged item affects net income. The change in fair value
of the ineffective portion of a financial instrument is recognized in net income
immediately. The gain or loss related to financial instruments that are not
designated as hedges are recognized immediately in net income.

WARRANTY EXPENSES

Estimated product warranty expenses are accrued in Cost of products sold at the
time the related sale is recognized. Estimates of warranty expenses are based
primarily on historical warranty claim experience and specific customer
contracts. Warranty expenses include accruals for basic warranties


                                     Page 26

<PAGE>

for products sold, as well as accruals for product recalls and other related
events when they are known and estimable.

ASSET RETIREMENT OBLIGATIONS

A conditional asset retirement obligation is recognized at fair value when
incurred, if the fair value of the liability can be reasonably estimated.
Uncertainty about the timing or method of settlement of a conditional asset
retirement obligation would be factored into the measurement of the liability
when sufficient information exists. Eaton believes that for substantially all of
its asset retirement obligations, there is an indeterminate settlement date
because the range of time over which the Company may settle the obligation is
unknown or cannot be estimated. A liability for these obligations will be
recorded in the period when sufficient information regarding timing and method
of settlement becomes available to make a reasonable estimate of the liability's
fair value.

ESTIMATES

Preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions in certain circumstances that affect amounts reported in the
accompanying consolidated financial statements and notes. Actual results could
differ from these estimates.

FINANCIAL PRESENTATION CHANGES

Certain amounts for prior years have been reclassified to conform to the current
year presentation.

NEW ACCOUNTING PRONOUNCEMENTS

EMPLOYERS' DISCLOSURES ABOUT POSTRETIREMENT BENEFIT PLAN ASSETS

In December 2008, the Financial Accounting Standards Board (FASB) issued FSP 132
(R)-1, "Employers' Disclosures about Postretirement Benefit Plan Assets." FSP
132 (R)-1 provides guidance on an employer's disclosures about plan assets of a
defined benefit pension or other postretirement plan. The guidance addresses
disclosures related to the categories of plan assets, concentration of risk
arising within or across the categories of plan assets, and fair value
measurements of plan assets. This Staff Position is effective for Eaton in 2009
and will have no effect on its consolidated financial position or results of
operations.

DISCLOSURES ABOUT DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative
Instruments and Hedging Activities - an amendment of FASB Statement No. 133."
SFAS No. 161 provides for enhanced disclosures of how derivative and hedging
activities affect an entity's financial position, financial performance, and
cash flows. This Statement is effective for Eaton in 2009 and will have no
effect on its consolidated financial position or results of operations.

BUSINESS COMBINATIONS

In December 2007, the FASB issued SFAS No. 141 (R), "Business Combinations."
This Statement establishes principles and requires the buyer to:

     -    Recognize, with certain exceptions, 100% of the fair values of assets
          acquired, liabilities assumed, and non-controlling interests in
          acquisitions of less than a 100% controlling interest when the
          acquisition constitutes a change in control of the acquired entity.

     -    Measure shares issued in consideration for a business combination at
          fair value on the acquisition date.

     -    Recognize contingent consideration arrangements at their
          acquisition-date fair values, with subsequent changes in fair value
          generally reflected in earnings.

     -    With certain exceptions, recognize pre-acquisition loss and gain
          contingencies at their acquisition date fair values.

     -    Capitalize in-process research and development assets acquired.

     -    Expense, as incurred, acquisition-related transaction costs.


                                     Page 27

<PAGE>

     -    Capitalize acquisition-related restructuring costs only if the
          criteria in SFAS No. 146, "Accounting for Costs Associated with Exit
          or Disposal Activities," are met as of the acquisition date.

     -    Recognize in income tax expense changes in income tax valuation
          allowances and accruals for income tax uncertainties that were
          recorded in a business acquisition, including acquisitions of
          businesses completed prior to 2009.

This Statement will be effective for Eaton in 2009. Statement 141 (R) will
affect Eaton's consolidated financial position or results of operations based on
the specific conditions related to future acquisitions.

NONCONTROLLING INTERESTS IN CONSOLIDATED FINANCIAL STATEMENTS

In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements - an amendment of ARB No. 51." This Statement
clarifies accounting and reporting for a noncontrolling interest, sometimes
called a minority interest, which is the portion of equity in a subsidiary not
attributable, directly or indirectly, to a parent company. This Statement will
be effective for Eaton in 2009. The Company expects that this Statement will not
have a material effect on its consolidated financial position and results of
operations.

FAIR VALUE MEASUREMENTS

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." This
Statement defines fair value for financial and non-financial assets and
liabilities, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. The guidance applies to other
accounting pronouncements that require or permit fair value measurements. In
2008, Eaton adopted the provisions of SFAS No. 157 for financial assets and
liabilities and for non-financial assets recognized or disclosed at fair value
in the financial statements on a recurring basis (at least annually). These
primarily included short and long-term investments, derivative financial
instruments, assets related to defined benefit pension plans, and financial
assets and liabilities related to acquired businesses. The adoption of this
Statement in 2008 had an immaterial effect on Eaton's consolidated financial
position and results of operations. In 2009, Eaton must adopt the provisions of
SFAS No. 157 for other non-financial assets and liabilities, primarily goodwill,
intangible assets, non-financial assets and liabilities related to acquired
businesses, and impairment and restructuring activities. The Company expects
that this Statement will not have a material effect on its consolidated
financial position and results of operations.

ACQUISITIONS OF BUSINESSES

In 2008, 2007, and 2006, Eaton acquired certain businesses and formed a joint
venture in separate transactions for combined net cash purchase prices of $2,807
in 2008, $1,433 in 2007 and $256 in 2006. The Statements of Consolidated Income
include the results of these businesses from the effective dates of acquisition
or formation. A summary of these transactions for 2008 and 2007 follows:

<TABLE>
<CAPTION>
                                                             DATE OF        BUSINESS
ACQUIRED BUSINESS                                          ACQUISITION       SEGMENT         ANNUAL SALES
--------------------------------------------------------   -------------   ----------   ----------------------
<S>                                                        <C>             <C>          <C>
Integ Holding Limited                                        October 2,    Hydraulics        $52 for 2007
     The parent company of Integrated Hydraulics                2008
     Ltd., a U.K.-based manufacturer of screw-in
     cartridge valves, custom-engineered hydraulic
     valves and manifold systems

Nittan Global Tech Co. Ltd.                                 Operational    Automotive          New joint
     A joint venture to manage the global design,            October 1,                         Venture
     manufacture and supply of engine valves and                2008
     valve actuation products to Japanese and
     Korean automobile and engine manufacturers.
     In addition, during the second half of 2008,
     several related manufacturing joint ventures
     were established.
</TABLE>


                                     Page 28

<PAGE>

<TABLE>
<S>                                                        <C>             <C>          <C>
Engine Valves Business of Kirloskar Oil Engines Ltd.       July 31, 2008   Automotive         $5 for 2007
    An India-based designer, manufacturer and
    distributor of intake and exhaust valves for diesel
    and gasoline engines

PK Electronics                                             July 31, 2008   Electrical         $9 for 2007
    A Belgium-based distributor and service provider
    of single phase and three-phase uninterruptible
    power supply (UPS) systems

The Moeller Group                                          April 4, 2008   Electrical       E1.02 billion for
    A Germany-based supplier of electrical                                                       2007
    components for commercial and residential
    building applications and industrial controls for
    industrial equipment applications

Balmen Electronic, S.L.                                      March 31,     Electrical         $6 for 2007
    A Spain-based distributor and service provider            2008
    of uninterruptible power supply (UPS) systems

Phoenixtec Power Company Ltd.                              February 26,    Electrical        $515 for 2007
    A Taiwan-based manufacturer of single and                 2008
    three-phase uninterruptible power supply (UPS)
    systems

Arrow Hose & Tubing Inc.                                    November 8,    Hydraulics        $12 for 2006
    A Canada-based manufacturer of thermoplastic               2007
    hose and tubing for the industrial, food and
    beverage, and agricultural markets

MGE small systems UPS business from                         October 31,    Electrical          $245 for
Schneider Electric                                             2007                              2007
    A France-based global provider of power quality
    solutions including uninterruptible power supply
    (UPS) systems, power distribution units, static
    transfer switches and surge suppressors

Babco Electric Group                                        October 19,    Electrical           $11 for
    A Canada-based manufacturer of specialty low-              2007                              2007
    and medium-voltage switchgear and electrical
    housings for use in the Canadian oil and gas
    industry and other harsh environments

Pulizzi Engineering                                        June 19, 2007   Electrical        $12 for 2006
    A U.S. manufacturer of alternating current (AC)
    power distribution, AC power sequencing,
    redundant power and remote-reboot power
    management systems

Technology and related assets of SMC Electrical             May 18, 2007    Electrical           None
Products, Inc.'s industrial medium-voltage adjustable
frequency drive business

Fuel components division of Saturn Electronics &            May 2, 2007    Automotive        $28 for 2006
Engineering, Inc.
    A U.S. designer and manufacturer of fuel
    containment and shutoff valves, emissions control
    valves and specialty actuators

Aphel Technologies Limited                                 April 5, 2007   Electrical        $12 for 2006
    A U.K.-based global supplier of high density,
    fault-tolerant power distribution solutions for
</TABLE>


                                     Page 29

<PAGE>

<TABLE>
<S>                                                        <C>             <C>          <C>
    datacenters, technical offices, laboratories and
    retail environments

Argo-Tech Corporation                                        March 16,     Aerospace         $206 for 2006
    A U.S.-based manufacturer of high-performance              2007
    aerospace engine fuel pumps and systems,
    airframe fuel pumps and systems, and ground
    fueling systems for commercial and military
    aerospace markets

Power Protection Business of Power Products Ltd.            February 7,    Electrical         $3 for 2006
    A Czech Republic distributor and service provider          2007
    of Powerware(R) products and other uninterruptible
    power supply (UPS) systems
</TABLE>

The allocations of the purchase prices for certain acquisitions in 2008 are not
final, and may be subsequently adjusted based on final purchase price allocation
reports and other information.

As described above, in 2008 Eaton acquired The Moeller Group electrical business
and the Phoenixtec electrical business for combined cash purchase prices of
$2,695. Assets and liabilities for these businesses were recorded at estimated
fair values as determined by Eaton's management based on available information
and on assumptions as to future operations. The Company is in the process of
completing the purchase price allocations, including the finalization of
valuations of certain tangible and intangible assets, and the finalization of
integration and income tax liabilities. The preliminary allocations of the
purchase prices are summarized below:

<TABLE>
<S>                          <C>
Current assets                $  702
Property, plant & equipment      447
Goodwill                       1,624
Other intangible assets        1,073
Other assets                     107
                              ------
Total assets acquired          3,953
Total liabilities assumed      1,258
                              ------
Net assets acquired           $2,695
                              ======
</TABLE>

Other intangible assets of $1,073 include estimates of $640 of customer
relationships having a useful life of 10 to 15 years, $251 related to trademarks
having a useful life of 15 to 20 years, and $182 of technology having a useful
life of 3 to 13 years. Goodwill of $1,232 for Moeller and $392 for Phoenixtec
are non-deductible for income tax purposes.

As described above, in 2007 Eaton acquired the Argo-Tech aerospace business and
the MGE small systems UPS electrical business for combined cash purchase prices
of $1,346. In 2007, the assets and liabilities for these businesses were
recorded at estimated fair values as determined by Eaton's management based on
available information and on assumptions as to future operations. As completed
in 2008, the final allocations of the purchase prices, which did not differ
materially from preliminary estimates, are summarized below:

<TABLE>
<S>                           <C>
Current assets                $  223
Property, plant & equipment       23
Goodwill                         899
Other intangible assets          582
                              ------
Total assets acquired          1,727
Total liabilities assumed        381
                              ------
Net assets acquired           $1,346
                              ======
</TABLE>

Other intangible assets of $582 included $42 related to trademarks not subject
to amortization, $436 of customer relationships having a useful life of 5 to 25
years, and $104 of technology having a useful life of 5 to 25 years. Goodwill of
$420 for Argo-Tech and $479 for the MGE small systems UPS electrical business
are non-deductible for income tax purposes.


                                     Page 30
<PAGE>

PRO FORMA RESULTS OF CONTINUING OPERATIONS

In order to portray the results for Moeller, purchased in April 2008;
Phoenixtec, purchased in February 2008; the MGE small systems UPS business,
purchased in October 2007; and Argo-Tech, purchased in March 2007, as if they
had been acquired and consolidated with Eaton at the beginning of 2007,
unaudited pro forma results for continuing operations are presented below. The
pro forma results include estimates and assumptions, which Eaton's management
believes are reasonable. However, the pro forma results do not include any cost
savings or other effects of the planned integrations of these businesses and,
accordingly, are not necessarily indicative of the results which would have
occurred if the business combinations had been in effect on the dates indicated.
These unaudited pro forma results do not include businesses acquired in 2008 and
2007 that were immaterial.

<TABLE>
<CAPTION>
                                                       2008      2007
                                                     -------   -------
<S>                                                  <C>       <C>
Net sales                                            $15,853   $15,106
Income from continuing operations                      1,070       946
Income from continuing operations per Common Share
   Assuming dilution                                 $  6.59   $  6.29
   Basic                                             $  6.68   $  6.42
</TABLE>

RESTRUCTURING LIABILITIES

Eaton has undertaken restructuring activities at acquired businesses, including
workforce reductions, plant consolidations and facility closures. In accordance
with Emerging Issues Task Force (EITF) Issue No. 95-3, "Recognition of
Liabilities in Connection with a Purchase Business Combination", liabilities for
these restructuring activities were recognized in the allocation of the purchase
price related to the acquired business. A summary of these liabilities, and
utilization of the various components, follows:

<TABLE>
<CAPTION>

                               Workforce reductions    Plant
                               --------------------   closing
                               Employees    Dollars   & other   Total
                               ----------   -------   -------   -----
<S>                            <C>          <C>       <C>       <C>
Balance at January 1, 2006         944       $ 24      $ 37      $ 61
Liabilities recorded               417         17        28        45
Utilized                          (285)        (8)      (43)      (51)
                                 -----       ----      ----      ----
Balance at December 31, 2006     1,076         33        22        55
Liabilities recorded               282          7         2         9
Utilized                          (699)       (13)      (12)      (25)
                                 -----        ---       ---      ----
Balance at December 31, 2007       659         27        12        39
Liabilities recorded                52          3         2         5
Utilized                          (428)       (18)      (13)      (31)
                                 -----       ----      ----      ---
Balance at December 31, 2008       283       $ 12      $  1      $ 13
                                 =====       ====      ====      ====
</TABLE>

ACQUISITION INTEGRATION & PLANT CLOSING CHARGES

ACQUISITION INTEGRATION CHARGES

In 2008, 2007 and 2006, Eaton incurred charges related to the integration of
acquired businesses. These charges which consisted of plant consolidations and
integration, were recorded as expense as incurred. A summary of these charges
follows:

<TABLE>
<CAPTION>
                      2008      2007      2006
                    -------   -------   -------
<S>                 <C>       <C>       <C>
Electrical            $ 47      $ 12      $  7
Hydraulics               6        12        11
Aerospace               20        39        12
Truck                                        5
Automotive               3         1         5
Corporate                1
                      ----      ----      ----
Pretax charges        $ 77      $ 64      $ 40
                      ====      ====      ====
After-tax charges     $ 51      $ 42      $ 27
Per Common Share      $.31      $.28      $.17
</TABLE>


                                    Page 31

<PAGE>

Charges in 2008 were related primarily to the integration of the following
acquisitions: in the Electrical segment, Moeller, Phoenixtec and the MGE small
systems UPS business; in the Hydraulics segment, Ronningen-Petter and Synflex;
in the Aerospace segment, Argo-Tech, PerkinElmer and Cobham; and in the
Automotive segment, Saturn and the engine valve business of Kirloskar Oil
Engines Ltd.

Charges in 2007 were related primarily to the integration of the following
acquisitions: in the Electrical segment, the MGE small systems UPS business,
Schreder-Hazemeyer, Senyuan and Powerware; in the Hydraulics segment, Synflex,
Hayward and Walterscheid; in the Aerospace segment, Argo-Tech, PerkinElmer and
Cobham; and in the Automotive segment, Saturn.

Charges in 2006 were related primarily to the integration of the following
acquisitions: in the Electrical segment, Pringle and Powerware; in the
Hydraulics segment, Synflex, Hayward, Winner and Walterscheid; in the Aerospace
segment, PerkinElmer and Cobham; in the Truck segment, Pigozzi; and in the
Automotive segment, Tractech and Morestana.

PLANT CLOSING CHARGES

On October 20, 2008, Eaton announced the closure of its automotive engine valve
lifters manufacturing plant in Massa, Italy. There were approximately 350
employees affected by the closure decision. The action was taken to better align
manufacturing capacity with future industry demand and to improve the
competitive position of the valve actuation business. Aggregate pretax charges
associated with this closure were $27, which were recognized in the fourth
quarter of 2008, when management approved this action. These costs, which
consisted of charges of $17 for severance, $7 for the write-down of assets and
$3 for other costs, reduced operating profit of the Automotive segment.

In first quarter 2006, Eaton announced, and began to implement, its Excel 07
program. This program was a series of actions concluded in 2006 intended to
address resource levels and operating performance in businesses that
under-performed in 2005, and businesses that were expected to weaken during
second half 2006 and in 2007. As part of this program, charges were incurred
related to plant closings in four business segments in 2006. A summary of
charges incurred by each segment related to these plant closings, including
workforce reductions, plant integration and other charges, follows:

<TABLE>
<CAPTION>
                 2006
                 ----
<S>              <C>
Electrical       $ 12
Hydraulics          7
Truck              29
Automotive         58
                 ----
Pretax charges   $106
                 ====
</TABLE>

SUMMARY OF ACQUISITION INTEGRATION & PLANT CLOSING CHARGES & RELATED LIABILITIES

A summary of acquisition integration charges and plant closing charges and
remaining liabilities follows:

<TABLE>
<CAPTION>

                               Workforce reductions     Plant
                               --------------------    closing
                               Employees    Dollars   & other     Total
                               ---------   --------   ---------   ------
<S>                            <C>         <C>        <C>         <C>
Balance at January 1, 2006         166       $  3       $  1       $   4
Liabilities recorded             2,339         85         61         146
Utilized                          (902)       (39)       (56)        (95)
                                ------       ----       ----       -----
Balance at December 31, 2006     1,603         49          6          55
Liabilities recorded                 4          2         64          66
Utilized                        (1,044)       (37)       (69)       (106)
                                ------       ----       ----       -----
Balance at December 31, 2007       563         14          1          15
Liabilities recorded               422         21         87         108
Utilized                          (451)       (14)       (84)        (98)
                                ------       ----       ----       -----
Balance at December 31, 2008       534       $ 21       $  4       $  25
                                ======       ====       ====       =====
</TABLE>

The acquisition integration and plant closing 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.


                                    Page 32

<PAGE>

SUBSEQUENT EVENT - EMPLOYMENT REDUCTION ACTIONS IN 2009

Eaton took significant employee reduction actions in January 2009 due to the
severe economic downturn. These actions related to approximately 5,200 employees
and will result in a pretax charge of approximately $110 in the first quarter of
2009.

DISCONTINUED OPERATIONS

In the third quarter 2007, Eaton sold the Mirror Controls Division of the
Automotive segment for $111, resulting in a $20 after-tax gain, or $.12 per
Common Share. In the third quarter 2006, certain other businesses of the
Automotive segment were sold for $64, resulting in a $35 after-tax gain, or $.23
per share. The gains on sale of the Mirror Controls Division and the businesses
sold in 2006, and other results of these businesses, are reported as
Discontinued operations in the Statements of Consolidated Income.

SHORT-TERM INVESTMENTS

Eaton invests excess cash generated from operations in short-term marketable
investments and classifies these investments as "available-for-sale" under SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities." In
accordance with SFAS No. 115, available-for-sale investments are recorded at
fair value, with the unrealized gain or loss recorded in Accumulated other
comprehensive income (loss) in Shareholders' equity. A summary of the carrying
value of short-term investments follows:

<TABLE>
<CAPTION>
                                                     2008   2007
                                                     ----   ----
<S>                                                  <C>    <C>
Time deposits & certificate of deposits with banks   $237   $198
Bonds issued by foreign governments                    63    121
Money market investments                               34    174
Other                                                   8     11
                                                     ----   ----
                                                     $342   $504
                                                     ====   ====
</TABLE>

The carrying value of short-term investments approximates the fair value of
these investments.

GOODWILL & OTHER INTANGIBLE ASSETS

A summary of goodwill follows:

<TABLE>
<CAPTION>
              2008     2007
             ------   ------
<S>          <C>      <C>
Electrical   $2,834   $1,570
Hydraulics    1,002      984
Aerospace     1,037    1,069
Truck           143      148
Automotive      216      211
             ------   ------
             $5,232   $3,982
             ======   ======
</TABLE>

The increase in goodwill in 2008 was due to goodwill for businesses acquired
during 2008, partially offset by the final allocation of purchase price for
businesses acquired prior to 2008 and foreign currency translation. These
transactions are described in the "Acquisitions of Businesses" Note above.

A summary of other intangible assets follows:

<TABLE>
<CAPTION>
                                                           2008                       2007
                                                -------------------------   -------------------------
                                                Historical   Accumulated    Historical    Accumulated
                                                   cost      amortization      cost      amortization
                                                ----------   ------------   ----------   ------------
<S>                                             <C>          <C>            <C>          <C>
Intangible assets not subject to amortization
(primarily trademarks)                            $  525                      $  530
                                                  ======                      ======
Intangible assets subject to amortization
   Customer relationships                         $1,327         $144         $  690         $ 73
   Patents                                           443          131            192          102
   Manufacturing technology                          429           50            246           25
   Other                                             190           71            153           54
                                                  ------         ----         ------         ----
                                                  $2,389         $396         $1,281         $254
                                                  ======         ====         ======         ====
</TABLE>


                                    Page 33

<PAGE>

Expense related to intangible assets subject to amortization for 2008 was $161.
Estimated annual pretax expense for intangible assets subject to amortization
for each of the next five years is $161 in 2009, $162 in 2010, $158 in 2011,
$142 in 2012 and $129 in 2013.

DEBT & OTHER FINANCIAL INSTRUMENTS

Short-term debt of $812 at December 31, 2008 included $767 of short-term
commercial paper for operations in the United States which had a
weighted-average interest rate of 2.0%, $7 of other short-term debt in the
United States, and $38 of short-term debt for operations outside the United
States. Borrowings for operations outside the United States were largely
denominated in local currencies. Operations outside the United States have
available short-term lines of credit aggregating $437 from various banks
worldwide.

A summary of long-term debt, including the current portion, follows:

<TABLE>
<CAPTION>
                                                             2008     2007
                                                            ------   ------
<S>                                                         <C>      <C>
E100 million floating rate notes due 2008
   (4.91% at December 31, 2007 - EURIBOR+0.375%)                     $  147
7.40% notes due 2009                                        $   15       15
Floating rate senior notes due 2009
   (2.88% at December 31, 2008 - LIBOR+0.08%)                  250      250
Floating rate senior note due 2010
   (2.44% at December 31, 2008 - LIBOR+0.25%)                  281      281
5.75% notes due 2012                                           300      300
7.58% notes due 2012                                            12       12
4.9% notes due 2013
   ($50 converted to floating rate by interest rate
   swap)                                                       300
5.80% notes due 2013                                             7        7
12.5% British Pound debentures due 2014                          8       12
4.65% notes due 2015
   ($50 converted to floating rate by interest rate
   swap)                                                       100      100
5.3% notes due 2017                                            250      250
7.09% notes due 2018                                            25       25
6.89% notes due 2018                                             6        6
7.07% notes due 2018                                             2        2
6.875% notes due 2018                                            3        3
5.6% notes due 2018
   ($325 converted to floating rate by interest rate swap)     450
4.215% Japan Yen notes due 2018                                110
8-7/8% debentures due 2019
   ($25 converted to floating rate by interest rate
   swap)                                                        38       38
8.10% debentures due 2022                                      100      100
7.625% debentures due 2024
   ($25 converted to floating rate by interest rate
   swap)                                                        66       66
6-1/2% debentures due 2025                                     145      145
7.875% debentures due 2026                                      72       72
7.65% debentures due 2029
   ($50 converted to floating rate by interest rate
   swap)                                                       200      200
5.45% debentures due 2034
   ($25 converted to floating rate by interest rate
   swap)                                                       150      150
5.25% notes due 2035                                            72       72
5.8% notes due 2037                                            240      240
Other                                                          257       99
                                                            ------   ------
Total long-term debt                                         3,459    2,592
Less current portion of long-term debt                        (269)    (160)
                                                            ------   ------
Long-term debt less current portion                         $3,190   $2,432
                                                            ======   ======
</TABLE>

In February 2008, Eaton borrowed $250 under a 364-day $3.0 billion revolving
credit agreement to partially finance the acquisition of Phoenixtec. In April
2008, Eaton borrowed E1.33 billion under the revolving credit agreement to
finance the acquisition of Moeller. In order to refinance this debt, Eaton sold
18.678 million of its Common Shares in a public offering in the second quarter
of 2008, resulting in


                                    Page 34

<PAGE>

net cash proceeds of $1.522 billion. In May 2008, Eaton issued $300 of 4.9%
notes due in 2013 and $450 of 5.6% notes due in 2018. The cash proceeds from the
sale of the Common Shares and from the issuance of the notes were used to repay
borrowings incurred to fund the acquisitions of Moeller and Phoenixtec, and to
repay commercial paper issued under the $3.0 billion revolving credit agreement.
Subsequently, in May 2008 Eaton terminated the $3.0 billion revolving credit
agreement.

In May 2008, Eaton entered into a new $500 revolving credit facility. The
facility replaced the existing $300 facility that expired in May 2008. The
facility increased Eaton's United States long-term revolving credit facilities
with banks to $1.7 billion, of which $700 expire in 2010, $500 in 2011 and $500
in 2013. These revolving credit facilities support Eaton's commercial paper
borrowings. There were no borrowings outstanding under these revolving credit
facilities at December 31, 2008.

The $281 Floating Rate Senior Note due 2010 was issued by a subsidiary of Eaton
in order to refinance short-term borrowings related to the acquisition of
Argo-Tech in 2007. As of December 31, 2008, the Note is no longer secured by the
assets of any subsidiary and the Note does not restrict net assets of any
subsidiary.

Aggregate mandatory annual maturities of long-term debt for each of the next
five years are $269 in 2009, $281 in 2010, $0 in 2011, $312 in 2012 and $307 in
2013. Interest paid was $206 in 2008, $204 in 2007 and $151 in 2006.

Eaton has entered into fixed-to-floating interest rate swaps to manage interest
rate risk. These interest rate swaps are accounted for as fair value hedges of
certain long-term debt. The maturity of the swap corresponds with the maturity
of the debt instrument as noted in the table of long-term debt above. A summary
of interest rate swaps outstanding at December 31, 2008, follows:

<TABLE>
<CAPTION>
                  Interest rates at December 31, 2008
           -------------------------------------------------
             Fixed    Floating
           interest   interest
Notional     rate       rate         Basis for contracted
 Amount    received     paid     floating interest rate paid
--------   --------   --------   ---------------------------
<S>        <C>        <C>        <C>
  $ 50       4.90%      3.32%        6 month LIBOR+0.73%
  $ 50       4.65%      2.48%        6 month LIBOR+0.16%
  $325       5.60%      3.82%        6 month LIBOR+1.22%
  $ 25       8.88%      6.17%        6 month LIBOR+3.84%
  $ 25       7.63%      6.31%        6 month LIBOR+2.48%
  $ 50       7.65%      5.16%        6 month LIBOR+2.57%
  $ 25       5.45%      4.65%        6 month LIBOR+0.28%
</TABLE>

The carrying values of short-term debt on the balance sheet approximated
estimated fair value. Long-term debt and current portion of long-term debt had a
carrying value of $3,459 and fair value of $3,427 at December 31, 2008 compared
to $2,592 and $2,661 at the end of 2007.

RETIREMENT BENEFIT PLANS

ADOPTION OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 158

On December 31, 2006, Eaton adopted SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statements No. 87, 88, 106, and 132(R)." SFAS No. 158 required employers to
recognize on their balance sheets the net amount by which pension and other
postretirement benefit plan liabilities are overfunded or underfunded, with an
offsetting adjustment to Accumulated other comprehensive loss in Shareholders'
equity, net of income tax benefits. As a result of the adoption of SFAS No. 158,
at December 31, 2006, Eaton recorded a non-cash charge in Accumulated other
comprehensive loss in Shareholders' equity of $248 ($163 after-tax) for pension
benefits and $238 ($119 after-tax) for other postretirement benefits as a
one-time adjustment to initially apply the new Statement. Retirement benefit
plan funding requirements are not affected by the recording of these charges.
The adoption of SFAS No. 158 did not change the amounts recognized in the income
statement as net periodic benefit cost.

In 2008, Eaton adopted the measurement date provision of SFAS No.158, which
requires measurement of the funded status of all pension and other
postretirement benefit plans to be as of the date of the year-end financial
statements. Previously, the measurement date for Eaton's pension and other


                                    Page 35

<PAGE>

postretirement benefit plans was November 30. As a result of the change in
measurement dates, in the fourth quarter of 2008, Eaton recorded a charge to
retained earnings of $19 for one month of costs ($11 after-tax) related to
pension benefits and other postretirement benefits with no corresponding
adjustment to net income.

RETIREMENT BENEFIT PLAN LIABILITIES & ASSETS

Eaton has defined benefit pension plans and other postretirement benefit plans.
Components of plan obligations and assets, and recorded liabilities and assets,
follow:

<TABLE>
<CAPTION>
                                                                     Other postretirement
                                              Pension liabilities        liabilities
                                            ----------------------   --------------------
                                                2008      2007         2008       2007
                                            ----------   ---------   -------   ----------
<S>                                         <C>          <C>         <C>       <C>
Changes in benefit obligation
   Benefit obligation at the beginning
      of the year                            $(3,092)     $(3,125)    $(859)     $(854)
   Service cost                                 (137)        (147)      (15)       (15)
   Interest cost                                (190)        (163)      (49)       (47)
   Actuarial gain                                 67          175        58          3
   Benefits paid                                 287          247        87         90
   Prescription drug subsidy received                                    (8)        (7)
   Foreign currency translation                  239          (57)        4         (3)
   Business acquisitions                        (419)         (29)                 (26)
   Other                                         (43)           7         3
                                             -------      -------     ------     -----
Benefit obligation at the end of the year     (3,288)      (3,092)     (779)      (859)
                                             -------      -------     ------     -----
Change in plan assets
   Fair value of plan assets
     at the beginning of the year              2,403        2,173
   Actual return on plan assets                 (641)         194
   Employer contributions                        217          216        87         90
   Benefits paid                                (287)        (247)      (87)       (90)
   Foreign currency translation                 (214)          33
   Business acquisitions                         171           26
   Other                                          25            8
                                             -------      -------     ------     -----
Fair value of plan assets at the end of
   the year                                    1,674        2,403
                                             -------      -------     ------     -----
Funded status                                 (1,614)        (689)     (779)      (859)
Contributions after measurement date                            7                    5
                                             -------      -------     ------     -----
Amount recognized in the Consolidated
Balance Sheet                                $(1,614)     $  (682)    $(779)     $(854)
                                             =======      =======     ======     =====
</TABLE>

Amounts recognized in the Consolidated Balance Sheet follow:

<TABLE>
<CAPTION>
                                                                     Other postretirement
                                              Pension liabilities        liabilities
                                            ----------------------   -------   ----------
                                              2008          2007       2008       2007
                                            ----------   ---------   -------   ----------
<S>                                         <C>          <C>         <C>       <C>
Non-current assets                           $    67       $  10
Current liabilities                              (31)        (11)     $ (76)      $ (82)
Non-current liabilities                       (1,650)       (681)      (703)       (772)
                                             -------       -----      -----       -----
Amount recognized in the Consolidated
Balance Sheet                                $(1,614)      $(682)     $(779)      $(854)
                                             =======       =====      =====       =====
</TABLE>


                                    Page 36

<PAGE>

Amounts recognized in Accumulated other comprehensive loss follow:

<TABLE>
<CAPTION>
                                                                     Other postretirement
                                              Pension liabilities        liabilities
                                            ----------------------   -------   ----------
                                              2008          2007       2008       2007
                                            ----------   ---------   -------   ----------
<S>                                         <C>          <C>         <C>       <C>
Net actuarial loss                            $1,410        $764       $159       $232
Prior service cost (credit)                        3           3        (13)        (6)
                                              ------        ----       ----       ----
                                              $1,413        $767       $146       $226
                                              ======        ====       ====       ====
</TABLE>

Changes in pension plan assets and benefit liabilities recognized in Accumulated
other comprehensive loss in Shareholders' equity follow:

<TABLE>
<CAPTION>
                                                         2008     2007
                                                        ------   ------
<S>                                                     <C>      <C>
Accumulated other comprehensive loss at the beginning
of the year                                             $  767   $1,074
   Prior service cost arising during the year                4      (15)
   Net loss (gain) arising during the year                 772     (190)
   Foreign currency translation                            (44)      13
   Less amounts included in costs during the year          (83)    (115)
   Other                                                    (3)
                                                        ------   ------
Net change for the year                                    646     (307)
                                                        ------   ------
Accumulated other comprehensive loss at the end of
   the year                                             $1,413   $  767
                                                        ======   ======
</TABLE>

Changes in other postretirement benefit liabilities recognized in Accumulated
other comprehensive loss in Shareholders' equity follow:

<TABLE>
<CAPTION>
                                                         2008     2007
                                                        ------   ------
<S>                                                     <C>      <C>
Accumulated other comprehensive loss at the beginning
of the year                                              $226     $238
   Prior service cost arising during the year              (8)
   Net (gain) arising during the year                     (58)      (3)
   Foreign currency translation                            (3)       2
   Less amounts included in costs during the year         (11)     (11)
                                                         ----     ----
Net change for the year                                   (80)     (12)
                                                         ----     ----
Accumulated other comprehensive loss at the end of
   the year                                              $146     $226
                                                         ====     ====
</TABLE>

PENSION PLANS

Assumptions used to determine pension benefit obligations and costs follow:

<TABLE>
<CAPTION>
                                                     United States &
                                                    Non-United States
                                 United States      plans (weighted-
                                     plans              average)
                              ------------------   ------------------
                              2008   2007   2006   2008   2007   2006
                              ----   ----   ----   ----   ----   ----
<S>                           <C>    <C>    <C>    <C>    <C>    <C>
Assumptions used to
determine benefit
obligation at year-end
   Discount rate              6.30%  6.00%  5.60%  6.29%  5.96%  5.39%
   Rate of compensation
      increase                3.50%  3.50%  3.50%  3.61%  3.68%  3.67%
Assumptions used to
determine cost
   Discount rate              6.00%  5.60%  5.75%  5.96%  5.39%  5.51%
   Expected long-term
      return on plan assets   8.95%  8.75%  8.75%  8.44%  8.31%  8.35%
   Rate of compensation
      increase                3.50%  3.50%  3.50%  3.68%  3.67%  3.67%
</TABLE>


                                    Page 37

<PAGE>

The expected long-term rate of return on pension assets was determined
separately for each country and reflects long-term historical data taking into
account each plan's target asset allocation.

The components of pension benefit cost for continuing operations recorded in the
Statements of Consolidated Income follow:

<TABLE>
<CAPTION>
                                     2008     2007    2006
                                    ------   -----   -----
<S>                                 <C>      <C>     <C>
Service cost                        $(137)   $(147)  $(142)
Interest cost                        (190)    (163)   (147)
Expected return on plan assets        198      179     166
Amortization                          (49)     (74)    (67)
                                    -----    -----   -----
                                     (178)    (205)   (190)
Curtailment loss                       (1)      (1)    (10)
Settlement loss                       (35)     (41)    (41)
                                    -----    -----   -----
Costs recorded in the Statements
   of Consolidated Income           $(214)   $(247)  $(241)
                                    =====    =====   =====
</TABLE>

The estimated net loss and prior service cost for the defined benefit pension
plans that will be recognized from Accumulated other comprehensive loss into net
periodic benefit cost in 2009 are $90 and $1, respectively.

The total accumulated benefit obligation for all pension plans at December 31,
2008 was $3,083 and at December 31, 2007 was $2,874. The components of pension
plans with an accumulated benefit obligation in excess of plan assets at
December 31 follow:

<TABLE>
<CAPTION>
                                     2008     2007
                                    ------   ------
<S>                                 <C>      <C>
Projected benefit obligation        $2,819   $2,309
Accumulated benefit obligation       2,663    2,182
Fair value of plan assets            1,168    1,642
</TABLE>

United States pension plans represent 65% and 68% of benefit obligations at
December 31, 2008 and 2007, respectively.

The weighted-average pension plan asset allocations by asset category at
December 31, 2008 and 2007 are as follows:

<TABLE>
<CAPTION>
                                     2008     2007
                                    ------   ------
<S>                                 <C>      <C>
Equity securities                      70%      80%
Debt securities                        24%      18%
Other                                   6%       2%
                                      ---      ---
                                      100%     100%
                                      ===      ===
</TABLE>

Investment policies and strategies are developed on a country specific basis.
The United States plan represents 59% of worldwide pension assets and its target
allocation is 85% equity securities and 15% debt securities and other, including
cash equivalents. The United Kingdom plan represents 33% of worldwide pension
assets and its target allocation is up to 64% equity securities with the
remainder in debt securities.

Contributions to pension plans that Eaton expects to make in 2009, and made in
2008, 2007 and 2006, follow:

<TABLE>
<CAPTION>
                                    2009   2008   2007   2006
                                    ----   ----   ----   ----
<S>                                 <C>    <C>    <C>    <C>
United States                       $190   $115   $150   $100
Other                                 81     95     70     62
                                    ----   ----   ----   ----
                                    $271   $210   $220   $162
                                    ====   ====   ====   ====
</TABLE>

At December 31, 2008, expected pension benefit payments for each of the next
five years and the five years thereafter in the aggregate are, $230 in 2009,
$237 in 2010, $251 in 2011, $266 in 2012, $277 in 2013 and $1,608 in 2014-2018.


                                    Page 38

<PAGE>

The Company also has various defined-contribution benefit plans, primarily
consisting of the Eaton Savings Plan in the United States. Total contributions
related to these plans are charged to expense and were $64 in 2008, $59 in 2007,
and $55 in 2006.

OTHER POSTRETIREMENT BENEFIT PLANS

Assumptions used to determine other postretirement benefit obligations and cost
follow:

<TABLE>
<CAPTION>
                                                            2008   2007   2006
                                                            ----   ----   ----
<S>                                                         <C>    <C>    <C>
Assumptions used to determine benefit obligation
at year-end
   Discount rate                                            6.30%  6.00%  5.60%
   Health care cost trend rate assumed for next year        8.25%  8.30%  8.80%
   Ultimate health care cost trend rate                     4.75%  4.75%  4.75%
   Year ultimate health care cost trend rate is achieved    2017   2015   2014

Assumptions used to determine cost
   Discount rate                                            6.00%  5.60%  5.75%
   Initial health care cost trend rate                      8.30%  8.80%  9.60%
   Ultimate health care cost trend rate                     4.75%  4.75%  4.75%
   Year ultimate health care cost trend rate is achieved    2015   2014   2014
</TABLE>

The components of other postretirement benefits cost for continuing operations
recorded in the Statements of Consolidated Income follow:

<TABLE>
<CAPTION>
                                                            2008   2007   2006
                                                            ----   ----   ----
<S>                                                         <C>    <C>    <C>
Service cost                                                $(15)  $(15)  $(17)
Interest cost                                                (49)   (47)   (45)
Amortization                                                 (11)   (11)   (11)
                                                            ----   ----   ----
                                                             (75)   (73)   (73)
Curtailment loss                                                            (2)
                                                            ----   ----   ----
Costs recorded in the Statements of Consolidated
Income                                                      $(75)  $(73)  $(75)
                                                            ====   ====   ====
</TABLE>

Estimated net loss and prior service cost (credit) for other postretirement
benefit plans that will be recognized from Accumulated other comprehensive loss
into net periodic benefit cost in 2009 are $6 and $(2), respectively.

Assumed health care cost trend rates may have a significant effect on the
amounts reported for the health care plans. A 1-percentage point change in the
assumed health care cost trend rates would have the following effects:

<TABLE>
<CAPTION>
                                  1% Increase   1% Decrease
                                  -----------   -----------
<S>                               <C>           <C>
Effect on total service and
   interest cost                      $ 2          $ (2)
Effect on other postretirement
   liabilities                         21           (20)
</TABLE>

At December 31, 2008, expected other postretirement benefit payments for each of
the next five years and the five years thereafter in the aggregate are $87 in
2009, $86 in 2010, $91 in 2011, $88 in 2012, $86 in 2013 and $364 in 2014-2018.
The expected subsidy receipts related to the Medicare Prescription Drug,
Improvement, and Modernization Act of 2003, which would reduce the other
postretirement benefit payments listed above for each of the next five years and
the five years thereafter in the aggregate are, $9 in 2009, 2010 and 2011, $10
in 2012 and 2013, and $50 in 2014-2018.

PROTECTION OF THE ENVIRONMENT

Eaton has established policies to ensure that its operations are conducted in
keeping with good corporate citizenship and with a positive commitment to the
protection of the natural and workplace environments. For example, each
manufacturing facility has a person responsible for environmental, health and
safety (EHS) matters. All of the Company's manufacturing facilities are required
to be


                                    Page 39

<PAGE>

certified to ISO 14001, an international standard for environmental management
systems. The Company routinely reviews EHS performance at each of its facilities
and continuously strives to improve pollution prevention at its facilities.

As a result of past operations, Eaton is involved in remedial response and
voluntary environmental remediation at a number of sites, including certain of
its currently-owned or formerly-owned plants. The Company has also been named a
potentially responsible party (PRP) under the Federal Superfund law at a number
of waste disposal sites.

A number of factors affect the cost of environmental remediation, including the
number of parties involved at a particular site, the determination of the extent
of contamination, the length of time the remediation may require, the complexity
of environmental regulations, and the continuing advancement of remediation
technology. Taking these factors into account, Eaton has estimated the costs of
remediation, which will be incurred over a period of several years. The Company
accrues an amount on an undiscounted basis, consistent with the estimates of
these costs when it is probable that a liability has been incurred. The
Consolidated Balance Sheet included a liability for these costs of $85 at
December 31, 2008 and $64 at December 31, 2007.

Based upon Eaton's analysis and subject to the difficulty in estimating these
future costs, the Company expects that any sum it may be required to pay in
connection with environmental matters is not reasonably likely to exceed the
liability by an amount that would have a material adverse effect on its
financial position, results of operations or cash flows. All of these estimates
are forward-looking statements and, given the inherent uncertainties in
evaluating environmental exposures, actual results can differ from these
estimates.

CONTINGENCIES

Eaton is subject to a broad range of claims, administrative proceedings,
and legal proceedings, such as lawsuits that relate to contractual
allegations, patent infringement, personal injuries (including asbes-
tos claims) and employment-related matters. Although it is not pos-
sible to predict with certainty the outcome or cost of these matters,
the Company believes that these matters will not have a material ad-
verse effect on its financial position, results of operations or cash flows.

SHAREHOLDERS' EQUITY

There are 500 million Common Shares authorized ($.50 par value per share), 165.0
million of which were issued and outstanding at year-end 2008. At December 31,
2008, there were 8,548 holders of record of Common Shares. Additionally, 19,987
current and former employees were shareholders through participation in the
Eaton Savings Plan (ESP), Eaton Personal Investment Plan (EPIP) and Eaton
Electrical de Puerto Rico Inc. Retirement Savings Plan.

In the second quarter of 2008, Eaton sold 18.678 million of its Common Shares in
a public offering, resulting in net cash proceeds of $1.522 billion. The cash
proceeds from the sale of the Common Shares were used to repay borrowings
incurred to fund the acquisitions of Moeller and Phoenixtec, and to repay
commercial paper issued under the backstop provided by a $3.0 billion revolving
credit agreement that Eaton terminated in May 2008.

On January 22, 2007, Eaton announced that it had authorized a new 10 million
Common Shares repurchase program. The shares are expected to be repurchased over
time, depending on market conditions, the market price of the Company's Common
Shares, the Company's capital levels and other considerations. The number of
Common Shares repurchased in the open market and total cost, follows:

<TABLE>
<CAPTION>
                                    Shares
(Shares in millions)              repurchased      Cost
------------------------------    -----------   -----------
<S>                               <C>           <C>
2008                                 1.420          $100
2007                                 4.092           340
2006                                 5.286           386
</TABLE>

The number of stock options exercised and the resulting cash proceeds follows:


                                    Page 40
<PAGE>

<TABLE>
<CAPTION>
                       Stock options     Cash
(Shares in millions)     exercised     proceeds
--------------------   -------------   --------
<S>                    <C>             <C>
2008                       1.240         $ 47
2007                       3.713          141
2006                       3.083          108
</TABLE>

Eaton has plans that permit certain employees and directors to defer a portion
of their compensation. The Company has deposited $24 of Common Shares and
marketable securities into a trust at December 31, 2008 to fund a portion of
these liabilities. The marketable securities were included in Other assets and
the Common Shares were included in Shareholders' equity at historical cost.

STOCK OPTIONS

Under various plans, stock options have been granted to certain employees and
directors to purchase Common Shares at prices equal to fair market value on the
date of grant. Substantially all of these options vest ratably during the
three-year period following the date of grant and expire 10 years from the date
of grant. Beginning in 2006, in accordance with SFAS No. 123(R), "Share-Based
Payment", compensation expense is recorded for stock options and includes
expense for all options granted prior to but not yet vested as of the end of
2005, and expense for options granted beginning in 2006, based on the fair value
of the options at the date of grant. Expense is recognized on a straight-line
basis over the period the employee or director is required to provide service in
exchange for the award.

The fair value of stock options granted was estimated using the Black-Scholes
option pricing model. A summary of the assumptions used in determining the fair
value of options follows:

<TABLE>
<CAPTION>
                                           2008          2007          2006
                                       -----------   -----------   -----------
<S>                                    <C>           <C>           <C>
Expected volatility                      27% to 22%           22%           25%
Expected option life in years                  5.5             5             5
Expected dividend yield                        2.0%          2.0%          2.0%
Risk-free interest rate                3.6% to 1.7%  4.0% to 4.9%  4.3% to 5.0%
Weighted-average fair value of stock
options granted                             $16.59        $17.79        $16.80
</TABLE>

Application of the Black-Scholes option pricing model involves assumptions that
are judgmental and affect compensation expense. Historical information was the
primary basis for the selection of expected volatility, expected option life,
and expected dividend yield. Expected volatility was based on the most recent
historical period equal to the expected life of the option. The risk-free
interest rate was based on yields of U.S. Treasury zero-coupon issues with a
term equal to the expected life of the option, on the date the stock options
were granted.

A summary of stock option activity for 2008 follows:

<TABLE>
<CAPTION>
                                                           Weighted-
                                   Weighted-                average
                                    average                remaining     Aggregate
                                   price per              contractual    intrinsic
(Shares in millions)                option     Options   life in years     value
--------------------               ---------   -------   -------------   ---------
<S>                                <C>         <C>       <C>             <C>
Outstanding at January 1, 2008       $56.83     11.2
Granted                               82.75      1.9
Exercised                             39.68     (1.2)
Canceled                              78.79     (0.3)
                                                ----
Outstanding at December 31, 2008     $62.61     11.6          6.0           $45
                                                ====

Exercisable at December 31, 2008     $54.43      7.9          4.9           $45
Reserved for future grants at
    December 31, 2008                            2.6
</TABLE>

The aggregate intrinsic value in the table above represents the total pretax
difference between the $49.71 closing price of Eaton Common Shares on the last
trading day of 2008 over the exercise price of the stock option, multiplied by
the related number of options outstanding and exercisable. Under SFAS No.
123(R), the aggregate intrinsic value is not recorded for financial accounting
purposes and the value changes based on the daily changes in the fair market
value of the Company's Common Shares.


                                    Page 41

<PAGE>

Information related to stock options follows:

<TABLE>
<CAPTION>
                                                                 2008   2007   2006
                                                                 ----   ----   ----
<S>                                                              <C>    <C>    <C>
Pretax expense for stock options                                  $29   $ 30   $ 27
After-tax expense for stock options                                20     21     20
Proceeds from stock options exercised                              47    141    108
Income tax benefits related to stock options exercised
   Reported in operating activities in statement of cash flows      4     11      8
   Reported in financing activities in statement of cash flows     13     42     28
Intrinsic value of stock options exercised                         52    163    102
Total fair value of stock options vesting                          31     31     29
</TABLE>

As of December 31, 2008, the total compensation expense not yet recognized
related to nonvested stock options was $39, and the weighted-average period in
which the expense is expected to be recognized is 1.5 years.

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The components of Accumulated other comprehensive income (loss) as reported in
the Consolidated Balance Sheet follow:

<TABLE>
<CAPTION>
                                                                  2008     2007
                                                                -------   -----
<S>                                                             <C>       <C>
Foreign currency translation and related hedging instruments
   (net of income tax benefits of $77 in 2008 and $8 in 2007)   $  (532)  $ 190
Deferred loss on cash flow hedges (net of income tax
   benefits of $16 in 2008 and $4 in 2007)                          (29)     (6)
Pensions (net of income tax benefits of $501 in 2008
   and $274 in 2007)                                               (912)   (493)
Other postretirement benefits (net of income tax benefits of
   $81 in 2008 and $112 in 2007)                                    (65)   (114)
                                                                -------   -----
Accumulated other comprehensive loss at the end of the year     $(1,538)  $(423)
                                                                =======   =====
</TABLE>

A discussion of the adjustments related to pensions and other postretirement
benefit liabilities is included in the "Retirement Benefit Plans" Note above.

INCOME TAXES

Income from continuing operations before income taxes is summarized below based
on the geographic location of the operation to which such earnings are
attributable. Certain foreign operations are branches of Eaton and are,
therefore, subject to United States as well as foreign income tax regulations.
As a result, pretax income by location and the components of income tax expense
by taxing jurisdiction are not directly related. For purposes of this note to
the consolidated financial statements, non-United States operations include
Puerto Rico.

<TABLE>
<CAPTION>
                        Income from continuing
                    operations before income taxes
                    ------------------------------
                         2008     2007    2006
                        ------   ------   ----
<S>                 <C>          <C>      <C>
United States           $  118   $   52   $150
Non-United States        1,010      989    819
                        ------   ------   ----
                        $1,128   $1,041   $969
                        ======   ======   ====
</TABLE>


                                    Page 42

<PAGE>
<TABLE>
<CAPTION>
                                  Income tax expense for
                                   continuing operations
                                  ----------------------
                                    2008   2007   2006
                                   -----   ----   ----
<S>                               <C>      <C>    <C>
Current
   United States
      Federal                      $  36   $  7   $ 13
      State & local                    4      9     (9)
   Non-United States                 219    140      9
                                   -----   ----   ----
                                     259    156     13
                                   -----   ----   ----
Deferred
   United States
      Federal                        (17)   (15)    25
      State & local                  (29)   (20)    24
      Change in state and local
         valuation allowance         (13)
   Non-United States
      Local expense                  (96)   (39)    10
      Change in valuation
         allowance                   (31)
                                   -----   ----   ----
                                    (186)   (74)    59
                                   -----   ----   ----
                                   $  73   $ 82   $ 72
                                   =====   ====   ====
</TABLE>

Reconciliations of income taxes from the United States Federal statutory rate to
the effective income tax rate for continuing operations follow:
<TABLE>
<CAPTION>
                                                    2008    2007    2006
                                                   -----   -----   -----
<S>                                                <C>     <C>     <C>
Income taxes at the United States statutory rate    35.0%   35.0%   35.0%
United States state & local income taxes             0.3%    0.2%    1.6%
Other United States-net                             (0.4)%  (1.5)%  (1.0)%
Non-United States operations (earnings taxed
   at other than United States tax rate)           (18.9)% (20.3)% (18.9)%
Adjustments to worldwide tax liabilities and
   valuation allowances                             (9.6)%  (5.5)%  (9.3)%
                                                   -----   -----   -----
                                                     6.4%    7.9%    7.4%
                                                   =====   =====   =====
</TABLE>

In 2008, 2007 and 2006, Eaton recognized income tax benefits of $108, $57 and
$90, respectively, which represented adjustments to worldwide tax liabilities
and valuation allowances. The 2008 income tax benefits reduced the effective
income tax rate for 2008 from 16.0% to 6.4%. The 2008 benefits resulted from
multiple income tax items including a benefit of $44 related to the
consolidation of various legal entities and the recognition of $25 of tax
credits related to the transfer of operations from Massa, Italy. The 2007 income
tax benefits reduced the effective income tax rate for 2007 from 13.4% to 7.9%.
The 2007 income tax benefits resulted from multiple income tax items. Included
in the tax benefits were a $14 benefit from changes to state tax laws and a
favorable revaluation of worldwide deferred tax assets. The income tax benefits
for 2006 reduced the effective income tax rate for 2006 from 16.7% to 7.4%.

Significant components of current and long-term deferred income taxes follow:
<TABLE>
<CAPTION>
                                                2008                    2007
                                       ---------------------   ---------------------
                                                  Long-term               Long-term
                                       Current     assets &    Current     assets &
                                        assets   liabilities    assets   liabilities
                                       -------   -----------   -------   -----------
<S>                                    <C>       <C>           <C>       <C>
Accruals & other adjustments
   Employee benefits                    $  57       $ 821       $  85        $588
   Depreciation & amortization             (3)       (692)                   (461)
   Other accruals & adjustments           185         100         224         100
Other items                                            (5)                    (10)
United States Federal income tax
   credit carryforwards                               122                      75
United States state & local tax loss
   carryforwards and tax credit
   carryforwards                                      104                      96
Non-United States tax loss
   carryforwards                                      206                      82
Non-United States income tax
   credit carryforwards                                52                      55
Valuation allowance                                  (280)        (18)       (251)
                                        -----       -----       -----        ----
                                        $ 239       $ 428       $ 291        $274
                                        =====       =====       =====        ====
</TABLE>

At the end of 2008, United States Federal income tax credit carryforwards of
$122 were available to reduce future Federal income tax liabilities. These
credits include $2 that expire in 2017, $17 that expire

                                    Page 43
<PAGE>

in 2018, $51 that expire in 2025 through 2028, and $52 of which are not subject
to expiration. A valuation allowance of $10 has been recorded for these income
tax credit carryforwards. United States state and local tax loss carryforwards
with a future tax benefit of $60 are also available at the end of 2008. Their
expiration dates are $11 in 2009 through 2013, $9 in 2014 through 2018, $20 in
2019 through 2023, and $20 in 2024 through 2028. A valuation allowance of $45
has been recorded for these tax loss carryforwards. There are also United States
state and local tax credit carryforwards with a future tax benefit of $44
available at the end of 2008. Their expiration dates are $10 in 2009 through
2013, $17 in 2014 through 2018, $8 in 2019 through 2023, and $9 in 2024 through
2028. A valuation allowance of $31 has been recorded for these tax credit
carryforwards.

At December 31, 2008, certain non-United States subsidiaries had tax loss
carryforwards aggregating $740 that are available to offset future taxable
income. Carryforwards of $203 expire at various dates from 2009 through 2028 and
the balance has no expiration date. A deferred tax asset of $206 has been
recorded for these tax loss carryforwards and a valuation allowance of $171 has
also been recorded for these tax loss carryforwards. Tax credits at non-United
States subsidiaries of $52 were available to reduce future income tax
liabilities. These credits include $3 that will expire in 2015, $41 that will
expire in 2016, and $8 that are not subject to limitation. A valuation allowance
of $23 has been recorded for these income tax credits.

With limited exceptions, no provision has been made for income taxes on
undistributed earnings of non-United States subsidiaries of $4,311 at December
31, 2008, since it is the Company's intention to indefinitely reinvest
undistributed earnings of its foreign subsidiaries. It is not practicable to
estimate the additional income taxes and applicable foreign withholding taxes
that would be payable on the remittance of such undistributed earnings.

Worldwide income tax payments were $185 in 2008, $141 in 2007 and $129 in 2006.

UNRECOGNIZED INCOME TAX BENEFITS

Effective January 1, 2007, Eaton adopted FASB Interpretation (FIN) No. 48,
"Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 109." FIN No. 48 clarifies the accounting for uncertainty in
income taxes by establishing minimum standards for the recognition and
measurement of income tax positions taken, or expected to be taken, in an income
tax return. FIN No. 48 also changes the disclosure standards for income taxes.
Eaton's historical policy has been to enter into tax planning strategies only if
it is more likely than not that the benefit would be sustained upon audit. For
example, the Company does not enter into any of the Internal Revenue Service
(IRS) Listed Transactions as set forth in Treasury Regulation 1.6011-4. The net
income tax assets recognized under FIN No. 48 at January 1, 2007 did not differ
from the net assets recognized before adoption, and, therefore, the Company did
not record a cumulative-effect adjustment related to the adoption of FIN No. 48.

A summary of gross unrecognized income tax assets follows:

<TABLE>
<CAPTION>
                                                                             2008   2007
                                                                             ----   ----
<S>                                                                          <C>    <C>
Unrecognized income tax assets at the beginning of the year                  $ 96   $ 93
Increases and decreases as a result of positions taken during prior years:
   Transfers from (to) valuation allowances                                    (2)    10
   Other increases                                                             11      4
   Other decreases, including foreign currency translation                    (18)   (26)
Balances related to acquired businesses                                        30
Increases as a result of positions taken during the current year               35     33
Decreases relating to settlements with tax authorities                               (18)
Decreases as a result of a lapse of the applicable statute of limitations     (13)
                                                                             ----   ----
Unrecognized income tax assets at the end of the year                        $139   $ 96
                                                                             ====   ====
</TABLE>

If all of the gross unrecognized tax assets were recorded, the net impact on the
effective income tax rate would be $118.

The Company recognizes interest and penalties related to unrecognized income tax
assets in the provision for income tax expense. The Company has accrued
penalties in jurisdictions where they are automatically applied to any
deficiency, regardless of the merit of the position. As of the adoption of FIN
No. 48, the Company had accrued approximately $23 for the payment of interest
and penalties and at


                                    Page 44

<PAGE>

year end 2007, $20 was accrued. As of December 31, 2008, the Company had accrued
approximately $38 for the payment of worldwide interest and penalties.

The resolution of the majority of the Company's unrecognized income tax assets
is dependent on uncontrollable factors such as law changes; new case law; the
willingness of the income tax authority to settle the issue, including the
timing thereof; and other factors. Therefore, for the majority of unrecognized
income tax assets, it is not reasonably possible to estimate the increase or
decrease in the next 12 months. For each of the unrecognized income tax assets
where it is possible to estimate the increase or decrease in the balance within
the next 12 months, the Company does not anticipate any significant change.

The Company or its subsidiaries file income tax returns in the United States and
foreign jurisdictions. The U.S. Internal Revenue Service (IRS) is currently in
the process of conducting an examination of the Company's U.S. income tax
returns for 2005 and 2006. The Company is also under examination for the income
tax filings in various state and foreign jurisdictions. With only a few
exceptions, the Company is no longer subject to state and local income tax
examinations for years before 2005, or foreign examinations for years before
2003. The Company does not anticipate any adjustments that would result in a
material change in financial position.

OTHER INFORMATION

ACCOUNTS RECEIVABLE

Accounts receivable were net of an allowance for doubtful accounts of $38 at
December 31, 2008 and $23 at December 31, 2007.

INVENTORIES

The components of inventories follow:

<TABLE>
<CAPTION>
                                 2008     2007
                                ------   ------
<S>                             <C>      <C>
Raw materials                   $  683   $  674
Work-in-process                    285      384
Finished goods                     702      533
                                ------   ------
Inventories at FIFO              1,670    1,591
Excess of FIFO over LIFO cost     (116)    (108)
                                ------   ------
                                $1,554   $1,483
                                ======   ======
</TABLE>

Inventories at FIFO accounted for using the LIFO method were 43% and 42% at the
end of 2008 and 2007, respectively.

WARRANTY LIABILITIES

A summary of the current and long-term liabilities for warranties follows:

<TABLE>
<CAPTION>
                                        2008   2007   2006
                                       -----   ----   ----
<S>                                    <C>     <C>    <C>
Balance at the beginning of the year   $ 167   $176   $157
Current year provision                    95     57     91
Business acquisitions                     13      7      1
Claims paid/satisfied                   (108)   (73)   (83)
Other                                     (2)           10
                                       -----   ----   ----
Balance at the end of the year         $ 165   $167   $176
                                       =====   ====   ====
</TABLE>

LEASE COMMITMENTS

Eaton leases certain real properties and equipment. Minimum rental commitments
at December 31, 2008 under noncancelable operating leases, which expire at
various dates and in most cases contain renewal options, for each of the next
five years and thereafter in the aggregate were, $117 in 2009, $97 in 2010, $73
in 2011, $50 in 2012, $36 in 2013 and $54 thereafter.

Rental expense of continuing operations was $173 in 2008, $133 in 2007, and $123
in 2006.


                                    Page 45

<PAGE>

NET INCOME PER COMMON SHARE

A summary of the calculation of net income per Common Share assuming dilution
and basic follows:

<TABLE>
<CAPTION>
(Shares in millions)                             2008     2007     2006
--------------------                            ------   ------   ------
<S>                                             <C>      <C>      <C>
Income from continuing operations               $1,055   $  959   $  897
Income from discontinued operations                  3       35       53
                                                ------   ------   ------
Net income                                      $1,058   $  994   $  950
                                                ======   ======   ======
Average number of Common Shares
   outstanding assuming dilution                 162.3    150.3    152.9
Less dilutive effect of stock options              2.1      3.0      2.7
                                                ------   ------   ------
Average number of Common Shares
   outstanding basic                             160.2    147.3    150.2
                                                ======   ======   ======
Net income per Common Share assuming dilution
   Continuing operations                        $ 6.50   $ 6.38   $ 5.87
   Discontinued operations                         .02      .24      .35
                                                ------   ------   ------
                                                $ 6.52   $ 6.62   $ 6.22
                                                ======   ======   ======
Net income per Common Share basic
   Continuing operations                        $ 6.58   $ 6.51   $ 5.97
   Discontinued operations                         .02      .24      .35
                                                ------   ------   ------
                                                $ 6.60   $ 6.75   $ 6.32
                                                ======   ======   ======
</TABLE>

FINANCIAL ASSETS & LIABILITIES MEASURED AT FAIR VALUE

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." This
Statement defines fair value for financial and non-financial assets and
liabilities, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. The guidance applies to other
accounting pronouncements that require or permit fair value measurements. In
2008, Eaton adopted the provisions of SFAS No. 157 for financial assets and
liabilities and for non-financial assets recognized or disclosed at fair value
in the financial statements on a recurring basis (at least annually). These
primarily included short and long-term investments, derivative financial
instruments, assets related to defined benefit pension plans, and financial
assets and liabilities related to acquired businesses. The adoption of this
Statement in 2008 had an immaterial effect on Eaton's consolidated financial
position and results of operations. A summary of financial assets and
liabilities that were measured at fair value at December 31, 2008, follows:

<TABLE>
<CAPTION>
                                                               Fair value measurement used
                                                      --------------------------------------------
                                                      Quoted prices   Quoted prices
                                                        in active       in active
                                                       markets for     markets for        Other
                                                        identical        similar      unobservable
                                           Recorded    instruments     instruments       inputs
                                             value     (Level 1)        (Level 2)       (Level 3)
                                           --------   -------------   -------------   ------------
<S>                                        <C>        <C>             <C>             <C>
Cash                                        $ 188          $188
Short-term investments                        342           342
Foreign currency forward exchange
   contracts                                   10                         $ 10
Commodity contracts                           (25)                         (25)
Fixed-to-floating interest rate swaps          93                           93
Long-term debt converted to floating
   interest rates by interest rate swaps      (93)                         (93)
                                            -----          ----           ----            ----
                                            $ 515          $530           $(15)           $
                                            =====          ====           ====            ====
</TABLE>

Assets of $1,674 related to defined benefit pension plans were also measured at
fair value at December 31, 2008.

The estimated fair values of financial instruments were principally based on
market prices where such prices were available and, where unavailable, fair
values were estimated based on market prices of


                                    Page 46

<PAGE>

similar instruments, including consideration of the creditworthiness of the
counterparties related to the instruments.

In 2009, Eaton must adopt the provisions of SFAS No. 157 for other non-financial
assets and liabilities, primarily goodwill, intangible assets, non-financial
assets and liabilities related to acquired businesses, and impairment and
restructuring activities. The Company expects that this Statement will not have
a material effect on its consolidated financial position or results of
operations in 2009.

BUSINESS SEGMENT & GEOGRAPHIC REGION INFORMATION

Eaton Corporation is a diversified power management company with 2008 sales of
$15.4 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 75,000 employees and sells products to customers
in more than 150 countries.

In the first quarter of 2008, Eaton realigned its business segment financial
reporting structure. The Fluid Power segment was realigned into the Hydraulics
segment and the Aerospace segment. The Electrical and Truck segments continued
as individual reporting segments and the automotive fluid connectors business
was transferred to the Automotive segment from Fluid Power. Accordingly,
business segment information for prior years has been restated to conform to the
current year's presentation. The realignment of the business segments did not
affect net income for any of the periods presented.

ELECTRICAL

The Electrical segment is a global leader in electrical control, power
distribution, uninterruptible power supply (UPS) systems and industrial
automation products and services. Products include circuit breakers, switchgear,
UPS systems, power distribution units, panelboards, loadcenters, motor controls,
meters, sensors and relays. The principal markets for the Electrical segment are
industrial, institutional, government, utility, commercial, residential, IT,
mission critical and original equipment manufacturer customers. These products
are used wherever there is a demand for electrical power in commercial
buildings, data centers, residences, apartment and office buildings, hospitals
and factories. These customers are generally concentrated in North America,
Europe and Asia Pacific; however, sales are made globally. Sales in the
Electrical segment are made directly and indirectly through distributors,
resellers, and manufacturers representatives to these customers.

HYDRAULICS

The Hydraulics segment is a worldwide leader in reliable, high-efficiency
hydraulic components and systems for use in mobile and industrial markets. Eaton
offers a wide range of power products including pumps, motors and hydraulic
power units; a broad range of controls and sensing products, including valves,
cylinders and electronic controls; a full range of fluid conveyance products,
including industrial and hydraulic hose, fittings, and assemblies, thermoplastic
hose and tubing, couplings, connectors, and assembly equipment; filtration
systems solutions; heavy-duty drum and disc brakes; and golf grips. The
principal market segments for Hydraulics include oil and gas, renewable energy,
marine, agriculture, construction, mining, forestry, utility, material
handling, truck and bus, machine tool, molding, primary metals, power
generation, and entertainment. Key manufacturers in these markets and other
customers are located globally, and these products are sold and serviced through
a variety of channels.

AEROSPACE

The Aerospace segment is a leading global supplier to the commercial and
military aviation and aerospace industries. Products include hydraulic power
generation systems for aerospace applications, including pumps, motors,
hydraulic power units, hose and fittings, electro-hydraulic pumps and power and
load management systems; controls and sensing products, including valves,
cylinders, electronic controls, electromechanical actuators, sensors, displays
and panels, aircraft flap and slat systems and nose wheel steering systems;
fluid conveyance products, including hose, thermoplastic tubing, fittings,
adapters, couplings, sealing and ducting; and fuel systems, including fuel
pumps, sensors, valves, adapters and regulators. The principal markets for the
Aerospace segment are manufacturers of


                                    Page 47

<PAGE>

commercial and military aircraft and related after-market customers. These
manufacturers and other customers operate globally, and these products are sold
and serviced through a variety of channels.

TRUCK

The Truck segment is a leader in the design, manufacture and marketing of a
complete line of powertrain systems and components for commercial vehicles.
Products include transmissions, clutches and hybrid electric power systems. The
principal markets for the Truck segment are original equipment manufacturers and
after-market customers of heavy-, medium- and light-duty trucks and passenger
cars. These manufacturers and other customers are located globally, and most
sales of these products are made directly to these customers.

AUTOMOTIVE

The Automotive segment is a leading supplier of critical components that reduce
emissions and fuel consumption and improve stability and performance of cars,
light trucks and commercial vehicles. Products include superchargers, engine
valves and valve actuation systems, cylinder heads, locking and limited slip
differentials, transmission controls, engine controls, fuel vapor components,
compressor control clutches for mobile refrigeration, fluid connectors and hoses
for air conditioning and power steering, decorative spoilers, underhood plastic
components, fluid conveyance products including, hose, thermoplastic tubing,
fittings, adapters, couplings and sealing products to the global automotive
industry. The principal markets for the Automotive segment are original
equipment manufacturers and aftermarket customers of light-duty trucks and
passenger cars. These manufacturers and other customers are located globally,
and most sales of these products are made directly to these customers.

OTHER INFORMATION

No single customer represented more than 10% of net sales in 2008, 2007 or 2006.
Sales from United States operations to customers in foreign countries were
$1,153 in 2008, $986 in 2007 and $988 in 2006 (8% of sales in 2008, 2007 and
2006).

The accounting policies of the business segments are generally the same as the
policies described under "Accounting Policies" above, except that inventories
and related cost of products sold of the segments are accounted for using the
FIFO method and operating profit only reflects the service cost component
related to pensions and other postretirement benefits. Intersegment sales and
transfers are accounted for at the same prices as if the sales and transfers
were made to third parties.

In accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," for purposes of business segment performance
measurement, the Company does not allocate to the business segments items that
are of a non-operating nature, or corporate organizational and functional
expenses of a governance nature. Corporate expenses consist of corporate office
expenses including compensation, benefits, occupancy, depreciation, and other
administrative costs. Identifiable assets of the business segments exclude
goodwill, other intangible assets, and general corporate assets, which
principally consist of cash, short-term investments, deferred income taxes,
certain accounts receivable, certain property, plant and equipment, and certain
other assets.


                                    Page 48

<PAGE>

GEOGRAPHIC REGION INFORMATION

Net sales and segment operating profit are measured based on the geographic
location of the selling plant. Long-lived assets consist of property, plant and
equipment-net.

<TABLE>
<CAPTION>
                             Segment
                            operating   Long-lived
                Net sales     profit       assets
                ---------   ---------   ----------
<S>             <C>         <C>         <C>
2008
United States    $ 8,775     $ 1,136      $1,136
Canada               428          60          21
Europe             4,002         270         820
Latin America      1,455         160         250
Asia Pacific       1,963         179         412
Eliminations      (1,247)
                 -------                  ------
                 $15,376                  $2,639
                 =======                  ======
2007
United States    $ 8,556     $ 1,177      $1,161
Canada               371          54          20
Europe             2,624         166         592
Latin America      1,246         150         345
Asia Pacific       1,144         121         215
Eliminations        (908)
                 -------                  ------
                 $13,033                  $2,333
                 =======                  ======
2006
United States    $ 8,530     $ 1,146      $1,188
Canada               337          44          16
Europe             2,313          65         579
Latin America      1,090         120         318
Asia Pacific         888          93         170
Eliminations        (926)
                 -------                  ------
                 $12,232                  $2,271
                 =======                  ======
</TABLE>

Business segment operating profit was reduced by acquisition integration charges
as follows:

<TABLE>
<CAPTION>
                2008   2007   2006
                ----   ----   ----
<S>             <C>    <C>    <C>
United States    $45    $27    $23
Europe            22     20      7
Latin America            12      6
Asia Pacific       9      5      4
                 ---    ---    ---
                 $76    $64    $40
                 ===    ===    ===
</TABLE>


                                    Page 49

<PAGE>

BUSINESS SEGMENT INFORMATION

<TABLE>
<CAPTION>
                                                    2008      2007      2006
                                                  -------   -------   -------
<S>                                               <C>       <C>       <C>
NET SALES
Electrical                                        $ 6,920   $ 4,759   $ 4,184
Hydraulics                                          2,523     2,391     2,203
Aerospace                                           1,811     1,594     1,295
Truck                                               2,251     2,147     2,520
Automotive                                          1,871     2,142     2,030
                                                  -------   -------   -------
                                                  $15,376   $13,033   $12,232
                                                  =======   =======   =======
OPERATING PROFIT
Electrical                                        $   863   $   579   $   474
Hydraulics                                            285       265       221
Aerospace                                             283       233       182
Truck                                                 315       357       448
Automotive                                             59       234       143

CORPORATE
Amortization of intangible assets                    (161)      (79)      (51)
Interest expense-net                                 (157)     (147)     (105)
Minority interest                                     (12)      (14)      (10)
Pension & other postretirement benefit expense       (141)     (164)     (152)
Stock option expense                                  (29)      (30)      (27)
Contribution to Eaton Charitable Fund                           (16)
Other corporate expense-net                          (177)     (177)     (154)
                                                  -------   -------   -------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME
   TAXES                                            1,128     1,041       969
Income taxes                                           73        82        72
                                                  -------   -------   -------
INCOME FROM CONTINUING OPERATIONS                   1,055       959       897
Income from discontinued operations                     3        35        53
                                                  -------   -------   -------
NET INCOME                                        $ 1,058   $   994   $   950
                                                  =======   =======   =======
Business segment operating profit was reduced
   by acquisition integration charges as
   follows:
      Electrical                                  $    47   $    12   $     7
      Hydraulics                                        6        12        11
      Aerospace                                        20        39        12
      Truck                                                                 5
      Automotive                                        3         1         5
                                                  -------   -------   -------
                                                  $    76   $    64   $    40
                                                  =======   =======   =======
</TABLE>


                                    Page 50

<PAGE>

BUSINESS SEGMENT INFORMATION

<TABLE>
<CAPTION>
                                                 2008      2007      2006
                                               -------   -------   -------
<S>                                            <C>       <C>       <C>
IDENTIFIABLE ASSETS
Electrical                                     $ 3,055   $ 1,960   $ 1,669
Hydraulics                                       1,132     1,192     1,123
Aerospace                                          798       852       669
Truck                                              801       996     1,015
Automotive                                         947     1,145     1,105
                                               -------   -------   -------
                                                 6,733     6,145     5,581
Goodwill                                         5,232     3,982     3,034
Other intangible assets                          2,518     1,557       969
Corporate                                        2,172     1,746     1,833
                                               -------   -------   -------
Total assets                                   $16,655   $13,430   $11,417
                                               =======   =======   =======
EXPENDITURES FOR PROPERTY, PLANT & EQUIPMENT
Electrical                                     $   162   $    82   $    74
Hydraulics                                          54        56        83
Aerospace                                           23        39        25
Truck                                               69        62        66
Automotive                                          54        79        92
                                               -------   -------   -------
                                                   362       318       340
Corporate                                           86        36        20
                                               -------   -------   -------
                                               $   448   $   354   $   360
                                               =======   =======   =======
DEPRECIATION OF PROPERTY, PLANT & EQUIPMENT
Electrical                                     $   110   $    79   $    79
Hydraulics                                          59        62        63
Aerospace                                           27        26        24
Truck                                               89        84        77
Automotive                                          97        94        87
                                               -------   -------   -------
                                                   382       345       330
Corporate                                           27        23        22
                                               -------   -------   -------
                                               $   409   $   368   $   352
                                               =======   =======   =======
</TABLE>


                                    Page 51

<PAGE>

MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS

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

OVERVIEW OF THE COMPANY

Eaton Corporation is a diversified power management company with 2008 sales of
$15.4 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. It has approximately 75,000 employees and sells products to customers in
more than 150 countries.

In the first quarter of 2008, Eaton realigned its business segment financial
reporting structure. The Fluid Power segment was realigned into the Hydraulics
segment and the Aerospace segment. The Electrical and Truck segments continued
as individual reporting segments and the automotive fluid connectors business
was transferred to the Automotive segment from Fluid Power. Accordingly,
business segment information for prior years has been restated to conform to the
current year's presentation. The realignment of the segments did not affect net
income for any of the periods presented.

The principal markets for the Electrical segment are industrial, institutional,
government, utility, commercial, residential, IT, mission critical and original
equipment manufacturer customers. These products are used wherever there is a
demand for electrical power in commercial buildings, data centers, residences,
apartment and office buildings, hospitals and factories. Customers are generally
concentrated in North America, Europe and Asia Pacific; however, sales are made
globally. Sales are made directly and indirectly through distributors, resellers
and manufacturers representatives to these customers.

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, power
generation and entertainment. Customers are located globally, and 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. 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 and passenger cars. Customers are located globally, and most
sales are made directly to these customers.

HIGHLIGHTS OF RESULTS FOR 2008

Eaton reported record sales of $15.4 billion in 2008, which grew 18% over 2007,
and record net income of $1.06 billion, which rose 6% over 2007. Net income per
Common Share was $6.52, a 1% decline from 2007 reflecting a higher number of
average Common Shares outstanding in 2008 compared to 2007. Results for 2008
improved over 2007 despite the negative effect on Eaton's end markets of the
turmoil in the world credit markets in 2008 and weaker than expected conditions
in end markets that fell sharply in the fourth quarter of 2008.

The growth in financial results in 2008 was due in part to Eaton's improved
business and geographic balance which allowed Eaton to grow despite downturns in
certain end markets, especially in the fourth quarter of 2008. Eaton achieved a
fundamental repositioning of the business in 2008, as seen by the fact that in
the second half of 2008, the Electrical, Hydraulics and Aerospace businesses
earned almost 90% of business segment operating profits. During 2008, sales and
operating profits for the Electrical, Hydraulics, and Aerospace segments all
increased compared to 2007 and were new all-time records, and operating margins
for Electrical and Hydraulics in 2008 were also new records. Sales of the Truck
segment increased in 2008 compared to 2007, while operating profit for this
segment fell 12% in 2008 from 2007. The reduction in operating profit was
primarily due to operating inefficiencies related to the inability to absorb
fixed manufacturing costs resulting from volatility in end markets in 2008.
Sales of the Automotive segment decreased 13% in 2008 from 2007, and operating
profit fell 75% in 2008, due to declines in automotive unit production in North
American and European end markets, especially in the


                                    Page 52

<PAGE>

fourth quarter of 2008, and expenses related to the closing of a plant in Massa,
Italy announced in the fourth quarter of 2008.

The following are highlights of 2008:

<TABLE>
<CAPTION>
                                                                     Increase/
                                                  2008      2007    (Decrease)
                                                -------   -------   ----------
<S>                                             <C>       <C>       <C>
Continuing operations
   Net sales                                    $15,376   $13,033       18%
   Gross profit                                   4,185     3,651       15%
      Percent of net sales                         27.2%     28.0%
   Income before income taxes                     1,128     1,041        8%
   Income after income taxes                    $ 1,055   $   959       10%
Income from discontinued operations                   3        35
                                                -------   -------
Net income                                      $ 1,058   $   994        6%
                                                =======   =======
Net income per Common Share assuming dilution
   Continuing operations                        $  6.50   $  6.38        2%
   Discontinued operations                          .02       .24
                                                -------   -------
                                                $  6.52   $  6.62      (1)%
                                                =======   =======

Return on Shareholders' equity                       17%       22%
</TABLE>

Sales growth of 18% in 2008 over 2007 consisted of 14% from acquisitions of
businesses, 3% from organic growth, and 1% from foreign exchange. Acquisitions
of businesses were primarily The Moeller Group, acquired in April 2008;
Phoenixtec, acquired in February 2008; and the MGE small systems UPS business,
acquired in October 2007, all of which are included in the Electrical segment,
along with the Argo-Tech aerospace business, acquired in March 2007. These
acquisitions further increased the proportion of Eaton's sales outside of the
United States. Organic growth included 2% from growth in end markets and 1% from
outgrowing end markets.

Gross profit increased 15% in 2008 over 2007. This increase was primarily due to
sales growth of 18% which included sales of acquired businesses; the benefits of
integrating acquired businesses; and continued productivity improvements driven
by the Eaton Business System (EBS). These increases in gross profit were
partially offset by the impact of rising prices for raw materials, supplies and
other commodities, and expense of $27 related to the announced closing in the
fourth quarter of 2008 of the automotive engine valve lifters manufacturing
plant in Massa, Italy.

Net income in 2008 increased 6% over 2007. The increase was primarily due to
higher sales and the other factors that affected gross profit discussed above,
along with lower income taxes. These increases were partially offset by
increases in selling, administrative, research and development, and interest
expenses resulting from the inclusions of Moeller and Phoenixtec, and higher
levels of expenses to support sales from existing operations. In addition, a $20
after-tax gain on the sale of the Mirror Controls business was included in
income from discontinued operations in 2007 that was not present in 2008. Net
income per Common Share in 2008 decreased 1% from 2007 due to the factors
that resulted in increased net income discussed above, offset by the increase in
average shares outstanding resulting from the sale of 18.678 million Common
Shares in the second quarter of 2008.

In 2008, Eaton acquired six businesses and entered into a joint venture in
separate transactions. The Statements of Consolidated Income include the results
of these businesses from the effective dates of acquisition. These acquisitions
are summarized below:

-    On October 2, 2008, Integ Holdings Limited, the parent company of
     Integrated Hydraulics Ltd., a U.K.-based manufacturer of screw-in cartridge
     valves, custom-engineered hydraulic valves and manifold systems, was
     acquired. The business had sales of $52 in 2007 and is included in the
     Hydraulics segment.

-    Nittan Global Tech Co. Ltd., a joint venture, became operational on October
     1, 2008. The new joint venture will manage the global design, manufacture
     and supply of engine valves and valve actuation products to Japanese and
     Korean automobile and engine manufacturers. In addition, during the second
     half of 2008, several related manufacturing joint ventures were
     established.


                                    Page 53
<PAGE>

-    On July 31, 2008, the Engine Valves Business of Kirloskar Oil Engines Ltd.,
     an India-based designer, manufacturer and distributor of intake and exhaust
     valves for diesel and gasoline engines, was acquired. The business had
     sales of $5 in 2007 and is included in the Automotive segment.

-    On July 31, 2008, PK Electronics, a Belgium-based distributor and service
     provider of single phase and three-phase uninterruptible power supply (UPS)
     systems, was acquired. This business had sales of $9 for 2007 and is
     included in the Electrical segment.

-    On April 4, 2008, The Moeller Group, a Germany-based supplier of electrical
     components for commercial and residential building applications and
     industrial controls for industrial equipment applications, was acquired.
     The business had sales of E1.02 billion in 2007 and is included in the
     Electrical segment.

-    On March 31, 2008, Balmen Electronic, S.L., a Spain-based distributor and
     service provider of uninterruptible power supply (UPS) systems, was
     acquired. The business had sales of $6 in 2007 and is included in the
     Electrical segment.

-    On February 26, 2008, Phoenixtec Power Company Ltd., a Taiwan-based
     manufacturer of single and three-phase uninterruptible power supply (UPS)
     systems, was acquired. The business had sales of $515 in 2007 and is
     included in the Electrical segment.

Net cash provided by operating activities was $1,416 in 2008, an increase of
$255 over $1,161 of net cash provided by operating activities in 2007. The
increase in operating cash flows, which demonstrated the strength of the mix of
Eaton's businesses, was primarily due to higher net income of $64, a $123
increase in non-cash depreciation and amortization related to businesses
acquired, an increase of $66 in cash received from the termination of interest
rate swaps, and $9 in lower working capital funding. These increases were
partially offset by the year-over-year changes in non-cash expense for deferred
income taxes of $174. Strong cash flow from operations allowed commercial paper
to be reduced to $767 at the end of 2008 and allowed Eaton to end 2008 with cash
and short-term investments that totaled $530.

Net working capital of $1,050 at year-end 2008 compared to $1,108 at year-end
2007, or a net reduction of $58. The reduction in net working capital was
primarily due to the net $116 decrease in cash and short-term investments and
the $109 increase in the current portion of long-term debt in 2008. These
changes were partially offset by the $87 increase in accounts receivable and the
$71 increase in inventories, which primarily resulted from the acquisitions of
Moeller and Phoenixtec. The current ratio was 1.28 at December 31, 2008, almost
the same as the ratio of 1.30 at year-end 2007.

In February 2008, Eaton borrowed $250 under a 364-day $3.0 billion revolving
credit agreement to partially finance the acquisition of Phoenixtec. In April
2008, Eaton borrowed E1.33 billion under the revolving credit agreement to
finance the acquisition of Moeller. In order to refinance this debt, Eaton sold
18.678 million of its Common Shares in a public offering in the second quarter
of 2008, resulting in net cash proceeds of $1.522 billion. In May 2008, Eaton
issued $300 of 4.9% notes due in 2013 and $450 of 5.6% notes due in 2018. The
cash proceeds from the sale of the Common Shares and from the issuance of the
notes were used to repay borrowings incurred to fund the acquisitions of Moeller
and Phoenixtec, and to repay commercial paper issued under the backstop provided
by the $3.0 billion revolving credit agreement. Subsequently, in May 2008 Eaton
terminated the $3.0 billion revolving credit agreement.

Total debt of $4,271 at December 31, 2008 increased $854 from $3,417 at year-end
2007. The increase in total debt included the issuance of $860 of long-term
notes and $796 of commercial paper and other borrowings, partially offset by the
repayment of $989 of notes, commercial paper and other debt. The increase in
total debt largely resulted from funding the acquisitions of Moeller,
Phoenixtec, and other businesses in 2008 for $2,807 and borrowings to fund
working capital and other requirements, offset by cash proceeds of $1,522 from
the sale of 18.678 million Common Shares in the second quarter of 2008. The
net-debt-to-capital ratio was 37.2% at December 31, 2008 compared to 34.9% at
year-end 2007, reflecting the combined effect during 2008 of the $854 increase
in total debt, the $116 decrease in cash and short-term investments, and the
$1,145 increase in Shareholders' equity, which primarily resulted from the sale
of Common Shares in the second quarter and from net income of $1,058 for 2008,
partially offset by other items.


                                     Page 54

<PAGE>

On January 21, 2008, Eaton increased the quarterly dividend on its Common Shares
by 16%, from $.43 per share to $.50 per share, effective for the February 2008
dividend.

RESULTS OF OPERATIONS - 2008 COMPARED TO 2007

<TABLE>
<CAPTION>
                                                                     Increase/
                                                 2008      2007     (Decrease)
                                                -------   -------   ---------
<S>                                             <C>       <C>       <C>
Continuing operations
   Net sales                                    $15,376   $13,033       18%
   Gross profit                                   4,185     3,651       15%
     Percent of net sales                          27.2%     28.0%
   Income before income taxes                     1,128     1,041        8%
   Income after income taxes                    $ 1,055   $   959       10%
Income from discontinued operations                   3        35
                                                -------   -------
Net income                                      $ 1,058   $   994        6%
                                                =======   =======
Net income per Common Share assuming dilution
   Continuing operations                        $  6.50   $  6.38        2%
   Discontinued operations                          .02       .24
                                                -------   -------
                                                $  6.52   $  6.62      (1)%
                                                =======   =======
</TABLE>

Sales growth of 18% in 2008 over 2007 consisted of 14% from acquisitions of
businesses, 3% from organic growth, and 1% from foreign exchange. Acquisitions
of businesses were primarily The Moeller Group, acquired in April 2008;
Phoenixtec, acquired in February 2008; and the MGE small systems UPS business,
acquired in October 2007, all of which are included in the Electrical segment,
along with the Argo-Tech aerospace business, acquired in March 2007. These
acquisitions further increased the proportion of Eaton's sales outside of the
United States. Organic growth included 2% from growth in end markets and 1% from
outgrowing end markets.

Gross profit increased 15% in 2008 over 2007. This increase was primarily due to
sales growth of 18%, which included sales of acquired businesses; the benefits
of integrating acquired businesses; and continued productivity improvements
driven by the Eaton Business System (EBS). These increases in gross profit were
partially offset by the impact of rising prices for raw materials, supplies and
other commodities, and expense of $27 related to the announced closing in the
fourth quarter of 2008 of the automotive engine valve lifters manufacturing
plant in Massa, Italy.

RESULTS BY GEOGRAPHIC REGION

Net sales and segment operating profit are measured based on the geographic
location of the selling plant.

<TABLE>
<CAPTION>
                          Net sales              Segment operating profit     Operating margin
                ----------------------------   ----------------------------   ----------------
                                                                  Increase/
                  2008      2007    Increase    2008     2007    (Decrease)     2008     2007
                -------   -------   --------   ------   ------   ----------   -------   ------
<S>             <C>       <C>       <C>        <C>      <C>      <C>          <C>       <C>
United States   $ 8,775   $ 8,556       3%     $1,136   $1,177      (3)%        12.9%    13.8%
Canada              428       371      15%         60       54       11%        14.0%    14.6%
Europe            4,002     2,624      53%        270      166       63%         6.7%     6.3%
Latin America     1,455     1,246      17%        160      150        7%        11.0%    12.0%
Asia Pacific      1,963     1,144      72%        179      121       48%         9.1%    10.6%
Eliminations     (1,247)     (908)
                -------   -------
                $15,376   $13,033      18%
                =======   =======
</TABLE>

In the United States, sales in 2008 increased 3% compared to 2007. The increase
in sales was primarily due to growth in the Electrical, Aerospace and Hydraulics
segments, as well as the acquisitions in 2007 of Argo-Tech and other businesses.
These increases were partially offset by reduced sales in the Automotive segment
due to the sharp decline in the North American automotive market during 2008,
and reduced sales of the Truck segment. The 3% decline in operating profit in
the United States reflected improved performance of the Electrical and Aerospace
segments due to sales growth from existing businesses and the benefits of
integrating acquired businesses, offset by reduced operating profit of the
Automotive and Truck segments due to reduced sales resulting from declines in
end markets. Acquisition integration charges were $45 in 2008 compared to $27 in
2007.


                                     Page 55

<PAGE>

Growth in Canada in 2008 of 15% in sales and 11% in operating profit was
primarily due to higher sales in the Electrical segment resulting from growth in
end markets and from acquired businesses.

Sales growth in Europe in 2008 of 53% was primarily due to higher sales in the
Electrical segment, which was largely due to the acquisitions of Moeller in 2008
and the MGE small systems UPS business in 2007, as well as growth in end
markets. Sales growth was also due to increased sales in the Aerospace,
Hydraulics, Truck and Automotive segments largely due to growth in end markets.
The 63% increase in operating profit in Europe was largely due to higher
operating profits of the Electrical segment resulting from the acquisitions of
Moeller and MGE and sales growth from existing businesses. This increase also
reflected improved results of the Aerospace and Hydraulics segments. These
increases in operating profits were partially offset by reduced operating
profits of the Truck and Automotive segments, and expense of $27 related to the
announced closing in the fourth quarter of 2008 of the automotive engine valve
lifters manufacturing plant in Massa, Italy. Acquisition integration charges
were $22 in 2008 compared to $20 in 2007.

In Latin America, sales growth in 2008 of 17% was largely due to the Truck,
Electrical and Hydraulics segments, primarily due to growth in end markets. The
7% increase in operating profit in Latin America was attributable to higher
sales in 2008 and lower acquisition integration charges in 2008 compared to
2007. There were no acquisition integration charges in 2008 compared to $12 in
2007.

Growth in Asia Pacific in 2008 of 72% in sales and 48% in operating profit was
primarily due to the acquisition of the Phoenixtec electrical business in 2008
and higher sales in the Electrical, Hydraulics, Automotive and Truck segments,
mainly resulting from growth in end markets. Acquisition integration charges
were $9 in 2008 compared to $5 in 2007.

OTHER RESULTS OF OPERATIONS

In 2008 and 2007, Eaton incurred charges related to the integration of acquired
businesses. These charges, which consisted of plant consolidations and
integration, were expensed as incurred.

Charges in 2008 related primarily to the integration of the following
acquisitions: in the Electrical segment, Moeller, Phoenixtec and the MGE small
systems UPS business; in the Hydraulics segment, Ronningen-Petter and Synflex;
in the Aerospace segment, Argo-Tech, PerkinElmer and Cobham; and in the
Automotive segment, Saturn and the engine valve business of Kirloskar Oil
Engines Ltd.

Charges in 2007 related primarily to the integration of the following
acquisitions: in the Electrical segment, the MGE small systems UPS business,
Schreder-Hazemeyer, Senyuan and Powerware; in the Hydraulics segment, Synflex,
Hayward and Walterscheid; in the Aerospace segment, Argo-Tech, PerkinElmer and
Cobham; and in the Automotive segment, Saturn.

A summary of these charges follows:

<TABLE>
<CAPTION>
                    2008   2007
                    ----   ----
<S>                 <C>    <C>
Electrical          $ 47   $ 12
Hydraulics             6     12
Aerospace             20     39
Automotive             3      1
Corporate              1
                    ----   ----
Pretax charges      $ 77   $ 64
                    ====   ====
After-tax charges   $ 51   $ 42
Per Common Share    $.31   $.28
</TABLE>

Acquisition integration charges in 2008 included $46 for the United States, $22
for Europe, and $9 for Asia Pacific. Charges in 2007 included $27 for the United
States, $20 for Europe, $12 for Latin America and $5 for Asia Pacific. 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 segment.

On October 20, 2008, Eaton announced the closure of its automotive engine valve
lifters manufacturing plant in Massa, Italy. There were 350 employees affected
by the closure decision. The action was taken to better align manufacturing
capacity with future industry demand and to improve the competitive position of
the valve actuation business. Aggregate pretax charges associated with this
closure were


                                     Page 56

<PAGE>

$27, which were recognized in the fourth quarter of 2008, when
management approved this action. These costs, which consisted of charges of $17
for severance, $7 for the write-down of assets and $3 for other costs, reduced
operating profit of the Automotive segment.

In 2008 and 2007, Eaton recognized income tax benefits of $108 and $57,
respectively, which represented adjustments to worldwide tax liabilities and
valuation allowances. The 2008 income tax benefits reduced the effective income
tax rate for 2008 from 16.0% to 6.4%. The 2008 benefits resulted from multiple
income tax items including a benefit of $44 related to the consolidation of
various legal entities and the recognition of $25 of tax credits related to the
transfer of operations from Massa, Italy. The 2007 income tax benefits reduced
the effective income tax rate for 2007 from 13.4% to 7.9%. The 2007 income tax
benefits resulted from multiple income tax items. Included in the tax benefits
were a $14 benefit from changes to state tax laws and a favorable revaluation of
worldwide deferred tax assets. Further analysis regarding the change in the
effective income tax rate in 2008 compared to 2007 is found in "Income Taxes" in
the Notes to the Consolidated Financial Statements.

Net income in 2008 increased 6% over 2007. The increase was primarily due to
higher sales and the other factors that affected gross profit discussed above,
along with lower income taxes. These increases were partially offset by
increases in selling, administrative, research and development, and interest
expenses resulting from the inclusions of Moeller and Phoenixtec, and higher
levels of expenses to support sales from existing operations. In addition, a $20
after-tax gain on the sale of the Mirror Controls business was included in
income from discontinued operations in 2007 that was not present in 2008. Net
income per Common Share in 2008 decreased 1% from 2007 due to the factors
that resulted in increased net income discussed above, offset by the increase in
average shares outstanding resulting from the sale of 18.678 million Common
Shares in a public offering in the second quarter of 2008.

RESULTS BY BUSINESS SEGMENT

ELECTRICAL

<TABLE>
<CAPTION>
                    2008     2007    Increase
                   ------   ------   --------
<S>                <C>      <C>      <C>
Net sales          $6,920   $4,759      45%
Operating profit      863      579      49%
Operating margin     12.5%    12.2%
</TABLE>

Sales of the Electrical segment reached record levels in 2008. The 45% increase
in sales over 2007 consisted of 37% from acquisitions of businesses, primarily
Moeller, Phoenixtec and the MGE small systems UPS business, and 8% from organic
growth. End markets for the Electrical segment grew about 4% during 2008
compared to 2007, with both U.S. markets and non-U.S. markets growing 4% during
the year. However, due to the economic downturn, end markets for this business
grew only about 1% during the fourth quarter of 2008, a slowdown from the 4%
growth in the third quarter and the rest of the year. Nonresidential
construction spending in the United States held up well in 2008, but Eaton
expects it to begin to decline by the second quarter of 2009.

Operating profit rose 49% in 2008 over 2007, and operating margin rose to 12.5%,
both of which were records for this segment. The increase in operating profit
was largely due to growth in sales, results of acquired businesses, and
continued productivity improvements. Operating profit was reduced by acquisition
integration charges of $47 in 2008 compared to charges of $12 in 2007, which
reduced the operating margin by 0.7% and 0.3% in 2008 and 2007, respectively.
Acquisition integration charges in 2008 primarily related to Moeller,
Phoenixtec and the MGE small systems UPS business. Charges in 2007 related to
MGE small systems UPS business, Schreder-Hazemeyer, Senyuan and Powerware. The
incremental operating margin for 2008 (the increase in operating profit compared
to the increase in sales) was 13%. The operating margin for acquired businesses
for 2008 was 14%.

New businesses acquired during 2008 in the Electrical segment include the
following:

-    On July 31, 2008, PK Electronics, a Belgium-based distributor and service
     provider of single phase and three-phase uninterruptible power supply (UPS)
     systems, was acquired. This business had sales of $9 for 2007.

-    On April 4, 2008, The Moeller Group, a Germany-based business which is a
     leading supplier of electrical components for commercial and residential
     building applications and industrial controls


                                     Page 57

<PAGE>

     for industrial equipment applications, was acquired. This business had
     sales of E1.02 billion for 2007.

-    On March 31, 2008, Balmen Electronic, S.L., a Spain-based distributor and
     service provider of uninterruptible power supply (UPS) systems, was
     acquired. This business had sales of $6 for 2007.

-    On February 26, 2008, Phoenixtec Power Company Ltd., a Taiwan-based
     manufacturer of single and three-phase uninterruptible power supply (UPS)
     systems, was acquired. This business had sales of $515 for 2007.

HYDRAULICS

<TABLE>
<CAPTION>
                    2008     2007    Increase
                   ------   ------   --------
<S>                <C>      <C>      <C>
Net sales          $2,523   $2,391       6%
Operating profit      285      265       8%
Operating margin     11.3%    11.1%
</TABLE>

Sales of the Hydraulics segment reached record levels in 2008. The 6% increase
in sales consisted of 3% from foreign exchange, 2% from organic growth and 1%
from acquisitions of businesses. Global hydraulics end markets grew 2% in 2008
compared to 2007, with U.S. markets up 1% and non-U.S. markets up 3%. However,
global hydraulics markets declined markedly in the fourth quarter of 2008, led
by steep production cutbacks by customers around the world. During the fourth
quarter of 2008, hydraulics markets declined 8% compared to the same period in
2007, with U.S. markets down 9% and non-U.S. markets down 8%.

Operating profit rose 8% in 2008 over 2007, and operating margin increased to
11.3%, both of which were records for this segment. The increase in operating
profit was due to growth in sales, the benefits of integrating acquired
businesses, and an overall improvement in operating efficiencies. Operating
profit was reduced by acquisition integration charges of $6 in 2008 compared to
charges of $12 in 2007, which reduced the operating margin by 0.2% and 0.5% in
2008 and 2007, respectively. Acquisition integration charges in 2008 primarily
related to Ronningen-Petter and Synflex. Charges in 2007 largely related to
Synflex, Hayward and Walterscheid. The incremental operating margin for 2008 was
15%.

On October 2, 2008, Integ Holdings Limited, the parent company of Integrated
Hydraulics Ltd., a U.K.-based manufacturer of screw-in cartridge valves,
custom-engineered hydraulic valves and manifold systems, was acquired. The
business had sales of $52 in 2007.

AEROSPACE

<TABLE>
<CAPTION>
                    2008     2007    Increase
                   ------   ------   --------
<S>                <C>      <C>      <C>
Net sales          $1,811   $1,594      14%
Operating profit      283      233      21%
Operating margin     15.6%    14.6%
</TABLE>

Sales of the Aerospace segment reached record levels in 2008. The 14% increase
in sales consisted of 13% from organic growth and 2% from acquisitions of
businesses, partially offset by a decrease of 1% from foreign exchange.
Aerospace end markets in 2008 grew 3%. Non-U.S. markets grew 11%, driven by
strong deliveries from Airbus, while U.S. markets were flat, driven by a decline
in deliveries of new aircraft from Boeing as a result of a strike at its
manufacturing operations.

Operating profit rose 21% in 2008 over 2007 and was a record for this segment.
The increase in operating profit was due to growth in sales, the benefits of
integrating acquired businesses, and an overall improvement in operating
efficiencies. Operating profit was reduced by acquisition integration charges of
$20 in 2008 compared to charges of $39 in 2007, which reduced the operating
margin by 1.1% and 2.4% in 2008 and 2007, respectively. Acquisition integration
charges in 2008 and 2007 primarily related to Argo-Tech, PerkinElmer and Cobham.
Despite inefficiencies incurred as a result of the Boeing strike, this segment
earned a 15.6% operating margin in 2008. The incremental operating margin for
2008 was 23%.


                                     Page 58

<PAGE>

TRUCK

<TABLE>
<CAPTION>
                                      Increase/
                    2008     2007    (Decrease)
                   ------   ------   ----------
<S>                <C>      <C>      <C>
Net sales          $2,251   $2,147         5%
Operating profit      315      357       (12)%
Operating margin     14.0%    16.6%
</TABLE>

Sales of the Truck segment increased 5% in 2008 over 2007. The 5% increase in
sales consisted of 2% from organic growth and 3% from foreign exchange. End
markets were up 1% in 2008 over 2007, with U.S. markets down 5% and non-U.S.
markets up 9%. Production of North American heavy-duty trucks in 2008 totaled
205,000 units, a decrease of 3% from 2007, with particular weakness in the
fourth quarter.

Operating profit of $315 in 2008 was 12% lower than 2007, primarily due to
operating inefficiencies related to the inability to absorb fixed manufacturing
costs resulting from volatile end markets. In spite of end markets for the Truck
segment that performed unevenly in 2008, this segment achieved an operating
margin of 14.0% in 2008.

AUTOMOTIVE

<TABLE>
<CAPTION>
                    2008     2007    Decrease
                   ------   ------   --------
<S>                <C>      <C>      <C>
Net sales          $1,871   $2,142      (13)%
Operating profit       59      234      (75)%
Operating margin      3.2%    10.9%
</TABLE>

The 13% decrease in sales of the Automotive segment in 2008 from 2007 reflected
a 15% decrease in sales volume, partially offset by a 2% increase from foreign
exchange. In 2008, global automotive markets declined 7% compared to 2007, with
U.S. markets down 16% and non-U.S. markets down 2%. The North American markets
were weak throughout 2008, and Europe, Brazil and China also weakened
dramatically during the year. In addition, the strike at a major U.S. automotive
supplier was not fully resolved until very late in the second quarter of 2008,
further reducing automotive production in the U.S. in 2008. Additionally, due to
the economic downturn in the fourth quarter of 2008, automotive markets dropped
sharply around the world, with automotive unit production in the fourth quarter
declining by 24%.

Operating profit decreased 75% in 2008 from 2007, largely due to the decline in
sales volume and changes in product mix. The sharp slowdown in end markets in
2008, as well as continued shifts in mix to smaller vehicles in the U.S,
resulted in the inability of this business to absorb fixed manufacturing costs,
which severely impacted operating profit. The sudden drop in sales volume during
the fourth quarter of 2008 created significant additional manufacturing
inefficiencies and necessitated significant reductions in personnel. In
addition, an action was taken in the fourth quarter of 2008 to close the Massa,
Italy, valve actuation plant, which resulted in a charge in the fourth quarter
of $27. Operating profit was also reduced by acquisition integration charges of
$3 in 2008 as compared to $1 in 2007, which reduced operating margin by 0.2% in
2008 and 0.1% in 2007. Acquisition integration charges in 2008 related to Saturn
and the engine valve business of Kirloskar Oil Engines Ltd. Charges in 2007
related to Saturn.

On October 1, 2008, Nittan Global Tech Co. Ltd., a joint venture, became
operational. The new joint venture will manage the global design, manufacture
and supply of engine valves and valve actuation products to Japanese and Korean
automobile and engine manufacturers. In addition, during the second half of
2008, several related manufacturing joint ventures were established.

On July 31, 2008, the engine valves business of Kirloskar Oil Engines Ltd. was
acquired. This India-based company, which had sales of $5 in 2007, designs,
manufacturers and sells intake and exhaust valves for diesel and gasoline
engines.

CORPORATE

Amortization of intangible assets was $161 in 2008, an increase from $79 in
2007, reflecting amortization of intangible assets associated with recently
acquired businesses, primarily the Moeller, Phoenixtec and MGE small systems UPS
electrical businesses.


                                     Page 59

<PAGE>

Interest expense was $157 in 2008, an increase from $147 in 2007. The increase
was primarily due to borrowings to finance recently acquired businesses,
primarily the Moeller, Phoenixtec, MGE small systems UPS electrical businesses,
and Argo-Tech.

Corporate pension & other postretirement benefit expense was $141 in 2008, a
decrease from $164 in 2007. The decrease was primarily due to the effect of
updated actuarial assumptions.

LIQUIDITY, CAPITAL RESOURCES & CHANGES IN FINANCIAL CONDITION DURING 2008

Net cash provided by operating activities was $1,416 in 2008, an increase of
$255 over $1,161 of net cash provided by operating activities in 2007. The
increase in operating cash flows, which demonstrated the strength of the mix of
Eaton's businesses, was primarily due to higher net income of $64, a $123
increase in non-cash depreciation and amortization related to businesses
acquired, an increase of $66 in cash received from the termination of interest
rate swaps, and $9 in lower working capital funding. These increases were
partially offset by the year-over-year change in non-cash expense for deferred
income taxes of $174. Strong cash flow from operations allowed commercial paper
to be reduced to $767 at the end of 2008 and allowed Eaton to end 2008 with cash
and short-term investments that totaled $530.

Net working capital of $1,050 at year-end 2008 compared to $1,108 at year-end
2007, or a net reduction of $58. The reduction in net working capital was
primarily due to the net $116 decrease in cash and short-term investments and
the $109 increase in the current portion of long-term debt in 2008. These
changes were partially offset by the $87 increase in accounts receivable and the
$71 increase in inventories, which primarily resulted from the acquisitions of
Moeller and Phoenixtec. The current ratio was 1.28 at December 31, 2008, almost
the same as the ratio of 1.30 at year-end 2007.

Eaton monitors the third-party depository institutions that hold its cash and
short-term investments on a daily basis. Its emphasis is primarily on safety of
principal and secondarily on maximizing yield on those funds. Eaton diversifies
its cash and short-term investments among counterparties to minimize exposure to
any one of these entities. Eaton also monitors the credit worthiness of its
customers and suppliers to mitigate any adverse impact on it.

Capital expenditures for property, plant and equipment were $448, an increase
from $354 in 2007. Capital expenditures for 2009 are expected to be $250, which
would be 44% below capital expenditures made in 2008.

In February 2008, Eaton borrowed $250 under a 364-day $3.0 billion revolving
credit agreement to partially finance the acquisition of Phoenixtec. In April
2008, Eaton borrowed E1.33 billion under the revolving credit agreement to
finance the acquisition of Moeller. In order to refinance this debt, Eaton sold
18.678 million of its Common Shares in a public offering in the second quarter
of 2008, resulting in net cash proceeds of $1.522 billion. In May 2008, Eaton
issued $300 of 4.9% notes due in 2013 and $450 of 5.6% notes due in 2018. The
cash proceeds from the sale of the Common Shares and from the issuance of the
notes were used to repay borrowings incurred to fund the acquisitions of Moeller
and Phoenixtec, and to repay commercial paper issued under the backstop provided
by the $3.0 billion revolving credit agreement. Subsequently, in May 2008 Eaton
terminated the $3.0 billion revolving credit agreement.

Total debt of $4,271 at December 31, 2008 increased $854 from $3,417 at year-end
2007. The increase in total debt included the issuance of $860 of long-term
notes and $796 of commercial paper and other borrowings, partially offset by the
repayment of $989 of notes, commercial paper and other debt. The increase in
total debt largely resulted from funding the acquisitions of Moeller,
Phoenixtec, and other businesses in 2008 for $2,807 and borrowings to fund
working capital and other requirements, offset by cash proceeds of $1,522 from
the sale of 18.678 million Common Shares in the second quarter of 2008. The
net-debt-to-capital ratio was 37.2% at December 31, 2008 compared to 34.9% at
year-end 2007, reflecting the combined effect during 2008 of the $854 increase
in total debt, the $116 decrease in cash and short-term investments, and the
$1,145 increase in Shareholders' equity, which resulted principally from the
sale of Common Shares in the second quarter and from net income of $1,058 for
2008, partially offset by other items. Aggregate mandatory annual maturities of
long-term debt for each of the next five years are $269 in 2009, $281 in 2010,
$0 in 2011, $312 in 2012 and $307 in 2013. As of December 31, 2008, Eaton had no
debt agreements that resulted in any material restriction on the net assets of
any of its subsidiaries.


                                     Page 60

<PAGE>

In May 2008, Eaton entered into a new $500 revolving credit facility. This
facility replaced two existing facilities totaling $300 that expired in May
2008. The new facility increases Eaton's United States long-term revolving
credit facilities with banks to $1.7 billion, of which $700 expire in 2010, $500
in 2011 and $500 in 2013. These revolving credit facilities support Eaton's
commercial paper borrowings. There were no borrowings outstanding under these
revolving credit facilities at December 31, 2008. Eaton also had short-term
lines of credit of $437 at December 31, 2008.

Eaton's ability to access the commercial paper market, and the related cost of
these borrowings, is due to the strength of its credit rating and overall market
conditions. To date, Eaton has not experienced any material limitations on its
ability to access these sources of liquidity. Eaton maintains $1.7 billion of
long-term revolving credit facilities with banks in support of its commercial
paper program, as discussed above. It has no direct borrowings outstanding under
these credit facilities.

On January 30, 2009, Standard & Poor's lowered their credit rating for the
Company by one notch from A/A-1/Negative to A-/A-2/Stable (long-term
rating/short-term rating/outlook). Standard & Poor's rating action was based on
their view that weak end market conditions would limit Eaton's ability to return
to credit metrics consistent with Standard & Poor's target levels for an A/A-1
rating in the near term. Eaton maintains an A2/P-1/Negative rating at Moody's
and an A/F-1/Negative rating at Fitch, the two other credit rating agencies that
rate the Company. On December 31, 2008 Moody's issued a report maintaining their
rating of the Company. Fitch last reported on the Company specifically on August
14, 2008 at the rating noted earlier.

A $281 Floating Rate Senior Note due 2010 was issued in 2007 by a subsidiary of
Eaton in order to refinance short-term borrowings related to the acquisition of
Argo-Tech in 2007. As of December 31, 2008, the Note is no longer secured by the
assets of any subsidiary and the Note does not restrict net assets of any
subsidiary.

Financial instruments used by Eaton are straightforward, non-leveraged
instruments. The counterparties to these instruments are financial institutions
with strong credit ratings. Eaton maintains controls over the size of positions
entered into with any one counterparty and regularly monitors the credit rating
of these institutions.

On January 22, 2007, Eaton announced it had authorized a 10 million Common
Shares repurchase program. The shares are expected to be repurchased over time,
depending on market conditions, the market price of the Company's Common Shares,
the Company's capital levels and other considerations. Under the share
repurchase program, 1.4 million shares were repurchased in 2008 in the open
market at a total cost of $100 and 4.1 million shares were repurchased in 2007
at a total cost of $340.

On January 21, 2008, Eaton increased the quarterly dividend on its Common Shares
by 16%, from $.43 per share to $.50 per share, effective for the February 2008
dividend.

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." This
Statement defines fair value for financial and non-financial assets and
liabilities, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. The guidance applies to other
accounting pronouncements that require or permit fair value measurements. In
2008, Eaton adopted the provisions of SFAS No. 157 for financial assets and
liabilities and for non-financial assets recognized or disclosed at fair value
in the financial statements on a recurring basis (at least annually). These
financial assets and liabilities primarily included short and long-term
investments, derivative financial instruments, assets related to defined benefit
pension plans, and financial assets and liabilities related to acquired
businesses. The adoption of this Statement in 2008 had an immaterial effect on
Eaton's consolidated financial position and results of operations.

OUTLOOK FOR 2009

Eaton's end markets continued to decline during early 2009. Eaton expects its
end markets in 2009 to decline through the second, and possibly the third,
quarter. Eaton now expects its end markets to decline by between 10% and 11%
compared to 2008. It expects to outgrow the end markets in 2009 by approximately
$300 of sales, and also expects approximately $400 of sales growth from the
full-year impact of the six acquisitions completed in 2008. These increases are
expected to offset a decline in foreign currencies of 6%. As a result, sales in
2009 are now anticipated to decline by 11% compared to 2008.

                                     Page 61

<PAGE>

Eaton took significant employee reduction actions in 2008 in anticipation of the
severe economic downturn, and in January 2009 it took further action. The
employee reductions in 2008 and 2009 total approximately 10% of the full-time
workforce. Net of $110 of severance costs to be incurred in the first quarter of
2009, Eaton anticipates a year-over-year pretax earnings increase in 2009 of
$165 from these actions. In 2010, Eaton expects an additional year-over-year
increase in pretax earnings of $125.

Other cost reduction actions being implemented across the company to deal with
the further decline of Eaton's end markets include freezing wages where possible
and a reduction of certain benefits provided to employees. In addition, there
will be further savings from ongoing acquisition integration activities in 2009.
Eaton anticipates the savings from the two largest acquisitions, Moeller and
Phoenixtec, to add $0.30 per share to 2009 after-tax earnings.

Looking at the first quarter of 2009, Eaton expects that sales will be impacted
by plant shutdowns implemented by many of its hydraulics, truck, and automotive
customers late in the fourth quarter of 2008, which in many cases are extending
into the middle of the first quarter of 2009. These shutdowns will lower sales
in the first quarter of 2009 compared to the fourth quarter of 2008.

Eaton will be changing business segment reporting in 2009, dividing the
Electrical business into two segments. The segments will be based on geography,
with one segment focused on the Americas and the other on the Rest of the World.

For the Electrical Americas segment, Eaton expects end markets to decline in
2009 by approximately 9%. Nonresidential construction spending in the United
States held up well in the fourth quarter of 2008, but Eaton expects it to begin
to decline by the second quarter of 2009.

For the Electrical Rest of World segment, Eaton expects end markets to decline
by 7%.

For the Hydraulics segment, in 2009 Eaton anticipates a sharp contraction in
markets, with global end markets down approximately 18%. Markets in the U.S. are
expected to decline by 21% and non-U.S. markets are expected to decline by 15%.

For the Aerospace segment, Eaton expects markets to decline in 2009 by
approximately 1%. U.S. markets are expected to grow by 1%, driven by growth in
defense markets, while non-U.S. markets are expected to decline by 6%.

For the Truck segment, in 2009 Eaton expects its markets to decline by 20%. Its
U.S. markets are expected to decline by 22%. North American heavy-duty truck
production is expected to be between 145,000 and 150,000 units, as the economic
downturn and lack of financing will limit the desire of truck buyers to purchase
additional trucks in advance of the emissions law change on January 1, 2010.
Non-U.S. markets are expected to decline by 18% in 2009.

For the Automotive segment, Eaton expects that global automotive production will
likely drop by approximately 16% compared to 2008. Overall 2009 production
levels are likely to be broadly similar to the volume levels experienced during
the fourth quarter of 2008.


FORWARD-LOOKING STATEMENTS

This Annual Report to Shareholders contains forward-looking statements
concerning Eaton's first quarter 2009 and full year 2009, full year 2009 sales,
worldwide end markets, growth in relation to end markets, growth from
acquisitions, the benefits due to employee reduction actions, and estimated
savings from acquisition integration. These statements or disclosures 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 of Eaton's
control. The following factors could cause actual results to differ materially
from those in the forward-looking


                                     Page 62

<PAGE>

statements: unanticipated changes in the markets for Eaton's business segments;
unanticipated downturns in business relationships with customers or their
purchases from Eaton; 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; the impact of acquisitions and divestitures;
unanticipated difficulties integrating acquisitions; new laws and governmental
regulations; interest rate changes; changes in currency exchange rates; stock
market 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.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires Eaton's management to make
estimates and use assumptions in certain circumstances that affect amounts
reported in the accompanying consolidated financial statements. In preparing
these financial statements, management has made their best estimates and
judgments of certain amounts included in the financial statements, giving due
consideration to materiality. For any estimate or assumption there may be other
reasonable estimates or assumptions that could have been used. However, the
Company believes that given the current facts and circumstances, it is unlikely
that applying such other estimates and assumptions would have caused materially
different amounts to have been reported. Application of these accounting
policies involves the exercise of judgment and use of assumptions as to future
uncertainties and, as a result, future actual results could differ from
estimates used.

REVENUE RECOGNITION

Sales are recognized when a sales agreement is in place, products have been
shipped to customers and title has transferred in accordance with shipping terms
(FOB shipping point, FOB destination or equivalent International Commercial
(INCO) Terms), the selling price is fixed and determinable and collectability is
reasonably assured, all significant related acts of performance have been
completed, and no other significant uncertainties exist. Shipping and handling
costs billed to customers are included in Net sales and the related costs in
Cost of products sold. Other revenues for service contracts are generally
recognized as the services are provided.

ACCOUNTS RECEIVABLE

The Company performs ongoing credit evaluation of its customers and maintains
sufficient allowances for potential credit losses. The Company evaluates the
collectability of its accounts receivable based on the length of time the
receivable is past due and the anticipated future write-off based on historic
experience. Accounts receivable balances are written off against allowance for
doubtful accounts after a final determination of uncollectibility has been made.

IMPAIRMENT OF GOODWILL & OTHER LONG-LIVED ASSETS

SFAS No. 142 "Goodwill and Other Intangible Assets" provides that goodwill and
indefinite life intangible assets should be tested annually for impairment in
accordance with the specified methodology. Further, goodwill and indefinite life
intangible assets should be reviewed for impairment whenever events or changes
in circumstances indicate the carrying amount exceeds its fair value. During
2008, Eaton completed annual impairment tests for goodwill and indefinite life
intangible assets as of July 1, 2008, as required by SFAS No. 142. In addition,
based on changes in the global economic environment in second half of 2008,
goodwill and indefinite life intangible assets were also tested for impairment
in the fourth quarter of 2008. These tests confirmed that the fair value of
Eaton's reporting units and indefinite life intangible assets exceed their
respective carrying values and that no impairment loss was required to be
recognized.

Goodwill is tested for impairment at the reporting unit level and is based on
the net assets for each unit, including goodwill and intangible assets. A
discounted cash flow model is used to estimate fair value. The model requires
the exercise of significant judgments, including judgments about appropriate
discount rates, perpetual growth rates and the timing of expected future cash
flows. Discount rate assumptions are based on an assessment of the risk inherent
in the future cash flows of the respective reporting unit.


                                     Page 63

<PAGE>

Goodwill and other intangible assets totaled $7.8 billion at the end of 2008
and represented 47% of total assets. These assets resulted primarily from the
$2.1 billion (E1.33 billion) acquisition in 2008 of The Moeller Group, a leading
supplier of electrical components; the $587 acquisition in 2008 of Phoenixtec, a
manufacturer of uninterruptible power supply (UPS) electrical systems; the $614
acquisition in 2007 of the MGE small systems UPS electrical business; the $731
acquisition in 2007 of Argo-Tech, a manufacturer of aerospace, airframe, and
ground fueling pumps and systems for commercial and military aerospace markets;
the $573 acquisition in 2004 of Powerware Corporation, the electrical UPS
business; the $1.6 billion acquisition in 1999 of Aeroquip-Vickers, Inc., a
mobile and industrial hydraulics business; and the $1.1 billion acquisition in
1994 of the electrical distribution and controls business unit of Westinghouse.
These businesses, as well as many of the Company's other recent business
acquisitions, have a long history of operating successfully and profitably and
hold significant market positions in the majority of their product lines. Their
products are not subject to rapid technological or functional obsolescence.
These factors, coupled with continuous strong product demand, support the
recorded values of the goodwill and intangible assets related to acquired
businesses.

Long-lived assets, other than goodwill and indefinite life intangible assets,
are reviewed for impairment whenever events or changes in circumstances indicate
the carrying amount may not be recoverable. Events or circumstances that would
result in an impairment review primarily include operations reporting losses, a
significant adverse change in the use of an asset, the planned disposal or sale
of the asset, a significant adverse change in the business climate or legal
factors related to the asset, or a significant decrease in the estimated fair
value of an asset. The asset would be considered impaired when the estimated
future net undiscounted cash flows generated by the asset are less than its
carrying value. An impairment loss would be recognized based on the amount by
which the carrying value of the asset exceeds its fair value.

INCOME TAX ASSETS & LIABILITIES

Deferred income tax assets and liabilities have been recorded for the
differences between the financial accounting and income tax basis of assets and
liabilities, and for certain United States and non-United States tax loss
carryforwards and income tax credit carryforwards. Recorded deferred income tax
assets and liabilities are described in detail in "Income Taxes" in the Notes to
the Consolidated Financial Statements. Significant factors considered by
management in the determination of the probability of the realization of
deferred tax assets include historical operating results, expectations of future
earnings and taxable income, and the extended period of time over which certain
temporary differences will reverse. A valuation allowance of $280 has been
recognized for certain deferred income tax assets at December 31, 2008, because
management believes there is a low probability of the realization of deferred
income tax assets related to certain United States Federal income tax credit
carryforwards and tax loss carryforwards, most United States state and local
income tax loss carryforwards and income tax credit carryforwards, and most
non-United States tax loss carryforwards and income tax credit carryforwards.

PENSION & OTHER POSTRETIREMENT BENEFIT PLANS

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

The discount rate for United States plans was determined by constructing a
zero-coupon spot yield curve derived from a universe of high-quality bonds as of
the measurement date, which was designed to match the discounted expected
benefit payments. Those bonds rated Aa3 or better by Moody's Investor Services
were included. Callable bonds with explicit call schedules were excluded and
bonds with "make-whole" call provisions were included. 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 are appropriate for each 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 for
selecting the bonds to be used in determining the discount rate.


                                     Page 64

<PAGE>

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 $23 effect on pension expense. Likewise, a 1-percentage point change in the
discount rate is estimated to have approximately a $33 effect on pension
expense. A 1-percentage point change in the discount rate is estimated to have
approximately a $2 effect on expense for other postretirement benefit plans.
Additional information related to changes in key assumptions used to recognize
expense for other postretirement benefit plans is found in "Retirement Benefit
Plans" in the Notes to the Consolidated Financial Statements.

STOCK OPTIONS GRANTED TO EMPLOYEES & DIRECTORS

Application of the Black-Scholes option pricing model involves assumptions that
are judgmental and affect compensation expense. Historical information was the
primary basis for the selection of expected volatility, expected option life,
and expected dividend yield. Expected volatility was based on the most recent
historical period equal to the expected life of the option. The risk-free
interest rate was based on yields of U.S. Treasury zero-coupon issues with a
term equal to the expected life of the option, on the date the stock options
were granted.

FAIR VALUE

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." This
Statement defines fair value for financial and non-financial assets and
liabilities, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. The guidance applies to other
accounting pronouncements that require or permit fair value measurements. In
2008, Eaton adopted the provisions of SFAS No. 157 for financial assets and
liabilities and for non-financial assets recognized or disclosed at fair value
in the financial statements on a recurring basis (at least annually). These
financial assets and liabilities primarily include short and long-term
investments, derivative financial instruments, assets related to defined benefit
pension plans, and financial assets and liabilities related to acquired
businesses. The adoption of this Statement in 2008 had an immaterial effect on
Eaton's consolidated financial position and results of operations.

In 2009, Eaton must adopt the provisions of SFAS No. 157 for other non-financial
assets and liabilities, primarily goodwill, intangible assets, non-financial
assets and liabilities related to acquired businesses and impairment and
restructuring activities. In 2009, this Statement is not expected to have a
material effect on Eaton's consolidated financial position or results of
operations.

In determining fair value, Eaton uses various valuation techniques and
prioritizes the use of observable inputs. The availability of observable inputs
varies from instrument to instrument and depends on a variety of factors
including the type of instrument, whether the instrument is actively traded and
other characteristics specific to the instrument. Eaton assesses the inputs used
to measure fair value using a three-tier hierarchy based on the extent to which
inputs used in measuring fair value are observable in the market. Level 1 inputs
include quoted prices in active markets for identical instruments. Level 2
inputs include quoted prices in active markets for similar instruments. Level 3
inputs are not observable in the market and include management's judgments about
the assumptions market participants would use in the pricing the asset or
liability, however, Eaton does not currently have any instruments valued with
Level 3 inputs. The use of inputs is reflected in the hierarchy assessment
disclosed in the "Financial Assets & Liabilities Measured at Fair Value" in the
Notes to the Consolidated Financial Statements. Eaton's fair value processes
include controls that are designed to ensure that fair values are appropriate.
Such controls include model valuation, review of key inputs, analysis of
fluctuations between periods, and reviews by senior management.

PROTECTION OF THE ENVIRONMENT

As a result of past operations, Eaton is involved in remedial response and
voluntary environmental remediation at a number of sites, including certain of
its currently-owned or formerly-owned plants. The Company has also been named a
potentially responsible party (PRP) under the Federal Superfund law at a number
of waste disposal sites.

A number of factors affect the cost of environmental remediation, including the
number of parties involved at a particular site, the determination of the extent
of contamination, the length of time the remediation may require, the complexity
of environmental regulations, and the continuing advancement of remediation
technology. Taking these factors into account, Eaton has estimated the costs of


                                     Page 65

<PAGE>

remediation, which will be incurred over a period of several years. The Company
accrues an amount on an undiscounted basis, consistent with the estimates of
these costs, when it is probable that a liability has been incurred. At December
31, 2008, the balance sheet included a liability for these costs of $85. All of
these estimates are forward-looking statements and, given the inherent
uncertainties in evaluating environmental exposures, actual results can differ
from these estimates.

CONTINGENCIES

Eaton is subject to a broad range of claims, administrative proceedings,
and legal proceedings, such as lawsuits that relate to contractual
allegations, patent infringement, personal injuries (including asbes-
tos claims) and employment-related matters. Although it is not pos-
sible to predict with certainty the outcome or cost of these matters,
the Company believes that these matters will not have a material ad-
verse effect on its financial position, results of operations or cash flows.

OFF-BALANCE SHEET ARRANGEMENTS

Eaton does not have off-balance sheet arrangements or financings with
unconsolidated entities or other persons. In the ordinary course of business,
the Company leases certain real properties and equipment, as described in "Lease
Commitments" in the Notes to the Consolidated Financial Statements. Transactions
with related parties are in the ordinary course of business, are conducted on an
arm's-length basis, and are not material to Eaton's financial position, results
of operations or cash flows.

MARKET RISK DISCLOSURE

The Company is exposed to various changes in financial market conditions,
including fluctuations in interest rates, foreign currency exchange rates, and
commodity prices. Eaton manages exposure to such risks through normal operating
and financing activities.

Financial instruments used by Eaton are straightforward, non-leveraged
instruments. The counterparties to these 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.

Eaton monitors the third-party depository institutions that hold its cash and
short-term investments on a daily basis. Its emphasis is primarily on safety of
principal and secondarily on maximizing yield on those funds. Eaton diversifies
its cash and short-term investments among counterparties to minimize exposure to
any one of these entities. Eaton also monitors the creditworthiness of its
customers and suppliers to mitigate any adverse impact on Eaton.

Eaton's ability to access the commercial paper market, and the related cost of
these borrowings, is related to the strength of its credit rating and overall
market conditions. To date, Eaton has not experienced any material limitations
in its ability to access these sources of liquidity. At December 31, 2008, Eaton
had $1.7 billion of long-term revolving credit facilities with banks in support
of its commercial paper program, as discussed above. It has no direct borrowings
outstanding under these credit facilities.

Interest rate risk can be measured by calculating the near-term earnings impact
that would result from adverse changes in interest rates. This exposure results
from short-term debt, which includes commercial paper at a floating interest
rate, long-term debt that has been swapped to floating rates, and money market
investments that have not been swapped to fixed rates. A 100 basis point
increase in short-term interest rates would increase the Company's net, pretax
interest expense by approximately $13.

Eaton also measures interest rate risk by estimating the net amount by which the
fair value of the Company's financial liabilities would change as a result of
movements in interest rates. Based on Eaton's best estimate for a hypothetical,
immediate 100 basis point decrease in interest rates at December 31, 2008, the
market value of the Company's debt and interest rate swap portfolio, in
aggregate, would increase by $125.

Foreign currency risk is the risk that Eaton will incur economic losses due to
adverse changes in foreign currency exchange rates. The Company mitigates
foreign currency risk by funding some investments in foreign markets through
local currency financings. Such non-U.S. Dollar debt was $163 at December


                                     Page 66

<PAGE>

31, 2008. To augment Eaton's non-U.S. Dollar debt portfolio, the Company also
enters into forward foreign exchange contracts and foreign currency swaps from
time to time to mitigate the risk of economic loss in its foreign investments
due to adverse changes in exchange rates. At December 31, 2008, the aggregate
balance of such contracts was $313. Eaton also monitors exposure to transactions
denominated in currencies other than the functional currency of each country in
which the Company operates, and regularly enters into forward contracts to
mitigate that exposure. In the aggregate, Eaton's portfolio of forward contracts
related to such transactions was not material to its financial position, results
of operations or cash flows during 2008.

Other than the above noted debt and financial derivative arrangements, there
were no material derivative instrument transactions in place or undertaken
during 2008.

CONTRACTUAL OBLIGATIONS

A summary of contractual obligations as of December 31, 2008 follows:

<TABLE>
<CAPTION>
                                         2010    2012
                                          to      to     After
                                 2009    2011    2013     2013     Total
                                ------   ----   ------   ------   ------
<S>                             <C>      <C>    <C>      <C>      <C>
Long-term debt                  $  269   $285   $  621   $2,284   $3,459
Interest expense related to
   long-term debt                  170    316      278    1,324    2,088
Reduction of interest
   expense from interest rate
   swap agreements related
   to long-term debt               (22)   (53)     (49)    (182)    (306)
Operating leases                   117    170       86       54      427
Purchase obligations               547    120       60       34      761
Other long-term liabilities        286     28       27       65      406
                                ------   ----   ------   ------   ------
                                $1,367   $866   $1,023   $3,579   $6,835
                                ======   ====   ======   ======   ======
</TABLE>

Long-term debt includes obligations under capital leases, which are not
material. Interest expense related to long-term debt is based on the fixed
interest rate, or other applicable interest rate related to the debt instrument,
at December 31, 2008. The reduction of interest expense due to interest rate
swap agreements related to long-term debt is based on the difference in the
fixed interest rate the Company receives from the swap, compared to the floating
interest rate the Company pays on the swap, at December 31, 2008. Purchase
obligations are entered into with various vendors in the normal course of
business. These amounts include commitments for purchases of raw materials,
outstanding non-cancelable purchase orders, releases under blanket purchase
orders and commitments under ongoing service arrangements. Other long-term
liabilities include $271 of contributions to pension plans in 2009 and $126 of
deferred compensation earned under various plans for which the participants have
elected to receive disbursement at a later date. The table above does not
include future expected pension benefit payments or expected other
postretirement benefit payments for each of the next five years and the five
years thereafter. Information related to the amounts of these future payments is
described in "Retirement Benefit Plans" in the Notes to the Consolidated
Financial Statements. The table above also excludes the liability for
unrecognized income tax benefits, since the Company cannot predict with
reasonable reliability the timing of cash settlements with the respective taxing
authorities. At December 31, 2008, the gross liability for unrecognized income
tax assets totaled $139, including interest and penalties of $38.


                                     Page 67

<PAGE>

RESULTS OF OPERATIONS - 2007 COMPARED TO 2006

<TABLE>
<CAPTION>
                                                  2007      2006    Increase
                                                -------   -------   --------
<S>                                             <C>       <C>       <C>
Continuing operations
   Net sales                                    $13,033   $12,232       7%
   Gross profit                                   3,651     3,283      11%
      Percent of net sales                         28.0%     26.8%
   Income before income taxes                     1,041       969       7%
   Income after income taxes                    $   959   $   897       7%
Income from discontinued operations                  35        53
                                                -------   -------
Net income                                      $   994   $   950       5%
                                                =======   =======
Net income per Common Share assuming dilution
   Continuing operations                        $  6.38   $  5.87       9%
   Discontinued operations                          .24       .35
                                                -------   -------
                                                $  6.62   $  6.22       6%
                                                =======   =======

Return on Shareholders' equity                       22%       23%
</TABLE>

Sales growth of 7% in 2007 over 2006 consisted of 3% from acquisitions of
businesses, 3% from foreign exchange, and 1% from organic growth. Organic growth
included 2% from outgrowing end markets, offset by a 1 1/2% decline in end
markets, principally due to the anticipated sharp reduction in North American
commercial truck production.

Gross profit increased 11% in 2007 compared to 2006 and improved to 28.0% of net
sales, up from 26.8% of net sales in 2006. These increases were primarily due to
sales growth of 7%; benefits from the Excel 07 program; benefits of integrating
acquired businesses; continued productivity improvements driven by the Eaton
Business System (EBS); and net pretax costs of $154 in 2006 related to the Excel
07 program. The Excel 07 program was a series of actions taken in 2006 intended
to address resource levels and operating performance in businesses that
underperformed in 2005 and businesses that were expected to weaken during second
half 2006 and 2007. The improvements in gross profit in 2007 were partially
offset by higher prices paid for certain raw materials, supplies and basic
metals; and higher acquisition integration charges of $64 in 2007 compared to
$40 in 2006. Overall business segment operating margin in 2007 was a record
12.8%, with the Electrical, Hydraulics and Aerospace businesses representing 65%
of overall segment operating profit.

RESULTS BY GEOGRAPHIC REGION

Net sales and segment operating profit are measured based on the geographic
location of the selling plant.

<TABLE>
<CAPTION>
                          Net sales             Segment operating profit    Operating margin
                ----------------------------   --------------------------   ----------------
                  2007      2006    Increase    2007     2006    Increase     2007     2006
                -------   -------   --------   ------   ------   --------   -------   ------
<S>             <C>       <C>       <C>        <C>      <C>      <C>         <C>    <C>
United States   $ 8,556   $ 8,530      --      $1,177   $1,146        3%      13.8%    13.4%
Canada              371       337      10%         54       44       23%      14.6%    13.1%
Europe            2,624     2,313      13%        166       65      155%       6.3%     2.8%
Latin America     1,246     1,090      14%        150      120       25%      12.0%    11.0%
Asia Pacific      1,144       888      29%        121       93       30%      10.6%    10.5%
Eliminations       (908)     (926)
                -------   -------
                $13,033   $12,232       7%
                =======   =======
</TABLE>

In the United States, sales in 2007 were flat compared to 2006. Sales increases
in the Electrical, Aerospace and Hydraulics segments in the U.S. were due to
growth in end markets, as well as the acquisitions of Argo-Tech and other
businesses. This growth in sales was offset by reduced sales in the Truck
segment due to a decline in the U.S. commercial truck market. The 3% increase in
operating profit reflected improved sales and performance in the Electrical,
Aerospace and Automotive segments, partially offset by reduced operating profit
of the Truck segment; benefits of the Excel 07 program; benefits of integrating
acquired businesses; and $69 of net pretax costs in 2006 related to the Excel 07
program. Acquisition integration charges were $27 in 2007 compared to $23 in
2006.

Growth in Canada in 2007 of 10% in sales and 23% in operating profit was
primarily due to higher sales in the Electrical segment, resulting from growth
in end markets and sales from acquired businesses.


                                     Page 68

<PAGE>

Sales growth in Europe in 2007 of 13% was primarily due to higher sales in the
Electrical segment, which reflected the acquisitions of the MGE small systems
UPS business and other businesses, and growth in end markets. Sales growth also
was due to increased sales in the Hydraulics, Automotive and Aerospace segments
largely due to growth in end markets. These sales increases were partially
offset by reduced sales in the Truck segment due to a decline in end markets.
The sharp increase in operating profit of 155% in Europe reflected increased
operating profit in the Automotive and Truck segments, largely due to $77 of net
pretax costs in 2006 related to the Excel 07 program; sales growth; benefits
from the Excel 07 program; and benefits of integrating acquired businesses.
These increases were partially offset by higher acquisition integration charges
of $20 in 2007 compared to $7 in 2006.

In Latin America, growth in 2007 of 14% in sales was largely due to higher sales
in the Truck, Electrical, Hydraulics and Automotive segments, primarily due to
growth in end markets. The 25% increase in operating profit in Latin America was
attributable to higher sales; benefits of the Excel 07 program; an adjustment in
2006 related to Brazilian inventories in the Truck segment; the benefits of
integrating acquired businesses; and Excel 07 program expenses of $5 in 2006.
These increases were partially offset by higher acquisition integration charges
of $12 in 2007 compared to $6 in 2006, and a gain on the sale of the Brazilian
battery business in 2006.

Growth in Asia Pacific in 2007 of 29% in sales and 30% in operating profit was
primarily due to higher sales in the Hydraulics, Electrical, Truck and
Automotive segments, mainly resulting from growth in end markets and
acquisitions of businesses.

OTHER RESULTS OF OPERATIONS

In 2007 and 2006, Eaton incurred charges related to the integration of acquired
businesses. These charges, which consisted of plant consolidations and
integration, were expensed as incurred.

Charges in 2007 related to the integration of primarily the following
acquisitions: in the Electrical segment, the MGE small systems UPS business,
Schreder-Hazemeyer, Senyuan and Powerware; in the Hydraulics segment, Synflex
and Hayward; in the Aerospace segment, Argo-Tech, PerkinElmer and Cobham; and in
the Automotive segment, Saturn and Tractech.

Charges in 2006 related to the integration of primarily the following
acquisitions: in the Electrical segment, Pringle and Powerware; in the
Hydraulics segment, Synflex, Hayward, Winner and Walterscheid; in the Aerospace
segment, PerkinElmer and Cobham; in the Truck segment, Pigozzi; and in the
Automotive segment, Tractech and Morestana.

A summary of these charges follows:

<TABLE>
<CAPTION>
                    2007   2006
                    ----   ----
<S>                 <C>    <C>
Electrical          $ 12   $  7
Hydraulics            12     11
Aerospace             39     12
Truck                         5
Automotive             1      5
                    ----   ----
Pretax charges      $ 64   $ 40
                    ====   ====
After-tax charges   $ 42   $ 27
Per Common Share    $.28   $.17
</TABLE>

Acquisition integration charges in 2007 included $27 for the United States, $20
for Europe, $12 for Latin America and $5 for Asia Pacific. Charges in 2006
included $23 for the United States, $7 for Europe, $6 for Latin America and $4
for Asia Pacific. 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 segment.

In the first quarter of 2006, Eaton announced, and began to implement, its Excel
07 program. This program was a series of actions concluded in 2006 intended to
address resource levels and operating performance in businesses that
under-performed in 2005, and businesses that were expected to weaken during
second half 2006 and in 2007. As part of this program, charges were incurred
related to plant closings in five business segments. The net costs of this
program included plant closings, as well as costs of relocating product lines
and other employee reductions, partially offset by savings generated


                                     Page 69

<PAGE>

from these actions. A summary of the net costs incurred by each segment related
to this program follows:

<TABLE>
<CAPTION>
                 2006
                 ----
<S>              <C>
Electrical       $ 17
Hydraulics          7
Aerospace           1
Truck              60
Automotive         67
Corporate           2
                 ----
Pretax charges   $154
                 ====
</TABLE>

Excel 07 net costs incurred in 2006 included $69 for the United States, $77 for
Europe, $5 for Latin America, $2 for Asia Pacific, and $1 for Canada. The net
costs associated with the Excel 07 program were included in the Statements of
Consolidated Income primarily in Cost of products sold. In Business Segment
Information, the charges reduced Operating profit of the related segment.

In 2007 and 2006, Eaton recorded income tax benefits of $57 and $90,
respectively, which represented adjustments of worldwide tax liabilities. The
2007 income tax benefits reduced the effective income tax rate for 2007 from
13.4% to 7.9%. The 2007 income tax benefits resulted from multiple income tax
items. Included in the tax benefits were a $14 benefit from changes to state tax
laws and a favorable revaluation of worldwide deferred tax assets. The income
tax benefits for 2006 reduced the effective income tax rate for 2006 from 16.7%
to 7.4%. Further analysis regarding the change in the effective income tax rate
in 2007 compared to 2006 is found in "Income Taxes" in the Notes to the
Consolidated Financial Statements.

Effective January 1, 2007, Eaton adopted FASB Interpretation (FIN) No. 48,
"Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 109." The net income tax assets recognized under FIN No. 48 at
January 1, 2007 did not differ from the net assets recognized before adoption,
and, therefore, the Company did not record a cumulative-effect adjustment
related to the adoption of FIN No. 48. The adoption of FIN No. 48 is further
discussed in "Income Taxes" in the Notes to the Consolidated Financial
Statements.

In the third quarter of 2007, Eaton sold the Mirror Controls Division of the
Automotive segment for $111, resulting in a $20 after-tax gain, or $.12 per
Common Share. In the third quarter of 2006, certain other businesses of the
Automotive segment were sold for $64, resulting in a $35 after-tax gain, or $.23
per share. The gains on sale of the Mirror Controls Division and the businesses
sold in 2006, and other results of these businesses, are reported as
Discontinued operations in the Statement of Consolidated Income.

Net income and net income per Common Share assuming dilution for 2007 increased
5% and 6%, respectively, compared to 2006. The improvements in 2007 were
primarily due to higher sales and the other factors that affected gross profit
as discussed above, partially offset by increases in selling, administrative,
and research and development expenses; higher interest expense; a contribution
to the Eaton Charitable Fund; and a lower after-tax gain on the sale of certain
businesses of the Automotive segment in 2007 compared to a similar gain in 2006,
which were reported as Discontinued operations in the Statements of Consolidated
Income. Earnings per share in 2007 also benefited from a lower number of shares
outstanding due to the repurchase of Common Shares in 2007 and 2006 exceeding
shares issued from exercises of stock options. Return on Shareholders' equity
was 22%.

RESULTS BY BUSINESS SEGMENT

ELECTRICAL

<TABLE>
<CAPTION>
                    2007     2006    Increase
                   ------   ------   --------
<S>                <C>      <C>      <C>
Net sales          $4,759   $4,184      14%
Operating profit      579      474      22%
Operating margin     12.2%    11.3%
</TABLE>

Of the 14% sales increase in 2007 over 2006, 8% was due to organic growth; 3%
was from acquisitions of businesses, primarily the MGE small systems UPS
business; and 3% from foreign exchange. End markets for the Electrical segment
grew about 9% during 2007. The non-residential electrical and power


                                     Page 70

<PAGE>

quality markets recorded strong growth, offset by the decline in the U.S.
residential electrical market, which was negatively impacted by weakness in U.S.
housing starts.

Operating profit rose 22% in 2007 over 2006. The operating margin of 12.2% was a
significant improvement over 11.3% in 2006. The increase in operating profit was
largely due to growth in sales; benefits from the Excel 07 program; the benefits
of integrating acquired businesses; continued productivity improvements; and net
pretax costs in 2006 related to the Excel 07 program that were not present in
2007; partially offset by a gain in 2006 on the sale of the Brazilian battery
business. Operating profit reflected acquisition integration charges of $12 in
2007 compared to charges of $7 in 2006, which reduced the operating margin by
0.3% in 2007 and 0.2% in 2006. Acquisition integration charges in 2007 primarily
related to the integration of the MGE small systems UPS business,
Schreder-Hazemeyer, Senyuan and Powerware, while charges in 2006 related to the
integration of Pringle and Powerware. Net pretax costs of $17 related to the
Excel 07 program in 2006 reduced the operating margin by 0.4%. The incremental
operating margin for 2007 (the increase in operating profit compared to the
increase in sales) was 18%. The operating margin for acquired businesses was
13%.

New businesses acquired during 2007 in the Electrical segment include the
following:

-    On October 31, 2007, the Company acquired the MGE small systems UPS
     business from Schneider Electric. This business is a France-based global
     provider of power quality solutions including uninterruptible power supply
     (UPS) systems, power distribution units, static transfer switches and surge
     suppressors, and had sales of $245 for 2007.

-    On October 19, 2007, Eaton acquired the assets of Babco Electric Group, an
     Alberta, Canada-based manufacturer of specialty low- and medium-voltage
     switchgear and electrical housings for use in the Canadian oil and gas
     industry and other harsh environments. This business had sales of $11 in
     2007.

-    On June 19, 2007, Eaton acquired Pulizzi Engineering, a U.S. manufacturer
     of AC power distribution, AC power sequencing, redundant power and
     remote-reboot power management systems. This business had sales of $12 in
     2006.

-    On May 18, 2007, the Company acquired technology and related assets of SMC
     Electrical Products, Inc.'s industrial medium-voltage adjustable frequency
     drive business.

-    On April 5, 2007, Eaton acquired Aphel Technologies Limited, a U.K.-based
     global supplier of high density, fault-tolerant power distribution
     solutions for datacenters, technical offices, laboratories and retail
     environments. This business had sales of $12 in 2006.

-    On February 7, 2007, the Company acquired the Power Protection Business of
     Power Products Ltd., a Czech Republic distributor and service provider of
     Powerware(R) products and other uninterruptible power supply (UPS) systems.
     This business had sales of $3 in 2006.

HYDRAULICS

<TABLE>
<CAPTION>
                    2007     2006    Increase
                   ------   ------   --------
<S>                <C>      <C>      <C>
Net sales          $2,391   $2,203       9%
Operating profit      265      221      20%
Operating margin     11.1%    10.0%
</TABLE>

The 9% increase in sales in 2007 over 2006 consisted of 4% from organic growth;
3% from foreign exchange; and 2% from acquisitions of businesses. Hydraulics
markets grew 3% in 2007 compared to 2006.

Operating profit rose 20% in 2007 over 2006. The operating margin was 11.1%. The
increase in operating profit was due to growth in sales, including a more
profitable mix of businesses; benefits from the Excel 07 program; the benefits
of integrating acquired businesses; overall improvement in operating
efficiencies; and net pretax costs in 2006 related to the Excel 07 program that
were not present in 2007. Operating profit reflected acquisition integration
charges of $12 in 2007 compared to charges of $11 in 2006, which reduced the
operating margin by 0.5% in both 2007 and 2006. The acquisition integration
charges in 2007 primarily related to the acquired operations of Synflex and
Hayward. Charges in 2006 largely related to the acquired operations of Synflex,
Hayward, Winner and Walterscheid. Net pretax


                                     Page 71

<PAGE>

costs of $7 in 2006 related to the Excel 07 program reduced the operating margin
by 0.3%. The incremental operating margin for 2007 was 23%. The operating margin
for acquired businesses was 13% in 2007.

On November 8, 2007, Eaton acquired Arrow Hose & Tubing Inc. This business is a
Canada-based manufacturer of specialty thermoplastic hose and tubing for the
industrial, food and beverage, and agricultural markets. This business had sales
of $12 in 2006.

AEROSPACE

<TABLE>
<CAPTION>
                    2007     2006    Increase
                   ------   ------   --------
<S>                <C>      <C>      <C>
Net sales          $1,594   $1,295      23%
Operating profit      233      182      28%
Operating margin     14.6%    14.1%
</TABLE>

The 23% increase in sales in 2007 over 2006 consisted of 15% from acquisitions
of businesses, primarily the Argo-Tech aerospace business; 6% from organic
growth; and 2% from foreign exchange. Aerospace markets grew 4% in 2007 compared
to 2006.

Operating profit rose 28% in 2007 over 2006. The increase in operating profit
was due to growth in sales; the benefits of integrating acquired businesses; and
overall improvement in operating efficiencies. Operating profit reflected
acquisition integration charges of $39 in 2007 compared to charges of $12 in
2006, which reduced the operating margin by 2.5% in 2007 and 0.9% in 2006. The
acquisition integration charges in 2007 primarily related to the acquired
operations of Argo-Tech, PerkinElmer and Cobham. Charges in 2006 largely related
to the acquired operations of PerkinElmer and Cobham. Net pretax costs of $1 in
2006 related to the Excel 07 program reduced the operating margin by 0.1%. The
incremental operating margin for 2007 was 17%. The operating margin for acquired
businesses was 30% in 2007.

On March 16, 2007, Eaton acquired Argo-Tech Corporation, a U.S.-based aerospace
business, which had sales of $206 in 2006. Argo-Tech is a leader in high
performance aerospace engine fuel pumps and systems, airframe fuel pumps and
systems, and ground fueling systems for commercial and military aerospace
markets.

TRUCK

<TABLE>
<CAPTION>
                    2007     2006    (Decrease)
                   ------   ------   ----------
<S>                <C>      <C>      <C>
Net sales          $2,147   $2,520      (15)%
Operating profit      357      448      (20)%
Operating margin     16.6%    17.8%
</TABLE>

Sales of the Truck segment decreased 15% in 2007 from 2006. The reduction in
sales reflected an 18% decline in sales volume, offset by a 3% increase from
foreign exchange. The decline in sales was due to a reduction in North American
commercial truck production in 2007 from 2006, with North American heavy-duty
truck production down 44%, and North American medium-duty production down 31%.
Brazilian vehicle production was up 17%, Brazilian agricultural equipment
production was up 41%, and European medium-duty truck production was down 2%
compared to 2006.

Operating profit decreased 20% in 2007 from 2006, primarily due to the reduction
in sales, partially offset by the benefits from the Excel 07 program, net pretax
costs in 2006 related to the Excel 07 program, and an adjustment in 2006 to
Brazilian inventories. The operating margin was 16.6% in 2007, down 1.2
percentage points from 17.8% in 2006. Operating profit in 2006 was reduced by
acquisition integration charges of $5 related to Pigozzi, which reduced the
operating margin by 0.2% in 2006; and net pretax costs of $60 related to the
Excel 07 program in 2006, which reduced the operating margin by 2.4%.

AUTOMOTIVE

<TABLE>
<CAPTION>
                    2007     2006    Increase
                   ------   ------   --------
<S>                <C>      <C>      <C>
Net sales          $2,142   $2,030       6%
Operating profit      234      143      64%
Operating margin     10.9%     7.0%
</TABLE>


                                     Page 72

<PAGE>

The 6% increase in sales of the Automotive segment in 2007 over 2006 reflected a
4% increase from foreign exchange, 1% from organic growth, and 1% from
acquisitions of businesses. In 2007, North American automotive production
declined by 2%, while European production grew 7%.

Operating profit in 2007 increased $91 over 2006, largely due to $67 of net
pretax costs in 2006 related to the Excel 07 program, benefits from the Excel 07
program in 2007, and sales growth in 2007. Operating profit reflected
acquisition integration charges of $1 in 2007 compared to charges of $5 in 2006,
which reduced the operating margin by 0.1% in 2007 and 0.3% in 2006. Acquisition
integration charges in 2007 primarily related to the integration of Saturn and
Tractech, while charges in 2006 related to the integration of Tractech and
Morestana. Net pretax costs of $67 related to the Excel 07 program in 2006
reduced the operating margin by 3.3%.

On May 2, 2007, Eaton acquired the fuel components division of Saturn
Electronics & Engineering, Inc., a U.S. designer and manufacturer of fuel
containment and shutoff valves, emissions control valves and specialty
actuators. This business had sales of $28 in 2006.

In the third quarter of 2007, Eaton sold the Mirror Controls Division of the
Automotive segment for $111, resulting in a $20 after-tax gain, or $.12 per
Common Share. In the third quarter of 2006, certain other businesses of the
Automotive segment were sold for $64, resulting in a $35 after-tax gain, or $.23
per share. The gains on sale of the Mirror Controls Division and the businesses
sold in 2006, and other results of these businesses, are reported as
Discontinued operations in the Statement of Consolidated Income.

CORPORATE

Amortization of intangible assets of $79 in 2007 increased from $51 in 2006 due
to amortization of intangible assets associated with recently acquired
businesses.

Interest expense of $147 in 2007 increased from $105 in 2006, primarily due to
borrowings to finance cash paid of $1,433 for acquisitions of businesses in
2007.

In 2007, corporate expense of $16 was recorded for a contribution to the Eaton
Charitable Fund.


                                    Page 73
<PAGE>

QUARTERLY DATA

<TABLE>
<CAPTION>
                                                 Quarter ended in 2008                   Quarter ended in 2007
                                       --------------------------------------   --------------------------------------
(Millions except for per share data)   Dec. 31   Sept. 30   June 30   Mar. 31   Dec. 31   Sept. 30   June 30   Mar. 31
------------------------------------   -------   --------   -------   -------   -------   --------   -------   -------
<S>                                    <C>       <C>        <C>       <C>       <C>       <C>        <C>       <C>
Continuing operations
   Net sales                            $3,487    $4,114     $4,279    $3,496   $ 3,374    $ 3,298    $3,248    $3,113
   Gross profit                            861     1,150      1,210       964       946        917       902       886
      Percent of net sales                24.7%     28.0%      28.3%     27.6%     28.0%      27.8%     27.8%     28.5%
   Income before income taxes              134       354        354       286       259        263       256       263
   Income after income taxes            $  163    $  315     $  333    $  244   $   252    $   238    $  240    $  229
Income from discontinued
   operations                                                               3         4         20         6         5
                                        ------    ------     ------    ------   -------    -------    ------    ------
Net income                              $  163    $  315     $  333    $  247   $   256    $   258    $  246    $  234
                                        ======    ======     ======    ======   =======    =======    ======    ======
Net income per Common Share
   outstanding assuming dilution
   Continuing operations                $  .98    $ 1.87     $ 2.03    $ 1.62   $  1.67    $  1.59    $ 1.60    $ 1.53
   Discontinued operations                                                .02       .04        .12       .04       .03
                                        ------    ------     ------    ------   -------    -------    ------    ------
                                        $  .98    $ 1.87     $ 2.03    $ 1.64   $  1.71    $  1.71    $ 1.64    $ 1.56
                                        ======    ======     ======    ======   =======    =======    ======    ======
Net income per Common Share basic
   Continuing operations                $  .98    $ 1.90     $ 2.07    $ 1.65   $  1.71    $  1.62    $ 1.63    $ 1.56
   Discontinued operations                                                .02       .03        .13       .04       .03
                                        ------    ------     ------    ------   -------    -------    ------    ------
                                        $  .98    $ 1.90     $ 2.07    $ 1.67   $  1.74    $  1.75    $ 1.67    $ 1.59
                                        ======    ======     ======    ======   =======    =======    ======    ======
Cash dividends paid per
Common Share                            $  .50    $  .50     $  .50    $  .50   $   .43    $   .43    $  .43    $  .43
Market price per Common Share
   High                                 $54.58    $84.33     $96.69    $96.18   $101.26    $102.55    $94.15    $85.53
   Low                                   38.78     53.77      78.94     77.55     85.29      85.12     83.85     73.80
</TABLE>

Earnings per Common Share for the four quarters in a year may not equal full
year earnings per share.


                                    Page 74

<PAGE>

TEN-YEAR CONSOLIDATED FINANCIAL SUMMARY

<TABLE>
<CAPTION>
(Millions except for per share data)     2008      2007      2006      2005     2004     2003     2002     2001     2000     1999
------------------------------------   -------   -------   -------   -------   ------   ------   ------   ------   ------   ------
<S>                                    <C>       <C>       <C>       <C>       <C>      <C>      <C>      <C>      <C>      <C>
Continuing operations
   Net sales                           $15,376   $13,033   $12,232   $10,874   $9,547   $7,796   $6,983   $7,092   $8,103   $7,789
   Income before income taxes            1,128     1,041       969       964      749      463      364      249      520      911
   Income after income taxes           $ 1,055   $   959   $   897   $   783   $  626   $  356   $  258   $  150   $  342   $  582
      Percent of net sales                 6.9%      7.4%      7.3%      7.2%     6.6%     4.6%     3.7%     2.1%     4.2%     7.5%
Income from discontinued
   operations                                3        35        53        22       22       30       23       19      111       35
                                       -------   -------   -------   -------   ------   ------   ------   ------   ------   ------
Net income                             $ 1,058   $   994   $   950   $   805   $  648   $  386   $  281   $  169   $  453   $  617
                                       =======   =======   =======   =======   ======   ======   ======   ======   ======   ======
Net income per Common Share
assuming dilution
   Continuing operations               $  6.50   $  6.38   $  5.87   $  5.08   $ 3.99   $ 2.36   $ 1.80   $ 1.07   $ 2.36   $ 3.94
   Discontinued operations                 .02       .24       .35       .15      .14      .20      .16      .13      .76      .24
                                       -------   -------   -------   -------   ------   ------   ------   ------   ------   ------
                                       $  6.52   $  6.62   $  6.22   $  5.23   $ 4.13   $ 2.56   $ 1.96   $ 1.20   $ 3.12   $ 4.18
                                       =======   =======   =======   =======   ======   ======   ======   ======   ======   ======
Average number of Common Shares
outstanding assuming dilution            162.3     150.3     152.9     154.0    157.1    150.5    143.4    141.0    145.2    147.4
Net income per Common Share basic
   Continuing operations               $  6.58   $  6.51   $  5.97   $  5.21   $ 4.10   $ 2.40   $ 1.82   $ 1.08   $ 2.39   $ 4.02
   Discontinued operations                 .02       .24       .35       .15      .14      .21      .17      .14      .77      .24
                                       -------   -------   -------   -------   ------   ------   ------   ------   ------   ------
                                       $  6.60   $  6.75   $  6.32   $  5.36   $ 4.24   $ 2.61   $ 1.99   $ 1.22   $ 3.16   $ 4.26
                                       =======   =======   =======   =======   ======   ======   ======   ======   ======   ======
Average number of Common Shares
outstanding basic                        160.2     147.3     150.2     150.2    153.1    147.9    141.2    138.8    143.6    145.0
Cash dividends paid per
Common Share                           $  2.00   $  1.72   $  1.48   $  1.24   $ 1.08   $  .92   $  .88   $  .88   $  .88   $  .88
                                       -------   -------   -------   -------   ------   ------   ------   ------   ------   ------
Total assets                           $16,655   $13,430   $11,417   $10,218   $9,075   $8,223   $7,138   $7,646   $8,180   $8,342
Long-term debt                           3,190     2,432     1,774     1,830    1,734    1,651    1,887    2,252    2,447    1,915
Total debt                               4,271     3,417     2,586     2,464    1,773    1,953    2,088    2,440    3,004    2,885
Shareholders' equity                     6,317     5,172     4,106     3,778    3,606    3,117    2,302    2,475    2,410    2,624
Shareholders' equity per
   Common Share                        $ 38.28   $ 35.42   $ 28.07   $ 25.44   $23.52   $20.37   $16.30   $17.80   $17.64   $17.72
Common Shares outstanding                165.0     146.0     146.3     148.5    153.3    153.0    141.2    139.0    136.6    148.0
                                       -------   -------   -------   -------   ------   ------   ------   ------   ------   ------
</TABLE>


                                     Page 75

<PAGE>

                                EATON CORPORATION
                         2008 ANNUAL REPORT ON FORM 10-K
                                 EXHIBITS INDEX

3 (i)  Amended Articles of Incorporation (amended and restated as of April 24,
       2008) - Incorporated by reference to the Form 10-Q Report for the three
       months ended March 31, 2008

3 (ii) Amended Regulations (amended and restated as of April 23, 2008) -
       Incorporated by reference to the Form 10-Q Report for the three months
       ended March 31, 2008

4 (a)  Pursuant to Regulation S-K Item 601(b) (4), the Company agrees to
       furnish to the SEC, upon request, a copy of the instruments defining the
       rights of holders of its other long-term debt

10 Material contracts

     (a)  Tender Offer for all of the shares of Phoenixtec Power Company Ltd.
          announced on December 20, 2007 - Incorporated by reference to the Form
          10-K Report for the year ended December 31, 2007

     (b)  Share Purchase Agreement between Green Beta S.a.r.l. and Eaton
          Corporation dated December 20, 2007 - Incorporated by reference to the
          Form 10-K Report for the year ended December 31, 2007

     (c)  Senior Executive Incentive Compensation Plan (effective January 1,
          2008) - Incorporated by reference to the definitive Proxy Statement
          dated March 14, 2008

     (d)  Executive Incentive Compensation Plan (effective January 1, 2005) -
          Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2005

     (e)  2005 Non-Employee Director Fee Deferral Plan (2008 restatement) -
          Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2007

     (f)  Deferred Incentive Compensation Plan II (2008 restatement) -
          Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2007

     (g)  Excess Benefits Plan II (2008 restatement) - Incorporated by reference
          to the Form 10-K Report for the year ended December 31, 2007

     (h)  Incentive Compensation Deferral Plan II (2008 restatement) -
          Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2007

     (i)  Limited Eaton Service Supplemental Retirement Income Plan II (2008
          restatement) - Incorporated by reference to the Form 10-K Report for
          the year ended December 31, 2007

     (j)  Supplemental Benefits Plan II (2008 restatement) - Incorporated by
          reference to the Form 10-K Report for the year ended December 31, 2007

     (k)  Form of Restricted Share Unit Agreement (2 year vesting) -
          Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2007

     (l)  Form of Restricted Share Unit Agreement (4 year vesting) -
          Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2007

     (m)  Form of Restricted Share Agreement (2 year vesting) - Incorporated by
          reference to the Form 10-K Report for the year ended December 31, 2007


                                    Page 76

<PAGE>

     (n)  Form of Restricted Share Agreement (4 year vesting) - Incorporated by
          reference to the Form 10-K Report for the year ended December 31, 2007

     (o)  Form of Restricted Share Agreement (Non-Employee Directors) -
          Incorporated by Reference to the Form 8-K Report filed January 28,
          2009

     (p)  Form of Stock Option Agreement for Executives (2008) - Incorporated by
          reference to the Form 10-K Report for the year ended December 31, 2007

     (q)  Form of Stock Option Agreement for Executives - Incorporated by
          reference to the Form 10-K Report for the year ended December 31, 2006

     (r)  Form of Stock Option Agreement for Non-Employee Directors (2008) -
          Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2007

     (s)  2002 Stock Plan - Incorporated by reference to the definitive Proxy
          Statement dated March 15, 2002

     (t)  2004 Stock Plan - Incorporated by reference to the definitive Proxy
          Statement dated March 19, 2004

     (u)  2008 Stock Plan - Incorporated by reference to the definitive Proxy
          Statement dated March 14, 2008

     (v)  Plan for the Deferred Payment of Directors' Fees (originally adopted
          in 1985 and amended effective September 24, 1996, January 28, 1998,
          January 23, 2002, February 24, 2004, December 8, 2004 and, in certain
          respects, January 1, 2005) - Incorporated by reference to the Form
          10-K Report for the year ended December 31, 2007

     (w)  1996 Non-Employee Director Fee Deferral Plan (amended and restated
          effective January 1, 2005) - Incorporated by reference to the Form
          10-K Report for the year ended December 31, 2006

     (x)  Form of Change of Control Agreement entered into with officers of
          Eaton Corporation - Filed in conjunction with this Form 10-K Report

     (y)  Form of Indemnification Agreement entered into with officers of Eaton
          Corporation - Incorporated by reference to the Form 10-K Report for
          the year ended December 31, 2002

     (z)  Form of Indemnification Agreement entered into with directors of Eaton
          Corporation - Incorporated by reference to the Form 8-K Report filed
          January 26, 2007

     (aa) Executive Strategic Incentive Plan (amended and restated January 1,
          2008) - Incorporated by reference to the definitive Proxy Statement
          dated March 14, 2008

     (bb) Executive Strategic Incentive Plan II (effective January 1, 2001) -
          Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2002

     (cc) Supplemental Executive Strategic Incentive Plan (effective as of June
          25, 2008) - Filed in conjunction with this Form 10-K Report

     (dd) Deferred Incentive Compensation Plan (amended and restated March 31,
          2000) - Incorporated by reference to the Form 10-K Report for the year
          ended December 31, 2000


                                    Page 77

<PAGE>

     (ee) 1998 Stock Plan - Incorporated by reference to the definitive Proxy
          Statement dated March 13, 1998

     (ff) Incentive Compensation Deferral Plan (amended and restated October 1,
          1997) - Incorporated by reference to the Form 10-K Report for the year
          ended December 31, 2000

     (gg) Trust Agreement - Officers and Employees (dated December 6, 1996) -
          Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2002

     (hh) Trust Agreement - Non-employee Directors (dated December 6, 1996)
          -Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2002

     (ii) Group Replacement Insurance Plan (GRIP) (effective June 1, 1992) -
          Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 1992

     (jj) 1991 Stock Option Plan - Incorporated by reference to the Form 10-K
          Report for the year ended December 31, 2002

     (kk) Excess Benefits Plan (amended and restated effective January 1, 1989)
          -Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2002

     (ll) Supplemental Benefits Plan (amended and restated January 1, 1989) -
          Incorporated by reference to the Form 10-K Report for the year ended
          December 31, 2002

     (mm) Eaton Corporation Board of Directors Policy on Incentive Compensation,
          Stock Options and Other Equity Grants upon the Restatement of
          Financial Results -Incorporated by reference to the Form 10-K Report
          for the year ended December 31, 2007

12   Ratio of Earnings to Fixed Charges - Filed in conjunction with this Form
     10-K Report

14   Code of Ethics - Incorporated by reference to the definitive Proxy
     Statement filed on March 14, 2008

21   Subsidiaries of Eaton Corporation - Filed in conjunction with this Form
     10-K Report

23   Consent of Independent Registered Public Accounting Firm - Filed in
     conjunction with this Form 10-K Report

24   Power of Attorney - Filed in conjunction with this Form 10-K Report

31.1 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act of 2002,
     Section 302) - Filed in conjunction with this Form 10-K Report

31.2 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act of 2002,
     Section 302) - Filed in conjunction with this Form 10-K Report

32.1 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act of 2002,
     Section 906) - Filed in conjunction with this Form 10-K Report

32.2 Certification of Form 10-K (Pursuant to the Sarbanes-Oxley Act of 2002,
     Section 906) - Filed in conjunction with this Form 10-K Report


                                    Page 78