Eaton Corp PLC

Ladies and gentlemen, thank you for standing by and welcome to the Eaton Fourth Quarter Earnings Conference Call. For the conference, all the participant lines are in a listen-only mode. There will be an opportunity for your questions and instructions will be given at that time. If you need any assistance during the call, please press star zero and operator will assist you offline. I'll turn the call now over to Mr. Don Bullock, Senior Vice President of Investor Relations. Please go ahead, sir.

Good morning. For those of you, I'm Don Bullock, Eaton Senior Vice President of Investor Relations. Thank you to all of you for joining us for Eaton's fourth quarter 2018 earnings call. With me today are Craig Arnold, our Chairman and CEO, and Rick Fearon, our Vice Chairman, Chief Financial and Planning Officer. The agenda for today's call includes our opening remarks by Craig highlighting the performance in the fourth quarter, our outlook, and our guidance for 2019. As we've done on our prior calls, we'll be taking questions at the end of Craig's comments today. Before we dive into that, I do want to make a couple of quick passing comments. Press release for our earnings announcement this morning and the presentation will go through, been posted on our website at www.eaton.com. Please note that the press release and the presentation include reconciliations to any non-GAAP measures. And a webcast of the call will be accessible on our website and available for replay after today's call. Before we get started, I do need to remind you that the comments today do include statements related to expected future results of the company and are, therefore, forward-looking statements. Any results that might differ materially from a forecast, it could be due to a wide range of risk and uncertainties, and those are described in the earnings released and the presentation, and they'll be also outlined in our related 10-Q filing. With that, I'll turn it over to Craig.

Okay. Hey, thanks, Don. I'll start on page three with highlights of our Q4 results, and I'll start by saying that I'm very pleased, naturally, with their report this morning and another very strong quarter performance, which really rounded out a solid year overall. Earnings per share of $1.46 a share, up 13% from last year and above the midpoint of our guidance. And this was driven by both strong growth in sales as well as higher margins. Sales are actually $5.5 billion in the quarter, an increase of 5%, and this includes 7% organic growth, and this was above our guidance of 6% for the quarter. Booking's growth in the quarter was also strong, led by double-digit growth in both electrical systems and services and in aerospace. And so we continue to be pleased with our margin performance as well, which increased 100 basis points to 17.4%. We had solid margin performance really across all of the segments and all-time record margins in electrical systems and services and in aerospace. We also generated very strong operating cash flows of $1.1 billion, up 27% and a quarterly record if you exclude the $300 million arbitration payment that we made earlier this year. And lastly, we reported and repurchased $700 million of shares in the quarter taking advantage of what we saw as a significant pullback in financial markets. And if you'll recall, we had planned to purchase $200 to $400 million in the quarter to achieve our target of $800 million to $1 billion for the year. I'd say for now, you can think about this as an acceleration of purchases that we were planning to make in 2019. However, if markets remain weak, we'll certainly take advantage of those opportunities as well and buy at higher levels. Moving to page four, you'll see our financial summary for the quarter. You can read these numbers for sure, but I'll provide maybe just a bit of context here. First, our operating segment profits increased 11%, and we generated strong incrementals of almost 40%. Second, segment margins of 17.4% were at the high end of our guidance range and 100 basis points above Q4 2017, and finally, Our net income, as reported, was flat with prior year, and prior year included income related to the U.S. tax bill. Excluding this one-time benefit from Q4-17, our net income increased 10%. On page 5, we'll start our segment overviews with electrical products. Revenues grew 3% in Q4. This includes 5% of organic growth offset by 2% in currency. And this was really a strong finish to the year, and it was actually our highest organic growth rate for electrical products since Q4 of 2014. As we expected, growth in our lighting business turned positive and was up mid-single digits, while orders increased 3%, and this was led by solid growth in the Americas. I'd also note here that our backlog increased 15%, and while we generally think about this as a book-and-bill business, This increase does suggest that we didn't see any unusual pre-buying at the end of the quarter. Segment margins were 18.2%, flat with prior year, and this was largely a result of some unfavorable product mix between the businesses. Next, we can move to page six, an assembly of our electrical systems and services segment. As I noted in my opening commentary, this segment posted excellent results for the quarter. The business continued to strengthen. We posted 10% organic growth in the quarter with strength across all major end markets. The 10% growth represented an acceleration of growth, which was above our Q3 growth rate of 9% and above the Q2 growth rate, which was up 7%. And as you can see, we did have some negative impact from foreign exchange and a small divestiture during the course of last year. Orders were even stronger, up 12%. on strong growth in all major end markets in the Americas and in EMEA. And I'd say that this strong growth in Q4 was against a very strong comp from last year where orders were up 12%. You'll recall from our Q3 earnings call that we noted a pause in orders during the month of September. We had expected that this was largely project timing and temporary, so things really played out as we expected in this segment. In addition, our backlog continued to increase and was up 13%. So overall, the segment is performing very consistent with what we would expect from this long cycle business. And lastly, segment operating profits were up 19%, and we generated all-time record margins in this segment of 16.6%, so a very strong quarter across the board. If you turn to page seven, we'll summarize the results of our hydraulics business. Here, we had another strong quarter of revenue growth with sales up 6%, 8% organic growth offset by 2% negative currency. And we continued to see strength really in mobile and with industrial OEMs, in construction and ag markets, and in the distribution channel, so pretty broad-based. Orders were down 4%, and I would say here on tough comps, and if you recall Q4 2017, our orders were up 25%. In the quarter, we did, however, see continued strength in Asia with orders up 10%. Orders in the Americas were flat but at very high levels. And we continue to see order weakness in EMEA with orders down some 24% as lead times continue to improve. And I'd also add here, but this was the region where we had our most difficult comp. Orders in Q4 of 2017 were actually up 38%. And so we feel, once again, pretty good overall about, the activity levels in the hydraulics business. Our backlog does remain strong. It increased 6% from last year. And turning to operating profits, we increased profit by 15%, and our operating margins increased 90 basis points to 13%. So I think the right conclusion here is that we made solid progress in this business, which was held back in some prior quarters by some supply chain issues, but that progress needs to continue and is expected to continue going into 2019. On page eight, we move to aerospace. And the business here is clearly firing on all cylinders. And I'll begin by noting that growth continued to accelerate in Q4 with organic revenue growth up 13%. And this is up from 9% growth in Q3 and 6% growth in Q2. Orders also accelerated, increasing 17% with strength in commercial transport, military fighters, and both commercial and military aftermarket. And our backlog continued to grow, up some 13 percent in the quarter. Now, the business here also demonstrated very strong operating leverage with profits increasing 30 percent and delivering record operating margins of 22.9 percent. I would add that favorable mix certainly contributed to these record margins as aftermarket revenues continued to perform well. but our team also is doing an outstanding job of executing. Moving to the vehicle segment on page nine, we're also very pleased with how this segment performed in the quarter. Our revenues were down 2% with flat organic revenues and 2% negative FX. The NAFTA Class A truck market remained very strong in the quarter and reached 324,000 units for 2018, and this is up some 27%. You'll recall here that revenues for our automated truck transmission business are now included in the Eaton Commons joint venture and are not consolidated in our financials. The JV actually had revenue growth of 45% in the quarter, so our business overall is performing extremely well. On the other hand, global light vehicle production was down in Q4, with North America modestly offset by slight declines in Europe and particular weakness, as you've all heard, in China. Despite flat organic revenues, operating profits increased 4%, and our operating margins increased 90 basis points to 17.9%. And finishing up our segment summaries, e-mobility is on page 10. Organic revenue growth was 11%, offset by 1% negative currency. Not unexpected, operating margins declined to 11.3% as we continue to ramp up our R&D spending. You'll recall that this new segment was created in Q1 of last year. At last year's investors meeting, we told you that e-mobility would become a new $2 to $4 billion segment of our company, and I'm pleased to say that we're on track. 2018 was a busy year and a year where we ended ahead of schedule. We're in ongoing discussions with a large number of customers on new programs, and we remain very optimistic about the long-term growth outlook for the business overall. We're ahead of schedule on new product developments. These new products are allowing us to quote on a broader range of opportunities and, quite frankly, to move from selling only components to selling systems. So we remain very excited about the future of this segment and the work that our team is doing and what this represents as a growth opportunity for Eaton as we move forward. And before we turn our attention to 2019, I would like to just take a moment to recap some of the key highlights from 2018, which we see as a strong year of progress. First, you know, end markets improved, allowing us to generate 6% organic revenue growth, and this was double the growth rate of 2017 and above our initial estimate for the year, which was 4%. We continued to make good progress on enhancing our margin performance with 100 basis point improvement and setting an all-time record for the company at 16.8%. As a result, our net income per share of $5.39, when you exclude the 48-cent impact from the legacy Cooper arbitration decision, was up 16% over 2017. And our teams very effectively offset both the impact of tariffs and commodity inflation with incremental price. We generated $3 billion of operating cash flow, and this would exclude the $300 million impact from the arbitration payment. This allowed us to return $2.45 billion to shareholders, $1.15 billion in dividends, and another $1.3 billion of share repurchases. And the $1.3 billion represents 4% of our shares outstanding at the beginning of the year. So overall, very proud of the team. We exceeded our financial commitments to shareholders. We invested in the future of the business and really are building a stronger company. Thank you. Now turning to 2019, let me begin by summarizing our growth outlook. Overall, we're expecting 4% to 5% organic growth, and this is consistent with the outlook that we provided in Q3 2018 during our conference call. As we take a look at our individual businesses, we expect 4% to 5% organic growth in electrical products with continued strength in industrial and large commercial projects. We expect modest growth in lighting and also modest growth in single-phase power quality and small commercial projects. For electrical systems and services, we see 5 to 6 percent organic growth. And here our backlog is very strong. We expect continued market strength in power distribution assemblies in the Americas and in the data center markets globally. We also see modest growth in both the utility and harsh and hazardous markets. For hydraulics, growth is expected to be 5 to 6 percent on revenue levels that are already very strong, but we see continued strength in mobile markets in Asia and in North America. And aerospace markets really are universally strong, and we expect to see 8 to 9 percent growth on strength in OEM and aftermarket, and really with both military and commercial customers. Vehicle markets are expected to be flat for both North America heavy-duty truck and for global light vehicles. But both are running at, I'd say, very high levels. And we expect to see strong growth in the Brazilian truck market. Overall, our organic revenues are expected to be down 2% to 1% for the year. But once again, keep in mind that our revenues for automated truck transmissions are expected to grow and are now a part and reported as a part of the Eaton-Cummins joint venture. Finally, we expect e-mobility to grow 11% to 12% organically consistent with the level of growth that we experienced in 2018. And while we're still a few years away from what we call a major growth inflection point, our optimism for this segment continues to grow as we look forward. Moving on to page 13, we lay out our margin expectations for 2019. For Eaton overall, we expect segment margins to be between 17% and 17.4%. At the midpoint, this represents a 40 basis point improvement over 2018, and it really places us solidly within the 17 to 18% range that we set as a 2020 goal, and I would add one year ahead of schedule. And with the exception of MeMobility, we're investing heavily in product development. Margins are expected to increase in each of our segments, specifically Electrical products at 18.6 to 19.2, a 50 basis point improvement. And electrical systems and services at 15.2 to 15.8, up 60 basis points. Hydraulics at 14 to 14.6, up 90 basis points. Aerospace at a very strong level already, but at 21.4 to 22, up 70 basis points. And vehicle at 17.4 to 18, up 20 basis points. E-mobility, as we noted, we're investing heavily in this segment. Margins will be down to 6.1 to 6.7, some 70 basis points, really just as a function of heavy R&D investment. And on page 14, we pick up the balance of our guidance for 2019. So we expect our full-year EPS to be $5.70 to $6 a share. At the midpoint, this represents a 9% increase. excluding the impact of the arbitration decision that reduced 2018 earnings by some $0.48. As we discussed, organic revenue is expected to be up 4% to 5%, but this growth is expected to be partially offset by some $250 million of negative currency translation. We expect our corporate costs, including pension and interest and other corporate items, to be flat with 2018 and our tax rate to be between 14% and 16%. This will result in operating cash flows coming in between $3.1 billion and $3.3 billion, and we expect CapEx to be $600 million. As I noted, we accelerated some $400 million of share repurchases into Q4. So the target purchases for 2019 are now at $400 million. And for Q1, we expect EPS to be between $1.18 and $1.28, a 12% increase at the midpoint. And for Q1, we also expect organic growth to be approximately 4%, to have segment margins between 15.5% and 15.9%, and a tax rate of between 13% and 14%. So overall, we expect another strong year. And I'd say, Don, this concludes my opening comments, and I'll hand it back to you, and you can open the lines for Q&A.