Eaton Corp PLC

Ladies and gentlemen, thank you for your patience and holding, and welcome to the Eaton Second Quarter Earnings Call. At this time, all participant phone lines are in a listen-only mode, and later there'll be an opportunity for question. Just a brief reminder, today's conference is being recorded. If you'd like to queue up for a question at any point during the presentation, you can always use star followed by one. At this point, I'll be happy to turn it over to Senior Vice President of Investor Relations, Yan Jin.

Good morning. I'm Yan Jin, Eaton Senior Vice President of Investor Relations. Thank you all for joining us for ETHAN's second quarter 2019 Earnings Call. With me today are Craig Arnold, our Chairman and CEO, and Rick Ferron, Vice Chairman and Chief Financial and Planning Officer. Our agenda today includes opening remarks by Craig, highlighting the company's performance in the second quarter. And as we have done in our past calls, we'll be taking questions at the end of Craig's comments. The price release from our earnings announcement this morning and the presentation we will go through today have been posted on our website at www.eaton.com. Please note that both the price release and the presentation include reconciliations to non-GAAP measures. A webcast of this call is accessible on our website and will be available for replay. Before we get started, I would like to remind you that our comments today will include statements related to expected future results of the company and are therefore forward-looking statements. Our actual results may differ materially from our forecasted projection due to the wide range of risks and uncertainties that are described in our earnings release and the presentation. They're also outlined in our related 8-K filing. With that, I will turn it over to Craig.

Okay. Thanks, Jim. Appreciate it. Hey, let's start with page three and a highlight of our Q2 results. And I'd say overall we delivered, you know, solid Q2 financial performance and on the back of it, what I'd really call good execution across the company. Earnings per share of $1.50 on a GAAP basis and $1.53 excluding transaction integration costs related to the acquisitions and divestitures. So at $1.53 per share, our results are 10% above last year and at the high end of our guidance range, which was $1.45 to $1.55. Our sales of 5.5 billion were up 2.5% organically, partially offset by 1.5% of negative currency. And similar to Q1, we continued to deliver strong margin performance. Segment margins of 17.9% were an all-time record for Eaton, including records for electrical products, electrical systems and services, and aerospace. Margins were also above the high end of our guidance range, and 90 basis points above prior year. We also generated very strong cash flow, operating cash flow of $880 million, up some 76% over Q2 of 2018, and once again, a second quarter record. And lastly, we repurchased $260 million of our shares in the quarter, bringing our year-to-date purchases to 410 million, or 1.2% of our shares outstanding at the beginning of 2019. Turning to page four, we provide a summary of our income statement versus prior year. And I'll only highlight a couple of points here. First, we're very pleased with our incremental margins, which were about 50% on the organic growth that we delivered in the quarter. So once again, strong execution. Second, we incurred about $0.03 per share of after-tax costs, primarily related to the spinoff of our lighting business. And finally, adjusted earnings increased 7%, and as we noted, adjusted EPS increased some 10%. Moving to page five, we summarized the quarterly results of our electrical product segment. Revenues were up 2%, which includes 4% organic growth, partially offset by 2% negative currency. Organic growth was driven by growth in both commercial and residential markets, largely in the North American market. Orders increased 1 percent, led by continued growth in residential and commercial construction in the Americas, partially offset by softness in some of the industrial markets. And our backlog was up 4 percent. Segment operating profits grew 8 percent, And operating margins were up 110 basis points to 19.6%, which was once again an all-time record. So we continue to be pleased with how well the segment is performing, both in terms of organic growth and in margin performance. On the next page, we summarize results for our electrical systems and services segment. Revenues were up 5% with 5% organic growth. and 1% growth from Ulusoy acquisition and 1% negative currency impact. Organic growth was driven by strength in the industrial projects as well as in commercial construction markets. On a rolling 12-month basis, electrical systems and services orders were up 3% with growth really across all regions. And I'd say it's worth noting here that prior year orders included an unusually high level of orders in hyperscale data centers. Excluding hyperscale data center orders, rolling 12-month orders were up some 8%, which is in line with our order growth in Q1. In addition, our backlog continued to grow, and it increased some 2% in the quarter. Electrical systems and service also produced all-time record margins of 17.4%, which were up some 240 basis points from prior year. This strong operating performance included solid operating leverage with profits up some 22% on 5% organic growth. Page 7 has our hydraulic results for Q2. Revenues were down 3%, and that's flat organic growth with 3% negative currency. Similar to Q1, we had tough comps with 13% organic growth in Q2 of 18, but revenue continued to slow. Flat organic revenues reflected growth in industrial equipment, largely offset by declines in agriculture and construction equipment. Our orders declined 8% from continued weakness in global mobile equipment markets really around the world, and our backlog declined some 12%. Segment operating margins were 11.5% in line with Q1, but certainly down some 200 basis points from last year. I'd say here we continue to work through some inefficiencies and costs related to repositioning the business during the quarter, but we made significant progress and we expect a better second half of the year. On the next page, we show our Q2 results for our aerospace business. Similar to Q1, the business continued to perform at a very high level, really delivering record performance on almost every metric. Revenues were up 12% with 13% organic growth, negative 1% currency. Orders on a rolling 12-month basis increased 15%, with particular strength in commercial transport, military fighters, and commercial aftermarket. And our backlog continues to remain robust, and it increased some 17% in the quarter. Again, we demonstrated really strong incremental margins, which led to a 41% increase in operating profits and a 520% basis points, improvement, and margin. Operating margins of 24.6% were another all-time high for the business. In addition to volume growth, we also experienced some favorable product mix in the quarter, which certainly helped. Lastly, you know, we're very excited to have announced in July Eaton's commitment to acquire Soria SunBank Connection Technologies for $920 million. Soria is a leader in aerospace connectors and provides us with the capability to more effectively serve more electric aircraft systems, which is certainly a trend in the industry. But beyond aerospace, we also have a significant opportunity to expand the distribution of Cereos products through our large electrical wholesale network. And as the whole world just becomes more electric, we think this technology and capability really becomes a real growth platform for Eaton. Soria has grown historically in mid-single-digit levels over the last several years, and we think we're paying a really attractive multiple of 11.8 times EBITDA before synergies and seven to eight times EBITDA on an after-synergy basis. Moving to page nine, we summarize our vehicle segment. Our revenues were down 11%, which includes a 9% reduction in organic growth and negative 2% from currency. Similar to Q1, organic sales declined 2% was driven by a combination of decline in light vehicle markets, which we think were off some 7%, and the impact of revenues that transferred into the Eaton-Cummins joint venture. I will point out that the revenues in the joint venture increased some 11% in the quarter. And also similar to Q1, we had tough comps. Organic growth in Q2 of 2018 were up some 11 percent. For the year, we continue to expect NAFTA Class A production to be roughly flat at 324,000 units, and we also expect global light vehicle markets to remain weak, and as a result, we've lowered our market outlook for the year. Operating margins were 16.9 percent, which were down some 160 basis points from prior year, but I would point out up 180 basis points sequentially despite slightly lower revenues versus Q1. So once again, really strong execution in our vehicle segment. Lastly, we summarize our e-mobility segment on page 10. Revenues were up 1%, which includes 2% organic growth, partially offset by 1% negative currency. And I'd say here the slower organic growth is made up of continued double-digit growth in the EV passenger market partially offset by slower internal combustion engine markets. And you should note that in this segment today, still some two-thirds of our revenue goes into legacy internal combustion engine and commercial vehicle markets. This will certainly change dramatically as the electric vehicle segment continues to grow, as electrification continues to grow. But for right now, it is still two-thirds legacy IEC markets. And as planned, we continued to accelerate R&D spending, which increased some 70% in the quarter, and as a result, segment margins declined to 8%. We're also extremely pleased to announce that we've won another large program valued at $160 million of mature year revenue for a high-voltage inverter for a new plug-in hybrid platform. So this was our second significant win since we created the segment, just over a year ago, and we certainly referenced this in our press release, but this brings our total new wins to $390 million since this segment was formed in 2018. So we're ahead of our original schedule and, once again, well on our way to creating a $2 to $4 billion segment of the company. Moving to page 11, we turn to our outlook for 2019. We now expect organic revenue for all of Eden to grow approximately 3%, down from our prior estimate of 4%. This reflects moderating global growth, particularly in Europe and in China, and specific weakness in our short cycle businesses, very much like you've heard from other companies. We're lowering our organic growth rate by 3% for both hydraulics and the vehicle segment. And in the hydraulics, we continue to see slow growth expectations in global mobile equipment markets, and so now we expect roughly flat organic growth for the year. And in vehicle, after a weak first half, we now expect organic revenues to be down some 7% to 8% due to continued weakness in global automotive markets. And please remember, once again, that we are seeing strong growth in our e-income and joint venture. We're also lowering our organic growth for our e-mobility segment from 11% to 12% down to 5% to 6% due to, once again, slower growth and legacy internal combustion engine platforms. We've not changed electrical products, electrical system service, or aerospace as our long-cycle businesses continue to perform in line with our guidance. And on page 12, we summarize our margin expectations for the year. Our Eaton Consolidate segment margin guidance remains unchanged with a range of 17.1% to 17.5% or 17.3% at the midpoint. We've narrowed the range for each of our segments to be plus or minus 20 basis points since we've really delivered the first half of the year and it's behind us at this point. We do have some puts and takes and margins with a 70 basis point increase in ESS, a 90 basis point increase in aerospace, offsetting a decline in the hydraulic segment. and the midpoint of our margin for the other segments remain unchanged. Our full year guidance for Q3 in 2019 are summarized on the last page, page 13. For Q3, we expect adjusted earnings per share of $1.50 to $1.60 per share. At the midpoint, this represents an 8% increase over last year, excluding the impact of the arbitration decision in 2018. Other assumptions in Q3 guidance include approximately 3% organic growth, margins of 17.7% to 18.1%, flat corporate expenses, and a tax rate of 16% to 17%. For the full year 2019, we're maintaining the midpoint and narrowing our adjusted EPS guide range by 5 cents at both the bottom and the high end of the range. Our new range is $5.77 to $5.97 per share. And at the midpoint, $5.87. And this, once again, represents a 9% increase over 2018, excluding, once again, the impact of the arbitration decisions last year. Other four-year guidance assumptions include organic revenue growth of 3%, $100 million of revenue from the Odesoy acquisition, Foreign exchange impact is a negative 300 million unchanged from prior forecasts. Segment margins of 17.3 percent at the midpoint also unchanged. And we've narrowed the guidance range for our full-year tax rate to 14.5 to 15.5. Once again, no change at the midpoint, but narrowing the range. However, our strong, you know, first-half cash flows are allowing us to really increase our operating cash flow and free cash flow guidance for the year by some $200 million. Operating cash flows will now be between $3.3 billion and $3.5 billion, and free cash flow will be between $2.7 billion and $2.9 billion. We're also increasing our share repurchases from $400 million to $800 million for the year. So overall, I'd step back and say, you know, a really strong start to the year, a strong first half. We're well-positioned for another year of good results, and our teams are doing a great job of executing in favor of the opportunity in front of us. And so with that, I'll turn it back to Yen and open it up for Q&A.