Eaton Corp PLC

Ladies and gentlemen, thank you for your patience in 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 will 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, Yen Jin.

Good morning. I'm Yen Jin, Eaton Senior Vice President of Investor Relations. Thank you all for joining us for Eaton second quarter to the 19th earnings call. With me today are Craig Arnold, our Chairman and CEO, and Rick Fehran, 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'll go through today have been posted on our website at .eaton.com. Please note that both the price release and the presentation include reconsiderations to non-GAP 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 forelooking statements. Our actual results may differ materially from our forecasted projection due to a wide range of risks and uncertainties that are described in our earnings release and the presentation. They're also outlined in our related 8K filing. With that, I will turn it

over to Craig. Okay. Thanks, Yen. 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 what I'd really call good execution across the company. Earnings per share of $1.50 on a GAP 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 .5% organically, partially offset by a percent and a half of negative currency. And so much of Q1, we continue to deliver strong margin performance. Segment margins of .9% were an all-time record for Eaton including records for electrical products, electrical systems and services, and aerospace. Margin 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 of today purchases to $410 million or .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 3 cents per share of after-tax costs primarily related to the spin-off of our lighting business. And finally, adjusted earnings increased 7% and as we noted, adjusted EPS increased some 10%. Moving to page five, we summarize 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, you know, largely in the North American market. Orders increased 1% 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%. Segment operating profits grew 8% and operating margins were up 110 basis points to .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 Ullasoy 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 services also produced all-time record margins of .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 .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 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 point improvement in margin. Operating margins of .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 SunVane 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 Sirio's products through our large electrical wholesale network. And, you know, 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 -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 7 to 8 times EBITDA on an after synergy basis. Moving to page 9, 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%. 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 .9% 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 electrical 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 continue 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 the 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 these 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 week 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 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 .5% or .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 in 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 guidance 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. This once again represents a 9% increase over 2018 excluding once again the impact of the arbitration decisions last year. Other full year guidance assumptions include organic revenue growth of 3%, $100 million of revenue from the ULTASOI acquisition, foreign exchange impact is a negative 300 million unchanged from prior forecast, segment margins of .3% 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 face 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. Hey,

thanks, Craig. Before we begin the Q&A section of our call today, as you see we have a number of individuals in the queue with questions. Given our time constraint of an hour today and our desire to get to as many of these questions as possible, please limit your opportunity to just one question and a follow up. Thanks for your cooperation in advance. With that, I will turn it over to the operator to give you guys the guidance.

Certainly, thank you. So ladies and gentlemen, if you'd like to queue up here for question, you can do so immediately by pressing star followed by 1. And if you are using a speakerphone here this morning, it may be helpful to lift the handset before pressing the keys. But once again, star followed by 1 to queue up immediately.

Okay, we'll take our first question from Jeff Ray with Vertical Research.

Thank you. Good morning, everyone.

Hi.

Good morning, Jeff. Hey, good morning. First, just thinking about hydraulics in vehicle. This is obviously the second quarter in a row now. We've marked down the top line and marked down the margin outlook a little bit. Would you say the forecast as you've laid it out here is, you know, is kind of a run rate forecast on what you see over the balance of the year? Or are you making some underlying assumption that things, you know, pick up? And I was wondering if you could also just as part of that, just elaborate on, you know, how we get comfortable with the hydraulics margins given kind of the recent trajectory there.

Yeah, I appreciate the question, Jeff. And I'd say, you know, I think you've characterized it the right way. It's really a look at kind of run rate in those two businesses, specifically with respect to growth. Certainly in vehicle markets, global markets around the world have been weak in the first half of the year. And we're essentially assuming that, you know, we see a similar picture for the balance of the year, perhaps with a little bit of a pick up in the China market given kind of the depth of the fall that we experienced in the first half of the year. But other than that, it's really largely run rate in both of those businesses. And I'd say specifically in hydraulics, you know, today what we continue to see in hydraulics is we continue to see inventory corrections take place in the channel, both in distribution as well as in OEMs, and we're also clearly seeing today our lead times have been reduced. And so there's a fairly sizable inventory correction taking place across the board. In the economic activity, if you take a look at kind of retail sales, those numbers are much better than what we're seeing certainly in the underlying order intake. And so it's largely kind of a run rate picture. And then specifically with respect to margins in hydraulics, I'd say, you know, Q2 is essentially the last quarter where we really were dealing with a number of inefficiencies and repositioning costs. And so what we're really banking on going forward is that essentially, you know, normal kind of incremental, declamentals on the business, but without the additional kind of repositioning costs and inefficiencies that have, you know, we've experienced in the business in the first half of the year. So very comfortable with the second half guidance at this point for hydraulics.

And maybe then as my follow up to all that, Craig, thank you, is just on the inventory correction that you are seeing. Do you have any way to kind of gauge how far along we are in that process? How much excess inventory might be out there? And, you know, how many quarters this takes to run its course?

I'd say really difficult to estimate, Jeff, as you know, so much of this is a function of, you know, kind of everyone's forward view of where markets are going and given a lot of the economic uncertainty and trade uncertainty that we've been dealing with. I think everyone's trying to find their way through in terms of figuring out, you know, how much, you know, real underlying demand do we have versus how much of this is just general nervousness that we're experiencing as a result of these other, you know, extraneous factors. And so I really difficult to judge for certain. I will say that as we take a look at, you know, inventory levels in the channel, we did see, you know, really more broadly and also a little bit in our electoral business as well, some inventory, you know, correction that took place. But it's really difficult to call in terms of whether or not it's done. There's more out in front of us or we're at the point now where they're comfortable really building some inventory back into the system.

Great. Thank you.

Our next question comes from Jeff Hadman with KeyBank.

Hey, good morning, guys. Hi. Good morning, Jeff. Just a few questions on the electrical side. One, you know, you talked about the big step up in ESS margins. Congrats there. Just, you know, no real revenue change. What's really driving the step up there? And then just any update on the lighting spin. When do we expect like a Form 10, et cetera? Thanks.

Yeah. I'll take the first step and then I'll let Rick take the second. But in terms of ES and S and the margin step up, I'd say, you know, in a word, I'd say strong execution. Our teams are just doing an outstanding job of converting on the opportunities in front of us and, you know, running our facilities better. As we've talked about in the past, we've done some work around the portfolio and where we're choosing to compete. And those things are paying off in the form of higher margins inside of the business. And so we're very comfortable with the level of margin guidance that we provided and taking the margins up. And our teams are just doing a great job of executing. And we'd expect it to continue.

And on the lighting spin, Jeff, we've had initial comments from the SEC relatively modest set of comments. And so we would expect to get the Form 10 filed towards the end of the third quarter, might just lap into the beginning of October. But that's the timeframe.

Okay. And then just as a follow on, on the SORIO acquisition, you gave kind of the adjusted valuation with synergies. Can you kind of expand on where you think those opportunities are? I recall the business has a fairly large, you know, France footprint. And so I know sometimes those costs are onerous to take out. Yeah.

Yeah, appreciate the question once again. Jeff, and I think today, you know, they run a very effective operation today in France, by the way, until we have no intentions of closing any of the French manufacturing facilities. If that is the basis of your question. Today, as you know, we operate today as Eden in France. And we operate very successful businesses in the country. And so we're very comfortable with their manufacturing operations in France. We're right now in the period of obviously putting the, you know, some of the finishing touches on what our exact integration plans are going to be. We've not communicated those plans to the organization yet. And so clearly, you know, before we'd make any public statements, we'll obviously need to work through our own internal announcements. But specifically as it relates to manufacturing in France, very comfortable with that team, very comfortable with their capabilities and how effectively they've managed that business over a very long period of time.

Okay, great. Thanks, Greg.

Our next question comes from Scott Davis with Millions Research.

Hi. Good morning, guys. Hi. I want to just follow up a little bit on the questions around visibility, inventories, et cetera. I mean, can you give some granularity on what types of projects you're seeing and non-res in your backlog?

Yeah, you know, I'd say that, you know, when we think about kind of what's going on today in electrical systems and services, I'd say, you know, we're seeing a lot of strength, certainly in the U.S. Commercial construction continues to be, you know, quite strong. You know, orders were up, you know, some 6% in Q2. Industrial orders were also up nicely in the quarter. So we're seeing pretty broad-based strength. Our electrical systems and services business had a really strong quarter of orders in the U.S. as well. If we look at kind of around the world in terms of what's going on in other regions of the world where, you know, Europe, you know, what we call, you know, EMEA, Europe Middle East, Africa, India, we saw, you know, big projects in industrial, also in data centers. Data centers in Europe were up strongly in Q2. Krauss-Heinz business, oil and gas, had a very strong Q2, as well as our engineering services business in Europe as well, also strong. And in Asia where we saw the strength primarily was in power quality markets, which were up, you know, double digits in the quarter. And so I'd say that in electrical systems and services we're seeing, generally speaking, you know, nice growth in almost all of the end markets other than what we talked about, which was, you know, this, you know, let's say highly sickle piece of the segment, which is kind of a hyperscale data center, where those orders just tend to be lumping. And we're really anniversarying some really huge numbers from the Q1 and Q2 of 2018, other than that we're seeing pretty good strength across, you know, residential, commercial data centers and industrial buildings.

Yeah, seemingly so. But does it scare you at all, Craig, when you look across, just across more broadly across industrials, I mean, the quarter's been pretty weak overall, and you guys have had decent numbers, of course. But is there a recession playbook that you guys are dusting off? Is there, you know, are you, is there any internal plans to, you know, delay hiring or do anything to kind of play a little bit more defense versus offense?

Yeah, I think it's fair to say that, you know, we too have seen kind of a general slowdown in the macro economy during the course of Q2. And it's obviously caused us all to kind of stop and pause and take stock of, you know, what's generally going on in the market and where we think things are headed. And so I think it would be fair to say that we always have a restructuring playbook ready at the ready. We always, you know, encourage our businesses and our teams to think about what would you do in the event of an industrial recession. And I, you can rest assured that our teams are thinking about that, have plans at the ready. But at this point, you know, we're not prepared to declare or pull that trigger because we still are in fact seeing growth in our end markets. But rest assured, you know, we have plans. We have contingencies built in. And in the event that we ended up experiencing an economic downturn, we think once again, you know, the company playbook that we laid out, if you recall back to our investor days, that we'd essentially, you know, use our strong balance sheet, our strong cash flow. We certainly would step up our share repurchases. And so, you know, we think the company, you know, has a playbook that we've already laid out and quite frankly even communicated in terms of what we would do in the event of an economic slowdown or an industrial recession.

Okay. Thank you. Good luck, guys.

Thank

you. Our next question from John Welsh with Credit Suisse.

Hi. Good morning.

Hi.

Question around the aerospace margins, obviously another very strong quarter, taking the margins higher again. I think last quarter you alluded to, you know, some favorable mix, but just wanted to get your kind of thoughts around where the aerospace margins are going to exit this year and kind of the sustainability of that.

Yeah, you know, it's, you know, I'd say that, you know, we have a really a number of different, you know, positive events that are taking place in aerospace. And I want to begin with once again our teams and how effectively they're executing. And we are just doing an outstanding job across that business and really converting on the opportunities in front of us and running our facilities, you know, very efficiently. And that's obviously giving us a bit of a margin lip. And the difference to that, we're seeing today, you know, quite frankly, as we talked about in prior years, there simply are fewer big aerospace programs that we're spending R&D dollars on. And that's obviously paying a dividend. And I don't anticipate that changing dramatically unless, you know, the big OEs and commercial, you know, platform bills decide to launch some major new program that's not currently on the horizon. And so that's obviously favorable for the business. And then the third element is aftermarket continues to be quite strong. You know, the aftermarket segment of the business continues to grow nicely. And we're converting on mods and upgrade opportunities. And so we really do think that this business is going to be performing at, you know, much higher levels of profitability than it has historically. And if you think about, you know, the guidance that we provided, you know, for the year, you can expect the business to continue to perform in those levels.

Thank you. And then I guess maybe just some color around the acquisition pipeline. I guess we've had now one deal strengthen each side of the house. You're going to generate, you know, very strong free cash flow. You have a balance sheet kind of. What does the pipeline look like and what's the appetite to continuing to deploy it for M&A?

Yes, I'd say maybe, you know, take the first question first. The pipeline, I'd say the pipeline today is much more robust than it's been historically, certainly much more robust than we've seen in the last three to five years. And so we are certainly looking, I'd say, at more opportunities than we ever have. You know, having said that, I will also point out, though, you know, valuations in many cases are still quite elevated. And we're going to continue to be disciplined as we think about how we deploy our capital and what we said. And it continues to be the priorities. It will continue to focus on largely our electrical business, our aerospace business, and perhaps in certain, you know, opportunities around e-mobility. Those continue to be the company's priorities in terms of how we think about deploying our M&A dollars. But, yeah, the pipeline is more robust today than it's been in quite some time.

And if I could just add one thing. We've actually announced three transactions, ULASOY in electrical, Intelligent Switchgear, a much smaller transaction, and then this new ASORIO transaction. And to Craig's point, the first two were at multiples of seven to eight times EBITDA and ASORIO higher, but it'll come down to levels close to that after we enact the integration program.

Good. Our next question comes from Cody Blatt with Deutsche Bank.

Yeah, thanks. Good morning, guys. Hi. So maybe starting with the short cycle businesses, it's been clearly a pretty common theme this quarter. And we've heard from a lot of companies that things could just decelerate a little bit in June, and that's kind of continued into July. So just curious about anything you're willing to share on the monthly trends within the short cycle piece of your portfolio.

I'd say that Nicole's story is not terribly different than that. I'd say that the month of June really was weaker than what we were originally anticipating. And once again, the question, you know, there's a lot going on in the global environment in the month of June, whether it's around trade and additional tariffs or whether it's just around the general direction of the overall economy. And so to what extent did a lot of our customers and distributors put things on pause in the month of June, you know, we'll have to wait and see. I will say that, you know, so far in the month of July, things are playing out largely as we anticipated. And so very much consistent with the guidance that we provided. And so we don't think necessarily that June kind of is the new standard, but we did, in fact, see a slowdown in the month of June, very much consistent with what other companies have reported.

Got it. That makes sense, Craig. Thanks. And then from my follow-up, just around data centers, if you could provide a little bit more of an update of what you're seeing there, we've heard, you know, increased concerns about push-outs from the hyperscale players. So we'd love to hear what Eaton's seeing.

Yeah, and I'd say that, you know, for us, you know, we always talk about data centers being kind of a long-term growth market where we think the market will, in fact, continue to grow on a long-term trend basis, you know, high single digits. And so we think it's a great space to be in. And Eaton has a great strategic position in data centers, both on the equipment side, as well as on the power quality side. But there is this, you know, fairly large segment of the market, you know, called hyperscale that is very lumpy. And it's been lumpy historically and probably will continue to be lumpy in the future. And if you just look back at, you know, what happened in our business in, let's say, in the first half of 2018, we got very large multi-year orders from a number of the data center hyperscale players. And as a result of that, you know, we kind of anniversary that in the first half of the year and we'll have a better second half comparable for sure. But that business is lumpy today. It will continue to be lumpy. But we think data centers, you know, long-term and quite frankly in the near term is a great space to be in and will continue to be a real growth engine for the company.

Thanks, Craig.

Our next question comes from Joe Ricci with Goodman-Sachs.

Thanks. Good morning.

Hi. Good morning,

everyone. So maybe just kind of taking that arrow margin question slightly differently. So obviously the first half of the year, the margins were incredibly strong. If I take a look at your guidance for the full year, the implied guidance for the second half would be that second half arrow margins are going to be lower than first half arrow margins. And so my question is, was there anything, you know, specific about the first half that really helped boost margins or anything that's potentially going to impact margins in the second half on the arrow side?

Yeah, I think, you know, the simple answer to that question I'd say is no. I mean, you know, we certainly outperformed our expectations in the first half of the year. We certainly saw very positive aftermarket mix in the first half of the year. Question is, is that going to continue into the second half? At this point, I think it's tough to say. And so we've lifted margins overall, but I think very much consistent with the business probably going back to an historical view of OE aftermarket mix. But other than that, there were absolutely no one-time items or other things that drove the improvement in margins in the business outside of what I articulate, which was largely strong execution in our businesses, strong aftermarket, and, and quite frankly, as I mentioned, lower R&D spending.

Got it. That makes sense and good to hear there, Craig. I guess my follow-on question, and this is, you know, is really just around, you know, hydraulics and how you're thinking about that business longer term. You've taken down the margin guidance. It's now below the longer term threshold for that business. And I guess, just how are you, how are you thinking about the, the, you know, I guess the trajectory of this business as part of the portfolio, you know, just given the performance that we've seen recently?

Yeah, you know, appreciate the question. You know, you know, clearly, you know, it's a business today, you know, that, you know, we're not pleased with the way the business is performing. We're not pleased with, you know, the way we've converted on the opportunity that's in front of us, the margins are in fact below, you know, the, the, the overall guidance for the company. You know, I will say that today, you know, they, hydraulics accounts for 8% of our company, we delivered .9% all-time record margins, despite the fact that we have one of our businesses that's not today firing on all cylinders. And I really look at that as saying, you know, wow, what an opportunity for what this company will look like, you know, once we get hydraulics performing at the level that we know that they're capable of. And so I'd say that, you know, as we think about the first half of the year, we were still working through some repositioning costs. We're still working through some inefficiencies. As I mentioned, they will have a better second half of the year. You know, we're very much confident in the plan that the team laid out in front of us. But we have work to do and we have something to prove still in a hydraulics business. But I'd say for us, at the end of the day, it's, you know, and a company as large and as diverse as Eaton, you know, it's unusual to find every single business firing on all cylinders, it's really, I think, a testament to the strength of the company that, despite the fact that you can have, you know, one of these cylinders not firing completely, that the company can still deliver record all-time margins, you know, across the board. So I think a real testament to the strength of franchise.

Fair enough. Thank you. Our next question comes from Dave Russell with AeroCorp.

You know, there was some concern going into the quarter on ESS orders and the organic for the second half, but obviously your comments about X hyper scale, the orders didn't even slow on the -over-year basis. And the rest of the year, you're implying organic for that business, as strong as you saw in the first quarter. So, as soon as you're very comfortable with the top line, can you help us a bit with the margin in the back half of the year? Like, what's in the backlog when it comes to mix, any price cost you can help us with? Because I see the incremental in the back half of the year is about 36%. It's actually a little lower than the first half, so it doesn't seem that challenging, but if you can just help us a bit with what's in the backlog to gain comfort with that, you know, important business.

Yeah, you know, what I would say in general is that, you know, our backlog is very much reflective of, you know, what we experienced in the first half of the year. And clearly the guidance that we provided incorporated, you know, what we have visibility to into our backlog. And so I'd say once again, in our electrical systems and services business, very much like, you know, so many other parts of the company, the team is just executing well on the opportunity in front of us. And I'd say if you think about price versus cost, you know, what we've always said and which is largely kind of still our point of view is that, you know, it'll be kind of a net neutral to us. You know, clearly, you know, we're getting price in places where we're dealing with inflation and places where we're dealing with tariff, you know, derived cost increases. And as a result, our businesses are managing that very effectively. So we think that's going to be a net neutral and essentially the margin expansion will really come from our ability to really manage the portfolio in terms of where we choose to compete. It'll come from our ability to continue to wring out inefficiencies inside of our businesses.

So nothing unique in the backlog help or hurt on the margin from what we've seen?

No, very much consistent with what we've experienced in the first half.

All right, that's great. Thank you very much.

Our next question comes from Ann Dignan with JP Morgan.

Hi. Good morning, everybody. Good morning, Ann. Hi.

Morning.

Yeah, a lot of my questions have been answered. But Craig, I think on hydraulics, you commented that you're seeing more broad-based slowdown in agriculture geographically. I think the last part you were saying, just North America. Maybe you could just update us on that and what you're seeing more broadly.

You know, I think that's fair. And it's, you know, whether it's in ag markets or, quite frankly, even in construction equipment markets, I think we've seen a general slowdown really around the world in most of the mobile equipment markets. Slowdown certainly in terms of the absolute rate of growth. You see that in some of the big OEMs who've already reported their numbers. But the other big thing that's taking place clearly across the business is this inventory correction that we're seeing, you know, both in both the OEM channel as well as in the distribution channel, and probably largely in anticipation of a slowdown. And so we were really dealing with both of those factors right now inside of the business. But so, you know, so I'd say today very much factored into, you know, our guidance and one of the reasons why we lowered the revenue outlook for the hydraulics business this year.

Okay. I appreciate that. And then on the vehicle side, your outlook for NAFTA heavy duty production is flat this year. You know, the OEMs are all still quite upbeat about end market demand. And we know where orders are. We know where backlogs are. But what are you hearing, Pete, on the street that's making you more cautious than your OEM customers?

Yeah. You know, I'd say, you know, it's very possible, Anne, that the market can be stronger than what we're calling right now. I said, you know, we're calling it flat. And we do know there's others out there who are calling for some modest growth in North America Class A truck this year. And so we'll have to see how that all plays out. But if we just take a look at, you know, the general level of the economy overall, the fact that we are in fact seeing slowing, you know, we are in fact seeing, you know, inventory levels today that are at elevated levels. And so let's have to wait and see how that one plays out. But to your point, you know, there are a couple of others out there who have more robust forecast for North America Class A truck than we have.

Okay. So it's more erring on the side of caution, Rob. Yeah. Yeah,

absolutely. I think it's really more erring on the side of caution, recognizing that, you know, in the event of a general slowdown in the economy, as you know better than most, and that business tends to move quite quickly. And so we think this error on the side of caution is probably the prudent place to be.

Yep. And keep in mind, by

the way, for us, just to me, it's a good point to make the point where so much of our revenue today, you know, goes to the joint venture. And so, you know, one of the things that we really tried to do as a company is really de-risk eaten from a standpoint of its exposure to North America Class A truck markets. And so you'll see that volatility largely in the joint venture, but you'll see very little of that volatility in our own results. And so I think it's an important point to emphasize. It was a deliberate part of our strategy. And so you'll see that largely in the JV. You'll see very little of that. You'll see some of it, but you won't see a lot of that show up in Eaton's results.

Okay. So the margin reduction in vehicle was primarily auto-related?

Yeah. And that's where we're seeing the weakness. By the way, we held the margins, by the way, just as a point of clarification. We actually held the margin guidance. We narrowed the range.

You narrowed it. Yeah.

Sorry. We held the midpoint in vehicle. And once again, we held the midpoint despite the fact that we're seeing, you know, a slowdown in our automotive markets around the world. And that is largely the reason why we reduced the revenue guidance. But, you know, the fact that we held margins really, once again, again, goes back to, you know, our teams and our ability to execute in a declining revenue environment.

Okay. Per point, I'll leave it there. Thank you.

Our next question comes from Dean Dwayne with RBC.

Thank you. Good morning, everyone.

Hi, Dean.

Hey, I'd like to go back to the Soria deal if we could. And Craig, since this is the largest deal you've done since becoming CEO, some color in terms of how did the deal come together? The structure is a bit unusual. Maybe you can comment on that and then whether there's an opportunity in that funnel to do larger deals like this.

Yeah. Dean, I'm not sure specifically in terms of the structure being, you know, unusual. I think it's a pretty straightforward, you know, there's some unique rules with respect to the way, you know, deals are announced in France in terms of, you know, the unions having to approve transactions. And maybe that's what you're referring to in terms of

the

announcement. But we think that's largely, you know, a matter of, you know, form over function. And we think the deal will close in good stead. And we think it will close, you know, by the end of the year, no later than. And we don't think there's anything other than that that's unusual about the deal. And as I said, you know, strategically, we really love this deal. I mean, it's if you think about the whole world becoming more electric, including aircraft. If you think about Eaton being a big electrical company, we think we have a great opportunity to take their technology and their products into so many different applications in our core electrical business. And quite frankly, in everything that we do, as the world becomes more electric, we think the electrical connectors that Soria manufactures really gives us a great growth platform inside of the organization. And so I think what you're going to find from us is that we'll continue to look for opportunities in aerospace. We like the business for a lot of reasons. And you'll continue to see us do more stuff in electrical. This just happens to be one that really cuts across, you know, two of our big growth platforms, both aerospace and electrical. And so it's very unique in that respect. But other than that, I think it's a deal that's really right down Main Street. We think we bought it at a very reasonable multiple for an aerospace asset. And we think it really provides, once again, a real lever for growth in the future.

And then just I'd also ask whether that's maybe emboldens you to do bigger deals.

Yeah, I can actually, you know, bigger deals for us is really a function of where the opportunities lie and whether or not you can acquire them, you know, with the right kind of financial returns. And so we absolutely would not shy away from, nor have we ever shied away from strategic acquisition of scale where we feel like we can buy it at the right price and add significant shareholder value. And so I would say that the deal doesn't embolden us to do bigger deals. But then again, there's nothing that prevents us from taking a bigger swing if the asset is strategically important and we feel like we can add value.

Got it. And then just the follow-up question on lighting, in the extent to which you can comment on this, there was some discussion that you would entertain bids for the company as opposed to a spin. What has been the interest along those lines and any caller there would be appreciated?

Yeah, we are in discussions with multiple parties and we'll see how that plays out, Dean. We'll obviously take the course of action that is value maximizing for even shareholders. Terrific. Thank you.

Our next question come from Nigel Cole with Wolf Research.

Thanks, guys. Good morning. So the channel corrections in electrical is a bit of a new development. And I think lighting was an area where we expected to see it. And obviously, you know, one of your competitors called out commercial as an area where there's a little bit of headwinds. So maybe just dig into that and maybe just address, you know, the extent to which you think this is caused by the price increases in tariffs, as opposed to just general, you know, end market weakness and the normal kind of these stocking activity. Any color there would be very helpful.

Yeah, and then I wish, quite frankly, Nigel, we had clear and more definitive answers for you in terms of what actually caused the slowdown. I think the truth of the matter is we and many others are are speculating in terms of what actually caused it. But we clearly have, you know, and there's a lot of geopolitical uncertainty in the world right now. And I'd say that it probably reached a high point in the month, certainly the early, you know, couple of weeks in June, you know, around trade disputes between, you know, the U.S. and China and Mexico and, you know, some of the other just general weakness that we're seeing in some of the some of the macros. And so I just think that there was enough out there in the month of June for people to pause and just take stock of exactly where we were at. But beyond that, we would really be out on a limb trying to speculate exactly what caused the slowdown. I will say that, you know, as we take a look at the back half of the year and, you know, we obviously factored in what we saw in the month of June into our outward forecast for our businesses. And so I think this thing can go either either way. I think we probably just a higher probability that you're going to see a return to to to growth, the normalized growth, as you're probably going to see a, you know, of the deceleration. And at the end of the day, we're going to be ready, you know, our businesses and we're focusing on making sure that we have contingency plans in So in the event that we end up in an economic slowdown that's more severe than what we're currently forecasting, our teams will be ready to flex our cost, to flex our spending, to take whatever actions that we need to take to ensure that we continue to maximize performance.

Thanks, Greg. And another one on tariffs, you know, as you know, electrical products and lighting is one of the biggest categories of imports from China into the U.S. And obviously, you know, you feel the inflation on some of the componentry, but also your competitors who import from there, obviously facing some tougher barriers there. So I'm just wondering how the tariffs have impacted the competitive environments in both the low voltage, but also in lighting as well.

You know, I'd say on the low voltage side, I'd say, you know, really very minimal today that we talked about it pre-eaten, we said that tariffs would be order of magnitude, about a hundred million dollar bill for the company. And that's largely unchanged from what we forecasted the last time. And that doesn't necessarily, you know, have an outsized impact on our low voltage business at all. It does, to your point, have an outsized impact on lighting. But I will tell you that, you know, good news is that, you know, we and others in the industry, you know, have passed on tariffs. And at this point, we don't feel like the tariff issue today is in any way negatively impacting, you know, the margins of the business. And quite frankly, we had a fairly good quarter in lighting, both in growth and orders. And so we're very comfortable with our lighting business and the way our team is executing and managing, you know, the tariff impacts as it relates to their business.

Yeah, thanks, Greg. The question is more on the competitive impact, but we can take it offline. Thanks a lot.

Our next question comes from Josh Bokowinski with Morgan Stanley. OK, then we'll take a next one from Steve Walkman with Jefferies.

Great, I'm here.

OK, good.

Just a couple of quick cleanups, I guess, if I may. I was curious about the price cost question from a different perspective. We're starting to hear a little bit of signs of people sort of pushing back on price increases due to slower growth, due to lower raw material costs. And I'm just curious what your view of sort of price cost is over the next couple quarters.

You know, our point of view, Steve, is really largely where we've always been. And so we always think about price costs, you know, in the near term as neither being a headwind nor a tailwind for the business. And we try to manage it to be neutral. That's kind of been our position as we laid out our thinking for the year. And that's really where we're still parked. In some cases, there's very formulaic equations that drive what we're able to pass on to our customers and where prices go up and down as a function of a basket of commodities. In other cases, it's a function of, you know, obviously what's in the backlog in which you've negotiated. But as we think about the go forward view, you know, I'd say today it's still our view is net neutral. Price and cost for 2019 will neither be a positive nor a negative for the company.

OK, great. Thank you. And then, sorry if I missed this, but any update on the fluid conveyance divestiture?

Yeah, that's proceeding as well. And we are hopeful that it would close towards the end of the third quarter, perhaps the beginning of the fourth quarter.

Great. Thank you, guys.

Our next question comes from Rob McCarthy with Stevens. Can

you hear me, guys? Yeah. OK, great. So let me go ahead. The first question I would have is in the context of what you're seeing now, which is kind of a choppy, challenging conditions overall. Could you just frame how you think about kind of what your trough earnings could be if this is the peak this year? Is there any way you could attempt to answer that qualitatively or otherwise, Craig?

Yeah, you know, and we tried to address this one a little bit, Rob, when we had everybody together for our investor day early this year. And one of the things we talked about is the fact that, you know, as we think about eating in our new configuration and our new configuration would include, obviously, once we divest lighting, once we get rid of FCD and given the fact that we generate such strong free cash flow, we said, you know, what we're working on doing is standing up a company that even during a typical economic recession, defined as, you know, two or three quarters of GDP contraction, that our company would be able to still maintain flat earnings during that period of time. And so that's still the path that we're on. And that's what our teams are working on doing. And I think you see a lot of evidence today in our businesses, you know, using Viewquad as an example, despite the fact that, you know, clearly, you know, revenues are down pretty significantly. We're holding margins. And so so that's really the goal. And because we do generate so much free cash flow that it'll give us the ability in the event of an economic downturn to buy back more stock. And so that's really the formula that we continue to work towards and what we would intend to do in the event of of of an economic downturn.

That makes sense. And then forgive me for this other question. It's a little impolite, but, you know, in terms of your new announcements of the of the sector heads, obviously, Uday and Heath are very well regarded internally and externally and from all channel checks. The one thing I did get in terms of the feedback anonymously was the fact that, as good as Heath is, he's never run anything explicitly at a segment level. I mean, do you think he's up to this? I mean, obviously, you think he's up to the challenge. But how do you think about that going forward? Or is that a risk to management or execution for Eaton?

Sure. You know, certainly appreciate the question. I will tell you, the first thing I'd say is that, you know, Heath is an outstanding leader who's been around for a long time, you know, inside of Eaton and inside Cooper before that, and just an outstanding leader with outstanding judgment, outstanding decision making. And if you think about today, the way we're organized, Rob, today, we have really, you know, three businesses, right? And inside of these businesses, we have presidents who really run the day to day, who are great operators, who know how to execute. And what we're really looking for in these sector jobs is really strategic thought leadership. And Heath, by the way, has that in spades as does Uday. And so I would tell you that, you know, he's exactly what we need for the business at this point in time. The business is going through, in all three cases, a fair amount of strategic repositioning with a lot of moving parts and pieces in all three businesses, as we talked about. And what our really our businesses need is a partner, somebody who can work with them on how do you think about, you know, the future of these businesses and what strategic moves should we be making to maximize our results and our performance? And with really three strong operating guys, it made no sense to put, you know, four in the box and put somebody else with exactly the same background into those businesses. And Heath will bring exactly what we need for those businesses, which is really strategic thought leadership.

Thanks for entertaining my questions. Good. Last question from Andrew Obin with Bank of America. Hey,

guys, thanks for squeezing me in. Just a question on first on China, could you describe in more details what the trend has been through the quarter? Because it appears that, you know, something happened in June. And I wonder if you've seen a slowdown in June and if you could just describe the interquarter trend in China. Thank you.

You know, I can't say that we saw anything specific at all, Andrew, in the month of June. I think, you know, what we've generally reported is that in the certainly in the short cycle businesses, specifically in automotive and vehicle markets, you know, we clearly saw a weak quarter. We saw a little bit of a weaker quarter in hydraulics, for sure, in in in China. The long cycle businesses, you know, non-res construction, you know, ready residential construction continue to be strong during the quarter. And so I'd say this kind of bifurcation of these two different markets, depending on where you sit, that's kind of been a pattern that we've seen out of China for most of this year. And in Q2 in the month of June wasn't wasn't really much different than that. You know, we are optimistic that with some of the infrastructure related spending that's that and the stimulus initiatives that are being put into the China market, and we could have a better second half of the year. But at this point, we really didn't see anything significantly different in China that was unlike the pattern that we've really experienced all year.

And I apologize if I missed the question. Could you just comment on growth rate within ES&S? What's the growth rate for services? What was that in the quarter and what are the big trends there?

Yeah, as I mentioned, as I was walking through the businesses, we really had a really strong quarter of orders in our electrical systems and services business, you know, up strongly in the US, you know, some, you know, 15 percent. Europe was up also close to 15 percent. So services really was one of the standout performers for orders during the course of the second quarter. And so we continue to be optimistic about the outlook for services overall.

Terrific. Thanks for fitting me in.

Good. Thank you all. We have reached to the end of our call and we appreciate everybody's question. As always, Chip and I will be able to be available to address any follow up questions. Thank you for joining us today.

And ladies and gentlemen, that does conclude the presentation for this morning. Again, we thank you very much for all of your participation in using our executive teleconference service. You may now disconnect.