Eaton Corp PLC

Ladies and gentlemen, thank you for standing by and welcome to the Eaton Third Quarter Earnings Call. For the conference, all the participant lines will be in a listen-only mode. There will be an opportunity for your questions and instructions will be given at that time. If you should require any assistance during the call, please press star zero and operator will assist you offline. As a reminder, today's call is being recorded. I'll turn the call now over to the Senior Vice President of Investor Relations, Mr. Yen Jin. Please go ahead, sir.

Hey, good morning. I'm Yan Jin, Eaton Senior Vice President of Investor Relations. Thank you all for joining us for Eaton's third quarter 2019 earnings call. With me today are Craig Arnold, our Chairman and CEO, and Rick Ferron, Vice Chairman, Chief Financial and Planning Officer. Our agenda today includes the opening remarks by Craig, highlighting the company's performance in the third quarter. As we have done in our past calls, we'll be taking questions at the end of Craig's comments. The press release from our earnings announcement this morning and the presentation we'll go through today have been posted on our website at www.eaton.com. Please note that both the press release and the presentation includes reconciliations to the non-GAAP measures. A webcast of this call is accessible on our website, and it will be available for replay. Before we get started, I would like to remind you that our comments today will include statements related to the expected future results of the company and are therefore forward-looking statements. Our actual results may differ materially from our forecasted projections 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.

Thanks, Sean. Appreciate it. We'll start on page three with a highlight of our Q3 results. Overall, I characterize this quarter's results as really strong earnings results and strong cash flow despite weaker end markets. Earnings per share, as you saw in the press release, were $1.44 on gap basis. $1.52 excluding transaction costs and acquisition and divestiture and exit of businesses. At $1.52, our results were 6% above last year, excluding the 2018 arbitration decision, and within our guidance range of 150 to 160. However, sales were certainly lower than what we expected, down 1% organically, negative currency impacting us by a point and a half, and acquisitions adding a half a point to our results. We continue to deliver strong margin performance with another record in all-time earnings on margins. Segment operating margins of 18.7% were an all-time record for Eaton, and this includes records for electrical products, for electrical systems and services, and for aerospace. These margins were also above the high end of our guidance at 110 basis points above last year. We continue to generate very strong operating cash flows of $1.1 billion, up 8% over Q3 2018, and another quarterly record. And lastly, as a way of summarizing results, where we purchased 539 million shares in the quarter, bringing our year-to-date purchases to 949 million, or 2.8% of our shares outstanding at the beginning of the year. Turning to page four, we show a summary of our Q3 performance versus prior year. And I'll just point out a few highlights here. First, we delivered $41 million of increase in segment operating profits despite a 1% decline in organic revenue. And this was really driven by strong execution, effective cost control, and favorable mix in a couple of our businesses. Second, we incurred $0.08 per share of after-tax costs, primarily related to the planned divestiture of our lighting business. And lastly, adjusted EPS increased 6 percent, excluding the 2018 arbitration decision. These results, you know, I'd say are consistent with our broader message on how we intend to run the company during periods of market weakness, with strong execution, proactive cost control, and increasing our share repurchases. On page five, we show our quarterly results for our electrical product segment. Overall revenues were flat, made up of 1% organic growth, offset by 1% negative currency. We saw revenue strength in both commercial and residential markets in North America, partially offset by softness in industrial controls globally. Segment operating profits increased 6 percent, and operating margins were up 110 basis points to 20.3 percent, which was an all-time record for the segment. We also announced the sale of our lighting business to Signify for a price of $1.4 billion. And we see a good outcome for our shareholders and another example of how we're actively managing the portfolio to create higher margin and higher growth set of businesses for ETN. This was a decision that was also good for our employees, who will now be part of a larger and more focused lighting company. The transaction is expected to close in the first quarter of 2020, and I'd say for our core products business, which now excludes lighting, orders were up 1% led by strength in residential and commercial construction, largely, once again, in the Americas. Moving to page six, we summarize our results for our electrical systems and services segments. Revenues increased 3 percent, 3 percent organic growth. We also had a point and a half of growth from the acquisitions of and innovative switchgear solutions, and a point and a half of negative currency. Organic growth here was driven by strength in data centers, commercial construction, and actually also in engineering services. Our ES&S business also produced all-time record margins of 18.3%, which were up 290 basis points from prior year, operating profits increasing some 23% on 3% organic growth. This business benefited from higher sales for sure, but also had very good operational execution and conversion. And on a rolling 12-month basis, ES&S orders were up 5% with growth really across, I'd say, all regions here. And if you exclude hyperscale data centers, the 12-month rolling average of our orders was up 8%, which was really in line with what we saw in Q2. So once again, a long cycle business, very much performing at very high levels. On the next page, we show our results for hydraulics for Q3. Revenues were down 10% with an 8% decline in organic revenues and 2% negative currency. Organic revenue declines were driven primarily by weakness in global mobile equipment markets and, quite frankly, destocking that we've seen both at the OEM level and also within distribution. Segment operating margins were 11.9%, down 290 basis from last year. But I say on a sequential basis, margins were actually up 40 basis points despite seasonally lower Q3 revenues that came in about $100 million below Q2. And our order decline of 14% really as a result of continued weakness as we mentioned in global mobile equipment markets around the world. Turning to page 8, we summarize our quarterly results for our aerospace segment. Once again, this business posted very strong results with record top-line and bottom-line performance. Revenues increased 7% with 8% organic growth and 1% negative currency. Orders on a rolling 12-month basis increased 13% with particular strength in the military markets, specifically for fighters, for rotorcraft, and also aftermarket. We also saw strength on the commercial side in business jets. We continue to demonstrate strong incremental margins with nearly 60% growth in margins on organic revenues, which drove a 23% increase in operating profits and a 310 basis point improvement in our margins. And as you'll recall, we announced the acquisition of Sorial Sun Bank in July, and we expect this transaction to close before the end of the year. So all things are good in aerospace. On the next page, we summarize our Q3 results for the vehicle segment. Our revenues were down 13%, which includes a 12% decline in organic revenues and a negative 1% impact from currency. The organic sales decline was due to a combination of global weakness and light vehicle markets, which we think were down approximately 4% in the quarter, and primarily the impact of the transfer of revenues into the Eaton-Cummins joint venture. For 2019, the NAFTA Class 8 market remains solid. We expect production to be roughly 340,000 units this year and up 5% for 2018. We do, however, expect global light vehicle markets to be down some 4% for the year. Despite lower organic revenues and volume, operating margins continue to run at very high levels. At 18.3%, margins were down only 60 basis points from last year. So our vehicle team once again did a nice job of flexing spending, which allowed them to deliver decremental margins of approximately 25%. Moving to page 10, we show our e-mobility results for Q3. Revenues were down 1% with flat organic revenues and negative 1% from currency. Flat organic revenues in this case are due primarily to a mix of platforms that we're on. I'd ask you to keep in mind that in this business, is really made up of a mix of the new electric and hybrid platforms, plus the legacy electrical content that we have on internal combustion engines. Once again, we increased our R&D spending, which was really the primary reason why operating margins declined 740 basis points to 5.1%. But we continue to pursue a large number of additional electric and hybrid programs here, and we are very pleased with the progress that we're making to date. Next, on page 10, we summarize our outlook for 2019. We now expect organic revenue growth of approximately 1%. And as you know, this is down from our prior estimate of approximately 3%. And this is really based upon, you know, reduced global growth, particularly in our short-cycle businesses, but it also includes some slow growth and non-res construction as well. Still growth, but slow growth, which has impacted our electrical business. Within electrical, we now expect full-year organic growth of approximately 2.5% for electrical products and 4.5% for electrical systems and services. In hydraulics, global mobile equipment markets remain weak, and this weakness is being amplified by really stocking in both the OEM and distribution channel. As a result, we now expect organic revenues to decline approximately 4.5%. Aerospace remains strong across the board, and we're reaffirming the midpoint of our full year growth estimate of 9.5%. In vehicle, global automotive markets remain weak, so we're reducing our organic revenue estimates to be down approximately 10% for the year. And we've also slightly modified our estimates for e-mobility as well, which we think will be growth of 4% at the midpoint of 2019. And overall, our long-cycle businesses within ES&S and aerospace are expected to continue to deliver attractive organic growth rates for the year while we project low single-digit growth for electrical products overall. Business conditions, I'd say, have clearly been impacted by trade, by the political environment, and by, I'd say, a number of one-off events that have weakened our second half outlook. you know, maybe as a point of kind of, you know, confidence as we look to the future, we'd say, you know, with the fundamentals of the economy still solid, low interest rates, high employment, strong consumer confidence, and we'd hope that this pullback would be short-lived if we're off the wait-and-see. Moving to page 12, we show our margin expectations for the year. And I think based upon the strong Q3 margins, we're increasing our consolidated segment operating profit guidance 20 basis points to a new range of 17.3 to 17.7% or 17.5% at the midpoint. And this includes increasing margins for three of our six segments, electrical products up by 30 basis points, electrical systems and services up by 50 basis points, and aerospace up by 120 basis points. And due to expected volume declines, we're lowering margins in two of our segments, hydraulics by 110 basis points and vehicle by 40 basis points. With this updated guidance, I'd say that we're really on track to deliver another record year of margins with a strong 70 basis point increase at the midpoint over 2018, despite lower revenues than we anticipated. And finally, turning to page 13, we show our guidance for Q4 in 2019. For Q4, we expect adjusted earnings per share of $1.36 to $1.46. Other assumptions for Q4 in our guidance include we think our organic revenue will decline by approximately 2%. We'd expect segment margins of 17.2% to 17.6%. flat corporate expenses to last year and an adjusted earnings tax rate of approximately 17%. We are slightly lowering the midpoint of our full year 2019 adjusted earnings per share guidance to 572, 9 cents below the current consensus and due to lower market conditions. This does still represent a 6% increase over 2018 when you exclude the impact of the arbitration decisions. We're also increasing our operating cash flow guidance by another $100 million. You recall that we increased it by $200 million so far through this point, and we now expect to deliver at $3.4 billion to $3.6 billion for the year. I mentioned the second time that we increased our operating cash flow guidance, which highlights really the strong cash flow generation capability of our businesses. For 2019, our free cash flow to adjusted earnings conversion is expected to be over 120%, while free cash flow to sales is expected to estimated to reach approximately 14%. Other four-year guidance assumptions include 1% organic growth, $100 million of revenue from the acquisitions of Ulusoy and innovative switchgear solutions, foreign exchange impact of a negative $350 million, and this is actually $50 million worse than our prior guidance. Segment margins in the range of 17.3 to 17.7 percent, up 20 basis points at the midpoint. No change in our tax rate. We think our capex spending this year will be roughly $550 million, and this is about $50 million lower than prior guidance. And we estimate for our share purchases to be increased to roughly $1 billion. And this is up from our prior guidance of $800 million as we continue to deploy our strong free cash flow. So overall, I think we're very pleased with the company's performance this year. We're delivering very strong cash flow, solid EPS growth, despite, you know, what's turned out to be a much weaker economic environment for many of our end markets. So I'll stop with that and turn it back over to Yen for Q&A.