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 question 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 Invest Relations, Mr. Yen Jin. Please go ahead, sir. Hey,

good morning. I'm Yen Jin, Eaton Senior Vice President of Invest Relations. Thank you all for joining us for Eaton Third Quarter 2019 Earnings Call. With me today are Craig Arnold, our Chairman and CEO, and Rick Freelon, 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 .eaten.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 projection due to a wide range of risk 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. Craig Arnold. Thanks,

Jan. I appreciate it. And we'll start on page three with a highlight of our Q3 results. And overall, you know, 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 on the press release, were $1.44 on a GAAP 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 0.5 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 .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 and 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, in a way of summarizing the results, where we purchased 539 million shares in the quarter, bringing our -to-day purchases to 949 million, or .8% of our shares outstanding at the beginning of the year. Turning to page 4, 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 8 cents per share of after-tax costs, primarily related to the planned investiture of our lighting business. And lastly, adjusted EPS increased 6%, 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, strong execution, proactive cost control, and increasing our share repurchases. On page 5, 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%, and operating margins were up 110 basis points to 20.3%, 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've seen a good outcome for our shareholders and another example of how we're actively managing the portfolio to create higher margin, higher growth set of businesses for E-10. 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 6, we summarize our results for our electrical systems and services segments. Revenues increased 3%, 3% organic growth. We also had a point and a half of growth from the acquisitions of OlaSoi 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&F 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 in 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 declined to 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 SORIO SunBank 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 in light vehicle markets, which we think were down approximately 4% in the quarter, and primarily the impact of the transfer of revenues into the Eden-Cummons 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 low 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 a 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, it's 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-risk 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 .5% for electrical products, and .5% for electrical systems and services. In hydraulics, global mobile equipment markets remain weak, and this weakness has been amplified, but really stocking in both the OEM and distribution channel. As a result, we now expect organic revenues to decline of 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, you know, slightly modified our estimates for e-mobility as well, which we think will be growth at 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, you know, while we project low single digit growth for electrical products, you know, overall. Business conditions, I'd say, you know, have clearly been impacted by trade, by the political environment, and by, you know, by 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 of what 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 margin guidance 20 basis points to a new range of 17.3 to .7% or .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, you know, expected volume declines, we're lowering margins in two of our segments, hydraulics by 110 basis points, and vehicles by 40 basis points. With this updated guidance, I'd say that we really want to 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 for 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 for share guidance to $5.72, nine 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. This is the second time that we've 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 full year guidance assumptions include 1% organic growth, $100 million of revenue from the acquisitions of Udsoy 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%, 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 of 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 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. Hey, thanks, Craig. Before we begin the Q&A section of our call today, I do see we have a lot of individuals that have interest in the queue with questions. Given the time constraint of an hour today and our desire to go to as many of these questions as possible, please limit your opportunity just to one question and a follow-up in our second in the ones for your corporation. With that, we'll turn it over to the operator to give you guys the instructions.

Thank you. Ladies and gentlemen, if you would like to ask a question, please press star one. You'll hear a tone indicated and placed in the queue. If your question gets answered and you wish to remove yourself from the queue, please press the pound key. Again, star one if you have a question.

Okay, we'll take the first question from Nigel Cole with WALB Research.

Oh, thanks. Good morning. Good morning, Nigel. Yeah, obviously a lot of good detail on the call, but you did a great job of adjusting to the changing conditions in 3Q. Showed us a very nice margin. You are assuming margins stepped down a bit more than normal seasonality into 4Q. I'm just wondering what's driving that, Craig and Rick. Is there any additional restructuring coming through in 4Q and where do we stand on additional restructuring actions in light of the weekend mornings?

Appreciate the question, Nigel. So, I mean, to your statement, yeah, we absolutely... If you think about kind of the bridge between Q3 and Q2, we're really outstanding performance in Q3. There's a number of items that are impacting us in Q3 and Q4 that are taking the margins down. One is a higher level of restructuring, and you can imagine it's largely in those businesses where we're seeing additional market weakness. We certainly are seeing a higher tax rate in Q4 than we had in Q3. You saw the operational tax rate of roughly 17%. In addition to that, there's a few normal factors. Healthcare costs tend to run higher in Q4 than in prior quarters. So there's just a number of kind of, let's say, one-time items that we're dealing with in Q4. Obviously, we're dealing with a GM strike that has a little bit of an impact as well in Q4 that take the margins down. But I'd say that as you think about the outlook for 2020, I'd say a lot of these are one-time items, and I know that a number of the analysts wrote about extrapolating Q4 into next year. I'd just ask you to keep in mind that there are a number of one-time and seasonal items that are impacting Q4 that you really would not be justified in extrapolating to the full year.

Okay, that's great, Keller. We'll dig into the details offline, but I do want to just switch to ESS margins. And, yeah, we were probably two years ago thinking that 15% in this business would be a dream, and here we are, 18%. So I'm just curious, you know, how confident do we feel that you can defend this level of margin going forwards, and maybe just address what's changed to drive such a high margin?

Yeah, you know, once again, we agree. I mean, .3% is outstanding performance by our team in general. And I think, as I mentioned in my commentary, really a function of really strong execution by the organization on higher volumes that we saw in the quarter. And we will clearly need to revisit, you know, the long-term margin guidance for our ESS segment. If you recall, we talked about this segment performing at 13% to 16% through the cycle. We're already performing well above those numbers. And so as we think about, you know, giving kind of the outlook for the business and setting expectations, we do believe that this business will perform at higher levels on a go-forward basis.

That's great.

OK, good. Our next question comes from Jeff Hammond with KeyBank.

Morning,

guys.

Morning, Jeff. So if you could just talk about kind of where we stand in the de-stocking for hydraulics, and then just, are you seeing any de-stocking in electrical? And maybe just speak through where, you know, where in the guide you're seeing softness within, you know, I guess particularly EPG.

Yeah, you know, I'd say in terms of hydraulics, and as we talked about in our commentary, really we've seen broad-based de-stocking, you know, significant, let's say, de-stocking at the OEM channel as productions continue to run, you know, well below retail sales. And you see that in a lot of the public data. And also in distribution, we're seeing the same thing. I think the question becomes, you know, how long does this go on? I mean, we could sit here and attempt to speculate when does the de-stocking end. It's really going to be a function of what ultimately happens with the end markets and the end market demand. I will say that today we take a little confidence in the fact that the end market demand in many of these hydraulic markets around the world are certainly performing OK. We're talking about, let's say, on average, low single-digit growth in a market like construction, you know, slag slightly down in markets like ag. But what we're experiencing as a supplier is numbers that are much worse than that. And so we take some, you know, confidence in that, that, you know, we're approaching the end. But I think ultimately, you know, it'll really be a function of what's going to happen with these end markets in terms of de-stocking in the hydraulics business. You know, I say in the electrical business more broadly, you know, at this point we're not really seeing significant de-stocking in electrical. I mean, what's kind of impacted our growth a little bit in electrical in the quarter was largely, you know, project delays, you know, given the kind of the uncertain political environment that we're living in right now. More, it's been really more of that issue than it's been an issue of de-stocking and certainly you think about our electrical products business, much of which goes to distribution, you know, and periods of uncertainty, you know, they're kind of being cautious around the inventory levels that they're putting on the shelf in general, but not at this point that I'd say a significant amount of de-stocking.

Okay, great. And then Craig, I think in past years you provide kind of initial views on out year and third quarter and I didn't see anything in there. Can you just, anything you can give on kind of how you're thinking about the markets, you know, incrementals, any kind of non-operated items and kind of uses of cash around the, you know, the lighting sale? Thanks.

Yeah. Yeah, I mean, your observation is absolutely accurate, Jeff. We would typically in this call, you know, give a kind of some insight into 2020 given the level of uncertainty, you know, in the environment that we're currently dealing with, whether it's trade or geopolitical or some of these one-off customer events, we thought it would be prudent at this juncture not to provide guidance for 2020 to let, you know, some of the Q4 play through and that we would then be providing guidance as a part of our earnings call in January. And so that's kind of the way we're thinking about that. To the specific question around uses of cash, obviously, you know, we sold the lighting business for, well we will sell the lighting business for $1.4 billion and it would be our intention to use those proceeds to buy back shares. You know, we're going to attempt to be smart and strategic in the timing of the buyback program, but the intention would be to use those proceeds plus our very strong cash flow generating capabilities to make sure that we fully offset any dilution associated with the divestiture of lighting.

Okay, thanks, Craig.

Our next question comes from Dave Rastow with Alucor.

Good morning. I apologize, I missed the very beginning of the call, but for the electrical businesses sort of exiting 19 into 20, the lighting business is still officially in the guide for fourth quarter for EP, correct, just to be clear? Yes, yes. Okay, so the orders were up 1% X lighting for EP and ESS orders, I'd say overall, were, you know, probably a little better than people feared. But can you help us understand what you're seeing beyond the quarter in the sense of, what's in the backlog? Does that have further visibility than normal, shorter than normal? Just trying to get a sense of, can we still count on electrical to, you know, start the year healthy because obviously people are wondering, can we get the more cyclical businesses bottoming out, you know, at some point in the first half and hopefully they're all growing together in the end of the year?

Yeah, I appreciate the question, Dave. You know, the business that obviously we have the greatest visibility to is in our electrical systems and services business. And I will say that, you know, our order input in Q3 was quite strong across the board. You know, most of the end markets that we serve, I'd say, posted, you know, anywhere from mid to high single digit order growth in the quarter, which really bodes well, I'd say, for the long cycle piece of our business electrical systems and services into 2020. I think it's too early to make a call on it. And that's one of the reasons why we're not providing guidance. But certainly, if we take a look at the order book and what happened during the course of Q3 in electrical systems and services, we feel very good about, you know, the order intake and how, you know, 2020 is shaping up. And electrical products, which tend to be much more of a book and bill business, as we mentioned, you know, we did see a little bit of conservatism on the part of distribution. And in that business, it just doesn't tend to be a longer cycle business. And so we'll just have to see, you know, what happens with some of these other kind of world events and what level of distribution confidence we're taking in with us into 2020.

And the X lighting in the fourth quarter, or I should say it another way, is lighting down in the fourth quarter? I'm just trying to assume that'll be out of the business when we give the guide in January. And I'm just being sent to the court. What

I'd say and appreciate the question, Dave, given the fact that we've entered into a transaction and we've signed, you know, we prefer not to comment on lighting, you know, as it's going to ultimately be somebody else's business on a go-forward basis. And so, you know, as we think about lighting on a go-forward basis, we would prefer not to comment on that business, given the transaction and the fact that ultimately somebody else is going to own it.

I can appreciate that. OK, thank you.

Our next question comes from Scott Davis with Amelius.

Hi,

good morning, guys.

Hi. Greg, just to kind of address the elephant in the room, you know, when you have quarters like this where you miss your guidance on the top line, which doesn't happen to this extreme very often, does it make you kind of rethink the portfolio a little bit? I mean, you've got hydraulics and vehicle that will actually guide you around every cycle. And is it worth the headaches? I mean, you know, I'll just leave it at that.

Sure. You know, I appreciate the question, Scott, and as we've talked on this call before, you know, we really have, you know, let's say, laid out a criteria for businesses that we like and the conditions under which, you know, we think we're going to stay in business and the conditions under which we're going to step out. And I will say that if you take a look at our track record over time, Eaton has done, you know, I'd say a lot of work around the portfolio and the lighting, the vestiture is the latest example of that. You know, I will say at the end of the day, you think about today, hydraulics in the quarter delivered 7% of our company profits. And so at the end of the day, whether hydraulics, you know, grows 5% or shrinks 5%, it really doesn't have a significant impact on the ultimate, you know, earnings of our company. And so we like to think that we're getting some of the execution issues behind us and it is a cyclical business. It will always be a cyclical business. But at the end of the day, what really drives Eaton, as we said on the earnings call, 80% of our earnings come from electrical systems and services, electrical products and aerospace. And that's really what drives the company. And so we will continue to work on, you know, our internal plans to improve the execution of hydraulics. They know what they need to do in order to, you know, continue to deliver and be a value-creating part of the company. So I'd say at this point, we're comfortable with the portfolio, you know, and at the end of the day, we'll continue to focus on the things that we can control inside of the business, recognizing that these will always be cyclical businesses.

Fair enough, Greg. And just as a follow-up, I mean, I know you mentioned that you've got this billion dollars coming in and you're going to do more buybacks. But is there, is this the type of environment where you want to take another more aggressive look at M&A or is this the type of environment where it's so uncertain that it's better to, you know, push it to the right?

Yeah. You know, and also we always look at the trade-off, right, in terms of, you know, we've been very disciplined over the years around terms of understanding what our cost of capital is and we think it's, you know, roughly 8 to 9 percent and we'd expect a return, you know, order of magnitude 200 to 300 basis points over our cost of capital as a minimum. And so we've been a very disciplined buyer, you know, through both, you know, at all points in the economic cycle and we would continue to maintain that that's the way we'll run the company. And so for us, it's always going to be a matter of trading off what an acquisition would do for the company and both strategically and in terms of EPS versus the option that we have of buying back shares at very attractive prices. Okay. Good enough. Thanks. Good luck, guys. Thank

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

Hi. Good morning.

Hi.

Wanted to go back to the aerospace margins, obviously very strong. I know a couple of quarters ago we had a conversation around OE versus aftermarket mix, but, you know, similar to that ESS line of questionings, we are above kind of your, through the cycle look on that business. How do you view the sustainability of those really strong aerospace margins?

Yeah, and I appreciate the question and I'd say, as I've said on prior calls, this has really been a little bit of a Goldilocks period for the aerospace industry overall because you have really strong market demand, you have very strong aftermarket and you have relatively, by historical standards, low program spending. And so you're seeing the result of that deliver very strong margins. But that is certainly another one of the segments that we're going to clearly have to take a look at as we provide, you know, our, once again, our longer term outlook for the business in terms of what margins should look like through the cycle. And clearly that's one that we'll be revisiting and will likely go up given the level that the business is performing at today. But I'd say today when we think about, you know, whether or not, you know, 25% margins are pretty extraordinary and the business probably won't, you know, perform at that level every quarter. But I will say that, you know, we're very comfortable today that the margins in this business will perform at very high levels and very attractive levels for some time to come. And primarily because, you know, consumers are continuing to get on planes and that drives the aftermarket. The military business is really just kicking into gear right now and Boeing and Airbus are sitting on very large backlogs. And so we think this business will be good for a very long time.

Great. Thank you for that. And then, you know, obviously there's been a lot of questions around cap allocation and the strong cash that's going to be coming in the door. I know you don't want to get ahead of yourself for next year, but you've historically had this expectation to take down 1 to 2% of float next year. I mean, should we assume that the high end of that's kind of where we should be base casing it?

Yeah, it's Rick. I would think of it this way. Our expectation would be take down 1 to 2% float and then the proceeds from lighting on top of that. So you'll end up with considerably more than 1 to 2%.

Great. Thank you for that.

And this is an important point because, you know, one of the things that we committed to you and the investor community in general is that, you know, as we think about how we would manage the company during, you know, periods of market weakness is that we said that we would use our strong cash float generation capabilities and our balance sheet to essentially buy back shares to help offset, you know, pressures in terms of EPS. And that's clearly what we did in Q3. And you could expect that as we look into 2020, depending upon where markets end up, that we'll continue to kind of run the same play.

Great. Thank you.

Our next question comes from Nicole deBlaise with Deutsche Bank.

Yeah, thanks. Good morning, guys.

Hi.

So maybe just the first question around the increase in the operating cash flow guidance. I guess key drivers of that, it looks like the receivables balance is down, inventory is up a little bit. So just trying to reconcile, you know, where that's coming from.

You're right. Working capital was very strong. If you look at the combination of receivables and payables, the change from Q2 to Q3, you're just shy of $200 million. And so we have done a good job all year at managing working capital. We expect that to continue into Q4. And already our initial thinking about next year would have further improvements. There's a variety of programs relating to, for example, correcting any billing inaccuracies that makes a big difference in receivables, but also in payables, making sure that we are paying our suppliers in a commercially reasonable timeframe. And we believe we have further opportunities to improve both receivables and payables.

And to your point, Nicole, inventories actually are up slightly, you know, and typically when you're facing into an economic downturn, we typically take inventories out of the organization. So we, quite frankly, have a big opportunity still out in front of us in terms of really reducing our overall inventory levels. And so to Rick's point, we would expect 2020 to be another year of very strong cash flow.

Thanks, Craig. You actually just pre-answered my second question. So I guess I'll move on. Any thoughts on the monthly progression of organic growth throughout the quarter? Do things get a lot worse for you guys in September? And then I guess anything initial that you have to say on October relative to the guidance that you've provided today for the fourth quarter?

Yeah. And I'd say that, you know, one of the things, you know, I was out at the investor conference, Nicole, in Laguna, and I kind of indicated there that we'd already seen really in the first couple of months of the quarter, you know, some market weakness, which really I'd say persisted throughout the quarter. So I'd say no, not particularly. September wasn't a particularly weaker month than the other two months in the quarter in terms of the progression and how it unfolded. And I think in terms of October, I'd say, you know, what we've seen so far is largely consistent with the forecast that we provided.

Thanks. I'll pass it on. Thank you. Our next question comes from Joel Ricci, Risco Demand X.

Thanks. Good morning, guys.

Hi. Morning, Joe.

So, Craig, I wanted to touch on the disconnect between what you're seeing on the order growth side on ESS and what you're expecting from a growth perspective. You mentioned in your prepared comments project deferrals. And so I'd love to get a little bit more color on where you're actually seeing project deferrals and how that kind of plays out into 2020.

Yeah, and what you referred to as a disconnect, I would say largely, if you think about the electrical systems and services business, it does tend to be a longer cycle business. And so if you, probably the best proxy for what we would expect for that business in the fourth quarter probably would have been orders that we received in Q2 of 2019. And if you recall, we had a relatively weak order intake in Q2. So there is a time lag to that business. But once again, to your point, we did see very strong orders in Q3. And we think that does bode well for 2020. And so that's really the way I would think about that. And the second half of your question was with regard to

the... How that played out, yeah, just basically how that played out for 2020. And I mean, I guess if I were to ask a clarifying question, are you seeing any cancellations in your orders at all? Or is it just really just deferrals at this point?

Yeah, I'd say mostly deferrals. There's always the oddball cancellation that you would always see in these businesses. But I'd say nothing that's increased significantly. Mostly it's really delays.

Okay,

and

then I guess... That's particularly true on the larger industrial projects.

Okay, got it. Thanks, Rick. I guess my one follow-up, and somebody asked this earlier, but I wanted to see if we can get some type of quantification. On the arrow margins, what's the expectation for R&D stepping down both this year and into 2020?

Yeah, I think with respect to R&D, we've already seen the step down in R&D that's currently reflected in our businesses. And so today, I'd say we're probably running with respect to R&D as percentage of revenue. We're probably running right now at historically low levels, primarily a function, once again, of new platform development from our customers, both on the commercial and the military side. And so I would not expect an additional step down in R&D spending. It's really already reflected in the business's run rate today and in our earnings today.

Okay, got it. Thank you, guys.

Our next question comes from Jasper, it was worth your research.

Thank you. Good morning, everyone.

Morning, Jeff.

Just a question on restructuring, and I'll wrap it around lighting a little bit. I mean, is there... Just elaborate a little bit on what you're doing on the restructuring front. Maybe help us think about how much additional there is in Q4, and is there kind of a stranded cost element with lighting that we should be thinking about?

Yeah, I'd say that, you know, if you think about kind of the incremental of restructuring, you know, in Q4, I mean, you order a magnet to... Jeff, we're talking about a couple of two, three cents or so in Q4 from where we've been. You know, and the lighting, you know, I think the source of that question is, what do you do with the stranded cost, right? You sell a $1.7 billion business, obviously, there's some stranded costs associated with that, and we would fully expect to deal with all of the stranded costs, and so we will, obviously, in the context of the overall restructuring number that we put up and the cost of the exit, we talked about a $200 million of cost associated with the exit of lighting, embedded in that number was cost to deal with stranded costs, both at the corporate level and also inside of electrical products, and so we would expect to fully deal with stranded costs inside of the business.

Could you also elaborate a little bit, and I don't know if you need to pull it apart, EP versus CSS, but just kind of the trajectory of price in your business and just kind of the price-cost algorithm, you know, looking into Q4 in the early part of next year?

Yeah, you know, I'd say that, you know, what we've always said around price-cost is that we're net neutral, and that's really, today, I'd say, where we ultimately will end up. We certainly, I think, were slightly positive in Q3, you know, just slightly positive, but we would expect, once again, on a go-forward basis, that commodity cost inflation, you know, tariff-driven cost increases, that the company will fully offset that, and we'll do a better job of making sure that we're getting price at the same moment that we're experiencing the cost, but we'd really expect it to be net neutral to eat in overall.

Great, thank you.

Our next question comes from Andrew Olbin with Bank of America.

Hi, yes, guys. How are you?

Good,

great. Yeah, just great execution. Just a question on hydraulics. As we think about production costs at Cat and Deere, when do those get incorporated into your revenues? Are we seeing some of them in Q3, or is that something we're going to see in Q... When do we see the bulk of it? That's what I'm...

Yeah, so we typically, appreciate the question, Andrew, as well, because it's what we've been dealing with, but we typically would run about 90 days in front of our customers, in terms of, you know, whatever they're forecasting in, you know, Q4, we would have experienced in Q3, just given the lead time, all the way back through the supply chain on many of the components that we're sourcing. And so we have, you know, and this is typical, by the way, if you take a look at this business over time, you know, we typically see an outsized impact, both on the way up and on the way down, when our big OEM customers go through these periods of market correction.

Gotcha. And then the question, in terms of shortfall, I know there was a quote from you that you were expecting, 3%, you got 1%, and I know you gave it to us by end markets, but can you just give it big geography buckets, which one disappointed the most? Unless it's obvious, I mean...

Sure, sure. And I'd say that, you know, in terms of end markets specifically, it really was a down shifting in the growth rate, let's say, you know, the biggest market for us is always, you know, the America, the US market, and I'd say... That's what I

was referring to, yep.

Yeah, and, you know, growth, you know, still positive growth for sure across the board, but certainly we saw a down shifting in the rate of growth in the Americas, we saw it in our electrical systems and services business, in large projects, we saw it in the distribution channel on electrical products, we saw a down shifting in growth in the oil and gas space, specifically in our crowd science business.

Okay, thank you.

Our next question comes from Chris Glane with the Oprah Hammer.

Thank you, good morning. So on hydraulics with the restructuring kind of back tail and a little more in the fourth quarter, and some comments about moving past inefficiencies, just wondering, Bo, can you raise margins a little on, you know, moderately down revs next year and is the 13% kind of the bottom of your... through the cycle range, do you see that as being attainable?

Yeah, and I think, you know, appreciate the question and the goal that we set for this business, 13% at the bottom of the cycle, we think is absolutely the right goal for the business and we think is certainly attainable. I think the real question becomes, you know, where do these markets ultimately bottom out at, but I think it would not be an unreasonable expectation that the business deliver 13% margins, you know, at the level of economic activity that we're seeing right now in the business.

Okay, thanks. And then a bookkeeping one, any early kind of notional comments on the corporate guidance for next year? Should we just leave it comparable?

Well, we've got to work through our planning. As a general matter, you know, we have been quite successful at holding our corporate costs flat year to year and then down years, taking it down a little bit. So that will give you some color. Perfect, thank you.

Our next question comes from Ann Degnam with JP Morgan.

Hi, thank you. Most of my questions have been answered. Maybe on, if I look at the EFS, the Dodge Momentum Index has been weak all year, up a little bit in September, but that reflects just new projects being considered and should be a good leading indicator for EFS for next year. The worst disconnect that we've ever seen is that maybe not the Momentum Index, but you're seeing the actual Dodge data improved and that's what's driving current orders.

You know, and I appreciate the question, Ann, because we spent a lot of time obviously internally trying to figure this one out as well. It is a long cycle business playing across a very wide set of end markets. And I'd say that a lot of the macro data, to your point, and what we saw certainly in our own order book in Q3 was quite positive, and with orders up 5% on a rolling 12 and 8% excluding data centers, those are pretty strong numbers. And I'd say you can always find in this business that at any given quarter you could end up with numbers that vary from the kind of longer term or medium term growth rates. And I think what we experienced in Q3, as we indicated, was this largely a pullback in large projects and some project delays and a bit of slowdown on oil and gas. But certainly what we've seen in Q3 and what we've seen in most of the macro indicators for this business, non-res construction continues to do well across the world. I mean, a little bit of moderation in the growth rates, but still growth. And so we remain optimistic about the prospects for this business.

Okay, I appreciate the color. And then just to follow up on e-mobility, you normally report the mature year revenue wins that this business has accomplished. Could you update us on that?

Yeah, and in this quarter, Anne, we haven't had any new material wins in the quarter. So what we try to do in this business, as you know, these wins come in large chunks. And as we get large material wins, we'll be sure to update you on how we're doing. But by and large, we continue to be very optimistic. The business, as we reported historically, we're ahead of the schedule that we originally set out for the business. And we're still extremely confident in our ability to create a $2 to $4 billion new segment for the company.

Okay, and I had from last quarter that your mature revenue wins were about $390 million. Is that still what I should think about?

Yeah, I mean, they would have moved up slightly from that, Anne, but we'll try to just report material wins when the number moves in a material way. We'll give you an update.

Okay, I appreciate that. That's it from me. Thank you.

Our next question comes from Julian Mitchell with Spotless.

Hi, good morning. Hey,

Julian.

Hey, maybe just a first question around these ESS incrementals, you know, very, very good performance. Just wanted to make sure there was nothing particular you saw around mix or something as a tailwind that you think would fade. Or whether you think this is just normal course of business and reflect sort of good project discipline.

You know, I say that, you know, we obviously took a strong look ourselves at this business because the margins at .3% are very, you know, very, very high and above our own expectations. And no, we did not see favorable mix in the quarter. We looked at that issue specifically and it wasn't mixed. It really was largely this strong execution, you know, in the quarter. And, you know, obviously there's always a mix of projects in any given quarter in the S&S. But no, there wasn't no particular unusual, the one-time events that drove the performance.

Thank you. That's helpful. And then secondly, maybe switching to electrical products, you do have some reasonably large, you know, industrial and industrial controls exposure within EP, particularly now that lighting is coming out. Maybe talk about that more industrial piece of EP, you know, how you saw demand trends there in recent months. And if you're expecting Q4 demand in that industrial piece of EP to be any different in Q4 than Q3.

Yeah, we appreciate the question. I mean, without a doubt that the weakest piece of the business, you know, today, year to date and what we're forecasting is really what's going on in industrial markets in the manufacturing sector. And we generally talk about that being about a third of the business itself. And so it's a big material segment for us. And we clearly have continued to see weakness in the industrial controls part of the business.

And that was true, Julian, both on sales and orders in the third quarter.

Great. Thank you very much.

Our next question comes from Bob McCarty with Stevens. Hi,

Rob McCarty here. I guess the first question I would have is, you know, in thinking about the sale of lighting, I mean, I think it was seven and a half times trailing. It was certainly less than that on a Ford basis. Horseshoes and hand grenades paid between 11 and 12 times for Cooper. Even if that was at a company average, I mean, yes, it's a good to have certainty of what you're talking about. But this isn't exactly value creating if you're buying assets 12 times and then jettisoning them at seven and a half times trailing, you know, call it seven or eight years later. So, I mean, do you think that this kind of activity kind of belies the fact that perhaps you should take a look at a harder look at breaking up the company?

Well, Rob, let me just address that. I don't think your perspective is exactly correct. To give you an idea, the lighting business when we bought Cooper was just under 1.2 billion and now it's 1.7 billion. So we've grown the business quite significantly over the time period. And if you look at, you know, if you sort of disaggregate what we paid for the lighting business as part of Cooper, it's not an awful lot different than what we sold it for. And now we thought that the business could migrate in certain ways and meld closer to the broader electrical franchise and it really has not. And, you know, that's one reason we believe it's more appropriate as part of another lighting enterprise or possibly as a public company, which was our original game plan. But we would argue that we haven't dramatically impacted value in the case of lighting. It's as happened sometimes, businesses don't end up developing in a way that you expect.

All right. And then in terms of the cash generation of the businesses, I mean, in the context of how you're thinking about your trough and the cash EPS trough, certainly I think you would highlight rightfully so strong cash conversion overall. Are you still subscribing to the kind of the trough and the way to think about the trough as you articulated earlier in the year and has anything changed there with respect to either cash generation in the down cycle or the trough itself? You know, can we rely on that as a kind of anchor to win work, particularly as we go into a tougher macroeconomic environment?

If you're talking about by trough, will our cash flow change markedly in a down year? We still believe it's not likely to. And simply because we liquidate working capital at offsets, the profits lost through lower volume. So even if we add a down year at some point in the next couple of years, we don't think you'd see a market change in cash generation. And one thing, just one other point I would like to make about cash flow, I think it's important. If you think about our free cash flow in 2019 based on the guidance we've given and you look at that compared to 2018, we're guiding to up 23%. And I think that's a pretty notable number. At the end of the day, the real value of most businesses is the cash they generate. And we're generating really attractive increases in cash flow in 2019 and we would expect continuity in that cash generation next year.

And absolutely cash flow is very strong. I guess what I was alluding to specifically was the framework I believe Craig laid out for a trough scenario. You're still subscribing to that. Oh

yeah, you're talking about, can we have at least flat EPS in a trough year and we continue to believe that that is the base case plan.

And the only caveat we'd add is that we said post the spin over sale of lighting and post the vestiture of FCD and we'd expect to get the FCD transaction done by the end of the year and lighting sometime in Q1. But post those transactions, we absolutely have the plan and fully committed to delivering flat EPS, you know, don't what we call a typical economic recession which we define as two to three quarters of GDP contraction.

Thanks for your time. I appreciate it.

Good. Our last question comes from Din Zhui with RBC.

Thank you. Good morning everyone. Hi, Dean. Hey, I was hoping to get a spotlight on a specific geography and a vertical. What can you tell us about China, the tone of business, the outlook, and then data centers has come up during the call. Any specifics there in terms of the outlook?

Yeah, I appreciate the question, Dean. I think China, if you think about across the broad swath of businesses that we deal with, maybe deal with the positive first, I'd say kind of the non-res construction and quite frankly even res construction in China actually continues to perform very well. You see some of this data as well, but office starts in Q3 were actually up 10% and are up 16% year to date. Resinential starts are up 6% in Q3 and 9% year to date. So, you know, the whole kind of construction market in China is doing well. Quite frankly, even on the hydraulic side, excavator sales continue to grow quite nicely in Q3, up 16% in excavators and up 7% in wheel loaders. So, that piece of the business in China is actually doing quite well. By contrast, light motor vehicle production is down quite significantly, down 7% in Q3 and 12% year to date as well as heavy duty truck production is about flat. And so, it really is a very different story depending upon which end market you're referring to. But in the most important part of our company, let's call it the electrical side, non-res construction, the market is holding up quite well. And then typically the data centers, as we mentioned in the opening commentary, in our data center business performed very well in the quarter. We ended up seeing, you know, high single digit growth in data centers. And so, that market continues to perform very well. And as we've mentioned on other earnings calls that, you know, the hyperscale stuff does tend to be lumpy. And we can continue to see that lumpiness. But by and large, we continue to see very good growth in data centers.

Great. Great. Just the last one for me, the lowering of the capex by 50 million, is there any story behind that?

No, I'd say that's just really us fine tuning the outlook for the year. We, you know, our businesses tend to be a little optimistic during the course of the planning process around what they can get done. That's really just largely a true up. We've not done anything to put any clamps on our capex spending. We're still spending on every program that we can get done.

Great. Thanks for the caller.

Great. Thanks to you all. We have reached to the end of the call, and we do appreciate everybody's questions. As always, Chip and I will be available to address any follow-up questions. Thank you all. Have a good day.

Thank you.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.