Eaton Corp PLC

Ladies and gentlemen, thank you for standing by. Welcome to the Eaton Fourth Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. And if at any time during the conference you have a question, you may queue up by pressing 1 followed by 0. Should you require any operator assistance, please press star followed by 0. Also as a reminder, today's teleconference is being recorded. At this time, we'll turn the conference over to your host, Senior Vice President of Investor Relations, Mr. Yan Jin. Please go ahead.

Hey, good morning, everyone. I'm Yan Jin, Eaton Senior Vice President of Investor Relations. Thank you all for joining us today for Eaton's fourth quarter 2019 earning call. With me today are Craig Arnold, our Chairman and CEO, and Rick Fearon, Vice Chairman and Chief Financial and Planning Officer. Our agenda today includes opening remarks by Craig, highlighting the company's performance in the fourth quarter. As we have done 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 also the presentation we'll go through today have been posted on our website at www.eaton.com. Please note that both the price release and the presentation including reconciliation to non-GAAP measures. A webcast of this call is accessible on our website and will be available for replay. Before we get started, I would like to remind you that our comments today will include statements related to the expected future results of the company and are, therefore, forelooking statements. Our actual results may differ materially from our projected future earnings due to a wide range of risks and uncertainties that are described in our earnings release and presentation. They're also outlined in our related 8K filing. With that, I will turn it over to Craig.

Okay. Thanks, Shane. I appreciate it. Hey, we'll start with page three with recent highlights. You know, two weeks ago, as everybody knows, we announced the agreement to sell our hydraulics business to Danfoss for $3.3 billion, which represents a 13.2 times 2019 EBITDA. This decision is part of the ongoing transformation of Eaton into a company with higher growth, higher margins, and more consistent earnings. So we're really pleased with that. We believe this transaction will create substantial value for our shareholders and allow our hydraulics employees, importantly, to become part of a company that has a strong commitment to the hydraulics industry. Our team has made significant progress on other portfolio actions, including closing the acquisition of Serial Sumbank and the sale of our automotive fluid conveyance business at the end of the year. The sale of our lighting business is expected to close in Q1, And as you've read, we just announced the acquisition of Power Distribution, Inc. Power Distribution, Inc. is a $125 million company that serves the data center market and will become part of our electrical systems and services business. Switching to our Q4 results, and I'd summarize the quarter's performance as one with strong earnings, record margins, strong cash flow, despite slower than expected growth in our end markets. Organic revenue, excluding lighting and hydraulics, was down 2%. Earnings per share of $1.49 on the GAAP basis and $1.46, excluding $0.28 of acquisition and divestiture costs and $0.09 for costs we expect to incur related to vehicle warranty. At $1.46, our results were flat with last year and at the high end of our guidance range of $1.36 to $1.46. Our sales of $5.2 billion were down 4% organically, with negative currency of 0.5% offset by 0.5% from acquisitions. We continued to generate strong margins and delivered a Q4 record of 17.8%, excluding acquisition divestiture costs and the expected vehicle warranty costs. These margins were above the high end of our guidance range and 40 basis points above prior year. And we're also pleased with our operating cash flows, which were $937 million in the quarter. So stepping back, I think we'd all agree that it's been a busy and a very productive period for Eton. Turning to page four, we summarized our Q4 financial performance. And I'll note just a few highlights on this page. First, we increased our adjusted segment operating margins by 40 basis points. And our team, I'd say here, executed well. We had decremental margins of less than 10%. Second, our adjusted segment operating profits were $933 million, down 2% despite 4% lower organic sales. Net income of $452 million was down 28%. And this was primarily due to acquisition and divestiture costs of $114 million and vehicle warranty charges of $39 million. And both of these numbers, I would note, are on an active tax basis. Similar to Q3, these strong results are, I think, a good indication of how we intend to manage the company during periods of market weakness, running our operations efficiently, proactively managing costs, and accelerating our share repurchases. Moving to page five, we'll start with our segment summaries with electrical products. Revenues were down 2%, and excluding lighting, organic revenue increased 1%. Strength was driven by residential markets in the Americas, our distribution business, and Canada. Adjusted segment operating profits increased 9%, and adjusted operating margins were up 210 basis points to 20.3%, a Q4 record. The sale of our lighting business to Signify for $1.4 billion remains on track, and we expect to close in Q1. Excluding lighting, orders were down 2% with strength in residential commercial construction markets in the Americas, and this was really offset by industrial markets globally. Turning to page six, we show a summary of our electrical systems and services segment. Revenues increased 4 percent, with 2 percent organic and 2 percent from the acquisition of Ulusoy and Innovative Switchgear Solutions. Organic growth was driven by strength in the North American utility and commercial construction markets primarily. Adjusted segment operating profits increased 7 percent, with adjusted margins of 17.1 percent, up 50 basis points over prior year. And on a rolling 12-month basis, our electrical system to services orders increased 2.5%, with growth really across all regions of the world. Excluding hyperscale data centers, the 12-month rolling average of orders was up some 4%. And just yesterday, we announced the acquisition of Power Distribution, Inc., which is a leading supplier of mission-critical power distribution, switching, and power monitoring equipment for the data center market. Power Distribution, Inc. really builds on our strong position in the fast-growing data center market and adds new capabilities in the area of overhead busway and power distribution. So we're really pleased with the prospects of what PDI will add to our electrical systems and services business. Moving to page seven, we summarize our hydraulic results for Q4. Revenues were down 13%, with orders down 11%. And this is driven by continued weakness in global mobile-to-put markets and destocking that continues at both OEM and also with our distributors. And as I mentioned earlier, we're really pleased to have announced the agreement to sell the hydraulics business at Danfoss for $3.3 billion, and we expect this transaction to close at the end of the year. And as we've announced, we are retaining our filtration and golf grip businesses. We expect cash taxes from the sale of hydraulics to be approximately $450 million. So our net proceeds will be approximately $2.85 billion. And a number of you have asked how we intend to use proceeds. And I'd say that the options of additional acquisitions and share repurchase are both on the table. For M&A, I would also add that our pipeline remains very active, and so it's great to have this optionality as we look forward. On page eight, we summarize the results for our aerospace segment. Revenues were up 3%, including 2% organic and 1% from acquisitions. We experienced in this segment continued strength in commercial OEMs and also in commercial aftermarket. Orders on a rolling 12-month basis increased 6%, with particular strength in military and aftermarket and bizjet. Certainly strong execution in this segment led to a 9% increase in adjusted segment operating profits and 130 basis point improvement in adjustment margins, which were 24.2%. Can I just say here that, you know, this is the business delivered another quarterly record, you know, capping what's been a very strong year. We're also pleased to have closed the acquisition of Soria in late December. We've welcomed the Soria team to Eaton, and our integration teams have already begun working to deliver the synergy plans, which includes the opportunity to take our new electrical connectors capabilities into our core electrical markets. Turning to page 9, we summarize our vehicle business for Q4. Revenues were down 19%, and this includes 18% organic and 1% from currency. Declines here were due to a number of factors, the GM strike, Class 8 OEM orders. In fact, Class 8 production was down some 20% year-over-year, and continued global weakness in light vehicle markets, which were down 9%. And I say here, in a clear example of our grow the head and fix the tail strategy, which is really about how we really focus the company, we completed the sale of our automotive fluid conveyance business at the end of the year. During the quarter, we also took a $50 million pre-tax charge for expected warranty costs. This charge is being undertaken to correct the performance of one of our products that incorporated a defective part from a supplier. And we're actively looking for ways of recouping these costs as well. Adjusted operating margins were 17% at a very high level, but down 90 basis points from prior year. Next up on page 10, we summarize the results for our e-mobility segment. Revenues were down 6%. And I'd say here, you know, while growth in electric vehicle platforms, you know, this was more than offset by weakness and legacy internal combustion engine platforms. Operating margins declined to 1.3% due to a significant step up of research and development, as well as manufacturing startup costs associated with electric vehicle programs here. I would like to highlight that since the formation of this segment in the first quarter of 2018, the mature year revenue from New Winds is expected to be $450 million. And so this segment continues to run ahead of our own internal expectations. And as you can imagine, we're pursuing a large number of additional programs as the industry continues to make the transition to electric vehicles. Before turning to 2020 guidance, I would like to take a minute just to summarize results of 2019, which are shown on page 11. First, we generated all-time record margins of 17.6%. which were up 80 basis points over 2018, excluding acquisition investor costs and the expected warranty costs. In fact, over the last three years, our segment margins have increased 260 basis points, which we see as a strong validation of our strategy. Earnings per share of $5.76, excluding the one-time items I just mentioned, was up 7% over 2018. We set all-time records for both operating cash flow of 3.5 billion and free cash flow of 2.9 billion with growth of 17% and 20% respectively. Our free cash flow to sale was 13.4% and our free cash flow of net income conversion was 129%. This continues to be a key strength for Eaton and something that you can expect from us in the future. And as we noted, 2009 was a year of significant progress on our journey to transform Eaton into a company with higher growth, higher margins, and more earnings consistency. We closed three deals for $1.2 billion, Ula Soy, Innovative Switch Gear and Electrical, and Cereal Sunbake and Aerospace. We announced two divestitures with Automotive Fluid Conveyance closed in 2019 and Lighting scheduled to close in Q1. And our robust cash flow allowed us to return $2.2 billion to shareholders, including $1.2 billion of dividends and $1 billion in share repurchases. But also note that we purchased these shares at an average price of $80 a share. And finally, it was a very good year for our shareholders, who had a 43% total return, 50 basis points over the median of our proxy peer. So overall, I'd say another record year, and I'm clearly very proud of what our team was able to deliver. Turning to page 12, we provide our revenue and margin guidance for 2020. Overall, we expect organic growth to be anywhere from down one to up one, with weakness in the first half and a bit stronger in the second half as a result of easier prior year comps. Beginning with electrical products, we expect to see 1 to 3 percent organic growth with continued strength in residential and data center markets, flat commercial construction markets, and continued weakness in industrial markets. In electrical systems and services, we anticipate 0 to 2 percent organic growth with strength in utility markets, flat commercial construction, and weakness in industrial facilities, and particularly in oil and gas markets. For hydraulics, we're forecasting organic radical declines of 4% to 6%, driven by weakness in global mobile equipment markets. And in aerospace, we expect organic growth of 2% to 4%, with continued strength in military OEM markets, solid aftermarket growth for both commercial and military markets, partially offset by expected weakness in commercial OEM markets. For vehicle, we see organic revenue declines of 7% to 9%, and this is mostly due to the 33% decline that we're forecasting in NAFTA Class A truck markets, but also some weakness in global light vehicle markets as well. And for e-mobility, organic growth is expected to be up 3% to 5%. We're seeing double-digit growth for our electrical vehicles markets, offset by some modest declines in internal combustion engine platforms. Now turning to segment operating margins and operating margins for Eaton. We expect Eaton to be 17.8 to 18.2% at the midpoint of 40 basis points improvement from 2019. And in taking a look at our segments, electrical products we think will be 21.2 to 21.8. At the midpoint, 180 basis point improvement from 2019. And this is primarily a result of the lighting divestiture. For electrical systems and services, we're forecasting 16.4 to 70%, up 10 basis points at the midpoint. Hydraulics at 11.7 to 12.3, up 80 basis points at the midpoint. Aerospace at 22.9 to 23.5, down some 110 basis points, And this is largely due to the acquisition of Suria. And vehicle, we expect it to be between 15.7 and 16.3, down 80 basis points, and largely as a result of lower volumes. And e-mobility at 2.5 to 3% as we continue to invest heavily in R&D and startup costs in new manufacturing capabilities. And on page three, we pick up, page 13, excuse me, we pick up the balance of our 2020 guidance. And here I say, you know, we expect full-year adjusted EPS to be between 560 and 590. At the midpoint of 575, this is essentially flat with 2019 when you exclude the one-time items noted on previous slides. Organic growth is expected to be essentially down one to up one with acquisitions adding 2%. and divestitures negatively impacting sales by 7.5%. We expect our corporate costs, including pension, interest, and other corporate costs, to be flat with 2019 levels, and our tax rate to be between 14.8 and 15.8. Operating cash flow is expected to be between 3.4 billion and 3.6 billion, and capex of approximately $550 million. With strong cash flow plus the proceeds from the lighting sale, which we think will be $1.4 billion, we plan to significantly increase our share repurchases. And at this point, we expect to spend between $2.4 billion and $2.8 billion in share repurchases. And if I can just summarize our Q1 guidance, we expect EPS to be between $1.16 and $1.26. We expect organic revenues to be down 3%. 2% from acquisitions and 3% from divestitures. Segment margins are expected to be between 15.8% and 16.2%, and our tax rate should be between 15% and 16%. So overall, I say we expect really another solid year in 2020 with strong margins in cash flow. We have a lot of confidence in the Eaton business system and our ability to continue to execute strongly. We think the changes that we've made and announced will position Eaton for higher growth and higher margins and better earnings consistency as we go forward. And with our strong cash flow and proceeds from the hydraulic sale, we have outstanding optionality as we think through the best approach to create additional shareholder value. So with that, I'll stop there and turn it back over to Yen for questions.