Eaton Corp PLC

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton First Quarter Earnings Call. At this time, all participants are on a listen-only mode. Later, we'll conduct a question-and-answer session. Instructions will be given at that time. If you should require assistance during today's call, please press star, then zero. As a reminder, today's call is being recorded. Now I turn it over to your host, Yan Jin, Senior Vice President of Investor Relations. Please go ahead.

Hey, good morning. I'm Yan Jin, Eaton Senior Vice President of Investor Relations. Thank you all for joining us today for Eaton's Fourth Quarter 2020 Earnings Call. I hope that you and your families stay healthy and also stay safe. With me today are Craig Arnold, our Chairman and CEO, and Rick Fearon, Vice Chairman and Chief Financial and Planning Officer. Our agenda today, including opening remarks by Craig, highlighting the company's performance in the first quarter. As we have done in our past course, we'll be taking questions at the end of Craig's comments. The press release 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 include reconciliations to non-GAAP measures. A webcast of this call is accessible on our website and will be available for replay. I would like to remind you that our comments today will include statements related to expected future results of the company and are therefore full-looking statements Our actual result may differ materially from our forecasted projections 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.

Thanks, Ken. Appreciate it. Hey, let me start on page three, and I'd like to begin by providing an overview of how Eaton is addressing the impact of COVID-19 with our key stakeholders. our employees, our customers, our shareholders, and certainly our communities in general. The first thing I'd say is I couldn't be more pleased with how well our team is managing through the crisis. As always, the safety of our employee has been and continues to be our top priority. Most of you are very familiar by now with the best practices around eliminating the spread of COVID-19. At Eaton, we've adopted them all, and I'd say that most of them, even before they were commonplace, We learned from what we saw in China. We activated and stood up our pandemic management and response team early and created a COVID-19 playbook. This playbook has become part of the Eaton business system. It specifies exactly what we expect of our factories and offices around the world, including how we ensure compliance. We also continue to serve customers around the world. As you're aware, most of our products have been deemed to be a critical part of the global infrastructure. And as a result, our factories remain open with very few exceptions. We are, however, seeing lower utilization and weak demand in some of our own markets. And so we have had some temporary closures in a couple of facilities. And I'd also note that organic growth continues to be our top priority. We want to make sure that we're well positioned to take advantage of all opportunities, including the increases in expenditures on government infrastructure when it comes, and we do think it's coming. And I'm especially proud of the work that our employees are doing around the world to support our communities and caregivers. We've donated eating equipment, we're using our additive manufacturing capabilities to produce personal protective equipment, and we've increased our charitable giving to support those impacted by COVID-19. And finally, as I'll detail in the next couple of slides, we're also taking the appropriate cost reduction and cash management actions to ensure solid decremental profit margins, strong liquidity, and cash flow. Allow me to begin with liquidity and cash flow on page four, and both are actually in great shape. As of March 31st, we had $450 million of cash and short-term investments on hand, and access to $2 billion of undrawn multi-year bank facilities. In fact, We've never drawn on our bank facilities and don't expect to use them during 2020. We have been in touch with our bankers and are comfortable with our ability to access them if needed. We also have access to the commercial paper market, obviously. In 2020, we do have one relatively small debt maturity of $240 million, which is due at the end of Q4. As a point of reference, I'd note at the end of March that our debt to adjusted trailing 12-month EBITDA was only 2.1 times. And in terms of cash flow, we're updating our 2020 guidance, as you saw, and we expect now free cash flow to be in the range of 2.3 to 2.7 billion, with a midpoint of 2.5 billion. And I say that while this is lower than our original forecast, it represents strong performance and shows our resilient cash flow in whatever economic environment we find ourselves in. Our cash flow is more than sufficient to continue to invest in the business and to maintain our dividend. Many of you may not be aware, but Eaton has paid a dividend for nearly 100 years, and we don't see any scenario in which that would change. As planned, during Q1, we repurchased $1.3 billion of our shares using the proceeds from the lighting sale. And as you're also aware, we expect to receive $3.3 billion of cash from the sale of hydraulics by the end of the year, leaving us with much higher liquidity and even lower leverage. So with a strong balance sheet, our optionality for additional share repurchase and M&A really remains intact. We continue to think that our stock provides a very attractive return given the 3.4% dividend yield and a free cash flow yield of more than 7%. Now, we're equally focused on ensuring that we deliver attractive decremental margins as one of our top priorities, and we've moved quickly to put cost containment measures in place. We summarized some of these actions on page five. First, the first reduction was really the one taken by our leadership team, and they took the first and the biggest cut, 25% to 50%. reduction in base salaries in Q2. And our Board of Directors also agreed to a 5% reduction in their cash retainer for Q2, and these funds will actually go into an employee relief fund for those impacted by COVID-19. These actions are in place for Q2, but then they could be extended if the forecasted recovery comes later than expected. We've also dramatically reduced discretionary expenses, put in place hiring freezes for all but a few critical roles, and a number of other actions that include unpaid leave for most of our salary workforce. We delayed the planned 2020 merit increase until next year, and we've taken a significant reduction, as you can imagine, over the elimination of incentive compensation. All difficult but necessary steps as we work to ensure that we approach the challenge with shared sacrifice, but those of us with the greatest means naturally shouldering a bigger piece of the responsibility or burden. Lastly, we've eliminated non-essential capex. And as you'll see in the updated capex guidance in a few slides, it's a pretty significant reduction. Let me say that while the pandemic is new for all of us, Eaton has managed through severe economic declines in the past. And quite frankly, we've always emerged as a stronger company. It's something we fully expect to do this time around. Moving to page six, I'll turn to our traditional set of charts on quarterly results. Q1 earnings per share were, as you saw, $1.07 on a gap basis and $1.09, excluding the $0.02 charge for acquisition and divestiture. Adjusted earnings per share were reduced by an estimate of $0.14 due to the impact of COVID-19. This is a bit more than the $0.10 impact that we estimated in early March, as the impact of COVID-19 really spread beyond China and to the rest of the world. Our sales of $4.8 billion went down 7% organically, which includes a 3% decline that we anticipated in our original guidance, plus an additional 4% or $200 million impact from COVID-19. And this is some $50 million more than we estimated in early March. And you'll recall that at our March 2nd investor meeting, we indicated that revenue shortfall from COVID-19 would be approximately $150 million. SEGMENT MARGINS WERE 15.8%, DOWN SLIGHTLY FROM Q1 2019, BUT I'D ALSO NOTE THAT THIS INCLUDES ADDITIONAL AND UNPLANNED RESTRUCTION CHARGES AS WE MADE THE DECISION TO BEGIN TO RIGHT SIDE SOME OF THE BUSINESSES THAT ARE BEING HEAVILY IMPACTED BY THIS ECONOMIC DOWNTURN. OTHER NOTABLE EVENTS IN THE QUARTER, WE ANNOUNCED THE SALE OF THE HYDRAULICS BUSINESS TO DANFORK FOR $3.3 BILLION, WHICH WE EXPECT TO CLOSE AT THE END OF 2020. We closed the sale of lighting for $1.4 billion, and we deployed $1.3 billion to repurchase shares, equal to 3.4% of our shares outstanding at the beginning of 2020. And on page seven, we summarize our Q1 performance, and I'll just kind of note a few highlights here. First, we're changing our historical practice and are now recognizing all charges related to acquisitions and investors at corporate rather than in the segment level. So the gain, for example, in lighting would be at corporate, not in one of the segments. We think this makes it easier for you to forecast and model our segments as well as the overall company. Second, during Q1, acquisitions increased sales by 2%, which was more than offset by a 3.5% impact from divestiture. Negative currency also lowered sales by a percent and a half. Finally, our team continued to actively manage costs, and this is what enabled us to deliver decremental margins of 17% in the quarter. So we see, once again, this is a very strong set of results in this particular environment. Moving to page eight, we have the quarterly summary of our new Electrical America segment. Revenues were down 9%, with a 2% decline in organic revenues As a result of COVID-19 and a 6% decline from the divestiture of lighting and negative currency impact, it failed by 1%. As you can see noted on the chart, if you exclude lighting and the COVID-19 impact, organic revenues were up 2%. Strength in Q1 was driven by commercial construction and the utility in market. Operating margins increased by 20 basis points to 17.2%. And this is mostly due to the favorable impact from the divestiture of the lighting business in early March. Excluding lighting, orders were up 3% on a rolling 12-month basis, so pretty decent orders overall. Given the resegmentation, which combined electrical products and electrical systems and services into Americas, we're now reporting orders on a 12-month rolling basis going forward. And this will also be true for the electrical global sector. In the quarter, we saw strength in data centers and utility and residential markets really offset by weakness in industrial markets. Next, on page nine, we have our Q1 results for the electrical global segment. Revenues were down 8%, with a 6% decline organically. And this entire decline was driven by the impact of COVID-19, and most of this really coming out of China. We also had 1% growth from the Invisoy acquisition and a negative currency impact of 3%. Operating margins declined 80 basis points to 14.5%. And I point out that this number does include increased restructuring charges that were not planned that we're taking in this segment. Orders declined 1% here on a rolling 12 month basis. In the quarter itself, We saw significant growth in data centers, and this was more than offset by decline, as you would imagine, in global oil and gas markets. On page 10, we summarize our hydraulic segment. You'll recall that with the resegmentation announced in March, this segment now includes only the hydraulics business. Filtration and golf grip are now recorded as a part of the aerospace segment. I'd emphasize once again that we continue to expect the sale of this business advance loss to close at the end of 2020. Very strategic deal for them, and things look like they're remaining on track. For Q1, revenues were down 16%, so 14% organic decline, and this number includes an estimated 3% decline due to COVID-19 and negative currency impact of 2%. Operating margins improved 100 basis points to 10.8%. And orders for the quarter were down 11% year-over-year and driven really by continued weakness in global mobile equipment markets. Moving to page 11, we summarize our results for the aerospace segment. Revenues were up 13% with negative 1% organic growth. We estimate 3% of this decline due to COVID-19 and certainly saw a 14% increase as a result of the acquisition of Soria. Operating margins declined 110 basis points to 21.6%. This fell very strong, and this decline was primarily due to the acquisition of Soria, which obviously came in at lower margins than the underlying business. Organic, you know, orders declined 1% on a 12 month basis. In the quarter, we saw strength in military fighters and military aftermarket, but particular weakness, as you can imagine, in commercial transport. Turning to page 12, we look at our vehicle segment. Revenues here declined 26%, of which 20% was organic. In the organic revenue decline, we estimated that COVID-19 had a negative impact of some 5%. In addition, the divestiture of the automotive fluid conveyance business impacted revenue by 4%, and we had a 2% negative impact from currency. I say here that the largest part of Q1 revenue decline was expected, and it's really the result of lower Class 8 OEM production, which was down some 31%. and continued weakness in global light vehicle markets where production was down from 21%. As noted, operating margins declined 160 basis points to 13.5%. I'd also point out here, despite a significant reduction in volume, decremental margins were less than 20% as our team continued to proactively manage both discretionary and fixed parts. Given COVID-19, Now we now expect NAFTA Class A production to be 180,000 units down from our original forecast of 230,000 units or nearly 50% lower than 2019. And the last segment is e-mobility on page 13. Here revenues were down 13% with organic revenues down 12, including an estimated 4% impact from COVID-19 and we had a 1% impact from negative currency. Operating margins are applying to 1.4%. And this is a result of volume reductions on legacy internal combustion engine platforms, as well as manufacturing startup costs associated with new wins on electric vehicle programs. And lastly, we summarize our Q2 and 2020 outlook on page 14. And I'll begin by stating that due to the economic uncertainty from the COVID-19 pandemic, and we're withdrawing our four-year 2020 guidance. I wish we were in a position to provide revenue forecasts, but we just don't have that level of clarity at the moment. I would add that for the month of April, month-to-date revenues are running down approximately 30%. And inside of that 30%, obviously, electrical would be better than that number, and some of the more impacted businesses of vehicle and aerospace would be running slightly worse than that. But I would expect the month of May and June to be somewhat stronger, but clearly it's too early to tell for certain. We do have better visibility on decremental margins and free cash flow, and our guidance is as depicted. We're targeting decremental margins of 30% for Q2 and 25% to 30% for the full year. Like prior downturns, we're extraordinarily focused on cost control, We've taken a number of cost control actions already. And importantly, we have contingency plans in place to do more if needed. We do expect the incremental margins to be higher in Q2, since it's the quarter where we'd expect, quite frankly, the largest volume impact, as well as the quarter that we'll see the biggest restructuring charge. Our COPX forecast for the year is now approximately $40 million, down from our prior guidance of $550 million. And our free cash flow guidance now at $2.3 to $2.7 billion, $2.5 billion at the midpoint. So we continue to expect free cash flow convergence to remain strong. And we're also maintaining our dividend, which we increased by 3% in February. Let me just close by saying that while we recognize that the overall uncertainty created by COVID-19 and its economic impact As a company, we remain focused on generating strong cash flow, which we've always done. We're focused on implementing our long-term strategy around how we transform into a company that delivers over the long-term higher growth, higher margins, and certainly more consistent earnings. So with those opening comments, I will stop here, and I'll turn it over back to Jim for Q&A.