Eaton Corp PLC

With me today are Craig Arnold, our Chairman and CEO, and Rick Fier, Vice Chairman and Chief Financial and Planning Officer. Our agenda today includes opening remarks by Craig, highlighting the company's performance in the second quarter. As we have done on our past course, we will be taking questions at the end of Craig's comments. The price release and 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 include reconciliation 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 the expected future results of the company and are therefore for looking statements. Our actual results may differ materially from our forecasted projection due to a wide range of risks and uncertainties. that are described in our earnings release and presentation. They're also outlined in our related 8K findings. With that, I will turn it over to Craig.

Okay, thanks, Yen. We'll start on page three with recent highlights from the second quarter. And as you can imagine, I'm extraordinarily pleased with the way our teams have executed in the midst of this pandemic and the economic downturn. We've done a good job of keeping our employees safe, have delivered for our customers, and certainly generated exceptional cash flow all while flexing our costs at record rates. Our results, while well off of last year, certainly in absolute terms, were better than expectations, and we continue to make important investments for the future. Q2 earnings on a per share basis, 13 cents on a GAAP basis, and 70 cents on a adjusted basis, which excludes 20 cents of charges related to acquisitions and divestitures, and 37 cents related to the multi-year restructuring program that we just announced. Our Q2 revenues were $3.9 billion, down 22% organically. As we noted on our Q1 earnings call, April was down approximately 30%. This was followed by slightly better volumes in May, and then relatively strong finish in June, which was down, let's call it low double digits. In fact, I mean, just as a point of, you know, maybe amplification, our electrical business in the Americas, in Europe, and Asia all posted low single-digit organic growth in revenue in the month of June. And so, once again, our electrical businesses, you know, are remaining very resilient in the face of this pandemic and economic downturn. Segment margins were 14.7%, down 110 basis points from Q1, And our decremental margins were at 25%, five points better than our guidance of 30%. Once again, a good indication of how well our teams have done in controlling the elements that are really within our control. However, recognizing that some of our businesses could be looking at a slow and certainly what you could call a prolonged recovery, we announced a multi-year restructuring program of $280 million. including a $187 million charge in Q2. These actions will reduce structural costs for sure and are targeted in those end markets, including commercial aerospace, oil and gas, NAFTA Class A truck, and North America and European light vehicle markets, where these markets have been certainly highly impacted. I'll provide more details on this program in a few minutes, but they're covered on page 12. The other clear highlight for the quarter was our operating cash flow, which was $757 million, and free cash flow of $667 million. Both very strong results, which gives us the ability to really reaffirm our free cash flow guidance of $2.3 billion to $2.7 billion, and a midpoint of $2.5 billion. So teams continue to do great in converting on cash as well. Finally, as most of you know, we made an important announcement during the quarter regarding sustainability and our commitment to 2030 sustainability goals. I thought it would be helpful just to put this announcement into context in order to show you how it fits within the broader strategic framework of the company, which we do on page four. As I simply stated, sustainability really is at the core of our mission. We talk about our mission being to improve the quality of life and the environment. And certainly that means sustainability. In fact, if you think about all of our value propositions with customers, they're built around creating safe, reliable, and efficient solutions. Let's call them sustainable solutions. And so as we oftentimes say, what's good for the environment is good for Eaton. We believe that meaningful efforts to support the environment are fundamental to how we create value for customers. And it's certainly a place where we think Eaton should play a leadership role. Sustainability, as we think about it, really presents growth opportunities to help our customers solve their business goals. And to this extent, and to this objective, we've laid out 10-year plans that include investing $3 billion in R&D to create sustainable products over this period of time. This will also include reducing our emissions from our installed basic products and upstream sources by some 15%. Just to maybe give you an example of where we think this really fits with our overall strategy, sustainability really is about capitalizing for Eaton on secular growth trends around electrification, for sure, across all of our businesses, and also in energy transition. Sustainability, I tell you, is also an important part of how we run the company on a day-to-day basis. Since 2015, we reduced our absolute greenhouse gas emissions by some 16%. and we're certainly on track to deliver our 2025 targets. By 2030, we now have committed to achieve science-based targets of 50% reduction of greenhouse gas emissions from 2018 levels. We're also committed to be carbon neutral by 2030, a target that we'll achieve through a combination of initiatives, including carbon offsets, such as reforestation, continuing to optimize our sourcing of renewable electricity, in all of our operations as well as delivering energy storage solutions. And so pretty comprehensive set of plans that we have that we think will deliver this 2030 goal. And finally, to achieve these goals, we obviously have to continue to work on building a workforce that's engaged and passionate about making a difference. And so this will continue to be a large priority for the company overall. And so hopefully that provides just a little context in terms of why we think sustainability is such an important initiative for Eaton and how we're going to convert on that and turn it into accelerated growth for the company. Now turning to page five, we summarize our Q2 financial results, and I'd note just a couple of things on this page. First, acquisitions increased sales by 2%. This was more than offset by the 8% impact from divestitures, and also we had negative currency impact of negative 2%. Now, I'd also remind you that we now recognize all charges related to acquisitions, divestitures, and restructuring at corporate rather than at the segment level. And we did this because we'd hope it'd make it easier for you to do your forecast by quarter by segment without the volatility that comes with these types of one-time charges. Next, on page six, we show our results for electrical Americas. Revenues down 29%, 9% decline organic revenue, 19% impact from M&A, and this was primarily the divestiture of the lighting business, and a small impact from negative currency as well of 1%. Operating margins increased 130 basis points to 20.7%. And these margins were certainly favorably impacted by the divestiture lighting, but also our teams did a great job of controlling costs to really counter the impact of the economic impact of COVID-19. This combination resulted in a very strong decremental margin performance of 16%. So this segment continues to prove to be highly resilient when you look at margins, but also when you look at orders and backlogs. Orders increased 2.1% on a rolling 12-month basis. with strength in residential and utility and data centers. And of note here, our data center orders actually were up some 7% on a rolling 12-month basis. And lastly, our bookends remained strong. They were up 11% versus last year. Turning to Phase 7, we have our results for the electrical global segment. Revenues were down 16%, with 14% decline in organic revenues and 2% headwind from currency. Operating margins here declined some 160 basis points, but to a very, you know, respectable 16%. And decremental margins here were also very well managed, coming in at 26%. Borders declined 4.6% on a rolling 12-month basis, but with most of the significant declines coming, as you would expect, in global oil and gas markets and in industrial markets. So not an unexpected result with respect to where we saw strength and weakness. And lastly, our backlog for electrical level increased 2% on a year-over-year basis. On page 8, we summarize our hydraulic segment. For Q2, revenues were down 32%, with a 30% decline organically and a 2% currency impact. Operating margins were 9%, and orders for the corridor were down 33.7%. year-over-year, and this was driven really by weakness in both OEMs and the distributor channel, both. We continue to work closely with Danfoss in completing the customary closing additions and regulatory approvals, and I would tell you that Danfoss organization remains excited about owning the business. We do, however, now expect the transaction to close at the end of Q1 next year. The delay, as you can imagine, due to the COVID-19 impact, which has impacted the pace of some of the regulatory approvals that we expect. On page nine, we summarize results for the aerospace segment. Revenues declined 27% with a negative 35% in organic growth, offset by 8% increase from the acquisition of Soria. Operating margins declined to 14.8%, and really this is due to lower sales, but also the acquisition of Soria also had a dilutive impact on margins. Orders declined 12.8% on a rolling 12-month basis, with particular weakness in the quarter, as you would expect in commercial OEM and aftermarket. It is worth noting, I would tell you, though, that orders for the military aftermarket were up 13% on a rolling 12-month basis. Backlog was down 5% year-over-year overall. Certainly, as everyone here understands, the commercial aerospace markets are grappling with significant declines in passenger demand, and this is impacting our business and certainly impacting both the OEM and the aftermarket. Just maybe some context here. While we think about this as kind of a near-term dislocation and we're taking certainly the needed steps to position this business for the future, We remain confident in the long-term attractiveness of aerospace market, and we'll certainly do what we need to do in order to manage our margins in the meantime. Next, on page 10, we summarize the results for the vehicle segment. Revenues declined 59%, 52% of which was organic. In addition to the divestiture of the automotive fluid conveyance business, which impacted revenues by 4%, we had 3% negative impact in currency, The decrease in organic sales was really driven by, I'd say, widespread customer plant shutdowns due to COVID-19, which really resulted in lower Class VIII OEM production as well as continued weakness in light vehicle production. Once again, it's a little bit more color on this one. During Q2, most light and commercial OEMs had shutdowns that ranged between six and eight weeks. These shutdowns, which really began, let's say, in late March, throughout the month of April and extended into mid-May, and so many of our customers were shut down for almost half the second quarter. But production is now certainly beginning to come back online. Global light vehicle market production was down 55% in Q2, and Class 8 OEM build was down some 70% in Q2. We now project NAFTA Class 8 production to be 175,000 units for the year, which is down slightly from our prior forecast of 189,000 units, but still down some 49% from 2019. This steep reduction and certainly this sudden reduction in oil production led to operating margins of a negative 6.4%. But I would add, you know, this business has once again done a great job of managing decrementals, and despite this tremendous reduction in revenue, delivered a respectable decremental margin of 33%. not surprisingly and much needed we do expect better market conditions in the second half and our business will be well positioned to participate in this recovery moving to page 11 we have our e-mobility segment revenues were down 33 percent all of which was organic organic margins of negative 3.6 percent excuse me operating margins of negative 3.6 percent primarily due to lower volumes and particular weakness in the legacy internal combustion engine platforms, and once again, the ongoing increase in R&D expenditure. We continue to be enthused, by the way, about the long-term potential of the business, and quite frankly, have seen nothing but upward revisions in the expectation for the penetration of electric vehicles. And so a market that we still think will be very attractive long-term. We're very well positioned, once again, with the common technology platforms that we're creating, leveraging the strength in our core electrical business. A good example of this idea of everything becoming more electric is one of the recent wins that we've had with a truck OEM, a $21 million program for export power inverter for a major commercial truck customer. And so in almost every aspect of our business, there's more electrical content, and we're well positioned, once again, through this particular segment to participate in that growth. Overall, we've won programs with a value of approximately $500 million of mature year revenue. On page 12, we show the details of our plans to accelerate and I'd say expand our restructuring actions. And I say accelerate because for the most part, we're pulling forward a number of the restructuring ideas that we would have done anyway. Given the economic implications of the pandemic, we naturally have a greater sense of urgency and also more capacity to take on these projects. We announced the $280 million multi-year restructuring program, as we noted, designed to eliminate structural costs, and we've taken charges of $187 million in Q2, and we expect that the additional cost of $93 million realized through 2022. Just to characterize those additional dollars, we'd expect you know, delivered over the next three years, some $33 million of charges in the second half of this year, $55 million in 2021, and $5 million in 2022. We would expect to realize $200 million of mature year benefit from these actions once they're fully implemented, and we think four-year implementation is 2023. Practically two-thirds of these costs are in our industrial businesses, principally vehicle and aerospace, And the remaining one-third is within our electrical sector, particularly with an emphasis on our oil and gas business that will report through our electrical global segment. Naturally, we're focused on those businesses serving end markets that are more severely impacted by the pandemic. And then turning to page 13, we do our best to provide Q3 outlook on revenues versus last year. You can imagine that all of these markets will be stronger than what we realized in Q2. This is really a year-over-year look for Q3 versus last year. For electrical Americas, we expect organic revenues to be between down two and up two, so essentially flat, with strength in residential utility data centers, offsetting weakness in industrial markets. For electrical global, our current view is organic revenues will decline between 10% and 14% with strength in Asia Pacific and data center markets offset by declines in Europe and once again in the oil and gas market. For aerospace, we expect organic revenues will be down between 28% and 32% with continued strength in military offset by really significant declines in all of the commercial markets. And for vehicle, we project revenues will decline between 30% and 34%. So markets are still very weak in absolute terms, but these markets will be up significantly from Q2. And for e-mobility, we expect declines of between 13% and 17%, once again pressured from legacy internal combustion engine platforms. And lastly, for hydraulics, we think markets will be down between 23% and 27%. For heat and overall, we're estimating Q3 revenues to be down between 13% and 17%. And so an improvement versus Q2, which was down some 22%, but still in absolute terms, the markets are still in decline. Moving to page 14, here we provide our best look at guidance for Q3 and some commentary on the full year. But for Q3, we expect organic revenues to decline between 13 and 70%. And this really does include what we know about July, where we saw low double-digit declines. We've elected not to provide full-year revenue guidance, given kind of the ongoing uncertainty around the pandemic and its impact on markets in Q4. As many of you are aware, we are still dealing with the pandemic, and in various regions of the U.S. and around the world, we're still seeing a growth in a number of cases, and so we're still living in this period of uncertainty. We do think Q2 will be the trough for organic revenue declines. And barring a second wave of the pandemic, Q4 should be better than Q3. For Q3 and full year, we expect incremental margins of between 25% and 30%. And for Q3, we expect our tax rate on adjusted earnings to be between 15% and 16%. We're maintaining our free 2020 Free cash flow guidance, the range of 2.3 to 2.7 billion. And I would note that this range does, in fact, include now the impact related to the multi-year restructuring program that we announced, and that was not in our prior guidance. As a point of reference, in the first half, just to give you some comfort around our ability to deliver this number, we generated some 35% of our $2.5 billion midpoint that's in our free cash flow guidance. And this number is very consistent with our performance over the last five years, and so we do tend to be a bit back half loaded. We're providing new guidance for share buybacks, and we're saying between 1.7 billion and 1.9 billion for the year. And recall that we purchased 1.3 billion of shares in Q1 with the proceeds of the lighting sale. We continue to deliver strong free cash flow, and we now plan to buy back between $400 and $600 million, our shares, half of the year. And finally, it may be just, you know, like we are doing here inside our company, just to bring it back to kind of the broader, longer term strategy and where we're headed as an organization. And, you know, we will continue to effectively manage through the short-term challenges associated with the pandemic, but we also remain focused on the broader strategic and financial goals, you know, that we laid out in our meeting in New York. And we summarize once again, here on page 15. Number one, ensuring that we continue to move the company in the direction of becoming what we say as an intelligent power management company that takes advantage of important secular growth trends, and we talked about them being electrification, energy transition, IoT and connectivity, and blended power. So these trends are continuing, and despite whatever temporary hiccups we're experiencing, we think long-term it's the right place to be. By doing so, we're working on creating a company that's going to deliver better secular growth and better growth through various cycles, higher margins, and with much better earnings consistency. Our long-term goals have not changed. It includes 2% to 3% organic growth, 20% secular margins, 8% to 9% EPS growth, and $3 billion a year of free cash flow. And with our strong cash flow, we'll continue to be focused and disciplined in how we deploy it by investing in organic growth, as a top priority, delivering top quartile dividends, an ongoing program of share buyback, then actively managing our portfolio while being a disciplined acquirer. So we continue to remain excited by the Eaton story. I hope you are as well. And with that, I'll turn it back again.

OK, good. Thanks, Craig. Before we start our Q&A of our call today, I do see we have a number of individuals in the queue with questions. So I appreciate if you can limit your opportunity just to one question and a follow-up. Thank you in advance for your cooperation. With that, I will turn it over to the operator who will give you guys the instruction.