Eaton Corp PLC

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton Third Quarter Earnings Conference Call. At this point, all the participant lines are in a listen-only mode. However, there will be an opportunity for your questions. If you'd like to ask a question... We just lost them. Mr. Jin, can you hear me? Please go ahead.

Okay, now I can hear you. Okay, good morning, everyone. I'm Yan Jin, Eaton Senior Vice President of Investor Relations. Thank you all for joining us for Eaton Third Quarter 2020 Earnings Call. With me today are Craig Arnold, our Chairman and CEO, and Rick Fionn, Vice Chairman and 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 on our past course, we'll 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, including reconciliations to non-GAAP measures, a webcast of this call is accessible on our website, and it 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 forelooking statements. Our actual results may differ materially from our forecasted projection due to a wide range of risks and uncertainties that are described into our earnings release and our presentation. They're also outlined in our related 8-K filing. With that, I will turn it over to Craig.

Okay. Thanks, Yuan. You know, let's start on page three with a highlight of our Q3 results. And I'd say to begin by saying I'm really pleased with how the entire Eaton team has continued to deliver and perform during this ongoing pandemic and economic downturn. And our results, while certainly below last year in absolute terms, they were much better than our guidance for the quarter. Q3 earnings per share at $1.11 on a gap basis and $1.18 on an adjusted basis. which naturally excludes the $0.05 of charges related to acquisitions and divestitures and $0.02 related to multi-year restructuring program. Our Q3 revenues of $4.5 billion, down 9% organically compared with last year, but up 16% versus Q2. Segment margins were 17.6%. These margins were 290 basis points above Q2 levels, and our decremental margins of 25% were at the low end of our guidance range. Our organization, I just must say again, is doing an outstanding job of managing discretionary costs. We also generated strong cash flow in the quarter. Operating cash flow was $921 million, and our free cash flow was $832 million. As a result, we are reaffirming our 2020 guidance for cash flow with a midpoint of $2.5 billion of free cash flow and narrowing the range to 2.4 to 2.6 billion. And lastly, we repurchased 177 million of shares on the quarter, and we're at 1.5 billion on a year-to-date basis. Turning to page four, we summarize our Q3 results, and I'll just highlight a few items here. First, acquisitions increased sales by 2%, but this was more than offset by the 8% impact of our divestitures, and this was primarily, as you'll recall, the lighting business. Second, our second margins at 17.6% were down versus last year, but still at very healthy levels, especially given the reduction in revenue. And lastly, I would just remind the group that we now record all charges related to acquisitions and divestitures and restructuring costs at corporate rather than at the segment level. And we hope that this makes it easier for you to model our results on a going forward basis. Next, on page five, we show our results for the Electrical America segment, and we're very pleased that our largest operating segment returned to positive organic growth of 3% during the quarter. So it's better than the high end of our guidance range, which was up 2%, and this was really driven by particular strength in residential and utility markets. Revenues were naturally impacted by the sale of the lighting business, which reduced sales by 19%, and negative currency impacted sales by 1%. Operating margins increased 280 basis points to 22.2%. And so our margins continue to be favorably impacted by the divestiture of lighting, as well as by ongoing cost containment actions. Our America's business continued to show resiliency also when you look at our orders and backlog. Orders were down 1% on a rolling 12-month basis, excluding lighting. And we saw, once again, particular strength in residential and also in data center markets. Similar to what you've seen from others, circular growth is being driven by really this increased focus on the home in this work-from-home environment and all of our growing dependence on digital connectivity. On a rolling 12-month basis, residential orders were up 14% and data center orders were up mid-single digit. And sequentially, Q3 orders were up 16% from Q2. Lastly, our backlog was up 11 percent from last year, delivered by, once again, this noted strength in residential and data centers, but also by utility markets, as utility markets are benefiting from the increased investment in smart grid and this energy transition that's taking place. On page six, we have a summary of our electrical global segment. Revenues were down 8 percent, with 10 percent decline in organic revenues, partially offset by 2 percent tailwind from currency. Lower organic sales were driven principally by weakness in oil and gas and industrial markets. If you excluded oil and gas in industrial businesses, you know, our European business was slightly negative and our Asia business was slightly positive. Operating margins declined 280 basis points to 16.6 percent, but we're up 60 basis points on a sequential basis. Orders declined 6 percent on a rolling 12-month basis. but declines driven once again by oil and gas and industrial markets, partially offset by strength in residential data centers and utility markets. It's also worth noting here that data center orders were very strong in this segment, increasing some 40% on a rolling 12-month basis. We also had solid sequential growth in orders, up 12% from Q2. And lastly, we continued to draw a backlog, which increased 7% versus last year. Moving to page seven, we have the results of our hydraulic segment. Revenues were down 15%, which was all organic, but this was much better than the 25% organic decline at the midpoint of our Q3 guidance as end markets recovered faster than anticipated. Operating margins were 9.8% flat with the last year. And encouragingly here, I'd say, we saw momentum in our Q3 orders, which increased 8%. with strength in both agricultural and construction equipment markets. And lastly, we remain on track to close the Danfoss sale by the end of Q1 next year. Next, on page 8, we have the financial summary of our aerospace segment. Revenues declined 13%, down 26% organically, partially offset by a 12% increase from the acquisition of Soria, and a 1% positive currency impact. And as you would expect, organic revenue declines here were driven primarily by the continued downturn in commercial aviation, which was partially offset by growth in military. On a sequential basis, organic revenues were up 15% from Q2 levels. And while at healthy levels, operating margins declined to 18.5% due to lower sales volume and margins were certainly impacted by the impact of the serial acquisitions. You know, I would note here that margins were up 370 basis points from Q2, and that the business is really doing an outstanding job of right-sizing and reducing discretionary costs. Orders were down 22% on a rolling 12 on the basis, and the backlog was down 11%. Turning to page 9, we summarize the results for our vehicle segment. Revenues were down 25%, including 20% organic decline. The divestiture of the automotive fluid conveyance business impacted revenues by 4%, and we had a 1% negative headwind from currency. The 20% decline in organic revenues was, once again, much better than what we expected. We had 32% decline at the midpoint of our guidance, and both light motor vehicles as well as truck markets have rebounded more quickly than we anticipated. In fact, organic revenues were up some 75% from Q2. Global light vehicle market production in the quarter was down 4%, and Class 8 OEM build was down some 34% in Q3. But given the strength that we're now seeing, we now project NAFTA Class E truck production of some 200,000 units for the year, and this is up 14% from our prior forecast. Operating margins were 14%, down 430 basis points on a year-over-year basis, but up 20 basis points from Q2. And we're also pleased to see the 31% decremental margin performance in this business, given the magnitude of the revenue reductions due to end markets. And we certainly would expect these trends to continue through the balance of the year. Moving to page 10, we have the results of our e-mobility segment. Revenues were flat, with organic revenue declining 1%, offset by 1% positive currency impact. Operating margins were negative 2.5 percent as we continue to really increase investment in R&D in this segment. Our focus in this segment continues to be on executing key program wins as well as actively managing what we're looking at now as a multibillion-dollar pipeline of opportunities. We continue to see the electrification market as a significant growth opportunity, and we'd expect to see a sharp recovery as the market improves. In fact, I mean, Some analysts are estimating a year-over-year increase of more than 30% in Q4 alone. Turning to page 11, we provide our Q4 outlook on organic revenues versus the last year. For electrical Americas, we expect organic revenues to be between flat and up 3%. With continued strength in residential, in utility, data centers, healthcare, warehousing, and also in water wastewater, offset by some weakness in industrial markets, principally in office and lodging. For electrical global, we estimate organic revenues will decline between 7% and 10%, with strength in the Asia-Pacific region and data center markets, but being offset by weakness really in Europe and some declines in the oil and gas market. For aerospace, we project organic revenues will be down between 23% and 26%. with continued strength in military, but with continuing and ongoing weakness in commercial OEM and commercial aftermarket. For vehicle, we expect organic revenues will decline between 7% and 10%, with strong demand in China and other markets really continuing to recover from the Q2 lows. And for e-mobility, we estimate organic revenues to be between flat and up 3%, with recovering global vehicle markets and then with particular strength in electric vehicles as well. And lastly, for hydraulics, we estimate a decline of between 6% and 9%. So overall, we're estimating organic revenues to be down between 5% and 7%, and this would be another quarter of sequential improvement as the global economy continues to improve. Moving to page 12, we note our outlook for Q4 and for the full year. As I just noted, we expect organic revenue declines between 5% and 7% with modest sequential improvements versus Q3. We also expect our Q4 decremental margins to be 25%, which is once again at the low end of our prior guidance range, which was between 25% and 30%. Our Q4 tax rate on adjusted earnings is expected to be 14%, and then turning to the full year, We're reaffirming the $2.5 billion midpoint of our 2020 free cash flow guidance and narrowing the range to be between $2.4 billion and $2.6 billion. I'd say it's worth emphasizing, once again, the predictable nature of our free cash flow. We initiated guidance in the midst of the downturn back in April, and we really expect to be right in line with this number. Free cash flow as percentage of revenue continues to be very strong, and for 2020, it's on track to exceed 2019, which was 13.4%. I'd also note, you know, our free cash flow to adjusted earnings ratio, which is 142% on a year-to-day basis, and it's also well above the 120% levels achieved in 2019. You know, an important element of our free cash flow has been, you know, our work in capital management. where we've reduced net working capital by more than $350 million year-to-date, and this was driven principally by the reduction in inventory. We plan to buy back $200 to $400 million of our shares in Q4, and we're also reaffirming our full-year guidance, which is between $1.7 and $1.9 billion. So I think you'll agree that our cash flow generation remains resilient, and it does really position us well for the upcoming economic recovery. Next, on page 13, we show our preliminary 2020 outlook by end market within both the electrical and industrial sectors. And once again, these numbers reflect, if you look at these end markets, the percentage of the sector revenue that is accounted for by these various end markets. Within our electrical sector, data centers, utility, residential, institutional and infrastructure end markets make up some 50% of our revenue. and each of these markets is holding up well and expected to continue to grow. Industrial markets, which represent some 30%, where the outlook is more mixed with some areas of strength, like in machinery and industrial facilities, but also some areas of weakness, and particularly in oil and gas. We understand that there's been some concern raised about the near-term growth of commercial construction, but I think it's important to note here that commercial construction only represents 20% of electrical sector revenues. And within commercial construction, we do see some areas of strength, like in warehousing, that can partially offset areas of potential weakness that we would see certainly in the office and lodging segment. It's also worth noting, I'd say here, that retail is only 2% of total commercial construction markets, whereas the warehouse segment accounts for about 5% of the markets. So there's clearly some puts and takes in this market. And lastly, within the industrial sector, our preliminary outlook for 2020 includes growth within all of the end markets with particular strength in truck and electric vehicles. And finally, while we continue to manage through the short-term challenges of the pandemic, we also remain focused on our broader strategic and financial goals, which we summarize on page 14. I begin by first saying that We continue to move the company in the direction of becoming an intelligent power management company that's really taking advantage of these important secular growth trends that we've talked about in the past. Electrification, energy transition, IoT connectivity, digitalization. And our recent announcement of the Bright Layer Digitalization Initiative is a prime example of how this transformation continues. In simple terms, Bright layer for us is really where we extract data from our intelligent devices. It's where we use data science and machine learning to create new insights and software, and it's where we partner with customers to develop value-added solutions. But I'd also say that the overriding goals of the company remain the same, and that's to create a company that has better secular growth, that has higher margins, and better earning consistency. And with the added benefit of strong free cash flow, We'll continue to be smart in how we deploy it, investing in organic growth, paying a top quartile dividend, buying back shares, and actively managing our portfolio while being a disciplined acquirer. And while perhaps delayed by a year or so, our long-term financial goals remain unchanged. They include 2% to 3% organic growth, 20% segment margins, 8% to 9% EPS growth, and $3 billion a year in free cash flows. And so with that, I'll stop, and I'll turn it back over to Yen, and we'll open up Q&A.