Eaton Corp PLC

Ladies and gentlemen, thank you for your patience and holding, and welcome to the even fourth quarter of 2020 earnings call. At this time, all of your participant phone lines are in a listen-only mode, and later there'll be an opportunity for your questions. If you'd like to queue up during any portion of the presentation, please press 1 followed by 0 for us. Just a brief reminder, today's conference is being recorded. I'm now happy to turn the conference over to Senior Vice President of Investor Relations, Yen Jin.

Hey, good morning. I'm Yan Jin, Eaton Senior Vice President of Investor Relations. Thank you all for joining us for Eaton Fourth Quarter 2020 Earning Call. With me today are Craig Arnold, our Chairman and CEO, and Rick Freon, Vice Chairman and our Chief Financial and Planning Officer. Our agenda today, including 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 today and the presentation we will go through today has 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 ready for replay. I would like to remind you that our comments today will include the statements related to the expected future results of the company and are therefore forelooking statements. Our actual results may differ materially from our forecasted projections due to a wide range of risks and certainties. And they're also described in our earnings release and the presentation. They're also outlined in our related 8K filing. So with that, I will turn it over to Craig.

Okay. Thanks, Jen. Appreciate it. And we'll start on page three, and we naturally have a lot of good news to talk about today, but I'd say we'd be remiss if we didn't begin by at least acknowledging Rick Fearon and his upcoming retirement. As most of you know, Rick will reach mandatory retirement age of 65 in March and will retire on March 31st. And so I'd like to extend a sincere thanks to Rick for his 19 years of service to Eaton. Rick has obviously played just an instrumental role in the transformation and shaping of our company and the company that we have today. And he's been a trusted partner to the management team, to our board, and certainly to me personally. And looking back, Rick has participated in more than 75 of these earnings calls, and this will be his last one. So we certainly wish Rick and his family well as he makes this transition onto life after Eaton. If there is life after Eaton, I'm not sure, Rick. But Rick will also be around for another couple of months and also will attend the investor meeting on March 1st. And moving to page four, I'd also like to highlight welcome Tom Oakray to Eaton as well. Tom becomes Eaton's CFO effective April 1st. Tom was previously the CFO at WW Granger and joined the team in January. Throughout his career, he's held various leadership positions at Advanced Auto Parts, at Amazon, and GM. Tom is a seasoned CFO with a strong track record of success, and we anticipate that he'll bring a very unique perspective and set of skills to the role here at Eaton. He's operational, he's growth-oriented, and he just has outstanding knowledge of distribution channels. Like Rick, Tom is also a global leader who's lived around the world, including several countries in Europe as well as Korea. And so we're very happy to welcome Tom to the Eaton team as well and look forward to his contributions in the future. Now, on the move to more good news and turning to page five, Here we summarize a number of recent noteworthy accomplishments, and I'll begin with the recent announcements to acquire Triplight for $1.65 billion and Cobham Mission Systems for $2.8 billion, two very strategic acquisitions that improved the profitability and, quite frankly, the growth outlook for our company. The acquisition of Triplight will enhance the breadth of our edge computing and distributed IT product portfolio, and it will also expand our single-phase UPS business in the United States. We're paying approximately 12 times 2020 EBITDA, 11 times estimated 2021 EBITDA, and we expect this transaction to close in the middle part of 2021. Yesterday, we also announced the acquisition of Cobham Mission Systems. Cobham is the leading manufacturer of air-to-air refueling systems, environmental systems, and actuation. And Cobham also adds highly complementary products to our company, and has a strong position, importantly, on growing defense platforms. We're paying approximately 14 times 2020 EBITDA, 13 times estimated 21 EBITDA, and we expect this transaction to close in the early part of Q4. And if we can just turn to Q4 specifically, we certainly have a stronger than expected quarter and we're pleased with our solid results. Our team just continued to execute well despite the pandemic. Q4 earnings per share of $1.18 on a gap basis and $1.28 on an adjusted basis. Our Q4 revenues of $4.7 billion were down 5% organically, which was at the high end of the range that we provided, and it's up 3% versus Q3. And our decremental margins were 21%, you know, also better than the guidance of 25% that we provided. I'm also very pleased now with very strong free cash flow. I mean, our operating cash flows were $943 million, and our free cash flows were $845 million, both of which exceeded prior year levels. And for 2020, we generated $2.6 billion of free cash flow, which was at the top end of our guidance range, and an all-time record for free cash flow to sales at 14.3%. lot of really positive kind of things to talk about there as the business and the company continues to execute well turning to page six we summarize our q4 financial results and i'll only note a few items on this page first acquisitions increased sales by two percent which was more than offset by the vestige of lighting and automotive fluid conveyance which reduced sales by eight percent second Our segment margins of 17.4% were very strong for sure, and only 40 basis points below prior year, despite lower volumes. And then just as a bit of a reminder, I would note that we record all of our charges related to acquisitions, divestitures, and restructuring at corporate instead of at the segment level, which hopefully makes it easier to model the company going forward. Moving to page seven, we summarize our Electrical America segment. Revenues were down 18%, and this was made up of a 1% decline in organic revenues, and then 17% mainly due to the divestiture of lighting. In this segment, we saw a strong growth in data centers and residential markets, which was offset by weakness in industrial and commercial markets. Operating margins increased 120 basis points to 21.1%. And this very strong margin performance was due to really effective cost containment actions, but also aided by the divestiture of lighting. This combination resulted in very strong decremental margin performance of 15%. While orders were down 1% on a rolling 12-month basis, data zone orders were particularly strong and actually up double digits. Our backlog grew by 12%. And this was driven by strength in both residential and data center markets. Lastly, as I mentioned at the beginning, we're very pleased to announce the acquisition of Triplight. This business is just a tremendous strategic fit with our existing electrical franchise and will allow us to continue to capitalize on this digitalization trend that requires edge computing. And when you think about some of the future estimates suggesting that some 75% of enterprise generated data will be created and processed via edge computing. We expect this rapid growth to continue for some time to come. Next, on page eight, we show the results of our electrical global segment. Revenues declined 5% with a 7% decline in organic revenue, partially offset by 2% positive currency. And this was better than the midpoint of our expectations for the quarter. The lower organic sales were driven by weakness, not surprisingly, in oil and gas and industrial markets. And if you exclude oil and gas and industrial businesses, kind of more project-driven businesses, Europe was down slightly and Asia Pacific was actually up low single digit. Operating margins declined 40 basis points on a year-over-year basis. And here, once again, decremental margins were well managed at 25%. In this segment, our orders declined 6 percent on a rolling 12-month basis, with continued weakness in oil and gas and industrial markets, and excluding oil and gas and industrial markets, orders were down 1 percent, and we saw strength in data centers and residential markets. And in fact, data centers were actually up some 30 percent. We also continued to expand our backlog, which was up 14 percent, driven once again by strength in residential and data center markets. Lastly, we were pleased to announce in mid-December an agreement to buy 50% of Hanyu Hitech, which is based in China. Hanyu manufactures low-voltage circuit breakers and contactors in China and also throughout Asia Pacific. This investment, you know, will provide us access to really strong portfolio products, and it will open up significant growth opportunities for our company throughout Asia Pacific. And we'd expect this transaction to close you know, sometime in Q2. Turning to page nine, we summarized our hydraulic segment. Revenues were up 2%, which was all organic. This was much better than the down 7.5% at the midpoint of our guidance as markets just continued to recover faster than anticipated, and especially, I'd say, in China and in Europe. Operating margins were at 10.5%, up 70 basis points from Q3. The momentum in this segment really continued really throughout the quarter, resulting in a 25% increase in Q4 orders with strength in both agriculture and construction equipment markets. We're working towards closing the hydraulics transaction by the end of the first quarter. I would also add, though, but, you know, given some of the time needed to complete all of the regulatory approvals, we wouldn't be surprised to see this slip into the early part of the second quarter. Next, on page 10, we have the results for our aerospace segment. As expected, revenues declined 13%, down 25% organically, partially offset by an 11% increase from the acquisition of Soria and 1% positive currency. The organic revenue decline was primarily driven by the continued downturn, as we all know in commercial markets, partially offset by double-digit growth in military sales. Operating margins declined to 18.3%, but we see these at still very healthy levels of performance. And lastly, yesterday we announced the acquisition of Cobham Mission Systems. Cobham, a technology leader in important defense aerospace product lines, will add a number of complementary capabilities to our aerospace business. The acquisition will significantly increase our exposure to, once again, growing defense platforms, It will enhance our fuel systems business and strongly position our aerospace business for future growth. Moving to page 11, we summarize our vehicle segment. Revenues here declined 7%, including a 1% organic decline, a negative 5% from the divestiture of our automotive fluid conveyance business, and 1% headwind from negative currency. The 1% decline in organic revenues was, once again, much better than the 8.5% decline at the midpoint of our guidance, as both light motor vehicle and truck markets have continued to rebound more quickly than we anticipated. We had particular strength, actually, in South America and in Asia Pacific. NAFTA Class A production was down 6% in Q4, but once again, this was better than expected. We're certainly happy also to see the rebound in operating margins of 16.6%, down just slightly versus prior year, and up 260 basis points sequentially. And our decremental margin performance here was once again very solid at 23%. Turning to page 12, we show the results of our e-mobility segment. Revenues increased 13%, including 11% organic and 2% currency tailwinds. Organic growth was also here much higher than the 1.5% growth at the midpoint of our guidance. We experienced solid growth across all regions, which was driven by both high-voltage electrical solutions for passenger cars as well as low-voltage solutions for commercial vehicles. Operating margins were a negative 5.9%. And once again, it's just a reflection of the fact that we continue to invest more in R&D and program implementation in this fast-growing segment of the company. We have a robust pipeline of opportunities, and we continue to see electrification as a significant growth opportunity into the future. So before we turn our attention to 21, I'd like to take a minute to really summarize our results for 2020, and those are shown on page 13. First, while the pandemic caused certainly an unprecedented economic volatility and downturn, we remain focused on delivering for all of our stakeholders. We remain focused on keeping our employees safe, delivering for our customers, and certainly supporting our communities. And we're also proud of how well we performed for our shareholders. We took the appropriate cost reduction and cost management measures to ensure solid decremental margins of 23% and resilient cash flow of $2.6 billion. Our free cash flow to adjusted earnings conversion was very robust at 149%, and free cash flow to sales was 14.3%, 90 basis points over 2019, and another all-time record. We launched a $280 million multi-year restructuring program to reduce fixed costs. This is really targeted mostly in those businesses that have been impacted by the pandemic. And these actions will yield $200 million in mature year benefits and make certainly Eaton stronger in the long run. We also continue to transform our portfolio, announcing or completing divestitures valued at $4.7 billion. We acquired Power Distribution, Inc., and we also announced our intention to acquire 50% of Fund U High Tech. In addition, we returned $2.8 billion to shareholders via buyback and dividend payments. And lastly, we delivered very strong shareholder returns, results that were 20 basis points above the median of our peer group. And so we're certainly proud of that performance as well. Overall, certainly proud of the team and certainly even more encouraged by our prospects for the future. As we continue to transform Eaton into a company of higher growth, higher margins, and more consistent earnings, The company certainly feels like in 2020, we took an important step forward, demonstrating that it is, in fact, a different company, and we're well on our way to delivering against that goal. Moving to page 14, we list our revenue and margin guidance for 2021. Overall here, we expect organic growth between 4% and 6% with weakness in Q1, followed by strength thereafter, and obviously, given the comparisons, particular strength in Q2. In both our electrical segments, we expect organic growth to be 3% to 5%. And just starting with the Americas, we expect to see continued strength in residential, data center, and utility markets, solid growth in industrial control markets, and ongoing weakness in commercial construction markets. In electrical global, we anticipate strength in residential, data centers, utility, and industrial control markets, so very much like in the Americas. offset by softness in commercial construction, and in the oil and gas market. And for hydraulics, we expect organic growth to be between 4% and 6%, with broadly improving markets around the world. And in aerospace, we expect organic growth of 2% to 4%, with strength in military, offset by continued weakness in commercial markets. And for vehicle, we anticipate strong organic growth, some 10% to 12%, which strengthen both light vehicle markets and truck markets. And just as a reminder here, our Eaton Cummins joint venture will actually consolidate the revenues associated with this particular joint venture. And so much of this growth will show up in the joint venture, not in Eaton's revenue. And in e-mobility, organic growth is expected to be up 14% to 16% driven by strength in electric vehicles globally. Turning to segment margins, we expect Eaton to be between 17.8 and 18%. At the midpoint, 140 basis points improvement over 2020. And importantly, 20 basis points over the pre-pandemic levels in 2019. If we could turn to page 15, and really before we discuss the rest of our 2020 guidance, we'd like to show you the math behind our new definition of adjusted EPS. In 2020, we're revising our definition of adjusted EPS to add back amortization of intangibles. We believe this will provide investors with a more accurate measure of performance, and it'll also, quite frankly, make it easier for you to compare our performance with our peers. The table shows adjusted EPS using our current and new definitions for both 2020 and for our guidance range for 2021. It's important to note here as well that the applicable tax rate for intangibles is 23.5%, and this is really based upon the tax jurisdictions where the intangibles are located. For 2021, we expect full-year adjusted EPS to be between $5.40 and $5.80, and this includes $0.70 from the after-tax impact from intangibles, $0.25 of accretion from the addition of Triplight and Cobham, But this $0.25 is reduced by $0.15 due to lower than planned share repurchases and additional financing costs. So on a net basis, the two acquisitions will add $0.10 to our expectations for earnings for 2021. We're assuming that Triplight closes once again at the start of Q3 and Cobham closes at the start of Q4. Turning to page 16, we cover the balance of our 2021 guidance, organic growth, as we talked about, 4% to 6%, with investiture subtracting 8% and positive currency adding $200 million. Adjusted operating cash flow is expected to be between $2.3 billion and $2.7 billion, and CapEx will be approximately $500 million. On an adjusted free cash flow, this is projected to be $1.8 billion to $2.2 billion, with a midpoint of $2 billion. The way I would say to think about this is 2021 for us is really a bit of a transition year with several unusual items impacting cash flow, including approximately $200 million due to the sale of the hydraulics business. We have an incremental $125 million related to our multi-year restructuring plan, approximately $125 million due to the repayment of the CARES Act payroll deferral from 2020, And, as I noted, a $110 million increase in capital spending, which we really see as a return to more historical levels and the levels we were at prior to the COVID-19-driven reductions. I'd also note that the increase in capital spend is going to support strategic growth, and we're really pleased to put dollars to work here. For example, in Q4, we announced a $100 million investment to expand our North America electrical manufacturing and distribution centers. Excluding these items, as I think about this as a transition year, the midpoint of our guidance would really be approximately $2.6 billion. And lastly, our Q1 guidance is as follows. We expect earnings to be between $1.17 and $1.27, for revenues to be down 3% to 4%, for segment margins to come in between 15.7% and 16.1%. And consistent with the full year, we expect our tax rate to be between 15.5% and 16.5%. And finally, I'd like to conclude on page 17 with a summary, we'd say, of why we think Eaton remains a very attractive long-term investment. First, we're an intelligent power management company. And this means that we're well positioned to take advantage of perhaps what we think is the most important secular growth trend that we will experience in our lifetimes. An energy transition driven by climate change, increasing electrification really of everything, and explosive growth and connectivity. It's also helpful, and I'll remind you that we've been at it for some time in terms of being a leader in ESG practices, which is now becoming increasingly important around the world. In fact, I'd say that Eaton's commitment to sustainability is deeply embedded in the belief that what's good for the planet is also good for Eaton, and that environmentally friendly solutions will create growth opportunities for our company. As you know, our commitment to improve our business portfolio with a focus on high growth, higher earnings, and more earning consistency is ongoing. That's exactly what we've been doing over the last number of years and what we'll continue to do. Today, some 85% of our segment profits come from electrical and aerospace, and that percentage will actually continue to grow with these announced acquisitions. And while not complete, I think it's clear to say that our strategy is working. Our operating margin guidance for 2021 at 17.8% of the midpoint is an all-time record and 20 basis points above 2019. In addition, Our cash flow continues to be a real point of differentiation. As we demonstrated in 2020, it's not only strong, but it's resilient under all economic conditions, and you can expect this point of differentiation to continue. Lastly, we expect to deliver 8% to 10% EPS growth over the five-year planning horizon, including 14% in 2021. And so with that, I'll turn it back to Yun for Q&A.