Eaton Corp PLC

Ladies and gentlemen, thank you for standing by and welcome to the Eaton Corporation Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. If you wish to put yourself into the question queue, please press 1 then 0 on your telephone keypad. If you would require assistance during the call, please press star then 0. And as a reminder, this conference is being recorded. I would now like to turn the conference over to our 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 for Eaton's Fourth Quarter 2021 Earnings Call. With me today are Craig Arnold, our Chairman and CEO, and Tom Oakry, Executive Vice President and Chief Financial Officer. Our agenda today, including the opening remarks by Craig, highlighting the company's performance in the fourth quarter. 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. This presentation includes the adjusted earning per share, adjusted free cash flow, and other non-GAAP measures. They're reconciled in the appendix. A webcast of this call is accessible on our website, and it will be available for replay. I will 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 as outlined in our presentation release and presentation. With that, I will turn it over to Craig.

Okay, thanks, Ian. Let's start on page three with a few highlights of the quarter. I'll begin by saying that despite what's now very well publicized and ongoing supply chain issues. You know, our team delivered solid results in the quarter and a record performance for the year. And in Q4, we generated adjusted EPS of $1.72, a fourth quarter record. Our sales of $4.8 billion, up 6% organically. And I'd say here we had particular strength in residential data centers and in industrial markets. And I'd say also our aftermarket businesses in both commercial aerospace and vehicle continued to deliver strong growth. We were certainly impacted by supply chain constraints, which had an impact on our revenue, and I'd say especially in our electrical Americas and our vehicle segment. The good news is the markets remained strong. Order growth accelerated in the quarter, and we ended the year with a record backlog. For our combined electrical business, orders were up 21% on a rolling 12-month basis, and our backlog was up 56%. Our aerospace business also had a significant increase in orders, up 19% on a rolling 12-month basis, and the backlog was up 16%. We also continued to post strong segment margins, 19.3% in the quarter, and a Q4 record. And I say here, the actions that we've taken to mitigate inflation, our portfolio changes, and the restructuring savings are all contributing to the strong incremental margin performances. I'd also note that we benefited from favorable mix in the quarter. And I say that our portfolio changes continue to be an important part of our strategy. We're pleased to have completed the Royal Power Solutions transactions a few weeks ago. And the addition of Royal Power will allow us to accelerate our growth in e-mobility and actually in the broader electrical market as the economy continues to adopt more electric solutions. As I say, I think you'd agree that we're not sitting still. We're managing the things that we control operationally while continuing to advance our strategic agenda. Moving to page four, I'll highlight a few additional points on our quarterly results. First, total revenues of up 2%. We increased operating profit by 14%. continued to demonstrate strong operating leverage. Second, acquisitions increased revenues by 7%, which was more than offset by the sale of hydraulics, which was a 10% headwind. And while not complete, we're certainly pleased with our progress on the portfolio. We continue to drive changes to support our overall goals of creating a company with higher growth, higher margins, and more earnings consistency. Third, I just point out that our margins of 19.3%, as I noted, were above the guidance range of 18.8 to 19.2, and I think a good indicator of our team's ability to execute operationally while once again managing the things that are in our control. And lastly, as we noted, both adjusted EPS of $1.72 and second margins of 19.3 were Q4 records in the face of these significant supply chain constraints that we've been dealing with. Next, on page five, we show the financial results of our Electrical America segment. Revenues were up 13 percent, 5 percent organic, and 8 percent from the Triplight acquisition. The organic sales growth was really driven by strength in residential, industrial, and data center markets. And on a sequential basis, organic growth did step up from 1% in Q3 to 5%, so we're making progress, but still, as I noted, continue to be impacted by supply chain constraints. In some cases, our ability to meet demand was also impacted by labor availability as we had the spike in the Omicron version, certainly at the end of the year. Operating margins of 19.2% were down 190 basis points year over year, And the decline was driven really by higher input costs, labor, and supply chain inefficiencies and disruptions in our facilities. And on price recovery, we're making good progress. We made good progress in the quarter, but certainly not fast enough to prevent some margin erosion on the net between inflation and price and the way that plays through to operating margins. And as noted in my opening remarks, market demand remained strong, which was reflected in orders and the growth in our backlog. On a rolling 12-month basis, orders were up some 20%, accelerating from up 17% in Q3 and 13% in Q2. And our backlog reached another record, up 57% from last year, and that's 7% higher than it was in Q3. The strongest markets continue to be residential and data centers. And I say here also, beyond orders, we also have strong momentum in our negotiation pipeline, which was up some 11% in the quarter. Turning to page six, we summarize our electrical global segment. And as you can see, we delivered really strong results in this segment. Organic growth was 15%, with strength in all regions, and particular strength in commercial, data center, and industrial markets. We also delivered significant operating leverage with operating margins of 19.5% and incremental margins of 40%. We did have a little bit of favorable mix here from our exposure to industrial end markets, but we do expect this to continue. Like the Americas, orders remain strong, a 22% increase on a rolling 12-month basis and a step up from the 17% number we posted in Q3. And our growth and our backlog remained above 50%. In this segment, the order strength was especially strong in data centers, residential, and utility markets. Yeah, so I'd say overall, I'd say that our electrical global business had a very strong quarter on top of a strong year and is really carrying a lot of strong momentum into 2022. Moving to page seven, we summarize results for our aerospace segment. As you can see, we had a strong quarter. The industry's recovery has certainly begun. Revenues increased 40%, 4% organic, 37% from the acquisition of carbon emission systems, and currency at a 1% negative impact.

Aftermarket and bizjet.

This was partially offset by weakness in military markets. Operating margins were 24.9% in all-time record and up 660 basis points from prior year. In the quarter, we had solid incremental margins of more than 40%, which were helped by favorable mix, particularly the growth in aftermarket, and by our portfolio actions. Another bright spot in the quarter was the growth in orders and backlog. On a rolling 12-month basis, orders turned positive in Q3, and were up 19 percent in Q4, with particular strength in commercial markets. Commercial transport, biz jets, and commercial aftermarket were all up significantly. And lastly, our backlog was up 16 percent from last year. Next, on page eight, we show the financial results of our vehicle business. Revenue was down 2 percent, 1 percent organic, 1 percent from currency. We had strong organic growth in North America truck, and in our South America business, which was offset by weakness in global-like vehicle markets. As you're aware, we had certainly significant supply chain constraints in this segment, including a number of customer shutdowns that impacted our revenue. We do, however, think the worst is behind us here, and we'll see improvement in supply chain-related disruptions this year. Overall, I think our team executed well, delivering solid margins of 16.4%, and decremental margins of 30%. Turning to page 9, we have the results for our e-mobility business. Revenues were up 4%, with growth in North America and Asia partly offset by weakness in Europe. Like our vehicle business, we experienced significant supply chain constraints and customer shutdowns in this segment. And operating margins were negative 9.1% as we continued to invest heavily in R&D and startup costs associated with new program wins. As I mentioned earlier, we acquired Royal Power Solutions in January, and it will be reported within the e-mobility segment. This is an important acquisition. It's part of our strategy to improve the long-term growth rate of Eaton. First, it expands our addressable market for e-mobility with a portfolio of highly engineered terminal connectors for electrical applications. Second, Royal Power has a strong track record of profitable growth and will continue to grow as the electrical content in vehicles continue to expand. And third, Royal will allow us to offer a more complete customer solution as we bundle their products with our own power protection and power conversion products that we're selling in mobility markets. And I say here, with organic growth momentum, the completion of Royal Power acquisition, we're well positioned to realize our long-term objective here, which is building a new $2 to $4 billion e-mobility business inside of Eaton. And our cumulative new program wins are now at $800 million mature year revenue when you include the impact of new wins from Royal Power. Moving to page 10, I'll just take a minute to recap 2021 performance before we turn our focus to 2022. First, we delivered strong organic growth for the year, up 10%, with significant strength in our electrical global segment, up 15%, vehicle up 21%, and e-mobility up 16%. And I'm especially proud of the team for delivering record segment margins of 18.9%, 250 basis point improvement over 2020, despite the challenging supply chain environment. Our team executed at a high level and delivered incremental margins of 43%. We also had one of the most transformative years in the history of the company when you think about the portfolio. We completed $8 billion of portfolio actions towards our goal of building this higher growth, higher margin, and company with more earnings consistency. And we're off to a good start in 2022, with another value-enhancing acquisition in Royal Power. The results of our disciplined execution, the transformative portfolio actions allowed us to deliver 35% growth in adjusted EPS. And importantly, our shareholders were well rewarded for their commitment to Eaton with a total shareholder return of 47% for the year. 2021 results certainly set a high bar for what we expect of ourselves, and I'm sure what you expect of others, of us as well. But we're up for the challenge, and we think the best years are still in front of us. So let's just turn our focus to 2022. On page 11, we show organic growth and margin guidance by segment. Overall, we expect organic growth to be 7% to 9%. Starting with our electrical businesses, Americas and global are both expected to grow 7% to 9%. And we expect these businesses to see growth really across all end markets, with particular strength continuing in data centers, distributed IT, and industrial markets. In aerospace, we expect organic growth of 10% to 12%, with strong growth in both commercial OE and aftermarket channels. Our base assumption here is that travel continues to expand from the COVID-impact to downturns without any significant new variants. And we expect low single-digit growth in military markets. For vehicle, we're anticipating organic growth of 7.5% to 9.5% with strength in both light motor vehicles and truck markets. And in e-mobility, we're expecting organic growth to be 11% to 13% driven by the continued strength in electric vehicles. And just turning to segment margins, we expect Eaton to be between 19.9% and 20.3%. At the midpoint, this is 120 basis point improvement over our record margins that we delivered in 2021. And we expect to see margin expansion in all of our segments. Turning to page 12, we cover the balance of our 2022 guidance. Organic growth, as we noted, is expected to be 7% to 9%. with acquisitions and divestitures subtracting 3.5%, and currency is expected to be flat. We're also forecasting cost to be flat and our tax rate to be between 16% and 17%. Adjusted EPS is projected to be in a range of $7.30 to $7.70, at the midpoint of $7.50, a 13% increase. Operating cash flow is expected to be between $3 billion and $3.2 billion, and CapEx will be approximately $650 million. Now, at the midpoint, our operating cash flow is expected to increase 15% versus last year. Our free cash flow is expected to be between $2.4 and $2.6 billion, and at the midpoint of $2.5 billion, also a 15% increase. This represents free cash flow to sales of approximately 12% and free cash flow to net income of approximately 100%. And we expect share repurchases to be between 200 and 300 million. And this really reflects our pivot to what we think is going to be a higher priority on tuck-in acquisitions. And lastly, our Q1 guidance is as follows. We expect adjusted EPS to be between $1.55 and $1.65. Organic revenue growth to be up 7% to 9%, segment margins to come in between 18.4% and 18.8%, and we expect our tax rate to be between 15% and 16%. And just allow me for a moment. I'd like to close with, once again, page 13, which is a brief summary on how we think you should think about the company. I'd say, first, our top line is supported by strong secular growth trends. And I'd say of note, Most of this growth impact is just beginning to show up in our revenue, so most of it's still out in front of us. We've proven that we know how to expand margins and are comfortable with our ability to deliver 11% to 13% EPS growth over our planning horizon. We also have clear capital allocation priorities and a disciplined approach to M&A, which we think is paying off. As a result, I'd say we're a different company today. We've transformed our portfolio. We're now a company that will deliver higher growth, better margins, more earnings consistency. And I'd say, once again, we're not done. We also have a longstanding commitment to ESG. It remains at the forefront of what we do every day. In fact, the sustainability for us is really a part of how we drive growth in the company. Many of you have gotten to know our Chief Sustainability Officer, Harold Jones, and you'll be hearing more from him at our investor meeting next month. In the short term, you can count on us to continue to manage through these operating challenges as a result of COVID, the supply chain disruptions and labor shortages, by managing the things we can control. 2021, we think, was an important proof point on our journey to transform the company, and we're proud of our results. More importantly, we're ready to do it again this year. Now, I'll turn it back to Yen, and we'll be happy to address your questions.

Thank you, Craig. For the Q&A of our call today, please limit your opportunity just to one question and one follow-up. Thank you in advance for your cooperation. With that, I will turn it over to the operator to give you guys the instructions.

Thank you, ladies and gentlemen. If you wish to ask a question, please press 1, then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1-0 command. Our first question will come from the line of Jess Kerwinski with Morgan Stanley. Please go ahead.

I always know if there's a pause, it has to be coming to me so I can start unmuting. Morning, guys.

Hey, Josh. Morning.

So a couple questions here. I guess first on free cash flow conversion, how should we think about some of the moving pieces around there, working capital or otherwise? And when do you think we start to get back to kind of more historical conversion rates?

So thanks for the question, Josh. Appreciate it. We intentionally used gap earnings in our prepared remarks when we said we were close to 100% in our free cash flow conversion. And the reason we did this is it's important to look at gap earnings when you're going through multi-year restructurings and doing a lot of M&A. So there's really four main items that you need to think about as it relates to free cash flow conversion. One is acquisition, integration, and divestiture costs, which are going to generate cash requirements for us in 2022. The other one is the multi-year restructuring program. Now, while we're at the tail end of that, we will have cash requirements, which will also be in 2022. Another element is CapEx. As you probably noted for our guide, we're up $75 million in CapEx investing to grow. And then the final one is a smaller one, but it's relevant, the CARES Act. We still have 50%, which is due, which we'll pay in 2022. If you're using adjusted earnings, you likely got in the low 80s, mid 80s. If you adjust for those four items, you're gonna be well into the mid 90s. So I don't think it's a departure between what we've done historically. I think it's consistent. The other thing I would note is we're also growing operating cash flow by 400 million in the year, which is significant.

And I just say, in addition to that, Josh, we're obviously not through a number of these supply chain related challenges. And so we're certainly, as we think about today, how do we protect customers? How do we get out in front of some of these supply chain constraints? We're still sitting on a fairly large pile of working capital, specifically in inventory, as we're dealing with some of these supply chain related issues.

Got it. That's helpful. And then I guess just speaking of supply chain, You know, probably the volume output here is, you know, is held back. And we can see that in the 1Q guide, I guess, specifically in electrical. But if order rates hold, what sort of volume growth are you guys thinking about, you know, as kind of in a second half or exit rate or, you know, as some of these supply chain issues abate? How do you guys think about that in the guide here?

Yeah, I mean, it's certainly a tough question to really address. I mean, that you can appreciate, you know, we and others have got this thing wrong in terms of how long these supply chain constraints would be with us. But, you know, certainly the underlying order growth in the businesses is a good proxy for where the real demand is. And I'm sure the question that sits just behind this one is that, you know, to what extent do you believe, you know, there's overordering taking place, you know, restocking in the channel? And I can tell you, as we continue to test for that, we're not seeing it. And our distributors are certainly today calling for more inventory than we're currently able to deliver to them. So much of our business is project-driven, and so on projects, you're not over-ordering on a project. A project is a project. And so if you just look at the order levels that we're seeing in our business, I mean, orders and sales at some point converge to the extent that there isn't a bunch of over-ordering taking place. And so we feel really good about the underlying strength in our markets. You see this tremendous growth in our backlog, and eventually this stuff is converted to sales. And so we're talking about a guidance of seven to nine, which is well below the underlying order rate that we've seen in our electrical business. And so at some point, those two things converge.

Yeah, I guess for perspective, Josh, we estimated in Q4, just in the Americas, we probably lost about $100 million in sales related to supplier disruption.

Right. Timing. We didn't know. So we think that's wanting those revenues to push into 2022. It just went into the backlog.

Appreciate the call.

Thanks, guys.

Thank you. Our next question comes from the line of Andrew Obin with Bank of America. Please go ahead.

Hi, guys. Good morning. Hey, Andrew. Hey, how are you? Just a question on backlog. You know, how much visibility do you currently have from your project backlog, and how does the margin profile of those projects look relative to the current input costs because sort of mixed message? from various folks as to how that's going to play out in 22. Thank you.

Yeah, I'd say that, you know, we're naturally sitting on a lot more visibility today than we have ever in the history of the business. When you think about this 57%, 56% growth in the backlog for our global electrical businesses. And so we have much better visibility today than we would have going into almost any year in the history of the company. And I'd say with respect to pricing in the backlog, I mean, we naturally have seen this inflation trend coming for some time now. We certainly have had the ability to anticipate where it was going as well with respect to commodity inflation. And so we're very comfortable today with pricing in our backlog, and that's certainly reflected in the guidance that we have. But we don't expect, like perhaps you've heard from some others, to have a margin impact as a result of a backlog that's not reflective of today's commodity prices.

Excellent. And just maybe to build on the previous question, so you are highlighting that sort of the underlying free cash flow conversion is close to 100%, but look, I think cash flow is one of the factors here. As we sort of enter this what looks like, you know, industrial growth period. How generally do you think about sort of investments needed in capacity, working capital, supply chain to keep up with demand in the longer term? And how do you see managing it and what kind of impact do you foresee it having on margins, free cash flow conversions, return on capital, et cetera? Just big picture question. Thank you.

Yeah, and I'd say if you think about, you know, we talk about, you know, these important secular growth trends and the fact that we do expect our businesses as we look forward to be a much faster growing business than we have historically. And we have had to, and we've talked about some examples before, make some fairly sizable investments in new capacity to deal with some of this growth that we're going to be, that we're booking today and will be coming into the future. And so I would say, As you look into the future, certainly with respect to investments in capacity to support demand, you know, we would expect to see a bit of a tick up in capital spending requirements. Revenue is going to be growing as well. And so if you think about CapEx as a percentage of sales, it probably won't be a material change, but there'll probably be a bit of a tick up. And on the working capital side, I'd say today we still have opportunities. We are sitting today on record investments in inventory as we try to protect our customers and protect our sites so that they can keep running. And so I would say I would not anticipate today a large investment in working capital once we get through some of these supply chain specific driven transitory items. I would hope that at some point it will be a source of cash even as we continue to grow the business. And we literally have built that much inventory inside of the company to really try to protect customers. But on the working capital, on the CapEx side, we would anticipate continuing to make investments in capacity in our facilities, in resiliency, to ensure that we have the ability to support the growth that we see coming.

Andrew, I think it's also important to note is, you know, we're not walking away from our objective of 100% free cash flow conversion and 14% free cash flow as a percentage of sales. That remains something that, you know, we're focused on.

Really appreciate it. Thanks so much.

Thank you. Our next question comes from the line of Jeff Sprague with Critical Research. Please go ahead.

Thank you. Good morning, everyone.

Good morning, Jeff.

Hey, good morning. If we could just kind of peel the price-cost part a little bit further. I just wonder specifically on price if you can give us some sense of what the realization was in the quarter and what is embedded in your guide. And also as part of that, Craig, you just kind of mentioned you didn't expect price-cost to be a margin headwind. So are we Sounds like we're probably positive on a dollar rate, perhaps. Maybe you could confirm that and just clarify the margin impact, if you will.

Yeah, I appreciate the question, Jeff, and this is obviously one that we're spending a lot of time internally on ensuring that we're recovering all of the commodity inflation that we're seeing in our business. So my opening comment here, I talked about the fact that We saw a margin impact in our Electrical Americas business specifically as it relates to price and cost, largely because we are in fact recovering the dollars, but we're not getting a margin, at least in the fourth quarter, we did not get a margin on top of the recovery. And so it obviously had a dilutive impact on the margin rate. As we look forward, We do expect, you know, that we'll be slightly positive in price costs. We think about 2022, and that will just continue to build from this point forward. So 2022 will be a better year. It will be less of a headwind for sure than we experienced in 2021. And we certainly would expect from an EPS standpoint that it'll be positive to our EPS earnings. On the specific question of what the dollar percent is, Jeff, as we talked about, you know, on the last earnings call, and I know it's a number that everybody is looking for, and I can understand why, but we're in so many different businesses, and we have very different inflation rates. When you think about, you know, something in Kraus Heinz, which has a really heavy content of steel versus something that's in one of our other businesses, and so the inflation rates are quite variable, and so we have chosen not to provide that number so as not to confuse customers around prices they're seeing versus what we're talking about on our earnings calls.

Thank you for that. Since you mentioned steel, maybe I'll go there with my follow-up. Obviously, the futures are pointing a lot lower. Perhaps you could just give us an update on the likely lag effects of perhaps deflation on steel coming through the system. You do have some big backlogs to work through, so certainly would suspect it's going to take a couple quarters. But any color there on steel specifically or just the other key commodity inputs that we're all keeping an eye on here?

Yeah, we appreciate the question as well. And like you mentioned, we are in fact seeing steel prices kind of retrench a little bit versus where they were last year and certainly where they were in the fourth quarter. And the typical lag time on that can be anywhere from 30 days to 90 days, depending upon which segment of the business and what type of agreement we have with our suppliers. But I would say, with respect to commodities overall, is that we're really not seeing commodities overall essentially improve. Copper is up. Resin costs are still high. The cost of semiconductors, if you can get them, are up dramatically. And so we are still living in this inflationary environment And we would anticipate for much of 2022 that we continue to operate in this elevated environment of input costs. Steel is the one kind of good guy right now, but there are more than enough other bad guys out there in terms of where we're still seeing inflation that are offsetting the benefits that we're going to see from steel.

Great. Thanks for the call.

Thank you. Our next question comes from the line of Nicole de Blasé with Deutsche Bank. Please go ahead.

Yeah, thanks. Good morning.

Good morning.

I just kind of want to go back to the free cash flow and working capital discussion. So completely understand that this is an area of opportunity and that's kind of been reflected over a lot of companies that we've heard from over the past few weeks. But I guess when we think about your 2022 guidance, Have you embedded continued working capital build or are you anticipating that it will be a source of cash for this year?

I think what's embedded, correct me if I'm wrong, but I think it's a slight positive. Yeah. What's embedded in our forecast.

We're looking at some networking capital improvement primarily as it relates to inventory.

Right. So it's not a big needle mover for us in 2022. It is a slight positive is what I'd say. Okay, perfect. And once again, it could be an area of opportunity. If we get through some of these supply chain-related challenges more quickly than we're currently anticipating, it certainly could be an opportunity to generate stronger free cash flow.

Of course. Got it. Thank you. And then I guess just kind of following up and finishing up the price-cost discussion, Craig, you specifically caught out Americas, which makes sense. Are you having price-cost headwinds at the margin line in any of your other segments, or is this just really isolated as predominantly an Americas issue?

You know, I'd say we're having price-cost headwinds in all of our businesses for the most part. it is just most acute in the Americas. And so I'd say, you know, we haven't, you know, we've just, if you think about today what's going on, and it's kind of interesting what's going on around the world, it's really the U.S. businesses in general that have had the biggest challenges around price costs, and that's largely on the input side, that the inflation that we've experienced in our America's businesses and our U.S.-based businesses has been significantly higher than what we've seen in other markets around the world. But we're having, let's say, inflationary pressures every place. It's just most acute in the U.S.-based businesses.

Thank you. I'll pass it on.

Thank you. Thank you. Our next question comes from the line of John Walsh with Credit Suisse. Please go ahead.

Hi. Good morning. Maybe the first one, can you give us a little more detail on what you're seeing in the data center market globally and if you are actually booking out now to 2023 on some of those projects?

Yeah, John, the data center market has been extraordinarily strong for us during the course of the year and on the back of really what's been a multi-year trend of really strong market. And whether we're looking at hyperscale, whether we're looking at co-locations, whether we look at even on-prem, each of those markets have been extremely strong, as has been the IT channel in general. And so I'd say today, if we think about where we're challenged around our ability to really service customer demand to these really strong markets of data centers and residential that certainly have built very large backlogs. And today, we're struggling to keep up with demand. And quite frankly, we think that market stays strong for a very long period of time. And you link it back to some of the earlier conversations of where are you going to need to make some capital investments to really deal with some of these longer-term growth trends. It's going to be in markets like data centers, which we think is going to be you know, strong for a very long period of time as the world continues to, as I've said before, generate, consume, process, store just increasing amounts of data. And we're sitting on kind of the verge of another big growth wave when you think about 5G, when you think about, you know, autonomous vehicles. And so we think that market's going to be strong for a very long time, and we're going to have to continue to invest to keep up with the growth.

Great. Thank you for that. And then maybe one on aerospace margins. If I did the math right, it looks like there's a little pressure on the conversion, obviously absolute numbers, a nice improvement. Is that mix or is there something else happening there?

So when you say pressure on conversion, you're talking about Incremental margins in the quarter?

Yeah, the incremental margins. Maybe that's just mixed with OE growing faster or something happening, commercial, military. I'm calculating something in like the upper 20s, mid to upper 20s.

The incremental margins for aerospace business was 40%, 4-0.

Oh, I'm saying in the guide, sorry, in the forward look for 2022. 2022.

Why don't you let us get back to you on that in terms of the incremental margins in the guide? And I think you have an acquisition impact in that as well. And I'm not sure what you're assuming in terms of stripping out acquisitions, which obviously don't come at a normal incremental. They come at the underlying margin rate of the business. So why don't you let us get back to you on that one and maybe deal with that offline?

Sure. Appreciate you taking the questions. Thank you. All right. Thank you.

Thank you. Our next question comes from the line of Joe Ritchie with Goldman Sachs. Please go ahead.

Thank you. Good morning, everyone. Good morning. So, Craig, look, interesting dynamic occurring in the market right now on the inventory side. And, you know, saw you guys build inventories this quarter, which makes a ton of sense, obviously, to be able to supply the market. But I kind of want to try to square the comments on distributor inventories being lean, clearly no inventories if you're doing a project. What's your sense on the OEMs? Because we are hearing from some of our companies that, yeah, they are building inventories, but everybody's also saying that the market is still very lean out there.

Yeah, and I'd say that, I mean, I think it's fair to say everybody would like to build inventory, and we're getting lots of requests you know, to get back to historical levels of inventory with our distributors. And we're always carrying inventory. Many of them don't. Some of them do. But keep in mind, you know, so much of what we do today is project business and are electrical. And on projects, you typically are not finding, you know, obviously any inventory build there. And so I'd say that this is one that, It's certainly been one that we've been concerned about. We've been watching. We've been testing for it in terms of whether or not there is over inventory in the system, whether or not there's double ordering in the system. And I can just tell you, having talked with and been engaged with a number of our teams and our distributors, that's not what we're hearing or seeing. They would like more inventory and their inventory levels today are below where they'd like them to be given, you know, their forward look on revenue growth.

Yeah, that makes sense, Craig. I appreciate the comments there. I guess my one follow-on question, I guess, would be more around like Electrical America's margins and clearly understand the pressures that you're feeling this quarter. I think lots of other companies were feeling the same. How do you think, you know, I know that you guys have pretty healthy margin expansion baked into 2022. At what point does that start to turn positive year over year? And then maybe just providing a little bit more color around the cadence would be helpful.

So when do margins turn positive year over year? I mean, what quarter do the margins turn positive?

Yeah, just cadence around, like, the puts and takes on margins as we progress through, you know, 2022 in electrical Americas.

Yeah, I'd say that certainly, you know, by the time we hit, you know, Q2, we would expect that our margins would turn positive. I mean, obviously, we're dealing with a number of factors right now in the business, and obviously, you know, what's getting a lot of attention right now is supply chain-related issues, but I can tell you also, you know, a big part of the challenge, as I mentioned in my speaking, opening commentary, that we're seeing significant labor-related issues and inefficiencies in our plants, too. We had pretty large absentees in a number of our facilities at the end of last year, the beginning part of this year, as a result of COVID. Our suppliers are seeing the same thing, and so it's not just supply chain and we can't get parts. In many cases, we were challenged to get labor and to run our factories efficiently, and so all of these inefficiencies today are kind of built into the results in Q4 and to a certain extent in Q1 as well. I think it's really Q2 by the time we really get beyond some of the labor inefficiencies. We do think that supply chain continues to get better every quarter, but in some cases we think we're going to be dealing with supply chain challenges for the entire year when you think about components like semiconductors. But other components, whether that's copper, steel, or resins, we do think those things continue to get better every quarter.

Makes sense. Thank you, Craig.

It's important to note that at the midpoint, which you saw in our prepared remarks, we're 90 bps above the prior year margins in electrical America. So that reflects the bullishness that we feel about things correcting throughout the year.

Great. Thank you.

Thank you. Our next question comes from the line of Julian Mitchell with Barclays. Please go ahead. Hi, Julian.

Hi, good morning.

Good morning.

One starting point perhaps was just within the electrical America's business, I just wanted to try and understand sort of on the residential side of that, how much was residential as a whole, um, as a proportion of that business, uh, today, uh, and how strongly was the business up last year? And when you're thinking about this year ahead, you dialing in any kind of slow down there. Um, you know, I think people are obviously pretty cautious about a number of other resi facing product categories, uh, in multi-industry right now.

Sure. I appreciate the question. I mean, Resi today, I think we'd say 18% roughly of our business would go into residential markets. And that market did grow strongly during the course of 2021. I'd say that business was probably up, you know, double digit. Around 10%. Yeah. And we're clearly expecting that market to see somewhat of a slowdown, which is baked into our guidance for 2022. Still growth in the market, but not at the heavy levels that we experienced on the course of 2021. The other thing I think is important, though, as you think about residential markets to keep in mind, as you really think about this market over the near and the longer term, is that it's not just the growth in the housing stock. It really is also the growth in the electrical industry. content in buildings, residential buildings, multifamily buildings. As they adopt the new electrical codes, it requires additional electrical content. And as we really start moving seriously into energy transition, we think the opportunities continue to grow at a really attractive rate, as consumers have put electric cars in their garages and they have to change their electrical infrastructure support the electric vehicles, as consumers continue to look at things to improve their resiliency, whether that's solar, the ability to island the home, the ability to sell energy back to the grid. All of these things, all of these kind of secular growth trends that are taking place more broadly in the economy are going to also have an impact on residential. And even though, let's say, the housing numbers are not going to grow dramatically, the electrical content we think is going to grow at some multiple of that. That's what we've seen over the last, let's say, 10 to 15 years, and that really didn't even have the impact of some of these energy transition-related trends that we're talking about. The resi for us, we think, continues to be a really attractive market. We have great position in residential, and it's one we'll continue to invest in.

Thanks very much. And then my second question, I guess, is touching on what Joe had mentioned earlier about inventories. Because I guess if I look at, say, automotive is one area, or light vehicles, we've heard about all the constraints. But there was a very large OEM earlier this week who said wholesale volumes are up 20% plus in 2022, and they could liquidate inventory early in the year. you know that i thought was interesting because it suggests that you know that's a massive oem who feels like they have enough goods on hand to satisfy double-digit growth this year um and so i just want to sort of push a little bit on that point and ask you know are there any areas when you look across different regions or different markets where you know your sales people or your channel partners may think maybe there has been a good amount of inventory built up. I don't know if there's any kind of broad views you had on end markets that had more or less inventory relative to norms as you look today.

I'm sure they're out there someplace, Julian. I can tell you that if they're out there, their voices are being drowned out by probably 100 to 1 on the other side of customers asking us for more. And specifically as it relates to automotive inventory levels, I mean, the inventory levels today continue to run at record low levels. I mean, you think about an industry in the U.S. that has typically run 75 days of inventory, been running under 30 days of inventory. And so I'm surprised that any automotive OEM would say that they're comfortable with the levels of inventories. We're not hearing that from any of our customers. And so that, I think, is a bit of an outlier.

That's helpful. Thank you.

Thank you. Thank you. Our next question comes from Nigel Coe with Wolf Research. Please go ahead.

Thanks a lot. Good morning. You did 9 percent growth across electrical in 21. Your forecast is 7 to 9 in 22. your long-term target is four to six. So, you know, I don't want to get too far ahead of March, you know, the March investor day, but how are you thinking about growth, you know, beyond 22 in electrical? I'm assuming it might be above four to six, but, and then, you know, kind of allied to that is, you know, you're highlighting utility data center, Resi. I'm a little bit surprised you're not highlighting industrial and commercial institutional turning around because we are seeing some strength in orders there. So just wondering what you've seen in those two specific end markets.

Yeah, first of all, I appreciate your question around the longer-term growth outlook in our electrical businesses, and to your point, we will be addressing that at our Investor Day next month. And I do think it's reasonable to assume that we've seen certainly more strength than we anticipated, and it would be fair to probably anticipate that that number is going to move up slightly. With respect to the end markets, and I'd say for us, Certainly we talked about industrial. Industrial markets are doing well, and we talked about that as being one of the strong markets for us in general. And so we are seeing the strength in industrial. We're certainly seeing the strength in utility, resi data centers. Even in commercial, I'd say if you think about commercial, we've talked about this before, we're still seeing growth in office, low single-digit growth. It's not huge there, but we're still seeing positive growth in the office segment. But also what goes into commercial is things like warehouses. And as you think about the continued expansion of the Amazons of the world and the warehouse segments that have much higher, once again, electrical intensity than a office building or a retail store, we continue to think that there's going to be positive mix associated with, as we continue to move more and more of our retail activity online. And so, as we said, we think all of the markets are going to be growing next year, but we will see, you know, some, what we think would be outsized strengths in data centers, in industrial markets, in utility markets, but every market we would anticipate would see positive growth.

Yeah. I mean, to Craig's point, commercial and institutional, we saw high single-digit this year growth in the overall market, and for industrial, we saw you know, mid-teens growth, so very strong.

That's great. That's a great cover. And then a follow-on for Tom on free cash conversion. Sorry to go back to this one, but the four things you called out to make total sense. I see $0.25 or $0.30 coming in all days on restructuring charges and also, you know, kind of acquisition and charger things, what you call it. in the gap to headline earnings. But is there stuff wrapped up in purchase accounting on the balance sheet that's going to have cash outflows this year? Is this more of a purchase accounting issue?

No, no. It's really the four things that I described. You know, the acquisition, integration, and divestiture, the multi-year restructuring, the CAPEX, and the CARES Act. And I think you're probably alluding to pension funding and those types of things. Nothing extraordinary there.

Okay. Thanks a lot.

Thank you.

Thank you. Our next question comes from the line of Scott Davis with Melius Research. Please go ahead.

Good morning, everybody. Good morning, Scott. My questions have been asked. I'm kind of curious. It's been a while since we had an upcycle in Kraus Heinz. What's your order book look like in that part of the world? I would imagine you've probably taken some costs out of that business since the last peak. Perhaps you can just give us a little bit of color on that specific business.

I appreciate the question, Scott. For those of you who follow Kraus Heinz over the years, know that that business that we acquired many years ago from Cooper was a very profitable business, went through a cyclical industry downturn. But when we think about industrial, when we talk about industrial strengthening, that's where a lot of the crowd science business goes. I mean, many of you think about it as an oil and gas business, but a lot of what they do today goes into industrial markets. And that business is, in fact, growing. And so we are clearly seeing a rebound in the crowd science business. A lot of the industrial markets that they support and serve are growing nicely. And so we certainly think we're at the, once again, the front end of what should be a pretty attractive recovery in those markets.

Okay. Good. And then as a follow-on, just thinking in terms of the projects that are out there that you're bidding on, it has – Are there less people bidding on projects today than perhaps a couple years ago, just given the reality that everybody's kind of sold out? Or has the competitive dynamic not really changed much?

I would say that the fact that everybody's sold out means that I think everybody's being more selective around the projects that they take, and it obviously changes the price dynamic in the marketplace. And so I'd say that I can't necessarily say that we're seeing less competition on projects. Lead times are being pushed out for lots of companies. And as I said, it's never easy to recover inflation, but we're in an environment today where given how well-known the issue is and how public and visible it is, it's probably as easy as it's ever been in my professional career because everybody kind of understands what we're dealing with. But I'd say I can't really speak to whether or not we're seeing fewer bidders on projects, but, you know, I think every company, ourselves included, have the ability to be a bit more selective today given the fact that there's more demand than there is capacity.

That makes sense. Well, best of luck in 22, guys.

All right, thank you.

Thank you. Our next question comes from the line of Brett Lindsey with Mizuho America. Please go ahead.

Good morning, all. Good morning. I wanted to come back to capital deployment. This is probably the lowest share repo guide we've seen in a number of years, and you mentioned a focus on bolt-ons. Could you just spend a moment and talk about the actionability of the pipeline, some of the sizes you're shopping, and just trying to understand you know, where you're looking within the portfolio.

Yeah, I appreciate the question. I mean, you've probably observed over the course of the last 24 months, we've done quite a bit of portfolio transformation, you know, selling businesses, lighting, hydraulics, and we've done a number of acquisitions, and we continue to prioritize our electrical business and certainly making investments in electrical that are really tied to These big secular growth trends that we've talked about of electrification, digitalization, energy transition, and we'll continue to look for things in that space. You saw us acquire this company called Green Motion last year, which is a play into electric vehicle charging infrastructure. You've seen us do a number of transactions in the Asia Pacific region. to really participate in a very fast-growing Chinese market and participate in what we call the Tier 3 and Tier 2 market, where we historically have not played. So you're gonna see us do things geographically that allow us to penetrate underserved markets. You've seen us do the Triplight acquisition, which is obviously an important play into data centers and the IT channel. And so I think what you can expect as we move forward is for us to continue to do transactions in this kind of size and scale, really focused on these really important aspects of where we think the future growth is going to. We've said that aerospace continues to be a priority, and we've done a number of important acquisitions in aerospace. We'd like the composition of aerospace These are technology, highly differentiated businesses. You get paid for your technology. They have very strong aftermarkets. We want to make sure that we're on growth platforms, and that was essentially the play with Kaba. They're sole sourced on virtually every platform that they're on. They have a growth outlook for that business that takes it from $700 million to $1 billion based upon programs that they've already won, and it's a very profitable business. with a strong aftermarket. And so you can count on us to continue to look for acquisitions that are very much consistent with what you've seen us do over the last few years. And I'd say the pipeline today is better than it's been in a while. We're looking at a number of opportunities to really buttress our capabilities in and around some of these spaces that we talked about. Obviously, we're not in a position to talk about anything or to announce anything, but what you're seeing from us is a pivot towards, as we think about how do we deploy our capital and how we can create the most value for shareholders, we think that we can find value-creating acquisitions, pay a fair price for them, and generate more value today incrementally than before. perhaps buying back our stock. But having said that, you know, we've said before we're not going to let cash build up on the balance sheet. If we can't get deals done, we will, you know, go back into the market and buy our stock back. And so we're just always just trading off, you know, how do we create, you know, the most value for shareholders, either through M&A or stock buyback or some other way of returning capital to shareholders. But it's been a great time. I've seen from us, and we like what we're looking at in front of us. And we would hope to be able to deploy more capital to its value-creating M&A.

The only thing I would add is the secular trends give us some really exciting opportunities, such as royal power that we can leverage across e-mobility, aerospace, and our electrical sectors. So it's exciting that we're seeing REIT across.

That's great. And then just one last one for me on utility T&D. You noted as a driver of the order activity within international. Didn't get a call out in the America's business. So I'm just curious, what are you hearing from customers around CapEx? Any change in tone there at all?

Yeah, I'd say that the T&D market continues to be an attractive market. I think as you think about a place where it's in desperate need of some significant investments, aging infrastructure on the one hand, but also, once again, the changing nature of the grid which is also driving the need and requirement for some fairly significant investments and upgrades in the grid and grid resiliency. And so, yeah, we think that, you know, in the Americas as well, continues to be a really positive story for some years to come.

Yeah. Grew mid-single digits last year. We expect it to grow the same in 2022.

Great. Thanks for the questions.

Thank you. And our final question today will come from the line of Markus Mittermeier with UBS. Please go ahead. Markus Mittermeier Yes.

Hi. Good morning, everyone. Craig, you mentioned in your opening remarks that in the electrical Americas, the negotiation pipeline is up 11% if I remember the number right. Is there anything already in there on some of the semiconductor activity that we see we've heard from some machine builders that there's some early activity there? Just wanted to check if that's already part of that pipeline.

Yeah, I appreciate the question. It's a question I can't really answer. I don't have that information on my fingertips right now in terms of where the additional negotiations are coming from down at that level of specificity. But maybe we'll ask Yen and Jen to follow up with you on that question to give you the color on the composition of where those negotiations are coming from.

Absolutely, but the semiconductor opportunity obviously still remains sort of an interesting one.

There's no question. I mean, to the extent that you end up with a fairly sizable infrastructure build-out, restoring, and semiconductors and the like, those are all markets that need our electrical switchgear. And so they certainly create great growth opportunities for us.

Great. And then just maybe a very quick one on electrical global. You mentioned... on Krauss-Heinz earlier, the strong growth, obviously, that you see there. Should I interpret the very strong margin profile largely as an effect of Krauss-Heinz, or is it more broad-based inside of electrical global here in the quarter?

Oh, it's definitely broad-based, yeah. Krauss-Heinz is helping, but our electrical, you know, Europe business and electrical is doing a great job of expanding margins, and so we're seeing it both in, you know, let's call it the traditional electrical business, and we're seeing it in crowd signs as well. You know, the 19.5% margins in the quarter, I mean, which is an all-time record for our global, and it's really contributions from them, and quite frankly, contributions from our Asia team as well, I mean, our Asia business as well. Dramatic, you know, improvement in profitability over the last number of years, and so we're really seeing it. If you think about what makes up global. It is what we do regionally in Asia, what we do regionally in Europe, and then it's the global crowd science business. These tend to be global businesses, but all three of those businesses saw significant improvements in profitability during the course of 2021. Great.

Thank you very much. Good luck.

Thank you. Good. Hey, thanks, guys. As always, Chip and I will be available to address your follow-up questions. Have a good day. Thanks.

Thank you.

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