Eaton Corp PLC

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton Second 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 ask a question, please press 1 then 0. Should you require assistance during the call, please press star then 0, and an operator will assist you offline. And as a reminder, today's conference is being recorded. I would now like to turn the conference over to your host, Yan Jin, Senior Vice President of Investor Relations. Please go ahead.

Hey, good morning. I'm Yan Jin. Thank you for joining us for Eaton's second quarter 2022 earning call. With me today, Craig Arnold, our Chairman and CEO, and Tom Oakry, Executive Vice President and Chief Financial Officer. Our agenda today, including opening remarks by Craig, highlighting the company's performance in the second quarter. As we have done on our past calls, 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, including 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 would like to remind you that our comments today will include statements related to expected future results of the company and are therefore forward-looking statements. Our actual results may differ materially from our forecasted projections due to the wide range of risks and uncertainties that are described in our current earning release and the presentation. With that, I will turn it over to Craig.

Okay. Thanks, John. Appreciate it. Hey, we'll start with a summary of the quarter on page three, and I'll begin by noting that we had a strong quarter. We posted a number of all-time records led by 11% organic growth. Our performance was particularly strong in our electrical businesses, both in the Americas and global. And as you can see, orders remain strong, and we continue to build record backlogs, supporting the outlook for the year, and really, in many cases, I'd say into next year. And I'd emphasize that nearly all of our end markets remain strong, but we're seeing significant strength in commercial, in industrial, in data centers, in residential markets, in our electrical businesses. And in our aerospace business, we saw strong growth in the commercial business, both in aftermarket and in OEM. Now, this strength, I'd say, is reflected in order growth in electrical, which was up 25%, and the aerospace business, which was up 19% on a rolling 12-month basis. And our backlog was up some 74% in electrical and 12% in aerospace. As reported, we also delivered adjusted EPS of $1.87, a 9% increase over prior year, and an all-time record, more than offsetting a 12-cent headwind from the impact of acquisitions and divestitures. You'll recall that we owned the hydraulics business in all of Q2 last year. The $1.87 a share was close to the high end of our guidance range as well. We also posted an all-time record segment margins of 20.1%, up 150 basis points over prior year, and above the high end of our guidance. So in addition to strong growth, our teams have done really an effective job of managing price to offset inflation. And lastly, we're raising our full-year guidance as well. We're increasing our organic growth forecast from a range of up 9 to 11 percent to up 11 to 13 percent. And we're increasing our full-year adjusted EPS to $7.56 at the midpoint, 14 percent year-on-year growth, and despite additional headwinds from FX, from higher interest expense, and lower pension income. Moving to page four, we show the financial results for the quarter, and I'll just note a few items here. First, our revenues were flat year over year, with 11% organic growth, offset by the net impact of acquisitions and divestitures of some 9% and 2% from negative FX. And we're certainly very pleased with this level of organic growth, but I would also note that growth could have been much better, but for persistent shortages of electronic components and COVID-related lockdowns in China. Second, currency headwinds were worse than we expected in our guidance and almost $150 million impact versus prior year. As you'll see in our forward guidance, we expect this number to get worse in the second half. The FX headwinds will also reduce our adjusted EPS by approximately five cents in the quarter. Lastly, I'd like to emphasize that we really did achieve a number of all-time records in the quarter, including segment operating profits, segment operating margins, and adjusted EPS. Next, on page five, we have results of our Electrical Americas business, and really just a strong quarter across the board here. As you can see, organic growth up 16%, and record segment margins of 23.2%. We delivered strong growth across all end markets with particular strength in commercial, residential, and industrial markets. And organic growth actually accelerated from Q1 up some 10% with sequential acceleration in nearly all of our markets with the biggest increases coming from utility, data centers, and commercial markets. We did manage to, through a number of fairly significant supply chain constraints, but did see improvements in metals and resins and logistics, but continued to see challenges in electronic components. Orders on a rolling 12-month basis were up 29% with strength across all end markets with a range of anywhere from up 18% to up 39%. So we continue to be pleased with strong demand that we're seeing in our end markets. and with our backlog, which increased some 89% to a new record level. On a sequential basis, our backlog growth was up almost 20% from Q1. We also delivered record operating margins of 23.2%, up 190 points, driven largely by better-than-expected volumes. And of note, we were successful in offsetting inflation with price and expect this to continue to be on the plus side in the second half. Turning to page six, we show the results of our electrical global segment, which produced another very strong quarter, including all-time record sales. In fact, this is our fifth quarter in a row with double-digit organic revenue growth. Organic growth was 12%, with 7% headwind from currency. We saw growth in all regions with particular strength in data centers, commercial, and industrial markets. And orders on a rolling 12-month basis were up some 19%, while our backlog grew 38% to a new record level. We also delivered record Q2 operating profits and operating margins. At 18.9%, operating margins were up some 60 basis points from prior year. And lastly, we recently closed a new joint venture in China by acquiring 50% of Jiangsu Kuaneng Electric, which manufactures and markets low-voltage circuit breakers in China for the renewable energy market. And I'd say here, this is our third electrical JV in China in the last eight months, which allows us to expand our market participation by offering what we'd say is a multi-tiered portfolio of products serving this very high-growth market, both inside and outside of China. And on a combined basis, these three JVs increase our addressable market by about $17 billion. really important part of our future growth strategy coming out of these JVs. You know, before we move to our industrial businesses, here's where I'd summarize the performance of our combined electrical business. Overall, our electrical sector posted a strong Q2 with 14% organic growth and 150 basis points improvement in margins. And of note, we really have not seen a slowdown in any of our markets. We continue to see strong growth in orders and backlogs are at record levels. And I'd say that the secular growth trends that we've discussed in the past, including energy transition, are clearly showing up on our order book. Moving to page seven, we have a recap of our aerospace segment. Revenues increased 19%, including 10% organic growth, 12% growth coming from mission systems acquisition, and 3% currency headwinds. Organic growth in the quarter was particularly strong in our commercial, aftermarket, and commercial OEM businesses. On a rolling 12-month basis, orders increased 19%, while backlog was up 12%. In the commercial market, as many of you have read, travel continues to show positive improvements in both domestic and international markets, certainly a positive indicator for future growth, and is consistent with what we saw in the quarter. I would add that while strong, our commercial aftermarket bookings are only at 85 to 90% of their pre-pandemic levels, so we still have ample room for additional growth in this particular segment. And commercial OEM activities, as you've read, also continue to recover. For military markets, we expect to see increased tailwinds in defense spending, including an uptick in U.S. defense budgets. We've already seen renewed commitments from the European NATO members and expect this to lead to increased defense spending over the next several years. We're also pleased with the profitability of this segment, as operating margins stepped up 90 basis points to 21.9%. You'll recall that the peak margins for our aerospace business was 25%, so we expect this number to continue to move up over the next few years. Next, on page eight, we summarize the performance of our vehicle segment. Revenues were up 5%, which includes 7% organic growth and 2% negative currency. We had particular strength in the North America-like vehicle markets and in our South America business, which was partially offset by flat performance in Europe and weakness in China largely due to the COVID lockdowns. Operating margins were down some 260 basis points, driven primarily by margin compression from inflationary costs and the normal lag in our ability to recover price in the marketplace. We do expect that the price inflation equation will improve in the second half, and it's reflected in our outlook for the year. Turning to page nine, we show the results of our e-mobility business. Revenues increased 55%, which includes 11% organic growth, 46% from the acquisition of Royal Power, and a negative 2% currency impact. During the quarter, we also delivered more than $70 million of material wins, including a number of wins that leverage our core competency as a company in power distribution and power protection. And while still slightly negative, we narrowed the operating losses by some 530 basis points. This improvement was generated by higher volumes and certainly by the acquisition of royal power. You know, I'd also note that at the six-month point, our integration of Royal Power remains on track, and the expected synergies allowing Eaton to sell a broader solution to the marketplace is playing out just as we'd hoped. Overall, we continue to make steady progress towards our 2030 goal, which is to create a $2 billion to $4 billion business with attractive 15 percent segment margins. And as we noted at our investor meeting earlier this year, We expect the segment to deliver $1.2 billion of revenues and 11% margins by 2025. Next, on slide 10, we have the updated guidance for 2022. As you can see, for the second time this year, we're increasing our organic growth guidance for all but one of our segments, really based upon continued strength in all of our end markets. We're raising our overall organic growth from 9% to 11% to 11% to 13%. on the back really of strength in our electrical segment, where we've increased growth by 300 basis points in the Americas and 150 basis points in global. For margins, we're raising our full year guidance for Eaton to be in the range of 20% to 20.4%, which represents at the midpoint 130 basis point improvement over 2021. The two changes in the segment include increasing margin guidance for electrical Americas by 70 basis points to 22.2% at the midpoint, and lowering our margin targets for vehicle by 120 basis points to 16.5% at the midpoint. And as we talked about, the vehicle reduction really reflects the timing and margin compression associated with inflation versus price realization that we discussed earlier. So overall, I'd say a strong first half, including robust demand and orders, record levels of backlog, and we're very well positioned for the year. Moving to page 11, we show the balance of our guidance for the year. For the second time this year, we're raising our 22 guidance for adjusted EPS, which is now forecast to be between $7.36 and $7.76 a share. And as I covered on prior pages, we're increasing our organic growth outlook to 11 to 13 percent you know i would note that this is partially offset by 450 million dollars of negative currency which compares to our previous guidance of negative 250 million dollars the stronger dollar requires us to in this case offset some additional eight cents of earnings uh versus our prior guidance which we are clearly doing and is reflected in our outlook we also expect that our corporate expenses will now be 20 to 40 million dollars above 2021 levels, or between $580 million and $600 million. So another 4 to 8 cents headwinds that we are offsetting in our adjusted EPS guidance for the year. And this is primarily due to higher interest expense and lower pension income. So to recap, we're raising our adjusted EPS guidance by 4 cents, despite between 12 to 16 cents of incremental headwinds from FX interest, and pension. The remainder of our full-year guidance remains unchanged. And now just a few highlights on our Q3 guidance. We expect adjusted EPS to be between $1.95 and $2.05 a share, organic growth to be between 13% and 15%, and segment margins to be between 20.6% and 21%. And at the midpoint of our guidance, margins are expected to be up some 70 basis points from Q2. And at the EPS midpoint of $2 a share, our Q3 guidance represents 14 percent growth versus prior year. So, just wrapping up on page 12, just to recap a few points. First, I'd say that we continue to realize the benefits of our active portfolio management, which is certainly showing up in our record levels of financial performance. Second, we're seeing secular trends that are enhancing our in-market growth rate now. And we fully expect this to continue into the future. We've discussed growth and electrification and energy transition and digitalization for some time now. And these trends really, I'd say, have only accelerated. So despite all the talk about potential slowdown and downturn in the market, you know, and we'll be ready if we have one, we're focused on investing to capitalize on what we see as this super growth cycle driven by favorable trends and the recovery in some of our other end markets. So every time you hear sustainability, climate change, and resiliency, you're really hearing about growth opportunities for our company that we're capitalizing on today and will be for the foreseeable future. And this is certainly showing up in our sales results, our orders, and our backlog, which are all at record levels. Now, these factors obviously contribute to our confidence and our ability to read guidance for the year. But more importantly, I'd say they really give us confidence in the long-term outlook for the company. In the short term, we're working through supply chain disruptions, focusing on controlling the things that we can control, building more resiliency in our operations, and delivering our commitments. But with that, I'll turn it back to Yen, and we'll open it up for Q&A.