Eaton Corp PLC

Ladies and gentlemen, thank you for standing by and welcome to the Eaton second quarter 2023 conference call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session and instructions will be given at that time. Should you require assistance during the conference, please press star then zero and an operator will assist you offline. And as a reminder, your conference is being recorded. I would now like to turn the conference over to your host, Yin Jin, Senior Vice President of Investor Relations. Please go ahead.

Hey, good morning, guys. Thank you all for joining us for today's Eaton Second Quarter 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 includes the opening remarks by Craig, then he will turn it over to Tom, who will highlight the company's performance in the second quarter. As we have done in our past course, will be taking questions at the end of Craig's closing commentary. 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 will be available for replay. I would like to remind you that our comments today We're including statements related to expected future results of the company and are therefore forward-looking statements. Our actual results may differ materially from our forecasted projection due to a wide range of risks and uncertainties. That is describing our earnings release and the presentation. With that, I will turn it over to Craig.

Thanks, Jen. Hey, today we're pleased to mark the end of the first quarter with one of our strongest performances ever. and a performance that strengthens our conviction about our long-term growth prospects. Our teams continue to deliver on our commitments, propelled by both strong markets and good execution. We'll begin with some of the highlights of the quarter on page three. Well understood at this point, megatrends, reindustrialization, and infrastructure spending are continuing to expand our markets, driving our revenue, orders, and backlogs. We posted another quarter of record financial performance with strong revenue, margins, and earnings growth, and we executed well. And our first half performance, along with our growing backlog, is what allows us to once again raise our full-year guidance. We're raising our 2023 guidance for organic growth, margins, and adjusted EPS. Our EPS growth at the midpoint of our guidance is now up 16 percent. Tom will walk you through the details shortly, But from my perspective, the highlights of the quarter really are our growing backlogs, up 22% on electrical and 26% in aerospace, with a book-to-bill ratio of 1.2 for both electrical and aerospace. We also generated strong operating and free cash flow, $1.2 billion and $900 million of more than 200% and 600% respectively. The free cash flow in the first half of the year is almost $800 million above prior year, so we're on track to deliver our four-year guidance despite the higher growth and higher receivable balances. Overall, we're pleased with the results and well-positioned for the second half. Moving to slide four, we wanted to provide a simple framework that summarizes how we think about key growth drivers across our businesses. The important megatrends are listed here on the left. at Eaton Markets, and our segments are listed across the top of the page. At the intersection is where we see these trends having a material impact on our growth rate of our end markets. And without getting into a lot of the detail, the important message is that this long list of megaprojects is impacting many of Eaton's end markets. What we intend to do during the course of our quarterly earnings call today and really into the future is really to talk about these trends and how they impact our end markets. Today, we'll spend a few minutes on infrastructure spending and the Inflation Reduction Act, re-industrialization, and an update on megaprojects, as well as a look at Eden's position in the utility and aerospace markets. We're highlighting the Inflation Reduction Act since it's considerable upside to the initial estimates of future government spending and on megaprojects because they continue to grow dramatically. We picked the utility segment since it's quickly becoming one of our largest markets. It was approximately 15% of Electrical America sales last year and is running well ahead of that rate this year. We received also some extensive questions from investors about our position in this market. Lastly, we'll highlight our L-Space business through the double-digit growth outlook, ramping defense and commercial platforms, including a substantial new win on the Bell V280 dollar platform. Moving to slide five, we're showing an updated look at expected spending tied to the Inflation Reduction Act. Most of the spending is focused on improving U.S. infrastructure, and as you can see, the estimates have increased significantly. At the time of passage, estimates on the cost impact, including credits and incentives, was $271 billion. The legislation was recently rescored, and government spending is now expected to be $663 billion, up nearly two and a half times due to really what is an uncapped program. Importantly, these tax credits, because they're uncapped, are expected to continue to grow. These dollars are naturally a strong catalyst for infrastructure spending. Much of it targeted at industries where Eaton will be a significant benefactor. The implementation of the IRA is in the very early stages and we think will provide significant tailwinds over the next 10 years. Very little of this impact is currently in our order book and none of it has impacted revenue yet. On page six, we have an updated chart showing the continued growth of megaprojects in North America. We introduced this chart last quarter And you'll recall that we included announced projects that are greater than $1 billion in this category. The value of announced megaprojects has increased by $116 billion, or 20%, between March and June. So the momentum continues, and we'd expect the category to continue to grow at well above historical trends. We've seen recent announcements for EV, semiconductor plants, and new battery plants. So really across the board. And a few examples of some of the other major projects include $174 billion of downstream oil and gas or chemicals, $33 billion of LNG export terminals, and $64 billion in power generation and renewable energy projects. Just another confirming data point, the Dodge data for U.S. industrial projects continues to expand at a record pace. with 12-month manufacturing construction starts up 72 percent on a 12-month basis, on a rolling 12-month basis, and up 84 percent if you include LNG activity. And as a reminder, only 25 percent of these megaprojects have started, so we're just at the beginning of this re-industrialization megatrend. Lastly, I'd remind you that we expect each of these megaprojects to have between 3 and 5 percent electrical content. Moving to page seven, we highlight the utility segment of the Americas business. As we reported, in 2022, this market accounted for approximately 15% of Electrical America's revenue and represents an even bigger percent to date. We've historically viewed the utility segment as a stable but slow growth business, generally in the low single digits. Over the next decade, utility distribution CapEx will account for 60% the total utility capex globally growing at a CAGR of 9%. Over the 22 to 25 period, we would expect an 11% CAGR. The impact of sustainability initiatives across the globe have significantly boosted this number. This includes grid modernization, renewable energy, electrification of everything, enhanced reliability and safety needs, and government incentives are all contributing to this growth outlook. And while the electrical needs of the world continue to increase, our utility customers are finding it challenging to maintain an increasingly aging grid infrastructure. As a point of reference, over 70% of U.S. transmission and distribution lines are over 25 years old. We're naturally making capital investments to address the growth here and have already committed to new capacity in our three major product families, transformers, voltage regulators, and line insulation products. It's worth highlighting that in this quarter, our America's utility business backlog has increased 45 percent. Organic revenues grew 30 percent in the Americas and 20 percent in our global segment. The graphics on page eight highlight Eaton's unique position in the North American utility market, where we're primarily focused on distribution. And given the significant changes taking place in this market, including the need to integrate renewables, undergrounding for increased resiliency, the increased demand for grid services, we could not be more pleased with what we have to offer in this segment. You can see from this slide that we have a broad position in the market. In fact, we have the industry's broadest portfolio of utility solutions. This includes grid planning software, design and engineering services, a complete offering of critical utility products, automation software, as well as extensive project management expertise. We also offer a broad range of digitally enabled hardware, grid edge controllers for overhead, underground, and for substations. Lastly, our bright layer solution for utility includes distribution planning software, distribution and substation automation, as well as smart grid communications, sensors, and demand management. So overall, we're well positioned given our substantial portfolio of hardware, digitally enabled software, and solutions. And in the quarter, we secured a broad range of wins in the market, including hardware solutions for voltage regulators, power distribution, digital solutions for grid planning in our software we call SIME, in smart metering, and also in utility services. Moving to page nine, we'd like to highlight another well-known trend, the growth in aerospace markets. As you can see, we expect double-digit growth in each of the years between now and 2025, driven by the rebound in commercial OEM, commercial aftermarket, and increased defense spending. The commercial market is expected to be very strong as Airbus and Boeing are both significantly increasing production volumes and are expected to materially increase production on their most important platforms. For example, Airbus is expected to increase production on the A320 from 45 to 50 per month currently to 75 per month by 2026. And Boeing is expected to increase production on the 737 from 31 per month currently to 50 per month in the 25 to 26 timeframe. And global passenger air travel is expected to return to 2019 levels by the end of this year and grow at 11% CAGR between now and 2025. We also expect to see increased defense spending driven by various global conflicts and governments allocating more dollars to our type of equipment to improve fleet readiness. Our aerospace business is especially well positioned on key defense platforms, both those targeted for modernization and on new platforms that are being ramped up. On slide 10, in addition to the high volume single aisle growth that you hear so much about, the next group of key platforms driving a new growth today and into the future are listed here. These platforms are a good representation of important platforms ramping in the near term, over the next five years and critical growth platforms for future decades. In all cases, we have more content than ever on each of these aircraft. In the future category, we're showing the wind with the bell on the V-28 Valor program. The V-28 is a replacement for the Black Hawk helicopter, and we have five times more content and are still bidding for more opportunities. We put the KC-46A and the F-35 in the next category, aircraft that will be ramping in the near term and will contribute materially to our revenue growth beginning next year. As you can see, our content for aircraft here is 2 to 3x the legacy platform. And lastly, we're starting to see, once again, growth in the wide body market. The long-haul market has been especially weak during the COVID and post-COVID period and is now beginning to pick up. The important message here is that these programs, as these programs ramp up, we'd expect to grow faster than our end markets given the increased content on each of these programs. So between market recovery and increased content per platform, our aerospace business is expected to see significant growth over the next five years or even longer. Now I'll turn it over to Tom who will take us through the financial slides. Thanks, Craig.