Eaton Q1 2022 Earnings Call Transcript

Quartr
Provided by Quartr
May 2, 2022

There are 15 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Eaton First Quarter Earnings Call. At this time, all participants are in a listen only mode. 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, Yan Jin.

Operator

Please go ahead.

Speaker 1

Hey, good morning, guys. Thank you all for joining us for Itunes' 4th quarter 2022 earnings call. With me today are Craig Arnold, our Chairman and CEO And Tom Oakray, Executive Vice President and Chief Financial Officer. Our agenda today, including opening remarks by Craig, highlighting the company's performance in the Q4. As we have done in our past calls, we will be taking questions at the end of Craig's comments.

Speaker 1

The press release and the presentation we'll go through today have been posted on our website. This presentation, including adjusted earnings per share, adjusted free cash flow and other non GAAP measures, they are 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 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 projected forecasted projections due to wide range of risks and uncertainties That are described in our earnings release and presentation.

Speaker 1

With that, I will turn it over to Craig.

Speaker 2

Thanks, Jen. We'll start on Page 3 with highlights for the quarter. Overall, I'd say we had a strong start to the year, Q1 coming in modestly better than guidance despite additional headwinds on commodities in the quarter. We had a particularly strong quarter in our Electrical Global and Aerospace Businesses, and this enables us to deliver our 1st quarter record For adjusted EPS of $1.62 a 13% increase over prior year. Our sales were $4,800,000,000 up 10% organically from last year, and this was above the high end of our guidance range of 7% to 9%.

Speaker 2

Most of our end markets remain strong with Significant strength in industrial, commercial, residential markets for electrical and commercial aftermarket and commercial OE for aerospace. And our orders continue to accelerate, allowing us to post another record for backlog. For our combined Electrical business, orders on a rolling 12 month basis were up 30% and acceleration from last quarter, which was up 21%. And our backlog for electrical was up 76% compared to up 56% at the end of 2021. Our Aerospace business also had a significant increase in demand with orders on a rolling 12 month basis, up 35% organically compared to up 19% at year end.

Speaker 2

We also posted a 1st quarter record of operating margins of 18.8%, which were at the high end of our guidance range and 110 basis points over prior year. So overall, a good quarter with healthy end markets, Solid execution in what remains a challenging environment overall. I'd say we're also executing well on our Strategic growth initiatives as noted here on Slide 4 highlighted are here are several new wins tied to the secular growth trends that we're focused on. We talked about electrification, energy transition and digitalization. Overall, we continue to see an acceleration in each of these important growth drivers and are convinced that we have the right growth strategy.

Speaker 2

In the interest of time, I'll highlight one of these recent wins, but we're happy to provide more detail on the follow-up call. While we're not at liberty to disclose the customer, we had another very significant win on an energy transition project. This was a very large follow on order for EV charging stations in the U. S, where we're providing The full suite of Eaton solutions, including power distribution equipment, energy storages, inverters, Control automation and remote monitoring software. And we continue to work on a number of big opportunities focused on building out the needed Electrical charging infrastructure given the explosive growth in electric vehicles.

Speaker 2

Now, as the world continues to embrace sustainability, Our technologies will continue to play a key part of this solution. Moving to Page 5, we summarize our key financial metrics for the quarter, and I'll just note a few highlights here. First, 3% revenue growth included 10% organic growth, offset by net headwind of 6% from acquisition and divestitures. And Our acquisitions added 6 points of growth, while the divestiture of Hydraulics reduced growth by 12 points. We also had negative FX of 1% in the quarter.

Speaker 2

2nd, with 3% revenue growth, we posted solid operating leverage with 9% growth in operating profits and even stronger adjusted growth adjusted EPS growth of 13%. And 3rd, like last quarter, Both adjusted EPS of $1.62 and segment operating margins of 18.8 percent were Q1 records. Now this strong financial performance, we think, underscores the power of our portfolio transformation and our ability to execute well Under challenging operating conditions. Next on Page 6, we have the result of our Electrical America segment. Here, revenues increased 17%, including organic growth of 10%.

Speaker 2

And just as a comparison, this compares with 5% Q4 and 1% in Q3. The acquisition of Triplight added 7 points of growth. Our organic sales growth was driven by strength in industrial and residential markets, overall. And as you can imagine, we're still working through supply chain constraints, which saw modest improvements in the quarter, but remain challenging. Operating margins were 19.1%, down 100 and 40 basis points from last year.

Speaker 2

And I'd say this decline was driven primarily by higher input costs and supply chain inefficiencies and also some increased growth related investments. Importantly, we were successful in fully offsetting the expected Inflationary costs with price increases on a dollar basis. However, we did not earn incremental margins on inflation, which did compress margins. As you'll see in our full year guidance, we expect this to improve and we continue to expect 90 basis point of margin improvement for the full year. And as I mentioned in my opening comments, market demand remains strong.

Speaker 2

We had very strong order growth. Our rolling 12 month orders were up 31%, and this compares to up 20% in Q4. So things continue to accelerate. We had strength across all end markets with a range of up 28% to up 36%. And this led to a record backlog, which increased 86% on an organic basis.

Speaker 2

And on a sequential basis, we posted A large $1,300,000,000 increase in our backlog. Moving to Page 7, we have a summary of our Electrical Global Business, We had another very strong quarter. Organic growth was 18%, with 3% headwind from currency. We saw strength in all regions with particular strength in commercial and industrial markets. We also generated strong operating leverage, delivering Record Q1 operating margins of 19.4% and incremental margins of 36%.

Speaker 2

Similar to Q4, this included some favorable mix from our exposure to growing industrial end markets, but we expect this to continue. And as we saw in the Americas, orders on a rolling 12 month basis continue to accelerate, up 27% in Q1 compared to up 22% in Q4. We had strength across all end markets with a range of up 22% to up 41 And I'd say for the Q4 in a row, we continued to grow our backlog by 50% or more and achieved a new record in the quarter. So our Electrical Mobile business is very well positioned for continued strong growth Overall, just before we move to the industrial businesses, here's a way that I'd really summarize the performance of our combined The business delivered strong organic growth of 14%, built a sizable backlog, which strengthens certainly our outlook given the current operating environment. Let's move to Page 8, where we recap our Aerospace segment.

Speaker 2

As you can see, we delivered very strong results here with revenues up 38%. This includes 15% organic growth And 25% from the acquisition of Cabo Mission Systems and 2% currency headwind. Organic growth in the quarter was especially strong in commercial aftermarket and commercial OEM markets and certainly including business jets. Operating margins were 22.1%, up 3 60 basis points versus prior year and incremental margins were solid at 32 Another area of strength was accelerating orders, which we saw rolling 12 month orders, up 35% in the quarter and this compares to up 19% in Q4. We also ended the quarter here with a record backlog on an organic basis, up 14%.

Speaker 2

And consistent with the broader message of industry recovery, we're currently pursuing $1,300,000,000 of Life of the Program Opportunities for strategic military and commercial programs, all incremental revenue. So another segment that I'd say Very well positioned for growth today and for years to come. Next on Page 9, we have the financial summary of our vehicle business. Revenues were up 3% all organic. We continue to see solid growth in North America aftermarket business and in our South America business, which was offset By weakness in global light vehicle market.

Speaker 2

As you've read, this market continued to experience significant supply chain constraints, which certainly impacted revenues in the quarter. Just as markets here begin to see some improvements, supply chain issues tied to Primarily, the war in the Ukraine had a particularly large impact on this market. These constraints also contributed to operating inefficiencies in our business a 50 basis point reduction in our operating margins. We're undertaking a number of price and cost related measures To offset the additional inflation, but it will certainly take some time to get these in place, but certainly something we plan to do before the end of the year. Turning to growth.

Speaker 2

During our investor meeting earlier this year, we provided an overview of how we're transforming the business by focusing on New spaces and products not tied to the internal combustion engine. And the team is seeing good progress. We Worth $500,000,000 in the annual revenue for our powertrain solutions for leading EV OEMs, once again, all incremental. So I'd say that we're well on our way to transforming our legacy vehicle business by selling into EV and other new markets. And so this business is performing Very much like we expected.

Speaker 2

Moving to Page 10, we summarize our eMobility segment. Revenues increased 52%, including 7% organic and 46% from the acquisition of Royal Power with 1% negative currency. While still negative, we narrowed the operating loss in the quarter and then we expect to generate positive margins for the year. And the outlook for this market continues to strengthen. Consistent with what you're hearing, we're actively $600,000,000 of pipeline opportunities focused on their innovative solutions for terminal connectors and high voltage busbars.

Speaker 2

As a reminder here, our area of focus in eMobility is around power distribution, power conversion and power protection. And in the area of power protection, we had previously announced that when using our Breakdoor technology with a major European OEM manufacturer. That customer just awarded Eaton with significant additional volume as they're expanding the use of our innovative technology to more of their vehicle platforms. And so once again, another segment where things are progressing very much in the way that we anticipated. Now let's turn to Page 11, where we summarize our updated organic revenue and margin guidance for the year.

Speaker 2

Overall, and I'd say despite Uncertainties in the broader macro environment, we continue to experience strong demand in our end markets. We're increasing our guidance on organic growth for all segments, Which results in Eton's total organic growth stepping up from a range of 7% to 9% to our now expectation of 9% to 11%. This growth outlook, I'd say, is easily supported by our ongoing growth in orders and growing backlog. For margins, we're reaffirming our full year guidance for Eton at 19.9% to 20.3%, which represents 120 basis point increase over 2021 at the midpoint. Note, while we've increased organic revenues, We're maintaining our margin outlook.

Speaker 2

And I'd say this is largely due to additional inflation that we've experienced in the year and expect to see for the balance of the year. We continue to increase prices to offset inflation, but I'd say we're experiencing kind of a normal timing impact and not getting a normal margin on top of inflation. Within Electrical, we're reaffirming our margins for Electrical Americas On increasing the guidance range for Electrical Global by 10 basis points. We've also increased margin for our Aerospace business by 20 basis points Our vehicle business due to margin compression from the new wave of inflation that we experienced in the quarter and expect for the year and some inefficiencies as well in our operations. But at the midpoint, we expect to deliver record margins and to be north of 20% for the first time in Eaton's history.

Speaker 2

So on balance, a very strong year. Turning to Page 12, we provide the balance of our guidance for the year. We're raising our 2022 guidance on adjusted EPS to between $7.32 $7.72 which is 14% growth at the midpoint and reflective of what we think is going to be a strong year. We're increasing our organic growth, as we talked about, from $0.09 to $0.11 and this is partially offset by $250,000,000 of negative currency compared to our original guidance where we thought currency would be flat for the year. So if you think about it, we're also offsetting approximately $0.10 of headwinds from negative currency in our earnings.

Speaker 2

But for the new FX headwinds, we'd certainly be taking our guidance up more than we did today. And we did complete $86,000,000 of share repurchases in the quarter, and we're on track for full year guidance of $200,000,000 to $300,000,000 for the year. Lastly, our Q2 guidance includes adjusted EPS forecast between $1.78 $1.88 for Q2, Organic revenues growth between 7 excuse me, 9% and 11%. Negative currency, we think will be 75,000,000 And 8% net revenue impact from M and A. For segment margins, our Q2 guidance is 19.1% to 19.5%, which is a sequential improvement of 50 basis points at the midpoint from Q1.

Speaker 2

And if you adjust for the $0.10 headwinds from M and A, Our year on year EPS growth in Q2 would be 12%, so roughly in line with our full year guidance for the year of 14%. Lastly, on Page 13, I'll summarize by making here just kind of a few closing comments. As many of you heard at our Investor Day and as I highlighted at the start of the presentation, we continue to experience accelerating growth in our end markets. The secular growth trends are really playing out very much the way we anticipated, and it's really underpinning our strategy as a global We're delivering key project wins for sure that are also accelerating our growth rate. These two revenue drivers are certainly showing up in our order book and growing backlog.

Speaker 2

So it's pretty much just a case of markets inflecting positively. And despite high inflation and supply chain challenges, we're growing our margins. I would also point out that based upon our Q1 actuals And Q2 guidance, we expect to generate 46% of our full year adjusted EPS in the first half, And this is in line with our historical averages for first half earnings. So as the global economy continues to face unprecedented number of challenges, I'd say you can count on our team to continue to execute well to deliver our commitments in both the short and the long term. So with that, I'll turn it back to Again, for Q and A.

Speaker 1

Okay, great. Thanks, Craig. Now it's time for the Q and A. I'll turn it over to the operator to give you guys the instruction.

Operator

We'll go to the line of Josh Park Wieczynski with Morgan Stanley. Please go ahead.

Speaker 3

Hi, good morning guys.

Speaker 2

Good morning, Josh. Good morning.

Speaker 3

So Craig, you've been in this kind of accelerating order environment now for, call it, the last three quarters where maybe supply chain is kind of limiting what you can be able to deliver. And the world has changed quite a bit over that time, especially the last quarter or so. What's the composition of the order book look like? And I guess what I'm trying to get at is, Have you seen sort of a progression or handoff from some of the more early cycle stuff to maybe later cycle or more resource industries? Or is it just kind of a healthy mix of everything where it's harder to tease out what leadership is?

Speaker 2

Yes. I appreciate the question, Josh. And it certainly had been a period of time where I'd say we're really seeing broad based order strength. And as you know, we would typically highlight Strength in particular end markets, but quite frankly, we're seeing strength across the board. And it's why we talked about, for example, In our Electrical Americas business, we said we have a range of strength at the very low end, up 28%, At the high end, up 36%.

Speaker 2

The same thing is true in our global business where we said at the low end of the increase, it was 22%, At the high end, it's 41%. So as you can imagine, I mean, this is very broad based strength across just about every end market that we serve. So things today, I think, are very strong across the board and it's tough to really Find much in a way of differentiation between some of these end markets because the numbers are just that good.

Speaker 4

Got it. That's helpful.

Speaker 3

And then maybe just a follow-up more specifically on the relationship there with price. So I know there's a lot of factor Driving orders right now and you mentioned some of them just from the broad demand, but I would have to think that some of that comes from customers wanting to get ahead of price increases. And it seems like just listening to some of your peers out there that the pace of those increases is starting to kind of subside. What would be your observation on kind of that relationship between orders and folks getting out ahead? And have you noticed anything In your own book, here in 1Q is maybe there hasn't been quite the same rate of increases as you saw maybe second half last year.

Speaker 2

Yes. I'd say, this is one that we spent a lot of time, Josh, in really trying to get a sense for Assuring ourselves, 1st and foremost, that all of these orders are real. And as you know, we are largely in the project business, Where we can say that the orders that we're taking are all tied to project. Now are we getting some of these orders perhaps maybe a little earlier in the process, Project process in terms of the cycle, there could be a little of that taking place for sure. So to the extent that we're getting some benefit from seeing orders earlier in the project, that certainly may be giving us a little bit of lift.

Speaker 2

A A lot of our business, as you know, also goes through distribution. And I can tell you in the distribution channel, with almost no exception, They don't have as much inventory as they like and inventory levels today are below levels that they like to support their future outlook for the business overall. So I do think this is just a broad based strengthening in many of our end markets. To your point on price and or things slowing down, I think it's really a function of what your call is on inflation. I'd say that certainly coming into the year, we anticipated that Inflation would moderate and as a result, there'd be fewer price increases that we would put in forth during the course of 2022.

Speaker 2

Yet what we saw in Q1 is we saw commodities for the most part increase. And so we like others certainly are back in the market again, Taking prices up to deal with the latest round of inflation, some of which is obviously being driven by what's happening in the Ukraine, Some of which being driven perhaps by another wave of shutdowns that are taking place in China. But I would say that for the most part, certainly, We are seeing more inflation this year than we anticipated. And at this point, I'd say it's too early to call on whether or It is fundamentally slowed down at this point.

Speaker 3

Perfect. Thanks for the color. I'll leave there.

Speaker 2

Sure. Thank you.

Operator

Next, we go to the line of Joe Ritchie with Goldman Sachs. Please go ahead.

Speaker 5

Thank you. Good morning, everyone.

Speaker 2

Good morning, Joe.

Speaker 5

Craig, could you maybe just touch on margins for a second? You have a really good start to the year. When you take a look at the guidance, The updated guidance for the year, the one segment that probably has the most wood to chop, I guess, in terms of Getting within the range is Electrical Americas. So just help frame how much of this is either Additional price coming through, supply chain easing, better volume leverage, how do we get from that low-nineteen

Speaker 2

I appreciate the question, Joe. And I can tell you, one, we have a High level of confidence that Electrical Americas will absolutely deliver the guidance for the year. And what we've been chasing, as you can imagine, for some time now is we've been chasing commodities with price. As I mentioned a moment ago, we did anticipate coming into the year that inflation would have abated somewhat and we ended up Taking more inflation in Q1 than we anticipated. And so we've obviously had to go to the market for additional price.

Speaker 2

And so if you think about The back half of the year and going into subsequent quarters, we're going to have a better relationship between price and And inflation and the other thing that we certainly have seen in our Americas business, we've seen a lot of inefficiencies associated with Kind of supply chain disruptions. As you can imagine, if you're missing one small component, You have a bunch of people standing around in factories, not able to complete assemblies that drives fairly material inefficiencies in your operation. And So we do anticipate as we look at the back half of the year, although we're not looking for a dramatic improvement, we are expecting some modest improvements And supply chain, and we are expecting, quite frankly, deliver better price versus cost In terms of commodities in the back half of the year, and those would be the 2 principal things that will allow us to increase margins.

Speaker 5

Got it. Thanks, Craig.

Speaker 2

The other big piece is volume is increasing. So certainly, we look at Q1, it's always the lowest quarter for our Electrical Americas business. So it will be naturally some margin lift on simply the higher volumes that are going to come based upon the seasonality of the business.

Speaker 5

Makes sense. That's helpful. And then just maybe just a broader question. So fully recognize your Order rates have been really good and continue to accelerate. And to Josh's question earlier, the environment has changed.

Speaker 5

I'm just curious, From your perspective, how do you see this all playing out? In Europe, there's a lot of concern around demand rationing, China with the lockdowns, just help us kind of, love to get your perspective on how you think things will play out over the coming quarters.

Speaker 2

Yes. And I'd say that I wish I had a crystal ball to really give you kind of a Better than an educated guess on the way we see things playing out. But Our business certainly in Europe, we don't have, number 1, very large exposure to Russia, The Ukraine, that's an immaterial piece of our revenue overall. And so we don't think we're going to see Any material impact at all from a direct standpoint in terms of what's happening, we do have some supply chain, largely as we talked about in our vehicle business where We're seeing the biggest impact as you know as well. It certainly will have an impact on the semiconductor industry potentially.

Speaker 2

So I'd say at the micro level, we think it's very manageable in terms of what the ultimate impact will be On our business, on the more macro level in terms of the geopolitical and trade sanctions and the like, that one I think it's quite frankly Too early to make a call on what the downstream implications are going to be in terms of sanctions. As you know, I mean, Russia today is a very small part of global GDP. So I don't think once again having a decoupling of Russia from the global Economy will have a material impact on our end markets or our business. It just really becomes The sanctions and whether or not it does anything in terms of underlying business confidence and their willingness to make investments. But I can tell you so far, I mean, things have held up, as you saw in our order book, extremely well and we've not really seen any slowdown at all related to The war in Russia and the war, excuse me, in the Ukraine.

Speaker 2

And at this point, we're just as a company, like we always do, We think the key is you have to be agile and flexible and be willing to make adjustments as needed as the situation unfolds.

Speaker 5

Okay. Thank you.

Speaker 6

We'll next go to the

Operator

line of Steve Volkmann with Jefferies. Please go ahead.

Speaker 7

Hi, good morning guys. Thanks for taking the question. My question is also kind of related to the backlog in electrical, obviously very impressive. But at the same time, Craig, you've talked about raw materials sort of reaccelerating. So I'm curious sort of how we handle that, Those two things together in terms of do you have some ability to reprice backlog if you need to?

Speaker 7

Is that something that you're pushing more as the cycle Progresses or is there potentially a little risk if inflation continues to move up?

Speaker 2

Yes. I appreciate the question. And I'd say that while it's not something that we do often and we obviously think long and hard Before we would do it, but we have had to reprice the backlog in some cases. It's something that we went through in Q4. And I'd say that Today, what's baked into our guidance is very much manageable in terms of our expectation around Inflation in price and obviously we tried to anticipate some of this as we think about the next wave of price increases that are going in.

Speaker 2

And so As we sit here today, we don't have an expectation of needing to reprice the backlog. It's fully baked into our guidance and our plan. But I'd say that in the event that we ended up in a situation where things got materially worse in terms of commodity input costs, It's something that we've done in the past and we would be willing to do again. But at this juncture, we don't think we need to. We think we have a plan that makes good sense And it's fully baked into our guidance that commodities essentially stay at these relatively high levels.

Speaker 2

We're not anticipating that commodity costs retreat in any material way in the back half of the year. If we do, that's upside, but that's not our base case.

Speaker 7

Understood. Thank you. And somewhat unrelated, eMobility seems to be progressing well. And I'm curious now that we're a ways into this, are you Still convinced that having eMobility and vehicle sort of under the same umbrella as it were is a competitive advantage? Are there some Data points or anecdotes that might suggest that that's part of the success in eMobility is having a vehicle business?

Speaker 2

No, that's very much still the case, Steve, from our perspective. We from a very fundamental The idea that says they're all the same customers. And so we have a seat at the table. We have a reputation. They know us, we know them, we know the application and that's always been our thesis around why we thought we had the right to win And so we come at it from both a customer intimacy standpoint and an application intimacy standpoint by virtue of our legacy Precision and vehicle and we come at it from a technology standpoint given our heritage on the electrical side.

Speaker 2

And it really is this connection On both sides of the house that we think gives us the ability to win in that market. If you think about this break door win that we talked about in our eMobility business, I That's largely technology that was first created in our electrical business, then taken and lifted by the e mobility team modified For vehicle application, but the origins of that technology actually came out of our electrical business. And so we do think the synergistic Nature of what we do as a company is what gives us the right to win in the e mobility space.

Speaker 7

Super. Thanks a lot.

Speaker 2

Thank you.

Operator

Our next question will come from the line of Andrew Obin with Bank of America. Please go ahead.

Speaker 8

Yes. Hi, Craig. How are you?

Speaker 2

Hey, Andrew. Good. How about yourself?

Speaker 8

So just Big picture question. So structurally, right, I mean, I think most multis this quarter actually had negative volumes, right, despite Price being very positive. We had negative GDP. So structurally, what do you think needs To happen with the U. S.

Speaker 8

Supply chain to debottleneck it and what do you see actually happening Among your supply chain, how long do you think it will take to sort of normalize things? And what are the key bottlenecks as you see them? Know it's a big sort of picture question, but would love to pick your brain here. Thank you.

Speaker 2

Yes. No, I'd say that And as you rightly point out, Andrew, the U. S. Has been an outlier. We have not experienced anywhere near the same level of supply chain disruptions In our European or Asia business, and I do think that so much of the challenge in the U.

Speaker 2

S. Is that U. S. Companies, ourselves included, Have really relied very much heavily on global sourcing in our operations that has obviously Created greater interdependencies in terms of supply. We in the U.

Speaker 2

S. Had some of the unique issues around labor and So the port congestions, we also dealt with, as the world did, these pretty significant downturns In the markets associated with COVID and then a very strong V shaped recovery that has continued. And so it's in many ways, It's been a perfect storm with respect to creating challenges for global supply chain Businesses like our own. So I'd say, so what's happened since, I mean, clearly, you've read about and there's lots of discussion and work going on around, Certainly, near shoring, reassuring of manufacturing in the U. S, I think you're going to continue to see more of that.

Speaker 2

And that will certainly benefit Eaton given our relative outsized position in the U. S. Market. I think you have a lot of companies, ourselves including, who are really looking at their Supply chain resiliency in general and there'll be in many cases some dual sourcing to create Additional redundancy in supply chain, so as we end up having to go through another event like this that we can absorb the shock a little better than we did this time around. So I do think that this event, and I don't know if it's the Black Swan event or not, but it certainly has forced companies to really take a hard look Their supply chain resiliency and whether or not we have enough capability to deal with shocks in the system without fundamentally shutting down our businesses.

Speaker 2

And so there's going to be As a result of that, we think also good for Eaton. I think there's going to be more investments in facilities and plants and factories As companies continue to build out some redundancy in their capability and build more local sourcing into their supply chain.

Speaker 8

And just a follow-up question, you did sort of highlight that you see strength across the board. But can we talk about on the utility side, Clearly, more talk about renewables. We have stimulus. Are you seeing any projects start to get into the pipeline Tied to U. S.

Speaker 8

Or European stimulus there?

Speaker 2

Yes, I'd say tied to stimulus Dollars, yes, certainly we're seeing a lot of activity, a lot of, let's say, projects In this discussion phase, I don't know today, Andrew, if we've seen material dollars from stimulus that have Started to flow yet. We really think that's more of an end of 2022, 2023 kind of impetus for the business more than we're seeing in our business today. I think what we're seeing today largely in and around utility investment is really much more tied to Grid resiliency, it's much more tied to the fact that aging infrastructure, it's much more tied to the increase in electrification Much more today than it is tied to the direct stimulus dollars, but that's clearly coming.

Speaker 8

Thank you very much.

Operator

We'll now go to the line of Nigel Coe with Wolfe Research. Please go ahead.

Speaker 6

Thanks. Good morning. Good morning, Steve. Good morning, Craig.

Speaker 9

So Americas I want to come

Speaker 6

back to Americas margins. So the 1Q margin was actually Flat with 4Q. And I think I'm right in saying that normally 1Q would be weaker than 4Q. So I take that as a positive sign that things have improved there. What would you say is driving that improvement primarily?

Speaker 6

Is it price cost? Is it productivity? Be it labor or The kind of the sequencing of materials in, anything to help us on that sort of improvement sequentially? And then can we Then think about Americas margins doing the normal sequential uplift from 1Q to 2Q.

Speaker 2

Yes. I appreciate the recognition on that, Nigel. I mean, you're absolutely right, by the way. Q1 has historically always been a down quarter for electrical. A lot of that is volume related.

Speaker 2

And what we've seen historically in the business, we typically see a seasonal volume reduction in Q1 versus Q4 and as a result margins on a decrement basis go down. And we are pleased the fact that they actually held up nicely in this Q1. But the biggest difference between, I'd say, the overall profitability level largely is we're doing a better job in managing price costs overall. We did, in fact, in Q1, while still not out of the woods, we did see a little better Supply chain performance in Q1 around certain commodities that actually got a bit better in the quarter. And so I think it's really those two things, better price cost achievement in the quarter and a little better supply chain performance from our suppliers.

Speaker 10

Yes. Included in the price cost is how we're taking cost out of our direct material And our logistics as well. And to come back to the other part of your question, yes, you can expect

Speaker 6

Great. Thank you, guys. And then my follow on is, Aerospace. You took up Aerospace by 2 points For 2022, maybe just talk about that, what drove that? And I'm particularly interested in the outlook for defense Because that was obviously a problematic end market in your 2022 outlook.

Speaker 6

So wondering if given the kind of the good news or not the right word, but given the improvement in defense budget outlooks globally, are you starting to see some of that benefit commence through in the back half of the year?

Speaker 2

Yes. I appreciate once again that call out as well. And Aerospace really did have a very strong quarter And delivered very strong profitability overall. And I think in aerospace, it's really a function largely of Where we're getting the growth? I mean aftermarket, as you know, in aerospace had been depressed over the last number of years.

Speaker 2

And so we saw very strong growth in the aftermarket side of the aerospace business and aftermarket, as you know, carries a much higher profitability, and we certainly would expect that to continue as we look forward. We also in aerospace, like in our other business, did a better job of managing price versus input costs and getting price to offset inflation, Which was very helpful for the business. And then to your point on defense, I'd say defense spending largely we're looking at a year today where it's On average, flat to maybe up slightly. And we really think that the defense budgets, as you think about the fiscal 2023 Defense budget for the U. S.

Speaker 2

And around the world certainly influenced, we think, also by what's happening today in the Ukraine. We think budgets are going up on the defense side of the business. And so we had a base case assumption of what we thought defense market is going to look like over the next number of years. And we think that number is certainly going up given already public proclamations from many governments around the world around them increasing their defense spending. And so we think the aerospace outlook, although you hate to Benefit from these kinds of events in the world, but we certainly think defense spending is going to improve as we go forward.

Speaker 2

But it's largely going to be, we think, a 2023 story more than this 2022.

Speaker 6

Great. Thanks, Rick.

Operator

We'll now go to the line of Scott Davis with Melius Research. Please go ahead.

Speaker 11

Hi, good morning everybody. Just Craig on the topic of aerospace while we're there, are the airlines Starting to rebuild inventory and spare parts, have you seen that occurrence?

Speaker 2

I mean, the short answer is yes, and that's part of what's driving the strong growth that we're seeing in our aftermarket business. So absolutely.

Speaker 11

Okay. That's helpful. And then going back to kind of the early prepared remarks, you talked about this EV charging contract that you got and the Different SKUs that you supplied into it. What are you not getting? Meaning, are there Are there key components that could you potentially handle the full project?

Speaker 11

Will it ever get Bid out that way on a full project basis as opposed to buying componentry or how do you see that playing out, I guess, is an open question. Thanks.

Speaker 2

Yes. Thanks for the question, Scott. I mean, as you can imagine, I mean, there's just really large opportunities You know, by various customers and different parts of the platform. And so, yes, we're winning content and we're also Passing on content as well because we don't think it's going to deliver the returns that we expect as an organization. We're focused, as I said, on How do you distribute power?

Speaker 2

How do you convert power? And how do you keep it safe inside of the car? And so we are certainly Being selective, I'd say, in terms of where we think we can participate in this growth in EV. As we talked about, This goal that we set for creating a new leg inside of the company and the revenue goals that we set, that number could actually be much higher If we were going to be kind of less discriminate in trying to participate in every opportunity that's out there. So I'd say that this Kind of $2,000,000,000 to $4,000,000,000 number that we put out there is really taken into consideration that we think There's going to be places where we have technology that allows us to differentiate to offer real value to the customers.

Speaker 2

There's going to be other elements of what's happening in electrification that's more commoditized and we're going to stay away from the commoditized stuff and really focused on the places where we offer a differentiated technology based solution. And that's those are the kinds of programs That we're winning, those are the kinds of programs that we want to win.

Speaker 11

Yes. I was asking specifically about the charging contract, not the EV platform overall.

Speaker 2

Oh, you're checking the charging contract.

Speaker 11

Okay. Yes. Is it the same answer? I don't want

Speaker 2

to Okay. So that's also true, but I was thinking you were talking about The eMobility win specifically. No, I'd say on the charging contract specifically, as I talked about, It was unfortunately, we're not at liberty to disclose the customer's name, but it's one of the big names out there who today is Helping build out the nation's charging infrastructure as the world moves to EVs. And once again, I'd say that, but that answer largely applies. I mean, there are going to be clearly parts of what's going to happen in the context of charging infrastructure where there's going to be essentially A charger that doesn't have embedded intelligence, where it doesn't require a lot of sophistication around the way you manage the load, the energy required, the energy consumed and how you balance the load, Let's call that dumb charging, if you will.

Speaker 2

You plug it in and it is electrons flow and it doesn't really require much intelligence in between. And so we're really not today participating in that end of the market. The places where we've decided to compete is where it really does require A fair amount of sophistication in terms of understanding what's happening behind the meter and how much electricity is available, Where you typically have multiple vehicles plugged in at the same time, so you have to make sure there's enough Electricity available and you have to actually manage the charging in a very intelligent way. And that's where we once again think we bring the most And that's where we think we can make decent returns in that business.

Speaker 11

Okay. Thank you for clarifying. Greg, good luck. Appreciate it.

Speaker 5

Thank you.

Operator

We'll now go to the line of Julian Mitchell with Barclays. Please go ahead.

Speaker 4

Hi, good morning. One number that stood out to me from the release was the negative Free cash flow in the quarter, I think that's pretty unusual for Eton. So maybe just help us understand kind of the confidence in that Full year free cash flow guide, I think the inventories are up sort of 40% year on year. So how do we think about those Leveling out, and just to make sure that you're still sort of very confident that the inventories that you are very, very high, but

Speaker 10

Yes. Appreciate the question, Julie. And Prudently, we invested in working capital in Q1 for a number of reasons. One is to really protect The strong growth that we're seeing, another factor in that is the supply chain constraints, wanting to make We've also got a dynamic where we have an elevated amount of work in process inventory We're waiting for individual components. And then the final aspect is, we just have inflation and that's driving up Cost of the inventory, as you saw in the prepared remarks, we remain committed to our guide on

Speaker 4

Thanks. And then just on the point on sort of firm wide operating margin. So I think a lot of industrial companies I'm guiding for a big year on year improvement in operating margins in the second half, largely due to price cost dynamics. I think for Eton, it's Very, very level loaded. You're up, I think, 110 bps in the Q1.

Speaker 4

You're saying the year is up 120. So just trying to sort of gauge, I think you're saying that price cost dynamics improved for you as well, but it doesn't seem to be embedded in that margin rate guide. Is there any sort of specific headwind kind of coming the other way? I know aerospace has a tough margin comp in the 4th quarter and that kind of thing, maybe just any sort of help around that margin guide?

Speaker 2

The way I think about it, Julien, in general, there's still, As you guys know, as well as us, there's still a lot of uncertainties out there in the marketplace, whether it's Supply chain, whether it's COVID related shutdowns that are going on in China, whether it's the downstream implications of the war in the Ukraine, There is a lot of uncertainty that still exists in the marketplace. And so given where we sit today, we just think it's prudent To say that, let's be a little bit on the cautious side with respect to the outlook for the back Half of the year. I mean, the reality is, if we end up with a better supply chain environment, if the lockdowns in China Resolve themselves more quickly than we anticipate that they will. If the impacts of the war in the Ukraine are more contained Then perhaps they are right now. There could be certainly upside in the back half of the year.

Speaker 2

We just think at this juncture, it's really not prudent to make those assumptions. And so we put in place a forecast that we think makes sense In the context of the current economic environment and the global political environment that we're dealing in.

Speaker 10

And I just to reinforce something that's in the prepared remarks, which you noted, which is a very good thing. We don't have a hockey stick plan. We don't have a back half loaded And we're 46% in the first half. We're 54% in the second, which is consistent with what we've done in history.

Speaker 4

That's helpful. Thank you.

Operator

We'll next go to the line of Deane Dray with RBC Capital Markets. Please go ahead.

Speaker 12

Thank you. Good morning, everyone.

Speaker 2

Good morning, Dean.

Speaker 12

Can you comment on inventory in the Channel, specifically distributor inventory, where does that stand?

Speaker 2

Yes. And I'd say, I Mentioned that briefly in my comments in response to another question. I think today, Dean, every conversation I'm having with Our distributor partners is that they all want more. Today, inventory levels from where they sit are not where they'd like them to be. We continue to have challenges around today supporting all the demand.

Speaker 2

That's one of the reasons why certainly our backlog is growing The way it's grown principally in our electrical businesses. And so I'd say today inventories in the channel are They're in better shape than they want them to be in with respect to they don't have enough. And At this juncture, I'd say we keep testing for that and make it to ensure that there isn't double ordering taking place and ensuring that People aren't putting provisional orders in the systems to get their place in line. But I can just tell you today, based upon where inventories sit In respect to the outlook for the year, inventory levels in the channel today are below and in some cases well below Where they'd like them to be.

Speaker 12

That's helpful. And then on infrastructure spending, You're starting to see any of the initiatives around like grid hardening, bearing power lines. Has that started to show up in bid activity?

Speaker 2

Yes, I'd say it's still early days, Dean, and we think it's another place where it's certainly needed. We think it's coming. But I'd say today, in and around the margins, the utility markets, I'd say, like our markets in general, are performing well. How much of that is tied specifically to grid hardening? How much of that's tied to energy transition?

Speaker 2

Tough to really say and bifurcate the 2, but I'd say today we are certainly seeing strength in utility markets very much like We are in our other end markets as

Speaker 11

well. Great. Thank you.

Speaker 2

Next, we'll

Operator

go to the line of Jeff Hammond with KeyBanc. Please go ahead.

Speaker 9

Hey, good morning, guys. I just had one quick follow-up. Craig, you gave Color on kind of what's different between Global and Americas around supply chain and labor, but anything else in there around If you look at just the global margins versus Americas in terms of momentum around mix or Where they are on price cost or structural opportunities globally versus Americas?

Speaker 2

Yes. There's really not much to add, Jeff, to what we said. I mean, clearly, as we talked about the global segment, we're certainly getting a benefit From better mix as industrial markets continue to rebound, as the Krausz Heinz Business Global Krausz Heinz Business continues to rebound coming back to more historical levels of profitability. That's certainly helping profitability in Global. As I mentioned, once again, They're seeing less inflation in commodities.

Speaker 2

They're seeing fewer supply chain disruptions, so fewer operational inefficiencies in their facilities as Well, in the Americas business, and so that's also part of the story of, I'd say, more of what's holding the Americas back, why it's not Even better than it is right now. But no, I don't really think there's anything else going on. And certainly, if you take a look at our outlook for the year, we Fully anticipate that the Americas business margins will be up some 120 bps this year and so it's going to be a good year. Okay. Thanks a lot, Craig.

Speaker 2

Sure. Thank you.

Speaker 5

We'll go to

Operator

the line of Brett Linzey with Mizuho. Please go ahead.

Speaker 11

Hi, good morning all. Thanks.

Speaker 13

First question is just on backlog and revenue coverage. Obviously, backlog continues to build here. Given the project nature of your businesses, I'd imagine you have some visibility on timing. I'm curious of the current backlog, how much shifts this year Versus 2023. And are you starting to book orders for 2023 at this point?

Speaker 2

Yes. I Appreciate the question. And as I mentioned in some of my commentary, we are today with respect to backlog seeing some earlier orders perhaps On some projects than we would typically see them, but I'd say most of what we're experiencing in the backlog is fundamentally Strengthening in the markets. The markets are strong and that's largely what's driving the backlog. We are Today, in the backlog, there would be some orders that will certainly ship in 2023.

Speaker 2

Some of those are planned for 2023 for certain. But I'd say, by and large, the backlog coverage is as good as it's ever been in the history of the business. And so we have better visibility today into what's required wind than we ever have. And don't feel like There's much in the backlog today that would be in any way a double order or not tied to a very specific project That we've somehow won in the marketplace.

Speaker 13

Yes. Okay, great. And then just my follow-up on the EV charging stations. Is there a way to frame Eaton's content per site and what that profitability looks like as those wins ramp? And then was that booked in the quarter or was it in April?

Speaker 2

No, that win was the one we talked about specifically was in the Q1. What we try to do is be pretty clean with respect to orders. And so anytime we talk about an order booked And on these calls, it will always be in the context of the order the quarter that we're talking about. But I'd say in terms of The profitability of those businesses, I think it's really it's early, right, whereas we're still in the early stages fundamentally of The build out the electrical charging infrastructure in general, but I'd say, we have an expectation in the company and we have a standard in the company around What an attractive business looks like. And as we think about the way we bid projects and programs and the margin expectations, We have no reason to believe that the margin expectation in EV charging infrastructure will be any different than the underlying Profitability for our Electrical business.

Speaker 13

Okay, great. I appreciate the answers.

Speaker 2

Okay. Thank you.

Operator

And our final question will come from the line of Phil Buller with Berenberg. Please go ahead.

Speaker 14

Hi, good morning. Thanks for fitting me in. Just on the topic of Q2, I think, Q2, I think, Craig, you answered some of this in Julian's question. You were referencing that there's a lot of uncertainties out there, which you appear to have baked into a Relatively conservative margin guide for the course of the year. But I guess I'm just a little surprised that the Q2 top line guide Is as strong as it is, 10% organic at the midpoint just on a gut feel type basis feels pretty high given all of those Uncertainties that are out there, so I was hoping you could just expand on what the Q2 planning assumptions are.

Speaker 14

Is it equally broad based? Or are you bullish or potentially cautious on one specific end market or another, be that residential or industrial Perhaps there's some specific geographies that we need to be calling out, I'm thinking of places such as China. Thanks.

Speaker 2

I think it's I mean, as we think about the Q2 revenue guide at 10%, we don't think that's in any way An aggressive number. And if you take a look at the growth in the backlog, the growth in orders, I mean, that number could quite frankly be much higher If we had the ability to ship and satisfy all the demand that we're seeing in our businesses today, We are banking on the fact that we are going to see some modest improvements in supply chain and availability. But no, that Growth number is in no way an aggressive number in the context of the real underlying demand that we're seeing in our businesses. We're very comfortable with the growth number in Q2.

Speaker 14

That's great. And just to follow-up, just not wanting to labor the point, but To be clear, the order strength that we're seeing, we shouldn't be attributing much of that growth to the giant project type orders that you called out, EV charger, EV OEM charger type project, that's a big deal, a big project, but it's not the predominant driver of the The momentum we're seeing, it really is quite broad based.

Speaker 2

No, no, no. I appreciate the question. But the way the electrical industry works and the business works, All of these projects tend to be on in the scheme of the total business relatively small. And so no, it's So that's why one of the reasons we tried to give some color around the strength in end markets. If you think about today, we talk about we serve Commercial, we serve utility, we serve resi, we serve data center, we serve MOEM, we serve industrial.

Speaker 2

So we serve all of these end markets. And I talked about in the Americas, a range of growth in these end markets from 27% on the low end, right, to 36% on the high end. So every one of these markets are doing Very well right now and none of our order growth would be tied to any particular one project. The only piece that tends to be a little bit lumpy is sometimes data centers is When the hyperscale guys come in, we've talked about that on some earlier calls. Sometimes they'll come in with some lumpy big orders and sometimes they'll take a quarter off.

Speaker 2

But for the most part, we're seeing this broad based strength.

Speaker 5

That's great. Thanks guys.

Speaker 1

Okay, great. Thanks guys for reaching to the end of the call. As always, Chip and I will be available to do any follow-up call with you guys. Appreciate everybody joining

Operator

Thanks. Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT and T event conferencing. You may now disconnect.

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Earnings Conference Call
Eaton Q1 2022
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