Operator:

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton First Quarter 2024 Earnings Call. [Operator Instructions] And as a reminder, today's conference is being recorded.

Yan Jin:

Good morning. Thank you all for joining us for Eaton's Fourth Quarter 2024 Earnings Call.

Craig Arnold:

Okay. Thanks, Yan.

Operator:

[Operator Instructions] The first question will come from the line of Joe Ritchie from Goldman Sachs.

Craig Arnold:

No, we appreciate the question, Joe, and it's obviously one that we're spending a lot of time internally looking at, and it's one of the things that's quite frankly, tempering our outlook for the year is the fact that we do believe that labor continues to be a bottleneck in certain industries and really in the economy overall. And so at this point, I think it's really too early to say to what extent it's going to resolve itself.

Craig Arnold:

Yes. I mean I think the short answer is absolutely. We would intend and anticipate to narrow the gap between those two businesses and narrow the gap the right way, which is the Global business needs to do significantly better. We have no expectations at all that we'd see retrenchment in our Americas business. And so -- but I will say, as you think about the restructuring program that we launched, $375 million of spending, $325 million of benefits. 2/3 of that, more or less, will be in the Electrical segment with a heavy concentration in Global. So we are clearly working hard to improve margins in the Electrical Global business.

Jeffrey Sprague:

Just curious on data centers, Craig, your comment about like some of the mega projects haven't started yet there. Obviously, data center has been strong and a revenue driver for you there. So can you just elaborate on that? Are you kind of talking about you really haven't seen maybe kind of the AI-oriented investments coming through? Just kind of an interesting curious comment. And in last quarter when you did provide that kind of order conversion data for semi and other related investments, you didn't put data centers on that slide. So maybe you could address that element of the question also.

Craig Arnold:

What was the second question? I didn't...

Craig Arnold:

I think -- and correct -- the team can correct me around the room if I'm wrong, I think data centers were embedded in that data. We gave you the aggregate data, I thought data centers were embedded in what we gave you.

Craig Arnold:

Different kinds of projects. And we were showing you some examples of different kinds of projects, but embedded in the overall data, I think that definitely included data centers.

Jeffrey Sprague:

Yes. And then just a second question, I'm sorry. Just on Electrical Americas margins, what would cause the margins to go down sequentially, right? Usually, Q1 is actually the lowest margin quarter of the year. It's the lowest revenue quarter in dollar value. Is there something in mix or otherwise that would cause it to step down from these levels?

Operator:

And the next question is from Deane Dray from RBC Capital Markets.

Craig Arnold:

Yes. The short answer is, Deane, it's absolutely yes. We are living in an environment right now where the market has a number of constraints, including electrical equipment. It's one of the reasons why we announced $1 billion of incremental investments that we're making in the company to deal with the specific bottlenecks that we have in our own manufacturing operations so that we can address the demand that we see in front of us. And quite frankly, given the demand that we're seeing even today in the business, those numbers will likely go up.

Deane Dray:

All right. That's really helpful. And then just away from data centers, just the idea of these mega projects, do you anticipate any mix change in what you are doing for direct ship versus going through distribution?

Operator:

Next question is from Julian Mitchell from Barclays.

Craig Arnold:

Yes. I appreciate the question, Julian. I mean I'd say that we have, I would say, relatively modest growth assumptions for our Electrical Global segment. And we really, in Q1, performed largely in line with our expectations, a little weaker, quite frankly, in Europe than what we expected, but largely in line. And as I mentioned, in my outbound commentary, the comps get a bit easier as well in the second half of the year for Global. But today, I'd say we're growing in Asia. We had nice growth in our China and Asia Pacific business overall. Our GEIS business is growing, doing just fine.

Julian Mitchell:

That's helpful. And just my second question was really to circle back on the margin outlook. So yes, your second quarter, you've got the implied sort of total company margin down 50 bps sequentially with some sales growth sequentially. So is the delta all in that sort of higher investments in Electrical Americas pulling down that margin sequentially. Is that what's going on there in Q2?

Operator:

Our next question is from Steve Tusa from JPMorgan.

Craig Arnold:

Yes. I wouldn't call it an abrupt start-up cost. But as you know, we made some announcements last year around capacity expansions. And those new capacity expansions start to come online. So obviously, you turn on all the depreciation, you have start-up costs associated with commissioning new lines and new plants. We're making additional investments in some of these commercial opportunities to deal with the better growth outlook that we've talked about. And so in terms of the specifics, obviously, we're not going to give you an exact dollar amount. But I would tell you that it's really tied specifically to supporting the outlook for growth. And quite frankly, we could do better. I mean the reality is we did better in Q1. Our team is executing extremely well. So we could do better than what's currently reflected, but it is today reflective of our best thinking.

Craig Arnold:

I would say that lead times have not pushed out further. We talked over the last couple of years, the fact that the surge that we're seeing in orders has, in fact, extended lead times and for many of our markets overall. And I would say today, depending upon the product line, we've made some progress in terms of lead times, but we've also seen, as you saw in the data, also a resurgence quite frankly, of orders with very strong orders in Q1 that I would say in backlogs that continue to grow. So I would say, in general, lead times have not changed materially. They've gotten not materially worse, they've gotten not that materially better.

Craig Arnold:

Yes. I mean I'd say it varies depending upon which market segment. I mean there are -- in some cases, we are getting for some of the hyperscale data center guys are trying to get out in front and maybe placing some orders earlier than they normally would. But for the most part, there's been no significant change in the order pattern.

Scott Davis:

Kind of intrigued by this concept of long-term supply agreements because I don't believe that's really been something that we've seen in the past in this industry. But can you -- for whatever you're willing to share here, help us understand, are these like take-or-pay type contracts? What is kind of the vision in forming these type of partnerships. I saw the Schneider Compass announcement a few months ago, but haven't -- not exactly sure what you guys are doing.

Craig Arnold:

Yes, I'd say that we really haven't run the math, to be honest with you, Scott, in terms of what percent. I will tell you that maybe an easy way to think about it is that the long cycle parts of our portfolio generally today, we have capacity constraints on the long-cycle stuff and on the short-cycle stuff, not so much. And I think our split is roughly 75-25 between long cycle and short cycle. So maybe that's a good proxy for where we're actually at capacity or close to sold out and where we're not.

Nicole DeBlase:

Just maybe starting with Electrical Americas, obviously, really impressive 17% organic growth this quarter. You guys raised the guidance but still embeds pretty big decel throughout the year. So is that just -- can we kind of chalk that up to conservatism, Craig? Or is there something that you guys are seeing with respect to growth in the rest of the year, that kind of causes that step down?

Nicole DeBlase:

Got it. That's very fair. And then similar question on free cash. You didn't raise the guidance for the full year despite higher earnings. Is there something going on with net working capital or some other line item that causes the offset? Or is it just a bit early in the year, and you kind of want to see how that line item trends?

Operator:

And the next question is from the line of Andrew Obin from Bank of America.

Craig Arnold:

No, I appreciate the question, Andrew. And I would say our China business continues to perform very well. In fact, we grew high single digits in Q1 in our China business. And to your point, we do have a very specific strategy for how we play the China market specifically through joint ventures. And in many cases, as you know, these are minority joint ventures. And our joint ventures, by the way, if you just take a look at our joint venture performance, we obviously don't consolidate this revenue, but they grew some 35% in 2023. So we're getting a lot of great growth in the joint ventures in China.

Andrew Obin:

Excellent. And just a more technical question. I don't know if -- I apologize if I missed it, but can you just talk about electrical channel inventories on the product side? Where are we?

Operator:

Our next question is from the line of Jeff Hammond from KeyBanc.

Craig Arnold:

I would say that what we've seen since we posted those other numbers, which were quite frankly a little bit stale, was that we certainly have seen just fundamental data center market independent of what's happening with AI has been accelerating. The world, as we've talked about before, just continue to generate processed or increasing amounts of data. And then on top of that, you have this explosive trend in AI and these AI training data centers just require and consume just orders of magnitude more power than a traditional data center, and we're obviously starting to see those orders and those negotiations come through now. And so that's really what's driving the change in the outlook for the market, not so much that we've decided that the labor constraints have been resolved, particularly or any particular power constraints overall have been resolved. It's really simply a function of the fact that what we're seeing in our negotiations, what we're seeing in our orders have just accelerated that much between the old number and the new number.

Craig Arnold:

We do start to see, as I mentioned, in terms of kind of what holds the margin expansion back a little bit is the fact that we are, in fact, bringing on and starting up new lines and new facilities beginning certainly, a lot of the spending in Q1, but certainly in the second half of the year, we start to see some of that capacity come free to the point where we actually have the ability to deliver more. So it's really second half of this year and then into 2025 in earnest.

Philip Buller:

We've talked about capacity constraints several times. It sounds like you're pretty much at capacity in places. And I know you flagged this $1 billion of investment. I guess I'm wondering if $1 billion is actually sufficient to capture with that -- that growth that's yours to lose, I guess, as I'm sure you get a really nice return on making those kinds of investments. So do you see an opportunity to invest more beyond $1 billion for CapEx expansion? Or are you choosing not to do so because of these bottlenecks like other people's labor, perhaps meaning you don't necessarily need to invest today and instead can do a bit more on the pricing side? That's question one.

Craig Arnold:

Yes. No. I mean, not particularly. I mean everybody is obviously adding capacity. The market is good for everyone right now. One of the things that we tried to give you a sense for how we're doing is that by providing some of these win rate numbers that we showed you from mega projects, some of the win rate numbers that we showed you for non-res construction projects is an indicator of the fact that we think we're doing very well in the context of this expanding market. And so I'm not -- I don't anticipate dramatic share shifts in the market, especially in a period of time when the industry is sold out in so many places.

Operator:

Our next question is from Nigel Coe from Wolfe Research.

Craig Arnold:

Yes. The answer is yes and yes. Negotiation would be a place where we are actually in an active negotiation in response to an RFP, request for proposal a request for quote. And certainly, if you think about data centers and others, once again, these projects tend to be already permitted down the road. As I did mention in some of the outbound data, there's always been a level of cancellations, especially when you look at some of these mega projects, and we talked about in my outbound commentary that the cancellation rate that we're seeing is around 10%. That rate is actually below what we've seen historically, but there's always going to be a certain level of cancellations in any of these projects, but they -- absolutely these tend to be or generally approved projects before we get to a negotiation.

Craig Arnold:

Yes. I mean I think it varies depending upon which product line you're talking about. In some cases, it is, in fact, us adding a line in existing footprint because we do have capacity to do it. In some cases, it's adding additional shifts, utilizing existing assets. But in some cases, it means a new greenfield facility, and we've had to, in fact, stand up some additional manufacturing plants to deal with the growth that we're seeing. So it's really a combination of all of those and varies depending upon which particular product line or business you're referring to.

Craig Arnold:

All right. Thank you.

Operator:

Ladies and gentlemen, thank you for standing by and welcome to the Eaton Fourth Quarter 2023 Conference Call. [Operator Instructions] And as a reminder, your conference is being recorded. I would now like to turn the conference over to your host, Yan Jin. Please go ahead.

Craig Arnold:

Okay. Thanks, Yan. We're pleased to report our Q4 results and record performance for the year. Our team continued to deliver on our commitments, supported by strong markets and good execution. So let me begin with some highlights of the quarter on Page 3. We generated adjusted EPS of $2.55 for the quarter and $9.12 for the year, both all-time records. Adjusted EPS was up 24% and full year was up 20%. And we continued to post strong margins. Q4 was 22.8%, up 200 basis points and above the high end of our guidance. We also delivered strong incremental margins, 42% in the quarter. And we continue to see strong market activity. On a rolling 12-month basis, book-to-bill for Electrical and Aerospace was 1.1 and our backlog increased by 15% for Electrical and 13% for Aerospace. And as you've read, we're initiating guidance for 2024 and expect another year of strong organic growth, double-digit increases in adjusted EPS and continued strength in cash flow. And I'll go through the full guidance details shortly. Lastly, we're announcing a multiyear restructuring program that will eliminate fixed costs and improve our overall efficiency. The program will cost $375 million and deliver $325 million of mature year benefits. So the combination of market tailwinds, our internal growth initiatives and our continued focus on operating efficiency will allow us to deliver outstanding results for years to come. And speaking of market tailwinds, let's turn to Slide 4. In the last couple of quarters, we shared our framework while we think about key growth drivers for the company. The chart reflects the 6 secular growth trends that will positively impact our business today and for years to come. And we're stepping up our investment in R&D and capital to ensure that we're well positioned to capture this growth. We think Eaton is uniquely positioned in that most of our businesses are expected to see an acceleration in market-driven growth opportunities. In our prior 2 earnings calls, we provided a summary of progress on infrastructure spending, reindustrialization, utility and data center markets in Electrical and our Aerospace business. Today, we'll provide an update on the impact from reindustrialization and how it continues to drive a record number of mega projects in North America. We'll also provide you with a framework for how to think about the timing impact on mega projects from when a project is announced, to a negotiation, to an order and eventually, to a sale. So let's take a look at Slide 5 in the presentation. We've shared this data previously and it's a good proxy for the reindustrialization trend we're seeing. You'll recall, this summarizes the number of mega projects that we have announced since January of 2021. And a mega project, once again is a project with an announced value of $1 billion or more and there's been 333 of those through the end of last year, beginning in January 2021. Note that this is North America data but we're seeing a similar trend in Europe, although the dollars are not as large. A few points to note; first, at $933 billion, this number is 3x the normal rate and the increase translates directly into electrical markets. As a reminder, the electrical content on these projects is typically anywhere from 3% to 5%. Second, the number continues to grow and is up 9% from Q3. This will not go on forever, we're sure but there continues to be strong momentum for U.S. industrial projects and we're building a multiyear backlog. And third, about 72% of these projects are still in the planning phases and only 18% have actually started. Some 10% have been canceled or significantly delayed but this number is actually lower than historical rates. For those that have started, we've won over $1 billion in orders with a win rate of approximately 40%. And we're in active negotiations on another $1 billion of electrical content on a small subset of these total projects. So as you can see, mega projects are a compelling reason to be optimistic about the future. Turning to Slide 6; we want to highlight the timing and the duration of these mega projects as they become opportunities for our electrical business. The primary conclusion is we've not seen a significant impact from the large step-up in the number or size of mega projects yet but it's coming. While each project is different, we put together our view of 3 representative examples of reindustrialization projects, including a semiconductor, an EV battery and a health care example. This slide indicates the number of months between an announcement of a mega project and the time we begin to negotiate it, the time from an announcement of an order -- the time from an announcement to an order and from an announcement to a shipment. As you can see, it takes on average 3 to 5 years from when a project is announced to when it shows up in our revenue. So while the gratification is certainly delayed, this is what's showing up in our backlog and providing outstanding visibility to future growth. With over $1 billion of orders that we've already won, we expect revenues to be recognized over the next several years in line with each of these products' individual time lines. And just as a point of reference, our revenues in Electrical America for mega projects in 2023 was only about 3% of our total revenues. By contrast, they represent 16% of our negotiations and 6% of our orders. Hence, the conclusion that most of the impact from the significant step-up in mega projects is still ahead of us. And now let me just turn it over to Tom. But before I do, I do want to take this opportunity to thank Tom. I mean Tom has just been an outstanding leader for Eaton in his tenure with us and I couldn't have asked for a better partner or a more effective CFO. And Tom, we're absolutely disappointed to see you go, we fully understand the reason you made this decision. We wish you all the best of luck and thanks once again for this outstanding leadership over the last 3 years.

Craig Arnold:

Thanks, Tom. Turning to Page 16, we lay out our end market assumptions for 2024. You'll recall that we provided an early look at our 2024 assumptions during our Q3 earnings call at the end of October. Today, we're updating those assumptions. And with the exception of residential markets where we have increased our outlook from down slightly to flat in commercial vehicles where we have decreased our outlook from slightly declining to declining, all of our assumptions have remained the same. In contrast to what we're seeing in the macro economy, we continue to expect growth in about 80% of our end markets. And much of this growth is supported by large backlogs. Turning to Page 17. As you've read, we're announcing a new multiyear restructuring program to reduce fixed costs and enhance our efficiency. While we're structurally positioned to deliver higher levels of organic growth, we also have a vast number of opportunities to improve the way we run the company. And we're at a point in time where we have the organizational capacity to take on a number of these efficiency projects that have been in our pipeline for some time. The program will focus on reducing structural costs through the consolidation of rooftops, increasing shared services and deploying digital technologies. These actions will also free up time and resources in our businesses, allowing them to focus on growth and driving operational improvements. Overall, we expect $375 million of restructuring costs over the next 3 years with $325 million of mature year savings in 2027. This includes approximately $175 million of charges in 2024 and $50 million of savings, both of which are included in our 2024 guide and I'll cover those in the next several slides. While the company is performing well, we see these actions as an important part of how we'll continue to do so for years to come. Moving to Page 18. We summarize our 2024 revenue and margin guidance. Our organic growth for 2024 is expected to be between 6.5% and 8.5%, with particular strength in Electrical Americas and Aerospace, both expected to be up between 9% and 11% while eMobility is expected to grow some 30% as new programs are launched and the electric vehicle market continues to see solid growth. And I'd also add that the healthy end markets, combined with our large backlog provides actually better-than-normal visibility for our 2024 outlook. For segment margins, our guidance range of 22.4% to 22.8% is an improvement of 60 basis points at the midpoint from our 2023 all-time record of 22%. As we've communicated earlier, incremental margins of about 30% are what you should assume and that's what's reflected in our guidance. These incrementals are consistent with our plan to step up investments in R&D and with the investments we're making to expand our manufacturing capacity, all done to ensure future growth. On the next page, we have the balance of our guidance for 2024 and Q1. For 2024, our adjusted EPS is expected to be between $9.95 and $10.35 a share, $10.15 at the midpoint and up some 11% from 2023. And for operating cash flow, our guidance is between $4 billion and $4.4 billion, up 17% at the midpoint. The key drivers here are really a combination of higher earnings and improved working capital. We also expect to repurchase between $1.5 billion and $2.5 billion of our shares outstanding. And given our cash position at the end of the year, at the end of '23 and our strong cash generation this year, we'll still have plenty of room for strategic M&A. For Q1, we expect organic growth to be between 6% and 8%, segment margins between 21.3% and 21.7% and adjusted EPS in the range of $2.21 and $2.31 per share. Let me just close here on Page 20. As we transition into 2024, I think we can all conclude that Eaton has proven that we're a changed company, a company that delivers higher growth, higher earnings and does so consistently. And we're proud of our team's record performance in 2023. But once again, we see opportunities to be better everywhere. As we look forward, we continue to experience powerful megatrends that are driving higher growth in our end markets and we're investing to ensure that we're capturing these opportunities while gaining market share. We're also continuing to optimize the way we run the company, improving our operational execution, leveraging our scale and reducing our fixed costs. This is allowing us to invest like never before in R&D, in capacity expansion and in our people. So our expectations are high and our teams are looking forward to delivering another exceptional year. So with that, I'll open things up for any questions that you may have.

Operator:

[Operator Instructions] Then now this question will come from the line of Jeff Sprague from Vertical Research.

Craig Arnold:

Jeff. Appreciate the question. And -- I'm not sure for everybody else but I'm getting a little background noise on the call. I'm not sure -- okay, that's better. Jeff, we spent a lot of time as a company sorting this one out in terms of whether or not it made sense to take on these restructuring projects at this time. Because, to your point, things are going very well and we have perhaps more growth opportunities than we've ever had in the history of the company. But at the same time, we actually have more capacity today than we've had in a long time. As you'll certainly be aware, we haven't done many acquisitions over the last couple of years. In fact, we really haven't done any. And so we actually have more bandwidth as an organization today to take on these projects. And one of the things that we do as a company is that we always have a forward view of our opportunities to be better, to improve efficiencies, to eliminate redundancies, to build scale, to essentially leverage some of these new technologies that are coming forth. And so we, today, as an organization, as a leadership team, all agree with that. There's probably no better time than right now to take on these projects, to improve our cost position and really set the company up for margin expansion for the next 3 years on top of the growth that we're going to see as a business. So lots of confidence today in our ability to take it on and we have plenty of capacity as an organization to do so.

Craig Arnold:

Yes. That's a great point. I said that in my outbound commentary, this notion that essentially, we're freeing up time in our operations so that they can focus on growth and improving our operational execution, while some of our corporate teams take on a number of these support services. So you're absolutely right, Tom. Thanks for that amplification.

Craig Arnold:

Yes, no, I appreciate that question, Jeff and understand the nature of it. But I can just tell you, based upon at least what we're seeing and the nature of our backlog today and as I'm sure you're well aware of that, we, as Eaton and really, quite frankly, as an industry, we've had more demand than we've had capacity largely over the last couple of years. And so we think we have plenty of ability to accelerate, decelerate if necessary, backlog conversion to essentially keep the top line growing at an attractive rate in the event that you have some sort of order that would be moving in or out or some sort of lack of linearity in the order book itself. And so not a concern; we've not seen it to date. As we look at kind of the stratification of the backlog and when orders are due, we don't have that concern.

Andrew Obin:

Seems like you guys are doing great, yes. Just a different way of asking, I guess, Jeff's question. Can you just talk -- you mentioned capacity additions. Can you just -- and I appreciate that some of this is competitive. But what areas are you adding capacity? When will this capacity be available to really move the needle? And -- yes and anything you're doing differently on geographies post the whole COVID experience?

Andrew Obin:

Got you. And then just a follow-up, I guess, naturally builds on the first answer. In terms of your supply chain, what are the biggest challenges are you still experiencing? And what has gotten better over the past 3, 6 months? And what's still a problem?

Tom Okray:

Just to jump in Andrew, on the last point. I think that's really been key, partnering with the suppliers so we can grow together with them. And we've gotten much more efficient, probably as a result of the pandemic, understanding what we need on a go-forward demand basis.

Operator:

Our next question is from Chris Snyder from UBS.

Craig Arnold:

No, I appreciate the question. And I think I'd say long before we were talking about mega projects, we were talking about secular growth drivers, we were talking about energy transition, we were talking about the electrification of the economy. We were talking about digitalization. You think about -- today, mega projects deal with these big projects above $1 billion announcements but we've seen very similar growth in projects that are well below the $1 billion threshold until reindustrialization of the U.S. and other markets where today, you have production moving back in and big investments taking place. And so the trends are much broader than mega projects. The reason we've put this emphasis on mega projects is because it's a great indicator of the multiyear runway that we have and a chance to give the investor community visibility into the outlook over multiple years. But you're absolutely right. We're seeing broad-based growth in our business much beyond this mega project emphasis but the mega projects will become a bigger piece of our future. That's why we talked about 3% of sales, 6% of orders, 16% of negotiations, that continues to be a tailwind, a real impetus for future growth.

Chris Snyder:

Yes, no, absolutely. I appreciate the durability and sustainability that it brings. And then just kind of on that same topic, my back-of-the-envelope math suggests that this ramp in mega projects at least drives about a $25 billion incremental market opportunity over the next few years. So a pretty massive ramp for an industry that is already having trouble keeping up with demand. So I guess the question is, do you see a pathway forward for the industry to meet this demand? And how does that impact your multiyear expectations for our ability to push price and drive margins higher?

Operator:

The next question is from the line of Steve Tusa from JPMorgan.

Craig Arnold:

Yes, Steve, as you probably are aware, we don't provide specific price guidance. We don't separate price and volume. I will tell you that on a relative basis, when you compare, let's say, 2024 and 2023, 2022, the price will contribute a much smaller piece of our growth than volume will. And that's -- so we're going to be probably back to more of a historical level of price realization in terms of 2024. And that's really a function of the fact that we're not seeing inflation. We had to essentially work the price lever fairly significantly over the last couple of years as we dealt with this inflation that was in the system. Now we still have some inflation principally on the labor side. So we will still get price but its contributions to our growth will be significantly less than it had been in prior years.

Craig Arnold:

$2 billion at the midpoint -- okay, go ahead, Tom.

Steve Tusa:

Right. So it's a 2% lift from share count in general embedded in the guidance for EPS growth-ish?

Operator:

Our next question is from the line of Joe Ritchie from Goldman Sachs.

Craig Arnold:

Yes. I would say that the margin profile on these mega projects is not going to be terribly different than the margin profile in the underlying business. It's -- these -- we are in a position, as you can imagine, when your capacity constraint to be selective around where you win. And so we would not expect -- even though they're big projects and oftentimes you find a large project, margins take a bit of a haircut, we should -- you should not expect that as these mega projects translate into revenue.

Craig Arnold:

Yes, no, I appreciate the question and the concern. I mean given the upcoming elections and in many ways, it's kind of an unknowable in terms of how the election is going to turn out. And then, quite frankly, even with the change in the administration, difficult to know what position they will take with respect to a lot of the stimulus spending that is essentially underlying and supporting these mega projects. And I will tell you, what gives us a fairly high level of confidence that it's not going to change materially, is that a lot of these projects are going into red states. And so despite what may happen kind of on the political front, the benefactor of a lot of these projects are actually those red states. And it's walk to wait and see how it all plays. And we don't think today it's going to have a material impact. Today, we are looking at more demand and we have capacity to serve. So even if there was a little bit of a give back, the business is still in great shape and to support the long-term growth assumptions for the company. But in many ways, it's kind of the unknowable. We just don't know how the election is going to unfold and then what happens afterwards.

Julian Mitchell:

Thanks a lot, Tom, for all the help. Maybe just a first question would be around, when you think about sort of the mega projects and the impact on North America orders, so you've had a sort of a book-to-bill well over 1x in 2023 even with those trading 12-month orders being down somewhat off the high base. When you look at 2024, is it sort of a similar construct where I suppose you could have orders down but the book-to-bill still over 1x just because of the capacity constraints? And then more broadly, any concerns that you and your peers collectively are adding maybe too much capacity in electrical output?

Tom Okray:

Yes. And just to add a little bit more color to that. And Julian, we talked about this in previous calls and tried to put it in the prepared remarks but I think it's very important for everyone on the call. We have modeled year-over-year order decline, meaningful order decline. And in those scenarios, given our backlog coverage, as we said in the prepared remarks, we are able to have robust organic growth well into 2025. So that gives us great confidence that even if year-over-year orders continue to decline in a meaningful way, we've still got a good runway.

Craig Arnold:

Yes. Appreciate the question, Julian. And as you know, as we talked on our guidance, we're anticipating 30% growth in our eMobility business. And I can tell you that 30% number is today dialed back from what our customers are asking us for. We do recognize that the industry itself has gone through a little bit of a, I'd say, a wake-up call with respect to the underlying demand for EVs. By the way, still great demand, still good growth. Some 20%, I think, in the fourth quarter for us. But overall, a slower rate of growth than perhaps what people were anticipating maybe 12 months ago. So we think the industry will continue to grow and grow nicely. And what we try to do as we build our own plans and our guidance is to make sure we're appropriately hedged back to ensure that we're able to deliver our commitments. But at the same time, we have the flexibility to respond in the event that some of these customer forecasts and their outlooks are actually -- they actually come to fruition. So yes, we took about $1.5 billion, 11% return on sales. We are absolutely still -- see line of sight and committed to those goals and our forecasts have not changed.

Craig Arnold:

Yes. And to your point, Tom, it really is. And I think this was maybe your question, Julian, as well. It really is platform-specific. And our growth really comes from the launching of new eMobility platforms that we have content on. And that's why our growth, we think will clearly be well above the industry's growth rate.

Steve Volkmann:

Great. I want to go back to the cost-cutting program. The $325 million of benefits in 2027, should we think of that as kind of net in terms of the margin? Or will you have some increased investments that offset some of that?

Tom Okray:

Yes. And I was just going to say and the cash associated with it is in our cash guidance as well.

Craig Arnold:

Yes, no, I appreciate the question. I think you can just think about it, it's going to be pretty widespread. And you can think about the total kind of allocation of the benefits being pretty much aligned with the company, 2/3 will be in Electrical, 1/3 will be in Industrial. We'll be focused on taking out rooftops in the company, driving some shared services, leveraging digital. But a lot of these benefits will really cut across the company.

Craig Arnold:

And it's the way we help fund the growth, right? It's the way we're funding increases in investments, in R&D and other things that we need to do to grow the company.

Nigel Coe:

Sorry about. Mute button problems. So to cover a little ground but coming back to this capacity issue -- or capacity expansions. I mean the 9% to 11% growth in the Americas, Craig, I mean, it feels like given the backlog builds, obviously, orders continue to enter there, it feels like that could be relatively conservative. So just wondering if there's any kind of capacity constraints that are gating that growth forecast? And are you assuming there's going to be some backlog burn or conversion as we go through the year? Any sense there?

Nigel Coe:

Yes, yes. I appreciate that. And then it just feels like data center is the -- obviously, that's probably going to be your strongest growth vertical in '24. And I think you mentioned negotiations up 160% off a pretty high base. So just thinking about capacity in that single end market. I mean is that a concern? And does the $1 billion you put in [ph], does that cover the kind of growth that we should see coming through in '24, '25 then?

Nigel Coe:

Yes, exactly. That's a long time. And '24, do you think '24 will be in that 20% there or even better?

Tom Okray:

Yes. Just to add, the chart for the end markets, we have data centers and distributed IT growing strong double digit. So -- and everything from an order perspective, as Craig said, points to very robust growth in 2024.

Operator:

The next question is from Tim Thein from Citigroup.

Craig Arnold:

Yes. And I appreciate the question. I know we kind of created this monster a little bit but we're trying to get the investor community to move away from this systems versus product distinction. Because practically speaking, they're all connected. So any time you sell an electrical system, it encompasses all of our products and components. And so for us, we really think about the right way to think about the company is to really take a look at the end markets that we laid out. We have data centers, utilities, industrial facilities, commercial facilities and that will be perhaps the most informative way to think about the company in the context of where growth is going. And I can just tell you; in general, from a profitability standpoint today, there is not a significant difference today between the profitability of systems and the components that go into the system. So now there was a time inside the company back when, let's say, we were -- in the lighting business, for example. And lighting was considered a products business. It was a relatively large business with relatively lower margins than the rest of electrical. And it was a meaningful different perhaps held back by lighting that drove different profitability between the two. But today, we don't have a significant difference in profitability. And we really think the right way to think about the company is really the function of these end markets that we've laid out once again on Slide 16...

Craig Arnold:

Yes, no and it's an important question because, as you know, there is a very different profit profile in OE order versus an aftermarket order. Both will grow nicely in 2024. We do expect OE to grow slightly faster than aftermarket which holds margins back a little bit which is going to be reflected in our guidance. But we expect to see very strong growth in both commercial as well as the aftermarket piece of the business, the commercial OE and aftermarket.

Deane Dray:

And congrats, Tom, best of luck. And for -- I don't know if you can parse this out but is there any way you can frame your expectations on North America Electrical of what would be going through distribution versus direct ship? I'm not sure how precise you can get there but any color would be helpful.

Deane Dray:

Great. And I don't think I heard the word destocking come up at all today. So -- and it did create a chuckle there. But is there any destocking, any pockets of it? You all seem to have steered clear of any of that over the past 4 months or 4 quarters but just any color there would be helpful.

Operator:

Thank you. And at this time, there are no further questions in queue. Mr. Jin, please go ahead with closing remarks.

Operator:

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T teleconference. You may now disconnect.

Operator:

[Abrupt Start] Conference Call. [Operator Instructions] 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.

Craig Arnold:

Okay. Thanks, Yan. We are pleased to report our Q3 results in another record quarter. Our team continued to deliver on our commitments, supported by strong markets and good execution. So, let me begin with some of the highlights on Page 3. As we have shared for some time now, megatrends, including reindustrialization, energy transition, electrification and digitalization are continuing to expand our markets, revenues, orders and negotiations pipeline as these trends are once again evident in our results in the quarter, especially in our Electrical Americas business. We posted another quarter of record financial results with strong revenue, margins, earnings and cash flow growth. While our markets continue to be strong, we’re also continuing to improve on our overall effectiveness, which drove our record operating margins, and we’re once again raising our earnings outlook. We’re raising our ‘23 guidance for margins, adjusted EPS and cash flow. Our EPS growth for 2023 at the midpoint of our guidance is now 19%. I’d also like to highlight our growing backlog, which was up 15% in Electrical and 22% in Aerospace. And we continue to have a strong book-to-bill ratio of 1.1 for Electrical and 1.2 for Aerospace. Lastly, we recorded record third quarter operating cash flow of $1.1 billion, up 18% and free cash flow margins of 16%. Tom will share additional details. But overall, as you can tell, we’re pleased with the results and well positioned to close out a record year. Moving to Slide 4. In the last quarter, we shared a framework for how we think about our key market drivers for the company. The chart notes six megatrends that are driving growth capital investments and how they intersect with various businesses within Eaton. As you can see, we’re uniquely positioned in most of our businesses and expect to see accelerated growth opportunities. It’s our intention to cover each of these markets and megatrends during our earnings call and to keep you appraised of progress. In our Q2 earnings call, we provided a summary of progress on infrastructure spending, reindustrialization and the utility market in Electrical and our Aerospace business. Today, we’ll spend a few minutes on how reindustrialization continues to drive a record number of mega projects in North America and how Eaton is positioned to win in the fast-growing data center market. We received an extensive number of questions on each of these topics and hope our updates are helpful as you think about the growth outlook for the company. So let’s begin with Slide 5 in the presentation. We’ve shared this chart previously, and the data is a good proxy for reindustrialization and what we’re seeing inside of many of our markets. You’ll recall this chart summarizes the number of mega projects that have been announced since January of 2021, and a mega project is a project with an announced value of $1 billion or more. Note that this is the North America data, but we’re seeing a similar trend in Europe, although the dollar amounts are not as large. Three key points to note here. One, at $860 billion, this number is 3x the normal rate, which translates directly to future opportunities for electrical markets. As a reminder, the electrical content on these projects range from 3% to 5%. Two, this number continues to grow at a faster rate. Announced mega projects grew between 25 – grew 25% between Q3 and Q2, and Q2 was up 20% from Q1. This will not go on forever, but there continues to be strong momentum for industrial projects in North America. And third, only 20% of these projects have actually started. For those that have started, we’ve won roughly $850 million of orders with a win rate of approximately 40%. And we’re actively negotiating another $1 billion of electric content on a small subset of these announced mega projects. Turning to Slide 6. We highlight the data center market. I can’t think of many markets that have better secular growth dynamics than data centers. The world’s appetite for data, new insights and software solutions continues to grow at an exponential rate. And natural language processing, like ChatGPT, will only accelerate this trend. This is a very good thing for Eaton as we have a strong portfolio of data center solutions and the data center/IT channel represents 15% of our total revenue. While the numbers continue to be refined, we now think this market grows at a 16% compounded rate between 2022 and 2025 and likely for much longer. As expected, our customers are continuing to expand their data center CapEx build-outs, some of which are being modified to support the adoption of generative AI. Just consider some of these metrics. 120 zettabytes of data have been generated in 2023, a 60-fold increase over the 2 zettabytes generated in 2010. And the amount of data generated is expected to grow to 180 zettabytes by 2025, a 50% increase over 2023. And the AI impact is just starting to show up in our order book. During Q3, we won a large order of approximately $150 million for a new AI training data center and saw a roughly 61% increase in hyperscale orders overall. These AI data centers require both high-power and high-power density and as a result, higher electrical content. Another trend driving higher electric content is the need for solutions that allow bidirectional flow of power back to the grid and the ability to optimize the use of renewable energy to power data centers. So this market and Eaton are well positioned for higher growth for years to come. And on Page 7, we highlight Eaton’s unique positioning in the data center market and note that we have the electrical industry’s broadest portfolio of power manager solutions for data centers. Centralized data centers come in a variety of sizes with incoming power draws between 10 and 500 megawatts with the average data center of 40 to 50 megawatts, which is the variety that we show here on this slide. Eaton, we, support the flow of electrons from where they enter the facility from our transformers to our medium-voltage and low-voltage switchgear through our electrical busway to our uninterruptible power systems all the way into the server rooms, where we offer racks and power distribution units. In addition, we have a broad suite of software and service solutions that provide real-time diagnostics, prognostics and uptime support. As a rule of thumb, Eaton’s market opportunity in data centers is about $1.5 million per megawatt. Here, we’re distinguishing this market from the myriad of smaller data centers that exist to support many different markets and smaller applications. And we continue to improve our position in the market with our Brightlayer for data center suite of software solutions. This platform is the first in the industry to unite asset management, IT and operational device monitoring, power quality metrics and advanced electrical supervision into one single application. This new software provides electrical power, power quality, distributed IT equipment performance management that improves efficiency, data accuracy and certainly uptime. So overall, Eaton is well positioned and continues to build on our strength in this rapidly growing market. Given our broad set of megatrends and our growth outlook, we’re naturally investing to add capacity in many of our businesses, as noted on Slide 8. In fact, on the normal run rate, we’re investing more than $1 billion of capital to support the growth that we see over the next 5 years. These investments expand our production capacity across a wide range of markets and position Eaton to win more than our fair share of these opportunities. As you have heard, while somewhat improved, our lead times are still longer than ideal. And these investments will address the bottlenecks in our manufacturing sites. The primary investments are being made in utility markets to support transformers, both the regulators and our line insulation and production equipment and circuit breaker capacity to support the rapid growth in industrial projects and to add redundancy to our existing capability and in our global Electrical business to support growth in a number of fast-growing emerging markets, where we’ve been gaining share but have ample opportunities to do significantly more. And of course, we’re building a completely new eMobility business and making significant investments to build out new manufacturing capacity there. These capital investments support higher organic growth, provide excellent return on investment and are indicative of our confidence in the future of the company. We’ve made some of these capital investments this year, while others will be layered in over the next couple of years. Now I’ll turn it over to Tom to cover our financial results and outlook for the year.

Craig Arnold:

Thanks, Tom. So moving to Page 19 and turning our attention to next year. We provided our initial view on what we expect from our end markets. And first, I would note this as a starting point, we haven’t changed our view on 2023. And as you can see, we’re expecting attractive growth in nearly all of our markets in 2024. We expect strong double-digit growth in data centers and distributed IT segment, in utilities, commercial aerospace and electric vehicles. Additionally, we expect solid growth within industrial facilities, commercial and institutional and defense aerospace. And as you can see, global light vehicle market should be modestly positive with only the residential and commercial vehicle markets experiencing a decline. So it should be another year of significant growth with over 80% of our end markets seeing solid or better growth. Please note that much of this growth is supported by record backlogs, and we’ll provide more detailed color on organic growth as we come together with our 2024 guidance in February of next year. As you can see from the outlook, despite mixed signals in the economy and some historical indicators of growth, Eaton remains very well positioned to deliver what we call differentiated growth in 2024 and beyond. So I’ll close with a summary on Page 22 – on Page 20. Last quarter, I noted that we’re feeling good about how our markets are performing. And today, I reiterate that sentiment. We continue to experience powerful megatrends that are driving a higher outlook for our end markets, and we’re seeing it in our negotiations and order book. And once again, we delivered another record quarter of financial results, increased our earnings and cash flow outlook. Our orders continue to come in at historically high levels, and we continue to grow our backlog. I would note that our team is executing well, but we have an opportunity to be better everywhere than I’d say in every business. So the setup for 2024 is playing out as we expected, and it should be another strong year. With that, we will open it up for any questions you may have.

Operator:

Thank you. [Operator Instructions] The first question will come from the line of Andrew Obin from Bank of America. Please go ahead.

Craig Arnold:

Good morning, Andy.

Craig Arnold:

I appreciate the question, Andrew. And our team certainly performed extremely well during the quarter, and we’re proud of our teams and how well they executed in the quarter. And certainly, implied in the guidance are pretty attractive incremental as well. Maybe I’ll answer the last question kind of first with respect to as we think about incrementals going forward in 2024, and we still think 30% incrementals are the right way to think about the incrementals for the company. Clearly, we’re making some investments in the business that are going to kind of moderate incrementals. And certainly, if you think about price versus cost and the tailwinds that they provided during the course of 2023, we’re not expected to see the same order of magnitude of tailwinds in 2024. So we still think 30% is a good planning number for next year. And – but certainly, as we think about Q3 and Q4, we have a pretty strong line of sight to those incrementals that are embedded in our forecast for Q4.

Craig Arnold:

This is kind of a really attractive problem to have, Andrew, in terms of the growth that we’re seeing in many of our businesses and having to make some investments to deal with the stronger demand that we’ve seen over the last few years and certainly the demand that we expect to see into the future. And so we talk about kind of this growth outlook for the company in these strong markets. And we need to make some investments in capacity and some key bottlenecks. We talked about the $1 billion in my opening outbound commentary and where it’s going. And I’d say that these investments that we’re putting in will give us the capacity that we need to support the long-term growth outlook for the company and a little headwind above that if markets turn out to be even a bit stronger than what we anticipated. And so we are making the investments that we should be making and we need to make to get out in front of the pretty robust outlook that we have for the company’s growth.

Craig Arnold:

Thank you.

Joe Ritchie:

Thanks. Good morning, everyone.

Joe Ritchie:

Hey, Craig, can you maybe just talk a little bit about the mega projects for a second? I think you mentioned that 20% of the projects have started. When you think about the timing of when you typically will see a – like bidding on those projects and the orders coming through, how do you see this kind of playing out based on, again, the projects that have already started and now the funnel is continuing to increase?

Tom Okray:

And just to complement that, Craig, I mean, those are the mega projects, but we also said in the prepared remarks our negotiated pipeline for the U.S., which was up 33% year-over-year and up 18% sequentially. So a lot of good growth going on in those big projects but less than the $1 billion as well.

Craig Arnold:

Yes. It’s certainly one of the things that we’re watching and we’re concerned about as well, Joe. It’s perfectly logical to say that some of these projects could be delayed or put at risk, given much higher financing cost. I will tell you that we’ve not seen any evidence, any material evidence of that to date. But it’s certainly, once again, a potential risk. And that’s why I highlight this issue around 60% of these projects basically being financially supported by these government stimulus plans, which is very new. And the dollars, as you know, are quite substantial. And at this point, we will have to wait and see how it plays out. And we’re going to watch it and make sure that we’re taking the necessary precautions. But to date, we really haven’t seen that impact.

Joe Ritchie:

Great. Thank you, both.

Jeff Sprague:

Thank you. Good morning, everyone.

Jeff Sprague:

Hi, good morning. Can we pivot a little bit to Electrical Global? And just maybe a little bit more color on kind of the complexion of demand underneath the surface there by geography. And you noted some project activity starting to come to the floor there. It does seem like Europe, in particular, might end up in a bit of a bidding war with the U.S. on project stimulus and the like. So maybe just a little bit of color there on how you see things playing out into the first half of next year, not just Q4, but what kind of pipeline might be building.

Tom Okray:

Encouragingly, Jeff, we’ve seen some good order flow in EMEA. So that gives us – it gives us confidence to go to the low mid-single digits in Q4.

Jeff Sprague:

Great. And maybe just as a follow-up, different topic, though, is just thanks for the little many deep dive on data centers here. Can you just speak to how your content is changing? So obviously, you gave us a $1.5 million per megawatt, and we got a lot of megawatts coming, right? So you just grow on the back of that for sure. But is your dollar content per megawatt also going up as part of this equation and how so, where has it been? And where is it headed in your view?

Tom Okray:

Just to amplify, Jeff, just a little bit more on that, year-to-date in data centers, again, on our negotiation standpoint up 136%. And in the quarter, as we said in the prepared remarks, up 4x. So it’s growing faster than it was at the beginning of the year as well.

Operator:

Our next question is from Scott Davis from Melius Research. Please go ahead.

Craig Arnold:

Hey, Scott. Good morning.

Craig Arnold:

I appreciate the question, Scott. And first of all, I would say that with respect to M&A more generally, we said our priorities will be Electrical. They will be Aerospace. And then on the margin, if we could find the right asset, we would consider an acquisition in eMobility as well. But I think the broader message for the company is that we have enormous growth opportunities in front of us, the organic opportunities that we’re looking at across the business and our ability to grow organically. And I’d say, today, there are just growth opportunities every place. And unlike perhaps some times past, we don’t need to do deals to significantly grow the company. And that’s true as well in eMobility. As you heard in Tom’s presentation, we just had another quarter of huge wins, $600 million, Tom, was the number, I believe, in terms of quarter-over-quarter change?

Craig Arnold:

So each one of these wins in eMobility just results in just enormous growth for the organization. And so we set this chart of being $2 billion to $4 billion by 2030. We will be selective. We will essentially – as we talked about in some of the prior conversations, we will make sure that we’re going to play in eMobility, where we have the ability to leverage our scale, our technology and the expertise in our core electrical business. That’s where we have the right to win. That’s where we have the right to play, and that’s where we can really deliver attractive margins for Eaton. And so that’s really strategically what we’re focused on with respect to the areas of interest that we have in eMobility. So it really is about power distribution, power protection, doing the same things that we do in our core Electrical business. We get scale that we can leverage into eMobility at the same time, leverage that scale back into our core Electrical business. So I’d say today, you could expect us in terms of the thinking about M&A, tuck-ins, things that are very much digestible. Those are the kinds of opportunities we’re looking at in general, and those are the things today that I think makes sense for the company in terms of where we are today with respect to our organic growth opportunities in front of us.

Scott Davis:

That’s helpful. And guys, just to back up a little bit. If you think about Eaton historically, had been a company that always manage price around raw materials, particularly kind of steel and copper. Is the algorithm more likely in the future going to be pricing around the value you’re adding or perhaps pricing kind of dislocates from the underlying commodities? Or is that just kind of a bridge too far from how kind of customers are conditioned?

Scott Davis:

That’s very good. Helpful, thank you. Best of luck, guys. Thank you.

Operator:

Thank you. Our next question is from Steve Tusa from JPMorgan. Please go ahead.

Craig Arnold:

Thank you, Steve.

Craig Arnold:

Yes. And it’s really – you really can’t necessarily recognize – reconcile those two numbers and – because a start doesn’t mean that we’ve even got an opportunity to bid the project yet much less a negotiation or a win. And so you really can’t reconcile those two numbers. And I know it’s such a big number and a very attractive one that everybody is trying to get their head around exactly how it’s going to impact revenue for the organization. But those two numbers, you really can’t reconcile them. What we’re trying to provide is a bit of a framework is this win rate of 40%, which is essentially slightly above our underlying market shares in North America as an indication of what you can expect as these projects play out into the future. But you really can’t link the 20% to the $850 million.

Craig Arnold:

No, I think you’ve summarized it well. I mean, we are seeing very similar trends in some of the shorter-cycle businesses inside of our company, whether that’s residential or whether what we’re seeing today in the MOM segment or the IT channel. We, too, are seeing a slowdown. And we, too, are – experienced a bit of destocking in certain aspects of the business. And so that – those trends that others have talked about are certainly evident in our business as well. But I think you hit the nail on the head when you said that the other parts of the business, our systems and large project business, our data center business, the other pieces where we’re seeing the strength is just overwhelming those spots where we’re having this weakness. Now in Europe, we talked about it in our commentary, we did see weakness in Europe. And those trends clearly showed up in our European Electrical business in the quarter. It’s one of the reasons why we reduced the guidance there. But by contrast, we had this really outside strength. And we continue to see outside strength in the systems and the project-related business in the Americas that offset the weakness in the flow business in North America as well as what we’ve seen in Europe.

Craig Arnold:

Well, I mean, nothing is easy. And it’s certainly probably too early to put our hand on the scale and predict what’s going to happen in Europe during the course of 2024. But you’re right. I mean, given the fact that those businesses are weakening, assuming the market stabilizes and the inventory destocking is behind us and we certainly have embedded some of that in our Q4 outlook, yes, it should be a relatively better year for sure in Europe.

Operator:

Thank you. And the next question is from Chris Snyder from UBS. Please go ahead.

Craig Arnold:

Yes. No, appreciate the question. It’s obviously a topic that’s gotten a lot of attention. And I’d say that I would tell you, first of all, while AI and ChatGPT have gotten a lot of publicity of late, it’s not new. I mean, it has been around for some time. And so we have historically seen some benefit of AI embedded in the data center market. I’d tell you that, number one. Secondly, as I said in my outbound commentary, yes, the AI-centric bids and orders were up 4x, but we had a 61% increase in hyperscale in general. And that is really across the broad data center market. And so without a doubt, AI will be an accelerator of growth. But the broader message is essentially more data, more information, more insights requiring more data centers. And those numbers are big and growing as well.

Craig Arnold:

Yes, appreciate the question, and it’s certainly one that we’re spending some time trying to work through ourselves. I mean, orders have moderated. We talked about in the Americas, but we also were comping a 36% increase from last year. And so moderation off of a really big number last year, and the backlog does continue to grow. I think it’s really, in many ways, kind of the $64,000 question. It’s backlog is a function of how much demand you’re getting versus your ability to satisfy that demand. And at this point, I can only tell you based upon what we’ve seen and experienced to date is that we’ve not been able to materially eat into the backlog. We will at some point. I mean, this cannot go on forever. And we are adding some capacity. For sure, that’s going to help resolve some of the lead time issues and the bottleneck issues. And so we would expect backlog at some point to turn negative in absolute terms because keep in mind, we’re up 3x. We’re running a backlog of $9.4 billion in our Electrical business, $3.1 billion in Aerospace, but $9.4 billion in Electrical, and that’s 3x the historical backlog levels. And so yes, one, it’s a function of the fact that markets are good. And – but secondly, it is a function of the fact we got to get out in front of some of these capacity planning things so that we can satisfy all this demand. But at some point, backlogs will turn negative.

Craig Arnold:

And I would say we probably never get back to historical levels if you think about it in terms of absolute terms, right? We will be better, but we will never probably get back to a $3 billion kind of backlog. It’s a bigger business we will need. And so we will run a bigger backlog simply to support the fact that it’s a large, large business. But what we certainly would expect to, at some point, start eating into the backlog.

Operator:

Thank you. The next question is from the line of Nicole DeBlase from Deutsche Bank. Please go ahead.

Nicole DeBlase:

Can we just talk a little bit about the capacity investments that you guys are making and just the cadence of when that’s going to start kind of phasing and coming online over the next several years?

Nicole DeBlase:

Thanks Craig. And then just on free cash flow, thinking about how this progresses into 2024. Can you talk a little bit about your plans to reduce working capital and other major puts and takes that could influence conversion next year? Thank you.

Nicole DeBlase:

Thanks Tom. I will pass it on.

Julian Mitchell:

Hi. Good morning. Maybe I just wanted to ask a quick question about the sort of core revenue or organic revenue outlook. So, you had that very helpful slide on the main end market moving pieces. Should we sort of assume from that, that that blends to about kind of 6%, 7% market growth, and then you are adding about a point or so of share, and that’s kind of how you get that 7% to 8% organic growth number for next year that you discussed, I think in September?

Julian Mitchell:

That’s helpful. Thank you. And then just one thing I wanted to circle back to was around the sort of gap between the products and the systems on the electrical side. I guess historically, you had – those were sort of two sides of one coin, the products, the shorter-cycle piece, systems is the longer cycle piece and sort of where the lag one would follow the other. So, when we are thinking about next year, the gap between products and systems presumably narrows. Is the assumption that they sort of meet in the middle, products improve a bit, systems slows down because of comps, or any kind of way we should think about it maybe projects or mega projects mean the systems piece sustains a very wide outgrowth versus products, for example.

Julian Mitchell:

That’s very helpful. Thank you.

Steve Volkmann:

Hi. Great. Thank you, guys for fitting me in. Just a quick follow-up to go back to this kind of backlog thing, which I think you guys have explained pretty well. But Craig, is it a reasonable planning assumption that we end 2024 at sort of whatever the new normal is for backlogs that’s slightly higher than historical number?

Tom Okray:

Yes. Even reducing backlog, it would be hard to imagine based on the scenarios we have looked at that we would get our backlog at the end of 2024 to our historical backlog coverage.

Tom Okray:

For sure, yes.

Craig Arnold:

No, definitely appreciate that question. And as you know, this is independent of AI, we had been on this journey inside the company to really digitize and digitalize our company. And so that what we said is that every single product, every new product that we develop, we expect it to have a microprocessor to be able to stream and process data and information. And so that has been going on inside of the company for the better part of the last 5 years. And as a result of that, we have been able to create some really attractive and interesting new value propositions around how we essentially can monetize our own data. And it’s one of the things that we wrap up in this term you will hear us talk about called the Brightlayer platform. So, we have Brightlayer for data centers, Brightlayer for utility markets and Brightlayer for residential. So, this data platform that we use today to essentially find ways to monetize our data either in the form of data-as-a-service or software is something that’s happening broadly across the company and all enabled by the fact that all of our devices today, most of our devices today, I should say, are intelligent and have the ability to stream data. I would encourage for those of you on the call, one of the things we are going to try to do next year as a part of our investor meeting is to invite you to our center in Houston and to show you some very real examples of software and data solutions that we are selling today in various applications to our customer base that really monetizes our data and monetizes our software. So, a really exciting piece of this leg that we talk about these megatrends, one of which is digitalization, we see that in the data center market. And we also see that in the way we are bringing new products and new solutions to market as well across the company.

Operator:

Thank you. And the next question is from Nigel Coe from Wolfe Research. Please go ahead.

Craig Arnold:

Okay. So, I think there is three different questions there, but let’s take the first one around. So, the answer to the question is, yes, it is the entire market. So, that 16% growth rate is reflective of what’s happening in hyperscale, on-prem, colo. So, it is our view of the entire market. And yes, we would expect our businesses to grow faster than market and as a result of that do better than what we think the underlying market is doing. To the point around residential, yes, we have seen the slowdown in residential really around the world. And we have seen it in the U.S. and what happened in single-family first, though single family, quite frankly, had a little bit of a stronger Q4. Single-family starts were actually up some 6% in Q3. Multifamily wallet kind of record levels of units that are under construction clearly saw a slowdown in Q3. But we are definitely seeing the slowdown in residential. You see it most acutely, quite frankly, in Europe. Many of you see the market data coming out of Germany and France where residential housing starts are down quite significantly, and everybody has read about what’s going on in China as well. But to your point, residential as a company is not the biggest piece of our market. And I think the other thing I would add to that is that one of the things we have talked about in prior meetings is that we are seeing higher electrical content in all of the new homes that are built as they meet the latest requirements for UL standards in the U.S. or other standards, IEC standards around Europe or we see smart homes being built, and they are putting in more smart solutions. And so offsetting somewhat of that decline in units is the fact that we are seeing higher electrical content in new homes. And new homes are accounting for, quite frankly, a much higher percentage of the new housing market in general as people hold on to their legacy homes. And so yes, no question, residential has weakened up. We are seeing it in our business. But once again, the strength that we are seeing in the other end markets, big enough to offset those declines in residential.

Craig Arnold:

And I think it’s more a function of electrical content being higher, prices being better, the unit volumes would be down definitely as they would for others.

Craig Arnold:

Yes. I think that you would expect as you are well aware, and I don’t know this market works in vehicles that when they launch a platform, you will see a big change in the revenue as a function of when these new platforms launch. And so I would say that the volume does tend to be kind of chunky in the space as opposed to being linear. And once the vehicle launches and it’s in the market, then you will see kind of a linear pattern of growth. But once the program first launches, you will see more of a step function change in revenue. And so between now and 2025, that business will grow. And we talked about in some of the outlook numbers that we still expect our eMobility segment to see strong growth. It’s a very strong growth for 2024 in our guidance, but some of this growth will be chunky as we think about bringing on these new platforms that we have won.

Operator:

Thank you. And our next question is from the line of Phil Buller from Berenberg. Please go ahead.

Craig Arnold:

Yes. No. What I would tell you is that in simple terms, I would say no with respect to market share. When you take a look at our growth in our European business in any given quarter, you could find things bouncing around. But if you look at our growth on a 2-year stack or 3-year stack and you look at our revenues versus our peers, I think you would find the numbers to be quite comparable. But I would say that it is mega projects and the scale of mega projects that is driving the differences. It is where we play in, let’s say, the Americas versus where we play in Europe. I talked about our penetration in Europe being a lot of which is in MOEM and industrial equipment. We don’t have today as broad a portfolio in some of these other segments, call it, data center. We played very well in data centers, but we are not as big a player in data centers. We play in utilities, but we are not as big a player in the utility market. So, we just have a broader, more complete set of solutions in the Americas that are supported by these megatrends. And the other big difference is, once again, all the stimulus dollars that are being pumped into the U.S. economy that is essentially driving outside growth. And it’s driving outside growth in these same verticals, reindustrialization of industrial facilities, investments in utility markets, investments in chips and the Chip Act. And so you are finding these kind of broader trends being also turbocharged by government stimulus spending.

Craig Arnold:

No. I think – I mean I think in many ways even more than the U.S., I mean the European government has demonstrated their commitment to essentially moving towards a low-carbon society. And they are putting both dollars behind it and just as importantly, they are putting regulatory changes in place to drive the adoption of these green technologies, right. So – but as you can imagine, there is a lot going on in Europe today. There is a lot of challenges on a lot of different fronts in Europe that I think are today getting in the way and holding back some of the benefits that you would ultimately see in that space. And as we talk about the manufacturing segment, Europe is much more – has been much more of a manufacturing engine for the world in places like Germany. And those markets have clearly slowed dramatically. So – but where we participate, think about data centers, for example, our data center business in Europe is also up dramatically. So, where we have kind of some of these megatrends, energy transition where we play in energy transition markets, those markets are up dramatically in Europe. But the business mix is quite different. And in that case, it’s being held back. Those benefits are not showing up because it’s being overwhelmed by some of these other structural issues in some of the legacy businesses.

Craig Arnold:

Yes. I don’t think – I wouldn’t over-read that in terms of – we don’t anticipate a slowdown in Aerospace. As we talked about in our prepared remarks that the orders continue to grow, backlog continues to grow, so I would not over-read an implied number for aerospace in Q4. We still are very much pleased with that market and expect to see longer term kind of growth being quite attractive there.

Operator:

Thank you. And our next question is from Joe O’Dea from Wells Fargo. Please go ahead.

Craig Arnold:

I would say that in many ways, it’s quite the opposite. If you think about today where we tend to do well as a company and where our win rate tends to be higher, the bigger the project, the more complicated and sophisticated the project, the more likely it is that Eaton will win and garner higher share. So, if you think about today, the big mega projects and our win rate on a mega project versus our historical underlying market share, our win rate would be higher. It would be higher because once again, if you think about our total ability to deliver a complete solution, medium voltage, low voltage and everything in between, today, we have a much better capability than most of the companies that we are competing against in the North America market where most of these mega projects have taken place. And so yes, without a doubt, the competitive dynamic is such that it’s an attractive space. I will tell you that for the most part, most companies are struggling with the same capacity constraint that we are. So today, with respect to a disruptor coming in and doing something that would somehow change the dynamics around underlying market share, highly, highly unlikely because there is simply not enough capacity to do it. And then secondly, you need the capability. And if you think about the size and the scale of these mega projects, you need a company who has pedigree, a company who you can rely upon and trust to essentially bring these projects home for you. The stuff that we do is mission-critical. And it’s not the kind of place that you would tend to find companies or customers testing or trialing somebody new.

Operator:

Thank you. Next question is from Brett Linzey from Mizuho. One moment please. Please go ahead with your question.

Craig Arnold:

No, I would say today, we would not intend to provide any particular quarterly guidance or clarity on that, other than we can certainly let you know when the new capacity comes online, I think that’s perfectly fair. But the other thing to [ph] think about is that, yes, it’s a big investment. There is going to be a mix of capital and expense. That’s all kind of embedded – going to be embedded in our guidance as we go forward. But as the company has gotten bigger and our denominator, revenue and everything else has gotten bigger, yes, we have historically spent about 3% of revenue in CapEx. That number may pop up to 3.5% order magnitude. But so it’s not going to be – it’s a big number. It’s going to give us the ability to solve a lot of bottlenecks. But in the big scheme of things, you are talking about maybe 0.5 point movement in terms of our CapEx spend here. So yes, there is going to be some expense associated with it as well. But once again, all of that embedded in kind of the 30% kind of incremental numbers that we talked about for planning purposes.

Craig Arnold:

Alright. Thank you.

Craig Arnold:

Thank you.

Operator:

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Teleconference service. You may now disconnect.

Operator:

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton's 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. [Operator Instructions] And as a reminder, your 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.

Craig Arnold:

Thanks, Yan. 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 commitment 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, mega trends, reindustrialization, 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. In 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%. 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. 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 full 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 mega projects is impacting many of these 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, reindustrialization and an update on mega projects as well to look at Eaton's position in the utility and aerospace markets. We're highlighting the Inflation Reduction Act since its considerable upside to the initial estimates of future government spending. And on mega projects 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 Americas 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 aerospace business through the double-digit growth outlook, ramping defense and commercial platforms, including a substantial new win on the Bell V-280 Valor platform. Moving to Slide five, we're showing an updated look and 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 2.5 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 interest 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 mega projects in North America. We introduced this chart last quarter. And you will recall that we included announced projects that are greater than $1 billion in this category. The value of announced mega projects 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 chemical, $33 billion of LNG export terminals, and $64 billion 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% on a 12-month basis -- on a rolling 12-month basis, and up 84% if you include LNG activity. And as a reminder, only 25% of these mega projects have started, so we're just at the beginning of this reindustrialization mega trend. Lastly, I remind you that we expect each of these mega projects to have between 3% and 5% 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 Americas 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% of 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, enhance 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 Americas utility business backlog has increased 45%, organic revenues grew 30% in the Americas, and 20% in our global segment. The graphics on Page eight highlight Eaton's unique position in the North America 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 Brightlayer solution for utility includes distribution planning software, distribution and substation automation, as well as smart grid communication centers 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 support 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 SIM, 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 increase defense spending. The commercial market is expected to be very strong as Airbus and Boeing are both significantly increase in production volumes 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 a 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 from our organization, and our 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 win with a bow on the V28 Valor program. The V28 is a replacement for the Blackhawk 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 per aircraft here is 2 to 3x 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 increase 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'll take us through the financial slides.

Craig Arnold:

Thanks, Tom. Now turning to Page 20. As a reminder, last quarter, we raised our growth assumption for the utility market to strong double-digit growth, and we increased our residential market outlook to flat from declining. We're now increasing our growth assumption for the commercial institutional and for data center markets to strong double-digit growth. In addition to stronger than anticipated demand for new projects, existing buildings are being retrofitted with more electrical infrastructure as EVs continue to increase their penetration in the market. And data center demand continues to remain at very high levels and we now expect to see double-digit growth in this market as well. The balance of our end markets continue to perform well and are tracking along our prior projections. So while the macroeconomic outlook remains choppy, we continue to expect growth in almost all of our markets. I'll close with a summary on Page 21. As you can tell, we're feeling good about how our markets are performing this year, and we think that will be strong for many more years to come. In fact, the mega trends that we've discussed for some time now are expected to be even more impactful than we originally anticipated. Our markets are strong, but we also had solid execution in the quarter and delivered another strong set of results that included a number of financial records. And as we look to the back half of the year and into 2024, our increasing backlog provides great visibility on our growth outlook. As noted, we raised our guidance for growth and EPS for the second time, and our largest business, Electrical Americas continues to post new records. With that, we'll open it up for questions you may have.

Operator:

[Operator Instructions] Our first question will come from the line of Joe Ritchie from Goldman Sachs. Please go ahead.

Craig Arnold:

I appreciate the question, Joe. And I know there's been a lot of discussion around AI and how it's going to impact the world, not only kind of data centers. But I would tell you that the data center market, as we've talked about on these calls for some time now, has been strong and it's been strong for multiple years. On AI side, that market has been growing at double digit. And I'd tell you that the big wins that we booked during the quarter, I'd say most of that really has nothing to do with the AI impact yet. A lot of that is in the future. A lot of the major data center players are still trying to sort out the way they're going to configure their data centers, to deal with this AI environment and the increased energy intensity. So I'd say, for us, it was just another very strong quarter of data center wins that really has not seen the impact yet of this whole emergence of generative AI. So it's -- we're feeling great about that market and we think generative AI and its downstream implications are just going to keep that market strong for a much longer period of time, and we're well positioned there.

Craig Arnold:

Yes. I mean as you can imagine, we're not in a position to provide guidance at this point for 2024, given the fact that it's still early in the year, and we'll probably have an opportunity to do that towards the end of the year as we would normally do so. But to your point, I mean, the backlog continues to grow. And the backlog, as you saw in these reports, is up multiples of where we've been historically, which gives us much better visibility, better visibly than we've ever had into the outlook for the upcoming 12 to 18 months. And so we're feeling very good about what 2024 is going to look like. It will be another strong growth year for the company, and we'll certainly provide some guidance on what the year looks like as a part of our normal process and timing for giving the outlook. But the backlog certainly gives us a lot of courage with respect to what we think the year is going to look like, given that the growth and where it is relative to where it has been historically.

Joe Ritchie:

Super helpful. Thank you.

Josh Pokrzywinski :

Hey, good morning guys. So I feel like you guys have done a really great job of kind of scoring some of the background announcements, whether it's the mega projects or, I guess, Slide five, with some of the stuff from IRA. Maybe just give us an update on where we are in looking through that. I would imagine the vast majority of that is not really in the order book. You talked about really high customer interaction or engagement or kind of the front log, I forget what the exact term was. But where are we through kind of those orders or initial discussions yet?

Josh Pokrzywinski:

Got it. That's helpful. And then maybe just a quick follow-up, respecting that orders and backlog have kind of had their own cadence right now with what you guys are going through and just explained. Are the shorter cycle parts of Electrical seeing kind of that lead time normalization show up in orders? I think some of your peers have seen that. Obviously, you guys are longer cycle and things like switchgear maybe don't fall into it. But any part of that where you're seeing either like a destock or lead time normalization show up?

Josh Pokrzywinski:

Helpful colors always. Thanks a lot guys.

Chris Snyder :

Thank you. And I want to follow up on Josh's question, specifically around the Inflation Reduction Act. It sounds like not much orders yet on the back of the IRA. Is it reasonable to think that orders there could start coming through in 2024? And when we look across all the company's various business lines, which ones do you think will benefit most from the IRA specifically? Thank you.

Chris Snyder:

Sorry, which verticals within -- so there's verticals within the company. I apologize.

Chris Snyder:

Sorry, which vertical within the company?

Chris Snyder:

No, absolutely. I very much appreciate that. Then maybe following up on that industrial comment. Everyone, I think, has kind of seen the massive manufacturing starts that's now leading to higher activity put in place. How should we think about the lag in which that flows to your business from the start to when it starts generating revenue for Eaton? You guys said these are very long cycle projects. Just wondering kind of how long kind of single facility kind of generate revenue for you? Thank you.

Tom Okray:

And I think the exciting thing about it, as we said in the prepared remarks, we see each quarter like $100 billion coming in, and then it is going to give us a nice cadence going forward for quite some time. And just to come back to the Inflation Reduction Act, I mean, we put that particular act in for illustrative purposes, but just to draw your attention, we've also got the Infrastructure Act, the CHIPS Act and in Europe, the EU recovery plan. So when you put all this together, there's just a ton of government stimulus supporting key parts of our business.

Operator:

Our next question is from Nicole DeBlase from Deutsche Bank. Please go ahead.

Tom Okray:

Yes. That's a great question, Nicole. We were up almost $800 million. The majority of that around, let's call it, $550 million was with working capital optimization and $250 million was from earnings. We debated, do we take up the guidance on free cash flow. And we thought because it kind of fits within the range right now, we'd give it another quarter. We're happy the way it's going. Obviously, up 600% is something to be happy about. We've improved cash conversion cycle by nine days. That said, we still have a lot of work to do, and we want to get our free cash flow margin up even higher.

Nicole DeBlase:

Got it. Makes sense. And then on the non-resi vertical, obviously, like ongoing questions about the strength there. Are there any patches within the whole non-resi complex? Were you guys are seeing any signs of slowing activity?

Tom Okray:

That said, if you look at the first half of the year organic growth, I mean, we're up in every single end markets. Some of them obviously significant more than others.

Tom Okray:

Absolutely. And MOEM is also up first half of the year.

Operator:

The next question is from David Raso from Evercore ISI. Please go ahead.

Craig Arnold:

Yes, I appreciate the question, Dave. And I'd say that one of the reasons why we are forecasting a slowdown in growth between the first half and the second half is really the strong comparable. If you look at the back half of the year, we were up some 19% and a lot of that, quite frankly, was price, and we're getting a lot less contributions for price in the back half of this year. When you take a look at it actually on a two-year stack, the growth essentially is essentially the same. It's about 30% versus 2021, essentially normalizing for the really strong back half, a lot of which was priced. In terms of price in the backlog, I would say that as you will likely recall, one of the things that we did was we actually repriced our backlog and much of it. And so if you think about the underlying performance today, what you're seeing in the Electrical Americas business, and we're shipping a lot of that out of backlog because the backlog is so long is it's essentially. We don't expect backlog to have a material impact on the underlying performance of the business as we ship it.

Craig Arnold:

Sure. Sure. I know you're really trying to get at the split between price and volume that we've told you before on these calls, we're not going to provide it. And so what I would just tell you is that we are getting much greater contributions from volume than we are from price in the second half of the year.

Craig Arnold:

Thank you, Dave. Appreciate.

Craig Arnold:

And volumes are growing. I love to think we could get 15% price, but we can't.

Julian Mitchell :

Thanks. Good morning. I just wanted to start with the Electrical Global business. You mentioned some of the very strong markets and maybe some of those that are a little bit weaker. How long are you expecting that weakness to last? And when we look at the profitability in Electrical Global, you've got that nice sort of margin turnaround in the back half which I think is driving an acceleration in year-on-year profit growth to sort of close to double-digit levels in the second half. Maybe just help us understand the main drivers of that pickup?

Tom Okray:

Yes. A couple of other areas that we're counting on in addition to mix in the back half is higher volume and being better in terms of our productivity in terms of manufacturing.

Craig Arnold:

I appreciate the question, Julian. And in many ways, we're talking about the unknowable, right, given in terms of the uncertainty around what the future looks like. I would say though, if you think about Eaton's business, and that's why we thought it was so important you go back to Slide four in our PowerPoint presentation to talk about the breadth of our portfolio and how it's impacted by these various megatrends. And I would tell you that we aren't the same as other electrical companies, and some of them are exposed to some but not others. And I would just say what makes Eaton unique here is really the breadth of our portfolio and the end markets that we serve and how each of these markets are benefiting from these megatrends. And so I'm not sure what particular electrical period you're referring to, but I would say that we would likely have much broader exposure to a number of these trends than other electrical companies.

Craig Arnold:

And if you think -- I mean are there certain electrical companies, for example, who would play heavily inside of factories who maybe don't play on the infrastructure side. We are a massive infrastructure player. And so I just want to just point that out in terms of as you think about Eaton versus other companies, you can't really necessarily draw a straight-line correlation between us and them. We obviously have seen our peers announced and there's a very difference in growth in a number of the peers this quarter too, a function of the fact that we play in very different end markets than some of our other electrical peers.

Craig Arnold:

And in the point that Tom is picking up on that, I think is really an important one is this notion around if you take a look at what's happening with the number of our distributors, oftentimes, you want to draw a straight line between what you're seeing in the distribution channel to what we're experiencing in our own business. And to Tom's point, these big mega projects that we're talking about, a lot of the big infrastructure-related investments, these are direct projects that are not flowing through distribution. So you also will see perhaps a decoupling between how we could perform versus some of the electrical distributors as well.

Operator:

The next question is from the line of Steve Volkmann from Jefferies. Please go ahead.

Craig Arnold:

I appreciate the question and what you're kind of poking at a little bit understandably is the fact that OE margins tend to be well below aftermarket margins. But the good news here is we're finding that both OE and aftermarket, which is really tied to revenue passenger kilometers or revenue passenger miles, both of those pieces of the business are essentially ramping. And if you heard what we reported in our numbers, we actually saw even more growth in aftermarket in the quarter than we did on the OE side. And so we don't anticipate a negative mix impact from this ramp on the OE side as we look out to the forecast for the next number of years. But to your point, it is certainly something to watch if you ever get in many way, inverted there and OE is growing in aftermarket, it isn't, it would certainly have a negative impact on margins, but that's not our anticipation.

Craig Arnold:

And OE and aftermarket, which is really the important point.

Craig Arnold:

No. First of all, you're absolutely right. This is a very different electrical industry, a very different Eaton than the one that perhaps your grandfather and grandmother knew. And so as a result of that, we are making fairly sizable investments in capital equipment. We talked about it in the last earnings call, some of the big investments that we're making in the utility space. And I mentioned in my outfield commentary, we made investments in transformer capacity, both at regulators and line insulation products. These are essentially capital investments that are ongoing right now. We've made some fairly sizable investments in our circuit breaker capacity over the last couple of years. And so we are having to invest more in capital equipment. But I would say even in the big scheme of things, the level of investment is maybe going to tick up 0.5% more of sales, maybe another percent of sales, but very well manageable in the context of the overall growth of the company.

Steve Volkmann:

Great. Well, that I’ll let you go after lunch. Thank you.

Nigel Coe:

Thanks. Good afternoon. Lunch sounds good to me. So we've cut a lot of gram. So back to Electrical. You mentioned, I think, Craig, retrofit activity, which I think was in relation to C&I end markets in particular. And I know you talked about this in the past, increasing load content, and I think it was in relation to charging specifically. But maybe just talk about what activity you're seeing within retrofits and how you think that develops over the next couple of years?

Nigel Coe:

No, I agree. And then on data centers, I just want to take the other side of the -- of sort of the -- are you seeing any signs of weakness? Doesn't look like it, but are there any signs of weakness out there? I'm thinking maybe China perhaps might be a bit softer. And then when you think about generative AI and GPU racks, does this increase the revenue per megawatts? Or does this just increase the total megawatts in the market? Any thoughts there would be helpful.

Tom Okray:

Yes. And just a little bit more on Craig's point in your question on slowing. Each part of the world for the first half of the year, data centers, including hyperscale, grew double digit. It's just a matter of whether it grew mid-double digits or in the 20s or in the 30s. We're seeing robust growth across the board.

Operator:

And the next question is from Steve Tusa from JPMorgan. Please go ahead.

Craig Arnold:

Yes, that's primarily what we're referring to, Steve, because if you think about most of the big price increases that we put through in our business, most of those showed up in the second half of last year. We got some modest price increases this year, but most of the big price increases that we got in the second half of last year. So they're really baked into the comparable for 2020, 2022, and we're anniversarying those big increases right now. And so just on the relative contribution to growth, on a relative basis, we're going to giving it more from volume than we offer price in the second half of the year.

Craig Arnold:

Yes, I'd say that our team continues to execute well. We certainly had a little bit of perhaps favorable mix in Q2, and maybe that's what you're seeing in terms of the relative change between Q2 and in the back half of the year. But there's nothing -- there's no unusual in those numbers. That's just straight operating performance execution by our team. And yes, the simple answer is, yes, that should be the jumping off point as we think about what this business should look like into 2024 and beyond. And obviously, we're going to have volume growth and so the business is performing well, and we'd expect it to continue to perform well.

Steve Tusa:

Right. But is that the jumping off point for next year? Like is that a sustainable number that you can improve on next year?

Steve Tusa:

Okay. Straightforward. Thank you.

Deane Dray:

Thank you. Good day, everyone. Covered a lot of ground, but I did hear a couple of references to unknowables and a choppy macro. So it kind of begs the question about the initial assumption for this year so long ago, it seems for a mild recession. Is any clarity in terms of your assumption there? Or is it everything seems to be skewing much higher?

Tom Okray:

Yes. And Deane, I'll take you back to an earlier response. We've modeled even with downturns in order intake, if you use that for a proxy in terms of a mild recession, we are very confident that we can power through that given our backlog in the megatrend.

Craig Arnold:

Yes. No, I'd say as an industry, things are better. And I'd say we are -- the industry and some of the supply chain choke points are materially better today than they were, let's say, this time last year but we're clearly not out of the woods. And there are certainly certain markets and verticals that are still very much challenged with respect to lead times and the utility market is one of those. As we mentioned, on these calls before that, probably the longest lead time device we probably have in the company is a transformer that goes into the utility segment. And so very much a function of which end market and which product you're talking about. In general, things are getting better, but there's lead times are still extended. We're still not back to, let's call it, the pre-2019 levels of lead times. We Think our lead times are competitive with our peers in the marketplace and -- but yet, we're still not back to where we were in 2019, and we still are extended in certain product lines.

Operator:

And our next question is from Brett Linzey from Mizuho. Please go ahead.

Craig Arnold:

Yes. I mean I'd say, Eaton's relative performance, I think with respect to our peers, as we talked about before, and it's one of the reasons why we included that chart is that all of our peers aren't the same. We play very broadly across the utility end segment. As I said in my commentary, we think we are the broadest player. We have a broader portfolio of solutions in the utility market than any of our competitors. And so we think we are very well positioned to grow at market, to grow and perhaps grow faster than the market. We are today as our -- most of our peers capacity constrained. And so I do think that the real limiter on growth in terms of the utility market these days is really going to be our ability to add capacity to deal with the growth that we're seeing. And that is the one segment where lead times are still quite extended. And until we get this new capacity online, it's going to be very difficult for us to grow at a much faster rate than the overall market.

Tom Okray:

Yes. The negotiated, the major projects. Yes, it was up 17% year-over-year and 65% on a two-year stack.

Operator:

The next question is from Joe O'Dea from Wells Fargo. Please go ahead.

Craig Arnold:

Yes. And I'd say maybe just kind of addressing kind of the first part of your question, which is kind of on lead times and as I mentioned on the prior question, lead times are, in fact, still extended. They've improved somewhat, certainly more so in some of the shorter-cycle businesses. We talked about resi, OEM, distributed IT. For the big project-related stuff, a lot of those lead times today are still fairly well extended. And for utility markets, they probably haven't improved much at all. So it really does vary widely depending upon which vertical you're referring to. And it once again, I said we are sold out. We don't have a lot of excess capacity today to really deal with what has clearly been a much faster acceleration in growth than what we originated in some of these big industrial centered kind of product lines and businesses. And until capacity comes online, we would not anticipate that these lead times get materially better. And the same thing I would say would be true backlog, obviously, to your point, very much interrelated until you can release reduce lead times, barring a significant slowdown in the markets, which we don't anticipate, you're really not going to deal with reducing your backlogs either. And so we do think that under a normal planning horizon, the way we're thinking about it, backlog stay elevated for some period of time. I think what Tom was trying to do was simply to try to provide a little comfort around that even if markets slow down, we should continue to be able to post very attractive revenue growth because we can simply eat backlog.

Joe O'Dea:

Got it. Makes sense. Thanks a lot.

Yan Jin:

Thanks, guys. As always, Chip and I will be available to address any of your guys' follow-up questions. Thanks for joining us today. Have a great day.

Operator:

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton First Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. [Operator Instructions] And as a reminder, your conference is being recorded. I would now like to turn the conference over to your host, Yan Jin. Please, go ahead.

Craig Arnold:

Okay. Thanks, Yan. We'll start with some highlights of the quarter on page three. And I'll lead off by noting that we've delivered another strong quarter. We generated adjusted EPS of $1.88 for the quarter, well above our guidance range, record for the quarter and up 16% from prior year. And we continue to post strong margins. Q1 record of 19.7%, up 90 basis points over prior year. Our sales were $5.5 billion, up 15% organically, our third quarter in a row of 15% organic growth. We have particular strength in our Electrical Americas, which was up more than 20%, including very strong growth in commercial, institutional, utility and data center market. We also had exceptional growth in our Commercial Aerospace and eMobility businesses. Our orders also came in ahead of expectations for the quarter. On a rolling 12-month basis, Electrical orders were up 13% and Aerospace orders increased by 21% and which led to another quarter of record backlogs, up 39% for Electrical and 27% for Aerospace. I think it's well understood at this point, but I'd note once again that reindustrialization, infrastructure spending, along with secular growth trends of electrification, energy transition and digitalization have fundamentally changed the growth prospects for our company. Lastly, free cash flow in the quarter was nearly $300 million, driven by higher net income and improved working capital. So I'd say a good start to the year that keeps us on track to deliver our free cash flow guidance despite higher revenue and receivable balances. So on balance, I'd say, we're off to a very good start for the year. Moving to page four. I'd like to once again highlight that Eaton is marking its 100th anniversary of our listing on the New York Stock Exchange. And as many of you saw, we celebrated by ringing the bell on in early March. Eaton is one of 32 companies who have reached this milestone. And I'd say our longevity on the exchange and our resiliency is really a function of our ability to adapt to a changing world. But what has remained constant over that time is the spirit of innovation that guides us and our commitment to all of our stakeholders, our employees, our customers, our shareholders, communities and all of society. Now as Eaton stands at the forefront of perhaps the most significant growth trends that we'll see in our lifetime, we're convinced that our best days are still ahead of us. And we've been busy planning for this moment. As we look at Eaton today, we position ourselves as our customers' trusted partner across power management spectrum. And slide 5 provides a good example of how we're playing across the electrical value chain from power generation to power distribution, to how it's consumed in various applications. We're building a business that supports our customers with a full range of end-to-end solutions beginning with deep domain expertise in specific applications and the ability to specify electrical solutions, we're now providing intelligent electrical products, offering Data as a Service, providing software solutions, doing installation commissioning and providing aftermarket services. Our role has changed from simply selling components to helping owners fulfill their changing energy needs. We're also proving that we can leverage our technology and create scale solutions that serve all of our end markets. For those of you who are with us at our March meeting in New York, you saw an example of this and a new product we call Breaktor. Breaktor is a combination of a breaker and a contactor, we developed the technology in our Electrical business and have successfully sold it in our eMobility and aerospace businesses. And as the electrification of everything continues, the need for Eaton's technology and solutions will certainly continue to grow. And the primary source of this growth is coming from the mega trends that we've discussed. In addition to electrification, we're benefiting from energy transition from digitalization and the reindustrialization of the US and European market, and we're seeing record capital spending levels. And as you know, this capital is being supported by an unprecedented level of infrastructure spending by governments around the world. And while early, we're tracking a large number of infrastructure-related projects. For example, in our Electrical Americas business, we've already seen over $1 billion of projects and have won roughly $250 million of orders. And as this chart reflects, we're also at the beginning of a strong aerospace growth cycle and seeing rapid adoption of electric vehicles. Collectively, these trends have positioned the company for strong growth for the foreseeable future. Next, on page 7 of the presentation, we provide an example of how reindustrialization is creating a record number of mega projects, and we define a major project as a project with more than $1 billion of capital. Since 2021, announced non-residential mega projects have a cumulative value of almost $600 billion, at least 3x the historical run rate for non-residential projects. And this is North America only. $600 billion announced over the last nine quarters, $400 billion more than historical run rate. These projects are certainly in various phases of design, planning or construction. But as you can see, these secular trends are translating into specific projects, and they haven't slowed down. There's billions more in the planning stages, which will certainly sustain our growth for years to come. On slide 8, we take you from the $400 billion of announced mega projects and what it means for the electrical industry. We estimate that the electrical content on these projects is in a range of 3% to 5% of the total project value. This suggests $12 billion to $20 billion of incremental electrical revenue. Keep in mind, there's certainly a wide range of electrical content on various projects, and our exposure is tied more closely to building infrastructure. But assuming these projects get planned designed and built over the next five to seven years, they will expand the electrical market by some $2 billion to $4 billion a year. And that's just from what's been already announced in mega projects, we naturally expect more large and small projects to come. I'd say these projects are a good example of how mega trends are playing out in creating a very different growth outlook for the electrical industry and one, we think will run a decade or more. Another helpful proof point is represented on slide nine, where you can see how our negotiation pipeline has grown. As you can see, our negotiation pipeline has doubled from what we've seen historically. In 2022, we saw nearly $5 billion of projects in our negotiation pipeline in Electrical Americas alone. And similar to mega projects, we're seeing broad strength in manufacturing and data center, industrial and utility market. This large step-up in negotiation is further supported. Our expectations, further supports our expectations for strong markets and faster organic growth, as we go forward. And just one additional proof point is noted on page 10. Here, we show a few examples of how these projects are translating into specific orders. As we reported, our electric orders have been at record levels for two years now. So, what we're demonstrating here is how these mega projects are translating directly into large wins for our Electrical business. For example, we've won $180 million of orders to provide toll management solutions for two new EV plants in North America. Specifically, we're providing power distribution equipment and bright layer industrial remote monitoring software. Another example is a $100 million order for a new US semiconductor plant, and we're already working on Phase 2 of this project, which could be even larger. So overall, we're seeing record project announcements, record negotiations, a record set of orders that has led to record backlog. And keep in mind, the revenue impact is mostly in front of us. Moving to page 11. We're also benefiting from mega trends in Aerospace and Vehicle. We're at the beginning of an Aerospace growth cycle in both commercial and defense market. Specifically, Commercial OEM build rates are expected to grow in the mid-teens over the next several years. And our commercial aftermarket should also grow by double digits, as global revenues [ph] passenger kilometers continue to recover to pre-pandemic levels and beyond. We've also noted the significant step-up in defense orders and expect to see a significant lift in defense revenues beginning in 2024. As a point of reference, our defense orders have more than doubled from 2019 levels. And in recent years, we've run increased content on both Commercial and Defense platforms. In vehicle, electrification continues to accelerate, and we now expect global EV penetration rates to exceed 50% of global auto sales by 2030, up from our prior estimate of 40%. While we're not providing any new revenue updates today, we once again are relooking our forecast for our eMobility segment. And on page 12, we highlighted a few key wins in our Aerospace and eMobility businesses beginning with a $500 million win for cryogenic coolers and controllers for the CityAirbus urban air mobility program. The CityAirbus win is a good example of how digitalization, software and electrification are beginning to benefit our Aerospace business. And as Tom will report shortly, we're seeing more than 30% growth in our defense and commercial aftermarket orders. And in eMobility, we continue to realize significant wins. The most significant of which are coming from our power distribution product line within our eMobility business, you'll recall this is where we're able to leverage our broader electrical business and our unique breakthrough technology. Our latest set of wins comes from a leading European automotive OEM and will generate $100 million a year of mature year revenues. So like Electrical, our industrial businesses are delivering significant wins tied to long-term mega trends that will support faster growth. When you combine the businesses, we're confident that our market should grow at more than 2x their historical rates. And as we've stated, we're in the early innings. These trends are expected to deliver outside growth for years to come. With that, I'll turn it over to Tom to walk us through Q1 financial results and updated guidance.

Craig Arnold:

Thanks, Tom. Now, turning to page 22. As we continue to track our end markets, we want to provide a slightly rise look at our assumptions for the year. Once again, we do expect a mild recession 2023, and we've built that into our base case assumptions. But with healthy demand and strong secular growth trends, we continue to expect growth in almost all of our end markets, and we raised our growth assumption for the utility market from solid growth to strong double-digit growth. Here, energy transition and electrification continue to gain momentum. And we've increased our residential market from declining to flat. So while we recognize the slowdown in US single-family housing market, the combination of resilient renovation market, pricing momentum and strong backlog now supports an upward revision. And as Tom noted, we posted a 17% organic growth in residential in Electrical Americas in Q1. The balance of the forecast remains unchanged, and but I want to emphasize once again that despite market concerns about non-resident construction market, we have a robust negotiation pipeline, a growing backlog and strong orders. Data centers, utility, industrial, commercial institutions continued to perform extremely well. And I know that most of you have drawn reference to the declining PMI data, but I'd point out that our market and revenue growth are much more aligned with capital spending where we continue to see strong momentum. As a result, we do not expect any of our end markets to decline in 2023, and most are expected to see healthy levels of growth. Let me close on page 23 with just a few summary comments. Once again, we delivered a strong quarter and set a handful of Q1 record. We delivered 15% organic growth and have record backlog. While electric orders are experiencing some expected normalization, our supply chains continue to improve, the secular growth trends and strong execution on our backlog support another strong year of growth. Having exceeded our Q1 forecast and continued secular tailwinds, we're raising our guidance for the year. Despite macro uncertainty in markets -- despite macro uncertainties, our markets are performing well, and we're improving our internal execution. And as I highlighted, we're seeing more evidence that mega trends are accelerating. And we now think our end markets will grow at more than 2x historical growth rate. These market forces are just beginning to show up in revenue and will position the company for strong growth for the decade to come. I'll stop here and open it up for any questions you may have.

Q - Joe Ritchie:

Thanks. Good morning everyone, and great start to the year.

Joe Ritchie:

Let me just kind of start on the Electrical Americas margins. Clearly, a standout this quarter. I think your highest quarter -- highest first quarter ever. As you think about kind of like the incremental margins going forward, it looks like you posted about a 40% incremental in the first quarter. How should we be thinking about the rest of the year? Are there any items that potentially reverse as you progress, or do you expect incrementals to be as strong throughout the year?

Tom Okray:

Yes. And the only thing I would throw on top of that, Joe is -- to your specific question, there were no unusual items in the first quarter driving the Americas margin.

Craig Arnold:

Yes. I mean, this is something that had been long anticipated, quite frankly, Joe, by us is, as you think about all of these mega trends of whether it's electrification of the economy or energy transition, we knew at some point, the utility market would have to start to make the kinds of investments that are going to be needed to support the electrification of the economy. As I mentioned, I think, on the last earnings call, one of the longest lead time pieces of equipment that you could order today in the electrical industry is a transformer. And in many cases, lead times there are 12 months or beyond. And so we continue to see the utilities making investments in their distribution infrastructure to really support this energy transition that's taking place, the electrification of the economy. And so yes, we think the utility market is going to be a really strong growth market for some years to come as they deal with needed investments. And so no question, as we began the year, we were a little bit conservative in terms of what the expectation is, but it's coming through, as you heard from Tom and since some of the orders growth, orders growth are quite significant now, and we think that's going to go on once again for some years to come.

Operator:

Thank you. The next question is from Josh Pokrzywinski from Morgan Stanley. Please go ahead.

Craig Arnold:

Hey, Josh.

Craig Arnold:

No, I appreciate the question, Josh. And that's certainly one of the things that we're spending a lot of time trying to sort through right now. I mean clearly, as I mentioned, supply chain on the material side from our suppliers has improved. We're not out of the woods by any means, especially when you think about electronic and semiconductor-related components. They still are constrained constraining our growth. But to your point, labor is also a fairly significant constraint today. And so one of the reasons why I think you've seen this big gap between orders and revenue is because, once again, our extended supply chain and labor availability have been constraints on the industry. I don't really have an answer to your direct question in terms of -- from an industry perspective, what's the limiter because as you know, in these very complicated supply chains, it only takes one supplier, one player in the market to become the constraining factor. So it's a great question and one that we're trying to spend some time thinking through, but not one today that we have a really clear answer to today in terms of what is the real upper boundary of the industry's ability to deliver given labor, given our standard supply chains and some of these material constraints. I can tell you that today, things are getting better across the board. And we're feeling much better about the growth outlook for our company and for the industry and just tons of positives that we talked about in our opening commentary, where we're seeing significant broad-based strength and it's showing up in our backlog, they're showing up on our order books. And we would hope that we continue to post very strong revenue growth tied to these secular trends.

Craig Arnold:

Yes. No, I appreciate the question. And it's -- I mean there's a lot in the question that you asked very specific in terms of whether or not we're seeing a lot of churn. I'd say that, overall, economic activity, whether it's negotiations or orders or revenue, everything is kind of doing significantly better than it has historically and certainly better than even, quite frankly, we anticipated when we put our plan together for the year. So in general, things are positive. And we continue to -- with more negotiations, with more orders than we anticipated, obviously translating into more revenue. So, I'd say that stimulus specifically, we talked about that a little bit in some of the opening commentary. We are starting to see stimulus have an impact. We are in the very early innings. If you think about that $600 billion of projects, mega projects that we talked about, we think some 25% of that has already broken ground and started many of that, whether it's semiconductors or EV factories and battery factors are obviously being busters by some of the early Infrastructure Spending Act. The inflation Reduction Act, we really have not seen any impact from that yet. We're certainly seeing some impact from the Semiconductor Act. So yes, a little bit of a mixed bag there, but I'd say most of the impact there continues to be out in front of us and lead times today on these projects I would say, we have better visibility today, as these projects are bigger, they tend to run them over a multiyear period. And so we're feeling great about our visibility into the future, because of these very large projects that will be delivered over multiple years. But I'd say…

Tom Okray:

Yes. The only part that I would amplify on that is going back to our speaker remarks, our negotiation pipeline in the US quarter-over-quarter is up almost 25% year-over-year, up almost 25%. And some of the big segments are up well over 30% growth. So, we're seeing very robust pipeline here.

Tom Okray:

Thank you.

Scott Davis:

Good morning, Craig and Tom. How are you? Look, how -- I want to just fixate on these big projects because this is so new, at least since I've been covering this space. Maybe a couple of different angles to go out here. One is just the competitive dynamic. Does it change when you get to this size? Meaning, there's just a lot less people that can really at least be trusted suppliers for the customer when you're talking about orders and $10-plus million up to $100 million kind of total bid stuff?

Tom Okray:

And I think it really gives another lens in terms with these big projects, focused not so much on the PMIs, which we've all read historically. And to Craig's point, this reindustrialization, which is driven by these higher levels of CapEx, which we just don't see slowing down.

Craig Arnold:

Yes, we've spent some time with you over the years talking about the way we think about the sale of software to state of data and insights to that. For us, we really do think it's linked to the equipment. And so for us, for the most part, we're selling products that are digitally enabled. They're digitally native. These products all have the ability to stream data. From that data, we create algorithms and that allow us to provide insights, from the data coming off of our products, and we can either monetize that either in the form of Data as a Service or software. So for us, and it's not the same for every company in this space, we do link the sale of hardware, the places where we have deep domain knowledge and expertise to the sale of data and software and these services that we bundle together. So for us in the way we go to market, we do go together through the same channel through the same decision point. But that's not the same for every company in the space.

Craig Arnold:

Thanks, Scott.

Nicole DeBlase:

Yes. Thanks. Good morning, guys.

Nicole DeBlase:

Just maybe starting with the second quarter outlook for organic growth, embedding a bit of a deceleration from the 15% in the first quarter. Just can you talk a little bit about what's driving that deceleration from a segment perspective?

Nicole DeBlase:

Got it. That makes sense. Thanks, Craig. And then second question, just update on what you're seeing with respect to channel inventory in Electrical? Still pretty low relative to history or any movement there in the past quarter? Thank you.

Nicole DeBlase:

Thanks. I’ll pass it on.

Steve Volkmann:

Great. Good morning, guys. Thanks for fitting me in here. Craig, sort of a big picture question based on sort of what you were just saying. Do you think these backlog levels the new Eaton and we should think about Eaton operating with these types of backlog numbers going forward, or do you think as the world sort of normalizes from supply chain or whatever that backlog will come back down again?

Tom Okray :

Steve, where I would chime in on that. I think it's connected. Your question was backlog, but I think the new Eaton is definitely a higher growth Eaton. And as Craig said in his prepared remarks, we see the markets doubling over where they have been historically. And that's a big thing when you say doubling and that doesn't include our outgrowth that we think we can put on top of that. And just some perspective, if you look also at order growth that we've got going back to the first quarter of 2019 there, there's such strong numbers. Electrical Americas growing about 50% in terms of their quarterly orders, Electrical Global up over 25%, and aero up over 40%. So just a volume of quarterly orders that we're seeing coming in and the continued building of the backlog, I think the new Eaton is a much higher growth Eaton.

Craig Arnold :

I think it's certainly early for us to be putting out guidance for 2024. We'll have an opportunity to do that obviously later in the year. But I -- but your thesis is not off the mark. We do believe that certainly on the commercial side, that industry continues to ramp, both Airbus and Boeing have already put out numbers in terms of increases in line rates for [Technical Difficulty] is improving. Consumers are getting on planes. Revenue passenger miles and kilometers continue to grow, up, I think, some 60%, I think, in Q1, still not back to 2019 levels. So there's a long way to go just to get back to 2019 on revenue passenger miles, which, as you know, drives the aftermarket for us. And then on the military side, huge growth in orders this year that will begin to be delivered most of them into 2024. So I think the setup for our Aerospace business is certainly quite favorable right now, and we'll certainly be in a position later in the year to give you an indication of how good we think it's going to be.

Craig Arnold :

Thank you.

Nigel Coe :

Thanks. Good morning guys. Thanks for the question.

Nigel Coe :

I do want to come back to this -- these mega projects. But before we get into that quickly, just global margins, you went through the investments -- maybe just pick back going in on Global, what we're seeing in some of the major markets and what gets better from a margin perspective to get to that 19.7% full year?

Nigel Coe:

Okay. Volumes and more positive, that makes sense. And then at the risk of beating debt holes going back to the $600 million of megaprojects. In a very general sense, roughly what percentage of those have been bid on and awarded at this point? You said the majority haven't. So just wondering how that looks. And then what's your win rate? Your market share in the US, North America is about 3%, how does your win rate competitive that bogey?

Tom Okray:

The only thing I would amplify that for the given quarter, we were actually materially above our share win rate. So yeah, we're doing well in terms of closing the deal.

Operator:

The next question is from Julian Mitchell from Barclays. Please go ahead.

Craig Arnold:

Yeah. I'd say -- if we look at our own business, Julian, I'd say that price versus cost, I mean, while commodity costs are certainly down versus where they were a year ago commodity costs, in many cases, are actually up versus where they were in the fourth quarter. Take a look at steel, for example, a major commodity process steel, it's actually down about 25% from a year ago, but it's actually up 25% from where it was in the fourth quarter. So you have a mixed bag there. And then also on the labor side, as you can imagine, we're seeing more labor inflation in the business today. And so in our own company, the price versus volume piece may be is not as significant as it is for others. But I would say that as we look forward and embedded in our guidance is mostly, it's around volume at normal incrementals and the elimination of a lot of the inefficiencies that are in the business that's going to ultimately drive the growth in earnings and the growth in our margins more than it is this relationship between price and cost. As we said, from a strategic standpoint, we don't think price is either additive or subtractive from the underlying margin rates of the business, and that's the way we manage the company.

Julian Mitchell:

That's helpful. And then just my quick follow-up. Craig, you mentioned those inefficiencies just now, and those are most apparent in the first quarter's margins Electrical Global I think Vehicle. As we go through the year, we should see those margins kind of start to expand year-on-year. Just wondered when does that happen for the two segments? Is it as soon as the second quarter or it's more kind of the second half is when the margins expand in EG and vehicle?

Tom Okray:

For sure. And not to get too much into the accounting, but what we're seeing from last year rolled through the P&L in the first quarter and muted the margins somewhat because it was coming off of the balance sheet. So, it should be a tailwind going forward.

Operator:

The next question is from Chris Snyder from UBS. Please go ahead.

Craig Arnold:

Yeah. There's no question. It is the long-term view. As you think about most of the secular trends that we're talking about, whether it's energy transition, the move to renewables, the electrification of the economy, whether it's cars or cooking appliances or equipment in your factories. The growth in digital and data and connectivity, reindustrialization, you think about all the investment that needs to go into the US market as an example, to basically reinvest in manufacturing had had moved offshore and the stimulus dollars that are all supporting that. So this is clearly our long-term view that we think our markets would grow at least not 2x, but at least 2x the historical growth rates. And so we think those growth rates for the markets are in the mid-single-digit range.

Craig Arnold:

Yes. What I would tell you is that, where we get the most direct benefit is the fact that we tend to have higher market shares in the US. Most of the global electrical companies that we compete with around the world; they also have fairly much localized much of what they do. But our US market shares just tend to be higher. And so, we'll get an unfair share of projects as this reindustrialization and manufacturing takes place in the US market.

Operator:

Thank you. The next question is from David Raso from Evercore ISI. Please, go ahead.

Chris Snyder:

Yes. And I'd say that at this point, and we missed the front end of your question, but I think I get the gist of what you're asking that, based upon the implied numbers in our guidance, order of magnitude, 7% growth rate would be the exit rate for the year, and there's a lot of assumptions that we need to work through to really understand what's the guidance is going to be for next year, what happens with supply chain, how the year unfolds. But I don't -- given where we sit today, if you had to pick a number, that would not be a bad starting point if you're looking to make an assumption for what 2024 looks like. It wouldn't be a bad starting point. But keep in mind, as we talked about, there are certain of our markets that we think are going to really inflect very positively next year, Aerospace is one. And so, early days, but if you had to put an anchor down today as a starting point, it wouldn't be a bad place to start.

Chris Snyder:

We do.

Chris Snyder:

No, no. We do.

Chris Snyder:

We do have -- by the time we get to the fourth quarter of this year, we think North America Class 8 truck will be negative, and that is baked into our assumptions.

Chris Snyder:

Thank you, David.

Phil Buller:

Yes. Hi. Good morning. Thanks for fitting me in. A question for Craig in relation to the portfolio. Obviously, this has come along quite a lot on your watch, and you framed things with this, I guess, grow the head and shrink or fix the tail analogy, which is now align the group very nicely to these mega trends. But I'm wondering if there's much of a tail at this point? I don't get that sense from the prepared remarks, I get that there's always room for some incremental self-help here in there, and you touched on some of the efficiencies. But what, if anything, would you be deprioritizing from here in terms of organic or inorganic investment? And I guess I'm asking in relation to the Vehicle segment or trucks or potentially there's something else that you'd call out?

Tom Okray:

Yeah. A tangible example of that is if you go back to the prepared remarks and Electrical Global, we actually had a divestiture, which impacted the results in the quarter. It would be non-strategic by our GIS business, our old Cross fee line, and it's a great example of how we're fixing the tail. Craig is constantly challenging the organization for that.

Craig Arnold:

Yeah, I'd say strategically, the way we think about the Aerospace business is you're either in or out. And if you're going to be in Aerospace, you need to be in defense. It's an important part of national security for sure. So there's a -- we understand the ESG-related concerns. And we understand that many investors have this 5% threshold. Today, defense is close to that number for Eaton. It's maybe 5% to 6% of our business overall. But I'd say that for us, we're really focusing on good businesses that make strategic sense for the company. And Aerospace is a platform within the company that we'd like to continue to grow. It's a good business. It's got all the right characteristics in businesses that we like. It's high margin. It's a highly differentiated based upon technology. You've got great position on platforms with a huge aftermarket that runs for decades. And so it has all the right set of characteristics for businesses that we like. So we will continue to prioritize first and foremost, Electrical. As we've said in the past, for a lot of reasons including these secular tailwinds. But Aerospace from a priority standpoint, is second only behind Electrical.

Craig Arnold:

Thank you.

Craig Arnold:

Thank you.

Operator:

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T teleconference service. You may now disconnect.

Operator:

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton fourth quarter earnings call. [Operator Instructions]. I would now like to turn the conference over to Mr. Yan Jin, Senior Vice President, Investor Relations. Please go ahead.

Craig Arnold:

Thanks, Yan. We'll begin with the highlights of the quarter on Page 3. And I'll start by noting that we again delivered very strong results in the quarter and record performance for the year. We generated adjusted EPS of $2.06 for the quarter and $7.57 for the year, both all-time records in each period. Our Q4 adjusted EPS was up 20% from prior year. Our sales were $5.4 billion, up 15% organically and for the second quarter in a row with particular strength in utility, industrial, commercial institution, data center markets for electrical and commercial aerospace, vehicle and eMobility markets on the industrial side. And we continue to post strong margins. Q4 margins of 20.8% were up 150 basis points from prior year, near the high end of our guidance range. And incremental margins were 33% in the quarter. For the full year, we delivered record segment margins of 20.2%, up 130 basis points from prior year. And as noted here, orders continue to remain very strong. On a rolling 12-month basis, Electrical orders were up 25% and Aerospace orders increased 24%, which led, quite frankly, to record backlogs as well, up 68% in Electrical and up 21% in Aerospace. Now lastly, in what was an otherwise challenging year, we generated record free cash flow in the quarter with adjusted free cash flow up 41%. And our free cash flow as a percentage of sales was 18.1% in the quarter. While improved cash flow in the second half of the year, it wasn't enough to really achieve the full year cash flow targets. As we indicated, we continue to prioritize supporting higher organic growth, winning new orders and protecting our customers, which all contributed to higher levels of working capital. But we still have work to do and with a focus on those areas that don't impact revenue growth. On Page 4, I summarize our performance highlights for last year. Overall, I'd say, in a challenging operating environment, our team delivered strong financial results. And as noted here, we exceeded three of our four key financial metrics. First, for organic revenue, we posted 13% growth, which was actually more than 60% above our original guidance at the midpoint. Throughout '22, we raised our organic revenue growth in all segments, and the team delivered on the organic growth expectations that we set. It's worth noting that our largest business, Electrical Americas, delivered 16% organic growth, 2x the midpoint of our original guidance. Second, I'd note that we continue to demonstrate our ability to drive profitable growth with record margins of 20.2% in 2022, which was 10 basis points above our original guidance at the midpoint. Third, adjusted EPS of $7.57 was $0.07 higher than the midpoint of our original guidance. And I'd note that we fully offset the impact of some $500 million of unfavorable currency or roughly $0.20 a share. Lastly, I'd note that we did miss our free cash flow guidance for the year. Most of this miss went into working capital to support higher levels of sales and orders and the record backlogs. But I'd say here, once again, I know we can do better. As you might expect, supply chain disruptions and our decision to prioritize protecting customers with higher inventory played a major role in this inventory growth over the year. But overall, I'd say it was a good year despite a year filled with inflation, labor shortages, supply chain disruptions and FX headwinds, and the team delivered record financial results and we go into 2023 with positive momentum. So turning to Page 5. I hope at this point, you would agree that 2022 wasn't an exceptional year but just another year of delivering what we promised. And that it reflects the fundamental changes that we've made to the company over the last decade. We are a very different company today than we were 10 years ago. We've embraced the realities of a changing world and a necessity for us to change as well. We're now in attractive growth-oriented end markets, and we have a proven formula for how we run the company better through the Eaton Business System. With this transformation, we've become a stronger company that has delivered higher growth, higher margins and better earnings consistency. And we continue to be a good steward of your capital. The end result is the new Eaton where some 90% of our profits now come from Electrical and Aerospace businesses. But once again, when I'm done, we'll continue to apply our operational model, our strategic framework and our potential criteria, and we'd expect to continue to maximize value to all of our stakeholders. And as you can see on Page 6, what this transformation has delivered to our shareholders. As you would expect, our strong results have translated into very strong financial results. And for the sake of comparison, we charted total shareholder returns for 3, 5 and 7 years. And we've compared our results with the S&P 500, the medium of our peer group and the XLI Industrial Index. And in every case, Eaton has significantly outperformed our benchmarks. And as I'll explain in the next few slides, we do believe our best days are still in front of us. Turning to Page 7. Our transformation into a global intelligent power management company has positioned Eaton at the center of some of -- what we think are some of the most important trends that we'll see in our lifetime. The most significant being climate change and all the downstream implications that it brings. As we all know, climate change is driving the need to transition from fossil fuels to renewables, and increased regulations are driving the demand for new solutions. These solutions will require tremendous investments in renewables and grid infrastructure for both new and existing buildings. This trend is also closely coupled to need to electrify the economy. Cars, trucks, planes, buildings are all requiring more electrical content. And as we move away from fossil fuels, this allows us to take advantage of renewables. And digitalization is providing us access to data and insights that are allowing us to be more connected, more productive and more efficient than ever. It's also, by the way, creating a need for more data centers, an important end market for Eaton. Additive to these trends, we're also on the front end of an aerospace recovery cycle that will drive growth in both our commercial and military markets. I don't know about you, but I can tell you, I don't -- I can't think of a company with a better set of market dynamics than Eaton. And while we're not ready to change our long-term growth goals, I'd be surprised if we didn't exceed our previously announced targets of 5% to 8% annual growth. Next, on Page 8, we highlight how these megatrends are supported by unprecedented government stimulus spending really around the world. In fact, these programs will have a direct impact on the growth rate of more than half of our end markets. And in the U.S. alone, the Infrastructure Act from 2021 and the Inflation Reduction Act from 2022 will fund some $450 billion of grid modernization and other climate-related programs. And of particular importance to Eaton is the $88 billion that are set aside for power grid updates and EV charging networks and incentives. In Europe, the EU recovery plan recovers -- provides, excuse me, $244 billion of green energy transition, which member states are now working on implementing. And in China, the government has set clear goals to lower carbon emissions. They've laid out plans to strengthen their grid by 2025, including investments in more wind and solar. China also continues to lead the world in the adoption of electric vehicles. But even if you exclude China, we still estimate that between the U.S. and EU programs will expand Eaton's addressable market by some $11 billion to $14 billion over the next 5 years. And I'd say this is just another powerful tailwind that supports our confidence in the growth outlook of the company. Tom will pick it up here and take you through the numbers.

Craig Arnold:

Thanks, Tom. Turning to Page 18, we provide a look at our current market assumptions for the year. This chart has been updated from what we shared in our Q3 earnings call, but we really don't see any material changes here. I'll remind you that we do expect a mild recession in 2023. But given the secular growth trends that we've talked about, our strong orders and healthy backlog, we would expect to see growth in most of our end markets with six of our end markets representing some 70% of the company up nicely. And these markets are also, by the way, supported by a very strong negotiation pipeline. Of note, we now expect even stronger growth within our commercial and institutional segment given the relatively strong orders growth in the quarter and the continued strength in Dodge nonresidential construction contracts. The only down market is expected to be residential, which only accounts for 8% of our revenue. In total, we're encouraged to report that 85% of our markets are expected to see positive growth in 2023. And lastly, let me close on Page 19 just with a few summary comments. First, I'd say our thesis for Eaton as a changed company has continued to pay even better than we expected. Second, the growth trends, the right investments have delivered better top line growth, and we continue to run the company better. We delivered 13% organic growth with record orders and backlog. And despite supply chain challenges, an inflationary environment and significant FX headwinds, 2022 was a year of record profits, record margins, record adjusted earnings and adjusted EPS. And I'm particularly encouraged by our 20% increase in adjusted EPS growth in Q4, which I see as a positive indicator for 2023. So despite the macro concerns, we expect 2023 to be another very strong year. And the company is on track and likely ahead of schedule for delivering our 2025 goals for revenue, margins, free cash flow and adjusted EPS. So I'll stop here and open things up for any questions that you may have.

Operator:

[Operator Instructions]. And our first question is from the line of Nigel Coe from Wolfe Research.

Craig Arnold:

Yes. No, we're very pleased, obviously, with the growth that we're seeing in both our global business as well as in the Americas business, but the Americas business is clearly performing extremely well. And I think -- if you think about some of the things that we talked about, Nigel, whether it's this stimulus spending where the U.S. is really pumping fairly significant dollars into markets that are really important for us, you think about some of these large projects and let's call it, reshoring that's taking place in the U.S. market, that's certainly strengthening the U.S. business as well. So I do think there's a lot of macros today that are strong for the company across the board that are just, I'd say, intensified when you think about what's going on in the U.S. market right now. So the secular trends are everywhere. We talk about energy transition, electrification. It's taking place across the world. And I just think the U.S., because of this increased focus on infrastructure reindustrialization, is seeing an additional boost above some of the other regions of the world.

Tom Okray:

Yes. Thanks, Nigel. Most of that is going to be in interest expense and pension with interest expense even being greater than pension. And I would caution that there's a lot of moving parts on both of those, what's going to happen to interest rate, what's going to happen to the shape of the yield curve, discount rates, those types of things. But as we're projecting it now, the headwinds are really related to interest expense and pension with interest expense being the dominant one.

Joshua Pokrzywinski:

So Craig, you mentioned kind of planning for a mild recession and guidance. Can you maybe put that in the context of backlog conversion? And maybe specifically, I think data center and commercial construction, you're starting to hear a little bit more in the way of cyclical concerns. Obviously, the orders are so strong. But how would you think of how much backlog ideally you'd be converting, if any, this year in the context of that recession outlook?

Joshua Pokrzywinski:

Got it. That's helpful. Then just a follow-up. Really appreciate kind of the TAM expansion color that you gave from some of the stimulus. I know not a lot of folks have taken a stab at that. I remember from the Analyst Day correctly, I think you sized the TAM for Eaton before that -- in kind of the high $50s billion. Does this mean that we kind of take this extra $11 billion to $14 billion divided by 5, because it's over 5 years and you have sort of 4% uplift to growth like -- or is this an apples and oranges kind of discussion? Just any context how the TAM increase relates to kind of the growth uptick would be helpful.

Tom Okray:

Yes. And just to add a little bit more color on that, I mean going back to the prepared remarks, if you look at our major project U.S. pipeline, many of the end markets quarter-over-quarter are up over 100%. And that's also translating to order volume even higher than that. So we're just seeing some good tailwinds on these major projects.

Operator:

And the next question is from Andrew Obin from Bank of America.

Craig Arnold:

Yes. We -- as you can imagine, we anticipated this question because we too are reading some of the conflicting headlines in terms of what's going on in the data center market. And then as we talked about, our data center business continues to be very strong. And what you talked about, Josh, in the context of AI and these other various technology platforms that continue to be rolled out. That's just, once again, generating the need for more data, more processing and ultimately more data centers. And I know there's a little bit of a cause for some concern given what some of the hyperscale guys did with respect to their own outlook. But I can tell you that for us, the data center market continues to be very strong. And even the hyperscale guys are still talking about mid-teens kind of growth over the next 3 to 4 years. And so those are very strong numbers. And we haven't talked about autonomous driving and expansion of 5G. And every device that we make today and that is made by every company continues to get more intelligent, driving a greater need for data and processing. And so we think the data center market is going to be a great market for quite a number of years to come, and it's supported by our order intake and our negotiations. To your question specifically on capacity, at this point, we really don't have a lot of spare capacity. We're making investments to expand our capacity. But at this point, we have lots of visibility into the data center market, and it feels good.

Andrew Obin:

And just -- yes, sorry.

Andrew Obin:

And just a follow-up question. And at both stimulus, I think, related to IRA but also what's happening with LNG in Europe, what's the latest out of Crouse-Hinds? Because I think it is exposed to all these trends. And also have -- does Crouse-Hinds benefit from any decarbonization efforts, hydrogen, carbon sequestration? Just as I said, just maybe talk a little bit about what you're seeing in Crouse-Hinds.

Tom Okray:

Yes. I mean, for example, if you look at trailing 12-month orders in GEIS and utilities, they were close to 30%, very strong.

Stephen Volkmann:

Craig, maybe just start off, could you provide a little bit more color on what you're seeing in commercial and institutional that made you sort of bump that market outlook up?

Stephen Volkmann:

Okay. Great. And then I know it's early for this question. But Tom, since you brought it up, I think you mentioned something about breakout performance in 2024. Not sure if that was sort of military aero-specific. But just can you expand on that a little bit?

Craig Arnold:

In fact, our military OE orders for the last 12 months was up 45%-ish.

Craig Arnold:

In the quarter. So really strong.

Craig Arnold:

And given the lead times in that business, it will certainly support the growth assumption that we have baked in for 2023. But we do expect that 2024 will be a really strong year.

Operator:

The next question is from the line of Jeff Sprague from Vertical Research.

Tom Okray:

Yes. Thanks, Jeff. Let me start out with talking about the Americas margins. I mean the story is really when you look at it compared to Electrical...

Tom Okray:

Yes. No -- oh, yes. We have 20% in the Americas volume growth. We had 8% in Electrical Global. So there's the real disparity going on there. And if you look closer into Global as well, we had some transactional FX issue, not necessarily translational but transactional, where we still have dollar-denominated costs. And with the dollar weakening, that hurt us there. So that was part of also the compare and the hurting of the margins on Electrical Global.

Tom Okray:

Right. Yes. Thanks for the assist, Craig. Yes, coming back to the margin question, in addition to transactional FX, Jeff, we also saw weakness in China opening up. So APAC was weaker than we had expected.

Tom Okray:

Yes. We're not going to break it out specifically as per our policy. What I will say is that we expect to continue to effectively manage price/cost. It's something we really focus on, and we expect to manage it effectively.

Operator:

The next question is from the line of Nicole DeBlase from Deutsche Bank.

Craig Arnold:

Yes. I'd say -- in aggregate, Nicole, I would say that we've not seen that nor have we heard that from our big channel partners in aggregate. Today, if you look at -- once again, if you think about our order intake, our growth in backlog and you throw that up against -- Tom did a great job of laying out what it's meant in the context of our own inventory. And while we're building inventory, we're actually increasing our efficiency as it relates to a forward view of revenue. And I think that would be true for many of our distributors as well given the strength in the underlying market, certainly in the Americas. I would say that if you take a look at Europe specifically, while we're still seeing growth in our own orders in Europe, there has been a little bit of a slowdown in Europe. And while still growth, we have seen a little bit of a slowdown and a bit of an inventory adjustment that's taking place with some of our European distributors. And I think -- China, I think, will be going in the other direction as that market comes through COVID and begin to grow again. So very slightly regionally in aggregate. I'd say no inventory destocking to speak of at all. Regionally, a little bit of destocking in Europe with the U.S., and perhaps Asia market is still a little bit tight.

Nicole DeBlase:

Got it. And I guess, looking at the guidance for the first quarter, you got organic decelerating to the 8% to 10% range versus 15% in 4Q. I guess, can you just talk through some of the segment-level drivers there? And is that mostly a function of just tougher comps?

Operator:

The next question is from the line of Scott Davis from Melius Research.

Tom Okray:

Yes. Sure, Scott. Yes, nothing really in the prepared remarks because we're staying the course with our same capital allocation tenets. Obviously, first, we're prioritizing organic growth, which we think is so important, especially with all the megatrends and secular tailwinds that we're right in the middle of. We're going to pay a competitive dividend as well. It's important to our investors. Having said that, we continue to be in the market and look for good acquisitions. We're also -- if you noted, we're also shrinking the tail in terms of divestitures. We had a small one that we did in the quarter. So we're actively doing that. And then in terms of buying back shares, this year, we did about $290 million. We guided $300 million to $600 million, and we'll be optimistic -- I mean, opportunistic there as appropriate. But it really hasn't changed. We're in the market. We're always looking. And yes, staying the course on our capital allocation tenets.

Tom Okray:

Yes. And just to punctuate that, Scott, with a number. If you look at our backlog for Electrical and Aerospace back at the end of Q4 in '19, it was roughly a little over $4 billion. And as we said in the prepared remarks, we're at $11 billion now. So there's a lot of food on the table.

Julian Mitchell:

Just wanted to understand on that cash flow guide. I think it's at the midpoint guided up about $900 million year-on-year. Net income is about $300 million, I think, of increase. So that sort of the delta of $600 million there. Is that sort of just the $500 million miss from '22? I'm assuming you capture it in '23. Is that how we should think about it? And maybe on the working capital point, is it all inventory kind of shouldering that delta? Or is receivables or payables doing anything interesting?

Julian Mitchell:

That's clear. And just my quick follow-up, you talked about the first quarter sort of organic sales segment a little bit. Maybe on the margins. So I think you're calling for the segment margin to drop sequentially about 1 point from fourth quarter into first quarter. Are we assuming kind of every segment has that similar drop and then sort of builds from there through the year? Anything to call out on that front, the sort of margins as we start the year and then move on by segment?

Craig Arnold:

Other than the volume piece, Julian. As you know, there's certain cyclicality that we have in our various businesses. And that's generally the reason why the margins generally drop between Q4 and Q1. And to the extent that we have more cyclicality in one business or the other, you could see a slightly different play-through by segment, but that's really the primary issue.

Craig Arnold:

Yes.

David Raso:

The quarterly cadence of the organic sales growth, the 9% we discussed in the first quarter, the way you're thinking about the rest of the year, is it all just sort of at the same kind of 7.5% level? I'm just trying to get a sense in particular about some markets where there's a little more concern about a slowdown in the back half then maybe other areas that could be accelerating. So can you first confirm, is that sort of how you think of the cadence?

David Raso:

And within Vehicle, the thought of auto sort of later in the year and truck later in the year, the interplay there? And a similar question on Electrical Global. Europe so far is proving a bit resilient, how to think about China and Europe in the back half of the year? Just those two interplays in those two divisions. I'll leave it at that.

Operator:

The next question is from Chris Snyder from UBS.

Craig Arnold:

Yes. I think, one, to your point, we are certainly running ahead. I mean, if you take a look at, assuming the 2023 guidance is a good number, we've been running around 10% top line growth against the 5% to 8% target. So well ahead on growth. And quite frankly, we've become incrementally more positive on some of these secular growth trends. I think if you take a look at stimulus spending, that number has been topped up since we laid those goals out more than a year ago. I think today, if you think about climate change and some of the investments that are going into grid resiliency -- and so as we sit here today, I would tell you that the secular growth trends that we spent a lot of time talking about, we've become even incrementally more positive on what the longer-term implications are of these secular growth trends. Now that may not play out completely between now and 2025. I think there's going to be some capacity constraints in the industry, and we're already experiencing some of those. That could be a gating factor. But that just gives us a much longer runway on the back end of this thing in terms of what's going to happen with these markets over the long term.

Craig Arnold:

Yes. I mean, I think it's -- when you say reaccelerate. I think it's a question of relative numbers. We had a very strong year for the most part, a very, very strong first half of the year in our Global business. And we're still anticipating growth, but we are anticipating the rate of growth will have slowed from what we saw in 2022. A lot of that tied to this assumption around a global recession that could hit Europe perhaps more impactfully than it maybe would in other regions of the world. And so it could -- there's a possibility that we could see a reacceleration. That's not our base assumption. We assume that we're going to still see growth but growth at a slower rate.

Operator:

And our next question, which is the final one in queue, is from Brett Linzey from Mizuho Americas.

Craig Arnold:

Yes. I mean that's the same discussion I'm having with my operating leaders. Why isn't Q4 44% the new normal? And I'd say that, as you can imagine, in every quarter, there's always a number of things that can go positively in your direction and things that could go against you. And we just had a very strong quarter of execution and good mix in our Americas business in Q4 that drove those incrementals to be well above where they would normally run. We do think from a planning standpoint, especially given some of the investments that we need to continue to make to support this growth in R&D and an customer capture initiatives, that we think 30% is the right planning number to have. And as you think about the business on a go-forward basis and very much consistent with where we've been historically.

Brett Linzey:

And just one last follow-up. Where are we in this pricing cycle? I mean, is there more to do here? Have you made announcements for this year? And then maybe any context for what you're embedding for the price component of the 7% to 9% growth this year?

Yan Jin:

We have reached to the end of our call and do appreciate everybody's questions. As always, and I will be available to address your follow-up questions. Thank you for joining us today. Have a great day, guys.

Operator:

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] And as a reminder, today's conference is being recorded. I'll turn the call now over to your host, Yan Jin, Senior Vice President of Investor Relations. Please go ahead.

Craig Arnold:

Thanks, Yan. We'll begin with the highlights of the quarter on Page 3, and I'll start by noting that we delivered another very strong quarter and have again posted a number of all-time records, including adjusted earnings per share of $2.02, which is up 15% from prior year. This, despite negative impact of FX and the divested Hydraulics business, which took place in August of 2021. Our organic revenue growth also continued to accelerate in the quarter, up 11% in Q2 to up 15% in Q3. And I think, encouragingly, we had strength across all of our businesses with exceptional growth in Electrical Americas, in Vehicle and eMobility. We also posted all-time segment margins of 21.2%, up 130 basis points over prior year and above the high end of our guidance with incrementals of 38% in the quarter. I'd also note that our team continues to manage price effectively more than fully offsetting the impact of inflation. As noted here, orders continued to accelerate in the quarter as well. On a rolling 12-month basis, Electrical orders increased 27% versus 25% last quarter, and our Aerospace orders increased 22% compared to 19% last quarter. This order strength, I'd say, also led to another quarter of record backlogs in Electrical, which were up some 75%, and our Aerospace backlogs increased by 17%. Lastly, we did start to generate positive momentum in our cash flow results. We had a strong year-on-year performance with operating cash up 29% and a 30% increase in free cash flow. And our free cash flow as a percentage of sales was 15.6% in the quarter. So as expected, we're starting to see improved cash flow from both higher earnings and improved working capital performance. Moving to Page 4. And before I turn things over to Tom to go through the quarterly results, I want to highlight a few of the key themes that are really underpinning our confidence in our long-term growth outlook. As noted here, we continue to benefit from the 3 secular growth trends that we reviewed earlier

Craig Arnold:

Thanks, Tom. Turning to Page 14. We provide an early look at our end market assumptions for 2023. And let me begin by saying that we are expecting to see a typical model recession next year but don't expect it will have a significant impact on our growth given the secular growth trends, the strong orders and the record backlog that we're sitting on. Within Electrical, data centers, industrial facilities and the utility market are all expected to see very good growth. Together, they account for approximately 40% of our total revenue and, quite frankly, have some of the strongest orders and backlogs in the company. As a point of reference, industrial projects announced this year so far are up some 300%. So you can see really strong momentum in these segments of the business. Commercial and institutional as well as machinery are expected to see more modest growth. Of note, orders in C&I continued to accelerate in the quarter with significant strength in government and institutional. And this is the segment where you'd imagine we expect to see significant benefits from stimulus spending. The one relatively weak segment is expected to be residential. And while we've not seen a downturn yet and our orders are up some [23%] on a rolling 12-month basis through Q3, we do expect the segment of next year. I would, however, note that resi only accounts for 7% of the total company sales and that residential new build market will be somewhat offset by the renovation market and the renovation market accounts for some 40% of our residential sales. And I'd also note that we'd expect to see higher electric content per home, which is what we've been seeing over the last number of years. Within our Industrial sector, we're expecting it to be a big year for electric vehicles. Increasing government regulations and incentives and the large number of new EV introductions will keep the segment strong quite frankly for years to come. And in commercial aerospace and light motor vehicle markets are both expected to see a cyclical recovery. The need to rebuild inventories will support vehicle markets and the aerospace aftermarket growth and the ramp-up in commercial OEM production will drive aerospace markets higher next year. Lastly, we expect commercial vehicle market to be flat but quite frankly at quite healthy levels. So in total, 85% of our markets are expected to see positive organic growth next year. We'll naturally provide more details on our specific organic growth assumptions on our February earnings call, but we did want to share our preliminary thinking and let you know that we expect 2023 to be another good year of growth for the company. And lastly, on Page 15, I'd like to close with maybe just a few points here. First, I'd say I'm pleased with our Q2 results, particularly with our strong margins, our earnings and our orders growth. We continue to manage the business well and delivered record profits despite ongoing supply chain challenges and inflationary environment, significant FX and interest headwinds. The transformation of the portfolio has delivered what we promised, a higher-quality company with higher growth, higher margins and better earnings consistency. And for the balance of the year, we remain on track to deliver our commitments, including record operating margins, adjusted -- and adjusted earnings per share. And we're doing so despite offsetting once again the significant headwinds that I talked about around FX, pension and interest, and these headwinds increase in Q4. As we look into next year, we remain optimistic despite our recession expectations. We do expect a slowdown, and we'll be prepared in the event of a more significant downturn. We know how to flex our costs and deliver attractive decrementals. But as we've said, we have good reasons for optimism. Second, the growth trends are driving strong momentum in our businesses, and we have a growing pipeline of opportunities. We're going into next year with strong momentum with record backlogs and with an expectation that many of the operational inefficiencies and supply chain disruptions will get materially better next year. So we feel great about the quarter, great about the outlook. And with that, we'll turn it back to you, Yan, for Q&A.

Operator:

[Operator Instructions] Our first question will be from Nicole DeBlase with Deutsche Bank.

Craig Arnold:

I appreciate the question, Nicole. As you can imagine, we're working through our 2023 profit plans right now and have lots of activity going on and around the company to get prepared for that. But I would say that as you think about next year, I think kind of a 30% incremental rate would be kind of the right place to be thinking about running your models at this point. And we'll naturally be in a position by the time we get to the earnings call for Q4 in February to give you a more specific read on that. But we think 30% is probably a good planning number at this juncture.

Craig Arnold:

Yes. As we've talked about and shared in some of the -- commentary, we've had pretty broad-based strength in orders in our Electrical business. I mean in the Americas specifically, data centers were extremely strong, industrial markets very strong, utility markets we had orders up some 60%. And so it really was broad-based. Even in the resi market on a rolling 12-month basis, even there, we had orders that were still up some 20%. And so it's tough at this point to really call out any particular market in the Americas that I'd say that was weak, but we had really, really strong strength. And I'd say a lot of it really is tied to these big trends we talked about. Obviously, the utility markets in general are certainly benefiting today from some of these investments in not only energy transition but grid resiliency, data centers. And I know there's been lots of debate about that market and which direction it is heading. But we're really continuing to see really strong strength in the data center market, even to the point where customers today are looking to place long-term commitments and basically hold the slot in our production plans out into 2024. So we continue to see very strong strength in our Americas business, once again, tied to these trends that we've been talking about for some time. And we're absolutely pleased to see it showing up in our orders and that will obviously convert to revenue as we have the ability to ship and we resolve some of the supply chain issues that we continue to deal with.

Operator:

Next to the line of Josh Pokrzywinski with Morgan Stanley.

Craig Arnold:

Yes. No. And we tried to provide a little bit of color because I know there's this question around whether or not -- what kind of growth you're seeing in orders in the quarter, which is why we try to share that not just in the rolling 12 but actually in the quarter, we're seeing significant strength. Those numbers that Tom quoted were actually in the quarter, quarter-over-quarter numbers despite to your point, tougher comps. I'd say in terms of the order surge question, as I mentioned in my commentary, there have been a number of very large projects announced. And I'd say, as you think about whether it's reassuring or investment in grid infrastructure or its investment in new battery facilities, there are today perhaps different than some of the other cycles that we've been through, a lot more very large industrial projects that tend to be more electrical-intensive as an application that we're certainly seeing in our backlog, and that's certainly helping us. But that also gives us a lot of confidence as well because these tend to be big multiyear projects that will go on for some time to come. Stimulus, to your question, not yet. We certainly would anticipate that at some point down the road that we'll start to see a meaningful impact from stimulus. Most of those programs are still probably 6 to 12 months away from really having a meaningful impact on the company. But once again, that’s just another one of these vectors that we think will continue to give us a multiyear growth story that's pretty compelling. And as you know, a lot of those stimulus dollars are going directly into the markets in which we participate. It's about building out the electrical infrastructure. It's about grid resiliency. It's about energy transition. It's investments in efficiency -- and specifically -- at a point where they actually specify upgrading your electrical panel as particular parts of the program that qualify for these investments. And so it's just another one of these things, Josh, that gives us confidence in the long-term outlook of our Electrical business specifically.

Josh Pokrzywinski :

Got it. That's helpful. And then just a quick follow-up on the stimulus piece or, I guess, broader infrastructure spending that you guys are tracking. I know there's some big dollars there. Obviously, not all of that is electrical, but as you touched on, a lot of things sort of get in to Eaton's backyard at some point. How would you think about what those do to your addressable market here as those start to enter? Is that like a 5% increase, a 30% increase to addressable market? Like any sort of ring fencing would be helpful.

Operator:

Next, we'll go to Andrew Obins with Bank of America.

Tom Okray:

Andrew, we're getting some background noise. It's very hard to hear you.

Andrew Obin:

Just give me one second. Let me try this. Is this better?

Andrew Obin:

Yes. So just on data centers, if we could just focus on different geographies and different verticals within the data center market is just -- there's a lot of noise regarding this market. What are you guys seeing? I know you're bullish, but just as I said, more color by geography and vertical.

Andrew Obin:

Great. And just on capital allocation, as interest rates have gone up, you are clearly cash generative. You're more of a strategic buyer. How has the market landscape changed from your perspective? And does it make more likely or less likely to see a deal from Eaton in the next 12 to 18 months?

Operator:

And next, we'll go to Nigel Coe with Wolfe Research.

Craig Arnold:

I appreciate it -- we tried to kind of unpack that a little bit in my outbound commentary, but we're still seeing good growth in the C&I market. Orders on a rolling 12-month basis, by the way, globally, we're up 23% in the quarter. They were actually up 27%. And so actually, a very strong quarter with orders actually accelerating in the quarter. And I'd say on the commercial side, we're seeing growth, but we're seeing the biggest growth in what we call institutional and government. And as I noted in my commentary, that's really where you'd expect to see some of the early indications of some of the government dollars and government spending in and around institutional and government. But that market continues to do extremely well. And we really have not really seen any signs, particularly in that market of a letup. I think more generally speaking, the Americas as a region tends to be the strongest region in the world, really across most of these end markets. But we had a very strong quarter in Europe as well in the C&I market.

Craig Arnold:

I mean, so at some point, I mean, as somebody mentioned earlier, we're going to be anniversary-ing some really strong growth numbers. And we do expect these growth numbers to slow and moderate at some place in terms of the order intake. But also keep in mind, we're sitting on record backlogs that are up, in some cases up, more than 100%. And so even if you have a little bit of a slowdown in some of these end markets, which you'll likely see some of that, our backlogs today are giving us visibility into almost 60% of next year's demand. And that number is about 2x what we normally see.

Tom Okray:

Yes. No, I appreciate the question. We tried to touch on it in the prepared remarks. We had a very strong Q3 cash conversion cycle. We improved by 7 days. Days on hand went up 4 days, payables up another 2 days. So we felt really good about that. I think what we want to get in terms of the prepared remarks is to let you know we're going to prioritize taking care of the customer and protecting the orders and organic growth. Recognizing that, we've got work to do to hit our free cash flow objective. No question about it.

Scott Davis:

I don't think I've heard a price -- a specific price number And not asking for anything particularly precise, it can be a range. But of that 15% core was -- it's been running typically kind of a little bit more than half in price. Is that about the same this quarter?

Tom Okray:

Strong growth in volume as well.

Craig Arnold:

Yes. First of all, I'd say our end markets are doing very well. And so a lot of what we're seeing today is, in fact, a reflection of just heightened industrial activity, heightened investments in manufacturing. We talked about these big investments in things like semiconductors, new plants for building EV factories and new factories for building batteries and investments in grid hardening. And so in many cases, the markets that we're participating in are really strong markets right now. Having said that, I would say that our customers would like to build some more inventory, and that's -- and today, they're not. And we're not seeing any evidence at this point at all more broadly of overstocking in the distribution channel. There is some nervousness in the marketplace today around I need to get a place in line. And so as we mentioned before, we're probably getting orders a little bit earlier in the process than we would normally get an order. So we're getting more lead time. But in general, and you can see it in some of the distributor data as well, our distributors, their sales out are very strong. If you look at some of the big electrical distributors in the numbers that they reported.

Julian Mitchell :

I think just firstly, I wanted to focus on the fourth quarter for a second. So it looks like you're assuming kind of flattish sales sequentially and margins down maybe 50 bps or so. It seems like that's very concentrated in the aerospace division, where there's kind of a big margin reversal versus what you saw in the third quarter. Maybe just clarify that, please, on ARO and if there's anything else kind of going on sequentially on margins in the segments.

Julian Mitchell :

And then just my follow-up, I suppose, would be around kind of volume growth. As you said, it's been healthy in the third quarter. So assuming it's up, let's say, mid-single digit. As you think about the backlog from here as supply constraints ease, do you think we see an incremental kind of acceleration in backlog conversion into revenues? And so your volume growth could accelerate in the next few quarters even as sales slow down. Maybe just help us understand kind of that work through of orders into revenue volumes as supply chains are moving around?

Operator:

Next, we'll go to Joe Ritchie with Goldman Sachs.

Craig Arnold:

I mean, and as you know, Joe, you've been around the company for some years. We have, in the past, levered up for the right strategic deal. And as an organization, as a company, we tend to have very good cash generation. And so for us, I would say that for the right deal, we'd be perfectly willing to lever up and go to the same levels that we've been at historically. I will tell you that those deals are not right in front of us today. And so I just -- I don't want to be -- I don't want to set an expectation around some near-term transaction that's going to require that we lever up, which are likely to see from us are deals that are very much consistent with what we've done recently in terms of kind of bite-sized transactions that we can fund largely out of cash without the need to lever up and do larger transactions. But that's just a reality of the marketplace and the type of deals that we'll likely do. But at the same time, if we could find a bigger, more strategic one, we certainly would be willing to lever up in order to do it.

Joe Ritchie :

Got it. That's helpful. And then maybe just my follow-on question. I know Julian was trying to get at this as well. So maybe I'll focus my comments on the Electrical Americas business. It's hard to like get our head around like your backlog doubling year-over-year at a time when you're growing, call it, mid-teens this year in this business. It seems to suggest that for 2023, you kind of set yourself up for another year of double-digit organic growth. And so just maybe just help us kind of contextualize that or frame it just for the -- just for your Electrical Americas business.

Tom Okray:

I think the end market forecast, coupled with the secular trends chart at the beginning of the presentation, these secular trends are real. And we are seeing order flow and backlog consistent with that. And I think we're primed for a good run here.