Eaton Corporation plc (ETN) — Q1 2017 Earnings Call Transcript

Good morning. I'm Don Bullock, Eaton's Senior Vice President of Investor Relations. Thank you all for joining us for Eaton's first quarter 2017 earnings call. With me today are Craig Arnold, our Chairman and CEO, and Rick Fearon, our Vice Chairman and Chief Financial and Planning Officer. The agenda today, as typical, will include opening remarks from Craig highlighting the results in the quarter along with our outlook for 2017. As we've done in our past calls, we'll also be taking questions at the end of Craig's comments. The press release from our earnings announcement this morning and the presentation we'll go through today after some initial technical delays were posted on our website at www.eaton.com. Please note that the press release and the presentation do include reconciliations to non-GAAP measures. A webcast of this, today's call will also be available for replay after the call. Before we get started, I do want to remind you that our comments today do include forward-looking statements and the actual results may differ from those, and that any of those risks and uncertainties are outlined in our related 8-K that's filed. With that, I'll turn it over to Craig.

Thanks, Don. Hey, we're very pleased with our Q1 results. As you've seen, net income and operating EPS came in at $0.96 per share, which is 13% above the midpoint of our guidance, which was $0.85 a share. We are especially pleased to see the return to positive revenue growth in the quarter. This quarter represents the first quarter in over eight quarters where revenue growth is positive and reflects improving market conditions in many of our businesses with real acceleration in the month of March. Organic revenues were up 2%, with ForEx being a negative 1% in the quarter. Segment margins were 14.4%, and we'll speak in more detail about this later in the presentation, but excluding restructuring costs of $17 million in the quarter, segment operating margins were 14.8%. We also had very strong cash flow in the quarter of $463 million, which was a Q1 record. This does include a $100 million contribution that we made to our U.S. qualified pension fund in the quarter. In addition, we repurchased $255 million or 3.6 million shares in the quarter and increased our quarterly dividend from $0.57 to $0.60 per share, and we announced this back in February. Turning to page 4, we've outlined the major drivers of the Q1 EPS results which exceeded our guidance, which we, as you'll recall, was $0.85 at the midpoint. The real story here is revenue. Organic revenues were up slightly below 2%, but approximately 3 points higher than our original guidance. As you'll recall, our guidance for net revenues was going to be down 1.5%. FX was also 1% less negative than our original guidance of 1.5%. Total restructuring costs in the quarter were actually $20 million, with $17 million of that in the reporting segments, which was about $6 million lower than our original plans. We'll talk more about the restructuring program for Q1 and the remainder of the year later in the presentation. Finally, total corporate expenses were up about $0.02, driven largely by pension expense in the quarter, which was slightly higher than we anticipated. Overall, we think it was a very strong performance really led by the increase in volume. Quickly looking at the segment income statement. As we mentioned, organic growth was up 2%, driven principally by strength in Hydraulics and Electrical Products segments offsetting about 1% negative FX overall. Segment operating profits were up 4% or $30 million in the quarter to $700 million. Excluding the impact of restructuring costs, segment margins were down about 30 basis points from Q1 of 2016 but at 14.8%. As we discussed when we provided guidance for Q1, we did see commodity cost inflation in the quarter that largely offset some of the additional restructuring benefits that we would ordinarily have seen flow through. We do expect this issue to wash out by the time we hit the second half of the year. So we see it as largely a first half issue, and between the work that we're doing around cost and pricing, we don't expect to see this impact linger into the second half of 2017. Overall, restructuring expenses declined from $63 million in Q1 2016 to $20 million in Q1 2017, with a portion once again reflected in the segment results declining from $59 million to $17 million respectively. Turning to the Electrical Products segment, revenues were up 2%, with organic revenues up 3%, so you have 1% negative FX. Revenues were up in all regions, consistent with the pattern that we've been seeing, where we saw strength in residential products and lighting. What's really new this quarter is the strength that we experienced in industrial controls, particularly in the European market. Orders were up 3% in the quarter. We saw growth in the U.S. and in Europe. Residential products were up low double digits. Lighting was up low single digits. Industrial controls were up low single digits. Areas of strength were particularly offset by some weakness that we saw in single-phase power quality, largely a result of a one-time order that we had in Q1 of 2016. Order growth in Q4 2016 was also up 3%, so this is really a continuation of the pattern that we've seen in our Electrical Products segment. We're also very pleased with the operating margins at 17.4%, or 17.6% excluding restructuring costs, up some 50 basis points over Q1 2016. Looking at Electrical Systems and Services, organic revenues were flat in the quarter, and we see this as really good news after eight quarters of consecutive revenue declines. ForEx was down 1%. Sales in the quarter continued to be impacted by weakness in what we call large industrial projects and in the oil and gas segment, very much consistent with what you've likely seen from others. Regionally, we saw strength in Europe and Asia. We also experienced strength in the Americas in commercial assemblies and in three-phase power quality. Our orders in the quarter were flat. We saw notable order strength, however, in Asia, offsetting continued weakness in the Americas and Europe. I will point out though, flat orders in the quarter compare to a 7% decline in Q4 of 2016, so perhaps an inflection point. Margins were down 30 basis points year-on-year to 11.6%, down 90 basis points to 11.8% when excluding restructuring costs. We continue to experience a negative margin impact as large industrial projects and oil and gas remain weak in this segment. On to Hydraulics, perhaps the biggest story in the quarter, as it appears that markets are showing significant improvement. Organic revenue was up 9% in the quarter following strength in orders that we noted in Q4, and orders were up 22% in Q1 on strength we saw in really all regions of the world, particularly strength in Asia followed by Europe. The order strength really extended both to the OEM and the distribution channels, with both up double digits, showing a broad-based strengthening in our Hydraulics business. Segment operating margins continued to improve. They were up 280 basis points over Q1 of 2016 at 10.2%, and excluding restructuring costs, up 150 basis points year-on-year to 11.8%. This improvement reflects the continued benefit we're seeing from the restructuring program, but I’d also note that it's been somewhat mitigated by a regional mix impact from stronger revenue growth in Asia-Pacific where margins tend to be modestly below those in North America. Turning to Aerospace, organic revenues in the quarter were down 1%, with foreign exchange down 3% in the quarter. This is primarily a function of the weak British pound, where we have a major presence. We experienced weakness in military aftermarket and military rotorcraft, bizjets, and regional jets, which is consistent with what you've heard from other companies. However, this was offset by strength that we continue to see in commercial transport and also in commercial aftermarket. Orders were up 2% in the quarter on strength in commercial transport, commercial aftermarket, military rotorcraft, and bizjets, and this was particularly offset by weakness in military transports and fighters, and particularly in customer reimbursed engineering expenses. Excluding those, orders were actually up 6% in the quarter. We see that as an encouraging sign in our Aerospace business, and we continue to see strong margin performance out of the segment, with operating margins at 18.5%, or 18.7% when excluding restructuring costs. Lastly, in our Vehicle segment, organic revenues declined 2% in the quarter, largely driven by weakness in NAFTA heavy duty production, which was down some 20% in the quarter. You'll recall that in 2016, the year started quite strong but weakened significantly as the year progressed, so the comps do get easier from this point forward. We’d expect that Q1 was our most challenging comparable versus last year. Margins in the quarter were at 13.7%, 14% excluding restructuring, down about 240 basis points from the prior year. While largely consistent with our guidance, margins were below normal for two unusual items. First, we're ramping up the Procision medium duty transmission, and volumes are not yet at scale. We’re still running some inefficiencies there. Second, we had a warranty issue in the quarter, that also depressed margins. We expect things to improve from this point forward. Page 11 is a summary of the revenue guidance for the year, and as a result of strength we experienced in Q1, we're increasing our growth expectation in three of our segments: Electrical Products, Electrical Systems and Services, and Hydraulics. In all three businesses, revenues and orders came in above expectations in Q1, and we've generally seen better than expected conditions in several of the end markets that are important to each of these businesses. We're increasing, at the midpoint then, our guidance for Electrical Products by 1 point, in Electrical Systems and Services by 2 points, and in Hydraulics by 6 points. Our view is unchanged for the other two businesses. These three changes will take the midpoint of guidance for Eaton up 2% for the year, which is 2 points higher than our prior guidance. Now turning our attention to restructuring, we thought it would be helpful to provide more guidance on the pattern of restructuring spending for the remainder of the year since the pattern of this year's spending is somewhat different than what we've seen in prior years. If you'll recall, we pulled forward $70 million of spending originally planned for 2017 into Q4 of 2016, which resulted in our Q1 spending being somewhat lower than it would have otherwise been, with a step-up in restructuring beginning in Q2. We outlined this plan on page 12, our expectations for spending for the entire year. Consistent with prior guidance, we expect to spend $100 million this year, and we'll obtain $155 million of incremental benefits in 2017 over 2016. In Q1, we spent $20 million, modestly below our plan of $26 million, driven primarily by the timing of a couple projects that were shifted into Q2. In Q2, we plan to spend $40 million, with the remaining $40 million for the year planned in the second half. Overall, our restructuring plan remains on track. As we reported earlier, we expect, on an all-in basis, the program to cost $440 million and to see benefits of approximately $520 million. Page 13 is a summary of our segment margin guidance for the year. In Hydraulics, due to strength that we're seeing in markets and higher volumes that we now expect, we're raising the midpoint of our guidance by 40 basis points. Overall, other than Hydraulics, we think that each of our businesses are within the margin ranges that we guided to for the year. Due to the relative size of the Hydraulics business, the change in Hydraulics margins does not change the overall margin guidance for the company for the year. Another point I’d like to clarify, as a matter of practice, we would intend to change our margin guidance only when we believe our performance will be outside of the ranges provided. This holds true for each of the business segments individually and for the company overall. On page 14, we've provided the customary summary of our guidance for both the year and subsequent quarters. As we've covered most of these numbers in prior slides, I'll just summarize by indicating what's changed. First, a $0.15 increase in the midpoint of our guidance, with a new range of $4.45 to $4.60, a 2-point increase in the midpoint of our revenue guidance. Also, a change from our prior guidance, we think FX will be negative $150 million for the year, which is down from our prior guidance of $300 million, and all other items remained unchanged from prior guidance. Turning to Q2, we expect EPS to be between $1.05 and $1.15, with a midpoint of $1.10, organic revenue growth to be up 1% to 2%, and negative FX to be negative 1.5%, with segment margins between 15.2% and 15.6%, including restructuring costs. Lastly, a tax rate of between 8% and 9%. This guidance does not include any impact from the recently announced joint venture with Cummins, as we continue to expect it will close sometime in Q3. Lastly, page 15 is a summary of the key points covered in today's presentation. To close, we're encouraged by the signs of improvement we're seeing in several of our end markets, and we generally feel better about growth prospects for the year. We expect this to translate into higher EPS, and that’s our expectation reflected in our guidance. Our cash flows remain strong, our share repurchase plan is on track, as is our restructuring program. We remain cautiously optimistic that 2017 continues to represent a turning point for several of our end markets and for our company. I'll stop there and turn it back to Don.

The operator is going to provide us instructions for the question-and-answer session.

Our first question today comes from Scott Davis with Barclays.

Hi. Good morning, guys.

Good morning.

It's nice to see the Hydraulics numbers pick up so quickly, but I have to ask, can you satisfy demand that quickly in a segment you've been restructuring aggressively? I assume your supply chain is ready, and are you comfortable you can ramp up production fast enough?

Yes. The short answer to the question is, Scott, it will certainly take a concerted effort and good execution by our team. But we're ready for this turn. We've been living, as you know, in down markets in Hydraulics for the better part of three years, and so our team is ready, willing, and able to take on the volume challenges we're facing. At this point, we're comfortable that Eaton, and we're working through our supply chain to make sure that they're ready as well. But our team is ready for it.

Okay. Fair enough. And just on ESS, regarding the oil and gas markets, specifically pointing to commonly oil and gas markets negatively impacting margin. I assume part of that is Crouse-Hinds. But help us understand the mix of your oil and gas operations onshore versus offshore and if you expect that to come back in Q2. A lot of your peers have already seen a somewhat meaningful snapback, at least in the onshore stuff that’s short-cycle.

Yeah. Scott, it's Rick. Our mix historically has been more downstream than upstream, so we aren't as impacted by improvements on the upstream side. We have not really seen our upstream activities accelerate at this point. We're looking for it. We have seen a little bit of improvement in MRO in the harsh and hazardous space and even in the industrial controls that go into some of the onshore rigs particularly. But we have not seen any broad-based pickup yet on the project side.

Okay. Fair enough. Good luck, guys. Thank you. I'll pass it on.

Thank you.

Our next question comes from Joe Ritchie with Goldman Sachs.

Good morning. This is actually Evelyn Chow on for Joe. Maybe just turning to ESS for a second; very encouraging to see some incipient signs of stabilization or recovery. But it looks like the project business hasn't picked up much yet. Does your higher organic guide imply any acceleration there? Or is it flowing through things as status quo?

Yes, at this point it does not. I mean, we came into the year with what we'd say is a relatively well-grounded assumption regarding the way large projects would unfold through the year, and to date, I'd say it's largely playing out the way we anticipated. We do not have a return to growth in large projects built into the second half of the year.

That's helpful context, Craig. And then maybe just turning to price costs for a second. Totally understand the dynamic of things normalizing, but in the second half, just wanted to see how that squared with your previous expectation of about $80 million of material inflation in 2017.

Yes, appreciate the question. Certainly, as you pointed out, we did come into the year anticipating about $80 million of uncovered commodity price inflation that we would experience in the business and we'd indicated that would be largely a first-half issue. And that's largely what we've seen. We saw it certainly come through in Q1. We came into the year with an expectation that commodity prices would start high and we'd see some mitigation in commodity prices as the year unfolded. That is still largely our belief that number one, commodity prices will probably mitigate as the year unfolds, but more importantly, we'll have some time under our belt, and we'll have essentially been able to offset this commodity price with price increases in the marketplace. That is largely still our anticipation. It is mostly a second-half event, and that is the plan our teams are currently executing towards.

Thanks, guys. Congrats on a good quarter.

Thank you.

Our next question comes from Ann Duignan with JPMorgan.

Hi. Good morning.

Good morning.

Hi.

Could you just give us a little bit more color on the Hydraulics business, specifically on the orders? If you could break out maybe by region, mobile or construction versus agriculture, mobile versus distribution, and then just around the world. And then a follow-up, Craig, you highlighted the industrial controls in Europe being up. If you could just give us a little bit more color on that also, I'd appreciate it.

Yes, I'd say, Ann, if you think about Hydraulics orders, and you obviously know this market well, what we've seen is largely a relatively pronounced snapback beginning in the Asia-Pacific region, largely in mobile markets. Those markets have been down and down hard over a period of multiple years. The biggest strength we're seeing today inside of Hydraulics is coming out of the China market and largely coming out of the mobile market on the construction side of the business. Having said that, Europe was also quite strong and stronger than what we anticipated. A lot of the growth was in the mobile segment, but we also saw strength in the industrial segment as well. In general, the recovery in Hydraulics has been relatively broad-based, but principally led by mobile construction. Additionally, we find it encouraging that both the OEM channel and the distribution channel are similarly growing, with the distribution channel not building inventory at this point in the cycle.

And the comment on Europe industrial controls, Craig.

Yes, I think we see that more broadly. As I mentioned in the commentary, what's really changed today in our Electrical Products business is the fact that we're seeing pretty broad-based strength in industrial controls. I would argue that a lot of that strength is a function again of what's happening in the China market. As those markets continue to improve, we're seeing industrial controls in Europe pick up a lot of the equipment that actually flows into China. Even in the domestic market, we're continuing to see strength in industrial controls. It’s too early to say exactly how this unfolds long-term, but certainly a broad-based showing of strength in industrial controls during Q1.

Is that fair to say, Craig, just the ISM PMIs in Europe have been strengthening? GDP in Europe is strengthening. Is that underlying what you're seeing over there?

Yes. We're certainly seeing perhaps even more underlying strength in many of our end markets than the PMIs would suggest, and industrial production would suggest. This tells us perhaps some of that is also tied to what's going on in markets outside of Europe, particularly in China. But in general, what we've seen across each of our businesses and generally seen in industry is that Europe turned out to be much stronger than most of us anticipated.

Okay. Yes. That's what I was thinking you would say. So I'll get back in line. I appreciate the color.

Thanks, Ann.

The next question comes from Julian Mitchell with Credit Suisse.

Hi. Morning. Just one more on ESS, I'm afraid. I guess this question really surrounds the margin progression through the year. The margins were down a bit in the first quarter with flattish sales, so when you're thinking about your guidance for up margins for the year as a whole, is that because you see your backlog today, which gives you six to nine months of visibility? Or is it really just basic stuff around the restructuring charges comp from late 2016 and the commodity cost headwind abating in the second half, that sort of thing?

Yes. I think, Julian, it's more the latter. We've been undertaking a fairly significant restructuring effort in our Electrical Systems and Services business, and those benefits certainly improve as the year unfolds. Secondly, we talked about the commodity inflation issue we're dealing with, and so we certainly saw in our Electrical Systems and Services business, like we did for the balance of the company, we saw commodity price inflation that we were not able to offset with price increases or other cost-out measures in Q1. That begins to mitigate itself as the year unfolds, too. We think it's largely those reasons why we're confident margins will improve in Electrical Systems and Services. Volume typically grows, and we tend to be more back-end focused in Electrical Systems and Services from that standpoint, which will help margins as well.

Thanks. And then just switching over to Vehicles, you had a nice sequential increase in revenue in the first quarter, so back to some sort of normal seasonality, perhaps. Could you discuss your expectations for the balance of the year in terms of truck versus light vehicle? A lot of companies had a very strong first quarter for the light vehicle supply chain. To what extent do you think that persists? Any color you can provide on the truck side and the OEM build rate plans?

Yes. Firstly, regarding light vehicle markets around the world, they continued to perform and hold up very well. Quite frankly, we were surprised by the size of the strength in certain markets, mainly in Europe, where markets were quite strong in Q1. At this point, we believe there's no reason to suggest that light vehicle markets around the world are going to turn out to be any different than what we anticipated when we set our plan for the year, which was to be essentially flat to up slightly. We remain convinced that this forecast will hold true. Regarding NAFTA heavy-duty production, if you look at the production schedule from last year, it was a year where we started quite strong, but we saw weakness in the back half. Most indicators are that the NAFTA Class 8 market is strengthening. Q1 represented our most difficult comparable where production was down 20%, so we think things will improve from this point forward. Our forecast for the NAFTA Class 8 market remains flat for the year. Several forecasts are out there, some lower and some higher, but we remain confident that flat is the right call for 2017.

In the context of flat, this is how we think about the market. Or at least ACT data indicates that production was 51,000 units in Q1, and by the time you reach the back half, we project production per quarter will be in the neighborhood of 60,000 units, leading to flat results. If you examine the build plans we collect, they are planned to a bit more than flat, but we think it's too early to make that firm conclusion.

And the build plan typically is above the market, so it would be very consistent with historical patterns.

Very helpful. Thank you.

Our next question comes from Nigel Coe with Morgan Stanley.

Thanks. Good morning, guys. I just wanted to dig into lighting. Obviously, we've seen a couple of your big competitors in North America report somewhat disappointing trends. Your quarter had low single-digit growth in orders. I'm just wondering if you could shed some light on lighting pricing and any impact on margins this quarter from price pressure.

The way I'd characterize the underlying performance of our lighting business is this continues to perform in line with patterns we've seen. A lot of lighting is going into non-res construction, into commercial buildings and residential housing. We believe lighting performing up low single digits is consistent with market trends and what we expect going forward. Regarding margins, we continue to see the price of LED underlying technologies coming down. That's largely being passed on to the marketplace, allowing us to continue to get cost efficiency in lighting. That is largely in line with the underlying reduction in the input costs, and our underlying margins overall in our lighting business actually continued to improve.

Yes. I think the NEMA data indicates lighting will be flat to down this quarter. Anything in your footprint—new construction versus replacement, or residential versus commercial and industrial—that would explain that performance? Or do you think you're gaining share like-for-like?

Right. If I could just make a comment, Nigel. The NEMA data is not inclusive of the entire market, so it's a subset of the participants. Take that data with a grain of salt. As we create our own index of the lighting market, we use the NEMA data and estimates of what other participants likely did, and we believe the market is growing in the low to mid single-digit category.

We'd be disappointed if we weren't gaining a little share. That's certainly the expectation.

Right. Okay. That's interesting. And just a couple of quick ones. Rick, why would the second half tax rates be higher? That's obviously what's embedded in guidance. And then maybe just call out the impact of the warranty true-up this quarter in Vehicle.

The tax rate is largely this year, is a function of the mix. As we see seasonally higher growth and also seasonal higher earnings in the U.S., that typically pushes the rate up a bit, as well as in Brazil. We expect that economy to improve as we continue throughout the year. That's the major impact. If you're asking about the warranty impact in the truck, in the first quarter it was about $6 million.

Okay. That's great. Thanks.

Our next question comes from Jeff Sprague with Vertical Research.

Thank you. Good morning, everyone. Just one follow-up on lighting. Was there a distinction in your growth rate between non-res and residential, or between large projects and smaller projects on the non-res side?

Yes, Jeff. I don't really have the data. I don't believe there was, but we can certainly take that as a follow-up and Don can follow up with you after the call. I don't believe we saw any significant difference in our performance. Large projects in general are pretty much following the pattern we've seen. In general, there are fewer very large industrial projects, but that’s not what drives most of our lighting business. It's more the commercial projects and street lighting and residential, and we haven't seen any significant difference in sales or orders in those segments.

Okay, great. And just talking about the margin guide not moving; I'm wondering if there's some headwind. My rough math indicates 2 points of organic growth at a 30% incremental is around 60 bps of margin, and your margin guide range for the year is 60 bps. It seems like the better revenue should have knocked you outside of the range. Is 30% incrementals at this sales level not the right number, or is there something else you could point to?

I'm not sure what the calculus you’re doing, Jeff, but in our own calculus, reflected in our guidance, we think we are still within the range, and that's the basis for the guidance we provided. We don't think the volume changes and the other assumptions take us outside the range we indicated.

Okay. All right. Thank you. I'll follow up.

Our next question comes from Steve Volkmann with Jefferies.

Hi. Good morning. Thanks for taking the question. Curious about your thinking now that Hydraulics looks like it's clearly bottoming and getting better, how do we think about what sort of more normalized margins in that segment might look like, given all the cost saves you've done?

What we've said, Steve, about Hydraulics is that if you think about this business, we established a range of profitability of 13% to 16%. Even at the bottom of the economic cycle post-restructuring, we believe that's the very minimum that you could expect to see from this business. We're still very much convinced this is the case. From that point forward, you can expect margins to ramp from where we are now, and to expect pretty good incrementals. At this point, we're not prepared to go outside those established ranges. We have to prove we can sustain that. That's still where we are parked on the business: a range of 13% to 16% through the cycle.

Okay. Great. And then I think, Craig, you mentioned in the outset that the cadence of the quarter was positive, with March being a big month for you. I don't want to put words in your mouth, but I'm curious as you look at that; it sounds to me across the board that North America was the weaker of all the geographic markets. Are you seeing signs that North America is starting to participate in the green shoots we're observing?

I think it's accurate, first, to say that we saw an acceleration in the rate of growth in March, and that was pretty much across the board in all regions and all businesses. I will say regarding the U.S. market compared to the rest of the world, we continue to see more robust growth outside the U.S., and that pattern is really continuing.

Great. Thanks so much.

Our next question comes from Chris Glynn with Oppenheimer.

Thanks. A follow-up on tax rate: I think your long-term outlook expects roughly a 1-point increase a year. If the mix progression is as you expect going into the second half outlook, would we be looking at a little bit greater magnitude of tax rate increase for 2018?

Wow, that's, yeah, I haven't looked at that specifically. The biggest mover on our rate is the mix, with the U.S. and Brazil having the highest tax rates. I don't know what the tax rate is likely to end up with after the administration completes its work in the States. If Europe and Asia continue to grow faster than the U.S., then no, you wouldn't have a negative mix impact on the rate. If that flips and the U.S. accelerates, perhaps due to infrastructure programs or a tax cut that increases business investment, then yes, you might see the rate edge up a little faster.

Our next question comes from Andrew Krill with RBC.

On the lower restructuring in the quarter, could you give more specifics on which segments saw less than planned?

Andrew, we didn't catch the first part of your question.

Caught that in the middle. Can you repeat it?

Sorry. On restructuring. Could you provide specifics on which segments saw less than expected, and did this have anything to do with trying to avoid interrupting any orders on the verge of a possible recovery?

Yeah, it’s a $6 million delta from the original plan. Most of that delta was in the Electrical side of the house.

In Systems and Services, really. Projects we thought could get done but were moved into Q2.

Right. It had nothing to do with interrupting orders. It was simply our ability to finish and book everything in the quarter.

Got it. And then with demand seemingly on the verge of a recovery broadly speaking, is there a chance you may not need to complete all the restructuring you currently have planned?

What I'd say is that much of what we're doing is making structural changes to the businesses, fundamentally lowering our structural costs inside the company. That doesn't prevent us from flexing our businesses and growing as volumes increase. We believe this restructuring plan, independent of volume, is the right plan and positions our businesses to deliver higher margins through the cycle.

Great. Thank you.

Our next question comes from Rob McCarthy with Stifel.

Hi. Rob McCarthy here. I guess my first question is just an update on your outlook for M&A as a whole. Craig, when we spoke in February, you cited expensive valuations across the board. That's continued, seen in the slow rate of global M&A overall. Rick, there was some concern about achieving cost synergies particularly as people are more protective of their employees. Could you discuss how you view the M&A environment now? Is it incrementally worse? Does this urge you to think of doing other things with your cash right now?

Yes. I'll take that, Rob. Valuations are still high. However, earnings growth is accelerating, improving how we view these valuations. In recent months, we've encountered more situations where a sale could be possible. We are certainly more active in exploring opportunities. It’s hard to know what we might get done. We have a history of completing significant acquisitions and we believe we're skilled in that area, so we're dedicating more time to pursuing opportunities. Regarding synergies, it's challenging to determine the impact of institutional constraints on achieving cost synergies. Commentary surrounding that has subsided a bit, so we'll evaluate each situation on its merits regarding synergy potential.

Okay. And just any kind of, I might have missed this, but any update on the joint venture with Cummins, and the messaging surrounding that? I think there was an update today. Anything incrementally you want to add?

Yes, I'd say not really. In the call we had earlier, we laid out the strategic rationale for the joint venture and we’re excited about the prospects it will add to accelerate the growth rate in our automated transmission businesses. We do expect the transaction will close in Q3. There are seven antitrust filings we have to manage and are our long lead time item that we’re working through. We remain optimistic that Q3 is the right timing, and it strategically advantages our transmission business going forward.

Thanks for your time.

Okay. Thank you.

Our next question comes from Andrew Obin with Bank of America.

Yes. Good morning.

Hi.

Yes, just a question on the Hydraulics business: A, do you think you can continue to post positive order growth through the end of the year? And B, if you look at the normalized volume for this business, how does that compare to normalized volume: 80%, 70%, 60%?

Yes, Andrew, I think that's the $64,000 question concerning the future and if we’re at a key turning point in Hydraulics markets. Based on history, those of us who've been around this industry for a long time know you typically go through long upcycles. All indications suggest we're at the front end of an upcycle in Hydraulics. Thus, we expect orders to be positive throughout the balance of the year, but let’s see how Q2 unfolds. We remain cautiously optimistic that will be the case. As for normalized volume, I’d say we’re probably still about 25% below what we'd call normalized volume for those markets. We have a long way to run before achieving what would be considered normal market activity.

And just to follow up on Hydraulics, historically you've had strong exposure to agriculture. Can you provide some color, what you're seeing in those markets, and how much it's contributing to the order strength? The construction side is more apparent.

Yes, we had strong orders in agriculture as well in the quarter, Andrew. One comment I’d like to add regarding the order pattern across the year is that there’s a question concerning whether the very strong orders in China will continue. For instance, excavator sales are up dramatically, and that is one factor that could see improvements in the second quarter but could come down slightly. The growth remains positive, but perhaps not as positive as it was in Q1.

Okay. Thank you.

Our next question comes from Andy Casey with Wells Fargo.

Thanks. Good morning, everybody.

Good morning, Andy.

Hi.

Near-term question, and you may have just answered it, Rick; the Q2 revenue guidance implies, while including 1% to 2% organic versus 2% in Q1. Clearly it's slight, but it implies a deceleration. I'm trying to understand the drivers behind that. Is it end market, like the China comment you just made? Or is it something else, like fewer business days?

The first quarter rounded up to 2%, but was between 1.5% and 2%. Our guidance for Q2 really implies a very similar kind of organic growth in Q2 as Q1.

Another point I would add is that part of the hesitance you’re seeing from us and others relates to the strong month of March. It raises the question of how much of that was due to Easter falling in April this year versus March—normalization might occur. Therefore, we're hesitant to make a more robust call because March contributed significantly to the quarter.

Okay, Craig. I’m going to take the bait in that response. It’s somewhat related. Eaton has a relatively diverse view of the U.S. market, and based on your comments, March was a strong month globally. We've seen some deceleration in PMIs in the U.S. in April. I’m just wondering if the company has seen any similar deceleration in April relative to March.

No, actually, we haven't at this point. The month of April has unfolded largely as we anticipated, but our guidance indicates we anticipated Q2 would largely resemble Q1.

Okay. Thank you. And then squeeze one last in: just a clarification on ESS. I understand large project activity in oil and gas, you called out as remaining weak. Within that segment, did any end market demand actually get worse? Or is what we're seeing in that commentary more a function of comparisons?

I'd say it's largely a function of comparisons. The three-phase power quality market had some very large orders in the prior year, so you didn't see orders completely replacing those strong orders. Other than that, nothing significantly worsened.

There was some weakness in the Middle East, but that's not a giant part of the business. For example, in Saudi Arabia, there's some softness.

Okay. Thank you very much.

Thank you all for joining us today. With that, I think we're going to wrap up our call. As always, we'll be available to take questions and follow up for the next couple of days. Thank you for joining us.