Eaton Corporation plc (ETN) — Q4 2019 Earnings Call Transcript

Hey, good morning, everyone. I'm Yan Jin, Eaton's Senior Vice President of Investor Relations. Thank you all for joining us today for Eaton's fourth quarter 2019 earnings call. With me today are Craig Arnold, our Chairman and CEO; and Rick Fearon, Vice Chairman and Chief Financial and Planning Officer. Our agenda today includes the opening remarks by Craig highlighting the company's performance in the fourth quarter. As we have done in our past calls, we'll be taking questions at the end of Craig's comments. The press release from our earnings announcement this morning and also the presentation we'll go through today have been posted on our website at www.eaton.com. Please note that both the press release and the presentation include reconciliation to non-GAAP measures. A webcast of this call is accessible on our website and it will be available for replay. Before we get started, I would like to remind you that our comments today including statements relate to the expected future results of the company and are therefore forward-looking statements. Our actual results may differ materially from our projected future earnings due to a wide range of risk and uncertainties that are described in our earnings release and the presentation. They're also outlined in our related 8-K filing. With that, I will turn it over to Craig.

Okay. Thanks, Yan. I appreciate it. And we'll start with Page 3 with our recent highlights. Two weeks ago, as everybody knows, we announced the agreement to sell our Hydraulics business to Danfoss for $3.3 billion, which represents a 13.2 times 2019 EBITDA. This decision is part of the ongoing transformation of Eaton into a company with higher growth, higher margins and more consistent earnings. So we're really pleased with that. We believe this transaction will create substantial value for our shareholders and allow our Hydraulics’ employees, importantly, to become part of a company that has a strong commitment to the hydraulics industry. Our team has made significant progress on other portfolio actions, including closing the acquisition of Souriau-Sunbank and the sale of our Automotive Fluid Conveyance business at the end of the year. The sale of our Lighting business is expected to close in Q1. And as you've read, we just announced the acquisition of Power Distribution, Inc. Power Distribution, Inc. is a $125 million company that serves the data center market and will become part of our Electrical Systems and Services business. Switching to our Q4 results, I would summarize the quarter's performance as one with strong earnings, record margins, and strong cash flow despite a slower than expected growth in our end markets. Organic revenue, excluding Lighting and Hydraulics, was down 2%. Earnings per share of $1.49 on a GAAP basis and $1.46 excluding $0.28 of acquisition and divestiture costs and $0.09 for costs we expect to incur related to vehicle warranty. At $1.46, our results were flat with last year and at the high end of our guidance range of $1.36 to $1.46. Our sales of $5.2 billion were down 4% organically with negative currency of 0.5%, offset by 0.5% from acquisitions. We continue to generate strong margins and delivered a Q4 record of 17.8%, excluding acquisition and divestiture costs and the expected vehicle warranty costs. These margins were above the high end of our guidance range and 40 basis points above the prior year. We're also pleased with our operating cash flows, which were $937 million in the quarter. So stepping back, I think we'd all agree that it's been a busy and a very productive period for Eaton. Turning to Page 4, we summarize our Q4 financial performance and I'll note just a few highlights on this page. First, we increased our adjusted segment operating margins by 40 basis points. And our team executed well and we had decremental margins of less than 10%. Second, our adjusted segment operating profits were $933 million, down 2% despite 4% lower organic sales. Net income of $452 million was down 28% and this was primarily due to acquisition and divestiture costs of $114 million and vehicle warranty charges of $39 million. Both of these numbers, I would note, are on an after-tax basis. Similar to Q3, these strong results are I think a good indication of how we intend to manage the company during periods of market weakness, running our operations efficiently, proactively managing costs and accelerating our share repurchases. Moving to Page 5, we'll start with our segment summaries with Electrical Products. Revenues were down 2%, and excluding Lighting, organic revenue increased 1%. Strength was driven by residential markets in the Americas, our distribution business in Canada. Adjusted segment operating profits increased 9% and adjusted operating margins were up 210 basis points to 20.3%, a Q4 record. The sale of our Lighting business to Signify for $1.4 billion remains on track and we expect to close in Q1. Excluding Lighting, orders were down 2% with strength in residential and commercial construction markets in the Americas, offset by industrial markets globally. Turning to Page 6, we show a summary of our Electrical Systems and Services segment. Revenues increased 4% with 2% organic and 2% from the acquisition of Ulusoy and Innovative Switchgear Solutions. Organic growth was driven by strength in the North America utility and commercial construction markets, primarily. Adjusted segment operating profits increased 7% with adjusted margins of 17.1%, up 50 basis points over the prior year. On a rolling 12-month basis, our Electrical Systems and Services orders increased 2.5% with growth across all regions of the world. Excluding hyperscale data centers, the 12-month rolling average of orders was up some 4%. Yesterday, we announced the acquisition of Power Distribution, Inc., which is a leading supplier of mission critical power distribution, switching and power monitoring equipment for the data center market. Power Distribution, Inc. builds on our strong position in the fast-growing data center market and adds new capabilities in the area of overhead busway and power distribution. We're really pleased with the prospects of what PDI will add to our Electrical Systems and Services business. Moving to Page 7, we summarize our Hydraulics results for Q4. Revenues were down 13%, with orders down 11%. This was driven by continued weakness in global mobile equipment markets and destocking that continues at both OEM and with our distributors. As I mentioned earlier, we're pleased to have announced the agreement to sell the Hydraulics business to Danfoss for $3.3 billion and we expect this transaction to close at the end of the year. We've announced we are retaining our Filtration and Golf Grip businesses. We expect cash taxes from the sale of Hydraulics to be approximately $450 million, so our net proceeds will be approximately $2.85 billion. A number of you have asked how we intend to use proceeds, and I'd say that the options of additional acquisitions and share repurchases are both on the table. For M&A, we would also add that our pipeline remains very active. It's great to have this optionality as we look forward. On Page 8, we summarize our results for our Aerospace segment. Revenues were up 3%, including 2% organic and 1% from acquisitions. We experienced in this segment continued strength in commercial OEMs and in commercial aftermarket. Orders on a rolling 12-month basis increased 6% with particular strength in military and aftermarket and bizjet. Strong execution in this segment led to a 9% increase in adjusted segment operating profits and a 130 basis point improvement in adjusted margins, which were 24.2%. The business delivered another quarterly record, capping what's been a very strong year. We're also pleased to have closed the acquisition of Souriau in late December. We welcome the Souriau team to Eaton, and our integration teams have already begun working to deliver the synergy plans, which includes the opportunity to take our new electrical connectors capabilities into our core electrical markets. Turning to Page 9, we summarize the results for our Vehicle business for Q4. Revenues were down 19% and this includes 18% organic and 1% from currency. Declines here were due to a number of factors: the GM strike, Class 8 OEM orders; Class 8 production was down some 20% year-over-year and continued global weakness in light vehicle markets, which were down 9%. This is a clear example of our 'grow the head and fix the tail' strategy, which is truly about how we've really focused the company. We completed the sale of our Automotive Fluid Conveyance business at the end of the year. During the quarter, we also took a $50 million pre-tax charge for expected warranty costs. This charge is being undertaken to correct the performance of one of our products that incorporated a defective part from a supplier. We're actively looking for ways of recouping these costs as well. Adjusted operating margins were 17%, at a very high level, but down 90 basis points from the prior year. Next up on Page 10, we summarize the results for our eMobility segment. Revenues were down 6%. While growth in electric vehicle platforms was more than offset by weakness in legacy internal combustion engine platforms. Operating margins declined to 1.3% due to a significant step-up in research and development as well as manufacturing start-up costs associated with electric vehicle programs here. I would highlight that since the formation of this segment in the first quarter of 2018, the mature year revenue from new wins is expected to be $450 million, so this segment continues to run ahead of our internal expectations. As you can imagine, we're pursuing a large number of additional programs as the industry continues to make the transition to electric vehicles. Before turning to 2020 guidance, I would like to summarize the results of 2019, which are shown on Page 11. First, we generated all-time record margins of 17.6%, which were up 80 basis points over 2018 excluding acquisition and divestiture costs and the expected warranty costs. Over the last three years, our segment margins have increased 260 basis points, which we see as a strong validation of our strategy. Earnings per share of $5.76, excluding the one-time items I just mentioned, was up 7% over 2018. We set all-time records for both operating cash flow of $3.5 billion and free cash flow of $2.9 billion, with growth of 17% and 20% respectively. Our free cash flow to sales was 13.4%, and our free cash flow to net income conversion was 129%. This continues to be a key strength for Eaton and something that you can expect from us in the future. As we noted, 2019 was a year of significant progress on our journey to transform Eaton into a company with higher growth, higher margins, and more earnings consistency. We closed three deals for $1.2 billion: Ulusoy, Innovative Switchgear in Electrical; Souriau-Sunbank in Aerospace. We announced two divestitures with Automotive Fluid Conveyance closed in 2019 and Lighting scheduled to close in Q1. Our robust cash flow allowed us to return $2.2 billion to shareholders, including $1.2 billion of dividends and $1 billion in share repurchases. I'd also note that we purchased these shares at an average price of $80 a share. Finally, it was a very good year for our shareholders, who had a 43% total return, 50 basis points over the median of our proxy peer. Overall, I'd say another record year and clearly very proud of what our team was able to deliver. Turning to Page 12, we provide our revenue and margin guidance for 2020. Overall, we expect organic growth to be anywhere from down 1% to up 1% with weakness in the first half and a bit stronger in the second half as a result of easier prior year comps. Beginning with Electrical Products, we expect to see 1% to 3% organic growth with continued strength in residential and data center markets, flat commercial construction markets, and continued weakness in industrial markets. In Electrical Systems and Services, we anticipate zero to 2% organic growth with strength in utility markets, flat commercial construction, and weakness in industrial facilities and particularly in oil and gas markets. For Hydraulics, we're forecasting organic revenue declines of 4% to 6% driven by weakness in global mobile equipment markets, and in Aerospace, we expect organic growth of 2% to 4% with continued strength in military OEM markets and solid aftermarket growth for both commercial and military markets, partially offset by expected weakness in commercial OEM markets. For Vehicle, we see organic revenue declines of 7% to 9%, mostly due to the 33% decline that we're forecasting in NAFTA Class 8 truck markets, but also some weakness in global light vehicle markets. For eMobility, organic growth is expected to be up 3% to 5%. We're seeing double-digit growth for our electric vehicles markets, offset by some modest declines in internal combustion engine platforms. Now turning to segment operating margins and operating margins for Eaton, we expect Eaton to be 17.8% to 18.2% at the midpoint, a 40 basis points improvement from 2019 and in taking a look at our segments, Electrical Products we think will be 21.2% to 21.8%. At the midpoint, 180 basis point improvement from 2019 and this is primarily a result of the Lighting divestiture. For Electrical Systems and Services, we're forecasting 16.4% to 17%, up 10 basis points at the midpoint. Hydraulics at 11.7% to 12.3%, up 80 basis points at the midpoint. Aerospace at 22.9% to 23.5%, down some 110 basis points, largely due to the acquisition of Souriau. Vehicle we expect it to be between 15.7% and 16.3%, down 80 basis points largely as a result of lower volumes, and eMobility at 2.5% to 3% as we continue to invest heavily in R&D and start-up costs and new manufacturing capabilities. On Page 13, we pick up the balance of our 2020 guidance, and here I'd say we expect full year adjusted EPS to be between $5.60 and $5.90 at the midpoint of $5.75. This is essentially flat with 2019 when you exclude the one-time items noted on previous slides. Organic growth is expected to be essentially down 1% to up 1% with acquisitions adding 2% and divestitures negatively impacting sales by 7.5%. We expect our corporate costs including pension, interest and other corporate costs to be flat with 2019 levels and our tax rate to be between 14.8% and 15.8%. Operating cash flow is expected to be between $3.4 billion and $3.6 billion and CapEx of approximately $550 million. With strong cash flow plus the proceeds from the Lighting sale, which we think will be $1.4 billion, we plan to significantly increase our share repurchases and at this point, we expect to spend between $2.4 billion and $2.8 billion in share repurchases. If I can just summarize our Q1 guidance, we expect EPS to be between $1.16 and $1.26; we expect organic revenues to be down 3%, 2% from acquisitions and 3% from divestitures; segment margins are expected to be between 15.8% and 16.2% and our tax rate should be between 15% and 16%. Overall, I'd say we expect really another solid year in 2020 with strong margins and cash flow. We have a lot of confidence in the Eaton business system and our ability to continue to execute strongly. We think the changes that we've made and announced will position Eaton for higher growth, higher margins, and better earnings consistency as we go forward and with our strong cash flow and proceeds from the Hydraulics sale, we have outstanding optionality to create additional shareholder value. So with that, I'll stop there and turn it back over to Yan for questions.

Hey, thanks, Craig. Before we begin the Q&A section of our call today, I think that we have a number of individuals in the queue with questions. Given our time constraint of an hour, please limit your opportunity to just one question and a follow-up. Thanks everyone for your cooperation. With that, I will turn it over to the operator to give guys the instruction.

Hi, Jeff.

Okay. Hey, two things for me. First, on Hydraulics, given just kind of the slippery slope that the end markets are on, certainly great to see it go at that valuation. But are you guys subject to any kind of holdback or performance that could affect the ultimate price that you receive for the assets?

Yes. No, Jeff, we're not. I mean, and I think we actually posted our documents. And so that information is certainly available for public consumption. The $3.3 billion number is firm, and we fully expect to close, as Danfoss has also agreed to take whatever remedies would be required in order to ensure that the transaction closes.

Great. And just a guidance question, too. I was just wondering about ESS specifically, zero to 2%. Does that sort of imply you're going to be up a bit in the first half and then down in the second half? Or how do you see that really playing out relative to what's going on in your backlog?

I think we see it almost, Jeff, just the opposite of that. Given what we've seen certainly in our order intake and negotiations, we think that the back half of the year will be slightly stronger than the first half of the year. As we take a look at what we're experiencing today, one of the reasons why we guided to our overall revenues being down 3% in Q1. We do think at the back half of the year, we'll be slightly stronger. A lot of that is a function of easier comps when you look at the year-over-year comparisons. From an EPS standpoint, we're pretty much well balanced in terms of where we've been historically, where some 47% of our EPS is generated in the first half of the year and 53% in the second half. That’s very much consistent with our guidance this year as well.

Great. Thanks for the color.

Good morning, everyone.

Hi.

Craig, maybe just starting off on Hydraulics, and congratulations there, obviously. I guess as you think about the pipeline, you mentioned it’s very active. I'd love to hear how you're thinking about potential prioritization of acquisitions? And then also, you've been very active from a divestiture standpoint. Are we done at this point?

Yes. I appreciate the comment, Joe. As I mentioned in my opening commentary, we think it's an outstanding outcome for all parties. It's great for Eaton and our shareholders, outstanding for our employees, and great for Danfoss as well. The priority for us really hasn't changed. What we've said historically is that our priorities, from an M&A perspective, continue to be growing our Electrical business, Aerospace, and also selectively, we're looking at things that we could potentially do in this new space for us called eMobility. Those priorities really have not changed. As I mentioned in my commentary, we are seeing today a more active pipeline than we've seen historically. We think about the optionality of what we do with that cash; certainly, M&A is an option, and buying back shares is another option. We’re comfortable with where we sit in terms of making sure that we maximize shareholder value as we think about how we deploy those proceeds.

That's helpful. And then just one quick one on Aero. I don't recall you guys having much exposure to the MAX. But can you maybe just talk about that specifically as it relates to your guidance, and also how you think about margins in the Aero segment as well in 2020, just given the strength in 2019?

Yes. I think the MAX is an important program for Eaton as well. I think anybody in the aerospace industry; the MAX is going to be an important program for them. Our content tied to the MAX at the OEM level is, order of magnitude, just north of $100 million. What we've done as a part of the Aerospace forecast in our guidance is we've essentially taken what Boeing has given us in terms of their current build schedule, and that's what's reflected in our Aerospace guidance. One of the reasons why we're not seeing more robust growth in our Aerospace business in 2020 is clearly the impact of the MAX. I will tell you, as you think about the margin implications for the MAX, which one typically trades off with OEM volume is aftermarket volume. So we think from a margin perspective, independent of what happens with the MAX, we think the margins will be just fine. We think we'll be just fine from an EPS standpoint, but it could have certainly an impact on revenue. Our Aerospace margins as we provided guidance, 2019 was a record year with really extraordinary improvement in our margins. The margins will be down slightly in 2020, largely due to the acquisition of Souriau. But also, we were running at very frothy levels in 2019 in terms of the margins of the businesses. We think the guidance that we provided for 2020 is very much in line with where we think the business should be.

Thank you.

Hi, good morning.

Good morning.

Congrats on Hydraulics. I'll echo everyone’s comments. Can you help us or can you tell us what the exiting share count was? And then how we should be thinking about the cadence of the repurchases through 2020?

Yes, I will address that. The total share count for Q4 was 450 million, which wasn't very different at the end of the year. Regarding repurchases, we will proceed as we have in the past. We decided not to pursue an accelerated repurchase and will handle the transactions ourselves. We have the capability to buy approximately $70 million worth per day under the safe harbor, allowing us to make significant moves relatively quickly. We will carry out these repurchases in a manner that we believe is most effective for our shareholders, while also considering market conditions.

Great. Thank you. And then as we think about the EP orders ex-Lighting down 2%, can you maybe help parse that out between end market and if you're still seeing any kind of destocking at your distributor partners?

Yes. I appreciate the question. If we think about markets, as we provided a little bit of color on it, we think we still see growth in non-res construction. We did mention the fact that commercial construction is flat. We think industrial controls will be down, but residential continues to be up nicely, we think mid-single digit. The IT piece of data centers, which is reported through Electrical Products, we think it'll also be up low single digit. So we think on balance, these markets continue to bounce around the low single-digit growth neighborhood. Once again, we’re hopeful, as some of this uncertainty continues to ebb away as it relates to trade, and as it relates to the North American trade agreement, that, that continues to buoy confidence in our customers in general. I think in general, distribution is fine. Distribution certainly in Q4 held in there. Our distributors are generally pretty positive around 2020. So we think distribution continues to be a strong point as well.

Great. I’ll pass it along. Thank you.

Thanks. Good morning, guys.

Hi, Nigel.

Obviously, there's a lot of moving pieces on the portfolio. Just to be clear, so given the buyback you got in place for 2020, does that offset the dilution completely from Lighting, but you still have some dilution, obviously, coming in the first half of the year? And then, Rick, on the tax rate, does the portfolio moves have any significant impact on the tax rate, both ex Lighting, but also ex Hydraulics?

I can answer both those questions. Yes, the buyback does offset the dilution, so that's why we're able to keep earning EPS flat between the years. The tax rate, we don't think will be changed from these portfolio actions, so we still think it'll be between 14% and 16%.

Okay. Great. My follow-up question is regarding distributor consolidation. WESCO's an important channel partner for Eaton. How does larger distributor partners impact your business as you go to market?

Yes, I think it's obviously a question of which distributor combinations we're talking about. Relating to WESCO's acquisition of Anixter, we think that's an outstanding combination for Eaton and our relationship with WESCO going forward. We think this combination bodes well for our future together and certainly is positive for Eaton.

Great. Thanks, guys.

Hi, good morning, guys.

Hi, Scott.

A lot of good questions have been asked already, but I would love to hear your view, Craig, as you walk around the world, what markets you think are going to be or what geographies, I guess, more specifically, are going to be better or worse than perhaps the 2019 run rate?

Yes, I appreciate the question. If you'd asked me that question maybe three weeks ago before the coronavirus, I would say China for sure. We saw a much stronger Q4 in China, and that economy had continued to strengthen. We'll see what the coronavirus does in terms of the impact in China and the impact it has internationally. We see somewhat slowing growth in the U.S., but there are certainly pockets of strength. Residential markets continue to be strong. Data center markets continue to be strong. Utility markets are also strong. We think South America will have a better year than they had in 2019 as they work through some of their historical issues. We think Europe slows a bit overall. India had a tough year in 2019, but we think India is better as well. Emerging markets around the world should generally have better years in 2020 than they did in 2019.

Helpful. And the one thing that I know eMobility is small, but what are you thinking over the next three years we should be tracking and caring more about? Is it the backlog you're building in the business? Would you start to get a sell-through in 2021 that's meaningful? That segment starts to move the needle with some margin attached to it? Is this a five-year out, three-year out or start to see progress kind of a year-and-change from now?

Yes. The real inflection point for eMobility will be around 2022. Many of these new electric vehicle platforms will launch in 2021. So we think it's really 2022 before you see revenues that have a meaningful impact on our eMobility segment and for Eaton overall. The underlying assumption around electrification in general is much bigger than what’s happening in eMobility and passenger cars. Everything is becoming more electric. One of the real advantages we think we have with respect to our eMobility segment is that anytime you're dealing with automotive kinds of scales, you're also creating real advantages that you can take back into your core business. We think there's a much bigger story for Eaton as we think about how we play in eMobility than just what happens in the light vehicle market.

Okay. Perfect. Thank you. Good luck, guys.

Thank you.

Yes, thanks. Good morning, guys.

Hi.

Hi, good morning, Nicole.

I just want to begin with a clarification. I'm almost certain this is how you are approaching your guidance. But to confirm, Lighting is excluded starting from the first day of the second quarter. Is that correct?

Well, we actually have put it in for two months, sort of the middle of the first quarter.

Okay. That's helpful, Rick. And then when we think about rolling forward the calendar on free cash flow after you guys complete the Hydraulics sale, would that create a major change in your free cash flow relative to how you guys have guided for 2020?

We expect the sale to conclude at the end of the year, so it shouldn't have any impact on 2020.

Right. But I'm thinking about like framing 2021 free cash?

What you'll see from Eaton post-Hydraulics is a company that will deliver more consistent free cash flow; the cash flows in Hydraulics are about as volatile as the industry itself. What you see from Eaton post the divestiture will be a company that delivers strong free cash flow and consistency overall.

Got it. That’s fair. Thanks, Craig. I’ll pass it on.

Thank you.

Hi, good morning.

I just want to check whether I have the math correct backing out Lighting and looking at the Electrical Products margin improvement. The guidance shows 180 bps, and it depends on exactly the revenues for the 10 months that you won't have Lighting. I'm using about $1.45 billion. I know we don't have the exact margin on Lighting, but obviously, it was below the segment average. So I'm trying to back into what is the margin improvement just excluding Lighting from 10 months? I’m getting as much as 140 bps, 130 bps. And that leads to kind of legacy Electrical Products not really having to expand margins much to hit the target. Yes, I think that's a fair way of thinking about it, Dave. Something just north of 100 bps of improvement from Lighting and some underlying improvement in the business is the right way to think about it.

And that said then, if the margins are, let's say, run rating close to 21, just getting rid of Lighting, I know 2% organic is not that robust, but still the margin improvement is a bit modest relative to your recent performance. Is there something within the electrical mix, price/cost, whatever it may be, that's not allowing a little more expansion versus recent history?

No, I'd say that we certainly had a very strong year in 2019 and posted very strong margin improvement. At this point, as we look at the year, we think this is the best way to think about the segment for the year. Could we be a little better than that? We hope so, but at this point, we think this is the right way to think about the segment and the appropriate guidance.

I might have missed this, I apologize, but the assets that are left in Hydraulics after the sale, are those potential opportunities for further sales during the course of this year or is it all just TBD for right now?

Yes. If you think about what's remaining, we disclosed a bit in the context of the Hydraulics close. These are really attractive businesses that have great positions in their respective industries. We like those assets and we intend to retain them.

Okay, thank you very much, I appreciate it.

Hi, good morning. Maybe just a first question around the data center market. I heard that the outlook is pretty good in the EP side, wondered if there was any nuance or difference within ESS, and really the reason I ask is that the commentary from different people is mixed. Some of the internet service providers sound optimistic; some of the equipment suppliers talked about push outs in data center activity this morning. So just wondered what your core assumption was for that market for this year in the medium-term?

Yes, Julian, we appreciate the question, and it’s not surprising that your commentary around the segment could be in conflict depending upon every supplier's timing for some of these large projects. For us, we do think that the data center market, based upon everything we've seen, grows at kind of low single-digit in 2020, which, given the underlying trends around data generation and consumption, is a relatively modest number. We did see a better second half of the year in hyperscale specifically, and data centers continue to be a growth segment for us overall. But it will be lumpy; there will be periods of time when you see extraordinary growth, and there will be periods of time when the hyperscale guys take time to absorb what they've done and pause in their purchases.

Thank you, Craig. And then a second question for you, maybe a slightly broader one. You've certainly surprised me with the success on the margin ramp the last couple of years. It's really been extraordinary. Just wondered if you were at all worried that focus on the cost out hurts the organic growth profile of Eaton at all, and how satisfied you are with that. If we look at the last five years, the organic sales CAGR was about 1% company-wide. Do you think that the company is now poised for that to move higher in the medium term?

In many ways, that is the $64,000 question regarding future economic outlook. If you'd asked me that question a few weeks ago before the coronavirus, I would say that we've not sacrificed growth opportunities for the sake of margin. Most of the margin expansion has come from eliminating operational inefficiencies inside the company. So we continue to focus on the highest priority for the organization: driving organic growth. We think organic growth relative to our markets has been fine overall, and our public data says we've gained a little share in many of our businesses, but we need to do better.

That's very helpful. Thank you.

Thanks a lot. Good morning, everybody.

Good morning, Andy.

Within ESS ex the hyperscale data centers that you just went through, in the past, I think you talked about some project deferral in them. Incorporating the first half, second half directional comments, I understand those. But are you seeing any thought in the uncertainty driven project deferral at this point?

Yes. I'd say, Andy, maybe we continue to see project deferrals. I'd say the rate has not escalated from what we've seen in prior quarters, but there remains uncertainty around the global economy. The extent that we're dealing in this uncertain environment, whether it's trade or most recently the coronavirus; with Brexit, geopolitical events, there’s been a lot of reasons causing many of our customers and larger projects to wait and see a bit. But not necessarily at an increasing rate, more like in line with what we've seen during the second half of 2019.

Okay, thanks, Craig. And then secondly, on potential acquisition opportunities, can you talk about whether the pipeline is full at this point? And relative to what you saw last year, are valuations becoming any more attractive?

Yes, the pipeline is certainly more active than we've seen a year ago. Our teams are busy working through several potential opportunities. However, valuations for the most part continue to be quite sporty, and we'll maintain our discipline given our cost of capital and expected returns. We will ensure we are smart about deploying our ample free cash flow and continue to be comfortable with the option of buying back stock.

Okay. Thank you very much.

Hey, good morning, guys.

Hi.

Craig, just a question for you on EP. One of your competitors this morning had some tariff exemption that helped out with their electrical business and got a bit of a clawback going into even 2018. Anything that you guys qualified for in the EP portfolio, and any benefit that was recognized?

No, not at all. There were no one-time benefits, and we’d be interested to know what that was and we'll find out who that was and see if we missed something. There were no one-time benefits associated with tariff exemptions in our EP results.

As we've commented, we produce in region for region. So we don’t have large shipments coming out of China into other parts of the world, eliminating this opportunity for us.

Got it. That's helpful. And then just a follow-up on the acquisition pipeline. I think you guys have been very clear on your role in the data center kind of being end-to-end electrical and not wanting to stray too far from that. I guess, Craig, are there any gaps in that? Or are there other pieces that you could add on to either on the front end or closer to the rack? Given the attractiveness of the market, are you seeing other product sets within the data center that look more interesting to you?

On the margin, we have a great portfolio today with all the power distribution and power quality equipment we offer in data centers. The acquisition of PDI is about filling a product portfolio and giving us better access to co-located operators of data centers. There are some minor things we can do, but overall, we’re well situated, and no big gaps at all.

Thanks, Craig.

Thanks. Good morning and congrats on an excellent 2019.

Thank you.

Thanks.

I wanted to address Jeff's question regarding the ESS splits transitioning to Vehicle, which is down 8% organically. I want to ensure we have the scale correct in the first half. I'm curious about your perspective on the linearity of that.

I’m not sure if I understand the question.

Sorry. Just the same question.

Yes, I would say that if you think about our guidance with respect to revenue, we do think the second half of the year will be a bit stronger on an EV basis versus the first half. It’s more a function of the comparables year-over-year, second half of 2019 was a much weaker period for us than the first half. So that's really a function of the comparables more than anything else.

Okay. And then on the eMobility comments you made a couple of quarters in a row about being ahead of plan. I’m wondering if you're seeing that in terms of the pace of design cycles or your win rates?

I think there's probably a little bit of both. Every major automotive OEM and commercial vehicle customer today has an initiative around electrification of their fleet, and that has gained momentum. Our team has done an extraordinary job from a standing start building broad product capabilities that enable us to be an effective and viable alternative in this space.

Thank you.

Improvements over the years. You've been closing the gap, to a large extent, across the electrical businesses to some of your global peers, particularly if you look at European low voltage players. Now how should we think about this going forward? I mean are there any structural reasons why these margins shouldn't align to where some of your peers are? I mean you’ve already mentioned that if I take out the Lighting impacts in EP ex Lighting, you’re basically already up to the margin levels that you're guiding for. So how should we structurally think about this, maybe not into 2020, but sort of medium term, how much upside is that in closing that gap to the peers fully?

Yes, I wouldn't say we believe there is a gap. In fact, we think that today, when you take a look at our Electrical business relative to most of our peers, our margins are as good as or better than most of them. You really got to think about it in context, not sure which companies you’re referencing, but our Electrical Products business is largely a components business that goes to distribution. Those margins compare very favorably to the industry overall. In Electrical Systems & Services, I'd say once again that business performs very favorably, and our margins are as good or better than almost any of our competitors. By the way, we’re not done, and we think we have opportunities that remain to expand margins, and that’s what we expect to do.

Sure, that's very helpful. As a follow-up on aviation aftermarket OE, could you clarify the split for that in Q4 and what is included in the guidance for 2020?

Yes, I'd say you can think about our business as 60-40, 60% OE, 40% aftermarket. The numbers vary slightly depending upon what quarter or year you're talking about, but a long-term view, a 60-40 split is generally where we're at.

Great. Thank you very much.

Thank you.

Yes. Good morning. Thanks for squeezing me in and congrats on a good 2019. I wanted to go back to ESS as well and ask a couple of things. On Power Distribution, can you give us some color on margin for that business? And then how do you think about the cadence of the segment's margin through the year, given that you've got some pretty difficult comps on incrementals in Q2 and Q3?

Our power distribution margins inside of Electrical Systems & Services are largely in line with the segment overall. We don't see significant differences in the margins in power distribution assemblies; projects can impact that a bit more than some other parts of our business. In terms of cadence, this business tends to be a little bit back-end loaded; it's consistent with what we’ve seen over a long period of time.

Yes, Craig, just to clarify, I was talking about the acquisition, Power Distribution acquisition?

PDI. Okay. Yes. PDI's margins, I would say, today are below the average for Electrical Systems & Services. We like the business and the space, and think we have an opportunity to expand margins, but they do enter the company slightly below the margins of the segment overall.

We’ll make some improvement in terms of synergies this year, but probably more so in 2021 in PDI.

Sure. And then lastly, on Hydraulics, just looking at your guidance, your margin guidance for 2020 and kind of comparing it to what we've seen exiting 2019. How do you think about the drivers for margin expansion here? What's different going forward than what we've seen in 2019?

The answer in Hydraulics – we spent a lot of time over the last couple of years talking about inefficiencies that we were driving in the Hydraulics business as we dealt with a significant market ramp in the midst of a major restructuring program. We had so many inefficiencies as we were halfway complete on many restructuring programs. As we think about 2020 and where the improvement comes from, it's largely a function of completing these things and getting them behind us. We're very confident in our ability to deliver the margin guidance we've laid out for Hydraulics.

Great. Thank you.

Thank you. Good morning, everyone.

Hi, Deane.

Just got a couple of quick ones here. First, when I look at the 2020 guidance, the organic revenue growth of minus 1 to plus 1 seems a bit tighter than I would have expected, just given the macro uncertainty. So maybe some thoughts on that, if you could. And does that improve some of the cyclicality reducing the overall range?

The first thing, Deane, to your point, we agree it's a fairly tight range, and we could have called it approximately flat. There is uncertainty in these businesses, and I wouldn’t overread the range of minus 1 to plus 1 other than to say that we think our markets are going to be approximately flat for the year. We think once we get beyond 2020 into 2021 and after Hydraulics divested, there will be more earnings and revenue consistency in the organization.

Great. And then just last question would be, it's interesting how many questions you've had today on data center. Obviously, some of it come from Network Power acquisition. What do you make of the new ownership of the former Emerson Network Power? And does that change expectations about some of the competitive dynamics, maybe some more price competition? Be interested in your thoughts there.

I appreciate the question, Deane. I can imagine that Dave Cote will bring strong leadership to that business. But no, we love our position in data centers overall. We think we’re clearly number one or number two in the world depending on where you are. Our strategic position is very favorable, and competition is good; it makes us all better. So we think we’re well positioned to continue doing extraordinarily well in that market.

Thank you.

Good. Thank you all. We have reached the end of the call, and we do appreciate everybody's questions. As always, Chip and I will be available to follow-up. Thank you all for joining us today.