Eaton Corporation plc (ETN) — Q1 2022 Earnings Call Transcript

Good morning, everyone. Thank you for joining us for Eaton's Fourth Quarter 2022 Earnings Call. Joining me today are Craig Arnold, our Chairman and CEO, and Tom Okray, Executive Vice President and Chief Financial Officer. Our agenda today includes opening remarks from Craig, who will highlight the company's performance in the first quarter. As in previous calls, we will take questions after Craig's comments. The press release and presentation we will cover today are available on our website. This presentation includes adjusted earnings per share, adjusted free cash flow, and other non-GAAP measures, which are reconciled in the appendix. A webcast of this call can be accessed on our website and will be available for replay. I want to remind you that our comments today will contain statements regarding expected future results of the company, making them forward-looking statements. Our actual results may significantly differ from our forecasted projections due to various risks and uncertainties outlined in our earnings release and presentation. Now, I will hand it over to Craig.

Thanks, Yan. We'll begin on Page 3 with highlights for the quarter. Overall, we had a strong start to the year, with Q1 performing slightly better than expected despite additional challenges in commodities. Our Electrical Global and Aerospace businesses had particularly strong results, allowing us to achieve a record adjusted EPS of $1.62, representing a 13% increase over last year. Sales reached $4.8 billion, a 10% organic growth compared to last year, surpassing our guidance range of 7% to 9%. Most of our end markets remained robust, especially in industrial, commercial, and residential sectors, along with commercial aftermarket and commercial OE in aerospace. Our orders continued to grow, resulting in another record backlog. For our combined Electrical business, orders over the last 12 months rose by 30%, up from 21% last quarter. The backlog for Electrical increased by 76%, compared to 56% at the end of 2021. The Aerospace business also saw significant demand, with a 35% increase in orders over the last 12 months compared to 19% at year-end. We also achieved a record operating margin of 18.8% in the first quarter, at the high end of our guidance, and a 110 basis point improvement over last year. So overall, it was a solid quarter with strong market demand and effective execution in a challenging environment. We are also making good progress on our strategic growth initiatives as highlighted on Slide 4. These initiatives are aligned with ongoing secular growth trends such as electrification, energy transition, and digitalization. We are seeing acceleration in each of these critical growth areas, confirming our effective growth strategy. In the interest of time, I will mention one major recent success but can provide more details in a follow-up call. While we cannot disclose the customer, we recently secured a significant order related to an energy transition project involving EV charging stations in the U.S. This includes a full range of Eaton solutions like power distribution equipment, energy storage, inverters, control automation, and remote monitoring software. We are working on various major opportunities related to expanding the necessary electrical charging infrastructure due to the rapid growth of electric vehicles. As sustainability gains traction globally, our technologies will play a vital role in this solution. Moving to Page 5, we summarize our key financial metrics for the quarter, noting a few highlights. First, 3% revenue growth included 10% organic growth, offset by a net headwind of 6% from acquisitions and divestitures, primarily from the Cobham and Tripp Lite acquisitions, offset by the divestiture of Hydraulics. Our acquisitions contributed 6 points of growth while the divestiture reduced growth by 12 points, along with a 1% negative impact from foreign exchange. Second, with 3% revenue growth, we saw solid operating leverage with 9% growth in operating profits and even stronger adjusted EPS growth of 13%. Third, as in the last quarter, we set records for adjusted EPS at $1.62 and segment operating margins at 18.8%. This financial performance highlights the effectiveness of our portfolio transformation and our capability to execute under difficult operating conditions. Next, on Page 6, we cover the results from our Electrical Americas segment. Revenues grew by 17%, including 10% organic growth, compared to 5% in Q4 and 1% in Q3. The Tripp Lite acquisition added 7 points of growth, while our organic sales benefit came from strength in industrial and residential sectors. We are still navigating supply chain constraints that showed slight improvements but remain challenging. Operating margins stood at 19.1%, down 140 basis points from the previous year, mainly due to rising input costs, supply chain inefficiencies, and increased growth-related investments. Importantly, we successfully offset expected inflationary costs with dollar-based price increases; however, we did not achieve additional margins on inflation, affecting our overall margins. As we communicate in our full-year guidance, we anticipate improvement in this area, projecting a 90 basis point margin enhancement for the full year. As mentioned earlier, market demand stayed strong with significant order growth. Our rolling 12-month orders saw a 31% increase, compared to 20% in Q4, with all end markets showing strength ranging from 28% to 36%, resulting in a record backlog that increased by 86% on an organic basis. Our backlog saw a substantial sequential increase of $1.3 billion. Moving to Page 7, we summarize our Electrical Global business, which showcased another robust quarter with organic growth of 18%, factoring in a 3% currency headwind. We observed strong performance across all regions, particularly in commercial and industrial markets. Operating leverage was solid, yielding record Q1 operating margins of 19.4% and incremental margins of 36%. Similar to Q4, orders over a rolling 12-month period continued to accelerate, increasing 27% in Q1 versus 22% in Q4. Strength was consistent across all end markets, with growth ranging from 22% to 41%. For the fourth consecutive quarter, we maintained our backlog growth at 50% or more and achieved a new record for the quarter. Our Electrical Global business is well-positioned for continued strong overall growth. To summarize the performance of our combined Electrical business, we delivered strong organic growth of 14%, built a significant backlog that reinforces our outlook for future quarters, and improved margins by 20 basis points, resulting in a strong quarter given the current operating environment. Moving to Page 8, we recap our Aerospace segment, where revenues soared by 38%, combining 15% organic growth and 25% from the Cobham Mission Systems acquisition, along with a 2% currency headwind. Organic growth in the quarter was particularly robust in the commercial aftermarket and commercial OEM markets, including business jets. Operating margins reached 22.1%, a rise of 360 basis points year over year, with solid incremental margins at 32%. Another highlight was the accelerating orders, where rolling 12-month orders increased by 35%, compared to 19% in Q4. We concluded the quarter with a record organic backlog, up 14%. Reflecting the broader industry recovery, we're actively pursuing $1.3 billion in life-of-program opportunities in both strategic military and commercial programs, indicating strong growth potential for this segment now and in the years ahead. Next, on Page 9, we provide the financial summary for our Vehicle business. Revenues grew by 3%, all organic, supported by solid growth in the North America aftermarket and South America businesses, though offset by challenges in global light vehicle markets. As noted, this market faced considerable supply chain constraints that impacted revenues this quarter. Although we see some improvements in these markets, supply chain challenges primarily related to the war in Ukraine greatly affected this sector. These constraints contributed to operational inefficiencies within our business, resulting in a 50 basis point decline in operating margins. We are implementing several price- and cost-related strategies to counter the inflationary pressures, but it will take time to execute these changes, which we aim to have in place by year-end. In terms of growth, during our earlier investor meeting, we discussed how we transform our business by focusing on new spaces and products not associated with internal combustion engines. The team has seen promising developments, including a recent success with a Chinese OEM for our electronic traction control devices. Additionally, we are pursuing a $500 million pipeline in annual revenue for our powertrain solutions aimed at leading EV OEMs, which represents incremental growth. We are on track to successfully transform our traditional Vehicle business by entering EV and other new markets. Moving on to Page 10, we summarize our eMobility segment, where revenues soared by 52%, including 7% organic growth and 46% from the Royal Power acquisition, despite a 1% negative currency impact. Although we still reported an operating loss for the quarter, we anticipate generating positive margins for the year as the outlook for this market continues to strengthen. In alignment with broader trends, we are actively pursuing around $2 billion in new program opportunities, with this figure growing increasingly each quarter. Our acquisition of Royal Power has also brought nearly $600 million in pipeline opportunities centered on their innovative solutions for terminal connectors and high-voltage busbars. To reiterate, our focus in eMobility centers around power distribution, power conversion, and power protection. Moreover, we previously shared that a major European OEM has awarded us significant additional volume in using our Breaktor technology—expanding its application across their vehicle lineup. This illustrates another segment progressing very much in line with our expectations. Now let’s turn to Page 11, where we provide our updated organic revenue and margin guidance for the year. Overall, despite uncertainties in the market, we continue to witness strong demand in our end markets. We are raising our organic growth guidance for all segments, adjusting Eaton's overall growth expectation from 7% to 9% to now 9% to 11%. This growth outlook is supported by our ongoing order growth and rising backlog. Regarding margins, we are reaffirming our full-year guidance for Eaton at 19.9% to 20.3%, representing a 120 basis point increase over 2021 at the midpoint. Though we have increased organic revenue expectations, we are maintaining our margin forecast due to additional inflation impacts we have experienced and expect to continue seeing throughout the year. We are actively raising prices to manage inflation, although we are experiencing normal timing effects that prevent us from achieving usual margins above inflation. Within the Electrical segment, we are reaffirming margins for Electrical Americas and increasing the guidance range for Electrical Global by 10 basis points. We have also raised margin forecasts for our Aerospace business by 20 basis points and for eMobility by 50 basis points. These three segments are helping to counterbalance lower margin expectations in our Vehicle business due to margin compression from the new level of inflation and some operational inefficiencies we anticipate for the year. Nonetheless, at the midpoint, we expect to achieve record margins and exceed 20% for the first time in Eaton’s history, indicating a very strong year overall. Moving to Page 12, we provide more guidance details for the year. We are raising our 2022 guidance for adjusted EPS to between $7.32 and $7.72, reflecting a 14% growth at the midpoint and indicating a promising year ahead. Our organic growth expectation has increased to 9% to 11%, although this is partially offset by $250 million in negative currency impacts compared to our initial guidance that expected flat currency for the year. Therefore, we estimate offsetting around $0.10 in earnings due to these FX headwinds, and without those negative impacts, we would have raised our guidance even more significantly. In addition, we executed $86 million in share repurchases during the quarter and aim for $200 million to $300 million in total share buybacks for the year. Finally, our Q2 guidance projects adjusted EPS between $1.78 and $1.88; organic revenue growth from 9% to 11%; anticipated negative currency impact of $75 million; and an 8% net revenue effect from M&A. For segment margins, we estimate Q2 margins at 19.1% to 19.5%, representing a sequential increase of 50 basis points at the midpoint from Q1. Adjusting for the $0.10 headwind from M&A, our year-over-year EPS growth in Q2 would equate to 12%, aligning closely with our overall full-year guidance of 14%. In closing, on Page 13, I want to make a few comments. As highlighted during our Investor Day and reiterated at the start of this presentation, we continue to see accelerating growth in our end markets. The fundamental growth trends are unfolding as we anticipated, underpinning our strategy as a global intelligent power management company. We are securing important project wins that are boosting our growth rate, and these revenue drivers are prominently reflected in our order portfolio and growing backlog. This positive market development is notable. Despite high inflation and ongoing supply chain challenges, we are advancing our margins. Based on our Q1 results and Q2 guidance, we expect to generate 46% of our full-year adjusted EPS in the first half, consistent with our historical first-half earnings trends. As the global economy faces numerous unprecedented challenges, you can rely on our team to continue executing effectively to fulfill our commitments in both the short and long term. With that, I will turn it back to Yan for questions.

Okay. Great. Thanks, Craig. Now it's time for the Q&A. I will turn it over to the operator to give you guys the instruction.

Craig, you've been in this kind of accelerating order environment now for, call it, the last 3 quarters where maybe supply chain is limiting what you can be able to deliver. And the world has changed quite a bit over that time, especially the last quarter or so. What's the composition of the order book look like? And I guess what I'm trying to get at is, have you seen sort of a progression or handoff from some of the more early-cycle stuff to maybe later-cycle or more resource industries? Or is it just kind of a healthy mix of everything where it's harder to tease out what leadership is?

Yes. I appreciate the question, Josh. And it's certainly been a period of time where I'd say we're really seeing broad-based order strength. And as you know, we would typically highlight strength in particular end markets, but quite frankly, we're seeing strength across the board. And that's why we talked about, for example, in our Electrical Americas business, we said we have a range of strength at the very low end, up 28%; at the high end, up 36%. The same thing is true in our global business where we said at the low end of the increase, it was 22%; at the high end, it's 41%. So as you can imagine, I mean this is very broad-based strength across just about every end market that we serve. So things today, I think, are very strong across the board, and it's tough to really find much in the way of differentiation between some of these end markets because the numbers are just that good.

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

We invest considerable effort in confirming that all of our orders are legitimate. Our business primarily revolves around projects, and we can confidently say that the orders we receive are directly linked to these projects. It is possible that some of these orders are coming in earlier than usual in the project cycle, which might provide us with a slight advantage. Additionally, much of our business runs through distribution channels, where, almost universally, inventory levels are lower than desired, which does not support their future business outlook. This suggests a general strengthening across many of our end markets. Regarding pricing and the potential slowdown, it's largely dependent on inflation trends. At the beginning of the year, we anticipated a moderation in inflation, leading us to expect fewer price increases throughout 2022. However, in the first quarter, we observed a rise in commodity prices, prompting us, like others, to increase prices again in response to the current inflationary pressures, some of which stem from the situation in Ukraine and recent shutdowns in China. Overall, we are experiencing more inflation this year than we previously anticipated, and it is too soon to determine if there has been a fundamental slowdown at this point.

Craig, can you discuss margins briefly? You’ve had a strong beginning to the year. Looking at the updated guidance, it seems like the Electrical Americas segment has the most room for improvement in terms of hitting the range. Can you clarify how we can transition from that low-19 percentage range to the guidance for the year? Is it through additional pricing or better volume leverage in the supply chain?

Appreciate the question, Joe. And I can tell you, one, we have a high level of confidence that Electrical Americas will absolutely deliver the guidance for the year. And what we've been chasing, as you can imagine, for some time now is we have been chasing commodities with price. As I mentioned a moment ago, we did anticipate coming into the year that inflation would have abated somewhat, and we ended up taking more inflation in Q1 than we anticipated. And so we've obviously had to go to the market for additional price. And so if you think about the back half of the year and going into subsequent quarters, we're going to have a better relationship between price and inflation. And the other thing that we certainly have seen in our Americas business is we've seen a lot of inefficiencies associated with kind of supply chain disruptions. As you can imagine, if you're missing one small component, you have a bunch of people standing around in factories not able to complete assemblies. That drives fairly material inefficiencies in your operation. And so we do anticipate, as we look at the back half of the year, although we're not looking for a dramatic improvement, we are expecting some modest improvements in supply chain. And we are expecting, quite frankly, to deliver better price versus cost in terms of commodities in the back half of the year. And those would be the two principal things that will allow us to increase margins. The other big piece is volume is increasing, right? So certainly, look at Q1 as always the lowest quarter for our Electrical Americas business. And so there'll be naturally some margin lift on simply the higher volumes that are going to come based on the seasonality of the business.

That makes sense and is helpful. I have a broader question. I understand that your order rates have been strong and are continuing to rise. In light of Josh's earlier question, I acknowledge that the environment has shifted. I'm interested in your perspective on how you anticipate these changes will unfold. In Europe, there are many concerns regarding demand rationing, and in China, there are ongoing lockdowns. I would appreciate your insights on how you believe things will develop in the upcoming quarters.

Yes, I wish I had a crystal ball to provide a more accurate prediction of how things will unfold. In Europe, we have minimal exposure to Russia or Ukraine, which is a small part of our overall revenue. We don't expect any significant direct impact from the current situation. However, we do face some supply chain challenges, particularly in our Vehicle business, as you've noted. This may affect the semiconductor industry. At a micro level, we believe we can manage the impact on our business. On a macro level, it's still too early to determine the long-term effects of geopolitical issues and trade sanctions. Russia represents a minor portion of global GDP, so a separation from the global economy should not significantly affect our markets or operations. The real question is how sanctions might influence business confidence and investment decisions. So far, our order book remains strong, and we haven't experienced any slowdown due to the conflict in Ukraine. As always, our approach as a company will be to stay agile and flexible, making necessary adjustments as the situation evolves.

My question is also related to the backlog in Electrical, which is impressive. However, Craig, you've mentioned a resurgence in raw materials. I'm curious about how we manage these two aspects together. Do you have the capability to adjust prices for the backlog if necessary? Is that something you're considering more as the cycle evolves? Or is there a risk if inflation continues to rise?

Yes. No, appreciate the question. And I'd say that while it's not something that we do often, and we obviously think long and hard before we would do it, but we have had to reprice the backlog in some cases. It's something that we went through in Q4. And I'd say that today, what's baked into our guidance is very much manageable in terms of our expectation around inflation and price. And obviously, we tried to anticipate some of this as we think about the next wave of price increases that are going in. And so as we sit here today, we don't have an expectation of needing to reprice the backlog. It's fully baked into our guidance and our plan. But I'd say that in the event that we ended up in a situation where things got materially worse in terms of commodity input costs, it's something that we've done in the past and we would be willing to do again. But at this junction, we don't think we need to. We think we have a plan that makes good sense. And it's fully baked into our guidance that commodities essentially stay at these relatively high levels. We're not anticipating that commodity costs retreat in any material way in the back half of the year. If we do, that's upside, but that's not our base case.

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

No. That's still very much the case from our perspective. We believe that all customers are fundamentally the same, which gives us a seat at the table. We have established a reputation; they know us, and we know them and the applications. This has always been our belief about why we are in a strong position to succeed in eMobility: first, because we understand the customers, markets, and applications; and second, because it fundamentally involves electrical technology. We approach it from both a standpoint of customer understanding and application expertise, thanks to our legacy in vehicles, and from a technological perspective due to our background in electrical systems. This connection on both fronts enables us to thrive in that market. For instance, consider the Breaktor win we mentioned in our eMobility business; that technology originated from our Electrical business, was then adapted by the eMobility team for vehicle applications, illustrating how our different areas of expertise work synergistically. We believe this unique combination is what positions us to succeed in the eMobility sector.

So just a big-picture question. So structurally, right, I mean I think most multis this quarter actually had negative volumes, right, despite price being very positive. We had negative GDP. So structurally, what do you think needs to happen with the U.S. supply chain to debottleneck it? And what do you see actually happening among your supply chain? And how long do you think it will take to sort of normalize things? And what are the key bottlenecks as you see them? I know it's a big sort of picture question but would love to pick your brain here.

Yes, I would say that the U.S. has been an outlier. We have not faced nearly the same level of supply chain disruptions in our European or Asia operations. A significant part of the challenge in the U.S. arises from a heavy reliance on global sourcing, which has created greater interdependencies in terms of supply. We have faced unique issues in the U.S. related to labor and port congestion. Like the rest of the world, we encountered major downturns in the market due to COVID, followed by a strong V-shaped recovery. This combination has created a perfect storm for global supply chain businesses like ours. Since then, there has been considerable discussion and action around nearshoring and reshoring manufacturing in the U.S., which will benefit Eaton due to our strong position in the U.S. market. Many companies, including ours, are reevaluating their supply chain resilience and are implementing dual sourcing to enhance redundancy. This will help us respond better to future disruptions. Although I’m uncertain if this is a black swan event, it has certainly compelled companies to seriously assess their supply chain resilience and their capacity to manage shocks without fundamentally shutting down operations. Consequently, we believe this will lead to increased investments in facilities and local sourcing to enhance overall supply chain capabilities.

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

Yes. I think tied to stimulus dollars, certainly, we're seeing a lot of activity, a lot of, I could say, projects in the discussion phase. I don't know today, Andrew, if we've seen material dollars from stimulus that have started to flow yet. We really think that's more of an end of '22, 2023 kind of impetus for the business more than we're seeing in our business today. I think what we're seeing today largely in and around utility investment is really much more tied to grid resiliency. It's much more tied to the fact that aging infrastructure. It's much more tied to the increase in electrification much more today than it is tied to the direct stimulus dollars. But that's clearly coming.

So Americas, I want to come back to Americas margins. So the 1Q margin was actually pretty flat with 4Q. And I think I'm right in saying that normally, 1Q would be weaker than 4Q. So I take that as a positive sign that things have improved there. What would you say is driving that improvement primarily? Is it price/cost? Is it productivity, be it labor or kind of the sequencing of materials in? Anything to help us on that sort of improvement sequentially? And then can we then think about Americas margins due to the normal sequential uplift from 1Q to 2Q?

Yes. Appreciate the recognition on that, Nigel. You're absolutely right, by the way. Q1 has historically always been a down quarter for Electrical. A lot of that is volume-related. And what we've seen historically in the business, we typically see a seasonal volume reduction in Q1 versus Q4. And as a result, margins on a decremental basis go down. And we are pleased the fact that they actually held up nicely in this Q1. But the biggest difference between, I'd say, the overall profitability level largely is we're doing a better job in managing price/costs overall. We did, in fact, in Q1, while still not out of the woods, we did see a little better supply chain performance in Q1 around certain commodities that actually got a bit better in the quarter. And so I think it's really those two things: better price/cost achievement in the quarter and a little better supply chain performance from our suppliers.

Yes. Included in the price/cost is how we're taking cost out of our direct material and our logistics as well. And to come back to the other part of your question, yes, you can expect to see margins improving in Q2 versus Q1.

Great. Regarding Aerospace, you increased the forecast for 2022 by 2 points. Can you explain what influenced that decision? I'm particularly curious about the outlook for defense, as it was a challenging market in your 2022 forecast. Given the positive changes in global defense budgets, are you beginning to notice some benefits in the latter half of the year?

We appreciate your interest. Aerospace had a very strong quarter, resulting in significant profitability. The growth we are experiencing stems largely from the aftermarket sector, which had been underperforming in recent years. This quarter, however, we observed robust growth in the aftermarket, which tends to offer higher profitability. We expect this trend to continue as we move forward. Additionally, in Aerospace, similar to our other sectors, we effectively managed pricing against input costs, allowing us to counteract inflation, which greatly benefited the business. Regarding defense, we anticipate that defense spending will remain flat or increase slightly this year. The fiscal 2023 defense budgets in the U.S. and globally, particularly influenced by current events in Ukraine, are projected to rise. We have assessed that the defense market is likely to see an upward trend over the coming years, especially as many governments have indicated plans to boost their defense budgets. While we are hesitant to benefit from global events that prompt this increase, we believe defense spending will improve moving forward, although this narrative will mostly unfold in 2023 rather than 2022.

Just, Craig, on the topic of Aerospace while we're there. Are the airlines starting to rebuild inventory in spare parts at all? Have you seen that occurrence?

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

That's helpful. Regarding the earlier prepared remarks, you mentioned the EV charging contract and the various SKUs you supplied for it. What components are you lacking? Could you handle the entire project? Will it eventually be bid as a full project instead of just purchasing components? How do you envision that developing?

Thank you for the question, Scott. There are significant opportunities with various customers across different areas of the platform. We are successfully acquiring content, but we are also rejecting some offers that we believe won't yield the returns we expect as a company. Our focus remains on how to distribute power, convert it, and ensure its safety within vehicles. We are being selective about our participation in the growth of electric vehicles. The revenue targets we've set for a new segment of the company could actually be higher if we pursued every opportunity available. The range of $2 billion to $4 billion we've shared takes into account that we will focus on areas where our technology can provide unique value to customers. There will be aspects of electrification that are more commoditized, and we plan to avoid those in favor of opportunities where we can deliver differentiated technology-based solutions. These are the types of projects we are winning and aim to continue pursuing.

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

Oh, the charging contract. Okay. Yes, that's true, but I was thinking you were referring to the eMobility wins specifically. Regarding the charging contract, unfortunately, we cannot disclose the customer's name, but it is a notable company involved in developing the nation's charging infrastructure as the world transitions to electric vehicles. That answer largely applies here. There will be aspects of charging infrastructure where some chargers lack embedded intelligence and don’t require sophisticated management of load, energy consumption, and balancing. Let's refer to that as basic charging. In this case, you plug it in, and the energy flows without needing much intelligence in between. Currently, we are not participating in that segment of the market. We have chosen to compete in areas that require a significant level of sophistication to understand what's happening behind the meter and how much electricity is available, especially when multiple vehicles are charging simultaneously. It’s essential to ensure there’s adequate electricity and intelligently manage the charging process. We believe this is where we bring the most value and where we can achieve reasonable returns in this business.

One number that stood out to me from the release was the negative free cash flow in the quarter. I think that's pretty unusual for Eaton. So maybe just help us understand kind of the confidence in that full year free cash flow guide. I think the inventories are up sort of 40% year-on-year. So how do we think about those leveling out? And just to make sure that you're still sort of very confident that the inventories for you are very, very high, but the inventories that everyone you sell into and through are very, very low.

Yes. Appreciate the question, Julian. Prudently, we invested in working capital in Q1 for a number of reasons. One is to really protect the strong growth that we're seeing. Another factor in that is the supply chain constraints, wanting to make sure that we can serve our customers properly. We've also got a dynamic where we have an elevated amount of work-in-process inventory where we're waiting for individual components. And then the final aspect is we just have inflation, and that's driving up the cost of the inventory. As you saw in the prepared remarks, we remain committed to our guidance on operating and free cash flow, and we expect cash flow to get better throughout the year.

And then just on the point on sort of firm-wide operating margin. So I think a lot of industrial companies are guiding for a big year-on-year improvement in operating margins in the second half, largely due to price/cost dynamics. I think for Eaton, it's very, very level-loaded. You're up, I think, 110 bps in the first quarter. You're saying the year is up 120. So just trying to sort of gauge. I think you're saying that price/cost dynamics improve for you as well, but it doesn't seem to be embedded in that margin rate guide. Is there any sort of specific headwinds kind of coming the other way? I know Aerospace has a tough margin comp in the fourth quarter and that kind of thing. Maybe just any sort of help around that margin guide.

The way I see it, Julian, is that there are still many uncertainties in the marketplace. This includes supply chain issues, COVID-related shutdowns in China, and the downstream effects of the war in Ukraine. Given this uncertainty, we believe it is wise to adopt a cautious perspective on our outlook for the latter half of the year. If the supply chain situation improves, if the lockdowns in China resolve sooner than expected, or if the effects of the Ukraine conflict are more limited than they currently appear, there could be positive developments in the second half of the year. However, at this point, we think it’s not wise to rely on such assumptions. Thus, we have established a forecast that we believe is appropriate considering the existing economic and political conditions.

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

Can you comment on inventory in the channel, specifically distributor inventory? Where does that stand?

Yes, I mentioned this briefly in response to another question. Currently, every conversation I have with our distributor partners indicates that they all want more. Inventory levels are not where they would like them to be. We continue to face challenges in supporting all the demand, which is one reason our backlog is increasing, especially in our Electrical businesses. Inventories in the channel are currently not sufficient, and at this point, I can say we are monitoring for potential double ordering and ensuring that people aren't submitting provisional orders just to secure their place in line. Based on the current inventory situation and the outlook for the year, inventory levels in the channel are below, and in some cases, significantly below, where they want them to be.

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

Yes. I'd say it's still early days, Deane. And we think it's another place where it's certainly needed. We think it's coming. But I'd say today, even around the margins, the utility markets, I'd say, like our markets in general, are performing well. How much of that is tied specifically to grid hardening, how much of that's tied to energy transition, tough to really say and bifurcate the two. But I'd say today, we are certainly seeing strength in utility markets, very much like we are in our other end markets as well.

I just had one quick follow-up. Craig, you gave some color on kind of what's different between global and Americas around supply chain and labor. But anything else in there around if you look at just the global margins versus Americas in terms of momentum around mix or where they are on price/cost or structural opportunities globally versus Americas?

Yes. I don't have much to add, Jeff, to what we've already discussed. Clearly, in the global segment, we're benefiting from a better mix as industrial markets continue to improve. The global Crouse-Hinds business is returning to more historical levels of profitability, which is certainly boosting overall profitability in that segment. They are experiencing less inflation in commodities and encountering fewer supply chain disruptions, resulting in fewer operational inefficiencies compared to the Americas business. This is part of the reason the Americas is not performing better than it currently is. However, I don't believe there's anything else affecting the situation. Looking at our projections for the year, we fully expect that the margins for the Americas business will increase by around 120 basis points, indicating that it will be a strong year.

First question is just on backlog and revenue coverage. Obviously, backlog continues to build here. Given the project nature of your businesses, I'd imagine you have some visibility on timing. I'm curious, of the current backlog, how much ships this year versus '23? And are you starting to book orders for 2023 at this point?

Yes, thank you for the question. As I mentioned earlier, we are currently seeing some earlier orders for certain projects in our backlog than we would typically expect. However, the main factor driving our backlog is the strengthening of the markets. Currently, there are orders in the backlog that will definitely ship in 2023, with some specifically planned for that year. Overall, the backlog coverage is stronger than it has ever been in the history of our business, giving us better visibility into our requirements than we have had before. We do not believe there are any duplicate orders in the backlog; everything is tied to specific projects that we have successfully secured in the marketplace.

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

That win we discussed occurred in the first quarter. We aim to maintain clarity regarding orders, so whenever we mention an order booked during these calls, it will be related to the relevant quarter. Regarding the profitability of those businesses, it's still early as we are in the initial phases of building out the electrical charging infrastructure. However, we have a clear expectation and standard for what constitutes an attractive business. As we consider our bidding approach for projects and programs and our margin expectations, we believe that the margin expectations for EV charging infrastructure will align with the overall profitability of our Electrical business.

Just on the topic of Q2, I think, Craig, you answered some of this in Julian's question. You were referencing that there's a lot of uncertainties out there, which you appear to have baked into a relatively conservative margin guide for the course of the year. But I guess I'm just a little surprised that the Q2 top line guide is as strong as it is, 10% organic at the midpoint. Just on a gut-feel-type basis, feels pretty high given all of those uncertainties that are out there. So I was hoping you could just expand on what the Q2 planning assumptions are. Is it equally broad-based? Or are you particularly bullish or potentially cautious on one specific end market or another, be that residential or industrial? Or perhaps there's some specific geographies that we need to be calling out. I'm thinking of places such as China.

I believe that as we consider the Q2 revenue guidance at 10%, it does not appear to be an aggressive figure. Looking at the growth in our backlog and orders, that number could actually be much higher if we could ship and meet all the current demand in our businesses. We are optimistic about some modest improvements in the supply chain and availability. However, the growth number is certainly not aggressive when we take into account the real underlying demand we are observing. Therefore, we feel very confident about the growth number for Q2.

That's great. To clarify, the order strength we are experiencing shouldn't be largely attributed to the major projects like the EV charger project. While that is significant, it is not the main factor driving the order momentum we are observing. The growth is quite widespread.

I appreciate the question. However, in the electrical industry, the nature of our business and the projects tend to be relatively small overall. That’s why we aimed to highlight the strength we’re experiencing in various end markets. Currently, we serve a diverse range of sectors, including commercial, utility, residential, data centers, MOEM, and industrial. In the Americas, we’re seeing growth across these markets ranging from 27% on the low end to 36% on the high end. All these markets are performing very well, and our order growth is not linked to any single major project. The only area that can be a bit inconsistent is data centers, which can see fluctuations when larger clients make significant orders or take breaks. Overall, we’re observing strong and broad-based growth.

Okay. Great. Thanks, guys. We're reaching to the end of the call. As always, Chip and I will be available to do any follow-up call with you guys. Appreciate everybody joining us today. Thanks.