Ladies and gentlemen, thank you for standing by and welcome to the Eaton Third Quarter 2021 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host Senior Vice President of Investor Relations, Yan Jin. Please go ahead.

Good morning, everyone. I'm Yan Jin, Eaton Senior Vice President of Investor Relations. Thank you all for joining us for Eaton's Third Quarter 2021 Earnings Call. With 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 by Craig, highlighting the Company's performance in the third quarter. As we have done in our past calls, we'll be taking questions at the end of Craig's comments. The press release and presentation we will go through today have been posted on our website at www.eaton.com. This presentation includes adjusted earnings per share, adjusted and free cash flow, and other non-GAAP measures. There are reconciliations in the appendix. An audio cast of this call is accessible on our website and it will be available for replay. I would like to remind you that our comments today will include statements related to the expected future results of the Company and are therefore forward-looking statements. Our actual results may differ materially from our projected future due to a wide range of risks and uncertainties that are described in our earnings release and presentation. With that, I will turn it over to Craig.

Okay. Thank you. I will start on page 3 with highlights for the quarter, noting that our team delivered record results in Q3, despite the well-publicized supply chain challenges in this environment. We had strong execution across all of our businesses and focused on controlling what we could control. As you can see, we posted an all-time record for adjusted EPS of $1.75. Supply chain constraints did have an impact on our revenue, but we still posted 8% growth in the quarter. For the third quarter in a row, we delivered record segment margins at 19.9% in Q3, an all-time record and an increase of 230 basis points over the prior year. On top of record margins, we’re also pleased with our incremental margins, which were 46% in the quarter due to actions we took to mitigate inflationary costs, the portfolio changes we undertook, and savings from restructuring programs. We did have a bit of help from favorable mix as well in the quarter. While revenues were lighter than expected in our Electrical America segment, we are very pleased to see the strength in orders and the growing backlog. Overall demand remains very strong. For the electrical businesses overall, orders were up 17% on a rolling 12-month basis, and our backlog was up more than 50%, another all-time record. Next on Page 4, we summarize our Q3 results, and I will note just a few points here. First, our 9% revenue growth increased our operating profits by 23%, which reflects strong operating leverage and benefits from our portfolio actions. Second, our acquisitions increased revenues by 7%, which was fully offset by the sale of hydraulics. We are naturally pleased to have replaced hydraulic revenue with a collection of businesses that are higher growth, higher margin, and have more earnings consistency. Lastly, our margins of 19.9% were well above our guidance range of 19 to 19.4%, as our team did an outstanding job of executing despite the lower-than-expected revenues. Moving to page 5, we have the results of our Electrical America segment. Revenues were up 9%, including 1% organic and 8% from the acquisition of Tripp Lite. Organic sales growth was driven by strength in data centers and residential markets, partially offset by weakness in large industrial projects and sales to utilities. As I mentioned earlier, revenues were impacted by supply chain constraints. Our Electrical America segment, separate from the general supply chain constraints that we're all feeling, was disproportionately impacted by a few unique suppliers who were especially impactful to this business. We are naturally addressing these and other supply challenges and expect to do better in Q4. Operating margins continued to be strong at 21.7%, up 40 basis points from Q2. This is consistent with our expectations as we're doing a good job of getting price to offset inflation. The biggest highlight in this segment is continued growth in orders and backlog. On a rolling 12-month basis, orders were up 17% organically, an acceleration from up 13% in Q2. The strongest segments were utility and residential markets. Backlog is up more than 50% from last year and up 9% from Q2, both are encouraging signs supporting our expectation that the missed shipments will simply be pushed into future quarters. Turning to page 6, we summarize our electrical global segment results, which were strong across the board. Organic growth was 18%, with broad strength in really all end markets, and currency added 1%. We also posted all-time record operating margins of 20.1% and had very strong incremental margins of nearly 40%. The margin performance was driven by volume leverage, strong cost control, and savings from restructuring actions. Orders were very strong, up 17% organically on a rolling 12-month basis, particularly strong in industrial, commercial, and institutional markets. Like our Americas segment, backlog is up more than 50% and at record levels. Before we move to the industrial businesses, here's how I'd summarize the performance of our electrical businesses. When you add the two together, they delivered solid organic growth of 8%, built a sizable backlog, strengthening our outlook for future quarters, and improved margins by 110 basis points. On balance, I'd say a very strong set of quarterly results for our electrical businesses. Moving to page 7, we have the financial results of our aerospace segment. Revenues were up 38%, of which 4% was organic and 33% from the acquisition of Cobham Mission Systems, with 1% contribution from currency. Organic growth was primarily due to higher sales in commercial markets, partially offset by weakness in military markets. Operating margins were 22%, up 350 basis points from last year and 100 basis points sequentially. This strong performance gives us confidence that as aerospace markets continue to recover, we’ll meet or exceed the 24% margin targets set for this segment. In the quarter, we also had strong organic incremental margins driven by favorable mix, primarily from the growth of the commercial aftermarket business, and once again from savings from the restructuring actions we’ve taken. Q3 was the first full quarter where Cobham Mission Systems were part of the Company, and we’re very pleased with the financial performance of the business, while the integration process is going smoothly. Looking to the future, we're seeing encouraging signs of recovery in this segment with both orders and backlog now trending positively. On a rolling 12-month basis, orders were up 4%, primarily with strength in the business jet segment, and our backlog has increased by 5%. Next, on page 8, we present results for our vehicle segment. Organic revenues increased 11% with solid growth in North America's class 8 truck business, and strength in South America more than offset the weakness in North American light vehicle markets. As you're all aware, light vehicle production has been severely impacted by supply chain constraints. Operating margins were at 18%, and we generated very strong incremental margins of more than 50%. In addition to strong execution, we also had some favorable mix in the quarter, specifically in North America where the truck business benefited from strong aftermarket sales, up some 40% at attractive margins. Our North America light vehicle business also benefited from favorable mix as customers prioritized programs with more of our content, including more full-size pickups and SUVs while reducing smaller cars. Good mix, solid volume growth, and savings from our multiyear restructuring program all contributed to very strong quarterly results here. Turning to page 9, you will see the financial results of our eMobility segment, where revenues increased 6% organically. Like our vehicle business, customer production levels were reduced by supply chain constraints. Given the nature of the products that we sell in this segment, they were more significantly impacted by semiconductor shortages that we've all read about. As a result, our backlog is up significantly here. Operating margins were negative at 9.5%, once again due to heavy IR&D investments and startup costs associated with new programs. We continue to be pleased with the progress in this business, which has programs worth nearly $600 million of mature year revenue. We expect to see a significant ramp-up in revenues in 2023, which positions us well to achieve our long-term revenue targets of $2 to $4 billion by 2030. On page 10, we provide an update on our organic growth and operating margins for the year. With supply chain constraints in Q3 continuing into Q4, we now expect overall organic revenue growth of 9% to 11% for 2021. For Electrical America, we expect 5% to 7% growth. You'll note that the implied guidance for Q4 is actually 7% to 9%, a solid step-up from the 1% in Q3. Organic revenues in aerospace are expected to be roughly flat, with strength in commercial markets offset by weakness in military markets. Other segments had some minor reductions in revenue as well, but just minor. Despite slightly lower organic revenue growth outlook, we’re increasing our operating margin guidance by 20 basis points, from 18.6% to 19%. With this guidance, we’re on track to generate strong incremental margins of approximately 40% for 2021, which we see as outstanding performance given the current inflationary environment. Moving to page 11, we have the remaining items of our guidance for the year. We expect full-year adjusted EPS between $6.69 to $6.89. At the midpoint, this represents 35% growth over 2020. We’re also delivering significant margin improvement, up 240 basis points from last year at the midpoint of our increased margin guidance. I'm pleased that we have strong operating performance in the face of what we call historic supply chain challenges, and the businesses are doing well. Given more active M&A activities, we now expect share repurchase to be between $375 million and $425 million. Lastly, our Q4 guidance includes earnings between $1.60 and $1.78, organic revenue growth between 7% and 9%, and segment margins between 18.8% and 19.2%, an increase of 160 basis points at the midpoint versus prior year. Overall, once again, a strong 2021 with solid revenue growth, strong orders, and good execution, allowing us to deliver record margins. Next on page 12, we wanted to provide some preliminary assumptions for our end market outlook for 2022. As you can see, we're expecting attractive growth in nearly all of our markets, with very good growth in data centers, electrical businesses, and in commercial aerospace. Certainly in all vehicle markets. We'll provide more detailed color on organic revenue growth assumptions when we provide our 2022 guidance in February. But we wanted to share some of our preliminary thoughts. We also expect to see carryover benefits from pricing actions taken, which should help our year-over-year growth next year. On page 13, we provide some summary thoughts here. I'm proud of the record quarter results, particularly our strong margin performance. Our team has demonstrated that we can manage through a challenging operating environment with supply chain constraints and inflationary pressures while still improving margins and EPS. The long-term secular growth trends of electrification, energy transition, and digitalization are playing out just as we expected, or maybe even better. We also see 2021 as a transformative year for Eaton in terms of portfolio management. We're a higher growth, higher margin, and less cyclical company today. With strong year-to-date performance, we're well on track to deliver a strong 2021 with double-digit organic revenue growth and 35% adjusted EPS growth. Additionally, we have great momentum going into Q4 and into next year. We have strong order growth, a full backlog, and many of our end markets are poised for recovery. You'll recall that at the beginning of the year, we stated medium-term targets of 4% to 6% organic revenue growth annually, 400 to 500 basis points improvement in margins, and 11% to 13% annual growth in adjusted EPS. Evaluating our progress about one year in, I'd say we’re running ahead of expectations. With that summary, I'm pleased to turn it back over to Yan to open the session up for Q&A.

Okay, great. Thanks, Craig. For the Q&A section today, please limit your questions to one question and one follow-up. Thanks everyone for your cooperation. With that, I will turn it over to the operator to give you the instructions.

Our first question comes from Joe Ritchie with Goldman Sachs. Please go ahead.

Thank you. Good morning, everyone.

Good morning, Joe.

Craig, I know you want to give us some commentary or a way to provide exact commentary on 2022 organic growth expectations in February. In the context of the long-term framework of 4 to 6 and with your backlog in the Electrical business being up 30%. Is it fair to assume that just the Electrical business should be at a very minimum, at the 4% to 6% range for next year, or maybe slightly better just given what you're seeing across our business?

I appreciate the question, Joe. Certainly, if you look at the performance of the business this year and the backlog with 17% order intake, you can certainly make a case for that business performing better than the 4% to 6% numbers that we laid out. And you'll recall that as we laid out those targets for growth for the Company, all businesses are running towards higher growth numbers. We hedge those numbers back at the corporate level, recognizing that things happen in the world that you don't often anticipate. Q3 is a great example of that with some of the supply chain constraints and there's always uncertainties out there. Yes, there is a possibility that the electrical segments could perform better than that. We have internal plans suggesting better performance, but given the uncertainties, we still think for planning purposes, those are reasonable assumptions to make.

That's fair. Just following up, talking about pricing, it’s clearly a key topic in this call. As you think about your pricing mechanisms for 2022, could you talk a little about how much pricing we can expect to come through the system?

As we've talked about at the Laguna Conferences, our expectation continues to be that our businesses will fully offset inflation with price. It’s never easy to get price, but it’s probably easier today given some supply chain constraints. Our thinking hasn't changed regarding pricing. We have good mechanisms in place. Our pricing typically lags inflation by a quarter or two, depending on the segment of the market we're serving. We naturally have experienced more inflation as we went through Q3 than we originally anticipated. As a result, we, like others, had to pursue additional pricing in the market. By and large, this pattern continues, and we expect to more than fully offset the inflationary pressure experienced this year, potentially adding a little bit of a tailwind next year. Overall, our long-term expectation regarding price versus inflation is to fully offset it.

Thank you. Our next question comes from Andrew Obin with Bank of America. Please go ahead.

Good morning.

Good morning.

Just to build on Joe's question. How much supply chain challenge impacted your revenue in the third quarter, particularly in North America? I think you alluded to it, but could you quantify it?

Certainly, if you look at our Electrical business growing around 8% in the quarter. We saw a very different performance in our Electrical Global versus the Americas, where we had our biggest supply chain constraints. Our backlog grew by $280 million in the quarter. If you look at the shippable piece of that piece, we could say its order magnitude maybe something north of $100 million, let’s call it $130 million of revenue if you simply look at the shippable backlog itself. We would have easily posted a 9% growth number in the Electrical America business, but for those supply chain constraints.

Thank you. And how should we think about backlog versus normal? A number of companies in our coverage have talked about backlogs being up 40%, 50%, 30%. Does this mean more visibility or more uncertainty due to the unusual nature of our business?

We clearly see that it has more visibility. In a typical year, we would enter the year with about 25% to 35% of our orders in backlog for the upcoming year and we’re currently running at the high end of that. We feel that the backlog field is extremely solid, and although you can never be 100% certain, our customers and channel partners indicate that the backlog is legitimate, and we believe it provides stability.

Thanks so much, Craig.

Thank you.

Thank you. Our next question comes from Jeff Sprague with Vertical Research. Please go ahead.

Thank you. Good morning, everyone.

Good morning.

Just back on the supply chain, Craig. The 1% growth jumps out, right? Relative to competitors. I just wonder if you could elaborate more on the issues in Q3, and your confidence level that they're resolved.

I appreciate the question, Jeff. We are a market leader in North America. While we have strong supplier relationships, a few unique suppliers in our Electrical America business faced challenges that we are working through. If you see the backlog growth, sales could have easily reached 9%. We are confident that these are timing issues, tied to specific supplier problems we are addressing.

Great. Thanks for that clarification. On price, I assume you're in the same zip code as what we've seen, mid to high single-digit price increases. Is that directionally correct? Could you share thoughts on potential price impact in 2022?

I appreciate the question, and while pricing varies widely by customer and market, we're not going to provide more transparency than previously provided. We are achieving pricing to offset inflation, nearing neutral this year, and anticipate a net positive next year. However, we will not share specific numbers as many factors influence pricing differently across our customer base.

We will clearly have a wrap impact as you mentioned, just given the timing of the execution of pricing in 2021.

Thank you. Our next question comes from the line of Nicole Deblase with Deutsche Bank. Please go ahead.

Yeah. Thanks. Good morning, everyone.

Good morning, Nicole.

Just to take you back on Jeff's question. You mention a snapback in Electrical America in Q4. As you progressed through early Q4, have you seen some of those supply chain issues improve, providing confidence about achieving 7% organic growth?

Appreciate the question, Nicole. We've had direct conversations with suppliers who have made commitments to us for improvements. We are confident in our forecasts based on what we hear from our suppliers. We are not completely out of the woods, but Q4 should see improvement compared to Q3.

Got it. Thanks, Craig. Just to follow up on your positioning around margins for Q4, you’re expecting a step-down from record levels in Q3. Is it just the favorable mix dynamics you experienced in Q3 that may not carry over?

Yes, we did have some favorable mix in Q3 for sure. In Q4, we anticipate a bit of unfavorable mix as larger projects from backlog are expected to ship, which carry slightly lower margins than our components business.

Thanks, Craig. I'll pass it on.

Thank you.

Thank you. Our next question comes from the line of Josh Pokrzywinski with Morgan Stanley. Please go ahead.

Hi. Good morning, everyone.

Good morning.

I guess I’m on Joe's line here about backlog commentary. Given last year’s pattern, your backlog appears to end the year at $4 billion or $5 billion. Does this align with market demand and any impacts from pricing and backlog consumption?

Our economic forecasts generally bake price into demand. However, we need to think through how backlog may reduce depending on how supply chain unfolds. We may deal with supply chain challenges through the first half of next year, especially around semiconductors, possibly into 2023 before they fully resolve.

Helpful. Appreciate it. Good luck, guys.

Thank you.

Thank you. Our next question comes from the line of Scott Davis with Melius Research. Please go ahead.

Good morning, everybody.

Morning.

Are there customer segments you are concerned about double ordering due to shortages?

No. We have significant discussions on this topic. Distributors would need more inventory and their levels are lower than they would like. Although some double ordering may happen, our customer feedback suggests that inventories are in control overall.

That’s helpful. For Tom, regarding the new minimum tax treaty, how might it impact Eaton's overall tax rate?

We are following it closely. We'll maintain confidence in our relative tax advantage compared to our peers, but more detail will come.

Okay. Thanks. Good luck, guys.

Thank you.

Thank you. Our next question comes from the line of Ann Duignan with JPMorgan. Please go ahead.

Yeah. Hi. Thank you. Could you talk about your 2022 outlook by end markets? It’s interesting to see no red arrows across sectors.

It is unusual to have all our end markets growing, and we feel good about 2022. For residential markets, while orders are strong, macro indicators suggest a potential slowdown cannot be entirely ruled out. Demand for industrial markets continues to lead to an increased appetite for automation investments. We're also seeing strong performance in data centers and utility markets.

Do you worry that if demand continues strong and automotive production ramps up, it might worsen the supply chain problem as we haven't sorted through certain issues yet?

We spend considerable time on this issue. There are risks associated with supply chain bottlenecks. Overall, however, I believe 2022 will be better than 2021, but how much better depends on how quickly we resolve the supply chain constraints.

Thank you and good morning.

Morning.

I’m looking for perspective on the cost structure adjustments in the back half of this year. You cut 200 basis points from your top-line forecasts, but you raised your margin outlook. What enabled this good performance?

Beyond the mix we mentioned, we are dealing with extraordinary costs related to expedited materials and labor inefficiencies. We anticipated our revenue challenges early and executed effectively to enhance our performance, optimizing our operations to maximize the outcome despite supply chain challenges. The restructuring program also delivered benefits earlier than expected.

What about variable compensation and other components of your expenses? Was that impacted?

Compensation costs will likely be higher than initially planned, contributing positively to our performance.

In terms of supply chain, are things improving in Q4 relative to Q3, or are you adjusting by qualifying new suppliers?

It’s really all of the above. We are seeing improvements with some suppliers, while also qualifying new materials and optimizing our supply chain to address the ongoing issues. We're actively pursuing multiple initiatives to enhance the situation.

Hi. Good morning. I wanted to address the portfolio. Noting the reduced buyback guidance due to heightened M&A appetites, could you explain what has changed there?

The reduced buyback guidance doesn’t reflect a change in capital allocation. We have engaged in significant acquisitions this year and continue to seek strategic opportunities.

We’re seeing more deal flow than in recent years, although valuations remain stretched. We commit to not sacrificing our criteria for acquisitions, focusing on those that are strategic for our electrical business and eMobility segment.

Thank you. On free cash flow, year-to-date, adjusted EPS is up 40% while free cash flow is down mid-teens. When considering 2022, should we expect closer to 100% conversion and more CapEx than this year?

In Q3, our free cash flow conversion was approximately 100%, with free cash flow as a percentage of net sales at 12.4%. We aim to be at or above this level in the future. Our priority will always be to invest in growth opportunities.

Good morning.

Good morning, Nigel.

I want to revisit Electrical America. Given the tough comp you had in the prior year with inventory restocks, what are inventories trending like now?

Our channel checks indicate that distributor inventories are either in line with their needs or below what they would prefer. We aim to ship more than our capacity during this period of demand.

Lastly quick, what are your thoughts on pension funding levels?

Our pension is nearly fully funded. We don't anticipate additional contributions beyond this year, as future returns will depend on market conditions.

Thank you. My question relates to incremental margins next year in Electrical. How do you think them in light of your backlog?

There's nothing in the backlog we believe will significantly change performance going into 2022. For planning, consider incremental margins at around 30%. This year, our execution has been better than expected.

Regarding pricing, we’ve seen a range of increases. Are you hearing about any demand destruction with these increases?

We have not encountered demand destruction. Pricing pressures have been successfully passed to customers, and demand remains solid.

Good morning, everyone. Could you clarify that the sales missed due to supply chain in Electrical America are deferred and not lost?

While I can't guarantee 100%, the growth in backlog signifies that most shipment delays are simply future deliveries, especially with our project-based business, where switching suppliers is challenging.

Can we get some color on what you're seeing in China, specifically around data centers and industrial markets?

Despite recent macro challenges, our China team had an excellent quarter. Our Asia business growth aligns well with broader global trends, especially in data centers.

Thanks, everyone. We have reached the end of the call, and we appreciate everybody's participation and questions. As always, Craig and I will be available to address your follow-up questions. Thank you again, and have a great day.

Thank you, ladies and gentlemen. That does conclude our conference for today. We thank you for your participation and for using AT&T Conferencing Service. You may now disconnect.