Ladies and gentlemen, thank you for standing by and welcome to the Eaton Corporation Fourth Quarter Earnings Conference 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, Mr. Yan Jin. Please go ahead.

Good morning, everyone. I'm Yan Jin, Eaton's Senior Vice President of Investor Relations. Thank you all for joining us for Eaton's Fourth 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 the opening remarks by Craig, highlighting the Company's performance in the fourth quarter. We'll be taking questions at the end of Craig's comments. The press release and the presentation we'll go through today have been posted on our website. This presentation includes the adjusted earnings per share, adjusted free cash flow and other non-GAAP measures. That's reconciled in the appendix. A webcast of this call is accessible on our website and will be available for replay. I will 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 from projections due to a wide range of risks and uncertainties as outlined in our presentation release and the presentation. With that, I will turn it over to Craig.

Okay. Thanks, Yan. Let's start on Page 3 with a few highlights of the quarter, and I'll begin by saying that, despite what's now very well publicized and ongoing supply chain issues, our team delivered solid results in the quarter and a record performance for the year. In Q4, we generated adjusted EPS of $1.72, a fourth quarter record. Our sales of $4.8 billion were up 6% organically, and I'd say here, we had particular strength in residential, data centers, and in industrial markets. Our aftermarket businesses in both commercial aerospace and vehicles continued to deliver strong growth. We were certainly impacted by supply chain constraints, which had an impact on our revenue, especially in our Electrical Americas and Vehicle segments. The good news is the markets remain strong. Order growth accelerated in the quarter, and we ended the year with a record backlog. For our combined Electrical business, orders were up 21% on a rolling 12-month basis, and our backlog was up 56%. Our Aerospace business also had a significant increase in orders, up 19% on a rolling 12-month basis, and the backlog was up 16%. We also continue to post strong segment margins, 19.3% in the quarter and a Q4 record. The actions we've taken to mitigate inflation, our portfolio changes, and the restructuring savings are all contributing to the strong incremental margin performances. I'd also note that we benefited from a favorable mix in the quarter. Our portfolio changes continue to be an important part of our strategy. We're pleased to have completed the Royal Power Solutions transaction a few weeks ago. The addition of Royal Power will allow us to accelerate our growth in eMobility, and actually in the broader electrical market as the economy continues to adopt more electric solutions. I think you'd agree that we're not sitting still. We're managing the things that we can control operationally while continuing to advance our strategic agenda. Moving to Page 4, I'll highlight a few additional points on our quarterly results. First, total revenues were up 2%, and we increased operating profit by 14%. We continue to demonstrate strong operating leverage. Second, acquisitions increased revenues by 7%, which was more than offset by the sale of Hydraulics, which was a 10% headwind. While not complete, we're certainly pleased with our progress on the portfolio. We continue to drive changes to support our overall goals of creating a company with higher growth, higher margins, and more earnings consistency. Our margins of 19.3%, as I noted, were above the guidance range of 18.8% to 19.2%, a good indicator of our team's ability to execute operationally while managing the things that are in our control. Lastly, we noted both adjusted EPS of $1.72 and margins of 19.3% were Q4 records in the face of the significant supply chain constraints we've been dealing with. Next, on Page 5, we show the financial results of our Electrical Americas segment. Revenues were up 13%, 5% organic and 8% from the Tripp Lite acquisition. The organic sales growth was driven by strength in residential, industrial, and data center markets. On a sequential basis, our organic growth stepped up from 1% in Q3 to 5%. We're making progress but continue to be impacted by supply chain constraints. In some cases, our ability to meet demand was also impacted by labor availability, especially due to the spike in the Omicron variant toward the end of the year. Operating margins of 19.2% were down 190 basis points year-over-year, driven by higher input costs, labor and supply chain inefficiencies, and disruptions in our facilities. We're making good progress in price recovery, but not fast enough to prevent some margin erosion. Overall, market demand remains strong, reflected in orders and the growth in our backlog; orders were up 20%, accelerating from up 17% in Q3 and 13% in Q2. Our backlog reached another record, up 57% from last year. The strongest markets continue to be residential and data centers. We also have strong momentum in our negotiation pipeline, which was up 11% in the quarter. Turning to Page 6, we summarize our Electrical Global segment. We delivered strong results in this segment. Organic growth was 15% with strength in all regions, particularly in commercial data center and industrial markets. We delivered significant operating leverage with operating margins of 19.5% and incremental margins of 40%. While we had a bit of favorable mix here, we expect this to continue. Like the Americas, orders remained strong, with a 22% increase on a rolling 12-month basis and a step-up from the 17% number in Q3. Our backlog remained above 50%. In this segment, order strength was particularly strong in data centers, residential, and utility markets. Overall, I'd say that our Electrical Global business had a very strong quarter on top of a strong year, carrying strong momentum into 2022. Moving to Page 7, we summarize the results for our Aerospace segment. We had a strong quarter, with revenues increasing 40%. Of this, 4% was organic and 37% was from the acquisition of Cobham Mission Systems. Aftermarket and business jet revenues were up 24.9%, an all-time record, improving 660 basis points from the prior year. In the quarter, we had solid incremental margins of more than 40%, aided by a favorable mix, particularly the growth in aftermarket, and by our portfolio actions. Another bright spot in the quarter was the growth in orders and backlog. On a rolling 12-month basis, orders turned positive in Q3 and were up 19% in Q4 with particular strength in commercial markets. Commercial transport, business jets, and commercial aftermarket all saw significant increases, and our backlog was up 16% from last year. Next, on Page 8, we show the financial results of our vehicle business. Revenue was down 2%: 1% organic, and 1% from currency. We had strong organic growth in North America truck and our South America business, which was offset by weakness in global light vehicle markets. We had significant supply chain constraints in this segment, including customer shutdowns that impacted our revenue. We believe the worst is behind us, and we'll see improvement in supply chain-related disruptions this year. Overall, our team executed well, delivering solid margins of 16.4% and decremental margins of 30%. Turning to Page 9, we have the results for our eMobility business. Revenues were up 4% with growth in North America and Asia, partly offset by weakness in Europe. Like our vehicle business, we experienced significant supply chain constraints and customer shutdowns. Our operating margins were negative 9.1% as we continue to invest heavily in R&D and start-up costs associated with new program wins. As I mentioned earlier, we acquired Royal Power Solutions in January, and it will be reported within the eMobility segment. This important acquisition is part of our strategy to improve the long-term growth rate of Eaton. First, it expands our addressable market for eMobility with a portfolio of highly engineered terminal connectors for electrical applications. Second, Royal Power has a strong track rate of profitable growth and will continue to grow as the electrical content in vehicles expands. Lastly, this acquisition will allow us to offer more comprehensive solutions with our own power protection and power conversion products sold in mobility markets. With the completion of the Royal Power acquisition, we're well-positioned to achieve our long-term objective of building a $2 billion to $4 billion eMobility business inside of Eaton. Our cumulative new program wins now total $800 million in material revenue, inclusive of new wins from Royal Power. Moving to Page 10. I'll take a minute to recap our 2021 performance before we shift our focus to 2022. We delivered strong organic growth for the year, up 10%, with significant strength in our Electrical Global segment, which grew 15%; Vehicle, which grew 21%; and eMobility, which grew 16%. I'm especially proud of the team for delivering record segment margins of 18.9%, a 250 basis point improvement over 2020 despite the challenging supply chain environment. Our team executed at a high level and delivered incremental margins of 43%. We completed $8 billion of portfolio actions toward our goal of building a high-growth, higher-margin company with consistent earnings. We're off to a good start in 2022 with a value-enhancing acquisition in Royal Power. As a result of our disciplined execution and transformative portfolio actions, we delivered 35% growth in adjusted EPS. Importantly, our shareholders were well rewarded for their commitment with a total shareholder return of 47% for the year. Our 2021 results set a high bar for what we expect of ourselves and what you expect of us as well. But we're up for the challenge, believing that the best years are still ahead. Now, let's shift our focus to 2022. On Page 11, we present organic growth and margin guidance by segment. Overall, we expect organic growth of 7% to 9%. Starting with our Electrical businesses, both Americas and Global are expected to grow 7% to 9%, with growth anticipated across all end markets, particularly in data centers, distributed IT, and industrial markets. In Aerospace, we expect organic growth of 10% to 12%, driven by strong growth in both commercial OE and aftermarket channels. Our base assumption is travel continues to expand from the COVID downturn without significant new variants. We expect low single-digit growth in military markets. For Vehicle, organic growth is anticipated to be 7.5% to 9.5%, reflecting strength in both light motor vehicles and truck markets. In eMobility, we're expecting organic growth of 11% to 13%, driven by continued strength in electric vehicles. We expect Eaton's segment margins to be between 19.9% and 20.3%. At the midpoint, this reflects a 120 basis point improvement over our record margins in 2021 and is expected to see margin expansion in all segments. Turning to Page 12, we cover the balance of our 2022 guidance. Organic growth is projected at 7% to 9%, with acquisitions and divestitures subtracting 3.5%, and currency expected to be flat. We forecast costs to be flat, and our tax rate will be between 16% and 17%. Adjusted EPS is projected to be in a range of $7.30 to $7.70, at the midpoint of $7.50, which is a 13% increase. Operating cash flow is expected to be between $3 billion and $3.2 billion, with CapEx approximately $650 million. At the midpoint, our operating cash flow is expected to increase 15% versus last year. Our free cash flow is expected to be between $2.4 billion and $2.6 billion, and at the midpoint of $2.5 billion, also a 15% increase. This represents free cash flow to sales of approximately 12% and free cash flow to net income of approximately 100%. We expect share repurchases to be between $200 million and $300 million, reflecting our pivot to what we think will be a higher priority on tuck-in acquisitions. Lastly, our Q1 guidance is as follows: we expect adjusted EPS to be between $1.55 and $1.65, organic revenue growth to be up 7% to 9%, segment margins between 18.4% and 18.8%, and a tax rate between 15% and 16%. Allow me just to close with a brief summary on how we think you should consider the Company. First, our top line is supported by strong secular growth trends. Most of this growth impact is just beginning to show up in our revenue, so much of it is still out in front of us. We've demonstrated that we can expand margins and are comfortable with delivering 11% to 13% EPS growth over our planning horizon. We have clear capital allocation priorities and a disciplined approach to M&A, which we believe is paying off. As a result, we're a different company today, transformed into one that can deliver higher growth, better margins, and more earnings consistency. We're not done; we also remain committed to ESG, which is at the forefront of our daily operations. Sustainability is truly part of how we drive growth in the Company. Many of you have gotten to know our Chief Sustainability Officer, Harold Jones, and you'll hear more from him at our investor meeting next month. In the short term, you can count on us to continue managing through operating challenges from COVID, supply chain disruptions, and labor shortages by controlling the factors within our control. We believe 2021 was critical for our transformation journey, and we're proud of our results. Most importantly, we're ready to repeat that success this year. Now, I'll turn it back to Yan, and we'll be happy to address your questions.

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

Our first question will come from Josh Pokrzywinski with Morgan Stanley. Please proceed.

I have a couple of questions here. I guess first on free cash flow conversion. How should we think about some of the moving pieces surrounding that, such as working capital or otherwise? And when do you think we start to get back to kind of more historical conversion rates?

Thanks for the question, Josh. We intentionally used GAAP earnings in our prepared remarks when saying we were close to 100% in our free cash flow conversion. The reason we did this is it's important to look at GAAP earnings when going through multi-year restructurings and significant M&A activities. Four main items are relevant to consider for free cash flow conversion: acquisition, integration, and divestiture costs, which will generate cash requirements for us in 2022; cash requirements related to the multiyear restructuring program; increased CapEx investing to grow by $75 million; and the remaining portion of the CARES Act that we'll pay in 2022. Using adjusted earnings, you would likely be in the low 80s to mid-80s range. If adjusted for those four items, you'll be well into the mid-90s. So I don't see it being a departure from historically what we've done. I also note we're growing operating cash flow by $400 million this year, which is significant.

I'd just add, in addition to that, Josh, we're obviously not through many of these supply chain-related challenges. As we think about today, our priority is to protect customers and get ahead of some of these constraints, having a substantial amount of working capital, particularly in inventory, due to these supply chain-related issues.

Got it. That's helpful. Regarding supply chain, the volume output here is held back. If order rates hold, what sort of volume growth are you expecting in the second half or exit rate? As some of these supply chain issues abate, how do you view the guidance?

Yes, it's a tough question to answer precisely. We and others have misjudged how long these supply chain constraints would persist. However, the underlying order growth in our businesses is a strong indicator of genuine demand. To address your other concern about possible over-ordering for channel restocking, we’ve assessed this, and we’re not seeing indications for it. Our distributors are calling for more inventory than we can currently deliver. Much of our business is project-driven, so orders and sales should eventually converge unless there is substantial over-ordering. We're optimistic regarding the underlying strength in our markets, which is reflected in our growing backlog. We anticipate our guidance for 7% to 9% growth is well below the underlying order rate for our Electrical business.

For perspective, Josh, we estimated that in Q4, just in the Americas, we probably lost about $100 million in sales related to supplier disruptions.

Right, timing has pushed revenues into 2022 if we look at the backlog.

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

I have a question about backlog. How much visibility do you currently have from your project backlog? How does the margin profile of those projects look relative to the current input costs?

We have a lot more visibility today than we ever have in the history of the business, given this 56% growth in the backlog for our Global Electrical businesses. We anticipate with respect to pricing in the backlog that we've been able to anticipate where the inflation trends are heading, particularly around commodity inflation. We're confident today with the pricing in our backlog as reflected in our guidance. We don't expect to see a margin impact due to a backlog that isn't reflective of today's commodity prices.

I'm also curious how to think about investments needed in capacity, working capital, and supply chain to keep up with demand in the longer term. What impact do you foresee on margins, free cash flow conversion, or return on capital in the bigger picture?

We expect to see a bit of an increase in capital spending requirements to support demand given our anticipated faster growth than historically. Revenue will also be growing. So, regarding CapEx as a percentage of sales, it may not change materially, but we expect a slight increase. Today, we have the opportunity for revenue and working capital improvements as we sit on record inventory levels. Once we get through some supply chain transitory items, we hope it will become a source of cash as we grow. We believe we have built enough inventory to protect our customers in their operations. On the CapEx side, we anticipate continued investments in capacity and resiliency to support future growth.

It's also vital to note that we are still aiming to achieve 100% free cash flow conversion and a target of 14% free cash flow as a percentage of sales. This objective remains a priority for us.

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

Could you provide insights into price realization in the quarter and what is embedded in your guidance? I understand you didn't expect price/cost to be a margin headwind.

Thanks for the question, Jeff. We are focusing internally on ensuring that we're recovering commodity inflation affecting our business. In the previous quarter's commentary, I mentioned we saw a margin impact within our Electrical Americas segment related to price and cost; we were recovering dollars but did not achieve margin. As we look forward, we expect slight positivity in price costs throughout 2022, without the headwinds that we faced in 2021. We expect this to positively impact our EPS as well. Regarding dollar percentages, as mentioned last earnings call, we're diversified and have varying inflation rates across businesses; hence we have avoided sharing specific numbers to prevent confusion among clients.

Can you give any thoughts on lag effects of potential steel price deflation coming through the system considering you have significant backlogs?

We are observing steel prices declining from last quarter. The typical lag time on that can be anywhere from 30 days to 90 days, depending upon the business segment and the supplier agreement. We are still encountering high costs for commodities in general, much of which will remain elevated throughout 2022, despite some relief in steel prices. Other inputs like copper, resin costs, and semiconductors still pose challenges for us.

Thank you. Our next question comes from Nicole DeBlase with Deutsche Bank. Please go ahead.

I want to revisit the working capital and free cash flow discussion. As we consider your guidance for 2022, have you factored continued working capital build into the forecast, or do you anticipate it will be a source of cash this year?

What's embedded in our forecast suggests a slight positive in improving working capital, primarily related to inventory.

We're seeing some improvement in networking capital, primarily involving inventory.

Thank you. Could you clarify price/cost headwinds in any other segments outside the Americas?

We are experiencing price/cost headwinds in most of our businesses, but it's more pronounced in the Americas. We are facing inflationary pressures globally but to a greater degree in our U.S.-based operations due to higher input costs.

Thank you. Our next question comes from John Walsh with Credit Suisse. Please go ahead.

Can you share more about what you're seeing in the global data center market, and whether some of those projects are already booked through 2023?

The data center market has been exceptionally strong, supported by a multiyear trend. Whether regarding hyperscale, colocations, or on-prem markets, demand has remained robust and exceeding our supply capacity for customer demand. We foresee this market being strong for the foreseeable future, particularly linked with trends like 5G and autonomous vehicles. We are presently positioned for significant capital investments to meet this continued demand.

Regarding Aerospace margins, there seems to be a bit of pressure in conversion. Is this due to mix or other factors?

The incremental margins for the Aerospace business was 40%. For our guidance, let’s discuss the specifics after the call, regarding the material impacts of acquisitions.

Thank you. Our next question comes from Joe Ritchie with Goldman Sachs. Please go ahead.

Craig, we're observing interesting dynamics with inventory. You built inventories in this quarter to meet market demand. Are your OEMs also building inventories?

Many companies may want to build inventory today. Our distributors wish to recover to historical inventory levels. Our automotive customers continue to operate with record-low inventory levels. We've engaged with many distributors and have not observed over-inventory issues.

Regarding Electrical Americas margins, when do you project margins will turn positive year-over-year?

By Q2, we expect our margins to turn positive. We are grappling with several factors in the business, specifically those linked to supply chain disruptions and labor supply inefficiencies at our facilities, compounded by COVID impact. We foresee improvements in Q2 as operational efficiencies are restored. We anticipate that supply chain conditions will improve every quarter, but some, like semiconductors, may persist throughout the year.

At the midpoint, we are projecting 90 basis points above the prior year margins in Electrical Americas, indicating our optimistic outlook overall.

Thank you. Our next question comes from Julian Mitchell with Barclays. Please go ahead.

In Electrical Americas, how much does the residential market account for your business, and what are expectations for that market in 2022?

Residential currently represents approximately 18% of our business, which was up around 10% last year. We are anticipating some slowdown in this segment, which is considered in our 2022 guidance. Nonetheless, we see growth in the electrical content in buildings due to new codes and the energy transition driving demand for additional solutions, such as electric vehicle infrastructure.

With inventory dynamics in mind, are there areas across markets with more or less inventory relative to norms?

I think it’s fair to say that everyone would want to build up their inventory. We aren't observing significant inventory accumulation, particularly in the automotive segment; levels are substantially lower than the historical norm.

Thank you. Our next question comes from Nigel Coe with Wolfe Research. Please go ahead.

You achieved 9% growth in Electrical in '21 and are forecasting 7% to 9% for '22. How are you thinking about growth beyond '22 in Electrical?

We will address this at our Investor Day next month. It’s reasonable to anticipate more strength than initially forecasted. We expect improvements in long-term growth expectations beyond the current 4% to 6% target. Regarding industrial and commercial markets, we observe strength; we expect continued positive growth in all markets next year, particularly in industrial, utility, data center, and residential sectors.

Commercial and institutional markets exhibited high single-digit growth in the last year, while industrial markets saw mid-teens growth.

Thank you. Our next question comes from Brett Linzey with Mizuho America. Please go ahead.

Can you discuss the capital deployment strategies? The projected share repurchase guide is limited due to a focus on bolt-on acquisitions. What kind of pipeline do you see?

We've undertaken considerable portfolio transformation over the past two years. We're prioritizing Electrical business investments linked to electrification, digitalization, and energy transition trends. We aim to penetrate underserved markets through geographic transactions, specifically in Asia Pacific. Our recent acquisition of Royal Power reinforces our confidence in finding value-creating acquisitions. Our pipeline is engaged with many opportunities, and we hope to deploy more capital, focusing on M&A; but if suitable deals are not available, we’ll conduct stock buybacks. Our goal remains to create shareholder value whether through M&A or buybacks.

The current secular trends provide us exciting opportunities, such as the Royal Power acquisition that supports our eMobility, Aerospace, and Electrical sectors.

In terms of utility T&D, what is the tone from customers around CapEx?

The T&D market requires significant investments due to aging infrastructures and ongoing demand for upgrades. We expect continued strong demand and growth for several years to come in the Americas region.

The utility T&D business grew mid-single digits last year, and we anticipate similar growth for 2022.

Thank you. Our final question will come from Markus Mittermaier with UBS. Please go ahead.

Craig, could you elaborate on the negotiation pipeline increment you mentioned in Electrical Americas? Is there any semiconductor activity within it?

I don’t have specific information about the composition at this moment. We will connect with Yan to provide you the necessary details regarding the negotiations.

The semiconductor opportunity sounds interesting.

Indeed, a sizable infrastructure build-out for semiconductors creates numerous prospects for us, particularly in electrical switchgear.

Was the strong margin profile in Electrical Global primarily attributable to Crouse-Hinds?

The strong margin profile is broad-based; while Crouse-Hinds contributes positively, our Electrical Europe and Asia segments also improved profitability significantly.

Thank you, everyone. Chip and I will be available to address your follow-up questions. Have a good day. Thanks.

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.