Thank you for joining us for the Eaton Second Quarter Earnings Conference Call. All participants are currently in listen-only mode. We will have a question-and-answer session later. Please note that today's conference is being recorded. I will now hand over the call to your host, Yan Jin, Senior Vice President of Investor Relations. Please proceed.

Hi, good morning. I'm Yan Jin. Thank you for joining us for Eaton's second quarter 2022 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 second quarter. As we have done on our past calls, 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, including adjusted earnings per share, adjusted free cash flow and other non-GAAP measures, has been reconciled in the appendix. A webcast of this call is accessible on our website and will be available for replay. I would like to remind you that our comments today will include statements related to expected future results of the company and are therefore forward-looking statements. Our actual results may differ materially from our forecasted projections due to a wide range of risks and uncertainties that are described in our current earnings release and the presentation. With that, I will turn it over to Craig.

Okay. Thanks, Yan. Appreciate it. And we'll start with a summary of the quarter on Page 3, and I'll begin by noting that we had a strong quarter. We posted a number of all-time records led by 11% organic growth. Our performance was particularly strong in our Electrical businesses, both in the Americas and Global. And as you can see, orders remain strong, and we continue to build record backlogs, supporting the outlook for the year and really, in many cases, I'd say, into next year. I'd emphasize that nearly all of our end markets remain strong, but we're seeing significant strength in commercial, in industrial and data centers, and residential markets and our Electrical businesses. And in our Aerospace business, we saw strong growth, in the commercial business, both in aftermarket and in OEM. This strength, I'd say, is reflected in order growth in Electrical, which was up 25% and the Aerospace business, which was up 19% on a rolling 12-month basis. Our backlog was up some 74% in Electrical and 12% in Aerospace. As reported, we also delivered adjusted EPS of $1.87, a 9% increase over the prior year and an all-time record, more than offsetting a $0.12 headwind from the impact of acquisitions and divestitures. You'll recall that we owned the Hydraulics business in all of Q2 last year. The $1.87 a share was close to the high end of our guidance range as well. We also posted an all-time record segment margins of 20.1%, up 150 basis points over the prior year and above the high end of our guidance. So in addition to strong growth, our teams have done really an effective job of managing price to offset inflation. And lastly, we're raising our full year guidance as well. We're increasing our organic growth forecast from a range of up 9% to 11% to up 11% to 13%. And we're increasing our full year adjusted EPS to $7.56 at the midpoint, 14% year-on-year growth and despite additional headwinds from FX, from higher interest expense and lower pension income. Moving to Page 4, we show the financial results for the quarter, and I'll just note a few items here. First, our revenues were flat year-over-year with 11% organic growth offset by the net impact of acquisitions and divestitures of some 9% and 2% from negative FX. And we're certainly very pleased with this level of organic growth, but I would also note that growth could have been much better but for persistent shortages of electronic components and COVID-related lockdowns in China. Second, currency headwinds were worse than we expected in our guidance and almost $150 million impact versus the prior year. As you'll see in our forward guidance, we expect this number to get worse in the second half. The FX headwinds will also reduce our adjusted EPS by approximately $0.05 in the quarter. Lastly, I'd like to emphasize that we achieved a number of all-time records in the quarter, including segment operating profit, segment operating margins and adjusted EPS. Next, on Page 5, we have the results of our Electrical Americas business, and really just a strong quarter across the board here. As you can see, organic growth up 16% and record segment margins of 23.2%. We delivered strong growth across all end markets, with particular strength in commercial, residential and industrial markets. Organic growth actually accelerated from Q1, up some 10%, and with sequential acceleration in nearly all of our markets with the biggest increases coming from utility, data centers and commercial markets. We did manage to navigate through a number of significant supply chain constraints, but saw improvements in metals and resins and logistics while continuing to face challenges in electronic components. Orders on a rolling 12-month basis were up 29% with strength across all end markets with a range of anywhere from up 18% to up 39%. So we continue to be pleased with the strong demand that we're seeing in our end markets and with our backlog, which increased some 89% to a new record level. On a sequential basis, our backlog growth was up almost 20% from Q1. We also delivered record operating margins of 23.2%, up 190 points driven largely by better-than-expected volumes. And of note, we were successful in offsetting inflation with price and expect this to continue to be on the plus side in the second half. Turning to Page 6. We show the results of our Electrical Global segment, which produced another very strong quarter, including all-time record sales. In fact, this is our fifth quarter in a row with double-digit organic revenue growth. Organic growth was 12%, with a 7% headwind from currency. We saw growth in all regions with particular strength in data centers, commercial and industrial markets. Orders on a rolling 12-month basis were up some 19%, while our backlog grew 38% to a new record level. We also delivered record Q2 operating profits and operating margins. At 18.9%, operating margins were up some 60 basis points from the prior year. Lastly, we recently closed a new joint venture in China by acquiring 50% of Jiangsu Huineng Electric, which manufactures and markets low-voltage circuit breakers in China for the renewable energy market. This is our third electrical joint venture in China in the last eight months, which allows us to expand our market participation by offering what we see as a multi-tiered portfolio of products serving this very high-growth market both inside and outside of China. On a combined basis, these three joint ventures increase our addressable market by about $17 billion. This is an important part of our future growth strategy coming out of these JVs. Before we move to our industrial businesses, here's what I'd summarize about the performance of our combined Electrical business. Overall, our electrical sector posted a strong Q2, with 14% organic growth and a 150 basis point improvement in margins. We really have not seen a slowdown in any of our markets. We continue to see strong growth in orders, and backlogs are at record levels. The secular growth trends that we've discussed in the past, including energy transition, are clearly showing up in our order book. Moving to Page 7, we have a recap of our Aerospace segment. Revenues increased 19%, including 10% organic growth, 12% growth coming from the Mission Systems acquisition and a 3% currency headwind. Organic growth in the quarter was particularly strong in our commercial aftermarket and commercial OEM businesses. On a rolling 12-month basis, orders increased 19% while backlog was up 12%. In the commercial market, as many of you know, travel continues to show positive improvements in both domestic and international markets, certainly a positive indicator for future growth and is consistent with what we saw in the quarter. Our commercial aftermarket bookings are only at 85% to 90% of their pre-pandemic levels, which indicates ample room for additional growth in this particular segment. Commercial OEM activities also continued to recover. For military markets, we expect to see increased tailwinds in defense spending, including an uptick in U.S. defense budgets. We've already seen renewed commitments from the European NATO members and expect this to lead to increased defense spending over the next several years. We're also pleased with the profitability of this segment as operating margin stepped up 90 basis points to 21.9%. You'll recall that the peak margins for our Aerospace business was 25%, so we expect this number to continue to move up over the next few years. Next, on Page 8, we summarize the performance of our Vehicle segment. Revenues were up 5%, which includes 7% organic growth and 2% negative currency. We had particular strength in the North America light vehicle markets and in our South America business, partially offset by flat performance in Europe and weakness in China largely due to the COVID lockdowns. Operating margins were down some 260 basis points driven primarily by margin compression from inflationary costs and the normal lag in our ability to recover price in the marketplace. We expect that the price inflation equation will improve in the second half, which is reflected in our outlook for the year. Turning to Page 9, we show the results of our eMobility business. Revenues increased by 55%, which includes 11% organic growth, 46% from the acquisition of Royal Power, and a negative 2% currency impact. We also delivered more than $70 million of material wins during the quarter, including wins that leverage our core competency as a company in power distribution and power protection. While still slightly negative, we narrowed the operating losses by some 530 basis points. This improvement was generated by higher volumes and the acquisition of Royal Power. At the six-month point, our integration of Royal Power remains on track, and the expected synergies are allowing Eaton to sell a broader solution to the marketplace, which is playing out just as we had hoped. Overall, we continue to make steady progress towards our 2030 goal, which is to create a $2 billion to $4 billion business with attractive 15% segment margins. As we noted at our investor meeting earlier this year, we expect the segment to deliver $1.2 billion of revenues and 11% margins by 2025. Next, on Slide 10, we have the updated guidance for 2022. For the second time this year, we're increasing our organic growth guidance for all but one of our segments, really based upon continued strength in all of our end markets. We're raising our overall organic growth from 9% to 11% to 11% to 13% on the back of strength in our Electrical segment, where we've increased growth by 300 basis points in the Americas and 150 basis points in Global. For margins, we're raising our full year guidance for Eaton to be in the range of 20% to 20.4%, which represents, at the midpoint, a 130 basis point improvement over 2021. The two changes in the segment include increasing margin guidance for Electrical Americas by 70 basis points to 22.2% at the midpoint and lowering our margin targets for the vehicle by 120 basis points to 16.5% at the midpoint. As we talked about, the Vehicle reduction reflects the timing and margin compression associated with inflation versus price realization that we discussed earlier. Overall, I would say we had a strong first half, including robust demand and orders, record levels of backlog, and we're very well positioned for the year. Moving to Page 11, we show the balance of our guidance for the year. For the second time this year, we're raising our '22 guidance for adjusted EPS, which is now forecast to be between $7.36 and $7.76 a share. As covered on prior pages, we're increasing our organic growth outlook to 11% to 13%. I would note this is partially offset by $250 million of negative currency, which compares to our previous guidance of negative $250 million. The stronger dollar requires us to offset some additional $0.08 of earnings versus our prior guidance, which we are clearly doing and is reflected in our outlook. We also expect that our corporate expenses will now be $20 million to $40 million above 2021 levels or between $580 million and $600 million. Another $0.04 to $0.08 headwind is being offset in our adjusted EPS guidance for the year and is primarily due to higher interest expense and lower pension income. To recap, we're raising our adjusted EPS guidance by $0.04 despite between $0.12 to $0.16 of incremental headwinds from FX, interest and pension. The remainder of our full year guidance remains unchanged. Just a few highlights on our Q3 guidance. We expect adjusted EPS to be between $1.95 and $2.05 per share, organic growth to be between 13% and 15%, and segment margins to be between 20.6% and 21%. At the midpoint of our guidance, margins are expected to be up some 70 basis points from Q2. Our Q3 guidance represents 14% growth versus the prior year. Wrapping up on Page 12, just to recap a few points. First, I’d say, we continue to realize the benefits of our active portfolio management, which is certainly showing up in our record levels of financial performance. Second, we're seeing secular trends that are enhancing our end market growth rates now, and we fully expect this to continue into the future. We've discussed growth in electrification, energy transition, and digitalization for some time now, and these trends have only accelerated. Despite all the talk about a potential slowdown and downturn in the market, and we will be ready if we have one, we're focused on investing to capitalize on what we see as the super growth cycle, driven by favorable trends and the recovery in some of our other end markets. Every time you hear sustainability, climate change, and resiliency, you're really hearing about growth opportunities for our company that we're capitalizing on today and will be for the foreseeable future. This is certainly showing up in our sales results, our orders, and our backlog, which are all at record levels. These factors contribute to our confidence in our ability to raise guidance for the year. More importantly, they give us confidence in the long-term outlook for the company. In the short term, we're working through supply chain disruptions, focusing on controlling the things that we can, building more resilience in our operations, and delivering our commitments. But with that, I'll turn it back to Yan, and we'll open it up for Q&A.

Okay. Good. Thanks, Craig. For the Q&A section today, please limit your question to one question and one follow-up. Thanks in advance for your cooperation. With that, I will turn it to the operator to give you guys the instruction.

And our first question will come from the line of Andrew Obin from Bank of America.

So yes, a question for Craig. The view among investors, right or wrong, is that we will see an economic downturn soon. So how would Eaton's Electrical incremental margins perform in an environment where the majority of revenue growth is from pricing versus sort of more normal periods with a balance of volume and price contribution?

Appreciate the question, Andrew. In general terms, in our company, we've always performed well in an economic downturn. We know how to do a few things well. Certainly, one of those is flexing the company in the event of an economic downturn. We typically perform much better from a decremental basis than we do on an incremental basis. In a typical recession, we would see some 20% to 25% decremental performance in our business. I don't think that our Electrical business will be largely different than that. At this point, as I mentioned, we're not anticipating a reduction in growth in our business even in the event of a typical mild recession. We think our company and certainly our Electrical business will continue to grow. You saw some of those order numbers, the backlog numbers that we discussed. Our negotiation pipeline has never been stronger. So we think the company overall, as a result of a lot of portfolio-related changes and secular growth trends that we see, will perform well even in the event of an economic downturn. We have a playbook and projects identified ready to go if we end up in that scenario, but that is certainly not our base case. If you think about 20% to 25% decrementals in the event of a material economic slowdown.

Great. And then just a follow-up, maybe just speak to why you're confident, but can we get your initial view on Senator Manchin's news and the potential additional $370 billion in spending on energy security? How meaningful could this be for Eaton's end market? Have you started to see orders tied to U.S. stimulus bills, which have sizable energy infrastructure spending levels?

The compromise that Manchin and the other members of the House have come up with at this point would be certainly positive for our company. Those dollars will go toward energy transition, EVs, critical infrastructure, water, wastewater, airports, and are certainly a net positive for our company overall. At this juncture, we have not factored any of that in. That becomes an additional tailwind for the company. All of these spending bills need final approvals and ultimately to be signed off by the President. From a timing standpoint, this largely becomes a '23, '24 kind of tailwind for the company overall, as are most of the stimulus-related projects. Very seldom do you have a stimulus bill approved that results in any near-term impact on revenue, but it's certainly all positive for the long-term growth outlook, especially in our Electrical business where we'll see most of these benefits.

Any impact from what's been passed already? Are you starting to see it in the numbers, or do the robust numbers reflect a lot of it already?

At this juncture, there have been some minor projects where we've seen some benefit, but most of these will not have a material impact until we get into '23 and some of them will actually extend out into '24, depending upon the type of project and the lead time. But all positive, all net positive for the company.

The next question is from Nigel Coe from Wolfe Research.

This is Ryan Cooke on for Nigel. Just expanding more on the Electrical Americas segment, could you just talk a little bit about what might have changed during the quarter? Have you seen improvements in supply chain bottlenecks or factory labor productivity?

Strong quarter in our Electrical Americas segment. We had been very constrained across the board. During the quarter, some of the important commodities for us, whether it's copper, steel, aluminum, and logistics, have gotten materially better. We still have significant issues with electronic components and anything that requires semiconductors. We're not out of the woods there. We expect some modest improvements in the second half of the year, likely going to be sometime into the latter part of '23 before most of those issues resolve. In the Americas business, our end markets are very strong, and it's the growth in those end markets allowing our business to perform as well as it is.

Okay. That's great. And then just shifting gears for my follow-up on the Aerospace segment. Could you dig into the growth in commercial versus military and OEM versus aftermarket? I know you mentioned an uptick in defense spending over the next few years, so touching on that and any other supply constraints we should be considering in the latter part of the year?

In our Aerospace business with the acquisition of Cobham, we're now balanced about 50-50 between commercial and defense. We're seeing a strong recovery on the commercial side, both in the aftermarket and OEM side. But it's still below pre-COVID levels from 2019. The defense markets are expected to grow more favorably over the next few years than we anticipated earlier this year due to increased defense spending from NATO and the U.S.

And our next question is from Scott Davis from Melius Research.

It all sounds super positive, in fact, almost too positive. I have to ask, do you have a sense of where inventories are at in each of your key end markets and if there's a little buildup going on?

I can appreciate that it sounds too positive. The facts and data suggest things are good right now, evidenced by the strength in orders across the board in our Electrical business. In the passenger car market, inventories are at historically low levels. In the event of an economic slowdown, we need to rebuild inventories in the channel. We do test for inventory buildup and every time we test, the answer comes back that it's not the case. The channel today doesn't have the inventory they would like, especially in products like circuit breakers.

Scott, just to add a bit more color, if you look in the Electrical business in both sales and orders, every one of our end markets was up significantly, with some growing significantly more. It's really strength across the board.

The next question is from the line of Josh Pokrzywinski from Morgan Stanley.

Craig, just wanted to ask about Electrical Americas margins. They're pretty impressive here, and I would presume still primed for health for metals deflation later this year or next year. Where should we think about as sort of the ceiling on those over the next kind of 12, 18 months? Or maybe said differently, how high are you willing to let those go before you start putting the pedal to reinvestment?

We are reinvesting in the business at a rate higher than we've ever invested. Our R&D spending was up in the quarter considerably, and we'll continue to invest. We’ve set long-term margin targets for the business and will review those at our investor meeting. If you think about our execution performance today, we have many inefficiencies due to supply chain disruptions affecting operations. There is room to raise margins, as we’re not operating near peak efficiency regardless of market conditions.

Joshua, we're also investing in selling resources as well. In distribution, our freight is lower because of supply disruption.

Got it. That's helpful. Any specific markets that drove that performance versus the comp or if price played an unusual role?

The order side of these big numbers is real economic activity. It's real volume in the order growth. There was strong order growth in data centers and commercial which some were concerned about, as well as in residential.

The next question is from John Walsh from Credit Suisse.

I wanted to build on that Electrical Americas line of questioning. Just trying to conceptualize what backlog up 89% year-over-year really means? How much of that gives you visibility already into next year? I've always thought of that as kind of a shorter cycle. And then maybe just anything around what the price looks like in that backlog because I would assume that's going to be a margin tailwind as you deliver it.

The 89% increase in backlog reflects strong markets and some orders arriving earlier in projects than in the past, providing better visibility into 2023. Many of these projects will be delivered in 2023. I don't expect price in the backlog to have a material impact on margins; our margin guidance is consistent with current performance and has already incorporated underlying margin performance into our expectations.

And the next question is from Joe Ritchie from Goldman Sachs.

Yes. Maybe just parsing out those price-volume comments a little bit. How much of the organic growth this quarter was price? And Craig, as you think about the second half, what kind of positive impact are you expecting to see either on a dollar basis or from a margin perspective versus the first half?

We’re getting significant contributions from both volume and price, and we will not separate those numbers. We’re now overall on the plus side regarding recovery from inflation for most areas, but there are still some work to do in the Vehicle business as we have not fully recovered margin on inflation.

Helpful. Craig. And just my follow-on, since no one's asked it, can you provide some additional color on what you're seeing specifically across your end markets in Europe?

We’re watching macro issues very closely, including the impact the Ukraine war is having. We had a good quarter in Europe, both in sales and orders, which continue to be strong through Q2. All markets, except perhaps the Vehicle business, performed well. Orders in Europe are holding up better than expected; we remain optimistic about growth.

And the next question is from Stephen Volkmann from Jefferies.

Just a couple of end-market questions for me as well. Can you give us a little color on the real heavy industrial Crouse-Hinds kind of harsh and hazardous type end markets?

Those markets are performing well. Crouse-Hinds business is performing very well. We’re still below the peaks seen in the '08, '09 timeframe, but we're seeing strong double-digit growth and expect it to continue given energy investment trends.

Crouse is another one of our businesses that has seen broad sales increases across all end markets.

On data centers, anything to call out relative to the size of the data centers or locations?

Data center markets continue to be very strong. Our order growth in data centers was up some 25% in the quarter. All regions are showing strength, and I believe the data center market will remain attractive for a long time due to increasing global data consumption.

Our next question is from Julian Mitchell from Barclays.

Maybe a question for Tom. Can you help us understand free cash flow here? The guidance at the midpoint implies a sort of 70%, 80% increase year-on-year in the second half to hit the free cash flow guide. Please help us bridge that.

First, let’s review our cash conversion cycle. DSO was slightly favorable and DPO was favorable. Our primary investment was in inventory days on hand, an intentional choice to protect significant growth and to prepare for our customers amidst supply disruptions. In the second half, we generally generate a lot more free cash flow than the first half. The second half looks better, and we feel comfortable with our guide.

Is the view that there will be a significant inventory liquidation in the back half, the biggest lever behind earnings driving that cash flow up?

We need to balance that with order flow and supply chain, but potentially, we will be liquidating some working capital in the back half of the year.

Today, we’re dealing with enormous inefficiencies in our operations due to supply chain disruptions. Even one inexpensive component can prevent shipping a large piece of equipment, so we’re keeping inventory to meet forward demand. We expect better performance in DOH in the second half of the year.

We have a lot of work-in-process inventory waiting for components to ship our products, creating disruptions in labor and manufacturing.

The Vehicle segment is guided to be up high teens in the back half year-on-year organically. Can you help us understand how much is sustained growth in trucks versus a turnaround in light vehicles?

In the commercial truck market, we've actually taken our outlook down. We anticipate North America truck market to be around 294,000 units versus the previously expected 305,000. A lot of growth is from a return in China as they were shut down in Q2, and supply chain disruptions in light vehicles are starting to improve.

The next question is from Nicole DeBlase from Deutsche Bank.

Can you comment on Electrical order activity, particularly large projects versus the shorter-cycle component of orders?

I don’t have specific data on project sizes at my fingertips, but we see broad-based strength across all Electrical business segments. Our negotiations are up about 50% versus last year and 20% versus Q1.

We’re seeing growth in both commercial and industrial negotiations, both very strong compared to last year and the previous quarter.

Market volatility has increased. How do you feel about the M&A pipeline and potential for continued bolt-ons in this macro environment?

We still believe it's important to prioritize M&A this year. We're working through several interesting opportunities in the pipeline, but no announcements today.

The next question is from Brett Linzey from Mizuho.

I want to return to pricing and its stickiness. Are you experiencing any pushback from distribution on the compounding prices? Some investments around solutions tend to hold price better historically. How do you see that playing out in a deflationary environment?

This inflationary environment is unlike any we've seen in our lifetimes. Historically speaking, price has been very sticky in our business, and as long as the world holds up, it’s good for our distributors. With 70% of our business through distribution, we expect price to be sticky. While we may see some commodity retracement, labor, logistics, and energy costs are up, keeping inflation at higher levels than expected.

Could you discuss investment in enhancing capacity to capture secular trends? Are you selectively investing in brick-and-mortar and new capacity? What is the current plant utilization for your Electrical business?

We are making investments in brick-and-mortar for secular growth trends to support strong order growth. Confidence in market conditions drives us to expand capacity in our Electrical business, and this will include R&D as well as producing necessary solutions.

The next question is from Deane Dray from RBC Capital Markets.

Can you elaborate on circuit breaker scarcity? It seems related to semiconductor shortages, but some companies are talking about gradual improvement. How has that impacted your electrical side and circuit breakers?

You are correct that our largest challenges are in anything that requires a microprocessor. There is significant demand for intelligent circuit breakers, and while it is improving, we are not out of the woods concerning supply shortages. Our backlog reflects high demand, and while we have searched extensively for components, lead times remain extended.

Thanks, guys. We have reached the end of the call, and we appreciate everybody dialing in to ask questions. As always, Chip and I will be available to address your follow-up questions. Thank you. Have a good day.

Thank you, and that does conclude our conference for today. Thank you for your participation and for using AT&T Event Conference. You may now disconnect.