伊頓 (ETN) 2015 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Eaton first quarter earnings conference.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn this conference over to our host, Eaton's Senior Vice President of Investor Relations, Mr. Don Bullock.

Please go ahead, sir.

Good morning.

I'm Don Bullock, Eaton's Senior Vice President of Investor Relations.

Thank you for joining us today for Eaton's first quarter 2015 earnings call.

With me this morning are Sandy Cutler, our Chairman and CEO; and Rick Fearon, Vice Chairman and Chief Financial Officer.

Our agenda today includes opening remarks by Sandy, highlighting the Company's performance in the first quarter along with our outlook for the remainder of 2015.

As has been our practice on prior calls, we'll be taking questions at the end of Sandy's comments.

The press release today from our earnings announcement this morning and the presentation we'll go through have been posted on www.eaton.com.

Please note that both the press release and the presentation include reconciliations to non-GAAP measures.

A webcast of this call is accessible on our website and will be available for replay.

Before we get started with Sandy's comments, I'd like to remind you that our comments today will include statements related to expected future results of the Company and therefore, are considered forward-looking statements.

Our actual results may differ from those forecasted projections due to a range of risks and uncertainties we've described in the earnings release and our presentation that are also outlined in a related 8-K.

With that, I'll turn it over to Sandy.

Thanks, Don and welcome everybody.

I'm going to work from the presentation that was posted on our website earlier this morning.

I'm going to start on page 3. I'll give you a moment just to get there.

It's titled Highlights of Q1 Results.

We started the year, I think as you've all seen, with a solid, high-quality quarter, in spite of what was obviously weak economic conditions, I think we've all just seen this morning the 0.2% US GDP growth.

In summary, really, our balance strategy is working.

Our balance -- from the geographic point of view, our balance across our individual businesses and that's what allowed us to deliver, what we think, is a solid first quarter.

Operating earnings per share of $1.01 was a penny above our guidance, about $0.03 above consensus and we when we look through the individual pieces the top line was just marginally weaker, split about half between physical volume and additional FX impact.

You've seen in our guidance that we now think that the FX full-year impact will be larger than we thought it would be when we start of the year and I will comment more on that in just amendment.

We continue to do, I think, a very strong job of controlling our corporate expenses.

They were down about a penny and our tax rate came in closer to 8% versus the midpoint of our guidance for the full year of 10% and that accounted for about $0.02.

Overall, we think a very strong quarter in spite of some bumps out there and the economy and off to a good start for the year.

Our sales were $5.2 billion, down 5%.

When you carve that apart, organic growth of 1% and then this larger impact of FX of a negative 6%.

Segment margins came in right where we thought they would be, 14.6%, up from 14.5% a year ago, down from 15.9% in the fourth quarter but, as I said, in line with our expectations for the first quarter, which is normally a seasonally weaker quarter for us.

We did repurchase $170 million of our shares, about 2.4 million shares.

You recall that last year we had repurchased 650 million shares or about 2% of our outstanding.

And our Cooper integration is right on track.

You'll recall this year we are counting on $150 million of incremental synergy profits compared to 2014.

And then, the first quarter, we did achieve $29 million, so we are on track and I will talk more about that as we go through the two electrical segments.

If you turn to page 4, just a quick summary.

Overall, the financial results, you see the comments in the light green box in the lower hand corner about organic growth versus ForEx.

You also get a sense looking at the sales number, obviously a decrease in sale, but obviously, was positive organic growth.

I think you've probably digested most of the numbers on the page, so I'm going to recommend return on page 5 and start with an overview of the performance of our individual segments.

Let's start with the electrical products segment.

Significant, obviously, it's about 33% of the total company revenues.

Sales were down 2% from last year, but if I could refer you to start, here looking at the light wind box in the lower left-hand corner, organic growth was up 4%.

Very solidly, again.

You recall it was up 5% in the fourth quarter.

Clearly, we saw a big impact from ForEx here, a negative 6% and that's what results of the overall down 2%.

In terms of the booking activity, very strong bookings.

Once again, up 5%.

You recall a in fourth quarter they were up 4%.

The story is the but same as we've shared with you over the last couple of quarters.

The strength within the Americas where we were up 7% and then weaker outside of the US.

We were particularly pleased -- and you'll hear this as we talk about many of our businesses -- the quarter started quite weekly -- in January and February.

We commented on that when we were in New York in our meetings then.

We were very gratified, obviously, that the months ended strongly in March.

You'll see strong bookings results in a number of our businesses.

That parallels what we were seeing in the economy, generally, with a slow January and February, and then quite a recovery in the month of March.

If we think about markets, we are continuing to see real strength in the residential and nonresidential construction markets, particularly strength in lighting where again we were up very strongly at 16% this quarter.

So, a very strong quarter.

Also, I've seen some rebound in our businesses -- in our electrical businesses in Latin America and Canada, the weakness in the US has been around industrial.

I think you've heard that from a couple of companies, that there seems to be a little bit more of a malaise and industrial spending.

In Asia-Pacific, as I mentioned, conditions continue a little weaker.

Mixed country by country.

In Europe, they are still caught in waiting for the recovery really to occur.

I did want to comment on the margin.

You see the margins of 15.7% actually below last year's 16.2% and obviously, there are a couple of things going on there that I wanted to provide some insights to you.

The volume was down and we shared with you this year that we thought our incremental or decremental would be on the order of 20%.

We did achieve about half of that synergy savings and remember, the synergy savings of $29 million is made up of $24 million of cost and $5 million are profits that come from higher sales.

So, what you would see on this line is really half of the $24 million or a positive $12 million.

What was offsetting it was actually embedded exchange of about a negative $10 million and this has to do with product made in the US that is then used in Canada.

Typically, you've heard us talk about our practices beyond the manufacture in zone of currency.

Clearly, the drop in the Canadian dollar has not had quite the highlight that the euro and resilient Riau have, but it did impact us.

We've been able to -- [it's] worth to comment a little later on it, to put mechanisms in place that we think solve this in the second quarter but it did hit us in both this segment and you will see also in the electrical systems and services.

In spite of that we made our four guidance.

Last would be, we've had a little bit of negative mix in here and we think that recovers full-year we've not changed our overall guidance.

So, we'd be glad to talk more about that when we got to questions.

If we moved to electrical systems and services segment, this particular segment is about 29% of the company's revenue is, as you recall.

We had -- as you see, sales down some 5%.

If you look down to the lower left-hand corner you'll see that for ForEx the big contributor to that.

Although, organic sales were down about 1%.

You'll recall that last year we talked quite a bit about the fact that the way to think about this segment is to look at bookings in the previous couple quarters, are good indication of what you'll see in shipments.

Because this is a backlog business and you'll recall in the fourth quarter, bookings were flat in the first quarter, they were flat.

A little different regional participation here.

The real strength here was in APAC with the rest of the regions, America flat, Europe down, Asia-Pac up.

The business that really was up for us in Asia-Pacific was the large three-phase power quality market shipping into large data centers and we had a particularly successful booking quarter in that regard in Asia.

Very pleased with the margin performance.

Obviously, stronger than a year ago even though the volumes were lower and we also were offsetting some Canadian embedded exchange problems here and you see the benefits coming through of about $12 million of synergy cost-benefits in this segment, as well.

If we switch to the hydraulics segment, again, roughly about 13% of the company sales down 15%.

If the organic pressure has not been enough and obviously you see it's 9% in this quarter, it was 2% last quarter, negative.

ForEx impact obviously hit this segment pretty hard as well, a negative 6%.

So, overall volumes down 15%, margins at 10.1%.

We did, as we had shared with you, we are doing restructuring in this business in light of the end markets.

We can talk more about that later.

The way I'd have you think about the restructuring, is that in light of the magnitude of the downdraft's in these end markets, we will have restructuring expense and every quarter as we go through this year and it will be on about the same level as we had this year.

Basically, taking somewhere between 1 point and 1.5 points out of margins and every quarter as we go through the year.

If we talk about bookings, bookings down 18%.

I don't think the OEM news is probably noteworthy in terms of this is not a tremendously different experience that we've been seeing over the last several quarters.

But, you recall in the fourth quarter, our distributor orders were actually positive and they were negative in this quarter.

And what we are seeing, is the roll through into distribution of some of these end markets we've talked about, oil and gas, Ag, both of them, we served some of the smaller OEMs through distribution of those marketplaces and that's where we see the weakness in distribution.

We see strength in other areas, in terms of construction, locational vehicle, some of the Marine markets and flattish conditions in industrial.

But, I think, really, what we are seeing here is the continued roll-through of negative oil and gas and negative Ag investment.

As we go outside the US, (inaudible) the story is very much the same in terms of the weakness and the global agricultural markets and the China construction equipment market really does not show much signs of improvement, at this point.

So, conditions not terribly different than we've been talking about except for we are starting to see the roll through in the distribution side and that's why (inaudible) now will see we've taken our guidance down in terms of the margin in this business.

And I'll talk also, a little bit, about a more negative outlook in terms of end markets, here.

The good news, is if you turn the page, it's just being made up for by the performance in our Aerospace segment.

Again, one of the benefits of balance for Eaton.

Flat sales, profits up 24%.

Again, we were quite pleased with the organic sales here.

If you look in the lower left-hand corner, 8% positive organic sales.

That followed 9% organic last quarter.

Being offset by the divestitures that you remember that we divested in the second quarter of last year and then negative ForEx.

As we look at this, the bookings -- maybe a little caution note when we look at the 1%.

But we still think the conditions are quite strong.

Generally, we saw that some of the placements from the commercial transport segment within commercial weren't quite as strong during this quarter as we've seen them.

We will remain buoyant, however, by the forward-looking line rates which we had from all our OEMs which are continuing to expand.

So, we think that's fairly temporary.

The military side was down this quarter, but the aftermarket strong and we are pleased about this continuing aftermarket booking, particularly on the commercial side, where we've seen it pickup during the last three quarters, know.

And then finally, if we could move to chart nine, our vehicle business, about 17% of the company.

Sales down 4% but again if you look to the small green chart in the left-hand corner, organic up 4%.

You remember last quarter, organic was up 8%.

So, continued strong performance offset by not only euro, but here you see the big impact of the Brazilian currency down 8% and so, overall, the overall business down 4%.

Profits healthfully up 9% and our outlook remains much the same as you've heard us talk about here in North America.

Where we continue to think that this year's Class 8 build forecast will be about 330,000 units.

It's pretty well balanced, half in the first half and half in the second have, in terms of our outlook.

We continue to think the backlog is healthy and supports that.

Good strength in the light vehicle markets, here.

But further weakness in South America vehicle and agricultural equipment markets, not unlike, I think, you've heard from a number of other companies and that's why we've actually lowered our growth outlook for the full year in terms of these markets.

It's all based on the South American weakness.

If we move to chart 10, as I said, the economic conditions started a little weaker in 2015.

We think we've had very strong margin performance in Aerospace and vehicle that help to offset some of the weakness on the hydraulics side.

The overall 3% bookings improvement when you put the two electrical sectors together, is encouraging to us, particularly the pace in March.

On the other side, clearly, we are seeing continued weakness in hydraulics.

We're pleased we were able to achieve a 10 basis point improvement in our margins on only a 1% organic growth increased.

Our decision to go ahead and repurchase $170 million of shares continues our pattern of opportunistic purchases.

If we turn to chart 11, just a quick recap of our expectations of organic revenue.

You'll recall that our guidance, when we talked with you at the beginning of the year, in total for the company was 3% to 4%.

It's now 2% to 3%.

And really where that change has taken place, is the biggest changes in the hydraulics markets, where we had started this year thinking they would be somewhere between zero and negative 2%.

You can see based upon weaker conditions in the US, Europe and Asia, we think it's likely to be more now in the order of negative 2% to negative 4%.

No change in Aerospace.

Vehicle has come down from 5% to 7% to 3% to 5%.

That's all based upon the continued negative outlook and South America.

No change in EMEA or North America.

And then electrical, is down just 1 point from where we started the year and that's really based on a little bit more tepid growth in Asia, no real change in the US or Europe outlooks at this point.

Turning to page 12, I commented a little bit on this and you'll recall that when we give our guidance this year we talked about 20% incrementals and decremental's and that was based upon this economic outlook that I've talked a little bit about.

Slow global growth, challenges, particularly in Europe and Latin America.

Hydraulic market downdraft and FX pressure.

So, what you'll see here, that is that we have not changed our overall margin performance.

We came in where we expected to be in the first quarter.

We've strengthened our outlook in Aerospace based upon the very strong performance in the first quarter and our expectations of that continuing on a pretty steady rate through the balance of the year.

And then, we've lowered hydraulics down 1 point in light of the weaker start this year and where we think the markets are likely to be this year without any recovery.

Moving to page 13, a couple of quick points about our guidance.

This is our first guidance we're providing for the second quarter.

$1.10 to $1.20 operating earnings per share.

Obviously, the midpoint of that is $1.15.

You all know, for those of you who followed Eaton for some time, that we have a pretty standard 5% seasonal revenue increase between Q1 and Q2 on a physical volume basis, that's again what we expect this year.

We think it's supported by what we are seeing in our markets.

Offset by, probably, negative 1 point of additional FX compared to the first quarter of this year.

So, that nets you out at sort of a 4% net of FX topline.

We do expect to get about a 1 point improvement in our margins.

Again, pretty usual for us between the first and second quarter.

Because the tax rate started a little lower this year and we are maintaining our full-year guidance of 9% to 11%, we think that the second through fourth quarters are likely to be more in that area of 10% to 11%, in terms of the tax rate.

Full year, we revised our guidance to $4.65 to $4.95.

Pretty much in line with current consensus that's been out there of $4.82.

And the reduction of 2% from our original guidance this year is primarily due to the higher negative FX impact.

You recall, we started the year thinking that FX would negatively impact our top line on the order of about $900 million.

We think it's closer to $1.2 billion at this point and that really is the explanation for the change.

If we flip to page 14, we've tried to give you a quick summary of our guidance.

We provided you with in February.

All the points I just made about our April guidance.

You can see where the changes are, down 1 point on organic growth, down $300 million with additional FX pressure.

No change in the segment margins, but down in hydraulics, up in Aerospace.

Again, the benefit of our breadth.

About a $20 million reduction in the collection of our corporate expenses that we show you there.

And then, that obviously leaves the $0.10 reduction or a 2% reduction in our overall guidance for the year.

I think, significantly, if you look at the operating cash flow number, you'll recall while we've not changed those numbers, still $2.7 billion to $3.1 billion, they do represent a 15% increase from last years $2.5 billion to $3 billion in operating cash flow.

So, we remain quite bullish on our cash outlook and that really sets up the discussion we will have with you about capital structure following our second quarter's earnings release.

So, if we moved to the 15, our summary, again, we think a very solid first quarter.

We did see a necessary acceleration in March recovering from the weak January/February.

I've mentioned the FX that we think now will impact our top line by about a negative 5%.

Again, the trade-off of Aerospace versus hydraulic margins and then if we think about this overall guidance of $4.80, it does represent 3% growth over last year.

But within it, are the factors we've talked with many of you about this year, is that we are anticipating, obviously, this $1.2 billion negative impact of ForEx which is about a $0.26 full-year negative for us.

That's higher, obviously, than what we outlined to you in January and then about a negative $0.17 for the tax rate.

So, there's about a negative $0.42 from those two items that are embedded in our year-to-year comparison and that negative $0.43 as compared to the $0.36 that we had outlined for you in the first quarter.

And then once again, the Cooper integration savings very much on target.

Obviously, it's one of the reasons that our profitability is higher in the second half than the first half because you'll recall, back to Tom Gross's presentation in February, we are finishing up many of the manufacturing plant moves.

And that's the next big piece, really, the savings that come in and I'm very pleased to report those plans and actions are very much on plan at this point.

So, with that, Don, why don't we open things for questions?

(Operator Instructions)

Before we begin our Q&A session today, I see that we have a number of individuals queued up with questions.

Due to our time constraints for an hour today, I would ask that you please hold it to a single question and a follow-up.

Thank you very much in advance of your cooperation so we can get to as many of these questions as possible.

Our first question is from Scott Davis with Barclays.

Good morning, guys.

I'm trying to get a sense of if the strength in March continued through April.

And what would you attribute the strength in March to, given the weak start of the year?

Was it inventories finally got low enough where there was a bit of a restock or do think there's some real macro acceleration, particularly things like non-res?

We don't have April results, yet, Scott.

But our thoughts about March is that we really saw fairly weak order patterns in January and February.

Hard to know whether those are attributed to weather, whether they were attributed to concerns about port strikes or all of the above.

We're pleased that what we did see was very strong activity in March.

I don't want to overplay that because you normally find that the third month in the first quarter is disproportionately important.

So, we see some of that pattern every year.

But, it was stronger.

It was stronger, really, across the board in terms of the end market segments we saw within those businesses.

And we're off to, I would say, a reasonable start, from what we can tell in April, but we don't have final numbers, yet.

Understood.

I don't know much about the hydraulics business but when I look at your total year forecast, negative 2% to negative 4%, coming off of a negative 9% this quarter, that does imply maybe you expect a real improvement, back-end loaded improvement.

I'm asking if it's a realistic assumption.

When I look at it, I'm a little skeptical.

Maybe you can make us feel a little bit better about that?

I think the issue, again, what we're seeing, we've seen most of the weakness come out of the OEM side.

That's not atypical when the hydraulics market is going through a change in cycle.

So, most of the bookings that we are receiving now are bookings that are coming in for the short term, one through three months.

It feels like a lot what we saw when we saw the inflection changes back in 2008, 2009.

We've looked pretty hard at this forecast.

We think it's a realistic forecast, at this point.

But we are not forecasting this business will look pretty flattish as we go through this year.

There will be some improvements in margins that'll come from the restructuring we are doing, but we obviously took 1 point out of our margin guidance for the year in light of the fact that we don't see this rebound really happening at this point.

Okay.

Good answer.

Thanks, guys, and good luck.

Joe Ritchie with Goldman Sachs.

My first question, this would be on the aero margins this quarter.

Was there anything specific that really drove the strength, the 320 basis points I see that you guys have a step down as the year progresses.

I'm just curious, what was really underlying the strength in that business this quarter?

Again, if you look back over the last portion of last year, our business was strengthening, as well.

We've got a business that we think is being very well run.

There always is the two issues that are going on in any aerospace business.

There is the current shipments and then there is the development project or new order project work.

I think the team is doing a good job on both of those.

So, I wouldn't point out any one issue of being unusual.

We had good order placements all last year.

You're seeing the commercial side of the market continue to be quite strong.

The defense side hasn't been as bad as some people had forecasted.

Now, that has a lot to do with the specific programs we are on but I think we're also doing a better job of managing our new development projects, so that is a help to margin structure, as well.

While we're saying that we think the margins will be fairly consistent through the end of the year, I think that's a reflection that we're comfortable with the market outlook.

And I think our teams are doing a really good job on managing these big projects.

Okay.

Fair enough.

And my follow-up, I just had a question, Sandy.

When you were walking through the puts and takes on electrical products, this quarter, clearly the organic growth was good.

It seems like you had $12 million in synergies that came through, there was a positive.

FX was a negative $10 million.

Yet, operating profit was down despite the organic growth that came through.

So, I'm just curious, was there something about your mix this quarter on why you weren't able to grow profit on the electrical products side this quarter?

I did mention that there was a negative mix.

And I think most people know the lighting industry doesn't have quite the margins that some of the component businesses that we are in do.

I mentioned our lighting business was up some 16% in the quarter.

Again, doing very well.

So, we are very pleased with that business, but it didn't have a positive mix impact upon us.

Okay, great.

Helpful.

I will get back in queue.

Jeff Hammond with KeyBanc.

Just back on that FX transaction dynamic with Canada, can you quantify what that was all-in in the quarter?

Then, I think, Sandy, you mentioned -- Rick could maybe clarify -- what you are doing going forward to pull that out of the dynamics?

I mentioned there was about $10 million in the product segment and it's less than that.

It's around $5 million.

Systems and services segment.

The situation, Jeff, is that, as you know, we largely neutralize that back by manufacturing and selling in the same region.

Where we have an intra-region exposure, we attempt to put hedges in place to neutralized that.

But you are limited by uncertainty about volumes and, in some cases, by regulatory limitations.

In the case of the flow to Canada, it's really the Cooper product flowing to Canada.

They have not had a program in place because of some regulatory changes that occurred towards the end of last year.

We weren't able to hedge as much of that Cooper flow as we normally would.

But The good news is that we now have gotten through and those flows will be hedged starting in the second quarter.

This is an issue that should go away, as those hedges work their magic.

Okay.

Great.

Can you just, Sandy, give us an update assessment of what you're seeing in your energy-facing businesses relative to how you are thinking about it?

And maybe, jus to slide in one more, just give us a free cash flow number for the quarter.

Our view on the oil and gas business is very similar to what we described to you upfront.

You may recall, our forecast for this year was that it might have a little bit more pressure than some others had outlined early in the year.

The way we think about it is oil and gas is about 6%.

That's the same number I told you last quarter.

And that you really have to think about this in terms of the upstream, midstream and downstream exposure.

The majority of Eaton's exposure is downstream, approximately 70%.

So, when we look through all this, we've said we thought that the upstream onshore would be on the order of a 35% impact negative this year.

Offshore would be closer to something around 25%.

You've got to take all these with -- it's a plus or minus 5 off of them.

There's no accounting accuracy to a forecast out in the market like this.

And we think that downstream gets affected a little less, it's more on the order of about 20%.

When you put that all together, you come up with something that probably says that we see something on the order of 20% pressure in terms of oil and gas for Eaton this year.

That, indeed, is we've spent a lot of time in a lot of regions of the world talking to OEMs, users, distributors, EPC s. It seems to be pretty well laying out in terms of the activity as we see it.

We've also indicated, Jeff, that we think that some of the order weakness that people will see this year will manifest itself next year in terms of shipments.

So, a lot of the shipment impact will occur in the second half and then into next year, because there are a lot of projects under way that they're going to complete versus just stopping those halfway through it.

So, that's our view of oil and gas, at this point.

It's felt differently in distribution than it is in terms of the OEM side, as well, a little different timing.

Jeff, you asked about operating cash flow and free cash flow.

Operating cash flow before the pension contribution was $300 million.

We made a $223 million pension contribution both US-qualified, as well as the nonqualified portions and the international portions in the quarter.

CapEx was just over $100 million.

Our next question comes from David Raso with Evercore.

Questions on the electrical outlook.

Your order growth accelerated a bit but you lowered the organic sales outlook.

Can you flush that out for us a little bit?

Yes.

It really is a mix, as we look around the world, David.

As I mentioned, we have not changed the US.

That is where we continue to see strength, and did last year, as well.

We are seeing conditions be a little bit choppy in Asia.

And clearly China is, I think, a question in many people's minds as exactly what the growth will be and what segment.

Our view is that it is slower than we had originally anticipated, there.

So, that's the primary change.

We are continuing to do quite well and the US, and that is the area -- obviously it's the best house in the neighborhood, currently.

You made a comment about Europe not necessarily seeing a recovery yet.

Is there any signs at all in the order book or it's just status quo and it's just optimism at this stage?

No.

We've actually seen, on the product side, speaking to electrical, we've actually seen, there, a slight uptick.

We are seeing orders up on the order of 2% to 3%, there.

We've not seen it on the larger system side at this point, in Europe.

Maybe a little bit more of a maintenance spend, if you will.

Now, we are seeing a lot written about, with the euro dropping, that we're going to see M-OEM or machine builders start to be more competitive.

We've not seen that, yet.

Our experience with that is that it generally takes more than a couple of months.

It's usually six months to a year of these basic currency changes to see substantial changes in the export patterns.

So, that may still be out ahead of us.

Lastly, the CEO succession planning doing with the mandatory retirement, when should we expect an announcement regarding that?

We don't have a further update for you.

The Board will make that announcement when they're ready to make the announcement.

Okay.

I appreciate it.

Thank you.

Shannon O'Callaghan with UBS.

Sandy, you mentioned the recovery paralleling what you are seeing in the economy.

A fair amount of the economic data has been choppy, too.

Can you maybe just flush that out a little bit?

We were hearing during the early part of the year, January/February, people were asking questions -- would do see a similar weather impact that we saw last year.

While it was cold, we didn't have what I would call the devastating ice storms that we had a year ago that really the Carolinas in such a big way.

I think as people got through that they relaxed a little bit about the full impact of the weather.

We obviously had the port strike that went on that affected some portions of the economy.

I think it's clear that January and February were weak.

We saw those months not being spectacular months.

I'm talking to the US, in terms of activity.

I'd say the second issue that's a little different this year than a year ago, and you are all well aware of this, is that Chinese New Year was really a prolonged period of time this year.

Some people talk about it being almost five weeks long, I think a reflection of the fact, again, that governments and companies took advantage of the holiday time to simply extend it to try to eat up some of the weak economic conditions.

But then March obviously came on much stronger and I think that's somewhat of the recovery for maybe people under-spending in January and February.

Having said that, and having the benefit of four hours or three hours since the GDP numbers came out this morning, I don't think many people were surprised that the US GDP came out at this fraction of what was already a pretty dollar forecast of 1%, and it came out obviously, you all saw it, as well, at 0.2.

That's not a whole lot of growth in the economy that's supposed to be the one that's the most ebullient in the period of time.

I think, again, it simply says we are in a period of time of relative moderate global growth.

And that's why these self-help stories, such as the $150 million of incremental sables from the Cooper deal, are particularly important.

Okay.

Great.

Thanks.

Just on the strength in three-phase power quality in Asia, should we think about that as just a nice win for you in a tough market?

Or are you actually seeing market conditions get any better there?

There's a lot of data center building being talked about in Asia.

I would say the number they are being let is still not a very high number.

So, I think it's a reflection that we're doing quite well in a market that's not growing as quickly as it was a couple of years ago.

Okay.

Great.

Thanks.

Next question from Ann Duignan with JPMorgan.

Can we go back to hydraulics for a moment?

I have to admit that I share Scott Davis's skepticism.

Given that 50% of that business is either energy, agriculture or construction/mining, where exactly are you expecting the improvement, given what we saw in Q1 and where the orders are?

Again, our forecast is pretty flat in this business.

We are not expecting, from a shipment point of view, substantial improvement during this year.

We are continuing to receive orders.

But if you go back and look -- part of the challenge looking at the order comparison, as you go back and look at orders, they were still relatively good in the early part of last year.

We're living off the orders of the second year, so we're much more consistent with the order patterns in the second half of last year in our shipment patterns.

So, we're not suggesting a big recovery.

Neither are we suggesting a huge recovery in margins.

We do think margins will be marginally better in the second half than the first half, but primarily as a result of the restructuring we're doing.

If you just look, Ann, I might add, at the growth rates, the comparisons get markedly easier as you go through the year, given that the business had started to substantially decline sales-wise in the second half of last year.

I appreciate that primarily in the ag space.

But okay.

I'll take it off-line, maybe.

Just a follow-up then on your trucks forecast.

Sandy, I think you mentioned in your comments that you now expect the 330,000 build to be roughly 50/50 first half, second half?

That's correct.

Last quarter, that was more skewed seasonally to first half versus second half.

What's changed there?

Or, is it just nuance?

I think it's far more nuance than anything else, Ann.

We continue to think this is going to be a very strong year for truck.

We aren't seeing any reasons to see it any differently.

That's in NAFTA, what we're talking about.

But we see, obviously, more weakness when we get down to Latin America, particularly driven by the real challenges in the Brazilian economy.

Okay.

I will leave it there.

Thanks.

Next question, John Inch, Deutsche Bank.

Sandy, if you look at the way this winter played out, the Northeast and Canada and Midwest had a really tough February.

And a year ago we had a tough January and March.

So I'm just trying to think back to electrical and what happened.

Is it possible, given end markets and stocking, destocking, that sort of thing, that effectively what happened is because March had, call it, easier compares than February and wasn't as bad, that maybe things that might have been delayed or deferred in February got slipped into March?

I'm just trying to understand if the March trends you've seen are sustainable.

I would say, John, in both years, we really did not see a destocking in one month and a restocking in the other.

I don't think that was as much of an issue because it's hard for distributors to simply destock one month, restock the next.

That's not normally the way they think.

They are now trying to think about spring, is what they're thinking about in March, and what they want to have on the shelves for that time period.

We think their view is the residential continues to be pretty strong this winter in the areas you just talked about.

There wasn't much going on, obviously with the weather being bad.

We can't put an accounting accuracy to that.

That's our best sense.

We're trying to do the same thing you are, is try to understand, with a very strong March, because it was both on the product side as well as on the systems and services side, does that automatically carry over in the spring.

It's a little too early for us to know because generally April is a tough month to read the whole quarter on.

May and June become very important in the second quarter.

Okay, I think that's a fair answer.

Obviously, we know non-resi and construction markets are still improving.

Here's the second part of my question.

I want to go back to restructuring.

I think you had targeted 35 to 40 for the year.

This was going to be weighted to hydraulics and so forth.

Your peer competitor in Cleveland, Parker Hannifin, you listen to their call and their off-line commentary and you look at the GDP print this morning, debatably we could almost already be in an industrial manufacturing recession.

I realize Eaton, every company has their own mix and you've been buying your shares and so forth.

But my question is, do you have a playbook that you would, theoretically, because you did restructuring last year, would be accelerating restructuring?

And if so, what is that playbook?

Or are you just not there yet because you don't have enough information?

A very appropriate question, John, because I think everyone is trying to get a sense, particularly on the industrial side of the economy, getting away from commercial construction and getting away from non-res as to what's really happening.

Our plan, I think, as you recall as we outlined it, is that this year in our electrical business, obviously, we're finishing up much of the integration of the Cooper business, and inherent in that is about $40 million that was in our guidance overall for integration expense of $45 million of work that we're doing there.

So, we have the benefit of still bringing those two franchises together and getting them sized and equipped well for what we think the current environment is.

We had said in hydraulics that restructuring would be somewhere between about 1 point or 1.5 point impact on margins.

You can obviously calculate that to the kind of number you just mentioned.

And we think that goes on all the way through this year.

We have a fairly active playbook, to your point, in place.

We have been, obviously, committed to being sure that we go deep enough to really deal with what is weaker in hydraulics, and we think that is the plan we've put in place.

We've got different businesses than some of our competitors, but we think we're well sized, at this point, for the outlook we've outlined for you.

And, Rick, raising debt to repurchase your shares, is that a new strategy, or are you being opportunistic?

It looks like you raised about $170 million of debt?

We didn't really raise debt.

We had a term debt maturity on April 1, which is a pretty unusual day to have a maturity.

So, we simply took down commercial paper to make that payment.

The plan is, as we get towards the end of Q2, we would not expect to have any substantial CP on the balance sheet at the end of Q2.

So, it was really just, I'd call it, a tactical funding requirement because of the calendar of the term debt repayment.

Got it.

Thanks, guys.

Eli Lustgarten with Longbow.

Can we talk a little bit -- a lot of questions -- of what's going on in some of the regions outside the US, particularly South America, which is, Brazil is a complete mess, it looks like, and it really has a big impact, probably, on hydraulics and vehicles in some of your reporting.

Touching on that, can you talk about pricing across that business and really around the world and what's happening in price competition at this point?

The business that has the biggest impact for us, Eli, in terms of Latin America, is our vehicle business.

As we've shared with you there, almost 30% of our revenues in vehicle come out of South America, in particular.

That's really the focal point for us, as we think about that area.

You're right, the Brazilian economy -- and we've talked with many of you at great depth about it -- our concern over the last couple of years -- that there were a lot of macro policies that were just going to end up with a problem.

And that's, indeed, what we've ended up with at this point.

We don't see the likelihood that that economy is going to recover this year.

Our own forecast is that the manufacturing IP is going to be negative several points in Brazil this year.

It's a GDP that is likely to shrink 1 to 2 points this year, and you don't see that in many countries.

So, I think it talks about the challenge there.

And you are right, you get to the West Coast and a couple of the economies that looked quite promising a couple of years ago, be they Peru or Chile, with the mining pull back they've obviously been heavily impact, as well.

It is a more difficult region in terms of growth.

There are individual product lines and all that we're doing well in, but I think you'd have to mark it as a disappointing region versus ours and many people's thoughts a couple of years ago.

Can you talk about pricing across the businesses?

It looks like there's not much inflation and pricing is getting relatively competitive in some of the electrical businesses and hydraulic businesses.

Our net, because the way we always think about pricing, is our cost versus pricing versus the new products that we're introducing that have got a better price point or a better margin.

Overall, pretty neutral for us this year.

We've just taken a pretty deep dive on that across all of our businesses.

It's not that the conditions aren't competitive, but I'd say in terms of impact for our margins, pretty neutral.

Great.

Thank you.

Josh Pokrzywinski with Buckingham.

Just a follow-up on the electrical guidance and some of the tweaks to the organic growth there.

Sandy, you mentioned Asia being a little bit of a drag there and that was the reason for the downward revision, but you also talked about strength in ESS and APAC.

So, I'm just trying to reconcile the two.

Where is the weakness?

Is there something in the order book that concerns you?

What's driving that?

I would start again and say recognize these are fine-tunings.

They are not what I would call wholesale changes and so it's a matter of which way we round things.

I'd say markets generally were weaker in the first quarter than we had thought they would start.

I think that's really across many of our businesses, not just electrical or hydraulics.

I think you see that in the GDP data, not only here, but elsewhere.

At the same time, there are a number of encouraging numbers that are out there, as well.

I think some of the news around residential in the US, you just saw a new ABI data this morning, which is never conclusive but at least it's pointing in a little more positive direction.

I wouldn't overreact one way or the other on it.

I think it's more of a fine-tuning.

One of the pieces of data that I think everything is struggling a little bit right now with this is the nonresidential information, which you saw as part of GDP this morning, showed a negative number in terms of non-res investment.

We actually think non-res construction was probably up in the order of something around 3%-ish in the first quarter and we think it will be somewhere between there and 5% when we look at the full year.

So, obviously, that means we think it picks up as you get into the better seasonal portions of this year.

Okay.

I meant, specifically, Asia sounded like it was both better and worse.

Let me come back to Asia.

On Asia, I would say it's really an issue of China.

We think China is continuing to slow.

That doesn't mean it's going negative, it means it's rate of growth is slower.

That does have an impact in terms of large projects in our power distribution business.

Okay.

And then just one more follow-up on the vehicle business.

Clearly, some headwinds that you guys are seeing in Brazil on the ag and truck side, but keeping the margin assumption there unchanged.

I understand it's a pretty high mix business for you guys.

Is there more that you are doing on structuring or some other benefit that's offsetting that?

No, I'd say that we think a 200 basis point expansion in margins, when volumes are coming down, it really speaks to the productivity.

But it is not wholesale restructuring.

You will recall, last year we did some restructuring in our vehicle business.

We had said it would provide some benefit this year but it's not as much about current year restructuring as it is about the benefits that we got from last year.

Recall, there's about $35 million of benefit that flowed into 2015 from restructuring actions that took place in our industrial sector, and vehicle was one of those segments we spent the money in last year.

Christopher Glynn with Oppenheimer.

If you take a look at the oil and gas, you described, down 25%.

And please correct some of my assumptions if they're off.

But I think about 90% of that is going to land in ESS and it's a pretty good mix, too.

Yet, you have solid margin expansion in the outlook.

So I'm just wondering how you're factoring in that mix impact.

Maybe FX is actually a positive to ESS margin.

I don't know.

Chris, I'm sorry, I missed the first part of your question because there was another comment on the line and we couldn't hear you.

Yes.

The oil and gas I think you summed as down 25% overall.

And I'm placing about 90% of that in ESS.

Has good margin mix, too.

So, I'm just wondering how that mix impact would square with the margin guidance for a pretty good improvement.

I would say, first, it's 20%, not 25% that we're thinking things will come down this year.

Actually, our oil and gas exposure goes across everyone except for aerospace.

It's less in vehicle.

It's not in aerospace, but it is in both our electrical and hydraulic.

And it's not disproportionately in one electrical versus the other, because we sell a fair amount of standard comp, the things that we call standard components into oil and gas as well as systems and services.

So, it's pretty well spread.

And then the upstream, you can obviously think of that as being upstream onshore is fracking, and that tends to be a fairly heavy use of hydraulics equipment.

Okay.

Thanks.

That helps.

Then, with lighting, I'm wondering about the LED opportunity for Eaton to leverage digital lighting and the low-voltage access for data capture and the whole IoT environment?

We are really very proud of the additional investments Eaton has made and the business we purchased from Cooper in our lighting business.

LED is now over half of our total lighting sales.

In some categories, it's as high now as 70%.

We're really pleased in this last quarter.

We've introduced a new product that we call Night Falcon, which now takes LED into outdoor architectural lighting, that has traditionally been the providence of metal halite and low-pressure sodium.

So, we're continuing to push those technologies into new areas.

And there's no question that one of the things we talked about when we bought Cooper was that we like the ability, now, to bring our ability to manage power for customers into the whole lighting arena, as well as our traditional strength in and around controlling and having efficiency in and around electrical motors.

That allows us now to have an even bigger play for people in energy savings.

So, yes, we are not only thinking of but are successful now, at this point, in really making that play work for us.

The issue about digital lighting, digital control, for those who have attended a couple of our workshops, you've seen us talk about where we think that real potential is.

And that's one of the reasons we're putting more money into this business.

Thanks for the color.

Julian Mitchell with Credit Suisse.

On the electrical systems and service margins, you didn't have much of an increase off a very low base in Q1.

Just wondering, in light of the soft bookings, maybe Q2 margins are also subdued.

Why do you think we should see a 100, 150 bps increase year on year in the second half, given how bookings are trending?

A couple of things, here, to think about.

Number one is, remember, about half of our synergies savings for the Cooper integration fall into each of our two electrical segments.

So, unlike last year where about 75% of it fell into products, this year it's about 50%/50%.

I shared with you that about $29 million of the total $150 million was in the first quarter.

Obviously, you can figure out what the balance has got to be.

And it gets higher each quarter as we go through the year, because that's when we are finishing up many of the manufacturing consolidations.

Secondly, Julian, we expect to eliminate, it actually was $8 million of embedded in change in this particular segment in addition to the $10 million in the other.

And we expect to eliminate that as we go in here to the second quarter.

And then there is the benefit of some additional volume that we do expect to see as the non-res portion, particularly in the US, continues to strengthen as we go through the year.

I would say those are the three primary elements.

Thank you.

And then my second question, just on capital allocation.

I think, before, you talked about maybe having $1.5 billion to $1.6 billion of available to deploy capital through the end of next year.

We look at the $170 million, we see at the trailing nine-month spend on buyback.

Have you changed your view on optimal leverage or should we assume that now the available capital to deploy at the end of March is now $1.3 billion or so?

Julian, we'll give a fairly complete view on this subject of capital structure as we come out of the second quarter, so I don't want to get ahead of that discussion.

But I think the timing, you will recall, we've said that we would invest capital structure and the elements of capital structure when we get to mid year and we'll do that at the time that we do our second-quarter earnings release.

But, it's still our expectation that we'll be in a position to share with you and all investors, our updated view of that here at mid year.

Great.

Thank you.

Dean Dray with RBC.

I know we've covered a lot of ground here.

If we could go back to the non-res comments and that disconnect between what the GDP indicators are saying, some negative spending, and your outlook for up 3% to 5%.

More specifically, what kind of customer behavior, either front log, is there a particular vertical that's feeling a bit stronger that would give you that outlook at this stage?

When we look across the preliminary information that was available on strength in non-res, it was pretty well spread across the different segments.

And, that we see that areas like wastewater, education, healthcare, commercial buildings, even the light industrial manufacturing, have been pretty busy.

There's also been some pretty good data center activity here in the US.

So, I'd say those are the areas that we see as being particularly strong.

Now, you get into utility, it tends to be not as strong as some of those other segments.

As I mentioned, the industrial area has been a little bit disappointing, as you get into the bigger industrial type of installations.

Great.

Thank you.

Rob McCarthy with Stifel.

Two questions, one on non-res.

Obviously -- and the interplay with the oil and gas -- I think you highlighted that 6% of your overall exposure is oil and gas.

Obviously, debatably there could be a larger portion of sales that's tied to that from a supportive nature and what's going on in terms of those trends.

Sandy, to be clear, on the last up cycle I do recall that you talked about nonresidential construction in the context of a supportive outlook for energy spending, as a whole.

So the question I have is, what is the echo effect of oil and gas on non-res?

And do you think there is a possibility that if we still continue to see challenging trends, here, it could potentially choke off a non-res recovery?

We don't see that, Rob, at this point.

I know there was a lot of speculation in the November, December, January time period as to would contracting spending in the oil and gas segment have a disproportionate impact upon oil and gas.

I think what we've all seen is that has not materialized and we don't believe it will, at this point.

We think as you go around to many of the major cities, you're seeing fairly active construction going on in those areas.

And not simply in what I would call the oil and gas boomtown, if you will.

Clearly, if you get out in the areas where there's been a lot of fracking activity, some of the activity that was just at a wild pace in some of those areas like the Dakotas, that wasn't so much big commercial, it was light commercial and resi, has pulled back.

And I think that portion has.

But it hasn't affected activity in San Francisco or New York or Philadelphia or Atlanta or Chicago, in markets where we are seeing a lot of building activity.

So, we don't see that having an impact.

I think the bigger question, really, right now, is around this discussion about heavy industrial investment and whether there is a pause in that.

Obviously, remember, that the noncommercial portion of non-res is about half of the non-res market.

That's the piece we've not seen pickup, the so-called really big projects, hasn't picked up through the cycle.

We didn't see it pick up in the first quarter, either.

We see this portion of the cycle being more of what I'm going to call the light commercial institutional type orientation without the breadth of really big projects that we've seen in historic rebounds in non-res.

Just as a follow-up, capital allocation, obviously, is pretty key here for the story, and you're going through management succession.

And you've spoken to that ad nauseum.

But, if a deal of size opportunity opened up, how do you think about the management of the Company in terms of managing a succession in a large acquisition?

Could you conceptually think that could occur?

Can you walk and chew gum at the same time, in that regard?

Or do you think it just takes a larger, more transformative deal off the table?

Rob, as we've indicated in numerous forums, there is no one person who makes decisions about major strategic alternatives for the Company.

We've always done that as a team.

It's a full management team and we have great depth in that regard and we've always done that with our Board.

I see no reason why, if we had the right opportunity and the pricing was right, that would not cause us any hesitancy in that regard.

It's always about whether we think we can get the right return for our shareholders.

That's really the determining issue.

Thanks.

And I do like the answers to my questions.

We have time for a couple of more this morning.

Our next question is from Andy Casey with Wells Fargo.

I just wanted to go back to that one question and just broad net out.

I'm trying to reconcile US industrial and construction trends.

Do you think it's possible for construction improvement to last a few years if industrial falls into persistent declines?

Hard to know, Andy.

Again, it's about 50% of the market is this noncommercial.

I'd have to go back and look at history, actually, to say can we see a period of time when that's been true.

I think, again, remember, part of what's in that lower area is oil and gas and manufacturing.

I would guess that if you saw industrial go into a steep decline -- and that's not what we are seeing -- we're just not seeing as heavy growth at this point -- that it would be difficult to see really big growth.

I think you'd be down in low single-digit type growth.

Having said that, we're seeing really quite good activity on what I'll call the light commercial activity, the institutional and the commercial side.

That piece has been encouraging.

But, actually, I'd have to go back and do a little research, Andy, to give you a really good answer on that one.

Okay, thank you, Sandy.

And then second, you mentioned within the strength that you saw in non-res construction during in the quarter, data centers activity was pretty good.

Did that impact the quarter for you or, that a yet-to-come type thing?

I would say it's a yet to come in terms of actually shipping the stuff.

Okay.

Great.

Thank you very much.

The last question today is from Steve Winoker with Bernstein.

Two questions.

One, operating cash flow, you are talking about growing 15% this year.

And we just saw ex-pension the number up about 6% last year.

Where is it coming from?

What are the real places, especially trying to think about that relative to the margin expansion you have elsewhere?

We always start, Steve, with, by far, our weakest operating cash flow quarter in Q1.

And it's buffeted by lots of Q1 type payments related to year-end activities, rebuilding working capital.

So, it's always a very modest number in Q1.

And I wouldn't look at the year-over-year comparison as a particularly good forecast for the balance of the year.

We do quite a granular buildup to our cash flow forecast and we continue to believe that that range we've given, 2.7% to 3.1%, is the most likely range.

Steve, I would add maybe two comments to Rick's.

We think this year we'll be very close to a one-to-one cash efficiency ratio.

And one of the other reasons for that is, you'll recall last year we talked about it when we started in on this process of moving over 20 manufacturing plants, we did put in some safety inventory to assure that our customers would not feel any interruption of service.

We are peeling that back out this year.

So, while we built some working capital last year, we will be peeling it back to what we think are more optimal operating levels this year.

Which will allow us to, if you think about DOH, day on inventory, it will allow us to move that down a bit because it had to be elevated to deal with some of the inventory builds.

Okay.

So, it sounds like mostly inventory as opposed to receivables or payables?

I think that's the right way to think about it.

Okay.

And then the second question on corporate expense, the reduction.

Can you just give us some clarity where that's coming from?

I would say, generally, once we saw that we were going to see obviously the hydraulic markets be a little lower, that the vehicle South America be lower, we are simply taking the approach -- and I wouldn't target it to any one area, but overall -- we're going to have to go through another round of really looking hard at expense levels.

That's what we did in the first quarter.

That's why we got an extra $0.01 in the first quarter from that one.

And that's what we would plan to duplicate for the rest of the year.

That obviously gets you roughly your $20 million if we do the same thing we did in the first quarter, do it three more times, we're right at that number.

It's a pretty big reduction, though.

Are these growth initiatives you are going to fund?

I'm just trying to get a sense for what activities no longer happen this year but maybe get deferred another year.

More than that, Steve, I would say it's much more the spirit of we have to continue all the time looking at ways to do more with less.

So, a lot of it's process change, it's the great work our teams are doing in terms of productivity improvements.

So, no, it's not cutting growth initiatives.

It's about let's identify what creates value and let's keep working on that issue, because we obviously are at a slower growth environment and that's got to be where your head is to create value.

Okay.

Great.

Thank you.

Thank you very much.

As always, we will be available for follow-up calls through the day and the remainder of the day and next week.

Thank you very much for joining us today.

Ladies and gentlemen, that does conclude your conference for today.

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