伊頓 (ETN) 2015 Q4 法說會逐字稿

Welcome to the Eaton fourth-quarter earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Vice President of Investor Relations Don Bullock.

Please go ahead.

Good morning.

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

Thank you all for joining us for Eaton's fourth-quarter 2015 earnings call.

With me today are Sandy Cutler, our Chairman and CEO; Craig Arnold, President and COO; and Rick Fearon, Vice Chairman and Chief Financial Officer.

Our agenda today will include opening remarks by Sandy highlighting the performance in the fourth quarter, along with our outlook for 2016.

As we have done on our past calls, we will take questions at the end of Sandy's comments.

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

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

In addition, a webcast of this call is accessible on our website, and will be available for replay.

Before we get started, 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.

Actual results may differ materially from those forecasted projections due to a wide range of risks and uncertainties that are described in our earnings release and our presentation.

They are also outlined in the related 8-K filing.

With that, I will turn it over to Sandy.

Great, Don, thanks very much.

Thank you all for joining us this morning.

I'm going to work from the presentation that was posted at our investor portal earlier today.

For the sake of brevity, I will start right on page 3, the highlights of our fourth-quarter results.

I think, as you saw, we have exceeded the guidance we gave for our revenue guidance.

We achieved record fourth-quarter segment margins.

We generated $742 million in operating cash flow, and we repurchased $228 million of our own shares -- we think a very strong quarter in the midst of pretty choppy end markets.

I think it concludes the year on a strong basis.

If we flip to the second chart, just a couple of the highlights in terms of the reconciliation to the mid-point of our guidance that we provided for the fourth quarter.

You recall the mid-point of our guidance was $1.10; our volume came in just slightly higher than we had guided to.

You recall that we had guided organic sales being down 3% from the third-quarter actuals.

They actually came in at 2%.

The net of our restructuring costs and our savings came in about $0.02 better.

We got all the savings and more that we were looking for, and we actually got it done at a little bit less cost.

Our tax rate did come in a little bit lower, about $0.02.

That's the 3.9% versus the roughly 5.5% we had guided to.

And then our corporate expenses reflecting that same orientation toward really getting our structural cost down that you saw also manifests itself in our very strong segment performance, contributed $0.02.

$0.07 beat for the quarter -- a nice way to finish up the year.

If we turn to page 5, just the overall financial numbers, I am sure you have had an opportunity to study these.

I would just reference one number in particular here, because it does tie in a lot to our thinking relative to having increased our restructuring over the next couple of years, is the organic growth number, which you see in the green box to the lower left of the chart, down some 4%.

It was down 3% last year -- or last quarter, the third quarter.

So, again, as you think through the year last year, we actually started up with a first quarter that was slightly up.

And then the second, third and fourth quarter we have seen our markets weaken.

Just a quick run through the individual segments, and then we will get on to the guidance for 2016, which I think is what most of you are most interested in trying to get some additional color around.

Let's start with the Electrical Products segment; that's on page 6.

As you can see, organic growth of down 1%.

It was actually flat in the third quarter.

You can see very strong margin performance, 17.7%.

Volume relationship to last year down 5%.

Obviously, you see ForEx was 4 points of that.

Looking into bookings, bookings were down 1%.

And it is interesting, as you look around the world, quite different conditions by region.

Americas were flattish; Europe was up nicely.

And Asia-Pacific, both in this segment, as well as in our Systems and Services Electrical segment, down fairly hard.

And we think that reflects the real weakness that has been going on in China.

We will talk a little bit more about that as we go on in the call.

Net restructuring, as you can see, a slight positive to the quarter -- a good solid quarter.

And as you get down within the individual areas, clearly we are continuing to see strength in our lighting products.

Residential continues to be strong here in the US.

Canada is weak; Middle East was quite strong, which was one thing that helped Europe.

And across Asia-Pacific, whether it be in China or whether it be in some of the electronic products we supply as well, a weaker quarter.

If we flip to page 7, Electrical Systems and Services segment, we think a good quarter of performance, a nice rebound from the third quarter if you look at the margins, up 13.9%.

So, one of the stronger quarters we have had this year in this segment.

The story is much the same, however, in terms of the markets.

If you look at the box in the lower left-hand corner again, the organic sales down 5%.

It was down 5% last quarter as well.

And the bookings being down 2% -- the playout is fairly similar that the real weak region was Asia-Pacific once again.

As we have talked over the last couple of years, we, of course, see that the bookings over the last couple of quarters are a fairly good predictor of revenue levels in the next several quarters.

And so, if you look back to the third quarter of 2015, our bookings were down some 3%.

Now they are down 2%, and I think that will help you understand our thinking relative to markets when we talk about that [in organic] growth for 2016.

If we move to the next page, page 8, our Hydraulic segment, very strong margin performance here as well, in spite of very weak market conditions.

You may recall that in the third quarter, we reported organic sales down 10%.

Here in the fourth quarter, they are down 12%.

Our bookings down 22%.

That is pretty much a worldwide story.

If you go around, whether it be the Americas or EMEA or Asia-Pacific, the numbers are all negative.

They are negative also when we look at both the distributor and the OEM cuts.

These markets continue to be very weak.

I think our team has done a really terrific job in terms of really containing costs and driving structural change.

And that's why you see we think stronger than most people expected margins in this segment of 11.2%.

If we move to chart 9, the Aerospace segment, a great quarter for our Aerospace business.

They continue to have really very, very strong margins.

Our bookings were up 6%.

And we are particularly pleased in the after market, which you know is an area that we have been working hard to continue to bolster.

It was up both on the commercial and the military side for an average of up 14%.

A lot of discussion over the last couple of weeks about what is happening in the commercial aerospace activity.

We will talk a little bit more about that when we talk about our guidance for next year, but we continue to see that outlook being strong as we move into 2016 and 2017.

If we move to chart 10, our Vehicle segment, really strong quarter of performance from a margin perspective, again.

And I know a number of you have had concerns that as this business begins to turn down that it would have a disproportionate impact upon our margins.

I think you see here in the fourth quarter, our operating plans and the great job our teams have been doing at getting structural costs out is really having a positive impact, not only here in the fourth quarter, but once again in our guidance for next year.

NAFTA Class 8 shipments, in fact, were down in the fourth quarter; they were down 6%.

But you see the really strong 18.4% margins here in the quarter.

As we look into next year, we will talk a little bit more about it in just a moment, but our forecast is that we will see the NAFTA heavy-duty market be on the order of 250,000 units.

That is down about 23% from this year, so that is fully incorporated in our planning for next year.

If we move to chart 11, maybe just to cap off 2015, we obviously saw organic growth be negative throughout this year.

But the fact that we moved in the second quarter to start to really drive structural cost reduction across the Company is why you are seeing the real benefits here in the fourth quarter.

That obviously sets up a really important part of our operating plan for 2016.

Segment margins were 15.2%.

Free cash flow was slightly below our target of 100% as we look at this year.

We did repurchase 2.4% of our shares outstanding; that's about $682 million we spent on that during this year.

We paid down $1 billion of debt this year.

And we have completed the Cooper integration.

And so, really, as we enter into this next year, you will see we virtually have no acquisition integration costs anticipated during 2016 as well.

2012, really just for your records, really gives you the breakout of how our restructuring plan laid out during 2015.

And as I mentioned up front, our net benefits in the fourth quarter were better than we had laid out for you earlier, and I think reflect the momentum we have within our overall restructuring program.

Page 13 titled 2015 Restructuring Costs and Benefit, really give you a view at that full-year activity more for your historical background as you think about our performance across the segments.

I may jump to chart 14 as we start to talk about our thoughts about 2016.

With the weaker markets that we had anticipated in October, you may recall those numbers.

I will go back over them for you in just a moment on a subsequent chart.

We've now accelerated and, in fact, expanded our restructuring actions.

And it is our view that a couple of you had commented on in your write-ups this morning that 2016 and 2017 will remain somewhat challenged time periods in terms of end market growth.

And so, our focus is getting the cost out, and using our balance sheet to buy back shares, and to really get the Company well positioned in what will be a period of lower growth than we had seen in previous years.

So, what you see in the chart up top -- we tried to lay out for your ease here is that our 2015 actuals, then our 2016 and 2017 cost, and then the incremental benefits that occur in each year, that's incremental to the previous year.

And then you can see the total.

The big news here is that we have expanded the program to a three-year program.

We are going to spend about $400 million.

We will get benefits of just over $400 million over this time period.

And as you think about 2016, because I know that is of real interest to you, we will spend about $70 million of that $140 million in the first quarter of this year.

About 50% of the balance -- so, of the balance of the $70 million -- will be spent in the second quarter.

And then during the third and fourth quarter, the spending is fairly equal.

The benefits, however -- not much of those incremental benefits of $185 million occur in the first quarter because we are just kicking off this second phase of actions.

And it builds through the balance of the year.

So, it is a reasonable expectation that it has a bigger contribution to operating earnings per share in the third and fourth quarter than it would have in the second quarter.

If we jump to chart 15, and I mentioned before that our view of our markets and organic growth opportunities are lower than they were when we last discussed this in October, you recall that we had not laid out a formal forecast but we shared with you some early thoughts on 2016 in our October earnings conference call.

And at that time, we talked about organic revenues being down on the order of 1% to 2%.

We now, with the benefit of the last several months, and I think all the economic news that not only we but you also have been reading, as well as our detailed discussions with our customers around the world, we think a better expectation tuned up for all that data is that our organic revenues would decline on the order of 2% to 4%.

As you go through these individual segments, let me just give you a sense for what has changed.

As you can see, a rate on the chart, our organic revenue growth projections for the individual five segments we report.

For Electrical Products, we think the organic growth will be in the range of 0% to 2%, and Electrical Systems and Services a negative 2% to negative 4%.

In October, we had said if you put those two together, we thought the growth would be about 1%.

In the Hydraulics area, we are now forecasting organic growth of negative 9% to negative 11%.

In October, we had said we thought it would be about negative 7%.

In Aerospace, we are saying 1% to 3%.

Not that much has changed; we thought it would be 3%.

And in Vehicle, we had thought it would be negative 7% -- excuse me, we had thought it would be negative 5% in October.

We now think it will be 7% to 9%.

So, what are the big drivers here?

Let me start from the bottom where I ended, with Vehicle.

We now think the North American heavy-duty market will decline to about 250,000 units -- that's the whole market for NAFTA down 23% from where we finished up just over 320,000 units in 2015.

We think the light vehicle markets in the US are going to remain strong, flat to 1% up.

We think China will continue to move along fairly well in terms of its light vehicle markets.

We think Europe -- we are in agreement with most of the consensus that's out there that it's probably up on the order of something like 2%.

And we continue to feel that Latin America is a very troubled area.

And really when we talk about the vehicle market, we are talking really about Brazil.

And so, those numbers will be down 10% to 15% this year.

That's what brings us to our 7% to 9%.

Within the Hydraulics market, I'd say really a continuation of the negative expectations in terms of the worldwide ag equipment market and the construction equipment market, and not much positive on the industrial side.

And I'd say, again, 9% to 11% is our best approximation, having talked to our customers.

And you have seen many of them release their own guidance for 2016; we think this is very much in line with our own projections.

If you move to chart 16 titled Segment Operating Margin Expectations, I think it is really noteworthy that in the fourth quarter we increased our operating margins in spite of negative organic growth.

And that is indeed exactly our plan again in 2016.

In spite of about a $1 billion volume decline, and again that is about $600 million in organic growth and about $400 million from ForEx, we expect to expand our segment margins.

They finished at 15.2% last year.

And as you can see, the mid-point of our guidance is 15.6%, so far, about a 40-basis-point expansion.

We can obviously talk about each of these as we field your questions.

But I would call your attention to Vehicle, because I know many of your concerns in terms of looking at the year of 2016 is that we would see a several hundred point contraction in vehicle margins as the overall marketplace began to decline.

As you can see, we are confident with our operating plan and the benefit of all the restructuring we are doing and the fine job that's being done by our team there that we are going to hold very attractive margins in that segment.

And I think it is really a key element in terms of thinking about the valuation of Eaton because this is one that you have been concerned about historically from a volatility point of view.

If we turn to chart 17, labeled Our Multi-Year Share Repurchase Program, you will recall, in July, we laid out our new capital plan, which outlined on an annual basis repurchasing 1% to 2% of our outstanding shares per year.

We paid off this last year, as I mentioned, about $1 billion of debt.

We repurchased $682 million or about 2.4% of our outstanding shares.

And we have commented through the fall that in this period of time where we are seeing such weakness in equity pricing and specifically our own, that we were tilting our balanced plan that we had of spending about 50% on share repurchase and about 50% on acquisitions, that we were tilting it toward buying back more of our shares.

What we are announcing today obviously is that we are targeting a $3 billion share repurchase program, and those are for the years 2015 through 2018.

And so, what that means with us having purchased back obviously $682 million last year, so this is about $2.3 billion of purchases over these next three years, about 10% of our outstanding shares.

That does move us a little closer to an annual buyback that is on the order of more like 2.5% versus 1.5%.

Now, specifically in terms of 2016 -- you will recall that I just mentioned the number in 2015, we bought back $682 million -- we would expect to buy back about that same level this year, roughly $700 million.

It will, as it normally is for us, be back-end loaded in terms of how our cash flow lays out through the year.

But it does play an important part in terms of how we offset a slightly higher tax rate.

I will talk about that in just a moment.

You will recall at year-end 2015, our share count was 460.4 million shares.

So, we will leave it to you to figure out back-end loaded buying back about where that will pull our full shares, but we think it is worth around about $0.09 of positive impact.

So, if you move to chart 18 to pull this all together in terms of our EPS guidance for 2016, let's start with the first quarter.

Our operating and fully diluted EPS this year is the same because we do not have acquisition integration cost this year.

We think our organic revenue compared to the fourth quarter, so the actual numbers we just reported, will come down about 5%.

For those of you who are already calculating, that means it is down about 8% from last year in the first quarter.

The tax rate will be between 8% to 10%.

And the segment margin, including the restructuring cost of the $70 million, will be somewhere between 13.5% and 14%.

That is what supports our $0.80 to $0.90 operating and fully diluted guidance for the first quarter.

In terms of the full year, again, no acquisition integration cost, so the $4.15 to $4.45 with a mid-point of obviously $4.30.

The guidance does include the full net restructuring benefit that we outlined for you that is on the previous charts of $174 million -- that is a year-to-year benefit from our restructuring -- and the $45 million from the Cooper integration savings, which is primarily the full-year benefit of the plant closings that we were concluding in the back half of last year.

So, the operating EPS -- and I think this is really the best way to think about our operating plan -- we will have flat operating EPS year to year.

We will actually be up 2% in terms of fully diluted because we do not have acquisition integration charges.

But that flat operating EPS year to year really incorporates having revenues down $1 billion -- $600 million of organic, $400 million of FX; margins up 40 basis points, driven by all the restructuring work that we got a good head start on by starting early in 2015; and then the share repurchases of approximately $700 million are basically going to offset the impact of what we anticipate is going to be an increase in the tax rate from roughly 8% last year to roughly 10% as the mid-point of our range this year.

So, if you turn to page 19, just to recap again, organic revenue down 2% to 4%.

You recall we had a couple of very small acquisitions, so we got a little positive in terms of $35 million in terms of additional revenue.

2% negative ForEx -- that is that $400 million top-line impact that I mentioned negative.

Operating margins with the 40-basis-point expansion from last year.

Corporate expenses continuing to reflect all of the work that we are doing to get our cost down, not only in our operating units, but across the Corporation as well.

Tax rate ticking up slightly from last year.

I just mentioned the flat operating earnings EPS -- operating EPS -- and the 2% increase in net income per share.

Operating cash flow $2.6 billion to $2.8 billion; free cash flow $2.1 billion to $2.3 billion.

Obviously that looks like it then is a cash conversion ratio of greater than 1, and yes, that is exactly what we are targeting.

And then CapEx of about $525 million.

I understand some of you may have a question -- gee, that is pretty similar to what you spent last year.

If your volumes are coming down, why are you spending as much CapEx?

We do have some capital that is involved in all these restructuring actions, and that is really the difference to facilitate getting them done in areas where we may be closing and consolidating facilities.

So, that is our outlook for 2016.

We think it is a tight plan.

We obviously have had the benefit of looking very hard at these markets, and we are really confident about the restructuring plan that we put together.

So, that restructuring plan and our share buyback very much in our own control, and those are the kind of variables we are trying to control as we move into 2016.

Don, with that, I will turn things back to you for questions.

(Operator Instructions)

Before we begin the Q&A section, I do notice we have a significant number of questions in the queue.

Given our time constraint today of an hour for the call and the desire to get to as many of these questions that you have as possible, I would ask that you limit your questions to a single question and a follow-up.

I appreciate your cooperation in advance.

With that, we will open the questions with Scott Davis from Barclays.

Thank you.

Good morning.

Sandy, you have only four months left or so of your tenure.

You have seen a bunch of cycles, and I would love to get your opinion on how does the world get better?

Your bookings are getting less negative for sure, but how do we get back to positive growth?

What's it going to take, in your opinion at least, from a world perspective to have a recovery in sight?

That is probably almost a tome question.

I think clearly we have a couple big issues going on.

We are in a commodity cycle, and it does not matter whether it be oil and gas, whether it be metals, whether it be ag.

We've seen as the world has slowed down, it is now having a fairly profound effect on a lot of these commodities.

This too will bottom.

We have lived through a bunch of these.

It is just our view that we will not see that end in 2016.

That is why we said that it is so important to take these restructuring actions in 2015 and 2016.

Hard to forecast right now, Scott, whether that turn-up is in 2017 or whether that turn-up is in 2018.

I think most forecasts have always proved to be wrong, but I think that the benefit of where we are right now, we are in the second year of this fairly deep commodity cycle.

And as we pointed out in our earnings release, this is really only the second time that we have seen our end markets be negative in two consecutive years.

We have to go all the way back to the 2000, 2001 time period.

People were pretty mopey then, and by 2002 and 2003, we popped back out of it.

And I think you will see the cycle come back out.

Fair enough.

And then vehicle, I am one of those who have been skeptical on margins, and you've proven us wrong here.

Help us just understand; is this all a function of restructuring?

Is there other benefits here, whether it be LIFO accounting or mix or something else?

No change in accounting.

This is just the plain old hard way of running a business really well.

And the team's really been working hard on restructuring and being sure that new products we introduce have attractive value propositions.

And I would say it is doing it the hard way.

So some of it is new products then.

Remember in the automotive business you tend to -- we have pretty good automotive and truck businesses.

We have pretty good visibility forward wise in terms of what we win.

So I think we have had another very good year of bookings in 2015, really on a global basis.

And so we feel comfortable both on the revenue side of how we are doing with our customers, but feel really good about the work that has been done in the business on all of the cost work.

Great.

Ann Duignan, JPMorgan.

Good morning.

Thank you for the color on the vehicle side and the hydraulic side.

Sandy, could you give us similar color regarding the subsectors in electrical products and electrical systems and what you are seeing in the different end markets?

Our comments probably aren't going to sound vastly different from many of our peers who have announced.

We are looking at the residential market in the US as being one that will continue to be a positive on the order of 3% to 4% next year.

Non-res, probably the hardest one of all those numbers to figure out, particularly here in the US, there are so many different opinions on non-res.

We think much of what has been published is perhaps a little too bullish.

We are more in the 3% to 5%.

I know there are some people that are at 8%.

Gosh, I hope they are right, but that is not what we are basing our expectations on.

Utilities are a little better than we have seen the last couple of years, but it is still a zero to 2%.

Industrial is quite troubled, still, in terms of just not seeing a lot going, so that is probably a zero to a negative number.

As you get into harsh and hazardous applications that have large portions of oil and gas around them, those are numbers that are like negative 15% type numbers.

When we look in the large power quality areas, I'd say those markets are likely to be slightly negative again this next year.

Last comment I would say is that we just don't see the big large industrial construction numbers that are being so vauntedly reported in many of the government statistics.

We are out there bidding on them all, and we are not seeing what they are talking about.

So that is our view as to how we look.

We don't see Asia-Pacific getting substantially stronger.

We think still that will be weakened up by the lack of the big projects there.

EMEA is coming back.

I mentioned in the fourth quarter we saw a pretty good tone there.

Again, we are a very low single-digit, but it is better than a negative.

Thank you for the color, Sandy.

Just a quick follow-up.

You had mentioned previously that on the manufacturing side in the US that the downstream build-out from oil and gas, but maybe you would start to see orders in that business pick up towards the back half of this year for delivery in 2017.

Is that still your expectation?

The big natural gas and exporting terminals that were committed, it looks to us like those are going ahead here in the second half.

That's still our expectation.

You are starting to see, obviously, some of the big integrateds are really slashing capital budgets again, and that is why our view has been that you have a second year of a negative in the oil and gas industry broadly in this year.

And once you start these big cycles, it takes a couple of years for them to swing back.

Thank you.

Steve Winoker, Bernstein.

Maybe a little bit more on the margin front.

Given the ambitious margin expansion you have set up for next year, the way I used to think about it with you was decrementals of, I think, 20% to 30% normally.

Plus you have pricing here soon, productivity, cost inflation.

Can you give us -- or deflation -- can you give us a sense for some of the pieces of this?

Obviously with restructuring being the biggest positive, but help us work through how you are getting there.

I think -- as we have watched volumes come down as strongly as they have all the way through 2015 and 2016, those incrementals or decrementals are getting bigger, because you are getting down to points where you really have big need curves.

And our own thinking is, it is probably a 35% at this point.

So that is how we look at the decrementals.

It has not changed a great deal for us in terms of ForEx.

Those are more like 10% to 11% type numbers.

And then the rest basically comes from the cost reductions that we are getting.

Remember to add in the $45 million of the acquisition integration benefits into the two electrical segments.

Okay.

And the other piece is pricing?

What is that in there?

It is fairly neutral.

I would say our expectation is that we do expect some tail winds this year, and that is really because commodity prices have come off as hard as they have in the fourth quarter.

And January sure looks that way from all the numbers we can see.

Commodities did not do much recovering in the month of January.

I would say a slight tailwind from commodities on margin this year, as well.

Just to follow up, that restructuring for the fourth quarter, you did $2 million of cost and you saved $10 million more versus plan.

Was that all timing in those two line items on page 12?

I would say that the big issue is we were able to complete that restructuring at a lower cost than we had thought it would take.

It was not that we pushed something out, it was not that we did not take some action.

It just was the actual cost turned out to be less than we thought it was going to originally take.

Thank you.

Julian Mitchell, Credit Suisse.

Starting with electrical products, you are guiding for a reasonable margin development in 2016.

But looking at the moving parts, lighting probably outgrows the rest, so that's a mix drag.

Harsh and hazardous a probably very difficult.

So why do you -- is there something in the mix, or is it purely restructuring that you think can give you that margin uplift in electrical product?

Our harsh and hazardous, remember, is in electrical systems and services.

But I would say it's the restructuring and it's the benefits from the Cooper.

Remember those first two segments, electrical products and electrical SNS, you will both have the restructuring savings and you will have about $45 million to put between the two.

And it is likely to be pretty equal between the two this year, the $45 million.

Understood.

My follow-up would be on the vehicle, not so much the margins but just the top line.

So in Q4, you had a 6% organic decline, NAFTA Class 8 shipments were also down 6%.

For 2016, you are saying NAFTA Class 8 down over 20%, but your organic sales guide for the year is only down high single-digit for vehicle.

So what is changing in 2016 versus Q4 leaving aside Class 8?

You get a little bit of seasonal here too, as well.

Remember in the fourth quarter, you have a bit of what I call second-half September shutdown -- second-half December shutdowns that occur.

So that is a piece of it.

Remember that North American, part of that falloff actually occurred in the fourth quarter too.

So of the 23% we talked about reduction, you had a 6 point falloff from a year ago occur in the fourth quarter.

And we are talking about full-year 23%, but I would say it is more seasonal.

Craig, anything else?

Maybe to add, the 6% was a delta from Q3.

If you actually take a look at North America Class 8 truck year over year, it was down much more in line with what we're forecasting for 2016.

And the North America Class 8 truck number is obviously an important number for the vehicle business.

But as Sandy went through, that's only one of the many segments that make up our vehicle business.

And we continue to see around the world pretty robust numbers and growth in our automotive markets around the world.

And so it is just one piece of the equation.

The other piece as we start to anniversary some of the really weak numbers that we have seen in South America, which is the biggest piece of our vehicle business or our Company's exposure in South America and Brazil, those comparatives just get much easier.

Thank you.

Joe Ritchie, Goldman Sachs

This is actually Evelyn Chow for Joe.

Thank you for taking my questions.

I want to touch on capital allocation in your $3 billion share buy-back program.

Not to put words in your mouth, but I think the view on the priority of investment has been first to address weaker markets and get cost out, and then as you get out to 2017 maybe there are other alternatives around your business portfolio that are available to you.

What is the impetus to commit so much of your cash now towards buy-backs over the next few years?

Again, it is not all of our capital.

We are tilting it toward that, and our view is that this time of relatively weak equity performance and weak market prospects is a time when we think we can take advantage of really buying back shares and creating value for our customers at a time when I think certainty is something that everyone is looking for.

And so that is our view in terms of tilting at this point.

That makes sense, Sandy.

Switching gears, it looks like bookings trends are moving in the right direction.

We have heard a lot of surprisingly positive commentary from industrial peers on short cycle trends in January.

Can you address what you are seeing in your Business here at the start of the year and what you see in your front log to drive that 8% year-over-year decline in 1Q?

Our view is there are a couple of distributors that have come out and talked about things being a little bit more positive.

Our direct business peers, I don't think you have heard as much commentary coming out about the first quarter.

I don't think we're seeing anything at this point that causes us to think that markets are better than what we are forecasting here.

We have seen markets coming off each quarter throughout 2015.

Typically our first quarter is seasonally weaker than our fourth quarter.

It is our weakest quarter of the year, and that's how we have laid out our guidance for this year.

So I think it is a little early to call the year, and fortunately we have not had a major snow event this year, which has not given us a big hit in January.

But I'd say no, we are not seeing any difference in our guidance at this point.

Thank you.

Jeff Sprague, Vertical Research.

Good morning everyone.

I wondered, Sandy, if we can come back around to price.

I think there was an earlier question on price, and I think you answered it more around cost relief.

When you were saying you see a tailwind there, were you commenting that price costs net is a tailwind?

Can you package that together for us and provide a little bit of color on the pricing side of the equation?

I would say yes, the price cost net a slight tailwind.

Of course, the conditions are very different in every one of our market segments.

Some have long-term contracts, some have price adjusters and they are based in contracts.

We are not seeing the environment being one where I would say there is undo price competition.

Obviously markets are down, things are tough.

But we see the markets behaving pretty well.

On the comment about the corporate expenses down, maybe for Rick, the $80 million decline, is that all in across corporate options and pension and everything?

Or is that actually just the corporate expense line?

That is all in, Jeff.

That is interest, amortization, pension and corporate cost.

So that whole complex of cost.

Thank you.

John Inch, Deutsche Bank.

Good morning.

I realize it is not a direct comp, but it is a big industrial.

Emerson more or less suggested that we were approaching a bottom with respect to its various markets, and they expect orders to actually turn positive after March.

Sandy, it is dovetailing on Scott's point -- do you think we are approaching a bottom?

It does not suggest there is recovery coming anytime soon.

Do you think we are approaching an overall bottom?

And then what do you think about your own orders?

Are we looking at a positive inflection at some point this year?

Perhaps the best indication, and we have talked about this point a lot in our own planning as we put the plans together this fall, we are not counting on an economic rebound in the second half.

We think that's been an unwise premise to go into these markets with.

If it does get stronger, so much the better.

We can scramble up, we have done that well in the past.

The restructuring actions that we are taking, this commitment to a three-year restructuring plan says that we think 2016 doesn't recover when you get to the second half.

First I wanted to echo some of the other comments.

I think your margin performance in the face of all of this is actually pretty commendable.

The one business that does stick out is hydraulics, right?

It does appear whether it's because of Asia or pricing or whatever, it appears to be getting worse.

And it appears -- your margins are still down despite the heavy emphasis of restructuring.

Your margins are still down a point year over year.

What I would be interested in is your thought process about -- and maybe Craig could add to this.

Hydraulics strategically, I mean I guess if we had had this perspective that the world would be this difficult, we may not have built these businesses or some of the M&A we did more recently.

Sandy, you have made the comment that you cannot really adjust your portfolio in terms of spins until about 2017 because of Cooper.

But you can always still do something on a sale basis or something else.

How should we be thinking about hydraulics?

Because it really is sticking out negatively, unfortunately versus the other segments at this juncture.

I will come back to a couple of the elements you mentioned.

You are right, we are not able to do tax respins until after the five-year anniversary.

We have indicated that we do have the strategic flexibility that if we decide to, we can sell businesses on a taxable basis just as we did the two aerospace businesses that Craig led last year that we felt we could better step out of because they were not strategically managed.

There is no question on hydraulics.

We are dealing with very difficult end markets.

We commented on that last year, we don't think that will change this year.

We actually think the margin performance is pretty commendable in light of where the volumes have been, but we understand it is not at the mid-teen levels right now that we would like to see it at.

We do think with the actions the team is undertaking, that as we get into the latter part of this year, you are going to see some far more attractive margin than you will see in the early part of this year, because we are taking some very significant steps within that business.

We're trying to get this business sized so that it can perform well without having to have a market rebound, because again, we think we are in a commodity cycle.

And clearly we do not have the benefit of the revenues we had a number of years ago when we were at the high point.

Craig, you want to add anything?

The only thing I would add to what you said is we really are living through what I would argue is a really unprecedented period in the hydraulic market.

You cannot find a hydraulic end market today that has not gone through a pretty precipitous downturn, whether it's ag or it's China construction or it is mining.

The oil and gas most recently, anything tied to capital purchases on the industrial side of the business.

So when we take a look at the end market that we serve, it is out of hydraulics period.

But for the great recession, over the last 15 years, we have never seen a period like this in hydraulics business.

To Sandy's point, to have a business that in this environment that can still stand up clearly margins that aren't at the Company average.

But margins that are 10% to 11% we think is pretty remarkable performance from that business.

And at some point these markets will turn, whether or not that's end of 2016, 2017.

But to Sandy's point, we are putting together a plan today that says we're going to make sure this business delivers attractive margins at this level of economic and activity.

And when it turns, it will throw up very handsome incremental profits.

So today clearly we are living in a period in the hydraulics space that we don't like any more than you do, we're doing what we think we need to do.

But we think this will be a very attractive business when markets turn, and they will turn.

Craig, would it also be fair to say -- Sandy intimated that you would still do a little bit of M&A even though you stepped up share repurchase.

Rather than just ride out hydraulics in the cyclicality, would it be fair to say you might want to make up for those others deals in terms of the timing and do some acquisitions in this space?

Is that on the table still?

What we said, really, is until we get a real sense for where markets will bottom out, it is really difficult at this point in the cycle to really value hydraulic assets.

To your point, we made a couple of acquisitions in the space a number of years ago, and quite frankly we and the whole world got markets wrong.

I would say as we think about hydraulics today in M&A, it really is a piece that is off the table until we get a sense for where markets are and that they have bottomed out.

And we can really then predict the future.

Thank you.

Eli Lustgarten, Longbow.

Good morning everyone.

Following that up, everyone picks on the toughest segment in the bottom, and if it ever turned, people say who benefits.

And you have a good sense of the benefit.

When we talk about the hydraulics and the rest of the Company, can we talk about where inventories are?

What do you see during the quarter as far as inventory liquidation?

Is most of it over, or are we close to doing it?

Where do you think inventories are as you go through this year for you and your channels, and particularly with lower volume probably coming down some more?

Our best sense, and I will talk about the two segments where there are distributor inventories.

I think that is the sense of your question.

On the electrical side, people have been seeing markets being tauter than they were a number of years ago.

So we actually think there has not been substantial change in inventories.

They have been low.

We don't think we are either suffering from liquidation, or there is a lot more liquidation to go on.

On the hydraulics side, clearly the point Craig just made, our distributors have been dealing with this for a prolonged period of time.

I think the one segment where you find, when you travel regionally and you talk to different customers, if an individual distributor whether they were electrical or they were hydraulic had an unusually high exposure to the oil and gas area, they may still be struggling with some inventories.

Because I think that has continued to move in a way that many people did not predict it would.

I'd say outside of that, I think they are fairly balanced.

I think people have their hats buttoned down tight, and they too are trying to live through a period of time when growth is less than they hoped it might be a couple of years ago.

Looking at production, equal effectively end market demand --

Pretty similar.

I think the major OEMs are very much that way too.

They have been at this for some time, as well.

With the exception of what I would call -- you find in some OEMs, the big issue is not the inventory.

It's that the equipment they have shipped is being utilized at a very low level.

So there the utilization rates have to come up before their demand, before new equipment comes up.

I think it is less of an inventory issue today and now it is just very low levels of utilization.

To follow up, we talked about what Emerson said yesterday in their numbers, but the one market they pointed to was that data center markets had bottomed.

And we talk about improving data center markets, which if you are seeing that or that does happen, is probably better than what you are anticipating.

Are you seeing any movement in the data center sector, or is that still hope that is happening rather than what everybody's saying?

We had mentioned last fall, and it has continued for us, there were during the first-half disappointing year in terms of significant bookings.

We saw really good activity and good wins in the second half of last year.

That will help us with our shipments this year.

And we have been very pleased with the fact that I think I mentioned on several occasions that we came out with a new high-end three-phase UPS which had an even higher energy saving component, which was really sized for the Web 2.0 type of data center.

So it is allowing us to compete very advantageously there.

You had forecasted improving data center markets as we go through this year.

Is that part of the electrical forecast?

I would say the overall PQ market not that great, but some of the top-end stuff is getting better.

Thank you.

Josh Pokrzywinski, Buckingham.

Good morning.

Just a follow-up on some of these comments on when we bottom and when comps get easier, to distill it down a little bit, Sandy, do you think we exit 2016, given the confluence of a little bit of destocking.

Obviously not that much based on your last comment, and easier comps?

Do we start to see a business like hydraulics inflect positive by the fourth quarter?

We are not forecasting it at this point.

We would love to be able to answer the question, believe us, for our own utilization, as well.

We just think we are better to plan on the fact that we are not going to see the rebound at that point.

If we do, it will be an upside.

There is so much time between now and the fourth quarter in terms of seeing what happens to crop prices and what happens to commodity prices.

And we have seen the volatility in these areas, so we are not able to forecast that.

So we will not assume it will occur.

Maybe from a margin perspective on the other side of that, as restructuring yields out, by the time we get to the fourth quarter, you should be running well above that 10% just given the timing element.

Any help you can give on that?

Very definitely.

If you go back to the comments I made about the restructuring, you would recall that of the $140 million of restructuring costs that we will incur during 2016, $70 million is in the first quarter, roughly $35 million in the second quarter, then the balance in the last two.

That just by itself helps margins.

Now you put the savings, which that whole incremental savings occurs over the quarters of two, three, four, and it gets bigger as three and four go on.

So yes, each of the margins should build and very distinctly in hydraulics, back to Craig's position.

You will start to see how this plan manifests itself.

I think the real big take away from yours and many other peoples' questions we are not counting on an economic rebound to drive our plan nor our earnings.

What we are counting on is the things we can control, and that's the very important change that we made at the second quarter last year when we announced that we were going to drive very significant restructuring, and that we have now added another year to that.

But then we also announced an enlarged buy-back.

Those are two things we can control.

And we think in this environment where there is so much that people are uncertain about, we're putting the premium on let's deliver certainty where we can.

Thank you.

Nigel Coe, Morgan Stanley

Good morning.

Kudos on the cost control, quite impressive.

Couple of things.

I just wanted to go back to restructuring, and I'm just wondering does the nature of the structuring change over the next couple of years?

And I am just wondering if we move from headcount to more facility-based restructuring.

Within that, maybe make a comment on the CapEx.

I thought the CapEx comments around restructuring was interesting, and I'm wondering are we seeing some capital substitution for labor here or is this primarily consolidating small facilities into larger ones?

This is Craig Arnold.

Maybe I will take that one for you.

The way we think about this whole road map to reducing our cost is, we really think about it in three buckets.

There is a big bucket around facilities, our manufacturing footprint around the world and distribution centers and offices.

We have a pretty healthy appetite and a backlog of opportunities to continue to right size our facility footprint.

So that is one big bucket of activity that is undergoing today, and we think that continues for the next several years or so.

There is another bucket that really gets to what we call support cost, the number of management layers we have and the span of control of our leaders, the size of our corporate infrastructure.

That is a whole other element of activities that we have done a lot to improve it in 2015, and we think that also plays out continually in 2016 and perhaps a little bit into 2017, as well.

The, there's a third bucket that I put in the category of really optimizing where you do what you do, and that is really moving more of our activities to low-cost centers.

We are opening up shared service centers in low-cost countries and putting various activities that we do today, but simply putting them in places where we can do it for much lower cost and in many cases more efficiently.

Those are the three buckets of activities that we are undertaking across the Company, and we think it continues to be part of our go forward plan.

That is good color.

Secondly, I appreciate the color on the cash deployment over the next three years.

On the free cash conversion, roughly 110% for next year, what gives you confidence that you can get the work capital out of the system as your sales are declining 4% or so?

I will take that.

There are really two big elements to the improvement in free cash flow from 2015 to 2016.

First of all, we are not going to make a US pension contribution, and so that is an improvement of about $160 million.

And secondly, with sales going down generally, classic working capital is about 18% of sales; the $420 million or so of organic sales decline gets you around $80 million.

And then we have inventories that we have built up as part of Cooper that come out.

And frankly, we ended the year with a little bit more inventory than we had hoped simply because of the speed at which sales have come down.

So all of that leads us to say the expectation of $160 million from lower pension contribution and another roughly $140 million of working capital liquidation, that's how you get from this $1.9 billion to $2.2 billion midpoint of free cash flow.

That is great color.

Thank you.

Andy Casey, Wells Fargo.

Sandy, I am wondering within the nonresidential commentary that you gave a little bit earlier, whether you have seen any of the weakness being seen in some of your industrial end markets in the US starting to impact any of the really non-manufacturing sectors of nonresidential construction.

Let me take oil and gas off the table, but if you speak to the other non-manufacturing, we actually had a very good quarter, fourth quarter in terms of quotations.

And we look at all the quotations and negotiations that we are involved in, the stronger part of the commercial market from our perspective and we have a very big window looking at -- I am speaking to the US here -- has been the smaller projects.

It has been projects that you can say start off the residential base and then get up into medium-size projects.

It's the really big ones that have tended to be a little bit less strong in the marketplace.

Now, you are seeing a number big stadiums built around the US that really started in the second quarter of last year.

And that will continue through this year.

But the weakness we have seen in construction in the US has been the very big power-using construction where a lot of medium voltage is used, and it tends to be industrial or very, very big commercial.

The strength has been more toward smaller projects.

Thanks.

Going back to some of the other questions, but taking a different viewpoint on it, if we look back at prior cycles and you see some of the things that are weakening fairly significantly off of peak conditions like truck, what probability would you put on the US, instead of staying in this stagnant thing, just starting to go into recession not this year, but maybe next year?

We don't see that as a high probability.

We do think that we are in this frustratingly slow environment that can often cause people to use the recession word.

But I think that's almost more of an emotional issue than it is a factual basis.

We think the GDP is likely to grow in the mid 2%s again this year.

However, if you're on the industrial side of the economy, we are seeing industrial production numbers that are more like one.

So that all that we have been -- I'm just repeating what we probably all read is there has been more action on the consumer and services side than there has been on the industrial side.

That is what been leading to the lack of capital investment for this MRO industrial malaise, and that has clearly been affecting ours and many of our peers' markets.

I think that is more of the tone, and you compare the US growth to around the world, it is not significantly different than the total global GDP.

There are countries slower and faster.

But that is how we see it.

We just think it's a time when it is really critical that companies get their cost base adjusted, that they don't assume that economic growth is going to bail them out.

If they control those things that they can control, and that is exactly what our plan is all about, but it is not based on, nor do we think it is a high probability that there is a recession.

Thank you.

Deane Dray, RBC.

A question on the aerospace number, the bookings up 14%.

How does that split between commercial and military, and how much of that will flow into 2016?

The commercial side continues to be the stronger side.

If we look at the three elements of booking within aerospace, we were seeing commercial be up on the order of roughly 7%.

Military was down on the order of about 6%.

After market was up to 14%.

That is not a bad way to think about how things work going forward as we think about a market we are saying will be up 2% next year.

You assume the commercial will be a slight premium to that market, the military will be a slight discount to it.

We would hope that the after-market that we could grow a little faster than the average.

It won't be like a 14% or 15% number, but it will be slightly above our average number.

For Rick, the tax rate for 2016, seeing a lift from 8% to 10%.

Maybe comment on just what is going on there, and is there any update on what might be the natural rate that Eaton would level out to?

Our rate, as you point out, was 8% for 2015; the midpoint of our guidance of 10% for 2016.

And really that is a function of more US income.

It is a function of the restructuring actions, a lot of which do increase US income, as well as the fact that the US is -- there are some parts of our US business that are still growing pretty healthily, certainly relative to some other parts of the world.

If you look longer term, I continue to believe that the rates will be somewhere between 10% and 15% and will probably slowly tick up.

But I would emphasize slowly: not likely more than 1 or 2 percentage point moves in a given year.

Thank you.

Jeff Hammond, KeyBanc.

I have a quick follow-up on corporate expense.

Can you split out of that $80 million how much is restructuring savings that we should put in the restructuring bucket and how much is something else like lower pension?

There is very little that is restructuring at this point.

I would regard that as principally the core corporate cost.

So we can figure that as a separate bucket from the incremental restructuring savings?

It is all built in to the total number that we gave you.

But what I am indicating is the amount of actual corporate cost for restructuring in 2016 are a very, very tiny part of that $140 million.

Single-digit millions.

How much is pension going to be down year on year?

There will be a substantial improvement in pension or reduction in pension cost.

It is a number that -- for two reasons it will be a number that is down on the order of north of $50 million.

The biggest part of that is going to be that we did move to the split rate pension that so many of our peers have moved to.

We think it is better accounting, so that is the biggest driver of that.

Also the US discount rate has gone up about 25 basis points, simply a reflection of where interest rates ended the year.

Thank you.

Chris Glynn, Oppenheimer.

With the commentary on the multi-year share purchase plan, you opened up to some longer term looking at the capital structure.

I think in 2017, you've got a hefty debt coming due, $1 billion of that is that extremely low rate.

Are you looking at rollover to stay consistent with comments on excess cash to repurchase, or is the current 2.5 times leverage still above a sustainable zone?

So more of a bevy of commentary than a single question.

Our expectation, Chris, is that we would refinance the debt coming due in 2017.

Okay.

Lastly on the split from the first half/ second half, given the highly strategic year and period of a restructuring program, maybe give color on the ramp of benefits into the second half, just in terms of perhaps an earnings split of the first half and the second half within the annual context.

As I mentioned, the restructuring cost is $70 million in the first, $35 million in the second and the last $35 million across the last two.

From a benefits point of view, all the benefits occur in quarters two, three, four.

And they build as you go from quarter to quarter, so the higher savings will be out in the third and fourth quarter.

Thank you.

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