伊頓 (ETN) 2017 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton Fourth Quarter Earnings.

(Operator Instructions) And as a reminder, we are recording today.

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

Please go ahead.

Good morning.

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

Thank you for joining us for Eaton's fourth quarter 2017 earnings call.

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

As is typical, our agenda today will include opening remarks by Craig, highlighting the performance in the fourth quarter and our outlook for 2018.

As we've done on our past calls, we'll be taking questions at the end of Craig's comments.

The press release from earning announcement this morning and the presentation will be posted on our website -- or have been posted on our website at www.eaton.com.

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

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

Before we dive into the details, I'd like to remind you that our comments today will include statements related to expected future results of the company and are, therefore, by definition, forward-looking statements.

The actual results may differ from those forecasted protections due to a wide range of risks and uncertainties that are all described in our earnings release and the presentation and are also outlined in our 10-K.

Before I turn it over to Craig, I do want to highlight a change that you may notice in our press release and presentation today.

Since about 2001, we've used the term operating earnings and operating earnings per share in description of our financial results.

Those terms have consistently been used to describe net income and net income per share less acquisition, integration and transaction costs.

The reconciliation of those measures to GAAP measures and net income and net income per share have also historically been provided on our website.

Going forward, the terms operating earnings and operating earnings per share will be replaced with adjusted earnings and adjusted earnings per share.

The definition of those measures remain the same as before, that is net income and net income per share minus any acquisition, integration and transaction charges.

We'll continue to provide you with reconciliations to the GAAP measures of net income and net income per share on our website.

With that, I will turn it over to Craig to go through the results.

Okay.

Thanks, Don.

I'll begin on Page 3, where we highlight our Q4 results.

And overall, I'd say we're very pleased with our fourth quarter results and just as important, the momentum that we're carrying into 2018.

We generated net income and adjusted earnings per share of $1.43.

And this includes, as we noted, $62 million of income from the Tax Cuts and Jobs Act.

You'll recall that we issued guidance in late December and we estimated that the impact of tax reform would lead to a onetime charge of between $90 million and $110 million.

As we completed Q4 and work through the details of the tax reform bill, this turned into a $62 million benefit.

The adjustment of our deferred tax assets and liabilities to the lower tax rate created $79 million of income, which was partially offset by a $17 million charge for the mandatory repatriation tax.

Excluding these onetime items, our net income and adjusted earnings per share were $1.29, $0.05 above the midpoint of our guidance and up 15% over last year.

So really, results that we're pleased with.

Sales were also strong in the quarter, up 7%, of which 7% was organic.

And as noted, orders were also strong across all of our segments.

Segment operating margins increased to a record 6.5%.

And excluding restructuring costs, we posted operating margins of 17.1%, which was up 80 basis points from prior year.

And given the strong orders, we decided to actually accelerate some of our restructuring initiatives, which resulted in us spending $41 million in the quarter, and this was some $16 million above our prior guidance.

We also continued to generate robust cash -- operating cash flow in the quarter, which was $879 million.

Our free cash flow to net income was 112%.

And excluding the $62 million of onetime income from the tax bill, it was 124%.

So once again, very strong performance.

And lastly, we repurchased $61 million of our shares during the quarter, which brought our full year share repurchase to $850 million.

Turning to Page 4. We summarize the key income statement items, and I'll just highlight a few key metrics here.

We've covered some of this data already.

So first, I'd highlight our segment operating margins were up 21%.

And excluding restructuring costs, margins were 17.1%, up 80 basis points year-on-year on the 5% organic growth.

And this reflects naturally the benefit that we're seeing from the restructuring program as well as incremental profits on our revenue growth.

I'd also note that our $41 million of restructuring expense in the quarter was $36 million in the business segments and $5 million at corporate.

Turning our attention to the segments.

I'll begin with Electrical Products.

Our Electrical Products business grew 6% in Q4.

3% of the growth was organic and 3% from positive currency.

And our orders increased 5%, with strength in both the Americas and the Europe region, what we call EMEA.

In the Americas, specifically, we experienced particularly strong growth in industrial and large commercial markets as well as in residential products and in the Canadian market.

And in Europe, we saw strength in our power quality business, industrial markets as well as in large commercial projects.

And so by and large, we're pleased with the order growth that we saw in the products segment in the fourth quarter.

On Page 6, we summarize results from the Electrical Systems and Services segment, where we really have a very positive story unfolding.

First, the business has returned to growth, both in revenue and in orders, in the quarter.

Sales were up 3%, 2% organic growth, 2% from positive currency, which was partially offset by 1% from a divestiture of a joint venture that we had.

I'd add here that the organic revenue turned positive, slightly ahead of our expectations, on strength largely in Harsh and Hazardous, the Canadian market and in power distribution assemblies business, which was primarily in the Americas.

Perhaps more significantly, orders in Q4 were up 12% over prior year and, once again, with strong growth in the Americas.

As we've seen for the last several quarters, we saw particular strength in large power distribution assemblies, Harsh and Hazardous systems and our Electrical Services business, which also posted strong growth in the quarter.

Operating margins also improved nicely.

Excluding restructuring costs, margins increased 140 basis points to 15.6%, and this improvement was primarily the result of incremental margins on the revenue growth but also the benefits from the restructuring actions that we've been taking.

You'll also notice that we referenced the small divestiture here and a stake in a joint venture during the quarter.

And I'd say the way to think about this is it really represents the work that we're -- is ongoing across the company to continue to review our portfolio for strategic fit and also for performance.

Turning the page.

We're also very pleased with the improvements that we're seeing in our Hydraulics business.

We continue to generate strong growth, 18% in the quarter, 17% of which was organic and 1% from currency.

And the improvement, I can only say that's very broad-based, with both distribution and OEM sales up both in the mid-teens.

And we continue to experience really strong order growth, increasing 25% in the quarter with solid growth in all regions, and the growth in the quarter really matches our growth for the year, both coming in at up 25%.

Operating margins also continue to expand, reaching 13%.

And this number excludes restructuring costs and represents 150 basis point improvement over last year.

And I'd say we're pleased that after several years of significant restructuring and hard work by our Hydraulics team, that margins, excluding restructuring costs, are now operating within the margin target range that we set for the business, of 13% to 16%.

We certainly have work to do in this segment, but we fully expect to continue to see margin improvements and to be solidly within the target margin range that we set for the business as we move forward.

As I noted last quarter, the business also continues to experience a significant ramp-up in orders.

As you can see, we're addressing these issues and making progress.

On Page 8, we cover Aerospace.

Our sales increased 4%, 2% coming from organic and 2% from positive currency.

And we also had another quarter of strong bookings, up a solid 9% with strength across almost all end markets.

And I'd specifically note, aftermarket bookings were up 9%, and we saw very strong order growth in military OEM markets.

Operating margins continue to represent strong performance and, excluding restructuring costs, increased 20 basis points to, as you can see, 20.2%.

Moving to our Vehicle business.

You'll note that we once again had a very strong quarter, with sales growth of 13%, 12% coming from organic growth, 3% from positive currency and 2% reduction as a result of us forming the Eaton-Cummins joint venture.

The strong order growth was driven primarily by strength in NAFTA Class 8 truck markets, which were up 37%.

And this was somewhat muted by global light vehicle markets, which were flat during the quarter.

Operating margins, excluding restructuring costs, were up a solid 250 basis points from prior year and reached 17.3%.

And like other businesses, this segment is really benefiting by delivering the incremental margins on the change in volume but also benefiting from the restructuring initiatives that have been undertaken in this segment.

Now before we turn the page completely on 2007 (sic) [2017], I thought it would be helpful to briefly summarize some of the notable highlights and what we think was a great year of progress, and our thoughts are summarized here on Page 10.

First, our markets returned to growth with modest acceleration as we saw in the second half of the year.

This resulted in 3% organic growth for the year.

It would also appear that we're in a period of, we call it, synchronous global growth, and we really have all seen the enthusiasm associated with the U.S. tax bill.

So we think these 2 factors are really setting the global economy and even up for modest acceleration as we enter 2018.

Our net income and adjusted earnings per share was $6.68.

And this includes naturally the gain from the formation of the joint venture with Cummins as well as the income on the tax changes.

Excluding these onetime items, our adjusted EPS was $4.65, and this was $0.20 above the midpoint of our original guidance and up 10% over 2016.

As we continue to generate strong operating cash flow, $2.7 billion, 2017 was a record year for the company.

And this, by the way, is after making a $350 million voluntary contribution to our U.S. qualified pension plan.

So very strong cash flow during the year.

I'd also add that our U.S. qualified pension plan was funded at 95% at the end of the year and as of last Friday, actually, was funded at 98%.

And so despite really having the lowest discount rates that we've seen in several decades, our pension plans are really close to fully funded, so we really feel good about getting that issue behind us.

Lastly, we completed our third year of our full year share repurchase program, repurchasing $850 million of our shares during the year.

And this was 11.5 million shares or 2.5% of our shares outstanding as of the beginning of the year.

And between the dividend and share repurchases, we actually returned $1.9 billion to shareholders in 2017.

So overall, I'd say I'm very proud of the entire Eaton team and the year that we had.

We delivered on our commitment to shareholders, and we continue to advance the mission that we set for the company.

Turning our attention to 2018.

Page 11 is a summary of growth and margin assumptions for Eaton overall and for each of our segments.

We expect organic revenue growth in the Electrical Products business to grow approximately 3%.

And our forecast of 3% organic growth in Electrical Products is about the same as we experienced in 2017 with really broad growth in all geographies.

In Electrical Systems and Services, our business is really in the early stages of a rebound, and we expect to see 4% growth in the year.

Our forecast reflects growth in the Americas, driven by power distribution assemblies, Harsh and Hazardous systems and moderate growth in the rest of the world.

For Hydraulics, we really anticipate another very strong year of double-digit organic growth of approximately 10%.

The 10% organic growth compares to 12% in '17, and it's certainly supported by the order book and the backlog that we carry into 2018.

And the growth, I'd say, here really continues to be driven primarily by the strength that we're seeing in construction markets around the world.

Our Aerospace business is expected to grow approximately 3%, and we expect to see strong growth in commercial OEM markets as well as in commercial aftermarket.

We also expect military OEM markets to grow modestly, and this is compared to a slight decline that we experienced in 2017.

And finally, Vehicle business is expected to see 1% organic growth, and the strongest market is once again expected to be NAFTA Class 8, which is expected to grow some 9%.

And it's important, I think, to note here that much of this growth will be reflected in the Eaton-Cummins joint venture where we don't consolidate revenue.

And so some of you may have been a little bit surprised by the relatively muted growth number for Vehicle, and that's largely because much of this growth has being captured inside of the joint venture.

And the global light vehicle market should grow 1% to 2%.

With this rate of organic growth and the benefits from the multiyear restructuring program, we expect to see segment margins in the ranges that you see noted on the page.

For Eaton overall, our segment margin guidance is in the range of 16.3% to 16.9%, and this includes the net impact of any restructuring actions.

And so all of our restructuring expenditures are embedded in this number.

So at the midpoint of 16.6%, this represents an 80 basis point improvement over 2017.

In looking at our segments.

Vehicle year-to-year margins are expected to be flat, with other segments improving between a low of 30 basis points in Aerospace to a high of 280 basis points in Hydraulics.

So we think 2018 will be another year of solid progress and the year in which we take another step forward towards delivering the 17% to 18% segment margins that we've committed as a part of our 5-year financial goals.

And Page 12, our final slide, we summarize our full year guidance for 2018.

Our guidance for net income and adjusted earnings per share is in the range of $5 to $5.20 a share.

At the midpoint of $5.10, this represents a 10% increase over 2017, and this obviously excludes any of the onetime items that benefited 2017.

On revenues, we've already gone to the details behind the 4% organic growth outlook.

But I'd note here that we also expect to see $150 million of positive impact from currency, but this will be largely offset by $150 million negative associated with the impact of the joint ventures.

And this includes both the formation of the Eaton-Cummins joint venture in Vehicle as well as the dissolution of the joint venture that we referenced in Electrical Systems and Services.

And as noted, we expect segment margins to be in the range of 16.3% to 16.9%, and we think corporate expenses will be flat during the year.

We're also updating our prior December '17 commentary on the impact of the U.S. tax reform in 2018.

After further review, we expect our tax rate to be between 13% and 15% instead of the 14% to 16% previously announced.

And importantly here, very important here, I'd say we expect our tax rate for 2019 onwards to stabilize in the 14% to 16% range.

So we think it -- as we think about tax reform, we're pleased that, that particular uncertainty has now been taken off the table as we move forward.

We also expect another year of record operating cash flow between $2.9 billion and $3.1 billion.

We expect to spend $575 million in capital expenditures, which results in free cash flow of $2.3 billion to $2.5 billion.

And you'll recall that 2018 is also the year that we complete the final leg of our 4-year, $3 billion share repurchase program.

And as a result, we're planning to repurchase $800 million of our shares during the year.

And so in summary, I'd say we're very pleased with our Q4 and 2017 results.

We expect 2018 to be another strong year and to continue to deliver on our commitments to shareholders that we outlined as a part of our 2016 to 2020 goals.

So at this point, I'll stop and I'll open it up for questions.

Our operator will provide you with the questions -- with the instructions for the question and answer.

(Operator Instructions)

Our first question comes from David Raso with Evercore.

The obvious star of this report here is the ESS orders.

Can you flesh that out for us a little bit more, this pop in orders?

And I like the core guidance is pretty healthy at 4% for that division.

But can you help us a little bit with the cadence of this kind of order strength as you see it starting the year further into '18?

And maybe some timings.

Is there some lag on those orders translating into revenue growth?

Yes.

I'd say we are very pleased with the strength that we're seeing in Electrical Systems and Services orders.

And as I noted in my opening commentary, we think this recovery piece is coming perhaps maybe a quarter, even earlier than what we originally anticipated.

But I'd say we're really -- we continue to see -- with oil prices rising, we continue to see a return to growth in our Harsh and Hazardous, our Crouse-Hinds business.

That business is picking up nicely.

And the one large piece of that business that had really been under a lot of pressure over the last couple of years or so are large projects.

And so our large systems business, really, not just this quarter but last quarter as well, had started to improve markedly, and so we're seeing that come through, obviously, in stronger orders into Q4.

As we think about the timing of orders, these are obviously big projects.

They tend to have longer lead time.

And so as we think about 2018, we think the business starts a little slower in the first half of the year and picks up in the second half of the year.

And that's just a function of the timing of a lot of these large projects.

Okay.

And just 2 clarifications, if you don't mind.

The impact on the LIFO, FIFO change on the inventory for the 2018 EPS.

And also, if I missed it, I apologize, the restructuring charge, the total for '17 and what we expect it to be in '18.

The restructuring costs flowing through.

Yes.

I'll address the first one, David.

It's Rick.

The impact on LIFO in the fourth quarter was $0.01 out of the $1.29, so it was not at all significant.

And typically, and as we look back at past years, LIFO has ranged between positive $10 million, minus $10 million.

So really, $0.01 to $0.02 tied to impact.

And just a comment because I did see an analyst report, somebody asked, why did you make this change?

Well, the great majority of our peers are only on FIFO.

And in fact, most of the rest of the world, you have to be on FIFO.

The reason that our U.S. operations have been on LIFO is that up until a couple of years ago, for income tax purposes, we were on LIFO.

And the rule was if you were on LIFO for income tax, you have to be on LIFO for book purposes.

But as we looked at all of our peers being mainly -- or most of our peers being on FIFO and we looked at the extra time and trouble it took to make these complex calculations that go into LIFO, it seemed to us that the better move was simply to move everything to FIFO.

It has a $0.01 to $0.02 impact in any given year.

And we will -- in our K, we will show you the impact over the last 5 years.

But it is $0.01 to $0.02 swing positive, negative in any given year.

The last comment I'll make just so people don't misunderstand, our segment results that we've been reporting all of these years have always been on FIFO.

So the only impact on LIFO is in corporate.

We take a LIFO charge or a LIFO income, and it shows up in our corporate numbers.

That's really helpful.

And the restructuring costs that flow through?

Yes.

And then on restructuring, we spent $116 million in restructuring in 2017, and embedded on our guidance for 2018, we're going to spend $90 million.

And so that's a little bit up from, I know, some of the prior guidance, and I think you ought to see that as a really positive thing.

The reality is we simply see lots of opportunities to continue to improve the company, and we continue to make those investments that have very attractive returns.

And I'll remind you once again that all of restructuring cost is fully embedded in the guidance that we provide.

Now as we mentioned before, we were on this multiyear restructuring program where we were, every quarter, talking about restructuring and calling it out.

What we would intend to do going forward is that it will simply be embedded in our business, it will be embedded in our results, and so we would not intend to talk about restructuring as we think about reporting our results during the course of 2018.

Craig, that's, in a way, more impressive because I don't think the restructuring would be that high in '18.

So you're still sticking to your 40% incrementals, but you're taking a bigger hit on the restructuring.

In a way, the year-over-year help from lower restructuring is not as helpful as I thought.

Did you bump up the savings?

Are the savings still supposed to be around $50 million?

Yes, I mean, if you think about some of the newer items that we're taking on, many of those benefits will be in the out years.

And so we would not necessarily expect to see a very big increase in restructuring savings in the year on the increment.

But I think it's simply a reflection of the fact that the underlying growth rates will be a little stronger than what we anticipated, and we took this opportunity to continue to reinvest in the business and to reinvest in programs that are going to have future benefits.

So your implied 39.2% incrementals here a little "cleaner," right?

They're not necessarily so much a year-over-year reduction in restructuring?

Absolutely.

That's the way to think about it.

Our next question comes from Scott Davis with Melius Research.

Just trying to reconcile a little bit the comments about global synchronous recovery and the guide on Electrical Products side.

I mean, particularly given bookings up 5%, I know the quarter was just up 3% core, but your comps are relatively easy.

I mean, what gives you -- or what -- I mean, other than just being conservative, I mean, is there anything else there that leads to some cautiousness as far as that ramp, that 2018 ramp versus 2007 (sic) [2017] on...

I'd say your reference to the comps being easy, I think our Electrical Products business during the course of 2017 had a solid year of growth.

And so it grew 3% in 2017 and I think posted growth in each of the quarters.

And so I don't know that -- the comps are never necessarily easy, but I'd -- maybe a little color on those markets that we think will perhaps grow a little faster and those that will grow a little slower.

As we think about the end markets, we think going into 2018, our industrial markets and large commercial business inside of Electrical Products will be above the average of that 3%.

We think the components that we sell even in this segment into the oil and gas markets and applications will be above that number.

We think that products going into [smaller] commercial applications could be a little below that number as well as single-phase power quality.

And the other piece, we report our Lighting segment inside of Electrical Products.

And that business, very much like you've seen from some of the others in the industry, we think the Lighting business in 2018 is more like flat to down slightly than it is growth.

And so that's also probably having a muting effect at least on the overall growth of our Electrical Products segment.

That's really helpful.

And then as a follow-up, Craig, there's always a lot of chatter around your portfolio and lots of companies, peers of yours going through different stages of deconglomeration and such.

I mean, is this the portfolio that you plan on [writing]?

Or can we expect further changes in 2018?

Yes, the way I would answer that question, Scott, every one of our businesses today are measured against a criteria, and we laid that out in New York last year and the year before, and we'll talk about it again this year.

And so one of the big changes as we think about the portfolio of the company is that we used to talk about the fact that we had a portfolio.

And the way this portfolio of businesses worked together would enable us to create a company that was good through the cycle.

Well, the big pivot that we made was that we said, today, every business has to be a good business in its own right.

And we laid out a criteria that says, here's the criteria.

You have to be a global business.

You have to grow faster than GDP.

You have to deliver mid- to high returns on -- and with sales.

You have to deliver mid-20s return on assets.

And if you're in a cyclical market, you have to deliver a minimum of 13%.

And so we laid out the criteria for each of our businesses.

And I can tell you that each of our businesses today is making great progress towards those objectives to the extent that they're not necessarily meeting them today.

So we like the portfolio today.

But having said that, we'll always look at it.

Throughout our history, we've always continued to be tough minded about businesses and things that made sense and things that don't.

So we'll always continue to look at the portfolio and to make changes wherever we think it makes sense from a shareholder value creation.

Now the way we think about portfolio management is more around the margins of what we do in our businesses, and that's where we talk about a number of small divestitures, things that we're stepping out of, things that we're doing to manage the portfolio inside of the businesses that we do have.

You can rest assure we'll keep looking at it.

Our next question comes from Joe Ritchie with Goldman Sachs.

Maybe just starting on ESS margins for a second, the guidance of 20 to 80 basis points.

Obviously, the fourth quarter was very strong, and part of that may have been a little bit less restructuring actions.

But this business has had tough times and slow growth for quite some time and need to see you thinking incrementals on this business as you're -- even if 4% turns out to be the right number from a growth standpoint next year or in 2018, and you expect the incrementals on this business to be very strong.

So maybe talk a little bit about that -- within the context of your guidance, your margin guidance, like what the puts and takes are for margins in 2018.

I'd say the Electrical Systems and Services business and what we provided in the form of guidance is that we expect 40% incremental rate all-in for Eaton inclusive of the restructuring benefit.

And I'd say, that business does tend to perform a little higher than that, and others inside the business perhaps are a little lower.

But I would say that all of the benefits associated with the restructuring and the 4% ramp that we're seeing are fully baked into the guidance that we are reflecting inside the company as we do continue to invest in the business across the board.

And we think that the numbers that we're proposing in terms of the guidance for 2018 are very much reflective of what we'd expect from the business at this point in the cycle.

Okay.

That's helpful, Craig.

Maybe asking this a little bit differently.

I guess if I were to think about potential headwinds for 2018 and specifically, as it relates to this business, I would think perhaps price, cost, you still have commodity inflations, so I'd be curious to hear how you guys are managing that and whether 2018 should be better than 2017.

And I guess, secondly, the other thing we're kind of seeing just from a logistics perspective, it seems like things are getting a lot tighter from a truck capacity perspective.

So any commentary on like freight costs as well would be helpful.

I think it's clear that as we think about price versus cost going into 2018, we think 2018 is a better year, an easier year than 2017.

You'll recall that we experienced a bunch of unanticipated material cost inflation in 2018, and we're basically chasing it all year.

You see the same reports that I do.

We've not really seen commodity prices let up at all, but I can tell you that the businesses today are very well positioned to react and respond and to manage in this increasing environment of commodity cost increases.

And so as we think about 2018, we don't expect commodity prices to -- for the full year create an issue for us as our teams work on plans and initiatives to either pass it through to the marketplace or to offset it with a number of different cost-out and productivity initiatives that we have inside of the business.

And to your point around truck capacity, yes, absolutely, we are seeing a little tightness there.

And that's part of, I think, what you see in the form of the strength in the North America Class 8 market as orders continue to drive up strongly, and that's because there is a bit capacity tightness there and it is being reflected in freight rates.

And so that's, once again, though, all fully baked into the guidance that we provided.

Our next question comes from Steven Winoker with UBS.

Just -- Craig, you just finished this multiyear restructuring program, as you noted, and that was an enormous effort that you've been talking about for years and really one of the main focuses of the organization.

So it begs the question of, on that front, what's next around continuous productivity and additional restructuring?

Are you finished?

Or where are you on the path now?

Yes.

What I'd say is no, we're not finished.

And as we've noted earlier that we said you don't -- always going to think about an underlying rate of restructuring spending in the business.

And we originally targeted a number of $60 million to $70 million, and as we talked about in our guidance for 2018, we'll spend $90 million.

And so we really do believe there is an infinite capacity to continue to improve things, to do things better, different, to be more efficient.

And so I don't think we ever really run out of an opportunity for the foreseeable future to continue to find good programs to invest in that results in us reducing our costs and building a more efficient organization.

And so it's too early to give you a guide beyond 2018, but I think you can count on us, just with a consistent cadence of spending dollars of restructuring, to continue to drive margin expansion.

Focused in any particular business units, though?

Yes.

I think you could generally think about it in the context of the higher the margin business, the less need to reach for restructuring.

I think you get to a point in some of these businesses where you over-toggle, so I'd just say you just think about it in the context of the margins.

And the lower the margins, the -- probably the higher participation those businesses will be in the restructuring programs.

Keep in mind, it will always be fully embedded in the guidance that we provide.

Right.

And that is best practice.

I know on ES&S, you left -- I think it was 14.4% or so in 2013, so you're getting there.

You think it can go beyond it?

Yes, absolutely.

I mean, keep in mind that, that business is just starting to cycle up, too, in terms of some of the key end markets that we participate in.

So we fully would expect -- we're not going to give you another range, right, we provided a range of 13% to 16% as a range through the cycle for that business.

And so we're not in a position yet to change that range, but absolutely, we would expect it to continue to improve.

And sorry, one last.

Any detail behind the lower incrementals on the Products front this last quarter?

I know it's a high-margin business, but is there any particular dynamics that worked?

Yes, I appreciate the question.

And we are overall pleased with the margins.

There were really 2 things inside of our Electrical Products that impacted us in Q4.

One, we had a mix issue in our European business, and nothing to worry about, we just had a number of very large shipments at the end of the year of products that just carried a much lower margin than we've typically seen in that business.

But once again, a onetime kind of event.

And the other thing, if you recall, we've highlighted earlier that we would be dealing with, in Q4, some of the fallout of the hurricanes that we experienced in Puerto Rico, and that also impacted our margins.

So when you factor in -- factor out those 2 events, our margins would have been 19.6% and a 20 basis point improvement versus prior year.

Our next question comes from Jeff Sprague with Vertical Research.

Just wonder if we could just drill on a couple businesses.

First, maybe back to ESS.

In the opening remarks, you didn't mention utility at all, or if you did, I missed it.

What do you see playing out in the utility space here as we exit 2017?

And what are you expecting for 2018?

We see the utility markets to continue to be in the low single-digit kind of growth range.

And so if you think about that in the context of the overall Electrical Systems and Services business, it maybe is a slight deduct from the 4% but not much.

And that's really what we experienced on the course of 2017 in the U.S. market, specifically, and that's really what we expect going forward.

And then on Lighting, I mean, what you're saying is definitely not inconsistent with what we've heard from others.

But what is your view on the disconnect, if you will, between relatively healthy commercial activity and Lighting continuing to lag?

Is it channel?

Is it share loss at the low end across the industry?

And do you have any view on when Lighting might reconnect with what's going on in the construction-related markets?

It really has been a bit of a conundrum, a market that has pretty consistently grown and grown faster than many of the other end markets.

We saw this period of retrenchment or flatness in 2017, and that's really kind of consistent with our view going forward.

I'd say there's probably a couple of things going on and once again, very much consistent with what you've heard from others.

We do think the market itself is probably more competitive today than it has been in the past as LED technology becomes more proven and more of a standard.

We think, certainly, you're probably seeing more competition, more price competition in that market than we've seen historically.

And so we have to wait and see how that plays through.

We're certainly continuing seeing the ramp in connected and controlled lighting.

In fact, our growth in that segment of the market was very handsome and very much consistent with what you've heard from others, but it's not yet a big enough piece to offset the decline in the legacy part of Lighting.

The other thing I would say, on the positive side, despite the fact that Lighting overall as a category has been a little bit flattish, we continue to see growth in LED.

In fact, our LED business continued to grow nicely in Q4.

Today, LEDs represent 79% of our revenues.

And so that continues to be a positive for us.

But it really is a bit of a wait-and-see story.

We take a lot of confidence in the fact that buildings are built, they need Lighting, and the end markets that we're serving continue to be quite robust.

So I think we're going through a little bit of a transition period right now, and we'll have to wait and see how it plays out longer term.

And then one last one from me, just on Hydraulics.

Could you comment a little bit on Hydraulics China?

And also, are you able to keep this good track of what's going on in the channel?

Any concern that maybe people are double ordering or anything here as we have kind of a scramble upward here?

Specifically, with respect to Hydraulics China, what we're seeing there is very much consistent with what we're seeing in the global hydraulics market, which is a very significant ramp in the construction equipment market.

And the excavator market in China has been up over 100%.

The wheel loader market has been up 50%.

So really strong growth that we're seeing out of China overall.

And I do think, to your point, overall, there's always a risk when you end up at this point in the cycle.

When lead times are starting to push out, there's always a risk that there's a little bit of over-ordering or booking early in the process.

One of the reasons why you'd say why 10% growth in Hydraulics or orders are up 25%, because we do believe there's a little bit of timing associated with what's going on inside of that market.

We'll have to wait and see.

I mean, we really are encouraged by some of the retail sales numbers, though, that you're seeing from some of the major equipment companies where retail sales are growing quite nicely.

So it is a little bit of a wait-and-see on that market as well, but we think 10% is a number that's very much supported by what we've seen in other cycles and what we think will ultimately deliver in the business during the course of the year.

Our next question comes from Jeff Hammond with KeyBanc.

Just back on ESS, any good lumpiness in the orders in 4Q that wouldn't repeat?

And then just maybe as you think of quoting and talking to customers, just the sustainability of this uptick you've seen in large projects and Crouse-Hinds.

Yes, I'd say, Jeff, no, not really.

We -- I wouldn't say that we've seen any particularly onetime orders or things that would be -- suggest that the underlying order rate is not sustainable in our order book.

And so no particular concerns there in the systems -- large systems business or in Crouse-Hinds.

And so -- and the other -- I'm sorry, the other part of your question was the...

Just on quoting in customers as you look forward, the sustainability around Crouse-Hinds in these large projects that have upticked.

Yes, I'd say and I would point to you, one of the things that we track is we track negotiations.

And so I would say that, very much consistent with what we're seeing in our order book, our negotiations for the year in that business, which is a prerequisite for an order, are actually all running up as well kind of mid-teen levels.

And so we are also seeing overall economic activity negotiations to be essentially growing at the same rate as the underlying orders.

And that's really encouraging for the future.

That's great.

And then just to understand on the Cummins-Eaton JV.

So the JV income, is that going to run through Vehicle segment op income?

And just update us on when you think the income from that JV starts to ramp.

Yes, the answer is yes.

It will run through the Vehicle segment.

And in terms of when the income starts to ramp, I can tell you today that we are investing heavily in the joint venture.

One of the big kind of reasons why we made the decision to partner with Cummins in this particular space is because we saw an opportunity to really accelerate our growth by introducing some new products and doing some things that would allow us to expand beyond our historical customer base.

And so at this point, we're not prepared to give you a longer-term forecast on income other than to say we're still significantly in the investment mode.

And so we would not expect in 2018 to see income come out of the joint venture as we continue to invest for growth.

And Jeff, we've already built in our -- the expectations of that investment into this 2018 guidance.

Our next question comes from Deane Dray with RBC.

This is Andrew Krill on for Deane.

I was hoping -- can you give us, I mean, your big picture views on nonresi for 2018?

I think a lot of people have had concerns it could be top-y but it continues to grind higher?

So any color you can give there?

I'd say in terms of nonresi markets, I'd say that the way we think about it is that kind of no real change from what we experienced on the course of 2017.

We think order of magnitude, we think growth in the 4% range is kind of the consensus number out there as well from the other forecasting organizations.

And so we think in many ways, it's almost a little bit of a repeat from what we experienced in 2017.

The one thing that could be a potential upside to that, if we end up with an infrastructure bill at some point in the U.S., some of these numbers could get better down the road.

But right now, we're planning on pretty much a repeat of what we experienced in 2017.

Okay.

Got it.

And then as a follow-up, I think one of your other, like, foreign-domiciled peers also note the dynamic where their tax rates should kind of go up in the out years.

Can you just give us any more insight into, like, the more -- the technicalities driving that?

Yes, I'll address that, Deane (sic) [Andrew].

As we said, we believe our rate for '18 will be 13% to 15%.

And we think '19 and beyond, it only goes up 1 percentage point, so to a rate of 14% to 16%.

And it goes up partly because the tax bill does have some elements that do ramp in.

In '18, there's a partial ramp, and then in '19, there's a larger ramp.

But we think that stabilizing in the 14% to 16% range seems to us to be a pretty good result and will be, we think, relative to most other multinationals, an attractive rate.

I would make one other -- or maybe 2 other comments here because there have been some things written on our taxes that were just not correct, and I want to make sure everybody understands.

I saw one analyst that suggested that because of the tax bill that we might need to change our manufacturing footprint, and that is just not correct.

We don't believe that there will be any need to make any significant changes to the footprint as a result of the tax bill.

And secondly, there was a comment that our dividend -- the treatment of our dividend from a tax perspective would change.

And that isn't correct either because at least in the intermediate term, we continue to believe that our dividend will be 100% return of capital.

And that means for U.S. shareholders, there will be no present tax owed on it.

And then at some point in the future, if our dividend ever became other than return of capital, the taxation of that dividend, the rates applied to it would be the same as applied to any other corporation based in the United States.

And so I just wanted to make those clarifications.

Our next question comes from Tim Thein with Citigroup.

Just going back to the commentary around -- on the JV with Cummins.

On the truck orders for -- in North America on the heavy duty side, Craig, what's the split or what are you anticipating the split to be in terms of AMTs versus manuals?

Just thinking about how your underlying growth will track this normal build rate.

I don't have the exact split, but clearly, AMTs are continuing to grow and manuals are continuing to decline.

And I can get to the further details through Don after the call.

Okay.

Okay, understood.

Then -- and maybe -- you touched a lot of markets within ES&S, but maybe just a word on power quality more broadly.

Obviously, impacting both single and 3-phase, but just curious in terms of what's embedded in the outlook here for 2018.

Yes.

Thanks for the question.

Certainly, power quality was one of the more disappointing markets in 2017.

And as we take a look at 2018, the single-phase piece of power quality, I think you'll recall that we report it to our Electrical Products business and the 3-phase we report to our Systems and Services business.

And we think the power quality markets in 2018, we think, grow in the range of low single digit.

So we think they have a better year than they had in 2017.

And we think that's another one of the positive, kind of year-over-year impetuses for growth in, certainly, our Electrical Systems and Services business.

Our next question comes from Andy Casey with Wells Fargo.

Can you -- I guess, can you comment on capital redeployment, just specifically on whether the acquisition pipeline activities picked up?

Because the balance sheet is -- net debt to total cap, solidly, mid-20s pension fully funded, heavy lifting from a management capacity for margin improvement seems to be done.

I'm just wondering where we should expect some of the improved cash flow to be allocated other than share repo.

It's Rick.

We are spending much more time looking at targets and evaluating situations.

Valuation levels are high, as you well know.

And you also know that we've been incredibly disciplined and we'll continue to be incredibly disciplined as we look at acquisitions.

So I can't tell you exactly what we might get done this year, but rest assured that we understand that we have very adequate capital and we would like to find ways to augment our growth and augment the strategic position of our various businesses.

But it's just hard to figure out exactly what will economically make sense over the course of the year.

And then having said that, I would just add that what we've always said is that the first call on capital is to reinvest in our businesses to drive organic growth.

And we certainly look forward to sharing with this group when we're together in New York some of the organic growth initiatives that we are investing in that really take advantage of some of the secular trends that are impacting our businesses.

And so we think we have some exciting opportunities to invest in internally to drive organic growth that perhaps can help bridge some of that gap.

Okay.

And then a little bit more specific on Vehicle.

You anticipated part of the question on revenue.

But even with that, the flat margin year-to-year at the midpoint seems a little bit muted.

Is that flat performance due to the accelerated investment into the JV that you mentioned?

Or do you expect Vehicle to see a little bit more restructuring this year than it did last year?

What I'd say, the way to think about it, once again, I appreciate the question, is it's really investment.

I mean, it's investment -- and we'll talk a little bit about this when we get together in New York.

It's really investment in some new technologies and electrification.

And so we're really taking this opportunity to reinvest in the business to really position the business to generate organic growth going forward.

Our next question comes from Mig Dobre with Baird.

Just a clarification.

So the guidance implies $26 million lower restructuring costs in '18 versus '17.

Can you remind us what the incremental savings are?

We -- Mig, what we've said is that we really, going forward, are not going to try to reconcile costs and -- restructuring costs and savings every year.

Frankly, it's just everyday activity.

And so we simply wanted to note that we had earlier said perhaps we would on a regular basis spend $60 million to $70 million on restructuring, and we're going to spend a little bit more than that.

But we are just going to treat it as regular operations and not get into the details on expected savings.

The way to think about it, we said, at this point in the cycle, we would typically perhaps deliver a 25% incremental.

And one of the reasons why we're delivering a 40% incremental is because those restructuring benefits are flowing through.

So a way of thinking about calibrating the benefits that we're seeing in the company.

Yes, I'm trying to understand, when I look at your first quarter guidance talking about 40 basis points of margin expansion versus the full year, I'm trying to figure out how the costs and the savings and whatnot are coming through to net debt.

Yes.

I mean, certainly, we always -- I mean, if you think about restructuring in general, it's always more front-end loaded than it is back-end loaded.

So I think you're probably seeing some of the impact associated with just timing of spending and benefits throughout the year.

Okay.

Then last question from me, back to ESS margins.

So if I look at your revenue in the segment, down something like $800 million over the last 3 years, things were difficult.

I guess when you look at that 13% to 16% target range that you put out there for margin, I'm wondering, at what revenue level do you think it's appropriate for us to be thinking that you can reach the high end of that range?

We will address that in a little more detail at our New York conference.

We have not modeled that exactly at this point.

But clearly, you're going to need a step-up in revenues from what we expect this year, given how far revenues have fallen in that business.

Our next question comes from Ann Duignan with JPMorgan.

Just on Vehicle, your outlook for organic growth of 1%.

I had always assumed that on the transmission side for heavy-duty North America trucks that you were still going to be kind of contract manufacturing, and therefore, your volume in trucks should be similar to the industry volume growth.

Am I missing something?

Yes.

So I think the way to think about the impact of the joint venture and how it impacts the Vehicle business is, first of all, the year-over-year deduct, right, because the joint venture was formed at the middle part of last year and so you have to take out the revenues that we enjoyed in 2017 out of 2018 as those revenues will now be reported inside of the joint venture, and Cummins will consolidate.

And the other thing you got to think about is that a lot of the growth that we are seeing in our markets in 2018 is coming out of North America Class 8 truck.

And that growth once again will show up not in Eaton's revenue, it will show up in the joint venture's revenue where we don't consolidate.

And so we do participate slightly because we are selling components into the joint venture, but the denominator, the base of that is quite small.

And so that's why you probably see a number that's perhaps more muted than you would have modeled for the Vehicle segment.

Okay.

So I guess, when I was looking at organic revenue growth guidance, I was thinking that it was apples-to-apples, but I should take into consideration...

You really have to deduct the JV revenues and then you have to factor in how much of the growth is going to show up in the joint venture, not in our Vehicle business.

Yes.

Okay.

I got it.

That's helpful.

And then just a quick kind of more philosophical question.

Do you need to be in the Lighting business long term?

I mean, is there a strategic reason why you would need to be in that business?

The way we think about Lighting is no different than the way we think about the rest of the portfolio.

We set very specific goals with respect to -- every one of these businesses have to be good businesses in their own right.

They have to stand on their own 2 feet.

And so Lighting is no different than the way we view Hydraulics or Vehicle or anything else.

And we constantly look at these businesses and say, is it a good business in its own right?

Will it add to our growth?

Can it deliver the margin targets that we anticipate?

And so every one of our businesses go through that screen.

Are there some synergies associated with going through similar distributors?

Sure, there's some.

But even having said that, every business has to stand on its own 2 feet.

And that's the way we view Lighting, and it's very much consistent with the way we view every piece of the portfolio.

At this point, we want to wrap up the call.

I know there are a number of other calls today.

We want to be respectful of those.

They've got to move on to other calls.

So we're going to wrap up the call today here at 11:00.

I do want to -- as always, we're available for follow-up questions.

Thank you very much for joining us today.

And ladies and gentlemen, that does conclude your conference for today.

Thank you for your participation, and thank you for using AT&T Executive Teleconference service.

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