伊頓 (ETN) 2019 Q2 法說會逐字稿

Ladies and gentlemen, thank you for your patience in holding, and welcome to the Eaton Second Quarter Earnings Call.

(Operator Instructions)

Just a brief reminder, today's conference is being recorded.

(Operator Instructions)

At this point, I'll be happy to turn it over to Senior Vice President of Investor Relations, Yan Jin.

Good morning.

I'm Yan Jin, Eaton's Senior Vice President of Investor Relations.

Thank you all for joining us for Eaton's Second Quarter 2019 Earnings Call.

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

Our agenda today includes opening remarks by Craig highlighting the company's performance in the second quarter.

And as we have done in our past calls, we'll be taking questions at the end of Craig's comments.

The press release from our earning announcement this morning and the presentation we'll 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.

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.

Our actual results may differ materially from our forecasted projection due to a wide range of risk and uncertainties that are described in our earnings release and the presentation.

They're also outlined in our related 8-K filing.

With that, I will turn it over to Craig.

Okay.

Thanks, Yan.

Appreciate it.

Okay.

Let's start with Page 3 and a highlight of our Q2 results.

And I'd say, overall, we delivered solid Q2 financial performance and on the back of what I'd really call good execution across the company.

Earnings per share of $1.50 on a GAAP basis and $1.53, excluding transaction and integration costs related to the acquisitions and divestitures.

So at $1.53 per share our results are 10% above last year and at the high end of our guidance range which was $1.45 to $1.55.

Our sales of $5.5 billion were up 2.5% organically, partially offset by 1.5% of negative currency.

And similar to Q1, we continue to deliver strong margin performance.

Segment margins of 17.9% were an all-time record for Eaton, including records for Electrical Products, Electrical Systems & Services and Aerospace.

Margins were also above the high end of our guidance range and 90 basis points above prior year.

We also generated very strong operating cash flow of $880 million, up some 76% over Q2 of 2018 and once again, a second quarter record.

And lastly, we repurchased $260 million of our shares in the quarter, bringing our year-to-date purchases to $410 million or 1.2% of our shares outstanding at the beginning of 2019.

Turning to Page 4. We provide a summary of our income statement versus prior year, and I'll only highlight a couple of points here.

First, we're very pleased with our incremental margins which were about 50% on the organic growth that we delivered in the quarter.

So once again, strong execution.

Second, we incurred about $0.03 per share of after-tax cost primarily related to the spin-off of our Lighting business.

And finally, adjusted earnings increased 7%.

And as we noted, adjusted EPS increased some 10%.

Moving to Page 5. We summarize the quarterly results of our Electrical Products segment.

Revenues were up 2%, which includes 4% organic growth, partially offset by 2% negative currency.

Organic growth was driven by growth in both commercial and residential markets largely in the North America market.

Orders increased 1% led by continued growth in residential and commercial construction in the Americas, partially offset by softness in some of the industrial markets.

And our backlog was up 4%.

Segment operating profits grew 8% and operating margins were up 110 basis points to 19.6%, which was once again an all-time record.

So we continue to be pleased with how well the segment is performing, both in terms of organic growth and in margin performance.

On the next page, we summarize results for our Electrical Systems & Services segment.

Revenues were up 5% with 5% organic growth and 1% growth from Ulusoy acquisition and 1% negative currency impact.

Organic growth was driven by strength in the industrial projects as well as in commercial construction markets.

On a rolling 12-month basis, Electrical Systems & Services orders were up 3% with growth really across all regions.

And I'd say, it's worth noting here that prior year orders included an unusually high level of orders in hyperscale data centers.

Excluding hyperscale data center orders, rolling 12-month orders were up some 8%, which is in line with our order growth in Q1.

In addition, our backlog continue to grow and it increased some 2% in the quarter.

Electrical Systems & Services also produced all-time record margins of 17.4%, which were up some 240 basis points from prior year.

This strong operating performance included solid operating leverage with profits up some 22% on 5% organic growth.

Page 7 has our Hydraulics results for Q2.

Revenues were down 3%, and that's flat organic growth with 3% negative currency.

Similar to Q1, we had tough comps with 13% organic growth in Q2 of '18, but revenue continued to slow.

Flat organic revenues reflected growth in industrial equipment, largely offset by declines in agricultural and construction equipment.

Our orders declined 8% from continued weakness in global mobile equipment markets really around the world, and our backlog declined some 12%.

Segment operating margins were 11.5%, in line with Q1, but certainly down some 200 basis points from last year.

I'd say, here, we continue to work through some inefficiencies and costs related to repositioning the business during the quarter, but we made significant progress and we expect a better second half of the year.

On the next page, we show our Q2 results for our Aerospace business.

Similar to Q1, the business continued to perform at a very high level, really delivering record performance on almost every metric.

Revenues were up 12%, with 13% organic growth, negative 1% currency.

Orders on a rolling 12-month basis increased 15% with particular strength in commercial transport, military fighters and commercial aftermarket.

And our backlog continues to remain robust and increased some 17% in the quarter.

Again, we demonstrated really strong incremental margins which led to a 41% increase in operating profits and a 520 basis point improvement in margin.

Operating margins of 24.6% were another all-time high for the business.

In addition to volume growth, we also experienced some favorable product mix in the quarter which certainly helped.

Lastly, we're very excited to have announced in July Eaton's commitment to acquire Souriau-Sunbank Connection Technologies for $920 million.

Souriau is a leader in aerospace connectors and provides us with the capability to more effectively serve more electric aircraft systems, which is certainly a trend in the industry.

But beyond aerospace, we also have a significant opportunity to expand the distribution of Souriau's products to our large electrical wholesale network.

And as the whole world just becomes more electric, we think this technology and capability really becomes a real growth platform for Eaton.

Souriau has grown historically in mid-single-digit levels over the last several years, and we think we're paying a really attractive multiple of 11.8x EBITDA before synergies and 7 to 8x EBITDA on an after-synergy basis.

Moving to Page 9. We summarize our Vehicle segment.

Our revenues were down 11%, which includes a 9% reduction in organic growth and negative 2% from currency.

Similar to Q1, organic sales decline of 2% was driven by a combination of decline in light vehicle markets, which we think were off some 7% and the impact of revenues that transferred into the Eaton Cummins joint venture.

I will point out that the revenues in the joint venture increased some 11% in the quarter.

And also similar to Q1, we had tough comps.

Organic growth in Q2 of 2018 were up some 11%.

For the year, we continue to expect NAFTA Class 8 production to be roughly flat at 324,000 units.

And we also expect global light vehicle markets to remain weak.

And as a result, we've lowered our market outlook for the year.

Operating margins were 16.9%, which were down some 160 basis points from prior year, but I would point out up 180 basis points sequentially despite slightly lower revenues versus Q1.

So once again, really strong execution in our Vehicle segment.

Lastly, we summarize our eMobility segment on Page 10.

Revenues were up 1%, which includes 2% organic growth, partially offset by 1% negative currency.

And I'd say, here, the slower organic growth is made up of continued double-digit growth in the EV passenger market, partially offset by slower internal combustion engine markets.

And you should note that in the segment today, still some 2/3 of our revenue goes into legacy internal combustion engine and commercial vehicle markets.

This will certainly change dramatically as electric vehicle segment continues to grow, as electrification continues to grow.

But right now, it is still 2/3 legacy ICE markets.

And as planned, we continue to accelerate R&D spending which increased some 70% in the quarter.

And as a result, segment margins declined to 8%.

We're also extremely pleased to announce that we won another large program valued at $160 million of mature year revenue for a high voltage inverter for a new plug-in hybrid platform.

So this was our second significant win since we created the segment just over a year ago.

And we certainly reference this in our press release, but this brings our total new wins to $390 million since the segment was formed in 2018.

So we're ahead of our original schedule and once again, well on our way to creating a $2 billion to $4 billion segment of the company.

Moving to Page 11.

We turn to our outlook for 2019.

We now expect organic revenue for all of Eaton to grow approximately 3%, down from our prior estimate of 4%.

This reflects moderating global growth, particularly in Europe and in China and specific weakness in our short-cycle businesses, very much like you've heard from other companies.

We're lowering our organic growth rate by 3% for both Hydraulics and the Vehicle segment.

And in Hydraulics, we continue to see slow growth expectations in global mobile equipment markets.

And so now, we expect roughly flat organic growth for the year.

And in Vehicle, after a weak first half, we now expect organic revenues to be down some 7% to 8% due to continued weakness in global automotive markets.

And please remember once again that we are seeing strong growth in our Eaton Cummins joint venture.

We're also lowering our organic growth for our eMobility segment from 11% to 12% down to 5% to 6% due to, once again, slower growth in legacy internal combustion engine platforms.

We've not changed Electrical Products, Electrical Systems & Services or Aerospace as our long-cycle businesses continue to perform in line with our guidance.

And on Page 12, we summarize our margin expectations for the year.

Our Eaton consolidated segment margin guidance remains unchanged with a range of 17.1% to 17.5%, or 17.3% at the midpoint.

We've narrowed the range for each of our segments to be plus or minus 20 basis points since we've really delivered the first half of the year and it's behind us at this point.

We do have some puts and takes in margins with a 70 basis point increase in ESS, a 90 basis point increase in Aerospace, offsetting a decline in the Hydraulics segment.

And the midpoint of our margin for the other segments remain unchanged.

Our full year guidance for Q3 and 2019 are summarized on the last page, Page 13.

For Q3, we expect adjusted earnings per share of $1.50 to $1.60 per share.

At the midpoint, this represents an 8% increase over last year, excluding the impact of the arbitration decision in 2018.

Other assumptions in Q3 guidance include approximately 3% organic growth, margins of 17.7% to 18.1%, flat corporate expenses and a tax rate of 16% to 17%.

For the full year 2019, we're maintaining the midpoint and narrowing our adjusted EPS guidance range by $0.05 at both the bottom and the high end of the range.

Our new range is $5.77 to $5.97 per share and at the midpoint, $5.87.

This, once again, represents a 9% increase over 2018, excluding, once again, the impact of the arbitration decisions last year.

Other full year guidance assumptions include organic revenue growth of 3%; $100 million of revenue from the Ulusoy acquisition; foreign exchange impact is a negative $300 million, unchanged from prior forecast; segment margins of 17.3% at the midpoint, also unchanged.

And we've narrowed the guidance range for our full year tax rate to 14.5% to 15.5%, once again, no change at the midpoint but narrowing the range.

However, our strong first half cash flows are allowing us to really increase our operating cash flow and free cash flow guidance for the year by some $200 million.

Operating cash flows will now be between $3.3 billion and $3.5 billion.

And free cash flow will be between $2.7 billion and $2.9 billion.

We're also increasing our share repurchases from $400 million to $800 million for the year.

So overall I'd step back and say, really strong start to the year, a strong first half.

We're well positioned for another year of good results.

And our teams are doing a great job of executing in the face of the opportunity in front of us.

And so with that, I'll turn it back to Yan and open it up for Q&A.

Thanks, Craig.

Before we begin the Q&A section of our call today, I do see we have a number of individuals in the queue with questions.

Given our time constraint of an hour today and our desire to get to as many of these questions as possible, please limit your opportunity to just one question and then a follow-up.

Thanks for your cooperation in advance.

With that, I will turn it over to the operator to give you guys the guidance.

(Operator Instructions)

Okay.

We'll take our first question from Jeff Sprague with Vertical Research.

First, just thinking about Hydraulics and Vehicle.

This is obviously the second quarter in a row now with markdown at the top line and markdown at the margin outlook a little bit.

Would you say the forecast as you've laid it out here is kind of a run rate forecast on what you see over the balance of the year or are you making some underlying assumption that things pick up?

And I was wondering if you could also just as part of that just elaborate on how we get comfortable with the Hydraulics margins given kind of the recent trajectory there.

Yes.

Appreciate the question, Jeff.

And I'd say, I think you characterized it the right way.

It's really a look at kind of run rate in those 2 businesses, specifically with respect to growth.

Certainly, in vehicle markets, global markets around the world have been weak in the first half of the year.

And we're essentially assuming that we see a similar picture for the balance of the year, perhaps with a little bit of a pickup in the China market given kind of the depth of the fall that we experienced in the first half of the year.

But other than that, it's really largely run rate in both of those businesses.

And I'd say specifically in Hydraulics, today, what we continue to see in Hydraulics is we continue to see inventory corrections take place in the channel, both in distribution as well as in OEMs.

And we're also clearly seeing today our lead times have been reduced.

And so there's a fairly sizable inventory correction taking place across the board.

And the economic activity, if you take a look at kind of retail sales, those numbers are much better than what we're seeing certainly in the underlying order intake.

And so it's largely kind of a run rate picture.

And then specifically with respect to margins in Hydraulics, I'd say Q2 is essentially the last quarter where we were dealing with a number of inefficiencies and repositioning costs.

And so what we're really banking on going forward is that essentially normal kind of incremental/decrementals on the business but without the additional kind of repositioning cost and inefficiencies that we've experienced in the business in the first half of the year.

So very comfortable with the second half guidance at this point for Hydraulics.

And maybe then as my follow-up to all that, Craig, is just on the inventory correction that you are seeing.

Do you have any way to kind of gauge how far along we are in that process, how much excess inventory might be out there and how many quarters this takes to run its course?

I'd say really difficult to estimate, Jeff.

As you know, so much of this is a function of kind of everyone's forward view of where markets are going.

And given a lot of the economic uncertainty and trade uncertainty that we've been dealing with, I think everyone's trying to find their way through in terms of figuring out how much real underlying demand do we have versus how much of this is just general nervousness that we're experiencing as a result of these other extraneous factors.

And so really difficult to judge for certain.

I will say that as we take a look at inventory levels in the channel, we did see really a bit more broadly and also a little bit in our electrical business as well some inventory correction that took place.

But it's really difficult to call in terms of whether or not it's done, there's more out in front of us.

We're at the point now where they're comfortable really building some inventory back into the system.

Our next question comes from Jeff Hammond with KeyBanc.

Just a few questions on the electrical side.

One, you had talked about the big step-up in ESS margins, congrats there.

Just no real revenue change, what's really driving the step-up there?

And then just any update on the Lighting spin, when do we expect like a Form 10, et cetera?

Yes.

I'll take the first half and I'll let Rick take the second.

But in terms of ES&S and the margin step-up, I'd say in a word, I'd say it's strong execution.

Our teams are just doing an outstanding job of converting on the opportunities in front of us and running our facilities better.

As we talked about in the past, we've done some work around the portfolio and where we're choosing to compete.

And those things are paying off in the form of higher margins inside the business.

And so we're very comfortable with the level of margin guidance that we provided and taking the margins up.

And our teams are just doing a great job of executing.

And we'd expect that to continue.

And on the Lighting spin, Jeff, we've had initial comments from the SEC, relatively modest set of comments.

And so we would expect to get the Form 10 filed towards the end of the third quarter, might just lap into the beginning of October, but that's the time frame.

Okay.

And then just as a follow-on.

On the Souriau acquisition, you gave kind of the adjusted valuation with synergies.

Can you kind of expand on where you think those opportunities are?

I recall the business has a fairly large France footprint.

And so I know sometimes those costs are onerous to take out.

I appreciate the question once again, Jeff.

Now I think today, they run a very effective operation today in France, by the way.

And so we have no intentions of closing any of the French manufacturing facilities if that is the basis of your question.

Today, as you know, we operate today as Eaton in France and we operate very successful businesses in the country.

And so we're very comfortable with their manufacturing operations in France.

We're right now in the period of obviously putting some of the finishing touches on what our exact integration plans are going to be.

We've not communicated those plans to the organization yet.

And so clearly, before we'd make any public statements, we'll obviously need to work through our own internal announcements.

But specifically as it relates to manufacturing in France, very comfortable with that team, very comfortable with their capabilities and how effectively they've managed that business over a very long period of time.

Our next question comes from Scott Davis with Melius Research.

I want to just follow up a little bit on the questions around visibility, inventories, et cetera.

I mean can you give some granularity on what types of projects you're seeing in non-res in your backlog?

Yes.

I'd say that when we think about kind of what's going on today in Electrical Systems & Services, I'd say particular strength certainly in the U.S. Commercial construction continues to be quite strong.

Orders were up some 6% in Q2.

Industrial orders were also up nicely in the quarter.

So we're seeing pretty broad-based strength.

Our Electrical Systems & Services business had a really strong quarter of orders and in the U.S. as well.

If we look at kind of around the world in terms of what's going on in other regions of the world.

Europe, what we call EMEA, Europe, Middle East, Africa, India, we saw big projects in industrial; also in data centers.

Data centers in Europe were up strongly in Q2.

Crouse-Hinds business, oil and gas, had a very strong Q2 as well as our engineering services business in Europe as well, also strong.

And in Asia, where we saw the strength primarily was in power quality markets, which were up double-digit in the quarter.

And so I'd say that in Electrical Systems & Services, we're seeing, generally speaking, nice growth in almost all of the end markets, other than what we talked about which was, let's say, highly cyclical piece of the segment which is kind of the hyperscale data centers where those orders just tend to be lumpy.

And we're really anniversary-ing some really huge numbers from the Q1 and Q2 of 2018.

Other than that, we're seeing pretty good strength across residential, commercial, data centers and industrial buildings.

Seemingly so.

But does it scare you at all, Craig, when you look across, just across more broadly across industrials?

I mean, the quarter has been pretty weak overall and you guys have had decent numbers, of course.

But is there a recession playbook that you guys are dusting off?

Is there any internal plans to delay hiring or do anything to kind of play a little bit more defense versus offense?

Yes.

I think it's fair to say that we too have seen kind of the general slowdown in the macro economy during the course of Q2.

And it's obviously caused us all to kind of stop and pause and take stock of what's generally going on in the market and where we think things are headed.

And so I think it would be fair to say that we always have a restructuring playbook ready, at the ready.

We always encourage our businesses and our teams to think about what would you do in the event of an industrial recession.

And you can rest assured that our teams are thinking about that, have plans at the ready.

But at this point, we're not prepared to declare or pull that trigger because we still are, in fact, seeing growth in our end markets.

But rest assured, we have plans.

We have contingencies built in.

And in the event that we ended up experiencing an economic downturn, we think, once again, the company playbook that we laid out, if you recall back to our Investor Day that we'd essentially use our strong balance sheet, our strong cash flow.

We certainly would step up our share repurchases.

And so we think the company has a playbook that we've already laid out and quite frankly, even communicated in terms of what we would do in the event of an economic slowdown or an industrial recession.

Our next question from John Walsh with Crédit Suisse.

Question around the Aerospace margins.

Obviously, another very strong quarter taking the margins higher again.

I think last quarter you alluded to some favorable mix, but just wanted to get your kind of thoughts around where the Aerospace margins are going to exit this year and kind of the sustainability of that.

Yes.

I'd say that we have really a number of different positive events that are taking place in Aerospace.

Number one, I'd begin with, once again, our teams and how effectively they're executing.

And we are just doing an outstanding job across that business in really converting on the opportunities in front of us and running our facilities very efficiently, and that's obviously giving us a bit of a margin lift.

In addition to that, we're seeing today, quite frankly, as we talked about in prior years, there simply are fewer big aerospace programs that we're spending R&D dollars on, and that's obviously paying a dividend.

And I don't anticipate that changing dramatically unless the big OEs and commercial platform builders decide to launch some major new program that's not currently on the horizon.

And so that's obviously favorable for the business.

And then the third element is aftermarket continues to be quite strong.

The aftermarket segment of the business continues to grow nicely and we're converting on mods and upgrade opportunities.

And so we really do think that this business is going to be performing at much higher levels of profitability than it has historically.

And if you think about the guidance that we provided for the year, you can expect the business to continue to perform in those levels.

And then I guess, maybe just some color around the acquisition pipeline.

I guess we've had now one deal strengthen each side of the house.

You're going to generate very strong free cash flow.

You have a balance sheet.

Kind of what does the pipeline look like and what's the appetite to continuing to deploy it for M&A?

Yes.

I'd say maybe take the first question first.

The pipeline, I'd say, the pipeline today is much more robust than it's been historically.

Certainly, much more robust than we've seen in the last 3 to 5 years.

And so we are certainly looking, I'd say, at more opportunities than we ever have.

Having said that, I will also point out though, valuations in many cases are still quite elevated.

And we're going to continue to be disciplined as we think about how we deploy our capital and what we said.

And that continues to be the priorities that we'll continue to focus on largely our Electrical business, our Aerospace business and perhaps in certain opportunities around eMobility.

Those continue to be the company's priorities in terms of how we think about deploying our M&A dollars.

But yes, the pipeline is more robust today than it's been in quite some time.

And if I could just add one thing.

We've actually announced 3 transactions: Ulusoy in electrical; Intelligent Switchgear, a much smaller transaction and then this new Souriau transaction.

And to Craig's point, the first 2 were at multiples of 7 to 8x EBITDA and Souriau higher, but it'll come down to levels close to that after we enact the integration program.

Our next question comes from Nicole DeBlase with Deutsche Bank.

Yes.

So maybe starting with the short-cycle businesses.

It's been clearly a pretty common theme this quarter.

And we've heard from a lot of companies that things just decelerate a little bit in June and that's kind of continued into July.

So just curious about anything you're willing to share on the monthly trends within the short-cycle piece of your portfolio.

I'd say that, Nicole, our story is not terribly different than that.

I'd say that the month of June really was weaker than what we were originally anticipating.

And once again, you question, with a lot going on in the global environment in the month of June, whether it's around trade and additional tariffs or whether just around the general direction of the overall economy.

And so to what extent did a lot of our customers and distributors put things on pause in the month of June, we'll have to wait and see.

I will say that so far in the month of July, things are playing out largely as we anticipated.

And so very much consistent with the guidance that we provided.

And so we don't think necessarily that June kind of is the new standard, but we did, in fact, see a slowdown in the month of June very much consistent with what other companies have reported.

Got it.

That makes sense, Craig.

And then for my follow-up, just around data centers.

If you could provide a little bit more of an update of what you're seeing there.

We've heard increased concerns about push outs from the hyperscale players.

So would love to hear what Eaton is seeing.

Yes.

And I'd say that, for us, we always talk about data centers being kind of a long-term growth market.

Well, we think the market will, in fact, continue to grow on a long-term trend basis, high single digits.

And so we think it's a great space to be in.

And Eaton has a great strategic position in data centers, both on the equipment side as well as on the power quality side.

But there is this fairly large segment of the market called hyperscale that is very lumpy.

And it's been lumpy historically and probably will continue to be lumpy in the future.

And if you just look back at what happened in our business in, let's say, in the first half of 2018, we had very large multiyear orders from a number of the data center hyperscale players.

And as a result of that, we kind of anniversary-ed that in the first half of the year and we'll have a better second half comparable for sure.

But that business is lumpy today.

It will continue to be lumpy.

But we think data centers long term and quite frankly, in the near term, is a great space to be in and will continue to be a real growth engine for the company.

Our next question comes from Joe Ritchie with Goldman Sachs.

So maybe just kind of taking that aero margin question slightly differently.

So obviously the first half of the year, the margins were incredibly strong.

If I take a look at your guidance for the full year, the implied guidance for the second half would be that second half aero margins are going to be lower than first half aero margins.

And so my question is, was there anything specific about the first half that really helped boost margins or anything that's potentially going to impact margins in the second half on the aero side?

Yes.

I'd say the simple answer to that question, I'd say, is no.

I mean we certainly outperformed our expectations in the first half of the year.

We certainly saw very positive aftermarket mix in the first half of the year.

Question, is that going to continue into the second half?

At this point, I think it's tough to say.

And so we lifted margins overall, but I think very much consistent with the business probably going back to historical view of OE aftermarket mix.

But other than that, there were absolutely no onetime items or other things that drove the improvement in margins in the business outside of what I've articulated, which was largely strong execution in our businesses, strong aftermarket and then quite frankly, as I mentioned, lower R&D spending.

Got it.

That makes sense and good to hear there, Craig.

I guess my follow-on question, and this is something I think I've asked you on prior calls, is really just around Hydraulics and how you're thinking about that business longer term.

You've taken down the margin guidance.

It's now below the longer-term threshold for that business.

And I guess just how are you thinking about the, I guess, the trajectory of this business as part of the portfolio just given the performance that we've seen recently?

Yes.

Appreciate the question.

Clearly, it's a business today that we're not pleased with the way the business is performing.

We're not pleased with the way we've converted on the opportunity that's in front of us.

The margins are, in fact, below the overall guidance for the company.

I will say that today Hydraulics accounts for 8% of our company.

We delivered 17.9% all-time record margins despite the fact that we have one of our businesses that's not today firing on all cylinders.

And I really look at that as saying, wow, what an opportunity for what this company will look like once we get Hydraulics performing at the level that we know that they're capable of.

And so I'd say that as we think about the first half of the year, we were still working through some repositioning costs.

We're still working through some inefficiencies, as I mentioned.

They will have a better second half of the year.

We're very much confident in the plan that the team laid out in front of us.

But we have work to do and we have something to prove still in the Hydraulics business.

But I'd say, for us, at the end of the day, it's -- in a company as large and as diverse as Eaton, unusual to find every single business firing on all cylinders.

It's really, I think, a testament to the strength of the company that despite the fact that you can have one of the cylinders not firing completely, that the company can still deliver record all-time margins across the board.

So I think a real testament to the strength of the franchise.

Our next question comes from Dave Raso with Evercore.

There was some concern going into the quarter on ESS orders and the organic for the second half.

But obviously, your comments about ex-hyperscale that your orders didn't even slow on a year-over-year basis.

And the rest of the year, you're implying organic for that business as strong as you saw in the first quarter.

So sounds like you're very comfortable at the top line.

Can you help us a bit with the margin in the back half of the year?

Like what's in the backlog when it comes to mix?

Any price/cost you can help us with?

Because I see the incremental in the back half of the year is about 36%.

It's actually a little lower than the first half so it doesn't seem that challenging.

But can you just help us a bit with what's in the backlog to gain comfort with that important business?

Yes.

What I would say in general is that our backlog is very much reflective of what we experienced in the first half of the year.

And clearly, the guidance that we provided incorporated what we have visibility to into our backlog.

And so I'd say, once again, in our Electrical Systems & Services business, very much like some of the other parts of the company, the team is just executing well on the opportunity in front of us.

And I'd say if you think about price versus cost, what we've always said and which is largely kind of still our point of view is that, it will be kind of a net neutral to us.

Clearly, we're getting price in places where we're dealing with inflation, in places where we're dealing with tariff-derived cost increases.

And as a result, our businesses are managing that very effectively.

So we think that's going to be a net neutral.

And essentially, the margin expansion will really come from our ability to really manage the portfolio in terms of where we choose to compete.

It will come from our ability to continue to wring out inefficiencies inside of our businesses.

So nothing unique in the backlog help or hurt on the margin from what we've seen?

No.

Very much consistent with what we've experienced in the first half.

Our next question comes from Ann Duignan with JPMorgan.

Yes.

A lot of my questions have been answered.

But Craig, I think on Hydraulics you commented that you're seeing more broad-based slowdown in agriculture geographically.

I think last quarter you were saying just North America.

Maybe you could just update us on that and what you're seeing more broadly.

I think that's fair, Ann, whether it's in ag markets or quite frankly, even in construction equipment markets, I think we've seen a general slowdown really around the world in most of the mobile equipment markets.

A slowdown certainly in terms of the absolute rate of growth.

You see that in some of the big OEMs who've already reported their numbers.

But the other big thing that's taking place clearly across the businesses is inventory correction that we're seeing in both the OEM channel as well as in the distribution channel, probably largely in anticipation of a slowdown.

And so we were really dealing with both of those factors right now inside of the business.

So I'd say today, very much factored into our guidance and one of the reasons why we lowered the revenue outlook for the Hydraulics business this year.

Okay.

I appreciate that.

And then on the Vehicle side.

Your outlook for NAFTA heavy-duty production is flat this year.

The OEMs are all still quite upbeat about end-market demand.

And we know where orders are, we know where backlogs are.

But what are you hearing -- feet on the street -- that's making you more cautious than your OEM customers?

Yes.

I'd say it's very possible, Ann, that the market can be stronger than what we're calling right now.

I said, we're calling it flat.

And we do know there's others out there who are calling for some modest growth in North America Class 8 truck this year.

And so we'll have to see how that all plays out.

But if we just take a look at the general level of the economy overall, the fact that we are, in fact, seeing slowing.

We are, in fact, seeing inventory levels today that are at elevated levels.

And so we'll just have to wait and see how that one plays out.

But to your point, there are a couple of others out there who have more robust forecast for North America Class 8 truck than we have.

Okay.

So it's more erring on the side of caution rather than what you're hearing specifically.

Yes.

Absolutely.

I think it's really more erring on the side of caution, recognizing that in the event of a general slowdown in the economy, as you know better than most, Ann, that business has tended to move quite quickly.

And so we think this erring on the side of caution is probably the prudent place to be.

And keep in mind, by the way, for us, it's a good point to make the point where so much of our revenue today goes through the joint venture.

And so one of the things that we really try to do as a company is really derisk Eaton from the standpoint of its exposure to North America Class 8 truck market.

And so you'll see that volatility largely in the joint venture, but you'll see very little of that volatility in our own results.

And so I think it's an important point to emphasize.

It was a deliberate part of our strategy.

And so you'll see that largely in the JV.

You'll see very little of that.

You'll see some of it, but you won't see a lot of that show up in Eaton's results.

Okay.

So the margin reduction in Vehicle was primarily auto-related?

Yes.

And that's where we're seeing the weakness.

And by the way, we held the margins, by the way.

Just as a point of clarification, we actually held the margin guidance.

We narrowed the range.

You narrowed it, yes.

We held the midpoint in Vehicle.

And once again, we held the midpoint despite the fact that we're seeing a slowdown in our automotive markets around the world.

And that is largely the reason why we reduced the revenue guidance.

But the fact that we held margins really once again, Ann, goes back to our teams and our ability to execute in a declining revenue environment.

Our next question comes from Deane Dray with RBC.

I'd like to go back to the Souriau deal, if we could.

And Craig, since this is the largest deal you've done since becoming CEO, some color in terms of how did the deal come together.

The structure is a bit unusual.

Maybe you can comment on that.

And then whether there's an opportunity in that funnel to do larger deals like this.

Yes.

Deane, I'm not sure specifically in terms of the structure being unusual.

I think it's pretty straightforward.

There's some unique rules with respect to the way deals are announced in France in terms of the unions having to approve transactions.

And maybe that's what you're referring to in terms of the...

Exactly.

Okay, in the announcement.

But we think that's largely a matter of form over function.

We think the deal will close in good stead.

And we think it'll close by the end of the year, no later than.

And we don't think there's anything other than that, that's unusual about the deal.

And as I said, strategically, we really love this deal.

I mean, you think about the whole world becoming more electric, including aircraft.

If you think about Eaton being a big electrical company, we think we have a great opportunity to take their technology and their products into so many different applications in our core Electrical business.

And quite frankly, in everything that we do as the world becomes more electric, we think the electrical connectors that Souriau manufacturers really gives us a great growth platform inside of the organization.

And so I think what you're going to find from us is that we'll continue to look for opportunities in Aerospace.

We like the business for a lot of reasons and you'll continue to see us do more stuff in Electrical.

This just happens to be one that really cuts across 2 of our big growth platforms, both Aerospace and Electrical.

And so it's very unique in that respect.

But other than that, I think it's a deal that's really right down Main Street.

We think we bought it at a very reasonable multiple for an Aerospace asset.

And we think it really provides, once again, a real lever for growth in the future.

And then just I'd also ask whether this maybe emboldens you to do bigger deals?

Yes.

I'd say bigger deals for us is really a function of where the opportunities lie and whether or not you can acquire them with the right kind of financial returns.

And so we absolutely would not shy away from nor have we ever shied away from strategic acquisition of scale where we feel like we can buy at the right price and add significant shareholder value.

And so I would say that the deal doesn't embolden us to do bigger deals, but then again, there's nothing that prevents us from taking a bigger swing if the asset is strategically important and we feel like we can add value.

Got it.

And then just the follow-up question on Lighting and the extent to which you can comment on this.

There was some discussion that you would entertain bids for the company as opposed to a spin.

What has been the interest along those lines?

And any color there would be appreciated.

Yes.

We are in discussions with multiple parties.

And we'll see how that plays out, Deane.

We'll obviously take the course of action that is value maximizing for Eaton shareholders.

Our next question comes from Nigel Coe with Wolfe Research.

So the channel corrections in electrical is a bit of a new development.

And I think Lighting was an area where we expected to see it.

And obviously, one of your competitors called out commercial as an area where there's a little bit of headwind.

So maybe just sort of dig into that and maybe just address the extent to which you think this is caused by the price increases and tariffs as opposed to just general end-market weakness and the normal kind of destocking activity.

Any color there would be very helpful.

Yes.

And then I wish quite frankly, Nigel, we had clear and more definitive answers for you in terms of what actually caused the slowdown.

I think the truth of the matter is we and many others are speculating in terms of what actually caused it.

But clearly -- and there's a lot of geopolitical uncertainty in the world right now.

And I'd say that it probably reached a high point in the month -- certainly, the early couple of weeks of June around trade disputes between the U.S. and China and Mexico and some of the other general weakness that we're seeing and some of the macros.

And so I just think that there was enough out there in the month of June for people to pause and just take stock of exactly where we were at.

But beyond that, we would really be out on a limb trying to speculate exactly what caused the slowdown.

I will say that as we take a look at the back half of the year and we obviously factored in what we saw in the month of June into our outward forecast for our businesses.

And so I think this thing can go either way.

I think we could -- probably just the high probability that you're going to see a return to growth, to normalized growth as you're probably going to see a deceleration.

And at the end of the day, we're going to be ready.

Our businesses, we're focusing on making sure that we have contingency plans in place.

So in the event that we end up in an economic slowdown that's more severe than what we're currently forecasting, our teams will be ready to flex our costs, to flex our spending, to take whatever actions that we need to take to ensure that we continue to maximize performance.

And then another one on tariffs.

As you know, electrical products and lighting is one of the biggest categories of imports from China into the U.S. And obviously, you feel the inflation on some of the componentry, but also your competitors who import from there are obviously facing some tougher barriers there.

So I'm just wondering how the tariffs have impacted the competitive environment in both the low voltage but also in lighting as well.

I'd say on the low-voltage side, I'd say really very minimal to that.

And we talked about it for Eaton, we said that tariffs would be order of magnitude about $100 million bill for the company.

That's largely unchanged from what we forecasted the last time.

And that doesn't necessarily have an outsized impact on our low-voltage business at all.

It does, to your point, have an outsized impact on Lighting.

But I will tell you that good news is that we and others in the industry have passed on tariffs.

And at this point, we don't feel like the tariff issue today is in any way negatively impacting the margins of the business.

And quite frankly, we had a fairly good quarter in Lighting, both in growth and in orders.

And so we're very comfortable with our Lighting business and the way our team is executing and managing the tariff impacts as it relates to their business.

Yes.

The question is more on the competitive impact, but we can take it offline.

Our next question comes from Josh Pokrzywinski with Morgan Stanley.

Okay.

Then we will take the next one from Steve Volkmann with Jefferies.

Great.

I'm here.

Just a couple of quick clean-ups, I guess, if I may.

I was curious about the price/cost question from a different perspective.

We're starting to hear a little bit of signs of people sort of pushing back on price increases due to slower growth, due to lower raw material costs.

And I'm just curious what your view of sort of price/cost is over the next couple of quarters.

And I'd say our point of view, Steve, is really largely where we've always been.

And so we always think about price/cost in the near term as neither being a headwind nor a tailwind for the business and we try to manage it to be neutral.

That's kind of been our position as we laid out our thinking for the year and that's really where we're still parked.

In some cases, there's very formulaic equations that drive what we're able to pass on to our customers and where prices go up and down as a function of a basket of commodities.

In other cases, it's a function of obviously what's in the backlog and what you've negotiated.

But as we think about the go-forward view, I'd say, today, it's still -- our view is net neutral.

Price and cost for 2019 will neither be a positive nor a negative for the company.

Okay.

Great.

And then I'm sorry if I missed this, but any update on the fluid conveyance divestiture?

Yes.

That's proceeding as well.

And we are hopeful that it would close towards the end of the third quarter, perhaps the beginning of the fourth quarter.

Our next question comes from Rob McCarthy with Stephens.

Can you hear me, guys?

Yes.

Okay.

Great.

So let me go ahead.

The first question I would have is, in the context of what you're seeing now, which is kind of a choppy, challenging conditions overall, could you just frame how you think about kind of what your trough earnings could be if this is the peak this year?

Is there any way you can attempt to answer that qualitatively or otherwise, Craig?

Yes.

And we tried to address this one a little bit, Rob, when we had everybody together for our Investor Day earlier this year.

And one of the things we talked about is the fact that as we think about Eaton in our new configuration.

And our new configuration would include, obviously, once we divest Lighting, once we get rid of FCD and given the fact that we generate such strong free cash flow, we said what we're working on doing is standing up a company that even during a typical economic recession, defined as 2 or 3 quarters of GDP contraction, that our company would be able to still maintain flat earnings during that period of time.

And so that's still the path that we're on.

And that's what our teams are working on doing.

And I think you see a lot of evidence today in our businesses.

Using Vehicle as an example, despite the fact that clearly revenues are down pretty significantly, we're holding margins.

And so that's really the goal.

And because we do generate so much free cash flow that it will give us the ability in the event of an economic downturn to buy back more stock.

And so that's really the formula that we continue to work towards and what we would intend to do in the event of an economic downturn.

That makes sense.

And then forgive me for this other question.

It's a little impolitic.

But in terms of your new announcements of the sector heads, obviously, Uday and Heath are very well regarded internally and externally and from all channel checks.

The one thing I did get in terms of a feedback anonymously was the fact that, as good as Heath is, he's never run anything explicitly at a segment level.

I mean, do you think he's up to this?

I mean, obviously, you think he's up to the challenge, but how do you think about that going forward?

Is that a risk to management or execution for Eaton?

Sure.

Certainly appreciate the question.

I will tell you, the first thing I'd say is that, Heath is an outstanding leader who's been around for a long time inside of Eaton and inside of Cooper before that and just an outstanding leader with outstanding judgment, outstanding decision-making.

And if you think about today the way we're organized, Rob.

Today, we have really 3 businesses, right?

And inside of these businesses we have presidents who really run the day-to-day who are great operators, who know how to execute.

And what we're really looking for in these sector jobs is really strategic thought leadership.

And Heath, by the way, has that in spades as does Uday.

And so I would tell you that, he is exactly what we need for the business at this point in time.

The business is going through, in all 3 cases, a fair amount of strategic repositioning with a lot of moving parts and pieces in all 3 businesses, as we talked about.

And what really our businesses need is a partner, somebody who can work with them on, how do you think about the future of these businesses and what strategic move should we be making to maximize our results and our performance.

And with really 3 strong operating guys, it made no sense to put 4 in the box and put somebody else with exactly the same background into those businesses.

And Heath will bring exactly what we need for those businesses, which is really strategic thought leadership.

Next question is from Andrew Obin with Bank of America.

Just a question on, first, on China.

Could you describe in more details what the trend has been through the quarter because it appears that something happened in June and I wonder if you've seen a slowdown in June and if you could just describe the intra-quarter trend in China.

I can't say that we saw anything specific at all, Andrew, in the month of June.

I think what we've generally reported is that, certainly, in the short-cycle businesses, specifically in automotive and vehicle markets, we clearly saw a weak quarter.

We saw a little bit of a weaker quarter in Hydraulics for sure in China.

The long-cycle businesses, non-res construction, residential construction continue to be strong during the quarter.

And so I'd say, this kind of bifurcation of these 2 different markets, depending upon where you sit, that's kind of been a pattern that we've seen out of China for most of this year.

And in Q2 in the month of June wasn't really much different than that.

We are optimistic that with some of the infrastructure-related spending and the stimulus initiatives that are being put into the China market that we could have a better second half of the year.

But at this point, we really didn't see anything significantly different in China that was unlike the pattern that we really experienced all year.

And I apologize if I missed the question.

Could you just comment on growth rate within ES&S?

What's the growth rate for services?

What was that in the quarter?

And what are the big trends there?

Yes.

As I mentioned, as I was walking through the businesses, we've really had a really strong quarter of orders in our Electrical Systems & Services business, up strongly in the U.S. some 15%.

Europe was up also close to 15%.

So services really was one of the standout performers for orders during the course of the second quarter.

And so we continue to be optimistic about the outlook for services overall.

Good.

Thank you all.

We have reached the end of our call.

And we appreciate everybody's question.

As always, Chip and I will be available to address any follow-up questions.

Thank you for joining us today.

And ladies and gentlemen, that does conclude the presentation for this morning.

Again, we thank you very much for all of your participation and using our Executive TeleConference service.

You may now disconnect.