The operator begins the conference call for Eaton's third quarter earnings and introduces Yan Jin, Senior Vice President of Investor Relations, who will be hosting the call. Yan Jin thanks everyone for joining and introduces Craig Arnold, Chairman and CEO, and Tom Okray, Executive Vice President and CFO. The agenda for the call includes opening remarks from Craig, followed by Tom's presentation on the company's performance in the third quarter. Questions will be taken at the end of the call. The press release and presentation have been posted on the company's website, and a webcast of the call will be available for replay. Yan reminds listeners that the commentary will include forward-looking statements and that the actual results may differ due to various risks and uncertainties. Craig then begins with the highlights of the third quarter results.

In the second quarter, Eaton experienced record financial results, driven by megatrends such as reindustrialization, energy transition, electrification, and digitalization. These trends are evident in their results, particularly in the Electrical Americas business. The company is also improving its overall effectiveness, resulting in record operating margins and a raised earnings outlook for 2023. Their backlog is growing and they have a strong book-to-bill ratio. They also recorded record operating cash flow and free cash flow margins. Eaton is well positioned to have a record year and they will continue to update investors on progress in key market drivers, including infrastructure spending, reindustrialization, and the utility market in Electrical and Aerospace.

The paragraph discusses the impact of reindustrialization on the number of mega projects in North America and how Eaton is positioned to benefit from the growth in the data center market. The chart shows a significant increase in the number of mega projects announced since January 2021, with a 3x increase compared to normal rates. The trend is expected to continue, with a 25% growth between Q3 and Q2. Only 20% of these projects have started, presenting a significant opportunity for electrical markets. In the data center market, there is strong secular growth due to the increasing demand for data and software solutions.

The use of natural language processing, specifically ChatGPT, will greatly benefit Eaton as they have a strong portfolio of data center solutions. The data center market is expected to continue to grow at a significant rate, with a projected 16% compounded growth rate between 2022 and 2025. This growth is driven by the increasing amount of data being generated and the adoption of generative AI. Eaton has already seen the impact of AI in their order book, with a large order for a new AI training data center and a significant increase in hyperscale orders. These data centers require high-power and high-power density, leading to higher electrical content. Eaton is well positioned in this market, with the broadest portfolio of power manager solutions for data centers. The average data center size is between 10 and 500 megawatts, with Eaton having a strong presence in the 40 to 50 megawatt range.

Eaton supports the flow of electrons in data centers through their electrical busway, uninterruptible power systems, and software and service solutions. Their market opportunity in data centers is about $1.5 million per megawatt. They continue to invest in adding production capacity to meet the growing demand in various markets and address bottlenecks in their manufacturing sites. Their Brightlayer for data center software suite is the first in the industry to combine asset management, IT and operational device monitoring, power quality metrics, and electrical supervision into one application.

In the sixth paragraph, the company discusses their primary investments in utility markets and global electrical business to support growth in emerging markets and the new eMobility business. These investments are expected to result in higher organic growth and provide a good return on investment. The company also achieved several records in their third quarter results, including all-time high sales, operating profit, and adjusted EPS. They also generated a record operating cash flow and free cash flow margin.

The Electrical Americas business has had a successful year so far, with organic growth up 12% and record-breaking sales, operating profit, and margins. The business has seen double-digit growth in most markets and has effectively managed price costs. While orders were down 3% on a rolling 12-month basis, backlog remains high and the company is confident in generating strong organic growth for several quarters into 2025. The backlog for Electrical Americas has increased 19% year-over-year and 5% sequentially.

In the third quarter, the company saw strong growth in orders for data centers, industrial facilities, and institutional markets. Their major project negotiations pipeline also increased significantly, particularly in data centers. Despite flat organic growth in the Electrical Global segment, the company achieved a record in sales and saw strength in commercial, institutional, industrial, and utility markets. However, there was weakness in EMEA markets, which is expected to be short-term. The company's operating margin also improved, driven by effective management of price and cost. Overall, the electrical segments had a strong quarter with organic growth of 11%, incremental margin of 53%, and a segment margin of 25.5%. In the Aerospace segment, the company also achieved all-time quarterly sales and operating profit records with 10% organic growth and a 3% contribution from foreign exchange.

The company has experienced strong growth in the Aerospace segment, with double-digit growth in 6 of the last 7 quarters. This was driven by growth in all markets, particularly in commercial OEM and aftermarket. Orders and backlog continue to increase, with a book-to-bill ratio of 1.2. In the Vehicle segment, organic growth was down 1% but foreign exchange had a positive impact. Operating margins were 17.4%, driven by effective price cost management and new business wins. The eMobility segment also had strong growth, with a 19% increase in revenue and improved margins. Overall, the company is encouraged by the growth prospects in this segment.

In 2023, the company has won new programs worth $1.1 billion, a 145% increase from the previous quarter. They have also increased their interim revenue target for 2025 by 25%. The backlog for Electrical and Aerospace segments has increased by 5% and 4% respectively, giving the company confidence in future orders. The company has adjusted its organic growth and operating margin guidance, with an increase in Electrical Americas and a decrease in Electrical Global and eMobility. The total Eaton margin guidance range has also been increased by 50 basis points due to an improved outlook in Electrical Americas.

The company is lowering margin guidance for Electrical Global by 50 basis points due to lower growth, but the midpoint still exceeds their target for 2025. They are raising their full year EPS, operating cash flow, and free cash flow guidance ranges due to strong earnings and working capital management. For Q4, they are expecting organic growth of 8% to 10%, improved segment margins, and an 18% increase in adjusted EPS. The company remains on track to deliver their third year of double-digit organic growth and all-time record margins. They also provide their initial view on end markets for 2024, expecting strong growth in data centers, utilities, commercial aerospace, and electric vehicles.

The company expects solid growth in multiple industries, with the exception of residential and commercial vehicle markets. Backlogs are at record levels and the team is executing well, leading to increased earnings and cash flow outlook. The company is well positioned for differentiated growth in 2024 and beyond. The operator then opens the call up for questions.

Craig Arnold, the CEO of Eaton Corporation, was asked about the company's strong incremental progression in the third quarter and how this will impact the fourth quarter and beyond. He stated that the company is still expecting 30% incrementals in 2024, but this may be moderated by investments and a decrease in tailwinds. He also mentioned that the company has a strong line of sight to the incrementals in the forecast for the fourth quarter. When asked about the impact of capacity additions on revenue, Arnold stated that the company has a strong end market growth assumption and the revenue from capacity additions should be quantified in relation to this.

Craig Arnold discusses the company's growth and investments in response to increased demand. He mentions the $1 billion investment and how it will support long-term growth. He also mentions the start of 20% of mega projects and how they will impact the company's orders.

The company has a variety of mega projects with different timelines, some taking 12 months and others taking 3 years or longer. On average, it takes a couple of years from start to revenue for these projects. These projects, which are mainly related to government spending, are a major driver of the company's growth prospects. However, the company also has a strong pipeline of negotiated projects, which are smaller in size but still contribute to growth.

During a conference call, Joe Ritchie asks about concerns regarding project financing and higher interest costs in the market. Craig Arnold acknowledges the potential risk of delays or cancellations due to these factors, but states that they have not seen any evidence of this happening yet. Tom Okray adds that the utility sector in the Americas is up over 25% year-to-date. Jeff Sprague then asks for more information on the demand for Electrical Global, specifically in Europe. Arnold notes that there is some project activity starting to pick up and there may be competition between Europe and the U.S. in this sector.

In response to a question about project stimulus and future pipeline, Craig Arnold explains that the global business for the company is made up of three main segments: Asia, GEIS, and electrical Europe. While the business in Asia and GEIS performed well, there was a slowdown in the European business, specifically in the manufacturing and OEM segment. This was due to destocking in the distribution channel and overbuying in the past 12 months. However, the company expects this segment to return to mid-single-digit growth in Q4, driven by electrification, energy transition, digital growth, and data centers.

Tom Okray and Craig Arnold discuss the good order flow in EMEA and their confidence in the low mid-single digits in Q4. They also mention keeping an eye on geopolitical tensions in the region and making necessary adjustments. In terms of data centers, they note that their dollar content per megawatt is increasing due to selling more software solutions and complete data center solutions. However, this growth is overshadowed by the overall growth in the market, with over $100 billion in backlog projects and significant construction and starts in the month of September. The rise of AI is also contributing to the market's growth.

The speaker discusses the potential for growth in the electrical equipment market in AI-centric data centers, which is five times larger than in conventional data centers. However, there are constraints in meeting the demand, with a backlog and negotiations taking up to five years. The data center market is performing well and is expected to continue to do so. The speaker also mentions that M&A opportunities will primarily focus on Electrical and Aerospace, with potential for acquisitions in eMobility as well.

The speaker believes that the company has many growth opportunities in front of them, both organically and through potential deals. They are particularly focused on eMobility and leveraging their scale and technology to deliver attractive margins. They are currently looking at small, digestible opportunities for M&A.

Craig Arnold, the CEO of Eaton, announced that the company's long-term target is to increase profits by 25%. However, in the last quarter, their mature year wins have already increased by 145%. The company has a lot of flexibility and a low net leverage on the balance sheet, giving them room to explore new opportunities. The company intends to earn margin accretion by running their businesses better and eliminating waste and inefficiencies, rather than relying on pricing around commodities. Despite record profitability, there are still opportunities for improvement in operating efficiencies.

Craig Arnold explains that the $850 million in orders and the 20% of mega product starts cannot be reconciled because a start does not guarantee a bid or a win. He provides a win rate of 40% as an indication of future revenue. Steve Tusa asks about potential destocking in the stock and ship business, but Craig Arnold says that they are not seeing it due to strong supply and demand.

The speaker discusses how their company is experiencing similar trends to other businesses in terms of slowdown and destocking, but the strength in other areas such as systems and large projects is offsetting this weakness. They also mention weakness in Europe but anticipate a better year in the future.

The speaker discusses the increase in negotiations in the data center market, which has been driven by the rise of AI technology. While AI has received a lot of attention recently, it is not a new concept and has already been incorporated into the market. The speaker also mentions that hyperscale orders have increased by 61%, indicating a broader trend of more data and information requiring more data centers. The speaker also addresses the company's backlog, stating that orders have moderated in the Americas but the backlog has continued to grow. The speaker is uncertain if the company will start working through the backlog or if it will remain at current levels until 2024.

The company has experienced a moderation in demand and a significant backlog, which is a result of a high level of demand compared to their ability to meet it. They are working to increase capacity and expect the backlog to eventually turn negative, but it may take several quarters to return to historical levels.

The company is expecting to see a larger backlog due to its large business, but it also expects to start using up that backlog at some point. Some capacity investments have already been made, while others are still in the early phases. The company is committed to bringing on new capacity to serve its growing business and take market share. As for free cash flow, the company plans to reduce working capital and has other strategies in place to improve conversion in 2024.

The company had a good quarter with a 73% increase in operating cash flow and a 90% increase in free cash flow year-to-date. The improvement was due to higher earnings and better working capital. Last year, the company invested in customers and growth, but has since become more efficient with working capital. They are not satisfied with their current progress and see opportunities for further improvement in cash flow. In terms of organic revenue outlook, the company expects a 6-7% market growth with a 1% share increase, resulting in a 7-8% organic growth for the next year.

The speaker discusses the outlook for 2024, stating that the market outlook slides are consistent with their current view. They do not anticipate any major changes unless something unexpected happens in the world. The gap between products and systems on the electrical side is narrowing, but the company suggests that it is not the most effective way to think about their business. They have changed their reporting structure to focus on the end markets they serve, such as commercial and institutional, data centers, utilities, and residential. They sell both products and systems into these markets.

In this paragraph, the speaker discusses the company's framework for predicting market performance and explains the differences between their business in Europe and the US. They believe it is more helpful to model the company based on end markets rather than product or system distinctions. The speaker also addresses a question about backlog and states that they hope to reduce it during the course of 2024, but cannot definitively predict the level it will be at by the end of that year.

The speaker discusses the success of the company in shortening lead times and responding to customer demand, but states that predicting future numbers is difficult. They hope to reduce backlog, but it may be challenging due to the current market conditions. The speaker also mentions the company's efforts to digitize and collect data, which has led to new value propositions for monetizing their own data.

The speaker clarifies that the 16% CAGR forecast for the data center market through 2025 is for the overall market, not just for Eaton. They also specify that they are referring to the entire data center market, including on-prem enterprise data centers, not just a subset.

Craig Arnold, the CEO of Eaton Corporation, discusses the company's performance in the residential market. He explains that the company's growth rate of 16% reflects the overall market, and they expect to outperform the market. However, they have seen a slowdown in the residential market, particularly in Europe and China. Arnold notes that residential is not the company's biggest market, and they are seeing higher electrical content in new homes as they meet new standards.

The residential market has weakened, but the decline in units is offset by higher electrical content in new homes. The strength in other end markets is enough to offset the decline in residential. Year-to-date, the overall electrical sector is positive from a residential perspective. The eMobility 2025 target of 1.5 is a big step-up from the prior 1.2 and is expected to support revenue growth in 2025. The volume in the eMobility market tends to be chunky rather than linear.

The company expects to see steady growth in its eMobility segment after the launch of a new vehicle, but also anticipates a step function change in revenue when the program first launches. The company believes that the differences in growth between the U.S. and Europe can be attributed to economic differences and the weighting towards data centers and utilities in the U.S., rather than changes in market share. Mega projects and their scale are driving the differences in growth between the two regions.

The speaker discusses the differences in the company's presence in Europe and the Americas, with a stronger focus on industrial equipment in Europe and a broader range of solutions in the Americas. They also mention the impact of government stimulus spending on various industries. The speaker believes that the European government is committed to moving towards a low-carbon society, but there are challenges that may currently be hindering progress.

The speaker discusses the impact of the manufacturing segment on Europe's economy, noting that while some markets such as data centers are thriving, others are slowing down due to structural issues. They also mention that there is no anticipated slowdown in the aerospace market, despite a slight moderation in Q4. They are pleased with the market and expect long-term growth. The speaker also mentions that they are evaluating opportunities in mega projects and that win rates may not be as high due to the magnitude of the opportunities.

Craig Arnold, the speaker, discusses how Eaton's win rate is higher for bigger and more complex projects. He also mentions that there is a capacity constraint in the market and it is unlikely for a disruptor to change the dynamics. Eaton's capability and track record make them a reliable choice for these large projects.

The speaker discusses a large investment being made by the company, which will involve a mix of capital and expense. They do not plan to provide quarterly guidance on this investment, but it is expected to increase the company's CapEx spend by approximately 0.5%. The team will follow up with any additional questions.

The paragraph concludes a conference call, with Craig Arnold and Tom Okray thanking the operator and participants for their involvement and announcing the end of the call.

This summary was generated with AI and may contain some inaccuracies.