Ladies and gentlemen, thank you for standing by. Welcome to the Eaton Q4 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. If at any time during the conference you have a question, you may queue up by pressing one followed by zero. Should you require any operator assistance, please press star followed by zero. As a reminder, today's teleconference is being recorded. At this time, we'll turn the conference over to your host, Senior Vice President of Investor Relations, Mr. Yan Jin. Please go ahead.
Hey, good morning, everyone. I'm Yan Jin, Eaton Senior Vice President of Investor Relations. Thank you all for joining us today for Eaton's Q4 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 fourth quarter. As we have done on our past calls, we'll be taking questions at the end of Craig's comments. The press release from our earnings announcement this morning, and also 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, including reconciliation 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 including statements related to the expected future results of the company and are therefore forward-looking statements. Our actual results may differ materially from our projected future earnings due to a wide range of risks 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. We'll start with page three with recent highlights. Two weeks ago, as everybody knows, we announced the agreement to sell our Hydraulics business to Danfoss for $3.3 billion, which represents a 13.2 times 2019 EBITDA. This decision is part of the ongoing transformation of Eaton into a company with higher growth, with higher margins, and more consistent earnings. We're really pleased with that. We believe this transaction will create substantial value for our shareholders and allow our Hydraulics employees, importantly, to become part of a company that has a strong commitment to the hydraulics industry. Our team has made significant progress on other portfolio actions, including closing the acquisition of Souriau-Sunbank and the sale of our automotive fluid conveyance business at the end of the year.
The sale of our lighting business is expected to close in Q1. As you've read, we just announced the acquisition of Power Distribution, Inc. Power Distribution, Inc. is a $125 million company that serves the data center market and will become part of our Electrical Systems and Services business. Switching to our Q4 results, I'd summarize the quarter's performance as one with strong earnings, record margins, strong cash flow, despite slower than expected growth in our end markets. Organic revenue, excluding lighting and hydraulics, was down 2%. Earnings per share of $1.49 on a GAAP basis and $1.46, excluding $0.28 of acquisition and divestiture costs and $0.09 for costs we expect to incur related to vehicle warranty. At $1.46, our results were flat with last year and at the high end of our guidance range of $1.36 - $1.46.
Our sales of $5.2 billion were down 4% organically, with negative currency of a half percent offset by a half a percent from acquisitions. We continued to generate strong margins and delivered a Q4 record of 17.8%, excluding acquisition divesture costs and the expected vehicle warranty costs. These margins were above the high end of our guidance range and 40 basis points above prior year. We're also pleased with our operating cash flows, which were $937 million in the quarter. Stepping back, I'd say I think we'd all agree that it's been a busy and a very productive period for Eaton. Turning to page four, we summarize our Q4 financial performance, and I'll note just a few highlights on this page. First, we increased our adjusted segment operating margins by 40 basis points. Our team, I'd say here, executed well.
We had decremental margins of less than 10%. Our adjusted segment operating profits were $933 million, down 2% despite 4% lower organic sales. Net income of $452 million was down 28%, this was primarily due to acquisition divestiture costs of $114 million and vehicle warranty charges of $39 million. Both of these numbers, I would note, are on an APA tax basis. Similar to Q3, these strong results are, I think, a good indication of how we intend to manage the company during periods of market weakness, running our operations efficiently, proactively managing costs, and accelerating our share repurchases. Moving to page five, we'll start with our segment summaries with Electrical Products. Revenues were down 2%, excluding lighting, organic revenue increased 1%. Strength was driven by residential markets in the Americas, our distribution business in Canada.
Adjusted segment operating profits increased 9%, and adjusted operating margins were up 210 basis points to 20.3%, a Q4 record. The sale of our lighting business to Signify for $1.4 billion remains on track, and we expect to close in Q1. Excluding lighting, orders were down 2%, with strength in residential commercial construction markets in the Americas. This was really offset by industrial markets globally. Turning to page six, we show a summary of our Electrical Systems and Services segment. Revenues increased 4%, with 2% organic and 2% from the acquisition of Ulusoy and Innovative Switchgear Solutions. Organic growth was driven by strength in the North American utility and commercial construction markets, primarily. Adjusted segment operating profits increased 7%, with adjusted margins of 17.1%, up 50 basis points over prior year.
On a rolling 12-month basis, our Electrical Systems and Services orders increased 2.5%, with growth really across all regions of the world. Excluding hyperscale data centers, the 12-month rolling average of orders was up some 4%. Just yesterday, we announced the acquisition of Power Distribution, Inc., which is a leading supplier of mission-critical power distribution switching and power monitoring equipment for the data center market. Power Distribution, Inc. really builds on our strong position in the fast-growing data center market and adds new capabilities in the area of overhead busway and power distribution. We're really pleased with the prospects of what PDI will add to our Electrical Systems and Services business. Moving to page seven, we summarize our hydraulics results for Q4.
Revenues were down 13%, with orders down 11%. This is driven by continued weakness in global mobile equipment markets and de-stocking that continues at both OEM and also with our distributors. As I mentioned earlier, we're really pleased to have announced the agreement to sell the hydraulics business to Danfoss for $3.3 billion, and we expect this transaction to close at the end of the year. As we've announced, we are retaining our filtration and golf grip businesses. We expect cash taxes from the sale of hydraulics to be approximately $450 million. Our net proceeds will be approximately $2.85 billion. A number of you have asked how we intend to use proceeds, and I'd say that the options of additional acquisitions and share repurchase are both on the table for M&A. Would also add that our pipeline remains very active.
It's great to have this optionality as we look forward. On page 8, we summarize our results for our aerospace segment. Revenues were up 3%, including 2% organic and 1% from acquisitions. We experienced in this segment continued strength in commercial OEMs and also in commercial aftermarket. Orders on a rolling 12-month basis increased 6%, with particular strength in military and aftermarket and bizjet. Strong execution in this segment led to a 9% increase in adjusted segment operating profits and 130 basis point improvement in adjustment margins, which were 24.2%. Can I just say here that the business delivered another quarterly record, capping what's been a very strong year. We're also pleased to have closed the acquisition of Souriau in late December.
We've welcomed the Souriau team to Eaton. Our integration teams have already begun working to deliver the synergy plans, which includes the opportunity to take our new electrical connectors capabilities into our core electrical markets. Turning to page nine, we summarize our vehicle business for Q4. Revenues were down 19%. This includes 18% organic and 1% from currency. Declines here were due to a number of factors. The GM strike, Class 8 OEM orders. In fact, Class 8 production was down some 20% year-over-year, continued global weakness in light vehicle markets, which were down 9%. I say here, in a clear example of our grow the head and fix the tail strategy, which is really about how we really focus the company, we completed the sale of our automotive fluid conveyance business at the end of the year.
During the quarter, we also took a $50 million pre-tax charge for expected warranty costs. This charge is being undertaken to correct the performance of one of our products that incorporated a defective part from a supplier. We're actively looking for ways of recouping these costs as well. Adjusted operating margins were 17% at a very high level, but down 90 basis points from prior year. Next up on page 10, we summarize the results for our eMobility segment. Revenues were down 6%. Can I say here, while growth in electric vehicle platforms, this was more than offset by weakness in legacy internal combustion engine platforms. Operating margins declined to 1.3% due to a significant step-up in research and development, as well as manufacturing startup costs associated with electric vehicle programs here.
I would like to highlight that since the formation of this segment in the first quarter of 2018, the maturing year revenue from new wins is expected to be $450 million. This segment continues to run ahead of our own internal expectations. As you can imagine, we're pursuing a large number of additional programs as the industry continues to make the transition to electric vehicles. Before turning to 2020 guidance, I would like to take a minute just to summarize results of 2019, which are shown on page 11. First, we generated all-time record margins of 17.6%, which were up 80 basis points over 2018, excluding acquisition investor costs and the expected warranty costs. In fact, over the last three years, our segment margins have increased 260 basis points, which we see as a strong validation of our strategy.
Earnings per share of $5.76, excluding the one-time items I just mentioned, was up 7% over 2018. We set all-time records for both operating cash flow of $3.5 billion and free cash flow of $2.9 billion, with growth of 17% and 20% respectively. Our free cash flow to sale was 13.4%, our free cash flow and net income conversion was 129%. This continues to be a key strength for Eaton and something that you can expect from us in the future. As we noted, 2009 was a year of significant progress on our journey to transform Eaton into a company with higher growth, higher margins, and more earnings consistency. We closed three deals for $1.2 billion with Ulusoy Innovative Switchgear in Electrical and Souriau-Sunbank in Aerospace. We announced two divestitures, with Automotive Fluid Conveyance closed in 2019 and Lighting scheduled to close in Q1.
Our robust cash flow allowed us to return $2.2 billion to shareholders, including $1.2 billion of dividends and $1 billion in share repurchases. I would also note that we purchased these shares at an average price of $80 a share. Finally, it was a very good year for our shareholders, who had a 43% total return, 50 basis points over the median of our proxy peer. Overall, I'd say another record year, and I'm clearly very proud of what our team was able to deliver. Turning to page 12, we provide our revenue and margin guidance for 2020. Overall, we expect organic growth to be anywhere from -1% to 1%, with weakness in the first half and a bit stronger in the second half as a result of easier prior year comps.
Beginning with Electrical Products, we expect to see 1%-3% organic growth, with continued strength in residential and data center markets, flat commercial construction markets, and continued weakness in industrial markets. In Electrical Systems and Services, we anticipate 0%-2% organic growth with strength in utility markets, flat commercial construction, weakness in industrial facilities, and particularly in oil and gas markets. For Hydraulics, we're forecasting organic revenue declines of 4%-6%, driven by weakness in global mobile equipment markets. In Aerospace, we expect organic growth of 2%-4%, with continued strength in military OEM markets, solid aftermarket growth for both commercial and military markets, partially offset by expected weakness in commercial OEM markets.
For Vehicle, we see organic revenue declines of 7%-9%. This is mostly due to the 33% decline that we're forecasting in NAFTA Class 8 truck markets, also some weakness in global light vehicle markets as well. For eMobility, organic growth is expected to be up 3%-5%. We're seeing double-digit growth for our electrical vehicles markets, offset by some modest declines in internal combustion engine platforms. Now turning to segment operating margins. In operating margins for Eaton, we expect Eaton to be 17.8%-18.2%, at the midpoint a 40 basis points improvement from 2019. In taking a look at our segments, Electrical Products we think will be 21.2%-21.8%. At the midpoint, 180 basis point improvement from 2019. This is primarily a result of the lighting divestiture.
For Electrical Systems and Services, we're forecasting 16.4%-17%, up 10 basis points at the midpoint. Hydraulics at 11.7%-12.3%, up 80 basis points at the midpoint. Aerospace at 22.9%-23.5%, down some 110 basis points. This is largely due to the acquisition of Souriau. Vehicle, we expect to be between 15.7% and 16.3%, down 80 basis points, largely as a result of lower volumes. eMobility at 2.5%-3% as we continue to invest heavily in R&D and startup costs in new manufacturing capabilities. On page three, we pick up-- page 13, excuse me, we pick up the balance of our 2020 guidance. Here I'd say, we expect full year adjusted EPS to be between $5.60 and $5.90. At the midpoint of $5.75, this is essentially flat with 2019 when you exclude the one-time items noted on previous slides.
Organic growth is expected to be essentially down 1% to up 1%, with acquisitions adding 2% and divestitures negatively impacting sales by 7.5%. We expect our corporate costs, including pension interests and other corporate costs, to be flat with 2019 levels, and our tax rate to be between 14.8% and 15.8%. Operating cash flow is expected to be between $3.4 billion and $3.6 billion, and CapEx of approximately $550 million. With strong cash flow plus the proceeds from the lighting sale, which we think will be $1.4 billion, we plan to significantly increase our share repurchases. At this point, we expect to spend between $2.4 billion and $2.8 billion in share repurchases. If I can just summarize our Q1 guidance, we expect EPS to be between $1.16 and $1.26. We expect organic revenues to be down 3%, 2% from acquisitions, and 3% from divestitures.
Segment margins are expected to be between 15.8%-16.2%, and our tax rate should be between 15%-16%. Overall, I'd say, we expect really, another solid year in 2020 with strong margins in cash flow. We have a lot of confidence in the Eaton Business System and our ability to continue to execute strongly. We think the changes that we've made and announced will position Eaton for higher growth and higher margins and better earnings consistency as we go forward. With our strong cash flow and proceeds from the hydraulics sale, we have outstanding optionality as we think through the best approach to create additional shareholder value. With that, I'll stop there and turn it back over to Yan for questions.
Hey, thanks, Craig. Before we begin the Q&A section of our call today, I see that we have a number of individuals in the queue with questions. Given our time constraint of an hour, please limit your opportunity to just one question and a follow-up. Thanks in advance for your cooperation. With that, I will turn it over to the operator to give you guys the instruction.
Thank you very much. Ladies and gentlemen, if you wish to ask a question, please press one then zero on your telephone keypad. You may withdraw the question at any time by repeating the one-zero command. If you are using a speakerphone, please pick up the handset before pressing the numbers. Again, if you have questions, you may press one followed by zero at this time. Our first question will come from Jeffrey Sprague with Vertical Research Partners. Please go ahead.
Hey, Jeff.
Solid. Hey, two things from me. First, on hydraulics. Given just kind of the slippery slope that the end markets are on, certainly great to see it go at that valuation. Are you guys subject to any kind of holdback or performance that could affect kind of the ultimate price that you receive for the asset?
Yeah. No, Jeff, we're not. I think we actually posted our documents, that information is certainly available for public consumption. The $3.3 billion number is firm, we fully expect to close, as Danfoss has also agreed, to take whatever remedies would be required in order to ensure that the transaction closes.
Great. Just a guidance question, too. I was just wondering on ESS specifically, 0-2, does that sort of imply you're going to be up a bit in the H1 and then down in H2 , or how do you see that really playing out relative to what's going on in your backlog?
Yeah, I think we see it up almost, Jeff, just the opposite of that. Given what we've seen, certainly in our order intake and negotiations, we think that the back half of the year will be slightly stronger than the first half of the year. As we take a look at what we're experiencing today, one of the reasons why we guided to our overall revenues being down 3% in Q1. We do think that the back half of the year will be slightly stronger. A lot of that, I'd say quite frankly, is a function of easier comps when you look at the year-over-year comparisons.
Right.
From an EPS standpoint, we're really pretty much well-balanced in terms of what we've been historically, where some 47% of our EPS is generated in H1 of the year and 53% in H2 . That's very much consistent with our guidance this year as well.
Great. Thanks for the color.
Thank you very much. Our next question in queue, that will come from Joe Ritchie with Goldman Sachs. Please go ahead.
Good morning, everyone.
Hi.
Craig, maybe just kind of starting off on hydraulics and congratulations there. Obviously, I guess, as you think about the pipeline, you mentioned very active. I'd love to hear how you're thinking about potential prioritization of acquisitions. Then also, you've been very active from a divestiture standpoint. Are we done at this point?
Yeah, appreciate the comment, Joe. As I mentioned in my opening commentary, we think it's an outstanding outcome for all parties. We think it's great for Eaton and our shareholders. We think it's outstanding for our employees and great for Danfoss as well. I'd say, the priorities for us really haven't changed. What we've said historically is that our priorities from an M&A perspective continue to be growing our electrical business, aerospace, and also selectively, we're looking at things that we could potentially do in this new space for us called eMobility. Those priorities really have not changed. As I mentioned in my commentary, we are seeing today kind of a more active pipeline than we've seen historically. As we think about the optionality of what we do with that cash, certainly, M&A is an option, buying back shares is an option.
We're very much comfortable with where we sit in terms of making sure that we maximize shareholder value as we think about how we deploy those proceeds that will come in. With respect to portfolio, we like where we sit. At this point, you think about the remaining parts of our company, and I know there's been a lot of speculation about vehicles. I'll go ahead and address that right up front. We like our vehicle business. It delivers extraordinary margins, and they tend to be at the very top of their industry with respect to returns. The business today, given what we've done today with our joint venture in Cummins, will be a lot less cyclical as we go forward.
It certainly helps us as the whole world moves towards this more electric outcome to getting the volume and scale that we need to really drive dividends across the organization. Yeah, we absolutely like our portfolio and where we sit today.
That's helpful. Just one quick one on Aero. I don't recall you guys having much exposure to the Max, can you maybe just talk about that specifically as it relates to your guidance? Also, how you think about margins in the Aero segment as well in 2020, just given the strength in 2019.
I think, the Max is an important program for Eaton as well. I think anybody in the aerospace industry, I'd say the Max is going to be an important program for them. Our content tied to the Max at the OEM level is order of magnitude, just north of $100 million. What we've done as a part of the aerospace forecast and our guidance is, we've essentially taken what Boeing has given us, in terms of their current build schedule, and that's what's reflected in our aerospace guidance. One of the reasons why we're not seeing more robust growth in our aerospace business in 2020 is clearly the impact of the Max. I will tell you, as you think about the margin implications for the Max, what you typically trade off, with OEM volume is aftermarket volume.
We think from a margin perspective, independent of what happens with the Max, we think the margins will be just fine. We think it will be just fine from an EPS standpoint, but it could have certainly an impact on revenue. Our aerospace margins, as we provided guidance, 2019 was a record year, with really extraordinary improvement in our margins. The margins will be down slightly in 2020, and this, as we mentioned, was largely a function of the acquisition of Souriau. Also, we were running at very frothy levels in 2019 in terms of the margins of the businesses. We think the guidance that we provided for 2020 are very much in line with where we think the business should be.
Thank you.
Thank you. Our next question that will come from John Walsh with Credit Suisse. Please go ahead.
Hi. Good morning.
Morning.
Congrats on hydraulics. I like everyone's comments. Can you help us, or can you tell us what the exiting share count was, and then how we should be thinking about the cadence of the repurchases through 2020?
Yeah, I'll address that. The total share count for Q4 was 415 million. It was not very different right at the end of the year. In terms of repurchases, we are going to do as we've done in the past. We decided against doing an accelerated repurchase. We're going to execute the transactions on our own. We do have the ability to buy about $70 million worth a day based on the safe harbor, so we can make significant moves fairly quickly. We will be executing those repurchases as we deem it most effective for our shareholders, obviously taking into account market conditions.
Great. Thank you. Then, as we think about the EP orders ex lighting down too, can you maybe help parse that out between end market and if you're still seeing any kind of de-stocking at your distributor partners?
Yeah, appreciate the question. If we think about markets, as we provided a little bit of color on it, we think today that we still see growth in non-res construction. We did mention the fact that commercial construction, we think, is flat. We think industrial controls will be down. Residential continues to be up nicely, we think mid-single digit. The IT piece of data centers, which is reported through Electrical Products, we think will also be up low single digit. We think on balance, these markets continue to kind of bounce around the low kind of single-digit growth kind of neighborhood. We're hopeful once again that, as some of this uncertainty continues to ebb away as it relates to trade, as it relates to the North America Trade Agreement, that that continues to buoy confidence in our customers in general.
I think in general, distribution is fine. Distribution certainly in Q4 held in there, and our distributors are generally pretty positive around 2020. We think distribution continues to be a strong point as well.
Great. I'll pass it along. Thank you.
Thank you. Our next question in queue will come from Nigel Coe with Wolfe Research. Please go ahead.
Thanks. Good morning, guys.
Hi, Nigel.
Obviously, there's a lot of moving pieces on the portfolio. Just to be clear, given the buyback you got in place for 2020, does that offset the dilution completely From lighting, but you still have some dilution obviously coming in the first half of the year. Rick, on the tax rate, does the portfolio moves have any significant impact on the tax rate, both ex lighting, but also ex hydraulics?
Yeah, I can answer both those questions. Yes, the buyback does offset the dilution. That's why we're able to keep earning EPS flat between the years. The tax rate we don't think will be changed from these portfolio actions. We still think it'll be between 14% and 16%.
Okay, great. My follow-up question is regarding distributor consolidation. Obviously, WESCO is an important channel partner for Eaton. How does few of our larger distributor partners impact your business the way you go to market?
I think it's obviously a question of which distributor combinations we're talking about. As it relates to WESCO's acquisition of Anixter, which is maybe the one that's prompted the question, we think that's an outstanding combination for Eaton and our relationship with WESCO as we go forward. So we think that one is really positive for Eaton. We have a very strong relationship with WESCO, as you know, and we have a very strong relationship with Anixter. So we think that combination bodes extremely well for our future together and certainly is positive for Eaton.
Great. Thanks, guys.
Thank you very much. The next question in queue will come from Scott Davis with Melius Research. Please go ahead.
Hi. Good morning, guys.
Hi, Scott.
A lot of good questions have been asked already, but I would love to hear your view, Craig, as you walk around the world, what markets you think are going to be, or what geographies, I guess, more specifically, are going to be better or worse than perhaps 2019 run rate?
Yeah. I appreciate the question, and I think in many ways, Scott, that is the $64,000 question in terms of what the future economic outlook looks like. I'd say if you'd asked me that question maybe three weeks ago, before the coronavirus, I would say China for sure. I mean, clearly we saw a much stronger Q4 in China, and that economy had continued to strengthen. We'll see what the coronavirus does in terms of the impact on China, really the impact that it has around the world. We clearly see somewhat slowing growth in the U.S., but there are certainly pockets of strength. Residential markets continue to be quite strong. Data center markets continue to be strong. Utility markets continue to be strong. We think South America will have a better year than they had in 2019 as they work through some of their historical issues.
We're clearly seeing some strengthening in South America. We think Europe slows a bit overall. We think India had a really tough year in 2019. We think India is better as well. If you think about a lot of the emerging markets around the world, but we think they generally have better years in 2020 than they did in 2019.
Okay. Helpful. The one thing that, I know eMobility is small, but what are you thinking over the next kind of three years we should be tracking and caring more about? Is it the backlog that you're building in the business? Would you start to get a sell-through in 2021 that's meaningful, that segment starts to move the needle with some sort of margin attached to it? Just a sense of, is this a five-year out, three-year out, or start to see progress kind of year and change from now?
Yeah, appreciate the question, Scott. It's one that we get from others as well. We'd say that the real inflection point for eMobility will be around 2022. A lot of these new electric vehicle platforms will launch in 2021. We think it's really 2022 before you get to the point where you start to see revenues that have a meaningful impact on our eMobility segment and for Eaton overall. As you think about the underlying assumption and what's going on in electrification in general, we think the story around electrification is obviously much bigger than what's going on in eMobility and passengers cars as we think about the more electric everything. Homes are becoming more electrified, commercial facilities, planes, trains, everything is becoming more electric.
One of the real advantages we think we have with respect to our eMobility segment is that anytime you're dealing with automotive kinds of scales, you're now also creating real advantages that you can then take back into your core business as well. We think there's a much bigger story and a much bigger play for Eaton as we think about how we play in eMobility than just what happens in the light vehicle market.
Okay, perfect. Thank you. Good luck, guys.
Thank you.
Thank you. Our next question will come from Nicole DeBlase with Deutsche Bank. Please go ahead.
Yeah, thanks. Good morning, guys.
Hi.
Good morning, Nicole.
I just want to start with a clarification. I'm pretty 99% sure this is the way you guys are doing your guidance, but lighting is excluded beginning in the first day of Q2 . Is that correct?
We actually have put it in for two months, sort of the middle of Q1 .
Okay, that's helpful. Thanks, Richard H. Fearon. When we think about rolling forward the calendar on free cash flow after you guys complete the hydraulics sale, would that create a major change in your free cash flow relative to how you guys have guided for 2020?
First of all, we expect the sale to conclude at the end of the year, so it shouldn't have really any impact on 2020.
Right. I'm thinking about framing 2021 free cash flow.
Yeah. What I'd say, Nicole, with respect to Hydraulics, I think what you'll see from the company in general, post-Hydraulics, is a company that will deliver, once again, more consistent free cash flow as a function of that industry in general. The cash flows in Hydraulics are about as volatile as the industry itself. I think what you'll see from Eaton, post the divestiture of Hydraulics, is a company that delivers, once again, very strong free cash flow, and you'll see a lot more consistency overall.
Got it. That's fair. Thanks, Craig. I'll pass it on.
Thank you.
Thank you. The next question in queue, that will come from David Raso with Evercore ISI. Please go ahead.
Hi, good morning.
Hi.
Just want to make sure I have the math correct backing out Lighting and looking at the Electrical Products margin improvement. The guidance shows 180 basis points, it depends exactly the revenues for the 10 months that you won't have Lighting. I'm using about $1.4 billion or so. I know we don't have the exact margin on Lighting, obviously it was below the segment average. I'm just trying to back into what is the margin improvement, just excluding Lighting from 10 months? I'm getting as much as 140 basis points, 130 basis points, that leaves the kind of legacy Electrical Products not really having to expand margins much to hit the target.
Yeah, I think that's a fair way of thinking about it, Dave. Something just north of 100 basis points of improvement from Lighting and some underlying improvement in the business is the right way to think about it.
That said, if the margins are, let's say, run rating close to 21%, just getting rid of Lighting, I know 2% organic is not that robust, but still the margin improvement's a bit modest, at least relative to your recent performance. Is there something within Electrical, mix, price, cost, whatever it may be, that's not allowing a little more expansion versus recent history?
I'd say that we certainly had a very strong year in 2019 and posted very strong margin improvement. At this point as we look at the year, we think this is the best way to think about the segment for the year. Could we be a little better than that? We hope so. At this point, we think this is the right way to think about the segment and the appropriate guidance.
I might have missed this, I apologize. The assets that are left in Hydraulics after the sale, are those potential opportunities for further sales during the course of this year, or is it all just TBD for right now?
Yeah. If you think about what's remaining, and we did disclose a bit kind of in the context of the Hydraulics close, these are really attractive businesses that have great positions in their respective industries. We like those assets, and we intend to retain them.
Okay. Thank you very much. I appreciate it.
Thank you. The next question will come from Julian Mitchell with Barclays. Please go ahead.
Hi. Good morning.
Hi.
Maybe just the first question around the data center market. Heard that the outlook's pretty good in the EP side. Wondered if there was any nuance or difference within ESS. Really the reason I ask is that the commentary, perhaps as always from different people, is mixed. Some of the internet service providers sound fairly optimistic. Some of the equipment suppliers like Regal or Cummins talked about push-outs in data center activity this morning. Just wondered what your core assumption was for that market for this year and the medium term.
Yeah, Julian, we appreciate the question. Not surprising, by the way, that you do hear commentary around the segment that in some cases could be in conflict, depending upon where every supplier is in the timing of some of these large projects and where you are in terms of your exposure to hyperscale and other pieces of the market. I'd say for us, we do think that data center market, based upon everything that we've seen, grows kind of low single digit in 2020, which given kind of some of the underlying trends around data generation consumption, is a relatively modest number. We did in fact see a better second half of the year in hyperscale specifically, and data centers continue to be a growth segment for us overall.
I'd say that no, Electrical Systems and Services, which as you know, and more the three-phase that we report as a part of ES&S and more the single phase that we report in Electrical Products, but we think that data centers largely as a category continues to be a very attractive category. It will be lumpy. There will be periods of time when you see extraordinary growth, and there'll be periods of time when some of the hyperscale guys essentially take time out to absorb kind of what they've actually done and will pause in their purchases.
Thank you, Craig. A second question for you, maybe a slightly broader one. You've certainly surprised me with the success on the margin ramp the last couple of years. It's really been extraordinary. Just wondered if you were at all worried that that focus on the cost out hurts the organic growth profile of Eaton at all, and how satisfied you are with that. If we look at the last five years or last 10 years, the organic sales CAGR is about 1% company-wide. Do you think that the company is now poised for that to move higher in the medium term?
Yeah. Maybe I'll deal with the margin question first, Julian, because I will tell you that if you think about where the margin expansion has come from inside of our company, it really has been essentially around eliminating operational inefficiencies in our company. We've not in any way sacrificed growth opportunities for the sake of margin. I think it's really around a lot of the portfolio work that we're doing. As we talk about what is it that drives the margin expansion at Eaton, we talked about running our factories more efficiently, we talked about leveraging our scale, and we talked about also where we focus this idea of grow the head and shrink the tail. Those are the things that we've been doing as a company to accelerate margin expansion, and quite frankly, we're not done. There's more opportunities there.
On the organic growth front, I'd say, we too have not been pleased with our organic growth. It's one of the reasons why we really set that as the number one priority for the organization, and we've been investing heavily in organic growth inside of our organization. We think that organic growth, relative to the markets that we've in, we think we've been fine. In fact, overall public data that we get says that we've actually gained a little share in many of our businesses, but we need to do better than that. That continues to be the number one priority for the organization to drive organic growth.
That's very helpful. Thank you.
Thank you. The next question in queue that will come from Andrew Casey with Wells Fargo Securities. Please go ahead.
Thanks a lot. Good morning, everybody.
Morning, Andrew.
Within ESS, ex the hyperscale data centers that you just went through, in the past, I think you talked about some project deferral in them. Incorporating H1 , H2 directional comments, I understand those, but are you seeing any thaw in the uncertainty-driven project deferral at this point?
Yeah. I'd say, Andrew, maybe not really. We continue to see, I'd say, projects deferred. I'd say that the rate has not escalated from what we've seen in prior quarters, but there remains a fair amount of uncertainty around the global economy. So I think, to the extent that we're dealing in this uncertain environment, whether it's trade or most recently the coronavirus, Brexit, there's been a whole host of geopolitical events that have caused many of our customers in and around large projects specifically to wait and see a bit, and that continues to be the case, but not necessarily at an increasing rate. More like in line with what we've seen during the course of much of H2 of 2019.
Okay. Thanks, Craig. Secondly, on potential acquisition opportunities. Can you talk about whether the pipeline is full at this point and, relative to what you saw maybe last year, are the valuations becoming any more attractive?
Yeah. I'd say the pipeline is certainly more active than we've seen a year ago, and our teams are busy working through a number of potential opportunities. I think with respect to valuations, I'd say that not really. Valuations, I think, for the most part, continue to be quite sporty, and what we commit to you is that we will maintain our discipline. We have a very clear view on what our cost of capital is and what our expected returns are, and so we will make sure that as we think about deploying our ample free cash flow, that we're smart in the way we do it, and we continue to be very comfortable with the option of buying back stock.
Okay. Thank you very much.
Thank you. The next question in queue will come from Josh Pokrzywinski with Morgan Stanley. Please go ahead.
Hey, good morning, guys.
Hi.
Hey, Craig, just a question for you on EP. One of your competitors this morning had some tariff exemption that helped out their electrical business and got a bit of a clawback going into even 2018. Anything that you guys qualified for in the EP portfolio and any benefit that was recognized?
No, not at all. There was no one-time benefits. We'd be interested to know what that was, and we'll find out who that was and see if we missed something. No, there were no one-time benefits associated with tariff exemptions in our EP results at all.
Josh, as we've commented that we produce in region for region, so we don't have large shipments coming out of China into other parts of the world. It wouldn't be something where there would be a big opportunity for us.
Got it. That's helpful. Just to follow up on the acquisition pipeline. I think you guys have been very clear on your role in the data center kind of being end-to-end on electrical and not really wanting to stray too far from that. I guess, Craig, are there any gaps in that, or are there other pieces that you could add on to, either on the front end or closer to the rack? As this market has evolved, are you seeing other product sets within the data center that just given the attractiveness of the end market start to look more interesting to you as you build out the portfolio? Thanks.
Josh, appreciate the question. I'd say on the margin, we have a great portfolio today that we offer and sell into data centers from all the power distribution equipment to the power quality equipment. We think this acquisition of PDI, by the way, as we mentioned, $125 million business that goes into the data center market, is very much about filling a product portfolio, and also, in this case, giving us better access to the co-located, the colo operators of data centers. On the margins, there are some minor things that we can do and we'll continue to look at, but by and large, we think our position in data centers is very well situated and no big gaps at all.
All right. Thanks, Craig.
Thank you very much. The next question in queue that will come from Christopher Glynn with Oppenheimer. Please go ahead.
Thanks. Good morning, and congrats on an excellent 2019.
Thank you.
Thanks.
Just want to kind of hit on Jeff's question about the ESS splits, transferring that to vehicle on the down 8% organic. Want to make sure we get the magnitude in the first half right, wondering how you're seeing that linearity.
I'm sorry. The transferring it to vehicle.
Yeah, Sorry, just the same question.
The H1 , H2 .
Okay. I'd say that, if you think about our guidance with respect to revenue, we do think that H2 of the year will be a bit stronger on a V basis versus the H1 I would say, but most of that, I would say, is really more function of the comps and the comparables year-over-year. If you take a look at H2 of 2019 was clearly a much weaker period of time for us than H1 . I think it's really a function of the comparables more than it is we're anticipating anything dramatically different in terms of the seasonality that we historically see in our business with respect to our own revenue growth.
Okay. On the eMobility comments, you made a couple of quarters in a row now about being ahead of plan. I'm wondering if you're seeing that in terms of the pace of design cycles or your win rates?
I think there's probably a little bit of both, but on that one, in terms of I think that every major automotive OEM around the world and commercial vehicle customer around the world, everybody today has an initiative around electrification of their fleet, and that has certainly gained momentum, and we've been a benefactor of that. At the same time, our team has done an extraordinary job from a standing start, really building a whole broad range of product capabilities that have enabled us to really be an effective alternative and a viable alternative in this particular space. I think it's really been a combination.
Thank you.
Thank you very much. The next question in queue will come from Markus Mittermaier with UBS. Please go ahead.
Improvements over the years. You've been closing the gap to a large extent across the electrical businesses to some of your global peers, particularly if you look at the European low voltage players. How should we think about this going forward? Is there any structural reasons why these margins shouldn't align to where some of your peers are? It's already mentioned that if I take out sort of the lighting impacts in EP, ex lighting, you're basically already at the margin levels that you're guiding for. How should we structurally think about this? Maybe not into 2020, but sort of medium term, how much upside is there to closing that gap to the peers fully?
Yeah, I guess, Markus, the first thing I would say with respect to our electrical business, I'd say we don't believe there is a gap. In fact, we think today, when you take a look at our electrical business relative to most of our peers, that our margins are actually as good as or better than most of them. You got to really think about it in the context, I'm not sure which companies you're referring to, but our Electrical Products business, for example, which is largely a components business that goes to distribution. Those margins, we think compare very favorably to the industry overall. In Electrical Systems and Services, I'd say once again, that business performs very favorably. I think you got to really think about the peers in the context of we play across the whole spectrum of electrical.
Some of the peers that maybe you're referencing tend to be more niche. Maybe they're an Electrical Products business only, or they're a components business only. When you look at in aggregate against our primary peers, the ones who play across the whole spectrum in electrical, I would argue that our margins are as good or better than almost any of our competitors. By the way, I would acknowledge, though, that we're not done. We think we have opportunity that remains to continue to expand margins, that's clearly what we expect to do. We'll, as a part of our investor meeting in the first week of March, we'll provide some guidance around what we think the future outlook looks like.
Sure. Great. That's very helpful. Then just briefly as a follow-up on aviation, aftermarket OE, what was that split in Q4 and what's embedded in the guide for 2020 here?
Yeah. I'd say you can think about our business as 60-40, 60% OE, 40% after market. Those numbers vary slightly depending upon what quarter you're talking about or what year you're talking about. Kind of the long-term view, a 60-40 split is generally where we're at.
Great. Thank you very much.
Thank you.
Thank you. The next question will come from Mig Dobre with Baird. Please go ahead.
Yes, good morning. Thanks for squeezing me in, congrats on a good 2019. I wanted to go back to ESS as well and maybe ask a couple of things. On Power Distribution, can you give us some color on the margin for that business? Then how do you think about the cadence of the segment's margin through the year, given that you've got some pretty difficult comps on incrementals in Q2 and Q3?
Yeah. Our power distribution margins inside of Electrical Systems and Services, I'd say, are largely in line with the segment overall. So I don't know that we see significant differences in the margins in power distribution assemblies overall, though obviously, projects can impact that perhaps a little bit more than some of the other parts of the business. In terms of cadence, this business always tends to be a little bit back-end loaded. If you think about the company split of revenue first half, second half, Electrical Systems and Services always tends to be a little bit of a back-end loaded business. As a result, you get higher volume and higher margins in the second half of the year. I think that's just very much consistent with what we've seen from this business over a very long period of time.
Yeah. Craig, just to clarify, I was talking about the acquisition, the Power Distribution acquisition.
Oh, PDI. Okay.
Yeah.
Yeah. PDI's margins, I would say today, are below the average for Electrical Systems and Services. We like the business. We like the space. We think we have an opportunity to clearly expand margins. They do come into the company at slightly below the margins of the segment overall.
We'll make some improvement in terms of synergies this year, but probably more so in 2021 in PDI.
Sure. Lastly, on hydraulics, just looking at your margin guidance for 2020 and kind of comparing it to what we've seen exiting 2019, how do you think about the drivers for margin expansion here, what's different going forward than what we've seen in 2019? Thank you.
Yeah. I think the answer on hydraulics, we've spent a lot of time over the last couple of years talking about the level of inefficiencies that we were driving in the hydraulics business as we dealt with this pretty significant market ramp in the midst of perhaps the biggest restructuring program in the history of the business. As I mentioned in prior calls, we were kind of caught in the middle of doing this massive restructuring and movement of parts and pieces when the industry ramped, and we had a lot of inefficiencies that were in the business as we were halfway complete in terms of many of these restructuring programs.
As we think about 2020 and where the improvement comes from, it's largely a function of getting these things completed and behind us, and we're very confident in our ability to deliver the margin guidance that we've laid out for hydraulics.
Great. Thank you.
Thank you very much. The next question that will come from Deane Dray with RBC Capital Markets. Please go ahead.
Thank you. Good morning, everyone.
Morning, Deane.
Hey, just got a couple quick ones here. First, when I look at the 2020 guidance, the organic revenue growth of -1% to +1% seems a bit tighter than I would have expected, just given the macro uncertainty. Maybe some reflect on that if you could? Is there any impact now with the recast portfolio, better earnings consistency? Does that reduce some of the cyclicality, and might that explain some of the tighter range?
I think the first thing, Deane, to your point, we agree it's a fairly tight range, and we could've said approximately flat. There always is a fair amount of uncertainty in general in these businesses, I'd say I wouldn't overread, at least for 2020, the fact that the range is -1 to +1, other than to say that we think our markets are going to be approximately flat for the year is the right way to think about that, Deane. To your point, lots of uncertainty. We'll see how the year unfolds, but that's really where we've landed at as an organization.
Yeah, I do think to your point, though, as we go forward, once we get beyond 2020 into 2021 and we get hydraulics divested, there's no question that there'll be a lot more earnings and revenue consistency inside of the organization when you go forward. It's very much consistent with the strategy that we laid out around deriving better consistency of earnings. Hydraulics will help tremendously in that regard.
Great.
I wouldn't overread the minus one to plus one.
Good. I promise not to overread. Just a last question would be, it's interesting how many questions you've had today on data center, obviously some of it from Network Power acquisition. What do you make of the new ownership of the former Emerson Network Power, and does that change in any way expectations about some of the competitive dynamics, maybe some more price competition? Be interested in your thoughts there.
No. I'd say appreciate the question, Deane. I know Dave Cote well. I used to work for him, by the way. I can imagine that he will certainly bring some strong leadership to that business. No, we'd say we love our position in data centers. Today, if you think about where we play, first of all, we don't overlap completely with Vertiv. We play in many cases, different parts of the market than they do. We think we're clearly number one or number two in the world, depending upon where you're at in data centers. We like our strategic position there. We think at the end of the day, competition is good. It'll make us all better. We like our position in data centers, and we think we're well-positioned. We think we continue to do extraordinarily well in that market.
No, we don't think it changes the competitive dynamic at all.
Thank you.
Good. Thank you all. We have reached to the end of the call, and we do appreciate everybody's question. As always, Chip and I will be available to follow up. Thank you all for joining us today.
Thank you very much. Ladies and gentlemen, that does conclude your conference call for today. We do thank you for your participation and for using AT&T's conferencing service. You may now disconnect.