Ladies and gentlemen, thank you for standing by. Welcome to the Eaton first quarter earnings call. For the conference, all the participant lines are in a listen-only mode. There will be an opportunity for your questions. Instructions will be given at that time. If you need any assistance during the call, please press star then zero, an operator will assist you offline. As a reminder, today's call is being recorded. I'll turn the call now over to Mr. Don Bullock, Senior Vice President of Investor Relations. Please go ahead, sir.
Good morning. I'm Don Bullock, Eaton's Senior Vice President of Investor Relations. Thank you for joining us today for Eaton's first quarter 2018 earnings call. With me today, as usual, are Craig Arnold, our Chairman and CEO, and Richard Fearon, our Vice Chairman and Chief Financial and Planning Officer. Our agenda today includes opening remarks by Craig highlighting the company's performance in the first quarter, along with our outlook for 2018. As we've done on our past calls, we'll be taking questions at the end of Craig's comments. The press release from our earnings announcement this morning and the presentations are posted on our website at www.eaton.com. Please note that the press release and presentation include reconciliations to non-GAAP measures. A webcast of the call will be accessible on our website and will be available for replay.
Before I get started, I do want to remind you that our comments today will include some statements on expected future results of the company and therefore are forward-looking statements. The actual results may differ from those from our forecasted projections due a whole wide range of risk and uncertainties that are described in both the earnings release and the presentation, and they're also outlined in our 10-K. With that, I'll turn it over to Craig to go through the presentation.
Okay, thanks, Don. Appreciate it. Before I dive into the Q1 results this morning, I thought I'd take a moment to just reiterate three key elements of the strategy that we've been working on as a company and how we're focusing on growing the company, expanding margins, and really effectively allocating capital. First, our organic growth initiative really is focused on new technology, how we're leveraging our channel and service capabilities, creating products that play across the entire spectrum of our customers' requirements, what we call delivering superior value. Next, we intend to continue to expand our margins by restructuring to eliminate fixed costs, to drive operational improvements across our plants and functions, and we're being more selective in where we invest, what we call fixing the tail and growing the head. Finally, we continue to be good stewards of capital.
By investing in our existing businesses, playing to win in every business that we're in, returning cash to shareholders through dividends and share buyback, and being disciplined in our approach to M&A. By consistently doing these three things well, we believe we'll drive superior value for our shareholders, both in the short term and over the long term. We made solid progress in Q1. A few examples that we've noted on page four, we launched our new eMobility segment, targeted at growth in electric vehicles, a $2 billion-$4 billion opportunity for Eaton, we're clearly working this opportunity with 30-plus pursuits that we're working on as we speak. We'll certainly talk about this more later in the presentation. We continue to make progress towards our goal of digitally enabling our product portfolio, including addressing the necessary infrastructure needed to ensure industry approvals and needed security protocols.
We launched a new microgrid initiative in Africa, combining our expertise in microgrid management with energy storage. We also had a very successful quarter growing our penetration in hyperscale data centers with over $60 million of new wins in the quarter. We launched a new Power Xpert circuit breaker product line for the harsh, hazardous, and corrosive circuit protection market, a market that we believe is $500 million in size and a new opportunity for us to serve it. Lastly, we continue to execute on our ongoing restructuring actions and completed three site closures in the quarter. While not an exhaustive list, we thought it would be helpful to provide a few notable examples of progress that we're making towards our strategy.
Turning to our financial results for Q1 on page five, I'll just add a bit of color to what you've already seen in our reported results. Earnings per share were $1.10, up 15% over Q1 2017, and at the high end of our guidance range of $1-$1.10. Our results were primarily driven by strong revenues, up 8% over Q1. This was driven by 6% organic growth, the highest growth that we reported since Q4 2011. Foreign exchange added 3% or approximately $150 million to reported revenues. We had expected $150 million of Forex for the entire year, certainly, a strong start there as well. Booking strength continued in the quarter with notable growth in Hydraulics and another quarter of strength in Electrical Systems and Services. Our operating cash flow in the quarter was $339 million.
If you recall, Q1 is typically our weakest quarter of cash flow generation. In addition, we're adding working capital to support higher growth in the quarter and a stronger outlook for the year. We repurchased $300 million of our shares in the quarter and are on track to repurchase $800 million in shares for the full year. Finally, we increased our dividend by 10%. This is consistent with our long-term goal of growing our dividend in line with our long-term earnings. Turning to page six, we show a summary of the income statement for the quarter. Here, I point out that our 8% or the growth was made up of 6% organic, 3% FX, offset by a negative 1% due to the divestiture in Electrical Systems and Services and the formation of the Eaton Cummins joint venture last year.
Margins were 15.2%, 80 basis points above prior year, and a Q1 record. We think a good indication that our restructuring plans are paying off. Consistent with our plans, our incremental margins on organic growth were approximately 30% in the quarter, and we remain confident in our ability to achieve 40% incrementals for the full year. We did see good volume leverage in the quarter, generating 12% net income growth on 6% organic growth, and we expect this relationship to improve as the year unfolds. Moving into the segments, I will begin with Electrical Products. Our revenues were up 5%, with 1% organic growth. Sales in this segment were impacted by our lighting business, which was down approximately 10% in the quarter. Excluding the impact of lighting, organic growth in the segment was 6%. Strong growth excluding lighting. Maybe just a word on the lighting weakness.
The weakness was driven primarily by what you've seen reported, weak markets. There were also a number of large projects in last year's results, and management's decisions, quite frankly, not to chase some unattractive projects during the quarter. We do expect lighting to have a relatively better next three quarters, and consistent with our prior guidance, we think the business will be down mid-single digits for the year. For the remainder of the business, we saw strength in a number of end markets, with particular strength in products going into industrial applications. Geographically, we saw strength in Europe and in North America. Bookings were down 2% in the quarter, also driven by lighting weakness. Excluding lighting, bookings were up 2%, with strength in power distribution components and industrial controls. Notably, our margins this quarter were up 30 basis points over the first quarter, a first quarter record as well.
The results for Electrical Systems and Services are on page eight. Revenues were up 4% in the quarter, with organic up 2.3%. We rounded it to 2% on the chart. Foreign exchange was up 2.2%. We also rounded it to 2% on the chart. The divestiture of our stake in a small joint venture reduced revenues by approximately 1%. In the quarter, we saw market strength in services, in harsh and hazardous and power distribution assemblies for industrial markets. Geographically, the U.S. markets saw the greatest strength. Bookings in the quarter were up 8% on strength in industrial projects and in services. As we noted in Q4, our backlog for industrial projects continued to expand, and as a result, we would expect to see organic growth accelerate beginning in the second quarter. I'd also note that our operating margins improved by 50 basis points in this segment.
Next, taking a look at the Hydraulics business. Sales were very strong, up 21%, with organic revenues up 16% and foreign exchange adding 5%. In the quarter, all regions were up significantly, with particular strength in construction equipment and through the distribution channel. Bookings were up 14% in the quarter, with strength coming primarily from OEM customers and really all end markets. We also saw booking strength across all geographies. Given our very large backlog, we expect this market will remain strong throughout 2018. Margins were 12.7% in the quarter, up 250 basis points over Q1 2017, and we continue to see the benefits of our structuring efforts as well as the benefits of higher revenues. We continue to experience some challenges as we continue to ramp this business in the face of very strong demand levels, but we do expect to see improvements beginning in Q2.
We're certainly on track to deliver our full-year margin guidance in this segment. For Aerospace, we had another strong quarter. We saw 7% sales growth with 6% organic. Sales growth was driven primarily by strength in military, which was up 13%, and the military strength extended across really all categories, including the military aftermarket. Always lumpy, orders in the quarter were up 1% on aftermarket and strength in rotorcraft, offset by weakness in both military and commercial transport. Margins were 19.4%, up 90 basis points over last year, and once again, a Q1 record. We also had a very strong quarter in the Vehicle business. Sales up 14%, of which organic revenues were up 13%, foreign exchange added 3%, and the divestiture impact from the joint venture formation with Cummins was a negative 2%.
NAFTA heavy-duty truck production was up 45% in the quarter. Also Brazil truck and bus was up nearly 6%. Lots of strength in our truck business around the world. In addition, order strength continued through the quarter. We now expect NAFTA heavy-duty production will be 295,000 units in 2018, significantly higher than the outlook of 275,000 that we had at the start of the year. U.S. and China light vehicle markets are expected to be flat for the year, Europe a bit better, strong growth in the emerging markets, specifically in India and Brazil. Margins were 14.8% in the quarter, up 110 basis points on better than expected revenue and benefits from prior restructuring efforts. Margins, while good, were held back somewhat by higher year-to-date restructuring costs in this quarter. We certainly expect them to improve in the out quarters.
Page 12 is the first look at the financial results of our eMobility segment. You'll find 2016 results for eMobility, including the restatement of our Electrical Products and Vehicle segments in our 10-Q, which will be out later today. Sales in the quarter were $77 million, up 22% from prior year, 19% coming from organic growth. The organic growth in the quarter was driven by new European electric vehicle penetration and growth in Electrical Products going in traditional internal combustion engine applications in North America. Margins in the quarter were 14.3%. This is down from prior year due to additional R&D investment and spending on specific customer programs. This is an exciting new segment for Eaton. We expect to see double-digit growth in this segment for some time to come.
Before we move into the remainder of the year, I do want to provide some additional background on our new eMobility segment for those who may not have had an opportunity to join us at our investment conference in New York. eMobility is really a great example of how we're capturing synergies across the company. In this case, to pursue emerging market opportunities in electric vehicles. What are we doing? In simple terms, we're combining the unique industry knowledge, customer relationships, and I'd say application knowledge from our Vehicle business with the proven technology that we've created in our Electrical business. All of the technologies and products that are needed to support electric vehicles, we're already selling in homes, in factories, and in offices in our Electrical business. More development and customer-specific changes are certainly needed. This is exactly what our Vehicle business does very well.
Electrification is a good thing for Eaton. Our addressable content per vehicle is actually eight to 10 times greater on an electric vehicle than it is on an internal combustion engine. Just turning to page 14, electrification of vehicles will no doubt be a very large market, we've decided to really focus on those areas where we can create the right to win and have unique technology. On page 14, we show you the specifics of where we intend to focus. That's in power electronics and conversion and on power distribution and circuit protection. You can see from the description that these technologies are critical to the safe and reliable operation of the vehicle. What you really can't see is what we already do, that's we have a very large business in both of these technologies across our electrical markets.
We're a market leader in power conversion from our UPS business and in power distribution and circuit protection from both our bus and fuses, as well as our legacy circuit breaker business. We're already selling many of the electrical products into both electric vehicles and into internal combustion engine markets, look forward to exploring the opportunity to expanding this opportunity as the electric vehicle market continues to grow. On page 15, we include an outlook for 2018. Here, we expect revenues to be approximately $320 million, 12% organic growth, we think the segment will deliver a 12%-13% full year margins. Our margins were down versus 2017 as a result of a significant step-up in R&D spending, where we expect to spend approximately $30 million in this segment for the year.
More importantly, I'd say, we expect to serve a market that will grow to over $33 billion over the next 10 years or so, we think Eaton can capture $2 billion-$4 billion of additional revenue by that same time frame. We're working with a number of global OEMs as we speak and are certainly excited about the opportunity to make eMobility a meaningful part of the company. At this point, I'll turn to our outlook, which is on page 15, excuse me, page 16. We now expect organic revenues to grow 5% for the year, up 1% from prior estimates, driven by, as you can see here, an increase in both Hydraulics and Vehicle.
We expect Hydraulics to be up an additional 3% and now forecast a 13% increase for the year, Vehicle to be up an additional 3%, we now expect a 4% increase for the year. The other segments are unchanged from our prior guidance. For margins on page 17, we're increasing our segment margin guidance for Eaton from 16.4% to 17%, or 16.7% at the midpoint, up from our prior guidance of 16.6% at the midpoint. We're also raising the margin expectations for our Vehicle segment to 16.5%-17.1% for the year. As we noted last year, we'd only intend to change margin guidance for our segments when they're outside of the prior guidance or ranges provided, hence the increase in Vehicle. Our other segments remain unchanged, as our expectations for the year continue to be within the prior ranges.
On page 18, we provide a summary of Q2 and our 2018 guidance. For Q2, we expect EPS of $1.25 to $1.35. This assumes 5% organic growth, margins of 16.2%-16.8%, and a tax rate of 11.5%-12.5%. For the full year, we now expect EPS of $5.10 to $5.30, up $0.10 at the midpoint from our prior guidance. Organic revenues up 5%, up 1%. We think foreign exchange will be a positive $250 million now, $100 million above our prior guidance. We think segment margins are now expected to be, as I noted, 16.4%-17%. Corporate expenses will be slightly higher than what we originally forecasted, $10 million above 2017. The prior guidance was flat. We expect our tax rate to be down modestly with a range of 12.5%-14.5%, down from our prior guidance of 13%-15%.
Cash flow, CapEx, share repurchase, and restructuring cost assumptions are really unchanged from the prior guidance. Just before I turn things back to Don for Q&A, I did want to once again take this opportunity to summarize why we think Eaton is a very attractive investment opportunity. The first I'd say, our markets have returned to growth, and we think the next three years will be better than the last three. In addition, we have a number of attractive organic growth initiatives that we think will allow us to grow faster than our end markets. Our restructuring is paying off. Our margins will be at an all-time high in 2018, and we expect our margins to continue to improve. Our balance sheet is in great shape. Net debt to capital is below 30%. Our pension plan is now funded at over 95%.
Our cash flow continues to be strong, we expect to consistently deliver cash flow at or above 100% of net income while generating $8 billion of free cash flow over the next three years. We're also returning cash to shareholders through a high dividend yield. Our dividend today is north of 3.5%, and we're buying back shares 1%-2% on an ongoing basis. Lastly, we'll deliver 11%-12% EPS growth over the next three years. We think it's a fairly compelling story, and once again, a very good reason to take another look at how you view the stock. With those opening comments, I'll pause and turn it back to Don for Q&A.
Operator's going to provide you instructions for the Q&A. Before I do, I would like to remind you that we have a large number of questions on the call today, and to try to keep it at an hour today, I'd ask you to limit your questions to a single question and a follow-up. With that, I'll turn it over to the operator to give you instructions.
Thank you. Ladies and gentlemen, if you would like to ask a question today, please press star one. You'll hear a tone indicating you've been placed in a queue. If your question gets answered and you wish to remove yourself from the queue, please press the pound key. Again, star one if you have a question.
Our first question today comes from Joe Ritchie with Goldman Sachs.
Hey, good morning, guys.
Morning.
Craig, can we maybe just start on lighting for a second? It's been a bit of a drag on growth and orders for the last several quarters, I'm just curious, how are you guys thinking about this business internally, just from a strategic perspective, how important is it to the overall portfolio?
Yeah, I appreciate the question. First of all, I'd say that the lighting results in Q1 were certainly below our expectations as a company, but very much in line with our outlook for the year. As we said back in New York, we thought this would be the one segment inside the company that would be under pressure during the course of the year. We still believe down low single-digit is very much in line with our thinking when we set our plan at the beginning of the year. To your point around strategically how we view lighting, I'd say lighting, very much like the rest of the company, has to live up to our company's expectations around the criteria that we set for what an attractive business looks like. We talked about it being businesses have to be leaders in their markets.
They have to grow in excess of GDP. They have to deliver attractive return on sales and attractive return on net assets. Where we're in cyclical businesses, they have to deliver a minimum level of profitability. I would say the lighting business inside of Eaton today is a business that has a lot of positive things and a lot positive going on, but it's also a business, I would say today, that still has something to prove. With respect to lighting, we have work to do to turn this into the type of business that meets all of Eaton's criteria for businesses that we want to be in. We continue to invest, we continue to like many of the prospects, but we clearly have something to prove in this business.
That's helpful color, Craig. Maybe for my second question, if I could just focus on ESS growth and orders. Clearly, the order momentum is there. It sounds like large project activity is picking up. No change to the organic growth guidance, but you're expecting an acceleration in 2Q. Maybe just provide a little bit of commentary around your thoughts on growth for the remainder of the year, the acceleration that's expected, and whether this is one where potentially we could get outside the range just given how strong the order momentum has been.
Yeah, at this point, I think I would say it's early in the year and perhaps too early to make a change to the guidance. We are in fact seeing very strong growth in our Electrical Systems and Services business, driven, as we said at the beginning of the year, by power distribution, large assemblies, harsh and hazardous markets, the Krauss-Maffei business. Certainly today, we're really seeing perhaps even more strength than we originally anticipated in our three-phase power quality business. Our negotiations are up solidly for Q1 as well. We certainly are hopeful that this business continues to grow at the rate that we expect, and we'll have to take another look at it in Q2.
At this point, we think the guidance that we provided is prudent, and we're optimistic that this business continues to grow not only in 2018, but we think the outlook for the next few years for our Electrical Systems and Services business is quite positive.
Good to hear. Thanks, guys. I'll get back in queue.
Our next question comes from Steven Winoker with UBS.
Thanks. Good morning, everybody.
Hi.
Could you maybe just give a little more color on the incremental walk that you're talking about for the rest of the year? I know, obviously, restructuring and you get the benefits from that, maybe pricing actions versus material and wage inflation and productivity. Just a little more color for how that's progressing given the 1Q performance.
Yeah. I'd say that if we think about our incremental performance in Q1, they were, in fact, largely in line with what our own expectations were as we built our profit plan. So we were quite pleased overall with how we did in Q1. As you think about why things will improve in subsequent quarters, I'd say there's really two pieces. You hit on one, it's restructuring net spending versus benefits, and those certainly will increase in each of the subsequent quarters. The other thing I would say is that our net price versus commodity inflation performance will actually improve as well as the year unfolds. So those are really the two, I'd say, things that will give us ultimately a lift in our margins.
We have some volume growth in some of our businesses as well, those are really the two big ones that will generate incremental margins and incremental return on sales as the year unfolds.
I would think the volume leverage would be very significant too, given the large step up you're looking at for the rest of the year.
Yeah, absolutely. We will also see a benefit there.
Just following up on your pricing point, in terms of actions that you've taken versus those that are kind of being phased in through the rest of the year, would you say that you're about a quarter of the way through those pricing actions? Have you taken more of them? Just some perspective on that.
Yeah, maybe the first thing, just to go back to what we said in New York, we talked about we anticipated that Section 232 would have an impact of roughly $50 million. That impact has been significantly reduced with all of the exceptions that have been made in terms of countries that are no longer in scope or potentially no longer in scope, and we'll see how it finally unfolds. That number went from $50 million down to about $10 million. Secondly, I'd say that inside of our businesses, we have already either taken or announced price increases, in each of our businesses, that essentially offset or more than offset the commodity inflation that we anticipate and can see at this point.
As we take a look at commodities in general, they're certainly running at higher levels than we planned originally, but our teams have gotten out in front. We've already, as I mentioned, taken price increases or announced price increases, and we're fairly confident that we don't expect commodity price inflation to be a drag on margins at all for us this year.
All right. Thanks, Craig. I'll hand it on.
Our next question comes with Ann from Ann Duignan with JP Morgan.
Hi, good morning.
Good morning.
Most of the operational questions have been addressed. I'd like to focus maybe on your comments on eMobility. Craig, I think you said that the content opportunity for Eaton is 8 to 10 times versus an internal combustion engine. Was that referenced just to gasoline engines or was that also diesel engines? Because if I recall, you probably have more content on a diesel engine than you do on a spark ignition engine.
Yeah. First, maybe just to clarify that point, no, we don't have more content on diesel than we do a gasoline engine. We have content on both platforms, we're not necessarily biased to one or the other. Perhaps, one of the pieces that you've referenced is the whole diesel issue in Europe and how that would impact the company. For us, it won't have any impact at all. Those become gasoline engines. We're just as well positioned as if they would be a diesel engine. To your other point, yeah, absolutely. If you think about the content available to Eaton as the world moves to more electric vehicles and commercial vehicles and off-road equipment, our opportunity as a company, it really does increase by 8 to 10 times.
That's simply the electrical content on those vehicles versus the content today that we would sell in the form of valves and valve actuation and superchargers and other products that you would typically find on an internal combustion engine. For us, it's an exciting opportunity and we think a real growth opportunity and the reason why we launched this eMobility initiative and are putting so much resource behind it.
Okay. This may be an unfair question for a quarter conference call, but are there any lessons learned from the penetration of LED lighting that can be used in eMobility? I look at the world, and I see companies like ZF have already also created an eMobility segment. Are there any lessons learned from conversion of industries where you can take the learnings from one division to another?
Yeah, I think there absolutely is, Anne. I think if there's one message, and if you had our lighting team on a call, they would probably say, play to win and make the early investments and bet on the technology winning. That's exactly the way we're approaching the eMobility opportunity. That's one of the reasons why the margins are down in 2018 in eMobility is because we were investing heavily in that segment. We clearly intend to play to win and to play to win globally, and our teams are excited by the opportunity.
Okay, I'll leave it there and get back in line. I appreciate it.
Thanks.
Thanks.
Our next question comes from Scott Davis with Melius Research.
Hi, good morning, guys.
Morning.
Hi.
Just following up a little bit with Ann on eMobility. I don't know what scale looks like in eMobility. It's still early days, but do you feel like you have enough? I look at the product portfolio, and you're really strong in circuit protection and power conversion, but there's a lot of electricals on the car. Does it change your M&A strategy, or are the things that you'd like to have or think about bolting on that you've sent your M&A guys out to explore?
The first thing I'd say is that as we think about kind of the places where we've decided to play around power conversion, power distribution, I'd say we're really leveraging the strength of what we do today. We have a very large electrical business today, where we provide exactly the same types of technology in buildings. I think one of the real advantages that Eaton has versus other companies who are approaching this opportunity, we have the ability to leverage existing technology and leverage the scale that we already get through participating in these technologies in our electrical business. Having said that, there is obviously customer-specific modifications that will be required, and in many cases, we'll have to make some additional investments. We certainly view this as a segment that we'd be willing to look at M&A opportunities and partnerships in.
I think we're in a great starting position because we do have this very strong base of technology and know-how and customer intimacy through our vehicle business.
Makes sense. Just to, again, go back to, a couple folks have asked about lighting, and I'll ask about it, too. When Eaton bought Cooper, most of us, I think, felt that Eaton might sell the lighting business, that it was something that was easy to parse off, and it's an industry that's desperately in need of some level of consolidation, it appears. Do you need to be in the lighting business? At what point do you just say, we're fighting too many wars here? You're trying to build an eMobility business at the same time, or gosh, you've got lots of SKUs here. Do you need to be in lighting, and how much time are you going to give it?
What I'd say is, first of all, I think we have an attractive lighting business. We are arguably the second largest lighting LED supplier in the North America market and have a really enviable position with a full product range. I'd say today, if you think about as lighting businesses go, we have one of the most attractive lighting businesses we think in the world. It's an attractive business in the context of the markets in which we compete. In some cases, we are in fact leveraging some common distributors. I'd say, do we have to be in lighting? Does it have a negative impact on the balance of our Electrical businesses if we're not in it? I'd say no.
One of the things we've said in general as we think about the company, every one of the businesses that are a part of Eaton has to stand on its own. It has to be a good business in its own right to earn the right to continue to be part of the company. No different than the criteria that we've set for Hydraulics or Vehicle or any part of the company, we have to prove that this is a good business in its own right, and if there's other synergistic things that it brings to the table as a part of Electrical, that's fine. The first thing we have to do is demonstrate that this is going to be a good business as a standalone business inside of the company. We think we're working on all of the right things to make improvements.
As we said with any part of the company, if we get to the point where we don't believe it can live up to our expectations, we'll be prepared to make other decisions.
Good answer. Thanks, guys, good luck to you.
Thanks.
Our next question comes from Jeff Sprague with Vertical Research.
Hi, thank you. Good morning, everyone.
Hi.
Hey, sorry to come back to lighting again. Just a few other things to clarify, if I could. I think, Craig, in your opening remarks, you said you thought it'd be down mid-single digit for the year. I think in response to a question, you said low. Could you clarify that as 0.1?
Yeah, I'd say that we're kind of parsing numbers at this point. I'd say low single digit is currently the viewpoint on the business in terms of where we think it'll land.
I was actually more curious just actually on the size of lighting. For it to be a 5-point impact on organic growth and down 10% implies the business is a fair amount bigger than I thought it was, like in the neighborhood of $3 billion plus or so. Is there some other adjustment you're making when you talk about how much it's down, maybe excluding the projects from last year? Or what other color could you give us on that?
Yeah, I'm not sure about kind of the way you did the math, but it's not close to $3 billion in revenue. We could maybe go offline, help you with your model, but it's
Jeff, let me just add, it's in the neighborhood of one and a half to one and three-quarter billion.
Yeah, that's what I thought. Okay. Thank you very much.
Okay, our next question comes from Mircea Dobre with Baird.
Yes, thanks. Good morning, everyone. Maybe going back to eMobility. Craig, help us maybe better understand the opportunity here. You're investing a lot in R&D. In order for you to win in this market, are we talking about you displacing already existing players? How would that process work over time? How should people think about incremental margin tiers we're thinking about beyond 2018 for this segment?
Yeah. I appreciate the question. I'd say that for us, what's most exciting about this opportunity is that, no, we don't have to displace existing companies in this space, as electrification is largely a new market today without a number of established competitors. Really, it's a wide open space today, and the ultimate kind of winners in this space are yet to be determined. We think, if you think about what Eaton brings to the table, we have as much of a right to win in this space as anyone, given what we do in our electrical business. We do believe that it's going to be a great opportunity. Yes, to your point, lots of companies are pursuing eMobility and electrification. I think the two areas in which we've chosen to focus are places where we are uniquely situated and have unique capabilities.
We think, if you think about the business long term, yes, some relatively large upfront investments, we think long term, we think the margins in this segment also become very much attractive and in line with the rest of the company.
Okay. My follow-up, maybe kind of a small modeling clarification. Is there a way to quantify the price cost drag that you had in the first quarter? I want to make sure that I'm clear on this. You're basically saying that you're going to be neutral in going forward or in the back half of the year on that, right?
Yeah. We won't specify specifically Q1, I will say that as you think about beginning in Q2, in the back half of the year, the price cost equation for us is better than it was in Q1. Despite the fact that we reported record margins in Q1, for Q1, we did have a little bit of drag, and it gets better as the year unfolds.
You're going to be neutral by year-end 2018? Are you going to catch up with that?
Yeah. We will basically be neutral. Commodity cost will not be an issue for us at all this year.
Okay. Appreciate it.
Our next question comes from Julian Mitchell with Barclays.
Hi. Good morning. Maybe just trying to understand within Electrical Products. I think that the margin guide for the year is for that to be up maybe close to 100 points or so at the midpoint. Q1 is starting out some way below that. I understand maybe there's some volume leverage as lighting comes back. I guess in the past, when lighting revenues grew a lot, it was called out as a mix headwind to margins. I guess I'm trying to understand what gets the EP margin momentum improving over the next three quarters, and whether lighting sales recovering is a contributor or a headwind to that process.
Yeah. I'd say the way to really think about it is there's a fair amount of cyclicality in this business in general. Our electrical businesses typically have higher volumes in the second half of the year. Q1 has always been historically a, relatively speaking, tough to call, north of 17% margins low, but for that business, it's always been kind of the weakest quarter. There's seasonality as a function of volume that impacts Q1 and positively impacts the subsequent quarters. Then, as I mentioned, as the price cost equation improves as the year unfolds, and we start to see even greater restructuring benefits in our business as the year unfolds. Those would be the three elements that I'd say that would result in the better margins as the year unwinds in the Electrical Products segment.
Lighting should be sort of a neutral impact on.
Yeah. Lighting, the changes in revenue are not going to have a material impact at all on the margins.
Very clear. Thank you. My follow-up would just be on capital deployment. You have the guidance of $800 million share buyback spending, I think, retained for this year as a whole. You spent $300 million in Q1. Should we think that if the share price stays around where it is, that $800 million guidance starts to look pretty conservative? Are you trying to be sort of deliberately opportunistic here on the amount spent on buybacks?
I think very much consistent with what we said is that, we will generate a lot of cash this year. We don't intend to let cash build up on the balance sheet. Our first priority is clearly investing in our businesses, which we're doing. We've committed to a very strong dividend and the $800 million of share buyback. In the event that our stock price kind of continues to languish at the levels that it's at right now, is we find our stock to be very attractive as an opportunity to accelerate buybacks or to buy back more. That continues to be an option that we're considering. We're obviously considering that in the context of obviously other opportunities around M&A. At the current pricing levels, we find our stock to be very attractive.
Great. Thank you.
Our next question comes from Deane Dray with RBC.
Thank you. Good morning, everyone.
Hi.
Hey, I'm going to avoid the penalty for piling on another lighting question. I just wanted to get some clarity on one of the businesses that you highlighted at the beginning in terms of accomplishments in the first quarter, the increased penetration in hyperscale data center market. That whole market has changed so much in the past couple of years. That market's expectations and use of UPS is drastically different from what mainstream data centers use. How is it that you've been able to address this market? Is it particular, is it new products? Is it service? What's the opportunity from here?
Yeah, no, I think to your point, it's actually a very attractive market. If you think about today, the data center markets today, most of what we sell into the data center markets actually is in our core electrical distribution business. Yes, we have a very big footprint as well in power quality, but it's a very positive story for our electrical distribution business as well. I'd say, so much of what's going on today, it's not so much new products as much as it is just most of our major customers building out their infrastructure to try to keep up with this massive generation and consumption of data that we all tend to generate.
I would put a bit more in terms of the market fundamentals, the secular trends that we all live with every day that's requiring that our customers build out more infrastructure.
Great. Just a follow-up question for Rick. Can you give any color regarding the tax rate being tweaked lower on the year? Is this any further clarification on tax reform, or is it something very company specific?
It's really company specific. We've now had a chance to digest all of the complexities of the tax bill, we've made some adjustments to our own structure and plans that allowed us to pull the rate down a little bit.
Got it. Thank you.
Our next question comes from Steve Volkmann with Oppenheimer. I'm sorry, Steve Volkmann with Jefferies. I apologize.
Good morning. I thought I had to change.
Sorry, I didn't mean to pre include an announcement there. Sorry, Steve.
Thanks. Who knows? Maybe you'll be prescient. Anyway, I will risk the piling on penalty. Just one more quick one on lighting. Craig, are there pieces of lighting that are doing well? I guess what I'm trying to get at is if you had to restructure the business, just to control what you can control because the market is what it is, are there things you could do that would improve that business?
Yeah, I'd say we're always working to restructure businesses to focus on one of the things we talked about across the company is that, in every business, it's a normal distribution of there's always things that are doing very well and/or with attractive margins. There's always pieces of every business, even an attractive business, where there's opportunities to improve them, what we call grow the head, fix the tail. That initiative really cuts across the company, and lighting is no different. We're certainly looking at opportunities to just be more focused, in our lighting business, on those places where we have unique technology and the right to win and looking at the other marginal activities where they tend to be more commoditized. I'd say that is absolutely a piece of the formula in lighting.
It's really a piece of the formula in the way we run all of our businesses.
Okay. Fair enough. Maybe on ESS, traditionally, when that business starts to grow backlog, there's an opportunity to improve pricing and sort of the margin that's in the backlog. As you look into the backlog, is that happening? Should we be expecting better margin in the backlog?
Yeah. Well, what I'd say, without commenting specifically on margin in the backlog, I think your general thesis is correct. In this environment where our Electrical Systems and Services business is growing, we are, in fact, building backlog. Orders are growing. It makes the opportunity to get price that much easier. I do think we are all fortuitous at this point in the cycle where we are, in fact, experiencing some commodity inflation. At the same time, markets are very strong, and in many of our facilities, we are pushing lead times out because many of our factories are sold out. It's a very positive environment and climate in general to get price.
Great. Thank you so much.
Our next question comes from Chris Glynn, who actually is with Oppenheimer. Chris, by the way, I'll be seeing my optometrist a little later in the day to get this problem fixed.
Thanks. You can borrow our in-house optom. Just on Hydraulics, I think about 24% reported incrementals, depending on how FX plays here. Maybe low relative to the full year Eaton target's around 40%. I know you've been fighting some market ramp inefficiencies there, wondering what you think Hydraulics incremental should be showing here in terms of internal views, absent ramp inefficiencies.
No, I think the number you quoted is a very good number. We think 40% incremental is the right incremental level to think about for our Hydraulics business. To your point, we certainly have been experiencing some ramp inefficiencies as orders continue to run, and outstrip our supply chain's ability to respond. We're expediting and running a lot more overtime and not as efficiently as we would ordinarily run as we try to catch this ramp in the cycle. I think 40% is absolutely the right number. As I mentioned, we think that business, once again, as we look forward, we think it starts to deliver much more consistently with those kinds of expectations.
Okay, great. I'll take a penalty for the team there and go back to lighting. Just wondering on the volume declines, what the relative impact roughly is between, you called out large project comps versus specifically how you serve the market, being more selective there. The point being the latter might actually be stable or favorable to margins.
Yeah. In terms of parsing the two, I can't say that one was more significant of an issue than the other. Both projects that did not repeat and being more selective around business that we take, both contributed to the decline in Q1. I would say, as we look forward and very much consistent with what we saw in the month of April, we think most of that's behind us at this point, and we're comfortable with our forecast for the year and our guidance for the year.
Great. Thank you.
Our next question comes from Jeffrey Hammond with KeyBanc.
Hey, good morning, guys.
Hi.
Just on EPG, I guess outside of lighting, I guess the orders came in a little bit more sluggish. You cited industrial. Maybe just speak to the construction markets, res, non-res, any anomalies there, and how you think that the orders play out.
Yeah. I'd say that we really have not seen any dramatic changes from what we forecasted or anticipated in the Electrical Products business, with the exception of perhaps a little bit of weakness we talked about in lighting. Industrial markets continue to do fine. We think industrial markets are up 3%-4%. Residential markets continue to be quite strong. We think those markets continue to grow mid-single digit. We think by and large, that our outlook for the year for our Electrical Products business and the key markets that they serve really have not changed much from our original guidance.
I might add, Jeff, it's early. We don't have a full accounting of orders for April, but the orders for April appear to be pretty strong. We're seeing a continuation of strong conditions in the product segment.
Okay, great. Just back on eMobility margins, is it right to think about for the foreseeable future, we're in the low double digits as you invest, or do we start to move back up to a level we saw, I guess, in the last year period? Thanks.
Yeah. I would say that as we go through this kind of investment cycle, which we think is really at least a couple years kind of investment profile, we're going to be seeing margins at these levels. You probably won't get back to the higher levels of margins until we get to a much higher level of revenue.
Thanks, guys.
Our next question comes from Rob McCarthy with Stifel.
Good morning, everyone. Two questions following up on two of the topics. Number one, on lighting. From my math, it would seem to suggest that kind of core volume declines or, excuse me, core declines is close to 15%-20%, which is pretty significant. Do you think there's going to have to be incremental restructuring or anything you're going to have to do internally that's going to be a lodestone to operating margin there? Could you comment qualitatively on any decremental leverage off that decline?
Yeah, I'm not sure how your math gets to those levels. Our lighting revenues in Q1 were down 10%, and actually, our profitability was essentially maintained. We very much delivered margins that were very much in line with our expectations in Q1 on a 10% revenue decline. As we look forward, as I mentioned, we think, lighting, obviously, on a go-forward basis, we have much better quarters in front of us than we had in Q1. We think the margins of this business continue to be very much in line with our expectations. We're not particularly concerned about a decremental margin issue in lighting that's going to have any impact on our business at all.
All right. I'll table those questions offline. I guess the next question is obviously a statement in drag. Going back to Julian's question about capital allocation, it would seem to me that obviously your preference is probably for M&A, given this environment with where the stock is a pretty significant market break here and kind of speed kills in terms of capital allocation and what you can do, particularly in the prevailing environment with cash repatriation, the strength of your balance sheet, the free cash flow generation, don't you think there's going to be some upward bias to think about expanding this buyback pretty significantly? That seems to be the best use of your capital at this point in time.
Yeah, I just think at this point, it's just too early to make a call on that. As we promised, we will not allow cash to build up on the balance sheet. To the extent that we don't have attractive M&A opportunities that deliver better returns, we'll certainly be very aggressive in buying back our stock.
Thanks.
Our last question for the night comes from Andy Casey with Wells Fargo.
Hey, guys. This is Chris Lasorenco on for Andy. A couple follow-ups, I wonder if I could zoom out a little bit for bigger picture. As we looked at the orders and the release, it seemed like there was a little bit of a slowing compared to the prior quarter's order growth rates. Is this mostly related to comparisons, or are you seeing anything sequentially weaken as you work through the backlog?
Yeah, no, we're really not. As Rick indicated, we're actually seeing some strength carry through in the month of April. I'd say there's always a little lumpiness in some of the businesses, like Aerospace, so I wouldn't read anything into that. We came off of a very strong 2017 of order input. Hydraulics, a little less strong, but our orders were up 22% in Q1 last year. We're up 14 on top of that. Many of this is simply a function of cyclicality or a function of what's in the denominator from last year, but no weakening at all. We're very confident that the order profile that we've seen so far this year is very much consistent with our guidance.
Okay. I wonder if you could talk about company incrementals as a whole. Is the 40% target for the company as a whole still good? I wonder if you could comment on what drove specifically the under-leveraging in Q1, also what you'd have to have in place to achieve it. Is that more volume related, price cost related, combination of both, plus additional things that I might be missing?
Yeah, no, I think it's the things that you mentioned. It's volume leverage. It's price cost, where we're certainly much better balanced in the subsequent three quarters. As I mentioned earlier, it's the net of restructuring spending and restructuring benefits. The incrementals that we delivered in Q1 were very much in line with our guidance for the year, which ties out to a 40% incremental for the year, and we're very much committed to that number, and that's very much consistent with what our expectations are for the year. We've seen nothing today in our businesses that would suggest that we will not deliver the 40% incremental.
Okay. I wonder if I could sneak one in since I'm the last one. In terms of the eMobility, could you comment on what the revenue ramp for the rest of the year looks like? Maybe about product introductions or leveraging the existing technology in the medium term, the next two years.
Yeah. There isn't going to be a gigantic ramp. You're going to see just a relatively modest ramp as you go through the quarters. Obviously, we are working very hard on a whole variety of customer projects right now, and that will impact a little bit the spending, depending on whether we end up going forward on some of these projects. Those are the two dimensions.
I'd say largely it'll be tied to our customers and the rate at which they introduce new electric platforms. You'll clearly see a step function change in revenue in this business as the big global OEMs introduce new electric vehicle platforms. That's really the pacing item more than anything.
Thanks very much for that. I appreciate the color.
That wraps up our call for today. As always, Chip and I'll be available for follow-up questions for the remainder of the day and into the rest of the week. Thank you for your time today.
Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.