Ladies and gentlemen, thank you for standing by, and welcome to the Eaton Third Quarter 2021 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.
If you wish to put yourself in the question queue, please press one, then zero on your telephone keypad. If you should require assistance during the call, please press star then zero. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Senior Vice President of Investor Relations, Yan Jin. Please go ahead.
Hey, good morning, guys. I'm Yan Jin, Eaton's Senior Vice President of Investor Relations. Thank you all for joining us for Eaton's third quarter 2021 earnings call. With me today are Craig Arnold, our Chairman and CEO, and Tom Okray, Executive Vice President and Chief Financial Officer. Our agenda today includes opening remarks by Craig, highlighting the company's performance in the third quarter.
As we have done on our past calls, we'll be taking questions at the end of Craig's comments. The press release and the presentation we'll go through today have been posted on our website at www.eaton.com. This presentation, including the adjusted earnings per share, adjusted and free cash flow, and other non-GAAP measures, has reconciliations in the appendix. A webcast of this call is accessible on our website, and it will be available for replay.
I would like to remind you that our comments today will include 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 due to a wide range of risks and uncertainties that are described in our earnings release and the presentation. With that, I will turn it over to Craig.
Okay. Thanks, Yan. We'll start on page 3 with highlights for the quarter and by noting that our team delivered, you know, record results in Q3, despite kind of the well-publicized supply chain challenges in this environment. We had strong execution across all of our businesses and as we focused on controlling what we could control.
As you can see, we posted an all-time record for adjusted EPS of $1.75. Supply chain constraints did have an impact on our revenue, but we still posted 8% growth in the quarter. For the third quarter in a row, we delivered record segment margins at 19.9% in Q3. It was an all-time record and an increase of 230 basis points over prior year.
On top of record margins, we're also pleased with our incremental margins, which were 46% in the quarter due to actions that we took to mitigate inflationary costs, the portfolio changes that we have undertaken, and savings from restructuring programs. We did have a bit of help from favorable mix as well in the quarter.
While revenues were lighter than expected in our Electrical Americas segment, we're very pleased to see the strength in orders and the growing backlog. Overall demand range remains very strong. For the electrical businesses overall, orders were up 17% rolling twelve-month basis, and our backlog was up more than 50%, another all-time record. Next on page four, we summarize our Q3 results, and I'll note just a few points here.
First, on 9% revenue growth, we increased our operating profits by 23%, which reflects strong operating leverage and benefits from our portfolio actions. Second, our acquisitions increased revenues by 7%, which was fully offset by the sale of hydraulics. We're naturally pleased to have replaced the hydraulic revenue with a collection of businesses that are, I'd say, higher growth, higher margin, and have more earnings consistency.
Last, our margins of 19.9% were well above our guidance range of 19%-19.4% as our team did an outstanding job of executing despite the lower than expected revenues. Moving to page five, we have the results of our Electrical Americas segment. Revenues were up 9%, including 1% organic and 8% from the acquisition of Tripp Lite.
Organic sales growth was driven by strength in data centers and residential markets, partially offset by weakness in large industrial projects and sales to utilities. As I mentioned earlier, revenues were impacted by supply chain constraints. Our Electrical Americas segment suffered from the general supply chain constraints that we're all feeling, but was actually disproportionately impacted by a few unique suppliers who were especially impactful to this business.
We're naturally addressing these and other supply challenges and expect to do better in Q4. Operating margins continue to be strong at 21.7% and we're up 40 basis points from Q2. This is consistent with our expectations, and we're doing a good job of getting price to offset inflation. I'd say the biggest highlight in this segment is the continued growth in orders and in backlog.
On a rolling twelve-month basis, orders were up 17% organically, and this was an acceleration from up 13% in Q2. The strongest segments were utility and residential markets. The backlog is up more than 50% from last year and up 9% from Q2. Both I'd say are encouraging signs and support our expectations that, you know, the missed shipments will simply be pushed into future quarters.
Turning to page 6, we summarize our Electrical Global segment's results, which I'd say were just strong across the board. Organic growth was 18% with broad strength in really all end markets and currency added 1%. We also posted all-time record operating margins of 20.1% and had very strong incremental margins of nearly 40%.
The margin performance was driven by volume leverage, strong cost control and savings, once again, from restructuring actions. Orders were very strong, up 17% organically on a rolling twelve-month basis, with particular strength in the quarter in industrial, commercial, and institutional markets. Like our Electrical Americas segment, the backlog is up more than 50% and at record levels.
You know, before we move to the industrial businesses, you know, here's the way I'd summarize the performance of our electrical businesses. You know, when you add the two together, they delivered solid organic growth of 8%, built a sizable backlog, which strengthens our outlook for future quarters, and they improved margins by 110 basis points. On balance, I'd say a very strong set of quarterly results for our electrical businesses.
Moving to page seven, we have the financial results of our aerospace segment. Revenues were up 38%, 4% organic and 33% from the acquisition of Cobham Mission Systems, and 1% from currency. Organic growth was primarily due to higher sales in commercial markets, partially offset by weakness in military markets. Operating margins were 22%, up 350 basis points from last year and 100 basis points sequentially.
This strong performance gives us confidence that as you know, aerospace markets continue to recover, we'll meet or exceed the 24% margin targets that have been set for this segment. In the quarter, we also had strong organic incremental margins, which were driven by favorable mix, primarily from the growth of commercial aftermarket business and as a result, once again, from savings from the restructuring actions that we've taken.
By the way, Q3 was the first full quarter where Cobham Mission Systems were a part of the company, and we're very pleased with the financial performance of the business and the integration process is going very smoothly. As we look to the future, we're seeing encouraging signs of recovery in this segment, with both orders and backlog now trending positively.
On a rolling 12-month basis, orders are up 4%, primarily with strength in the business jet segment, and our backlog has increased by 5%. Next, on page 8, we have the results of our vehicle segment. Organic revenues increased 11% with solid growth in North America Class 8 truck business and strength in South America that more than offset the weakness in North America light vehicle markets.
As you're all well aware, light vehicle production has been severely impacted by supply chain constraints. Operating margins were 18%, and we generated, you know, very strong incremental margins of more than 50%. In addition to strong execution, we also had some favorable mix in the quarter.
Specifically in North America, the truck business benefited from strong aftermarket, where sales were up some 40% at attractive aftermarket margins. Our North America light vehicle motor vehicle business also benefited from favorable mix as customers prioritized programs with more of our content, more full-size pickups and SUVs, and fewer small cars. Good mix, good volume growth, and savings from the multi-year restructuring program all contributed to very strong quarterly operating results here.
Turning to page nine, you'll see the financial results of our e-mobility segment, where revenues increased 6% organically. Like our vehicle business, customer production levels were reduced by supply chain constraints here as well. And given the nature of the products that we sell in this segment, they were more significantly impacted by the semiconductor shortages that we've all read about.
As a result, our backlog is up significantly here. Operating margins were a negative 9.5%, once again due to heavy R&D investments and start-up costs associated with new programs. We continue to be pleased with the progress in this business, which has won programs worth nearly $600 million of mature year revenue.
We expect to see a significant ramp-up in revenues in 2023, which positions us well to achieve our long-term revenue targets of $2 billion-$4 billion by 2030. On page 10, we provide an update on our organic growth and operating margins for the year. With supply chain constraints in Q3 continuing into Q4, we now expect overall organic revenue growth of 9%-11% for 2021.
For Electrical Americas, we expect 5%-7% growth. You'll note the implied guidance for Q4 is actually 7%-9%, which is a solid step-up from the 1% in Q3. Organic revenues in aerospace are expected to be roughly flat with strength in commercial markets being offset by weakness in military markets.
The other segments had some minor reductions in revenue as well, but just minor. Despite you know, slightly lower organic revenue growth outlook, we're increasing our operating margin guidance by 20 basis points from 18.6%-19%. I'd note that with this guidance, we're on track to generate strong incremental margins of approximately 40% for 2021, which we see naturally as outstanding performance given the current inflationary environment.
Moving to page 11, we have the remaining items of our guidance for the year. We expect full year adjusted EPS between $6.59-$6.69. At the midpoint, this represents 35% growth over 2020. We're also delivering significant margin improvement, up 240 basis points from last year at the midpoint of our increased margin guidance.
Yes, I'm pleased. We have strong operating performance in the face of what we call historic supply chain challenges, and the businesses are doing well. Next, you know, given, you know, more active M&A activities, we now expect share repurchase to be between $375 million and $425 million.
Lastly, our Q4 guidance includes earnings between $1.68 and $1.78, organic revenue growth between 7% and 9%, and segment margins between 18.8% and 19.2%, an increase of 160 basis points at the midpoint versus prior year. Overall, once again, a strong 2021 with solid revenue growth, strong orders, and good execution allowing us to deliver record margins.
Next on page 12, well, we did want to provide some preliminary assumptions for our end markets for 2022, and as you can see, you know, we're expecting attractive growth in nearly all of our markets with very good growth in data centers and electric and industrial facilities in our electrical business and our commercial aerospace business, and certainly in all vehicle markets.
We'll provide more detailed color on organic revenue growth assumptions when we provide our 2022 guidance in February, but we did want to share some of our preliminary thinking here. We would also expect to see carryover benefits from pricing actions taken, which would also help our year-over-year growth next year. Lastly on page 13, we provide just some summary thoughts here.
You know, I'd say first, I'm proud of the record quarter results and particularly our strong margin performance. Our team has demonstrated that we can manage through a challenging operating environment, supply chain constraints, inflationary pressures, and still improve margins and EPS.
In the long term, secular growth trends of electrification, energy transition, and digitalization are playing out just as we expected or maybe even better. We also see 2021 as a transformative year for Eaton in terms of portfolio management.
We're a higher growth, higher margin, and less cyclical company today. With strong year-to-date performance, we're well on our track to deliver a very strong 2021 of double-digit organic revenue growth and 35% Adjusted EPS growth.
I'd also add, you know, we have great momentum, you know, going into the Q4 and into next year. We have strong order growth, we have a full backlog, and many of our end markets are poised for recovery.
You'll recall at the beginning of the year, we set medium-term targets of 4%-6% organic revenue growth annually, 400-500 basis points improvement in margins, and 11%-13% annual growth in adjusted EPS. Evaluating our progress about one year in, I'd say that we're running ahead of expectations. With that summary, I'm pleased to turn it back over to Yan and to open the session up for Q&A.
Hey, great. Thanks, Craig. For the Q&A section today, please limit your question to one question and one follow-up. Thanks in advance for your cooperation. With that, I will turn it over to the operator to give you guys the instructions.
Thank you, ladies and gentlemen. If you would like to ask a question, please press 1, then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1-0 command. Our First question comes from the line of Joe Ritchie with Goldman Sachs. Please go a head.
Thank you. Good morning, everyone.
Good morning, Joe.
Craig, I know you wanna, you know, give us some commentary or wait to give us exact commentary on 2022 organic growth expectations in February. I guess just in the context of the long-term framework of 4%-6% and with your backlog in the electrical business being up 50%, I mean, is it fair to assume that just the electrical business should be at a very minimum at the 4%-6% range for next year or maybe slightly better just given what you're seeing across your business?
You know, I appreciate the question, Joe, and certainly if you take a look at, you know, the performance of the business this year and the backlog that we're building and 17% order intake, you can certainly make a case for, you know, that business performing better than the, you know, the 4%-6% numbers that we laid out.
You'll also recall by the way, as we laid out, you know, those targets for growth for the company, that the businesses are all running towards higher growth numbers. We hedge those numbers back at the corporate level, you know, recognizing that, you know, things happen in the world that you don't often anticipate and expect.
I mean, Q3 is a great example of that with some of these supply chain constraints, and there's always a number of uncertainties out there. I think, yeah, there's certainly a possibility that the electrical segments could perform better than that.
You know, we have internal plans that would suggest better performance than that. Once again, given the amount of uncertainties that we're dealing with, especially in today's supply chain environment, we still think for planning purposes, those are still reasonable assumptions to make. There could be upside.
Yeah, that's fair. I guess maybe just following up there, and just talking about pricing, obviously key topic of conversation across our conference calls thus far. As you think about your own pricing mechanisms and how this plays out for you in 2022, maybe talk a little bit about how much pricing we can expect to come through the system. Thank you.
Yeah, you know, pricing as we talked about a little bit at the Laguna Conference as well. I mean, you know, our expectation continues to be that our businesses will fully offset inflation with price. We are living in an environment today where I'd say it's never easy to get price, but it's probably easier today given some of the supply chain constraints that we're all dealing with than it's probably ever been, certainly in my professional career.
I'd say that our thinking really hasn't changed with respect to pricing. We have good mechanisms in place. Our pricing typically lags inflation by a quarter or two, depending upon which segment of the market we're serving. We naturally have experienced more inflation as we came through Q3 than we originally anticipated.
As a result, we, like others, have had to go to the market for additional price. By and large, you know, this pattern continues, and then we would expect that as we look forward to 2022, you know, to once again, you know, more than fully offset the inflationary pressure that we experienced this year, and maybe it's gonna add a little bit of a tailwind next year. By and large, our long-term kind of expectational price versus inflation is to fully offset it, and that's what we're tracking to for this year.
Thank you. Our next question comes from Andrew Obin with Bank of America. Please go ahead.
Hi, yes, good morning.
Hey, Andrew. Morning.
Just to build on Joe's question, how much supply chain challenge impact your revenue in the third quarter, particularly in North America? I think you alluded to it, but if you could care to quantify it.
Yeah, appreciate the question, Joe. You know, certainly if you take a look at on balance, our electrical business, you know, grew some 8% in the quarter when you combine the two, but very different performance in our Electrical Global versus the Electrical Americas business, which is where we had, you know, clearly our biggest supply chain constraints.
I'd mentioned in my opening commentary, you know, we have a number of unique suppliers in that business that, you know, really resulted in revenues being below what we anticipated. You know, as we think about it, and you try to quantify the impact in the quarter, you know, our backlog grew in the quarter by $280 million.
If you look at the shippable piece of that piece, that in the quarter, you know, we could say it's order of magnitude, something north of $100 million. Let's call it $130 million of revenue, if you simply look at the shippable backlog in the quarter itself. We could have very easily posted, I would say, a 9% growth number under the Electrical Americas business in the quarter, but for the supply chain constraints.
Oh, wow. Thank you. Just how should we think about just sort of backlog versus normal? Because we actually had a number of companies in our coverage that, you know, normally sort of known for more of a short cycle focus, sort of, you know, talk about backlogs up 40%, 50%, 30%.
As you guys think about the world, does it mean more visibility or actually more uncertainty because it's so unusual for a business like yours to care so much in terms of backlog? You know, how do you guys think about it internally? Thank you.
You know, we clearly see it as more visibility. If you think about in a typical year, we would go into, you know, let's say, the year with 25%-35% of our orders for the upcoming year in the backlog. We're certainly running today at the very high end of that. We clearly see it as better visibility.
We test, as you can imagine, you know, the quality of the backlog and whether or not, you know, the backlog is solid, you know, in terms of these orders. We're testing, you know, our customers and channel partners and, you know, the indication that we're getting, although you're never 100% certain, there probably is a little bit of, you know, order placement that's taking place to get your position in line. By and large, the backlog feels extremely solid.
Thanks so much, Craig.
Thank you.
Thank you. Our next question comes from the line of Jeff Sprague with Vertical Research. Please go ahead.
Thank you. Good morning, everyone.
Morning.
Morning. Hey, just back on the supply chain, Craig. You know, the 1% growth really does jump out, right, relative to Hubbell, nVent, Schneider, really everyone else. I just wonder if you could elaborate a little bit more on what the issues were in the quarter and just your confidence level, you know, that they're resolved. I just kinda think as the market leader in the U.S., if anybody could get this stuff, it would be you, and that didn't seem to happen in the quarter.
Yeah, no, I you know appreciate the question, Jeff. We are a market leader in North America. As you know, our North America Electrical business has really posted, you know, probably, you know, 10 years in a row of share gain.
We do have a very strong position in the market, and we have great supplier relationships in general. You know, I'd say that in our case, what was a little bit unique is that there were a few suppliers that we have that support our Electrical Americas business, who were suppliers that we have that are perhaps not suppliers to others in the industry, that that had some challenges that we're working through together.
As I talked about, if you see it in the growth in the backlog, you know, what sales could have easily been, but for these supply chain challenges, I think that number, you know, 1 becomes a 9% number, which I think you'd agree is much more in line with what you've seen from some of the others in the industry.
We're absolutely confident that it's timing. It's tied to very specific supplier issues that we're clearly focused on and working. We generally speaking, like I said, have very supportive and strong supplier relationships, and it's not about one of our competitors being over-allocated and us being under-allocated.
These are just suppliers that are unique to our business that are working through some particular issues in their own, you know, kind of, operations that they need to be worked through. Yeah, so I'd say, you know, by and large, it's timing. We'll get through this. You know, we're talking about growth numbers of around 8% or so in Q4, and we're setting up well for 2022.
You could see it in our Electrical Global business. I mean, they grew 18% in the quarter. I think that, you know, and on aggregate, when you look at our Electrical Global business, our growth is very much in line with others in the industry. We would have been better, you know, but for these supply chain issues that we're having in North America. You know, the franchise is in good shape. Nothing to worry about. You know, we really just see it as timing.
Great. No, thanks for that color. Then just on price, I think you've been a little reluctant to be specific on price, but I would assume you're in the same zip code as what we're seeing out there, you know, kinda mid, even high type single digit price increases. Is that kinda directionally correct? I don't know, could you just maybe share just a little bit more thought on what the wraparound price mix impact might be in 2022?
Yeah, no, appreciate the question on pricing and why you ask for more transparency on it. It varies widely by customers and in different markets that we're in. You know, we're not going to provide more transparency than we provided, other than to say that, you know, we're getting price to offset inflation.
We will be about neutral this year. We think it'll be slightly positive next year. But beyond that, we'd rather not, you know, comment on price. Obviously, you have lots of different customers who, you know, have different, you know, end markets.
You have different supply chain factors affecting different parts of the business. Overall, you know, our teams are doing well. We're getting price to offset inflation and it'll be a net, you know, neutral this year, maybe a net positive next year.
We'll clearly have.
Right
... a wrapped impact as you mentioned, Jeff, just given the timing of the execution of the pricing in 2021.
Yeah.
Okay, thanks. I'll leave it there. Thank you.
All right, thank you.
Thank you. Our next question comes from the line of Nicole DeBlase with Deutsche Bank. Please go ahead.
Yeah, thanks. Good morning, guys.
Good morning, Nicole.
Just to piggyback on Jeff's question, I guess, you know, you guys are embedding like kind of a snapback in Electrical Americas in Q4. Like, as you've progressed through the beginning of the fourth quarter, have you seen some of those supply chain issues go away, just to give us some confidence about the achievability of getting back to 7%-9% organic?
Yeah, no, appreciate the question, Nicole. You know, obviously as a part of providing guidance externally, you know, we're looking at our internal forecasts from our operations. We're obviously been in a number of very direct conversations with suppliers who've made commitments to us around improvements.
You can rest assured that, you know, that forecast is very much grounded in what we're hearing from our suppliers and what we're getting specifically from our businesses in terms of their expectations. I mean, we're confident in that forecast based upon what we're hearing from our suppliers. We're not-
Got it. Thanks, Craig.
I will say we're not completely out of the woods. We still have some challenges. You know, once again, Q4 could be better if we were completely resolved, you know, from some of the supply chains. We're not assuming that all of the problems are resolved in Q4, but certainly much better than in Q3.
Okay. Got it. Just maybe to follow up on that, thinking about how you guys have positioned margins for the fourth quarter, you do have a bit of a step down coming from these record levels in the third quarter.
Is that just some of this favorable mix dynamic that you experienced in 3Q, or are you assuming that goes away? Just trying to understand the puts and takes, 'cause I think normally from a seasonal perspective, margins would be more like flattish Q on Q.
Yeah, we did, as I mentioned in my commentary, we had some favorable mix in Q3 for sure. When we have a little bit of unfavorable mix in Q4, as a lot of these big projects that you know, essentially have been built in the backlog as we've you know, grown the backlog, you know, during the course of the year are expected to be shipped in Q4. A lot of these big projects just carry slightly lower margins than the components business. I'd say it's really, once again, nothing to worry about. It's really just a function of mix in the quarter.
Thanks, Craig. I'll pass it on.
Thank you.
Thank you. Our next question comes from the line of Josh Pokrzywinski with Morgan Stanley. Please go ahead.
Hi, good morning, guys.
Morning, Josh.
Craig, just to, I guess everyone's standing on everyone else's shoulders for questions this morning. I think I'm on Joe Ritchie's for this one. On the backlog commentary, I mean, if I'm kind of following the pattern versus last year, you guys look like you're gonna end the year up, you know, at the corporate level, you know, maybe $4 billion-$5 billion on backlog.
I guess, you know, first question, does that 2022 kind of preliminary color that's market demand, and then anything on price and backlog consumption is sort of incremental? Follow on to that, in other kind of cyclical environments, what would you view as kind of the bandwidth to be able to convert backlog in any given year? Like is that something that is kinda naturally stage-gated by throughput, even without supply chain constraints? Thanks.
You know, appreciate your question. I will tell you that as we think about the market outlook and our economic forecast, you know, the economic forecast of markets would generally include price. So price would be baked in. And you can debate whether it should be more or less than what we're assuming, but it's generally baked in.
You know, backlog reduction, you know, is clearly something that we're trying to think through right now as we develop our plan for next year. It's too early to make a call and give you specific guidance around what our assumptions are around burning down backlog and getting to more of an historical level.
A lot of that will be highly dependent upon, you know, the supply chain environment and how that unfolds during the course of Q4 and into the, you know, the first part of next year. I will say that, you know, as we think about the supply chain challenges in general, we think we'll probably be dealing with supply chain challenges through the first half of next year.
If you think about semiconductors or some of the electronic components, we think it's, you know, maybe it's more like 2023 before those issues become fully resolved. We'll give you more guidance in February when we lay out kind of our plan for the year. At this juncture, we're not. In those market outlooks, it does not necessarily assume burn down and backlog, but it would include price.
That's helpful. Appreciate it. Good luck, guys.
Thank you.
Thank you. Our next question comes from the line of Scott Davis with Melius Research. Please go ahead.
Hi. Good morning, everybody.
Morning.
Are there customer segments that you're selling into that you're concerned about double ordering or folks just perhaps taking product that they don't need right now, you know, with, you know, given the shortages that are out there in general?
No. You know, appreciate that question, Scott, and it's one that we've spent a lot of time pushing on and thinking about as well because, you know, when you're dealing with, you know, backlogs at these levels, that's a natural concern. As I mentioned in my commentary earlier, you know, as we tested this specifically with, you know, our customers and where you would typically find it is largely in the distribution channel.
Today, I'd say that distributors, they want more inventory. They would take more inventory if we could ship it to them, and their inventory levels are actually in reasonably good shape and lower than they'd like them to be certainly in a number of end markets.
While we can't be completely certain, and it would be reasonable to assume that there is a little bit of, you know, double ordering going on, but I can tell you, as we talk to our customers, it's tough to find it.
Okay. That's helpful. Then for Tom, this new minimum tax, you know, treaty/compromise or whatever that's been talked about in the press, and I know the fine details aren't probably there yet on how to enforce it. But is there any sense of how that impacts Eaton on an overall tax rate?
Yeah. No, appreciate the question, Scott. Obviously, we're following it very closely, very well connected with what's going on. What I would caution you on is, you know, you look at the headlines, and, you know, the devil is really in the detail in terms of what the tax code is going to be, the legislation that's gonna get passed, et cetera. What I can leave you with is we're very confident relative to our peers that we will maintain our relative advantage and strong position as it relates to tax. More to come on it.
Okay.
For sure.
Okay. Good enough. I'll pass it on. Thank you. Good luck, guys.
Thank you.
Thank you. Our next question comes from the line of Ann Duignan with JP Morgan. Please go ahead.
Yeah. Hi. Thank you. Perhaps we can turn to 2022 and your outlook by end markets. Appreciate the color, but it is kind of funny to see no red arrows at all across any of your sectors. If you could just talk about where the risks might lie for end markets that could potentially be down.
I would think maybe military aerospace. Then residential, you have it as flat, and yet I think you called it out, Craig, as orders in residential were very strong. If you could just reconcile that. Maybe this page reflects global, and you were talking about North America. If you could just talk through some of those end market assumptions, that would be helpful. Thank you.
Thanks, Anne. Appreciate the question. To your opening commentary, I mean, it is, you know, an unusual year where you have all of your end markets that you're expecting to see some growth in. So we're feeling very good about next year as a result of that. I'd say that, you know, if you think about, you know, specifically, you know, whether it's, you know, residential markets, you know, orders are strong.
If you look at some of the macro indicators around, you know, whether it's, you know, housing starts or the affordability index of housing, there are some macro indicators that would suggest that these markets should naturally slow down, that you can't keep posting these huge, you know, double-digit growth numbers, you know, for an indefinite period of time.
I'd say it's really more the macro indicators that we're looking at in residential that would have us suggesting that the market is flat-ish in 2022, and not at all consistent with the order growth that we're seeing today, which continues to be strong and not at all consistent with the back order growth and the backlog and the back order growth is also quite strong in residential. We'll have to see how it plays out.
Certainly at some point, that market will slow down and that's what's reflected in kind of that outlook for the year. I think in general, you know, data centers continues to be extraordinarily strong, and there's no reason that would suggest that data centers would in any way, you know, back up.
We're comfortable with the data center forecasts around the world, as people continue to consume, process, and store increasing amounts of data. Utility markets, I mean, you know, we think utility markets are poised for growth as well as they continue to invest in grid hardening and weather hardening and, you know, all these events that we're seeing around the world, weather-related events that will continue to drive investments in utility markets.
If you think about today, you know, and what's going on today in industrial markets, and, you know, we all deal with these labor shortages around the world, there's certainly gonna be an increased appetite, we believe, for investing in automation and factories and equipment.
You know, and, you know, we talk about, you know, these broader trends around, you know, energy transition and investments in, you know, you know, electric vehicle charging infrastructure to support all these electric vehicles that are gonna ultimately be produced and sold around the world.
I think we are in this little bit of a, you know, they call it a Goldilocks period with respect to a number of our end markets that, you know, most of the indicators are pointing positive as we think about the future.
Global vehicle markets, if you think about the challenges that they've experienced this year and all the demand that was unmet, I mean, that's another market that's just well-positioned to you know grow next year, and commercial aerospace will come back. Military markets, you say, you know, "What could go wrong? What are you worried about?" We continue to be worried about supply chain constraints.
That's still a bit of an unknown and uncertain. We worry a little bit about you know what's happening in Washington, but by and large, we think that's net positive in terms of these infrastructure bills that once again haven't even baked into our thinking in terms of you know whether or not we get you know these big infrastructure spending bills that will come out that'll certainly support many of our end markets.
I mean, we can certainly talk ourselves into maybe a scenario that's less optimistic, but by and large, looking at the macro indicators and how our company's positioned, we feel very good about not just 2022, but really the medium-term outlook.
Thank you. Craig, just as a follow-up to that, do you worry at all? I mean, if you're right about this outlook and, additionally, you know, automotive production comes back strongly, is there any risk that we just exacerbate the supply chain problem?
Because we haven't really sorted that out, particularly if we get the semiconductor issue sorted and then suddenly there are plenty of chips available, but we haven't sorted out the labor and the freight and all the rest. Is there any risk to next year's revenues that the supply chain issues continue for longer than anticipated? Is that something that you talk about internally? I'll leave it there. Thank you.
Yeah, it absolutely. As you can imagine, you know, we're spending an extraordinary amount of time right now talking exactly about that issue in terms of, you know, all the potential supply chain bottlenecks, not only the bottlenecks today, but what becomes the bottleneck tomorrow when you resolve this bottleneck.
It is and has been today a little bit of, you know, we're playing Whac-A-Mole because there have been a number of unforeseen supply chain challenges that have popped up, whether it relates to raw materials or whether it relates to labor availability, as you've all read about in the newspaper, as we all struggle to fill open jobs in our production operations. You know, I think that risk is out there.
I think the risk is out there, but I think, you know, will it be worse than in 2021? I don't think so. I think, you know, 2022 will be a better year than 2021. How much better you could debate based upon, you know, the rate at which the industry is able to resolve some of these supply chain constraints. Thank you.
Okay, Craig. Thank you. I guess I'll have to look up what Whac-A-Mole is.
Thank you. Our next question comes from the line of Mig Dobre with Baird. Please go ahead.
Thank you, and good morning.
Morning.
I'm just looking for maybe a little more perspective on the various items on a cost structure that you had to adjust in the back half of this year. I mean, you obviously cut 200 basis points from your top line, but you raised your margin outlook.
You mentioned mix helped you in the third quarter. I'm wondering if there are other puts and takes here in terms of what allowed for this obviously very good margin performance that we need to be aware of.
I'd say that, you know, other than the things, Mig, that we've laid out, you know, to the one that was probably, you know, outside of our control, kind of the good guy that we got was on the mix front.
You know, we're obviously on the, you know, dealing with a lot of other, I say, extraordinary costs that we would normally not have in the business around, you know, money we're spending to expedite materials and labor inefficiencies in our factories. So I think in any business, there's always a balance of goods and bads.
We did call out mix as a positive, but there's also, as I mentioned, a lot of other challenges that we're dealing with as we try to keep our factories fully staffed, fully running and productive given some of these supply chain constraints that we've had. I know I'd say that mostly it's just been good execution.
Our teams, as you know, we called it relatively early. We anticipated that we were gonna have a revenue issue due to supply chain. Our teams at that point, you know, went to work on the things that we can control, the things that we can do to maximize our performance and deliver our earnings despite these supply chain challenges. I think we've really just seen good execution.
The other place that we're seeing better benefits, quite frankly, than we originally anticipated was in our restructuring programs. We're running ahead of schedule on some of the benefits associated with restructuring. You'll see in the Q that we filed that we've taken the spending up on restructuring by about $40 million, and it's gonna deliver $30 million more benefits than we originally anticipated.
Our teams are really just, you know, laser focused on executing, controlling the things that we can control and managing the things that we can't to the best of our ability. It's just really good execution in the quarter. For the year, it'll be a very strong year.
I see. In terms of items like variable compensation or some other component of your
Yeah, no
structure that's variable. Nothing to call out there?
Well, I mean, sure. I mean, certainly it's gonna be a very good year, so the comp plan is higher than what we-
Spanned, yeah
would've originally planned for, which is, you know, good, a good thing. No, the comp plan is higher, not lower.
Okay.
We're having to offset that as well.
Okay. My follow-up, I'm just looking to kinda clarify. In terms of the supply chain, are things sort of getting less bad in the fourth quarter relative to the third? Your suppliers sorta catching up, and that's kinda how you kinda dig your way out of this hole, as it were? Or are you doing some things proactively in terms of qualifying new suppliers, making adjustments to your supply chain given all that transpired in 2021? Thank you.
I'd have to say, Mig, it's really all of the above. In many cases, you know, some of these supplier constraints that we've had are getting better. We're also, you know, working hard to where we have the ability to change materials, qualify different materials, we're working on that.
Where we've had some labor constraints, you know, whether it's in our own shops or with our suppliers. In some cases, we're actually sending some of our people to suppliers' operations to help man their lines. We're really, it's a whole host of things that we're working on and really pulling every lever that's within our control to improve the supply chain situation. Not one thing, it's really a whole multitude of different initiatives that are being undertaken by our teams around the world to improve the outlook.
Got it. Thanks.
Thank you. Our next question comes from the line of Julian Mitchell with Barclays. Please go ahead.
Hi, good morning. Maybe just the first question on the portfolio, which I don't think has been addressed yet in the Q&A. I'm intrigued that you took down the buyback guide, because of, I think, heightened M&A appetites. Maybe help us understand sort of what's changing there. Is it just that because it's such a buoyant M&A environment, you're seeing a lot more assets for sale sort of coming to market than you'd expected maybe 6 or 12 months ago? Also, I suppose it tells us that you think valuations for M&A look reasonable.
Maybe help us understand, you know, has anything changed on your returns hurdles, or is it just the volume of assets coming to market is what makes it so appealing? On the divestment side, if you're getting more intrigued to do M&A, should we expect divestments perhaps to also pick up again next year?
Yeah, thanks, Julian. I would not read too much into the level of buybacks that we've done year to date. It's about $123 million. You know, what I draw your attention to is the beginning of the year with the big acquisitions that we've done related to Cobham as well as Tripp Lite.
We're always on the lookout for very good quality strategic acquisitions, which these two have certainly proved to be. Therefore, we just took more of our capital dollars and put them to acquisitions as opposed to buybacks. I wouldn't read anything into it in terms of capital allocation strategy changes.
As it relates to divestitures, you know, as Craig has said many times, we're always on the lookout to grow the head and shrink the tail. You know, whether it's a part of our business that's not performing, we're always going to look at pruning it and adding on the upside. Nothing specific to report here.
Yeah. The only thing I would add to what Tom said, I mean, completely agree with all that, is that, you know, we have been more active this year than we anticipated. If you know, there's obviously the big headline deals of, you know, Cobham and the Tripp Lite, but we've done a number of other deals during the course of the year as well.
You know, in our electrical business, JVs that we've signed in the China market, we acquired a Green Motion business in Europe. We have been very active this year in the M&A market. I'd say from a portfolio transformation standpoint, I think it's one of the most transformational in the history of the company. We continue to be focused on opportunities.
We are in fact seeing. You know, a better deal flow today than we certainly have in the last couple of years. Valuations in many cases are still stretched. What I will commit to you and promise you is that we'll remain disciplined and you've seen the kind of multiples that we're paying for our acquisitions and the type of assets that we're acquiring, and we won't lose our way. We'll continue to be focused on those kinds of assets, focusing in our electrical business, focusing in our e-mobility segment, focusing in our aerospace business.
We are seeing a better deal flow today, and you know, given the trade-off between a value-creating acquisition that's highly strategic and buying back shares, you know, we're obviously leaning in towards, you know, spending those M&A dollars to grow the portfolio.
That's reassuring. Thank you. Maybe, you know, there's been a lot of questions on the sort of revenue and EBIT and so forth. Maybe just on the free cash flow. You know, year to date, your sort of EPS is up, I think, adjusted, you know, 40%. The cash flow, free cash flow is down in the mid-teens.
Realize there are some sort of one-timers maybe driving a wedge between the two metrics. When we look at 2022, should we expect, you know, conversion to be closer to 100%? Maybe any initial thoughts on, you know, does CapEx have kind of more of a lid on it next year than this year? You know, any context around that free cash outlook from here?
Well, I think it's important, Julian, to note that in the quarter, our free cash flow conversion was approximately 100%, and free cash flow as a percentage of net sales was, you know, 12.4%. Our midterm outlook, I think, was 14%, so we're on that trajectory.
You know, as it relates to next year and going forward, we would certainly wanna be at that 100% or higher of free cash flow conversion. As it relates to CapEx, you know, we're always gonna have our first priority in our capital allocation to invest in growth in the business. You know, we'd be looking for those opportunities.
Great. Thank you.
Thank you. Our next question comes from the line of Nigel Coe with Wolfe Research. Please go ahead.
Thanks. Good morning.
Good morning, Nigel.
Hi, good morning. I just wanna go back to Electrical Americas. You did have a tough comp in the prior year with some inventory restock benefits in 3Q 2020. I'm curious, any comments on, you know, where inventories are trending right now in your channels?
I'm guessing it wasn't helpful. And then just one more crack at the supply chain. You do have a pretty complex supply chain down in Puerto Rico and I think Dominican Republic. I'm just wondering if that was a factor behind some of these supply chain snags.
Okay. Yeah, on the latter question, Nigel, no, not at all. I mean, you know, we do have a number of our facilities in the Dominican Republic and Puerto Rico, and that was in no way related to the supply chain challenges that we're dealing with. It really was, you know, third party suppliers outside of our four walls where the issues were largely centered. I missed the first part of your question, Nigel. What was it? I missed the statement around the first part of your question. What was the first part of it?
Yeah. Just, you know, you're comping some inventory restock benefits, so, in the prior year. Just curious what you're seeing in the inventories within the channels, this quarter. I'm guessing it wasn't helpful, but any comments there.
Yeah. I'd say, you know, as we talked a little bit in the opening commentary, you know, as we've done these channel checks and talked to our distributor partners, and they would tell you today that on balance, inventories are either in line with, you know, where they'd like them to be, or in many cases below where they'd like them to be.
Unfortunately today, given some of the demand in the market and some of the supply chain challenges, we're probably disappointing more distributors than we'd certainly care to with our inability to ship due to supply chain constraints. Inventories at this juncture, I'd say by and large are well in control and in many cases below where they need to be.
Yeah. That's what I expected. Just a quick follow on with pension. I think you've got $0.2 billion of pension contribution this year. We've seen some nice benefits from discount rates rising. Obviously, market returns being positive. Just curious, you know, the best view on pension funding for the next two or three years based on the current funding levels.
Yeah. Our pension, as you know, is almost fully funded. You know, we don't anticipate making any additional contributions to it. How the pension plays out in the next year obviously is gonna depend on, you know, the returns and the discount rate at the end of the year. You know, more to come on that specifically when we talk in February.
Okay. Thanks, Tom.
Thank you. Our next question comes from the line of David Raso with Evercore. Please go ahead.
Thank you. My question relates to incremental margins next year in Electrical. Just trying to get some sense. When you look at your slide 12, the end market assumptions, just from what you know about what's in the backlog and also how these businesses are structurally, when you look at that mix, is that a positive for incremental margins, neutral, negative? Just trying to get some sense of how you think about those businesses and of course, what you know is in the backlog price, cost and everything else.
You know, I appreciate the question and I'd say that, you know, there's nothing specifically in the backlog that we think is gonna drive any changes in terms of the incremental performance of our business going into 2022, as we've you know kind of articulated in the past is that you really ought to think about the company is delivering about 30% incremental.
We're obviously delivering a bit better than that this year. There's been a lot of great work done inside the business. We're getting some earlier benefits from restructuring. We're getting some benefits from the portfolio moves that we made this year. But I think, you know, for planning purposes, I think a 30% incremental is really the right way to think about the incrementals for the electrical business and really for the entire company.
Also this month, I mean, Siemens, the way they price, right, they're playing a little catch up. You heard even low double-digit increases on their resi products, high single for non-resi. Seems like you, ABB, Schneider's at least kind of 5+, 5%-10%.
I mean, it appears by the first quarter of next year versus the end of last year, I mean, pricing might be up as much as, you know, almost 20% in aggregate. I'm not hearing it, but I'm just curious, maybe I'm mis- Are you hearing any demand destruction at all with this pricing?
Yeah, no, we're really not hearing any demand destruction at all. As I said, it's been a kind of an extraordinary period of time where, you know, pricing seems to be seamlessly passed through to the marketplace and the demand remains strong.
I mean, yeah, you know, to your point around incremental margins, I mean, clearly what we're dealing with in this environment where, you know, hyperinflationary environment, where you have really big pricing, you know, going into market, but you have big cost increases, that you typically don't get your normal, you know, margins on the commodity increase. \
There has been this year and, you know, a little bit of pressure on margins as a result of not recovering, you know, the full margin on the commodity cost increase. That is certainly something that's held margins back a bit.
Yeah. Remember, it's not just commodities increasing. We're also seeing, obviously, labor increases. We're seeing logistics increases. You know, those are likely sticky somewhat going into 2022 as well, which, you know, gets you back to a 30% incremental for planning purposes.
Yeah, which is nice. It just doesn't seem like, at least we don't find any demand destruction at all. You know, even if hopefully a year from now, the year-over-year costs are not up as much, even come down a little bit. I mean, this is price. This is not surcharge, so it should be pretty sticky. It should, hopefully in the back half of the year, you know, help incrementals even more so.
Yeah. I mean, we're hoping it plays through exactly the way you articulated it.
All right. Thanks a lot. Appreciate it.
Thank you.
Thank you. Our last question will come from the line of John Walsh with Credit Suisse. Please go ahead.
Hi. Good morning, everyone. Thanks for fitting me in.
Good morning.
Maybe just a clarification question. Obviously, we all wanna take the sales from the supply chain in Electrical Americas this quarter and run them through into next year. I just wanna confirm that these are truly deferred sales and kinda none of it was a lost sale in some of the kinda low voltage, faster, book and ship stuff and that goes through distribution.
Yeah. I mean, I think, though, and once again, this is one of the things, John, and I would never say that 100%, right? There's always gonna be on the margin, you know, perhaps an order or two that you've lost as a result of your inability to deliver.
By and large, the fact that, you know, the backlog, you know, is up more than 50%, you know, by and large, you know, we typically have in the Americas especially. We have dedicated distributors who are essentially, you know, Eaton distributors who are, you know, committed to, you know, our relationship and essentially, you know, to our business.
Once again, we feel very confident that with our order growth and backlog growth that you know our you know that we're gonna hold this business and you know it you know the lost missed shipment today becomes simply a future delivery. And that's kind of what we think is the case for you know the vast majority of the delta let's say in growth that we've experienced in the quarter.
Great. Just wanted to make sure I understood it correctly.
Keep in mind also that these are typically projects. Much of this business goes into projects. On a project where you specify a particular, you know, supplier for your electrical switchgear, you know, it's very difficult, you know, once a project has been specified and won by a particular supplier or the other, for that to just simply be changed out to another supplier. I'd say that, yeah, we feel fairly confident.
Great. Maybe could we just get a little color on what you're seeing in China, specifically maybe around data center, industrial, commercial, kinda more of those industrial verticals?
Yeah. I think we're all reading the same headlines with respect to what's going on in China today, in an economy that has certainly slowed a bit this year and more than anyone anticipated with some special pressures, let's say, on the residential segment of the market. I will tell you that in our own business that our China team just had an outstanding quarter.
They're certainly part of the Electrical Global segment, where, as you can see, you know, that segment posted 18% growth. I would tell you that our Asia business numbers weren't terribly different than that. We had a very strong quarter in China. I think we're starting to see, you know, some of these real benefits of the joint ventures that we put in place, and we're seeing a lot more opportunities today than we have historically.
Our data center business in the Asia Pacific region in China is doing well. We're obviously watching the headlines and reading them as well as anyone. To date, what we've seen in both orders and in revenue, our China business, our Asia business is doing quite well.
Great. Appreciate the color. Thank you.
All right. Thank you.
Okay. Hey, thanks, guys. We have reached to the end of the call, and we do appreciate everybody's participation and the questions. As always, Chip and I will be available to address your follow-up questions. Thank you again, and have a great day.
Thank you, ladies and gentlemen. That does conclude our conference for today. We thank you for your participation and for using AT&T Conferencing Service. You may now disconnect.