Eaton Corporation plc (ETN) Q4 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Eaton Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode, and later we’ll conduct the question-and-answer session and instructions will be provided at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Vice President of Investor Relations, Don Bullock. Please go ahead.

Good morning. I’m Don Bullock, Eaton’s Senior Vice President of Investor Relations. Thank you all for joining us for Eaton’s fourth quarter 2015 earnings call. With me today are Sandy Cutler, Chairman and CEO; Craig Arnold, President and COO; and Rick Fearon, Vice Chairman and Chief Financial Officer. Our agenda today will include opening remarks by Sandy, highlighting the performance in the fourth quarter along with our outlook for the 2016. As we’ve done on our past calls, we’ll take questions at the end of Sandy’s comments. The press release from our earnings announcement this morning and the presentation we’ll go through today have been posted on our website at www.eaton.com. Please note that both the press release and the presentation include reconciliations to non-GAAP measures. In addition a webcast of this call is accessible on our website and will be available for replay. Before we get started, I’d like to remind you that our comments today will include statements related to expected future results of the Company and are therefore forward-looking statements. Actual results may differ materially from those forecasted projections due to a wide range of risks and uncertainties that are described in our earnings release and our presentation. They are also outlined in the related 8-K filing. With that, I’ll turn it over to Sandy.

Great, Don. Thanks very much and thank you all for joining this morning. I’m going to work from the presentation that was posted at our investor portal earlier today, and for the sake of brevity, I'll start right on page three, the highlights of fourth quarter results. As you saw we exceeded the guidance we gave for our revenue guidance, we achieved record fourth quarter segment margins. We generated $742 million in operating cash flow and we repurchased $228 million our own shares. We think a very strong quarter in the midst of pretty choppy end markets and I think it concludes the year on strong basis. If you flip to the second chart just a couple of the highlights in terms of the reconciliation to the midpoint of our guidance that we provided for the fourth quarter. You’ll recall the mid-point of our guidance was $1.10. Our volume came in just slightly higher than we had guided to you, recall we had guided organic sales being down 3% from the third quarter, it actually came in at 2%. The net of our restructuring costs and our savings came in about $0.02 better, we got all the savings and more than we were looking for and we actually done at a little bit less costs. Our tax rate did come in a little bit lower about $0.02, that’s 3.9% versus the roughly 5.5% we had guided to. And then our corporate expenses reflecting that same orientation towards really getting our structural costs down that you saw also manifest itself in our very strong segment performance contributed $0.02. So $0.07 peak [ph] for the quarter, a nice way to finish up the year. If we turn to Page 5, just the overall financial numbers I am sure you had an opportunity to study these. I would just reference one numbers in particular here because it does tie in to a lot to our thinking relative to having increased our restructuring over the next couple of year. The organic growth number which you see in the green box to the lower left of the chart, down some 4%, it was down 3% last year. So, our last quarter, third quarter. So, again if you think through the year last year we actually started up with a first quarter that was slightly up and then the second, third and fourth quarter we've seen our markets weaken. Just a quick run through the individual segments and we’ll get on to the guidance for ’16, which I think most of you are most interested in trying to get some additional color around. Let start with the electrical product segment that’s on Page 6. As you can see organic growth was down 1%, it was actually flat in the third quarter. You can see very strong margin performance, 17.7% volume relationship to last year down 5%. And obviously C4X was four point of that. Looking in the bookings, booking were down 1% and it’s interesting if you look around the world, quite different conditions by regions. Americas were flattish, Europe was up nicely, and Asia-Pacific both in this segment as well as in our system and services lateral segment down fairly higher. And we think that reflects the real weakness that’s been going on in China and we'll talk a little bit more about that as we go on in the call. Our net restructuring if you’ll see slight positive to the quarter, a good solid quarter and as you get down within the individual area clearly we’re continuing to see strengthen in our lighting products, our residential continues to be strong in U.S., Canada is weak, Middle East was quite strong which was one of the thing that helped Europe and across Asia Pacific whether it would be in China or whether it would be in some of the electronic products we supply as well, a weaker quarter. If we flip to Page 7. Electrical System and Services segment. We think a good quarter performance, a nice rebound from the third quarter if you look at the margins, up 13.9%. So one of the stronger quarters we've had this year in that segment. The story is much the same however in terms of the markets. If you look at the box in the lower hand corner again the organic sales down 5%, it was down 5% last quarter as well and the bookings being down 2%. The play out is fairly similar that the real week region was Asia-Pacific once again. As we have talked over the last couple of years we off course see that the bookings over the last couple of quarters are a fairly good predictor of revenue levels in the next several quarters and so if you look back to the third quarter of 2015 our bookings were down some 3%, now they’re down 2% and I think that will help you understand our thinking relative to markets when we talk about that and organic for 2016. If we move to the next page, page eight our Hydraulics Segment very strong margin performance here as well in spite of a very weak market conditions you may recall that in the third quarter we reported organic sales down 10%, during the fourth quarter they’re down 12%. Our bookings down 22% and that's pretty much a worldwide story. I mean if you go around whether it would be the Americas or Asia-Pacific the numbers are all negative and they’re negative also when we look at both the distributor and the OEM cuts. So these markets continue to be very weak and I think our team has done a really terrific job in terms of really containing cost and driving structural change and that's why you see we think it was stronger than most people expected margins and a segment of 11.2%. If we move to the Chart 9, the Aerospace Segment. Great quarter for Aerospace business as its continuing to having really very-very strong margins. Our bookings were up 6% and we’re particularly pleased in the aftermarket which you know is an area that we've been working hard to continue to bolster. It was up both on the commercial and the military side for an average about 14%. A lot of discussion over the last couple of weeks about what's happening in the commercial aerospace activity, we’ll talk a little bit more about that when we talk about our guidance for next year, but we continue to see that outlook being strong as we move into 2016 and 2017. And if we move to Chart 10, our Vehicle segment. Really strong quarter performance from a margin perspective again and I know a number of you have had concerns that as this business begins to turn down that it would have a disproportionate impact upon our margins. I think you see here in the fourth quarter our operating plans and the great job our teams have been doing in structural cost out is really having a positive impact not only here on the fourth quarter but once again in our guidance for next year. NAFTA Class 8 shipments in fact were down in the fourth quarter, they were down 6% and -- but you see that the really 18.4%, the margins here in the quarter. As we look into next year we’ll talk a little bit more about it in just a moment, but our forecast is that we’ll see the NAFTA heavy duty market beyond the order of 250,000 units, that's down about 23% from this year. So that is fully incorporated in our planning for next year. If we move to Chart 11, maybe just to kind of cap off 2015. We obviously saw organic growth be negative throughout this year, but in fact that we moved in the second quarter, this is a start to really driven structural cost reduction across the company, is why you’re seeing the real benefits here in the fourth quarter and that obviously sets up a really important part of our operating plans for 2016. Segment margins were 15.2%, free cash flows slightly below our target of 100%. As we look at this year, we did repurchase a 2.4% of our shares outstanding that's about $682 million we spend on that during this year. We paid down $1 billion of debt this year and we have completed the Cooper integration and so really as we enter into this next year you’ll see we virtually have no acquisition integration costs anticipated during 2016 as well. 2012 really -- just for your records really gives you the kind of breakout on how are restructuring plan laid out during 2015 and as I mentioned upfront our net benefits in the fourth quarter were better than we had laid out for you earlier and I think reflect the momentum we have with an overall restructuring program. Page 13, titled 2015 Restructuring Cost and Benefit, really gave you a view of that full year activity more for your historical background as you think of our performance across the segments. Now jump to Chart 14, as we start to talk about our thoughts about 2016. With the weaker markets that we had anticipated in October you may recall those number, I'll go back over them for you in a just a moment on a subsequent chart, we've now accelerated and in fact expanded our restructuring actions and as our view that a couple of you had commented on your write-ups this morning that 2016 and 2017 will remain somewhat challenged time periods in terms of end market growth and so our focus is getting the cost out and using our balance sheet to buy back shares and to really get the company in well positioned in what will be a period of lower growth then we had seen in previous years. So what you see in that chart up top, we’ve tried to lay out for your ease, here is our 2015 actuals, than our 2016 and 2017 costs and then the incremental benefits that occur in each year, it's incremental to the previous year and you can see the total. The big news here is that we’ve expanded the program to a three year program, we’re going to spend about $400 million, we’ll get benefits of just over $400 million over this time period. And as you think about 2016 because I know that’s of real interest to you, we’ll spend about $70 million of that $140 million in the first quarter of this year. Above 50% of the balanced, so of the balance of the $70 million will be spend in the second quarter and then during the third quarter and fourth quarter the spending is fairly equal. The benefits however, not much of those incremental benefits of 185 occur in the first quarter because we’re just kicking off this second phase of actions and it builds through the balance of the year. So it is a reasonable expectation that it has a bigger contribution to operating earnings per share in the third quarter and fourth quarter than it would have in the second quarter. Let's jump to Chart 15. And I mentioned before our view of our markets and organic growth opportunities are lower than they were when we last discussed this with you in October. You recall that we haven’t laid out a formal forecast, but we had shared with you some early thoughts on 2016 in our October earnings conference call and at that time we talked about organic revenues being down on the order of 1% to 2%. We now, with the benefit of the last several months and I think all weaker and after [ph] news, it’s not only we but you also have been reading as well our detailed discussions with our customers around the world. We think a better expectation tuned up for that doubt is that our organic revenues would decline on the order of 2% to 4%. As you go through these individuals segments let me just give you a sense for what has changed. As you can see the rate on the chart our organic revenue growth projections for the individual five segments we report. For Electrical Products, we think the organic growth will be in the range of 0% to 2%. In Electrical Systems and Services, a negative 2% to negative 4%. In October we had said if you put those two together we thought the growth would be about 1%. In the Hydraulics areas we are now forecasting organic growth of negative 9% to negative 11%, in October we had said we thought it would be about negative 7%. In Aerospace we're saying 1% to 3% not that much as change, we thought it would be 3%. And in Vehicle we had thought it would be negative 5% in October, we now think it will be 7% to 9%. So what are the big drivers here, let me start from a bottom where I ended with Vehicle. We now think the North American heavy duty market will decline to about 250,000 units that's the whole market for NAFTA down 23% from where we finished up just over 320,000 units in 2015. We think light vehicle markets in the U.S. are going to remain strong kind of flat to 1% up, we think China will continue to move along fairly well in terms of its light vehicle markets. We think Europe, we’re in agreement with most of the consensus that’s out there that its probably up on the order of something like 2% and we continue to feel that Latin America is a very troubled area and really when we talk about the vehicle market, we’re talking really about Brazil and so those numbers will be down 10% to 15% this year. That’s what brings us to our 7% and 9%. Within the hydraulics market I would say really a continuation of the negative expectations in terms of the world wide Ag equipment market and the construction equipment market and not much positive on the industrial side. Then I would say again 9% to 11% is our best approximation having talked to our customers and you've seen many of them release their own guidance for 2016. We think this is very much in line with our own projections. If you move to Chart 16. Titled Segment Operating Margin Expectations, I think it's really noteworthy that in the fourth quarter we increased our operating margins in spite of negative organic growth and that is indeed exactly our plan again in 2016. In spite of about $1 billion volume decline and again that's about 600 million in organic growth and about 400 million from Forex, we expect to expand our segment margins. They finished at 15.2% last year and as you can see the midpoint of our guidance is 15.6%, so about 40 basis points expansion. We can obviously talk about each of these as we field your questions, but I would call your attention to Vehicle because I know many of you are concerned in terms of looking at the year of 2016 is that we would see a several hundred point contraction in vehicle margins as the overall market place began to decline and as you can see we’re confident with our operating plan and the benefit of all the restructuring we’re doing and the fine jobs been done by our team there that we’re going to hold very attractive margins in that segment. And I think it’s really a key element in terms of thinking about the evaluation of [indiscernible] because this is one that you’ve been concerned about historically from a volatility point of view. If we turn to Chart 17, labeled our Multiyear Share Purchase Program. You’ll recall in July we laid out our new capital plan which outlined on an annual basis repurchasing 1% to 2% of our outstanding shares per year. We paid of this last year as I mentioned about $1 billion of debt and we repurchased $682 million or about 2.4% of our outstanding shares and we have commented through the fall that in this period of time where we're seeing such weakness in equity pricing and specifically on our own that we were tilting our balanced plan that we had of spending about 50% on the share repurchase and about 50% on acquisitions that we were tilting it towards buying back more of our shares. And what we’re announcing today obviously is that we’re targeting a $3 billion share repurchase program and those are for the years 2015 through 2018 and so what that means was also having purchased back obviously 682 million last year this is about $2.3 billion of purchases over these next three years about 10% of our outstanding share. That does move us a little closer to sort of an annual buyback that on the order of more like 2.5% versus 1.5%. Specifically in terms of 2016 and you’ll recall that I just mentioned the numbers in 2015, we bought back 682 million, we would expect the buyback about that same levels this year, roughly $700 million. It will as it normally is for us be backend loaded in terms of how are cash flow lays out through the year. But it does play an important part in terms of how we offset a slightly higher tax rate and I'll talk about that in just a moment. You’ll recall at yearend's 2015 our share count was 460.4 million shares and so we’ll leave at you to kind of figure out backend loaded buying back about whether to pull out full shares, but we think its worth around about $0.09 of positive impact. So if you move to Chart 18 to kind of pull this all together in terms of our EPS guidance for 2016, let's start with the first quarter. Our operating and fully diluted EPS this year is the same because we don’t have acquisition integration across this year. We think our organic revenue compared to the fourth quarter so the actual numbers we just reported will come down about 5%, for those of you who are already calculating that means it’s down about 8% from last year in the first quarter. The tax rate will be between 8% to 10% and the segment margin including the restructuring cost of the $70 million will be somewhere between 13.5% and 14%. That's what supports our $0.80 to $0.90 operating and fully diluted guidance for the first quarter. In terms of the full year again no acquisition to raise [ph] cost so the $4.15 to $4.45 with the midpoint of obviously $4.30. The guidance does include the full net restructuring benefit that we outlined for you that’s on the previous charts of $174 million that's a year-to-year benefit from our restructuring. And the $45 million from the Cooper integration savings which is primarily the full year benefit of the plant closings that we were concluding in the back half of last year. So the operating EPS and I think this is really the best way to think about our operating plan. We’ll have flat operating EPS year-to-year, will actually be up 2% in terms of fully diluted. So we don’t have acquisition integration charges. But that flat operating EPS year-to-year really incorporates having revenues down $1 billion, $600 million of organic, $400 million of FX, margin’s up 40 basis points, driven by all the restructuring work that we got a good head start on by starting early in 2015 and then the share repurchases of approximately 700 million are basically going to offset the impact of what we anticipate is going to be an increase in the tax rate from roughly 8% last year to roughly 10% as the midpoint of our range this year. So if you turn to Page 19. Just to recap again organic revenue down 2% to 4%. You’ll recall we had a couple of very small acquisitions so we had a little positive in terms of $35 million in terms of additional revenue. 2% negative Forex, that’s that $400 million top line impact that I mentioned negative. Operating margins with the 40 basis points expansion from last year. Corporate expenses continuing to reflect all of the work that we're doing to get our cost down not only in our operating units but across the corporation as well. Tax rate ticking up slightly from last year, I just mentioned the flat operating EPS and the 2% increase in net income per share. Operating cash flow 2.6 billion to 2.8 billion, free cash flow of 2.1 billion to 2.3 billion, obviously that looks like it's been as a cash conversion ratio of greater than 1 and yes that’s exactly what we’re targeting. Then CapEx of about 525 million, I can understand some of you may have a question, gee that's pretty similar to what you spent last year, if your volumes are coming down, why are you spending as much CapEx? We do have some capital that is involved in all of this restructuring actions and that's really the difference to facilitate getting them done in areas where we may be closing and consolidating facilities. So that’s our outlook for 2016 and we think it's a tight plan. We obviously have had the benefit of looking very hard at these markets and we’re really confident about the restructuring plan that we put together. And so that restructuring plan and our share buyback, very much in our own control and those are the kind of variables we’re trying to control as we move into it into 2016. Don with that I’ll turn things back to you for questions.

[Operator Instructions].

Before we begin the Q&A session today, I do notice that we have a significant number of questions in the queue. So given our time constrain today of an hour for the call, and the desire to get to as many of these questions that you have as possible, I’d ask that you limit your questions to a single question and a follow up. I appreciate your cooperate in advance. With that we’ll open the questions with Scott Davis from Barclays.

Sandy you only have I think four months left or so of your tenure and you’ve seen a bunch of cycles and I’d love to get your opinion on how does the world get better? I mean how do we -- back here, your bookings are getting less negative for sure, but how do we get back to positive growth, what’s it going to take in your opinion at least from a world perspective to have a recovery insight?

That’s probably almost a [indiscernible] question. But I think clearly we’ve got a couple of big issues going on and we’re in a commodity cycle and it doesn’t matter whether it be oil and gas, whether it be metals, whether it’d be Ag, we’ve seen as the world has slowed down it's not having a fairly profound effect on a lot of these commodities. This too will bottom we’ve been -- lived through a bunch of these. It just our view that we’re not going to see that end in ’16, that’s why we said that it's so important really to get -- to take these restructuring actions in ’15 and ’16. Hard to forecast right now, Scott, whether that turn up is in ’17 or whether that turn up is in ’18, I think most forecasts have always proved to be wrong, but I think that the benefit of where we are right now, we’re in the second year of this fairly deep commodity cycle. And as we pointed out in our earnings release, this is really only the second time that we have seen our end markets be negative in consecutive years and we got to go all the way back to the 2000-2001 time period; people were pretty mopey then and by 2002-2003 we popped back out of that. And so I think you will see this cycle come back out.

And then Vehicle, I’m one of the guys who’ve been skeptical in margins and you’ve proven us wrong here. Help us just understand, is this all a function of restructuring? Is there other benefits here, whether it’d LIFO accounting or mix or something else?

No change in accounting. This is just plain old hard way of running a business really well, and the teams have really been working hard on restructuring and making sure that new products we introduce have attractive value propositions and just I’d say it's doing it the hard way.

So, some of it is new products that are not [multiple speakers].

But remember in the automotive business you tend to -- we have pretty good automotive and truck business. We have pretty good visibility forward wise in terms of what we win. So, I think we’ve had another very good year of bookings in 2015 really on a global basis. And so we feel comfortable both on that revenue side of how we’re doing with our customers. But I feel really good about the work that’s been done in the business on all of the cost work.

Our next question comes from Ann Duignan with JP Morgan.

Good morning and thanks for the color on the Vehicle side and Hydraulics side. Sandy could you give us similar color regarding your subsectors in Electrical Products and Electrical Systems? What you’re seeing in the different end markets?

I think our comments probably aren’t going to sound vastly different from many of our peers who have announced, we’re looking at the residential market in the U.S. as being one that will continue to be a positive on the order of say 3% to 4% next year, non-res is probably the hardest one of all of those numbers to figure out particularly here in the U.S. there are so many different opinions on non-res we think much of what’s been published is perhaps a little too bullish. We’re more in the 3% to 5%. I know there is some people that are at 8%, gosh I hope they’re right, but that’s not what we’re basing our expectations on. Utilities is a little better than we’ve seen it the last couple of years, but it's still a 0% to 2%. Industrial is quite troubled still in terms of just not seeing a lot going through that, so that’s probably a 0% to a negative number. As you get into harsh and hazardous applications that have large portions of oil and gas around them, those are numbers that are like negative 15 type number. And then when we look in the large power quality areas, I’d say those markets are likely to be slightly negative again this next year. Last comment I would say is that we just don’t see the big large industrial construction numbers that are being so quantitatively [ph] reported in many of the government’s statistics. We’re out there bidding on them all and we aren’t seeing what they’re talking about. So that’s our view as to how we look. We don’t see Asia Pacific getting substantially stronger, we think still that’s going to be weakened up by the lack of the big projects there. EMEA is coming back and I mentioned in the fourth quarter we saw pretty good tone there and again we’re at a very low single-digit but it's better than a negative.

Thanks for the color Sandy. And just a quick follow up, you had mentioned previously that on the manufacturing side in the U.S. the downstream built up from oil and gas. But maybe you start to see orders in that business pickup towards the back assets this year for deliver in '17, is that still your expectations?

The big natural gas and exploring terminals that we are committed [technical difficulty] to us like those are going ahead here in the second half, that’s still our expectations. You are starting to see some of the big integrator are really clashing capital budgets again and that’s why our view has been that you have a second year of a negative in the oil and gas industry broadly in this year. And once you start these big cycles it takes a couple of years for them to swing back.

Okay. Thank you, I leave it there and get back into queue. Thanks.

Our next question comes from Steve Winoker with Bernstein.

Maybe a little bit more on the margin front. So, given the ambitious margin expansion you've got set up for next year, the way I use to think about it with you was decrementals I think 20 to 30 normally, plus you got pricing here soon productivity kind of costs inflation. Could you give us -- or deflation -- give us a sense for some of the pieces of this, obviously with restructuring being the baggiest positive, but just help us work through how you’re getting there?

I think Steve the way is, as we have watched volumes come down as strongly as they have all the way through '15 and then '16. Those incrementals or decrementals are getting bigger because you’re getting down to points where you really have big knee curves. And so our own thinking is it’s probably a 35% at this point so that’s how we sort look at the decrementals. It hasn’t changed degree to yield for us in terms of Forex but those are more like 10% to 11% types numbers. And then the rest basically comes from the cost reductions that we’re getting. And remember to add in the $45 million of the acquisition integration benefits into the two electrical segments.

Okay. And then the other pieces like pricing, what that in there?

It's fairly neutrally, I would say our expectations is that we do expect some tailwinds this year and that’s really because commodity prices have come off as hard as they have in the fourth quarter and January sure look that way all the numbers we can see, commodity didn’t do much recovery in the month of January. So, I’d say a slight tailwind from commodity on margins this year as well.

And just a follow up. That restructuring for the fourth quarter, I guess you did $2 million of costs and you saved about $10 million more versus planned. Was that all timing in those two line items on Page 12?

No, I would say that the big issue is that we were able to complete that restructuring at a lower cost than we had thought it was going to take, it’s wasn’t that we pushed something out, it wasn't that we didn’t take some action, it’s just sort of the actual cost turned out to be less than we had thought it was going to originally take.

Okay, okay thanks.

Our next question comes from Julian Mitchell with Credit Suisse.

Just starting with Electrical Products. You are guiding for a reasonable margin development in 2016, but looking at the moving parts lighting probably outgrows the rest that’s a mix drag, it often has been, could be very difficult. So, why do you -- is there something in the mix or is it purely restructuring that you think can give you that margin uplift in Electrical Product?

Our [indiscernible] numbers is in Electrical Systems and Services. But I would say it's the restructuring and it’s the benefits from the Cooper. So, remember those first two segments Electrical Product, Electoral S&S that have both the restructuring savings and then you'll have about $45 million to put between the two and it's likely to be pretty equal between the two this year the $45 million.

Understood. And then my follow up would be on Vehicle, not so much the margins but just the top-line. So, in Q4 you had a 6% organic decline, NAFTA Class 8 shipments were also down six. For 2016 you are saying that NAFTA Class 8 down over 20, but your organic sales guide for the year is only down high single-digit for vehicle. So, I guess what's changing in 2016 versus Q4 leaving aside Class 8?

You get a little bit a seasonal here too as well. And remember in the fourth quarter you have a bit of what I will call second half December shutdowns that occurred. So, that’s a piece of it, remember that North American part of that fall of actually occurred in the fourth quarter to. So, of the 23 we talked about reduction you had a 6 points fall off from a year ago occur in the fourth quarter and we’re talking about full year 23. But I think it's more seasonal and Craig any other color on that?

Obviously, you just need the metrics [ph] to tell, the 6 was the Delta from Q3. If you actually take look at North America classic truck, year-over-year it was down much more in line with what the forecast in 2016 and the North America Class 8 truck number is obviously an important number for the vehicle business but as Sandy went through that point one of the many segments that make up our vehicle business. And we continue to see around the world pretty robust numbers in growth in our automotive markets around the world, and so just one piece of the equation. And then the other piece as we start to anniversary some of the really weak numbers that we’ve seen in South America which is the biggest piece of our Vehicle business or Company's exposure in South America and Brazil, those comparatives just get much easier.

Our next question comes from Joe Ritchie with Goldman Sachs.

Good morning. This is actually Evelyn Chan for Joe. Thanks for taking my question. Just wanted to touch on capital allocation and the 3 billion share buyback program, not to put words in your mouth, but I think the view on the priority of investment has been first to address weaker marketing that cost out and as than if you get our to 2017 maybe there are other alternative to running your business or portfolio that are available to you. So I guess what's the impedes to commit so much of your cash now towards buyback for the next few years?

And again it's not all of our capital, it's -- we’re tilting it towards that and our view is that this time of relatively weak equity performance and weak market prospects is a time when we can take advantage of really buying back shares and creating value for our customers at a time when I think certainty is something that everyone is looking for and so that's our view in terms of tilting over this point.

That makes sense Sandy. And then I guess maybe switching gears it looks like bookings trends are moving in the right direction and we've heard a lot of surprisingly positive commentary from the industrial peers on short cycle trends in January. Can you address what you’re seeing in your business here at the start of the year and what you maybe see in your front-log to drive back 8% year-over-year decline in 1Q?

Our view is that there are couple of distributors that have come out and talked about things being a little bit more positive. Actually our direct business peers, I don’t think you've heard as much commentary coming out about the first quarter. I don’t think we're seeing anything at this point that causes us to think that markets are better than what we’re forecasting here. This is a -- we've seen markets coming off each quarter throughout 2015 typically our first quarter is seasonally weaker than our fourth quarter, it's our weakest quarter of the year and that's how we've laid out our guidance for this year. So I think it's a little early to call the year. Fortunately, we haven’t had a major snow event this year which hasn’t given us a big hit in January, but I’d say no were not seeing anything different than our guidance at this point.

Okay, thanks very much.

Our next question comes from Jeff Sprague with Vertical Research.

Thank you. Good morning everyone. I wonder Sandy if you can come back around to price. So I think it was an earlier question on price and I think you answered it more around kind of cost relief, but when you were saying you see a tailwind there, where you kind of commenting that price cost net is the tailwind? Can you just price [ph] that together for us and provide a little bit of color actually on the pricing side.

Yes. I would say yes the price cost net, a slight tailwind. And [indiscernible] conditions are very different in every one of our market segments some have long-term contracts, some have price adjusters and then they’re based in contracts, were not seeing the environment being one where there I would say there is undo price competition. Obviously markets are down, things are tough and if we see the market is behaving pretty well.

And then on the comment about the corporate expenses down maybe towards the $80 million decline is that all in across corporate options and pension and everything or is that actually just the corporate expense line?

Yes. So that's interest amortization, pension and corporate cost, so that whole complex of cost.

Great, thank you.

Our next question comes from John Inch with Deutsche Bank.

Look I realize this is not a direct comp, but it is the big industrial, Emersion more or less suggested that we were approaching a bottom with respect to its various markets and they expect orders to actually turn positive after March. Sandy, it's kind of ductailing on Scott's point, I mean do you think we are approaching a bottom, it doesn’t suggest there is recovery coming anytime soon. But do you think we’re approaching an overall bottom and then what are you thinking about your own orders, are we looking at a positive inflection at some point this year?

Perhaps it's the best indication, we've talked about this point a lot John and our own planning is as we put the plans together this fall were not counting on an economic rebound in the second half. We think that's been kind of an unwise premise to go into these markets where if it does gets stronger, so much the better, we can scramble up, we've done that well in the past, but the restructuring actions that we’re taking, this commitment to a three year restructuring plan says that we think 2016 doesn’t recover when we get to the second half.

First I wanted to echo some of the other comments so I think your margin performance in the pace of while which is actually pretty commendable. The one business that does take out is Hydraulics right, it does appear whether it's because of Asia or pricing or whatever it appears to be getting worst and it appears margin, but I mean your margins are down despite the heavy emphasis of restructuring your margins is still down a point year-over-year. So what I'd be interested in is really your thought process about and maybe Craig’s even, add to this. Hydraulic strategically I mean I guess if we have had this perspective that's the world was going to be this difficult we may not have built this businesses, there is some of the M&A we get kind of more recently, but instead you’ve made the comment that you can’t really adjust your portfolio in terms of spins until what 2017 because of Cooper. But you can always still do something with the business on a sale basis or something else. How should we be thinking about Hydraulics? Because it really is sticking out negatively, unfortunately versus the other segments at this juncture.

Let me come back to couple of the elements that you mentioned. You are right is that we are not able to do tax free spins until after the five year anniversary. We have indicated that we do have the strategic flexibility that if we decide to we can sell businesses on a taxable basis just as we did the two aerospace businesses that Craig led last year that we felt we could better step out of because they weren’t strategically managed. There is no question on hydraulics. We’re dealing with a very difficult end market. We commented on that last year, we don’t think that’s going to change this year. We actually think the margin performance is pretty commendable in light of where the volumes have been, but we understand it's not at the mid-teen levels right now that we would like to see it at. We do think with the actions that the team is undertaking and if we get into the later part of this year, you’re going to see some far more attractive margins than you will see in the early part of this year because we’re taking some very-very significant steps within that business. We’re trying to get this business sized so that you can perform well without having to have a market rebound because again we think we are in a commodity cycle and clearly we don’t have the benefit of the revenues that we had number of years ago, when it was the high point. And Craig do you want to add anything to that?

No, the only thing I would add to what you said is we really are living through what I would argue is a really unprecedented period in the Hydraulic markets and you can’t find the hydraulic end market today that hasn’t gone through a pretty perceptive downturn, whether it's Ag or it's China construction, or its mining the oil and gas. Most recently anything tied to capital purchases and on the industrial side the business. And so when we take a look at the end markets that we serve inside our Hydraulics periods, but for the great recession over the last 15 years we’ve never seen a period like this in Hydraulics business and to say this point they have a business that in this environment that can still stand up clearly margins got on it the Company average, but margins that are 10% to 11% we think is pretty remarkable performance from that business. And at some point these markets will turn and whether or not that end of ’16, ’17 but to Sandy’s point we’re putting together a plan today that says we’re going to make sure that this business deliveries attract the margins at this level of economic activity and when it turns it will throw up very handsome new commendable profits. And so today clearly we’re living in a period in the hydraulics space that we don’t like it any more than you do, we’re doing what we think we need to do, but we think this will be a very attractive business when markets turn and they will turn.

And Craig would it also be fair to say, I mean Sandy intimated you, we’re still dealing with a little bit of M&A even though you’ve stepped up share repurchase. Rather than just ride out Hydraulics and the cyclicality, would it be fair to say you might want to make up for some of those other deals in terms of the timing and do some acquisitions in this space? Is that on the table still?

So what we said really is, until we get a real sense for where markets are going to bottom out, it’s really difficult at this point in the cycle to really value Hydraulic assets. And so to your point, we made a couple of acquisitions in this space a number of years ago and quite frankly we and the whole world got markets wrong. And so I would say as we think about hydraulics today in M&A it really is a piece that’s off the table until we get a sense for where markets are and nothing bottomed out and we can really then predict the future.

Our next question comes from [indiscernible] with Longbow.

Just following that up everybody picks on the toughest segment in the bottom and with every turn people say who benefits and you have good sector to benefit. But when we talk about hydraulics in front of the rest of the Company, can we talk about where inventories are, what did you see during the quarter as far as inventory liquidation and most of it’s over or are we close to doing it? And where do you think inventories are as you go through this year for you guys into channels and particularly with lower volume maintenance [ph], so we’re probably coming down some more?

Our best sense and talk about the two segments where there are distributor inventories, I think that to answer your question is on the electrical side people have been seeing markets be tighter than they were a number of years ago. And so we actually think there hasn’t been substantial change in inventory. They’ve been low. We don’t think we’re either suffering from liquidation or there is a lot more liquidation to go on. On the hydraulic side, clearly the point Craig just made, our distributors have been dealing with this for prolonged period of time. I think the one segment where you find when you travel regionally and you talk to different customers, if an individual distributor whether they were electrical or whether they were hydraulic had an unusually high exposure to oil and gas area. They may still be struggling with some inventories because I think that has continued to move in a way that many people didn’t predict it would. But I’d say outside of that, I think they’re fairly balanced. I think people have got their hatches buttoned down tight and they too are trying to live through a period of time when growth is less than they’d hoped it might be a couple of years ago.

So, we're looking at production, it will effectively end market demand? [Multiple speakers].

Pretty similar. I think the major OEMs are very much that way too, they've been at this for some time as well. So, with the exception of what I’d call you'll find in some OEMs the big issue isn't the inventory, it's that the equipment they have shift is being utilized at a very low level. So there the utilization rates has to come up before their demand, before new equipment comes up. But I think it's less of an inventory issue today and that was just very low levels of utilization.

And just a follow up, I mean we talked going up a little bit with Emerson's said yesterday in their numbers. But the one market that they pointed to was that datacenter market had bottomed and they talked about improving datacenter markets, I don’t know if you are seeing that’s or has that just happened, is probably better than what you are anticipating. Are you seeing any movements in the datacenter sector here or in Asia or so or is that still a hope that’s happening rather than [indiscernible]?

And we had action last fall and it’s continued for us, that they were -- during a first half kind a disappointing year in terms of significant bookings. We saw really good activity and good wins in the second half of the last year that is going to help us with our shipments this year. And we've been very pleased with the fact that I think I've mentioned on several occasions that we came out with the new high-end three phase UPS which had an even higher energy saving component which was really sized for the web point, a 2.0 type of datacenter. So, it is allowing us to compete very advantageously there.

You have forecasted improving datacenter markets as we go through this year as part of the Electrical forecast of this month?

Yeah. And I will say the overall PC market is not that great but some of that top end stuff is getting better.

Our next question comes from Joshua Pokrzywinski with Buckingham.

So, just on the follow-up to kind of some of these comments on when we bottom and when comps will be easier. I guess maybe this is still down a little bit Sandy, do you think we exit 2016 just given the comp influence of maybe a little bit of destocking obviously not that much based on your last comment on easier comp. Do we start to see a business like hydraulics inflect positive by the fourth quarter?

We are not forecasting it at this point, it's just we would love to be able to answer to the question, believe us for our own utilization as well but we just -- we think we're better the plan on the fact that we aren't going to see the rebound at that point. And if we do it will be an upside, there is so much time between now and the fourth quarter in terms of seeing what happens to crop prices, what happens to commodity prices and we've seen the volatility in these areas. So, we are not able to forecast that so, we are not assuming it's going to occur.

Got you. And then maybe from the margin perspective on the other side of that. As restructuring yields out, I mean by the time we get to the fourth quarter you should be running well above that 10% just given the timing now and maybe any help you can give on that?

Yeah. Very definitely, and again as we go back to the comments I made about the restructuring if you recall that of the $140 million of restructuring costs that we’re going to incur during 2016, $70 million is in the first quarter, roughly $35 million in the second quarter, then the balance in last two. So that just itself helps margins. Now, you put the savings which their whole incremental savings occurs over the quarters of two, three and four and it gets bigger as three and four go on. So, yes each of the margins should deal and very distinctly in Hydraulics, back to Craig's position you will start to see how this plan manifests itself. I think the real big takeaway from yours and many other people's question is that we are not counting on an economic rebound to drive our plan nor our earnings. What we are counting on is the things that we can control and that’s the very important change that we made at the second quarter of last year when we announced that we were going to drive very significant restructuring and that we've now added another year to that, but then we've also announced an enlarged buyback. Those are two things we can control and we think in this environment where there is so much that people are so uncertain about, we are putting the premium on, let's deliver certainty where we can.

Our next question comes from Nigel Coe with Morgan Stanley.

Thanks good morning and kudos on the cost control. Couple of things just wanted to go back for restructuring and I am just wondering does the nature of the restructuring change over the next couple of years and I am just wondering if we move from headcount to more facility based restructuring. And within that maybe just to make a comment on the CapEx, although the CapEx’s comments around restructuring was interesting. I am wondering are we seeing some capital perfect use of labor here or just primarily consolidating small some of these into larger ones?

Hi Nigel, this is Craig Arnold. Maybe I'll take that one for you. The way we think about kind of this whole roadmap to reducing our cost is, we really think about it in three buckets. These was a big buckets around facilities. Our manufacturing footprint around the world and distribution centers and offices, and we have a pretty healthy appetite and the backlog of opportunities to continue to right size our facility footprints. So that’s one big bucket of activity that is undergoing today and we think that continues for the next several years or so. There is another bucket that really gets to what we call support costs, a numbers of management layers that we have and the span of control of our leaders, the size of our corporate infrastructure and that’s a whole another element of activities that has done a lot to improve it in 2015 and we think that also plays out continually in 2016 and perhaps a little bit in 2017 as well. And then there is the third bucket that I’m put the category of really optimizing where you do, what should do and actually moving more of our activities to low cost centers and as we’re opening up shared servicing [ph] in low cost countries and putting various activities that we do today that simply putting them in places and where we can do it to a much lower cost and in many case more efficiently. And those are really the three bucket of activities that we’re undertaking across the company and we think it continuous being part of our go forward plans.

Okay. That's good color. And then secondly I appreciate the color on the cash deployment over the next three years. On the free cash conversion roughly $0.107 [ph] for next year what gives you confidence that that you can get the work to capital other system as your sales are declining 4% or so?

I'll take that Nigel. They are really two big elements to the improvement in free cash flow from 2015 to 2016. First of all we are not going to make a U.S. pension contribution and so that's is an improvement of about a $160 million and then secondly with sales going down generally classic working capital is about 18% of sales so as the 420 million or so of organic sales decline gets around $80 million and then we do have inventories that we have built up as part of Cooper that come out and frankly we ended the year with a little bit more inventories than we had hoped simply because of the speed of which sales had come down and so all of that leads us to say the expectation of a 160 million from lower pension contribution and another roughly a 140 million of working capital liquidation, that's how you get from this 1.9 to 2.2 midpoint of free cash flow.

Our question comes from Andy Casey with Wells Fargo.

Sandy I'm wondering within the nonresidential commentary that you gave little bit earlier whether you've seen any of the weakness being seen in some of your industrial end markets in the U.S. starting to impact any of the really nonmanufacturing sectors of nonresidential construction.

Let me take oil and gas kind of offset the table but if you speak to the other nonmanufacturing we obviously had a very good quarter, fourth quarter in terms of quotations. When we look at all quotations and negotiations we’re involved in the stronger part of the commercial market from our perspective and we've got a very big window looking at, I'm speaking to the U.S. here has been the smaller project so it's been project that you could say or it kind of start off the residential base and they get up into kind of medium size projects is the really big ones that are intended to be a little bit less strong in the marketplace now you are seeing a number of big stadiums build around the U.S. that really started in the second quarter of last year and that's going to continue through this year. What I'd say the weakness we've seen in kind of construction in the U.S. has been very big power using construction where a lot of medium vaults are just used and that tends to be industrial or very big-big commercial and the strength has been more towards the smaller projects.

Thanks. And then I think kind of going back to some of the other questions but taking a different view point on it, if we look back at prior cycles you see some of the things that are weakening fairly significantly off of peak conditions, like truck. What sort of probability would you put on the U.S. instead of staying in this stagnate and just starting to go into recession, not this year but maybe next year?

We don’t see that as the high probability, We do think that we are in this frustratingly slow environment that can often cause people to use the recession word, but I think that's almost a more of a kind of an emotional issues than it is a the factual basis, we think that GDP is likely to grow in the mid-two's again this year. However as we are on the industrial side of the economy were seeing industrial production numbers that are more like 1. So all that we’ve been and I'm just repeating what we probably all read is that there has been more action on the kind of the consumer and services side then there has been on the industrial side and that's what's been leading to the lack of capital investment for this MRO industrial malaise and that is clearly been affecting ours and many of our peers market. So I think I would say that's more of the tone and you compare the U.S. growth to around the world it's not significantly different in the total global GDP so there are countries slower and faster, but that's how we see it. We just think this is it is the time when it's really critical that companies get their cost base adjusted that they don’t assume that economic growth is going to bail them out hence they control those things that they can control and that’s exactly what our plan’s all about, but it's not based on and nor do we think it's the high probability that there is a recession.

Next question comes from Deane Dray with RBC.

Thank you. I had a question on the Aerospace number of the booking up 14%. How does that split between commercial and military, and how much of that will flow into 2016?

The commercial side, Deane, continues to be the stronger side. If we look at the three elements of booking within Aerospace, we were seeing commercial be up on the order of roughly 7, military was down on the order of about 6, and then aftermarket was up the 14. That’s not a bad way to think about how things work going forward. As we think about a market we’re seeing will be up too next year, you’d assume the commercials is going to be a slight premium to that market and the military is going to be a slight discount to it. And we would hope that the aftermarket that we could grow a little faster in the average, it won’t be like the 14% or 15% number, but it’d be slightly above our average number.

And then for Rick the tax rate for 2016 seeing a lift from 8% to 10%. Maybe just comment on what’s going on there? And is there any update on what might be the natural rate that Eaton would level out to?

Our rate as you point was 8% for ’15, the midpoint of our guidance of 10% for ’16. And really that’s the function of more U.S. income it's the function of the restructuring actions a lot of which do increase U.S. income. As well as the fact that the U.S. is -- some parts of our U.S. business that are still growing pretty healthily certainly relative to some other parts of the world. If you look longer term, I continue to believe that the rates will be somewhere between 10% and 15%, it’ll probably slowly tick up. But I would emphasize slowly not like more than 1 or 2 percentage point moves in a given year.

Our next question comes from Jeff Hammond with KeyBanc.

Just have a quick follow up here in corporate expense. Can you split out of that $80 million, how much is restructuring savings that we should put in the restructuring bucket and how much is something else like lower pension?

I think there is very little that’s restructuring at this point. And so I would regard that as principally the core corporate cost Jeff.

So, we can figure that as a separate bucket from the incremental restructuring savings?

No, it's all built into the total number that we gave you. But I guess what I am just indicating is that the amount of actual corporate cost for restructuring in ’16 are very-very tiny part of that $140 million, it's single-digit million.

How much is pension going to be down year-on-year?

There is going to be a substantial improvement in pension or reduction in pension costs. And it's a number that will be -- for two reasons it will be a number that is down on the order of north of $50 million and the biggest part of that is going to be that we did move to the split rate pension that so many of our peers have moved to, we think it's better accounting. And so that’s the biggest driver of that. And then also the U.S. discount rate has gone up about 25 basis points, simply a reflection of where interest rates ended the year.

Our next question comes from Chris Glynn with Oppenheimer.

So with the kind of commentary on the multiyear share repurchase plan, you opened up to some longer term, just looking at the capital structure. I think in 2017, you’ve got a hefty debt coming due, billion of that. Is that extremely low rate? Are we looking at roll over to stay consistent with comments on excess cash to repurchase, or is the current 2.5 times leverage still above a sustainable zone, so more of a bevy of commentary than a single question there.

Our expectation Chris is that we would refinancing the debt coming due in 2017.

And then lastly on the split from the first half, second half. Given the highly strategic year and period of restructuring program, maybe give color on the ramp of benefits into the second half just in terms of perhaps an earnings split of the first half and the second half within the annual context?

As I mentioned, the restructuring cost is 70 in the first, 35 in the second, and then the last 35 across the last two. And then from a benefits point of view, all of the benefits occurs in quarters two, three and four, and they build as you go from quarter-to-quarter. So the higher savings will be out in the third and fourth quarter.

Thank you all for joining us today. Unfortunately we’ve reached the end of our allotted time for the call today. As always, we’ll be available for follow up calls for the remainder of the day and the rest of the week. And again thank you very much for joining us today.