Eaton Corporation - Q1 2023

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by, welcome to the Eaton Third Quarter 2023 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. To get in queue to ask your question, please Press one then zero. Should you require assistance during the call, please Press Star zero and an operator will assist you offline. As a reminder, your conference is being recorded. I would now like to turn the conference over to your host, Yan Jin. Please go ahead.

Yan Jin (SVP of Investor Relations)

Hey, good morning. Thank you all for joining us for Eaton's fourth quarter 2023 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 include the opening remarks by Craig, then he will turn it over to Tom, who will highlight our company's performance in the fourth quarter. As we have done on our past calls, we'll be taking questions at the end of Craig's closing commentary. The press release and the presentation we'll go through today have been posted on our website. This presentation, including adjusted earnings per share, adjusted free cash flow, and other non-GAAP measures. They are reconciled in appendix. A webcast of this call is accessible on our website and will be available for replay.

I would like to remind you that our commentary today will include the statements related to the expected future results of the company and are therefore forward-looking statements. Our actual results may differ materially from our forecast projections 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.

Craig Arnold (Chairman and CEO)

Okay, thanks, Yan. We'll start with some highlights of the quarter on page three. I'll lead off by noting that we've delivered another strong quarter. We generated adjusted EPS of $1.88 for the quarter, well above our guidance range, record for the quarter, and up 16% from prior year. We continue to post strong margins. Q1 record of 19.7%, up 90 basis points over prior year. Our sales were $5.5 billion, up 15% organically. Our third quarter in a row of 15% organic growth. We have particular strength in our Electrical Americas business, which was up more than 20%, including very strong growth in commercial, institutional, utility, and data center markets. We also had exceptional growth in our commercial aerospace and eMobility businesses. Our orders also came in ahead of expectations for the quarter.

On a rolling 12 month basis, electrical orders were up 13%, and aerospace orders increased by 21%, which led to another quarter of record backlogs, up 39% for electrical and 27% for aerospace. You know, I think it's well understood at this point, but I'd note once again that reindustrialization, infrastructure spending, along with secular growth trends of electrification, energy transition, and digitalization have fundamentally changed the growth prospects for our company. Lastly, free cash flow in the quarter was nearly $300 million, driven by higher net income and improved working capital. I'd say a good start to the year to keep us on track to deliver our free cash flow guidance despite higher revenue and receivable balances. In balance, I'd say, you know, we're off to a very good start for the year.

Moving to page four, I'd like to once again highlight that Eaton is marking its 100th anniversary of our listing on the New York Stock Exchange. As many of you saw, we celebrated by ringing the bell in early March. Eaton is one of 32 companies who have reached this milestone. I'd say, you know, our longevity on the exchange and our resiliency is really a function of our ability to adapt to a changing world. What is the main constant over that time is the spirit of innovation that guides us and our commitment to all of our stakeholders, our employees, our customers, our shareholders, communities, and all of society. Now, as Eaton stands at the forefront of perhaps the most significant growth trends that we'll see in our lifetime, we're convinced that our best days are still ahead of us.

We've been busy planning for this moment. As we look at Eaton today, we position ourselves as our customer's trusted partner across power management spectrum. Slide five provides a good example of how we're playing across the electrical value chain, from power generation to power distribution, to how it's consumed in various applications. We're building a business that supports our customers with a full range of end-to-end solutions, beginning with deep domain expertise in specific applications and the ability to specify electrical solutions. We're now providing intelligent electrical products, offering data as a service, providing software solutions, doing installation commissioning, and providing aftermarket services. Our role has changed from simply selling components to helping owners fulfill their changing energy needs. We're also proving that we can leverage our technology and create scaled solutions that serve all of our end markets.

For those of you who were with us at our March meeting in New York, you saw an example of this in a new product we call BreakerDoor. BreakerDoor is a combination of a breaker and a contactor. We developed the technology in our electrical business and have successfully sold it in our eMobility and aerospace businesses. As the electrification of everything continues, the need for Eaton's technology and solutions will certainly continue to grow. The primary source of this growth is coming from the mega trends that we've discussed. In addition to electrification, we're benefiting from energy transition from digitalization and the reindustrialization of the U.S. and European markets, and we're seeing record capital spending levels. As you know, this capital is being supported by an unprecedented level of infrastructure spending by governments around the world. While early, we're tracking a large number of infrastructure-related projects.

For example, in our Electrical Americas business, we've already seen over $1 billion of projects and have won roughly $450 million of orders. As this chart reflects, we're also at the beginning of a strong aerospace growth cycle and seeing rapid adoption of electric vehicles. Collectively, these trends have positioned the company for strong growth for the foreseeable future. Next, on page seven of the presentation, we provide an example of how reindustrialization is creating a record number of mega projects. We define a mega project as a project with more than $1 billion of capital. Since 2021, announced non-residential mega projects have a cumulative value of almost $600 billion, at least 3x the historical run rate for non-residential projects. This is North America only.

$600 billion announced over the last nine quarters, $400 billion more than the historical run rate. These projects are certainly in various phases of design, planning, or construction. As you can see, these secular trends are translating into specific projects, and they haven't slowed down. There's billions more in the planning stages, which will certainly sustain our growth for years to come. On slide eight, we take you from the $400 billion of announced mega projects and what it means for the electrical industry. We estimate that the electrical content on these projects is in a range of 3%-5% of the total project value. This suggests $12 billion-$20 billion of incremental electrical revenue. Keep in mind, there's certainly a wide range of electrical content on various projects, and our exposure is tied more closely to building infrastructure.

Assuming these projects get planned, designed, and built over the next 5 to 7 years, they will expand the electrical market by some $2 billion-$4 billion a year. That's just from what's been already announced in mega projects. We naturally expect more large and small projects to come. As I say, these projects are a good example of how mega trends are playing out in creating a very different growth outlook for the electrical industry, and one we think will run for decades or more. Another helpful proof point is represented on slide 9, where you can see how our negotiation pipeline has grown. As you can see, our negotiation pipeline has doubled from what we've seen historically. In 2022, we saw nearly $5 billion of projects that are on negotiation pipeline in Electrical Americas alone.

Similar to mega projects, we're seeing broad strength in manufacturing and data center, industrial and utility market. This large step-up in negotiations further supports our expectations for strong markets and faster organic growth as we go forward. Just one additional proof point is noted on page 10. Here, we show a few examples of how these projects are translating into specific orders. As we've reported, our electrical orders have been at record levels for two years now. What we're demonstrating here is how these mega projects are translating directly into large wins for our electrical business. For example, we've won $180 million of orders to provide power management solutions for two new EV plants in North America. Specifically, we're providing power distribution equipment and Brightlayer industrial remote monitoring software.

Another example is a $100 million order for a new U.S. semiconductor plant. We're already working on Phase 2 of this project, which could be even larger. Overall, we're seeing record project announcements, record negotiations, a record set of orders that has led to record backlogs. Keep in mind, the revenue impact is mostly in front of us. Moving to page 11, we're also benefiting from megatrends in aerospace and vehicle. We're at the beginning of an aerospace growth cycle in both commercial and defense markets. Specifically, commercial OEM build rates are expected to grow in the mid-teens over the next several years. Our commercial aftermarket should also grow by double digits as global revenue passenger kilometers continue to recover to pre-pandemic levels and beyond.

We've also noted the significant step-up in defense orders and expect to see a significant lift in defense revenues beginning in 2024. As a point of reference, our defense orders have more than doubled from 2019 levels. In recent years, we've won increased content on both commercial and defense platforms. In vehicle, our electrification continues to accelerate, and we now expect global EV penetration rates to exceed 50% of global auto sales by 2030, up from our prior estimate of 40%. While we're not providing any new revenue updates today, we once again are relooking our forecast for our eMobility segment. On page 12, we highlight a few key wins in our aerospace and eMobility businesses, beginning with a $500 million win for cryogenic coolers and controllers for the CityAirbus urban air mobility program.

The CityAirbus win is a good example of how digitalization, software, and electrification are beginning to benefit our aerospace business. As Tom will report shortly, we're seeing more than 30% growth in our defense and commercial aftermarket orders. In eMobility, we continue to realize significant wins, the most significant of which are coming from our power distribution product line within our eMobility business. You'll recall, this is where we're able to leverage our broader electrical business and our unique breakthrough technology. Our latest set of wins comes from a leading European automotive OEM and will generate $100 million a year of mature year revenues. Like electrical, our industrial businesses are delivering significant wins tied to long-term megatrends that will support faster growth. When you combine the businesses, we're confident that our market should grow at more than 2x their historical rates.

As we've stated, we're in the early innings. These trends are expected to deliver outside growth for years to come. With that, I'll turn it over to Tom to walk us through Q1 financial results and updated guidance.

Tom Okray (EVP and CFO)

Thanks, Craig. On page 13, I'll start by providing a summary of our strong Q1 results. For the third consecutive quarter, we generated organic growth of 15%. Revenue was up 13%, with the organic growth reduced by 2% points of unfavorable foreign exchange. Operating profit, a first quarter record, grew 19%, and margins expanded 90 basis points to 19.7%, also a Q1 record. Adjusted EPS increased by 16% over the prior year to $1.88. All in, the strong organic growth and margins enabled us to report a first quarter record adjusted EPS. Our higher growth not only demonstrates the megatrends, but also the importance of prioritizing our customers by carrying higher levels of inventory when supply chains were challenged.

Our free cash flow of $209 million was nearly $300 million above prior year and exceeded our expectations. You will recall from our Q4 call, we expected free cash flow to be relatively flat year-over-year. Moving on to the next chart. Our Electrical Americas business had another very strong quarter. We have set Q1 records for sales, operating profit, and margin. Organic sales growth was 22%. Electrical Americas has generated double-digit organic growth for five consecutive quarters, including back-to-back quarters of at least 20% growth. On a two year stack, organic growth is up 32%. In the quarter, there was broad-based growth in all end markets, with especially robust growth in commercial and institutional, utility, and data center markets.

Specifically, we posted 25% organic growth in our data center revenues in Q1. We continue to see very strong growth in this important market. Utility and commercial and institutional were up more than 30%. It's also worth noting that we posted strong revenue growth of 17% in our residential business. The two-year stack is over 40% growth. We're seeing strength in multifamily homes, completion of single-family homes in process, and increased electrical content per home, which are more than offsetting weakness in new single-family start. Operating margin of 22.9% was up 380 basis points versus prior year, benefiting from higher volumes. Incremental margins were very strong at more than 40%. We continue to manage price effectively to more than offset inflationary pressures. Orders and backlogs show continued strength.

On a rolling 12 month basis, orders were up 18%, which remains at a high level, with particular strength in data center, distributed IT, utility, and industrial markets. On a quarter-over-quarter sequential basis, orders grew 19%. We're also continuing to build backlog. Backlog was up 51% versus prior year and up 9% sequentially. In addition to the robust trends in orders and backlog, our major project negotiations pipeline in Q1 was up more than 20% versus prior year and nearly 20% sequentially from especially strong growth in data center, water, wastewater, and transportation markets. Overall, Electrical Americas had a very strong quarter to start the year. On page 15, you'll find the results of our Electrical Global segment, which posted all-time record sales of $1.5 billion.

Organic growth was up 8%, which was partially offset by headwinds from foreign exchange and a divestiture. Organic growth was driven by strength in utility, data center, and distributed IT markets. Our data center revenues for Electrical Global increased 32% in the quarter. Utility was up 25% and distributed IT up 20%. Operating margin of 18.3% was down compared to prior year, primarily from manufacturing inefficiencies and investment in growth, partially offset by higher sales volume and inflationary price recovery. Orders were up 4% on a rolling 12-month basis, with strength in data center, commercial and institutional, and utility markets. Sequentially, orders grew 12%. Backlog increased 3% year-over-year and 6% sequentially. I'm also pleased to highlight that last month we closed the acquisition of a 49% stake in Jiangsu Ryan Electrical Company.

This is a Chinese-based business with approximately $100 million of revenues, which manufactures power distribution and sub-transmission transformers, and will accelerate Eaton's growth in renewable energy, data center, utility, and industrial markets. This is Eaton's fourth JV in China in the last two years, allowing us to expand our market presence, serving high-growth markets inside and outside of China. Before moving to our industrial businesses, I'd like to briefly recap the combined Electrical segment. For Q1, we posted organic growth of 16%, incremental margin of 34%, and operating margin of 21%, which was 180 basis points of year-over-year margin improvement. Orders grew 13% on a rolling 12 month basis, with sequential growth in the quarter of nearly 20%, compared to roughly flat sequential order growth in the six years prior to the pandemic.

Backlog grew 39% in the quarter and 8% sequentially. On a rolling 12 month basis, our book-to-bill for our Electrical sector remains very strong at above 1.2. It was also above 1.2 for Q1. We remain confident in our positioning for continued growth with strong margins in our overall Electrical business. The next page recaps our Aerospace segment. We posted Q1 records for sales and operating profit. Organic growth was 13% with a 1% point headwind from foreign exchange. Growth was primarily driven by strength in commercial aftermarket, up more than 30%, and commercial OEM, up more than 25%. Operating margin was 22.5%, which was 40 basis points over last year, driven by volume growth and inflationary price recovery. Order growth and backlog trends also remain encouraging.

On a rolling 12-month basis, orders were up 21% organically, with strength across all end markets, including continued outgrowth in defense OEM orders. Similar to the second half of last year, we continue to see strong growth in our defense orders in the quarter, with OEM up 55% and aftermarket up more than 40%. On a rolling 12 month basis, our book-to-bill for our Aerospace segment remains very strong at more than 1.2, including more than 1.25 for Q1. Year-over-year backlog growth increased 27% in Q1, an acceleration from up 21% in Q4. Moving on to our Vehicle segment on page 17. In Q1, revenue was up 10%, with 11% organic growth and 1 percentage point of unfavorable FX.

We saw particular strong growth in both the Americas and EMEA markets. Operating margins came in at 14.5%, with unfavorability to prior year primarily due to manufacturing inefficiencies, partially offset by higher sales volume and price cost. We continue to make progress towards securing more sustainable technology wins, which most recently includes multiple new programs for our ePowertrain solution. On page 18, we show results for our eMobility business. We generated strong growth in the quarter. Revenue was up 17%, including 18% from organic growth. Margin was down 30 basis points versus prior year, driven by higher manufacturing startup costs associated with new electric vehicle programs. We remain very encouraged by the growth prospects of the eMobility segment.

We continue to leverage our capabilities across our entire portfolio, including core technology in both Electrical and Industrial businesses. Since 2018, we have won $1.4 billion of mature year revenues in this business, with many of these programs ramping up in 2023 and 2024. This strong momentum includes additional recent wins with BreakerDoor, including on next generation battery platforms with a large European OEM. Next on page 19, we show historical backlog charts for the electrical sector and aerospace segments. We think it's important to illustrate how backlog has grown over time. Our record backlog was roughly $12 billion to end Q1. This is up nearly 3x the ending 2019 level. These metrics provide us with great confidence in the outlook for the full year and going forward.

On the next page, we show our fiscal year organic growth and operating margin guidance. We are raising our organic growth guidance for 2023. We continue to have a robust negotiations pipeline and build backlog with particular strength in Electrical Americas and aerospace. We now expect organic growth in Electrical Americas of 11%-13%, up 300 basis points from our prior 8%-10% guide. We're also raising Electrical Global 200 basis points to 6%-8% from 4%-6%. We're increasing aerospace 200 basis points to 10%-12% from 8%-10%. In total, we're increasing our 2023 organic outlook by 200 basis points from an 8% midpoint to a 10% midpoint.

Our strong end market growth forecast, combined with building backlog, provides tremendous visibility and confidence in this 2023 outlook. For segment margins, we're raising our guidance range for Electrical Americas by 20 basis points to a revised range of 23.3%-23.7%, which reflects the continued strong momentum that we have in this business. Overall, we are reaffirming our total Eaton margin guidance range of 20.7%-21.1%. As a reminder, this is a 70 basis point increase at the midpoint from our 2022 all-time record margin. For eMobility, we are adjusting both the organic growth and margin ranges. This is primarily due to delayed OEM launch plans and higher start-up costs related to large new program wins. In summary, we continue to be well-positioned to deliver another strong year of financial performance.

On page 21, we have the balance of our guidance for 2023 and Q2. Following our strong Q1 performance and improved organic growth expectations for the year, we are raising our full year EPS range to $8.30-$8.50. At the midpoint of $8.40, we have raised guidance by $0.16. This represents 11% growth in adjusted EPS in 2023. We're also raising our CapEx guidance from $630 million to approximately $700 million to fund additional investments for growth, including in our utility business, where we continue to experience strong increases. Free cash flow guidance remains unchanged. For Q2, we are guiding organic growth of 10%-12%, segment margins of between 20.5% and 20.9%, representing 60 basis points growth at the midpoint versus prior year.

An adjusted EPS in the range of $2.04-$2.14, a 12% increase versus prior year at the midpoint. I'll hand it back to Craig to wrap up the presentation.

Craig Arnold (Chairman and CEO)

Thanks, Tom. Turning to page 22. As we continue to track our end markets, we want to provide a slightly revised look at our assumptions for the year. Once again, we do expect a mild recession in 2023, and we've built that into our base case assumptions. With healthy demand and strong secular growth trends, we continue to expect growth in almost all of our end markets. We raised our growth assumption for the utility market from solid growth to strong double-digit growth. Here, energy transition and electrification continue to gain momentum. We've increased our residential market from declining to flat. While we recognize the slowdown in U.S. single-family housing market, the combination of resilient renovation market, pricing momentum, and strong backlog now supports an upward revision.

As Tom noted, we posted a 17% organic growth in residential and Electrical Americas in Q1. The balance of the forecast remains unchanged. I want to emphasize once again that despite market concerns about non-residential construction markets, we have a robust negotiation pipeline, a growing backlog and strong orders. Data centers, utility, industrial, commercial institutions continue to perform extremely well. I know that most of you have drawn reference to the declining PMI data, I point out that our market and revenue growth are much more aligned with capital spending, where we continue to see strong momentum. We do not expect any of our end markets to decline in 2023, and most are expected to see healthy levels of growth. Let me close on page 23 with just a few summary comments.

Once again, we delivered a strong quarter and set a handful of Q1 records. We delivered 15% organic growth and have record backlogs. While electric orders are experiencing some expected normalization as supply chains continue to improve, the secular growth trends and strong execution on our backlog support another strong year of growth. Having exceeded our Q1 forecast and continued secular tailwinds, we're raising our guidance for the year. Despite macro uncertainty and despite market, macro uncertainties, our markets are performing well, and we're improving our internal execution. As I highlighted, we're seeing more evidence that megatrends are accelerating, and we now think our end markets will grow at more than 2x historical growth rates. These market forces are just beginning to show up in revenue and will position the company for strong growth for the decade to come.

I'll stop here and open it up for any questions you may have.

Yan Jin (SVP of Investor Relations)

Thanks, Craig. For the Q&A today, please limit your opportunity to just one question and a follow-up. Thanks in advance for your cooperation. With that, I will turn it over to the operator to give you guys the instruction.

Operator (participant)

Thank you. Ladies and gentlemen, if you wish to ask a question, please press one then zero on your touch-tone phone. You will hear an acknowledgment tone that you've been placed in a queue, and you may remove yourself from queue at any time by repeating the 1-0 command. If you're on a speakerphone, please pick up your handset before pressing the number. Once again, if you have a question, please press one then zero at this time. Our first question is from the line of Joe Ritchie from Goldman Sachs. Please go ahead.

Joe Ritchie (Managing Director and Senior Equity Research Analyst)

Thanks. Good morning, everyone, and great start to the year.

Craig Arnold (Chairman and CEO)

Morning, Joe. Thank you.

Yan Jin (SVP of Investor Relations)

Thanks, Joe.

Joe Ritchie (Managing Director and Senior Equity Research Analyst)

Let me just kind of start on the Electrical Americas margins. Clearly a standout, you know, this quarter. I think your highest quarter, your highest first quarter ever. As you think about kind of like the incremental margins going forward, it looks like you posted, you know, about a 40% incremental in the first quarter. How should we be thinking about the rest of the year? Are there any, you know, items that potentially reverse as you progress, or do you expect incrementals to be as strong throughout the year?

Craig Arnold (Chairman and CEO)

You know, we appreciate the recognition, Joe, and our team in the Americas is just doing an outstanding job of executing. As we talked about last year, you know, we had, you know, fairly sizable inefficiencies in our manufacturing operations as we were dealing with a number of supply chain related disruptions. Those got clearly better into the first quarter. We would expect that as we go forward, while the incrementals for the company, we're still calling the company in and around 30%, we do expect our Americas business to perform better than that as we continue to see improvements in supply chain.

Yan Jin (SVP of Investor Relations)

Yeah. The only thing I would throw on top of that, Joe, is there, to your specific question, there were no unusual items in the first quarter driving the Americas margin.

Joe Ritchie (Managing Director and Senior Equity Research Analyst)

Got it. That's super helpful. Look, Craig, you outlined a lot of reasons to be excited about the growth dynamics for the companies going forward. I saw you took up the, you know, utilities expectation for the year. I'm curious, are you starting to see, you know, some of the money loosen from the Jobs Act, you know, particularly on the grid side? What's kind of driving your increased expectations on utilities growth for the year?

Craig Arnold (Chairman and CEO)

Yeah, I mean, I, you know, we this is something that had been long anticipated, quite frankly, Joe, by us. As you know, as you think about, you know, all of these megatrends of, you know, whether it's electrification of the economy or energy transition, we knew at some point the utility market would have to start to make the kinds of investments that are gonna be needed to support the electrification of the economy. As I mentioned, I think on the last earnings call, you know, one of the longest lead time pieces of equipment that you could order today in the electrical industry is a transformer. In many cases, lead times are, you know, 12 months or beyond.

We continue to see the utilities making investments in their distribution infrastructure to really support, you know, this energy transition that's taking place, the electrification of the economy. Yeah, we think the utility market is gonna be a really strong growth market for some years to come as they deal with needed investments. No question, as we began the year, we were a little bit conservative in terms of what the expectation is, but it's coming through. As you heard from Tom and some of the orders growth, you know, the orders growth are quite significant now and we think that's gonna go on once again for some years to come.

Joe Ritchie (Managing Director and Senior Equity Research Analyst)

Thank you.

Operator (participant)

Thank you. The next question is from Josh Pokrzywinski from Morgan Stanley. Please go ahead.

Josh Pokrzywinski (Executive Director)

Hi. Good morning, guys.

Craig Arnold (Chairman and CEO)

Hey, Josh.

Yan Jin (SVP of Investor Relations)

Hey, Josh.

Josh Pokrzywinski (Executive Director)

Good to see that supply chain looks like it's starting to unlock there in electrical. I guess even though it's not as bad today, you know, maybe labor, you know, with either in your plants or maybe on the installer side or somewhere else in some of these bigger projects might still be a limiting factor. Craig, I guess if you just sort of take a step back, you know, notwithstanding, you know, the current backlog demand's really good, all those sorts of things. Is there sort of a cap on how fast the industry can grow, thinking about, you know, kind of the totality of the supply chain, including that labor pool at the contractor level?

Craig Arnold (Chairman and CEO)

No, I appreciate the question, Josh. That's certainly one of the things that we're spending a lot of time, you know, trying to sort through right now. I mean, clearly, as I mentioned, you know, supply chain on the material side from our suppliers has improved. We're not out of the woods by any means, especially when you think about electronic and semiconductor-related components. They still are constrained, constraining our growth. To your point, labor is also a fairly significant constraint today. One of the reasons why I think is you've seen this big gap between orders and revenue is because, once again, our extended supply chains and labor availability have been constraints on the industry. I don't really have an answer to your direct question in terms of, you know, from an industry perspective, you know, what's the limiter?

Because as you know, in these very complicated supply chains, it only takes one supplier, one player in the market to become the constraining factor. It's a great question and one that we're trying to spend some time thinking through, but not one today that we have a really clear answer to today in terms of what is the real upper boundary of the industry's ability to deliver, given labor, given, you know, our extended supply chains and some of these material constraints. I can tell you that, you know, today things are getting better across the board, and we're feeling much better about the growth outlook for our company and for the industry.

Just tons of positives that we talked about in our opening commentary, where we're seeing just significant broad-based strength, and it's showing up in our backlog. It's showing up in our order books. And we would hope that we continue to post very strong revenue growth, you know, tied to these secular trends.

Josh Pokrzywinski (Executive Director)

Got it. That's, that's helpful. I understand it's not an easy question to answer just yet. Maybe shifting over to the pipeline for my follow-up. Anything you can share in terms of the book outrate and maybe any churn that you see in that pipeline with things like, you know, financing, supply chain, all these stimulus projects, some of which I would imagine are kind of mutually exclusive. Has there been any underlying volatility in that? You know, how should we think about the lead time between when something enters the pipeline and then maybe, you know, transmits in the backlog?

Craig Arnold (Chairman and CEO)

Yeah, no, I appreciate the question. It's, I mean, there's a lot in the question that you asked, very specific in terms of, you know, whether or not we're seeing a lot of churn. I'd say that overall economic activity, whether it's negotiations or orders or revenue, everything is kind of doing significantly better than it has historically, and certainly better than even, quite frankly, we anticipated when we put our plan together for the year. In general, you know, things are positive, and we continue to, you know, with more negotiations, with more orders than we anticipated, obviously translating to more revenue. I'd say that, you know, stimulus specifically, we talked about that a little bit in some of the opening commentary. We are starting to see stimulus have an impact.

We are in the very early innings. If you think about that $600 billion of projects, mega projects that we talked about, we think some 25% of that has already broken ground and started. And many of that, whether it's semiconductors or EV factories or battery factories, are obviously being buttressed by some of the early Infrastructure Spending Act. The Inflation Reduction Act, we really have not seen any impact from that yet. We're certainly seeing some impact from the from the Semiconductor Act. Yeah, a little bit of a mixed bag there, but I'd say most of the impact there continues to be out in front of us. And, you know, lead times today on these projects, I would say we have better visibility today.

As these projects are bigger, they tend to run then over a multiyear period. We're feeling great about, you know, our visibility into the future because of these very large projects that will be delivered over multiple years. I'd say.

Josh Pokrzywinski (Executive Director)

Hey, that's great color.

Craig Arnold (Chairman and CEO)

Not a churn, but slow churn positively.

Tom Okray (EVP and CFO)

Yeah. The only part that I would amplify on that is, you know, going back to our speaker remarks, our negotiation pipeline in the U.S. quarter-over-quarter is up almost 25%. Year-over-year, up almost 25%. Some of the big segments are up well over 30% growth. You know, we're seeing very robust pipeline here.

Josh Pokrzywinski (Executive Director)

Got it. Appreciate it, guys.

Tom Okray (EVP and CFO)

Thank you.

Operator (participant)

Thank you. The next question is from Scott Davis from Melius Research. Please go ahead.

Scott Davis (Chairman and CEO)

Yeah, good morning, Craig and Tom and how are you?

Craig Arnold (Chairman and CEO)

Morning, Scott. Good.

Scott Davis (Chairman and CEO)

Look, how I wanna just fixate on these big projects because this is so new, at least since I've been covering this space. Maybe a couple different angles to go at here. One is just the competitive dynamic. Does it change when you get to this size, meaning there's just a lot less people that can really, you know, at least be trusted suppliers for the, for the, for the customer when you're talking about orders and, you know, $10+ million up to a $100 million kind of total bid stuff?

Craig Arnold (Chairman and CEO)

Yeah, you mean to first of all, we'll acknowledge what you just said, Scott. These, you know, these, we've always had mega projects, but historically speaking, they've been, you know, relatively few and far between. I think it's really, if you go back to this, you know, broader theme that we talked about around reindustrialization of manufacturing in the U.S. for sure, to a certain extent also in Europe, you know, this is resulting in a really, let's say, a big surge of investing in the manufacturing sector in the U.S. To the point that you raised, the bigger the project, the more complex the project, the fewer companies who are able to essentially provide the services that our customers need.

We think the competitive dynamic in this environment certainly favors companies like Eaton because of our, you know, large, capable organization. Quite frankly, in general, when you think about the more complex projects in general, they're also more electric intensive. If you think about a typical office building versus a typical, you know, semiconductor plant or an EV factory, you know, the electrical intensity or a data center, the electrical intensity of these applications is much greater than your typical strip mall or office building, which also helps support the underlying growth of the industry and companies like Eaton. We think it certainly, it's an important trend that's going to drive growth for the industry, but should also allow our companies to grow at a faster rate.

Tom Okray (EVP and CFO)

I think it really gives another lens in terms of with these big projects, you know, focused not so much on the PMIs, which we've all read historically. To Craig's point, this reindustrialization, which is driven by these higher levels of CapEx, which we just don't see slowing down.

Scott Davis (Chairman and CEO)

Yeah, helpful. Then, yeah, just to back up a little bit, when you talk about selling less traditional products, and let's just say like software/remote monitoring, et cetera, is that a separate sales process into facilities like this? Is it the same? You know, I mean, I'm kind of picturing an EPC firm putting out a bid, but this is a little bit of a different animal. How's the sales process really changing and evolve with this type of unique product?

Craig Arnold (Chairman and CEO)

Scott, you know, as we spent some time with you over the years talking about, you know, the way we think about the sale of software to state of data and insights, is that for us, we really do think it's linked to the equipment. For us, you know, for the most part, we're selling products that are digitally enabled. They're digitally native. These products all have the ability to stream data. From that data, we create algorithms and, that allow us to provide insights from the data coming off our products, and we can either monetize that either in the form of data as a service or software.

For us, and it's not the same for every company in this space, we do link the sale of hardware to places where we have deep domain knowledge and expertise to the sale of data and software and these services that we bundle together. For us and the way we go to market, we do go together through the same channel, through the same decision point, but that's not the same for every company in this space.

Scott Davis (Chairman and CEO)

That's very helpful. Thank you. Best of luck, guys.

Tom Okray (EVP and CFO)

Thanks, Scott.

Operator (participant)

The next question is from Nicole DeBlase from Deutsche Bank. Please go ahead.

Nicole DeBlase (Managing Director and Senior Equity Research Analyst)

Yeah, thanks. Good morning, guys.

Craig Arnold (Chairman and CEO)

Good morning.

Nicole DeBlase (Managing Director and Senior Equity Research Analyst)

Just maybe starting with the second quarter outlook for organic growth, embedding a bit of a deceleration from the 15% in the first quarter. Just can you talk a little bit about what's driving that deceleration from a segment perspective?

Craig Arnold (Chairman and CEO)

Yeah, you know, I'd say that, you know, there's always a bit of uncertainty, Nicole, as you can imagine, when you look forward, in terms of where you think, the market's gonna land. You know, one of the things that I'd say is clearly, if you look at the balance between price and volume, as you move forward for the balance of the year, you get relatively smaller contributions from year-over-year price increase, and you get obviously a pretty significant contribution from volume. You clearly have that dynamic that's taken place, in the business throughout, the year and that inclusive of the second quarter. We'll see. I mean, at this point, you know, we're early days into Q2. We're off to a good start here.

If we're able to convert and we continue to have some of the supply chain, you know, issues resolved, it, you know, certainly we have a range of possibilities for the quarter. It could be better. At this point, I'd say we're taking a prudent view based upon the fact that we're not out of the woods completely from a supply chain standpoint. Once again, I mentioned less price on a relative year-over-year basis than we certainly had in Q1.

Nicole DeBlase (Managing Director and Senior Equity Research Analyst)

Got it. That makes sense. Thanks, Craig. Second question, just update on what you're seeing with respect to channel inventory and electrical, still pretty low relative to history or any movement there in the past quarter? Thank you.

Craig Arnold (Chairman and CEO)

Yeah, we think today, you know, channel inventories, you know, are actually in relatively good shape, obviously with some spots where they would like more. I think, you know, when you look at channel inventory, I think the, you know, the probably the most important message that I can leave with the group is that you really got to look at those inventories in the context of the size of the backlog, in the context of the orders. If you're looking backwards, you're gonna draw one conclusion with respect to inventories. If you're looking forward, you're gonna draw a very different conclusion.

It's one of the things that we try to express for our own company in our Q1 earnings call, where Tom laid out some of the ratios between inventory and backlog, inventory and orders to say that we, you know, they're actually below where they've been historically based upon a forward view of our industry and our markets. Today, I'd just say inventories in general are generally speaking in good shape. Our distributors today, where I'm having phone calls and discussions with distributors, it's 90% of the time it's about, "I need more." You know, "Can you help me solve a particular, you know, issue I have today with a customer because I don't have enough inventory?" In general, I'd say they're in fairly good shape.

We did see a little bit of an issue in the fourth quarter in Europe, where there was a little bit of de-stocking in Europe, in the fourth quarter. That has since that time turned around, and as Europe, it's performed better than even we anticipated. On balance, inventories are in good shape.

Nicole DeBlase (Managing Director and Senior Equity Research Analyst)

Thanks. I'll pass it on.

Operator (participant)

Thank you. The next question is from the line of Stephen Volkmann from Jefferies. Please go ahead.

Stephen Volkmann (Equity Research Analyst)

Great. Good morning, guys. Thanks for fitting me in here. Craig, sort of a big picture question, based on sort of what you were just saying, do you think these backlog levels are the new Eaton, and we should think about Eaton operating with these types of backlog numbers going forward, or do you think as the world sort of normalizes from supply chain or whatever, that backlogs will come back down again?

Craig Arnold (Chairman and CEO)

You know, it's a great question, and it's not one, once again, that I could tell you that I have, you know, a clarified, well-thought-through answer to specifically. Well, certainly as we think about for 2023, we don't anticipate reducing backlogs. We think we'll carry the same level of backlog throughout much of 2023. A lot of that will have to do with obviously lead times, and whether or not we can actually get out in front of some of these, you know, ramps that are taking place in the industries and the markets that we serve. Can we get capacity online quick enough to reduce lead time so that we can go back to perhaps where we've been historically in terms of, you know, stated lead times to our customers.

We're not there today, and I do think a lot of it will be a function of, you know, how the markets unfold, it not just in terms of demand level, because demand level, I think, we know is gonna be strong. You know, how quickly can we and others put capacity in to support this higher level of growth?

Tom Okray (EVP and CFO)

Steve, where I would chime in on that, you know, I think it's connected. Your question was backlog, but I think the new Eaton is definitely a higher growth Eaton. As Craig said in his prepared remarks, we see the markets doubling over where they have been historically. You know, that's a big thing when you say doubling, and that doesn't include our outgrowth that we think we can put on top of that. You know, just some perspective, if you look also at order growth that we've got going back to the first quarter of 2019, there's such strong numbers. Electrical Americas growing about 50% in terms of their quarterly orders. Electrical Global up over 25%, and Aero up over 40%.

The volume of quarterly orders that we're seeing coming in and the continued building of the backlog, I think the new Eaton is a much higher growth Eaton.

Stephen Volkmann (Equity Research Analyst)

Great. Thank you for that. Then switching gears to aerospace. We haven't talked about that one too much. Just kind of reading from the commentary on this call and others that I've heard you guys talk about, it feels like 2024 may be like a real stairstep for your aerospace business. I think you mentioned, Craig, that you have a bunch of military business that sort of ramps up. I'm just curious if we should be thinking that there's kind of a bigger increase in revenue and margin in 2024 than might normally kind of be the year-to-year case.

Craig Arnold (Chairman and CEO)

You know, I think it's certainly early for us to be putting out guidance for 2024. We'll have an opportunity to do that obviously later in the year. Your thesis is not, you know, off the mark. We do believe that certainly on the commercial side, you know, that industry continues to ramp. Both Airbus and Boeing have already put out numbers in terms of increases in line rates for single line is improving. Consumers are getting on planes. You know, revenue passenger miles and kilometers continue to grow, up I think some 60%, I think in Q1.

Still not back to 2019 levels, there's a long way to go just to get back to 2019, you know, on revenue passenger miles, which as you know, drives the aftermarket for us. On the military side, you know, huge growth in orders this year that will begin to, you know, be delivered, most of them, you know, into 2024. I think the setup for our aerospace business is certainly, you know, quite favorable right now, and we'll certainly be in a position, you know, later in the year to give you an indication of how good we think it's gonna be.

Stephen Volkmann (Equity Research Analyst)

Great. I appreciate the color. Thanks.

Craig Arnold (Chairman and CEO)

Thank you.

Operator (participant)

Thank you. The next question is from Nigel Coe from Wolfe. Please go ahead.

Nigel Coe (Managing Director and Senior Equity Analyst)

Oh, thanks. Good morning, guys. Thanks for the question.

Tom Okray (EVP and CFO)

Good morning, Nigel.

Nigel Coe (Managing Director and Senior Equity Analyst)

I do wanna come back to this, these mega projects. Before we get into that, quickly, just global margins, you know, you went through the investments. Maybe just peel back the onion on global, what we're seeing in some of the major end markets, and what gets better from a margin perspective to get to that 19.7% full year.

Craig Arnold (Chairman and CEO)

Yeah. I'd say the, you know, the big thing that gets better, you know, to get to the higher margins is one, you know, you're getting to higher volumes, and you're obviously delivering an incremental. I'd say the single biggest one is, as we talked about last year, we had fairly significant manufacturing inefficiencies in the business last year. You know, given the supply chain challenges, lots of people standing around in factories waiting for components that didn't show up on time and lots of expedited freight and logistics costs. We, you know, despite the fact that we had a record year of profitability in 2022, we had a year of record inefficiencies as well.

If I had to put it on one, you know, thing that's gonna get better, and it is getting better, it's really of the elimination of many of these manufacturing inefficiencies that we've experienced over the last, you know, 12-18 months or so.

Nigel Coe (Managing Director and Senior Equity Analyst)

Okay. Volumes and, more productivity. That makes sense.

Craig Arnold (Chairman and CEO)

Yeah.

Nigel Coe (Managing Director and Senior Equity Analyst)

Then at the risk of beating a dead horse, going back to the, $600 billion of mega projects. In a very general sense, roughly what percentage of those have been bid on and awarded at this point? You said the majority haven't, so just wondering, you know, how that looks. Then what's your win rate? You know, your market share in the U.S. North America's about 30%. How does your win rate compare to that bogey?

Craig Arnold (Chairman and CEO)

Yeah. As I said, on these mega projects, these are all announced projects. As I said, we said 25% of them are actually broken ground and are under construction. I'd say that our underlying win rate on these mega projects is essentially pretty much, you know, at or above the underlying market share for the company overall. We've been very pleased with our success rate. As we talked about earlier, the bigger the project, the more complex the project, the higher the likelihood that we would be selected. You know, the underlying win rate on these projects.

Keep in mind, these products will be delivered, you know, over the next, let's say, three to seven years, and so they have a fairly long tail on them, so I wouldn't necessarily expect to see big movements in the near term based upon these projects. The underlying win rate is good, and the underlying profitability is also good.

Tom Okray (EVP and CFO)

The only thing I would amplify that for the given quarter, we were actually materially above our share win rate. Yeah, it's. We're doing well in terms of closing the deal.

Nigel Coe (Managing Director and Senior Equity Analyst)

That's helpful. Thanks, guys.

Operator (participant)

The next question is from Julian Mitchell from Barclays. Please go ahead.

Julian Mitchell (Equity Research Analyst)

Thanks. Good morning. Maybe, just my first question would be around, you know, a lot of electrical equipment manufacturers and sort of broader multi-industry ones have had very disproportionate price tailwinds to revenue in Q1 and a very, very substantive price cost margin tailwind as well in Q1. I just wondered sort of on those two points, you know, how do you see the pace of normalization of those two tailwinds over the next 12 months?

Craig Arnold (Chairman and CEO)

I'd say, you know, as we look at our own business, Julian, I'd say that price versus cost, I mean, while commodity costs are certainly down versus where they were a year ago, commodity costs in many cases are actually up versus where they were in the fourth quarter. Take a look at steel, for example, a major, you know, commodity for us is steel. It's actually down about 25% from a year ago, it's actually up 25% from where it was in the fourth quarter. You have a mixed bag there. Also on the labor side, as you can imagine, we're seeing more labor inflation in the business today. In our own company, you know, the price versus volume piece maybe is not as significant as it is for others.

I would say that as we look forward, and embedded in our guidance is, you know, mostly it's around volume at normal incrementals and the elimination of a lot of the inefficiencies that are in the business that's gonna ultimately drive the growth in earnings and the growth in our margins more than it is this relationship between price and cost. We've said, you know, from a strategic standpoint, you know, we don't think price is either additive or, you know, subtractive from the underlying margin rates of the business, and that's the way we manage the company.

Tom Okray (EVP and CFO)

Yeah. What I would add, Julian, is we don't see ourselves losing business because of our price cost either. You know, we're not getting feedback from our sales organization that we've got too much price. We just think we're managing effectively.

Julian Mitchell (Equity Research Analyst)

That's helpful. Then just my quick follow-up. Craig, you mentioned those inefficiencies just now, and those were most apparent in the first quarter margins at Electrical Global and I think Vehicle. As we go through the year, we should see those margins kind of start to expand year-on-year. Just wondered, you know, when does that happen for the two segments? Is it as soon as the second quarter, or it's more kind of the second half is when the margins expand in EG and Vehicle?

Craig Arnold (Chairman and CEO)

You know, we would expect to see progress, Julian, in each quarter. I mean, without a doubt, you know, those are the two places where we had some challenges specifically, in inefficiencies. We would expect then in each of the subsequent quarters to see our businesses get, you know, sequentially better.

Tom Okray (EVP and CFO)

Yeah, for sure. Not to get too much into the accounting, but what we're seeing from last year rolled through the P&L in the first quarter and muted the margins somewhat because it was coming off of the balance sheet. It should be a tailwind going forward.

Nigel Coe (Managing Director and Senior Equity Analyst)

For sure. Not to get too much into the accounting, but what we're seeing from last year rolled through the P&L in the first quarter and muted the margins somewhat because it was coming off of the balance sheet. It should be a tailwind going forward.

Craig Arnold (Chairman and CEO)

For sure. Not to get too much into the accounting, but what we're seeing from last year rolled through the P&L in the first quarter and muted the margins somewhat because it was coming off of the balance sheet. It should be a tailwind going forward.

Nigel Coe (Managing Director and Senior Equity Analyst)

That's great. Thank you.

Operator (participant)

The next question is from Chris Snyder from UBS. Please go ahead.

Chris Snyder (Executive Director)

Thank you. Craig, you mentioned a few times that the secular drivers coming through are pushing market growth 2x above historical levels. Is this a 2023, 2024 comment? Or do you believe that the 2x market growth rate is now the long-term view? With that, could you just kinda quantify what the 2x uplift means for market growth from here? Thank you.

Craig Arnold (Chairman and CEO)

Yeah. Yeah. There's no question it is the long-term view. As you think about, you know, most of these secular, you know, trends that we're talking about, whether it's energy transition, the move to renewables, the electrification of the economy, whether it's cars or, you know, cooking appliances or equipment in your factories, the growth in digital and data and connectivity, reindustrialization. You think about all the investment that needs to go into the U.S. market, as an example, to basically reinvest in manufacturing that had moved offshore, and the stimulus dollars that are all supporting that. This is clearly our long-term view that, you know, we think our markets would grow at least 2x. Not 2x, but at least 2x the historical growth rates.

You know, we think those growth rates for the markets, you know, are in the, you know, the mid-single digit range.

Chris Snyder (Executive Director)

Thank you. I appreciate that. Then if I want to just my follow-up on the U.S. mega projects and just broader domestic investment. There's been a focus of the administration to drive higher domestic content on projects or infrastructure where the government's providing incentives. Does this have a material benefit for Eaton as a U.S. manufacturer? Could it allow the company to take higher share or even maybe just protect margins or support margins on these mega projects relative to prior cycles? Thank you.

Craig Arnold (Chairman and CEO)

Yeah. What I would tell you is that, you know, where we get the most direct benefit is the fact that, you know, we tend to have higher market shares in the U.S. You know, most of the, you know, global electrical companies that we compete with around the world, they also have, you know, fairly much localized much of what they do. Our U.S. market shares just tend to be higher, and so we'll get an unfair share of projects as, you know, this reindustrialization and manufacturing takes place in the U.S. market.

Chris Snyder (Executive Director)

Thank you.

Operator (participant)

Thank you. The next question is from David Raso from Evercore ISI. Please go ahead.

David Raso (Senior Managing Director and Partner)

To the growth rate exiting 2023. Just for the framework of how you're laying out your organic sales growth, is it right to assume, you know, it's 15% first quarter, you're saying 11% for the second quarter, and then the back half of the year is about 7%. Let's call it 8% in the third and 6% in the fourth. Is that just a decent general framework of how we're exiting 2023, that kind of 6% growth rate is the framework?

Craig Arnold (Chairman and CEO)

I'd say that, you know, at this point, and we missed the front end of your question, but I think I get the gist of what you're asking, that, you know, based upon the implied numbers in our guidance, you know, order of magnitude 7% growth rate would be the exit rate for the year, and there's a lot of assumptions that we need to work through, Dave, to really understand, you know, what's the guidance gonna be for next year, what happens with supply chain, how the year unfolds. I don't, you know, given where we sit today, if you had to pick a number, you know, that would not be a bad starting point if you're looking to make an assumption for what 2024 looks like. It wouldn't be a bad starting point.

Keep in mind, as we talked about, there are certain of our markets that we think are gonna really inflect very positively next year. Aerospace is one. Early days, but if you had to, you know, put an anchor down today as a starting point, it wouldn't be a bad place to start.

David Raso (Senior Managing Director and Partner)

Yeah. I'm just trying to think through how much negativity you already have baked into vehicle to end the year, you know, particularly the truck part would probably be viewed positively. I guess within vehicle, do we have truck down by the 4th quarter? Aerospace is, you know, 150% the size of truck. If aero's up big in 2024, no problem, you know, if truck's down even, you know, significantly.

Craig Arnold (Chairman and CEO)

We do.

David Raso (Senior Managing Director and Partner)

but you have the vehicle down-

Craig Arnold (Chairman and CEO)

No, no, we do.

David Raso (Senior Managing Director and Partner)

or truck down.

Craig Arnold (Chairman and CEO)

By the time we get to the fourth quarter of this year, we think North America Class eight truck will be negative, and that is baked into our assumptions.

David Raso (Senior Managing Director and Partner)

All right. That's helpful. Thank you so much.

Craig Arnold (Chairman and CEO)

Thank you, David.

Operator (participant)

The next question is from Phil Buller from Berenberg. Please go ahead.

Phil Buller (Head of Capital Goods and Aerospace and Defence Equity Research)

Hi. Good morning. Thanks for fitting me in. Question for Craig, in relation to the portfolio. Obviously, this has come along quite a lot on your watch. You frame things with this, I guess, grow the head and shrink or fix the tail analogy, which has now aligned the group very nicely to these megatrends. I'm wondering if there's much of a tail at this point. I don't get that sense from the prepared remarks. I get that there's always room for some incremental self-help here and there, and you touched on some of the efficiencies, but what, if anything, would you be deprioritizing from here in terms of organic or inorganic investment? I guess I'm asking in relation to the vehicle segment or trucks or potentially there's something else that you'd call out.

Craig Arnold (Chairman and CEO)

Yeah, no, I'd say that, appreciate the acknowledgement. We have done a lot of work, to, you know, position the portfolio to be where we are at this moment in time to really participate in these secular tailwinds, and that's certainly paying off. To your point as well, we think we're never done with the portfolio. I mean, clearly, every year we go through a fairly comprehensive process with our board of directors, looking at every business in the portfolio and understanding whether we like it today and we're gonna like it, you know, five years from now. That is a very well ingrained process inside of our company as we look at the portfolio. We will continue to do that. We'll continue to evaluate every piece of the portfolio, not only, you know, the vehicle businesses.

We're gonna evaluate everything. Today, we like where we are. We think there's a real synergistic element of what we do today across, you know, aerospace, across vehicle, as the whole world and the mobility space specifically continues to electrify. We're getting real benefits today by, as we launch this new eMobility segment, by being a legacy provider to all of the automotive OEMs around the world. Today it works. You know, we can't say that it's gonna always work, you know, into the future. Every business has gotta earn the right to stay a part of the portfolio. That message is one that we deliver to everything, to every part of the company, not just to the vehicle team.

Tom Okray (EVP and CFO)

Yeah. A tangible example of that is if you go back to the prepared remarks in Electrical Global, we actually had a divestiture which impacted the results in the quarter. You know, it was deemed non-strategic by our Geist business, our old Kraus M Line, and it's a great example of how we're fixing the tail. You know, Craig's constantly challenging the organization for that.

Phil Buller (Head of Capital Goods and Aerospace and Defence Equity Research)

That's great. Thank you. Just one very quick follow-up, if I may. In terms of the defense business, obviously it's a good spot to be in terms of the growth outlook, but there's a lot of investors where defense exposure is a bit of a hurdle, particularly so for some European investors. I'm wondering how you're thinking about defense M&A from here and whether or not that's a high or a low priority for you going forward. Thanks.

Craig Arnold (Chairman and CEO)

Yeah, I'd say, Stuart, strategically, you know, the way we think about the aerospace business is, you know, you're either in or out. If you're gonna be in aerospace, you need to be in defense. It's an important part of national security for sure, so there's a, you know... We understand the ESG related concerns. We understand that, you know, many investors have this 5% threshold. Today, defense is, you know, close to that number for Eaton. It's maybe 5%-6% of our business overall. I'd say that, you know, for us, we're really focusing on, you know, good businesses that make strategic sense for the company. Aerospace is a platform within the company that we'd like to continue to grow. It's a good business.

It's got all the right characteristics and businesses that we like. It's high margin. It's highly differentiated based upon technology. You got great position on platforms with a huge aftermarket that runs for, you know, decades. It has all the right set of characteristics for businesses that we like. We will continue to prioritize first and foremost electrical, as we've said in the past, for a lot of reasons, including these secular tailwinds. Aerospace, from a priority standpoint is second only behind electrical.

Phil Buller (Head of Capital Goods and Aerospace and Defence Equity Research)

That's great. Thanks very much.

Craig Arnold (Chairman and CEO)

Thank you.

Operator (participant)

Thank you. At this time, there are no further questions in queue. Please continue.

Tom Okray (EVP and CFO)

Okay, guys. Thanks. You know, as always, Chip and I will be available for answer any follow-up questions. Have a good day, guys.

Craig Arnold (Chairman and CEO)

Thank you.

Tom Okray (EVP and CFO)

Thank you.

Operator (participant)

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T TeleConference Services. You may now disconnect.