Craig Arnold: I mean, and as you can imagine, Scott, we’re living in an environment today where these industries are growing much faster than they have historically, and the outlook for growth continues to strengthen and, in many cases, get better and where — and you have capacity constraints. And so we are in a very different world today with respect to ensuring that we work with our customers and our suppliers on a multiyear basis to ensure that we have capacity to support the demand that’s out in front of us. And that’s really what’s driving this change in the way we contract and partner with many of our customers. So I think it’s a perfectly logical thing to do. It’s a needed thing to do in this environment. And to your point, I mean, most of these contracts are contracts that are structured in a way that ensures that while they won’t necessarily be exactly take or pay, but they ensure that we have protections for the investments that we’re making so that we’re not putting capacity in that’s not needed.
So we feel very good about the nature of the contracts, the way they’re structured, to ensure that the company is protected.
Scott Davis: Wow, that’s interesting, and congrats on that. So this is — I’m not looking for an exact number. I’m just trying to get a sense. If you think about — we all know transformers are lead times along. But when you think about the percentage of your SKUs that are sold out right now, is there some sort of number that you could guess 30%, 40% of your SKUs? I mean I know it’s broader than just transformers and switch gear, but any estimate there? I’m just kind of curious to see if that’s the majority or it’s still kind of sub-50% of SKUs?
Craig Arnold: Yes, I’d say that we really haven’t run the math, to be honest with you, Scott, in terms of what percent. I will tell you that maybe an easy way to think about it is that the long cycle parts of our portfolio generally today, we have capacity constraints on the long-cycle stuff and on the short-cycle stuff, not so much. And I think our split is roughly 75-25 between long cycle and short cycle. So maybe that’s a good proxy for where we’re actually at capacity or close to sold out and where we’re not.
Operator: And the next question is from Nicole DeBlase from Deutsche Bank.
Nicole DeBlase: Just maybe starting with Electrical Americas, obviously, really impressive 17% organic growth this quarter. You guys raised the guidance but still embeds pretty big decel throughout the year. So is that just — can we kind of chalk that up to conservatism, Craig? Or is there something that you guys are seeing with respect to growth in the rest of the year, that kind of causes that step down?
Craig Arnold: I appreciate the question, Nicole. And obviously, it was a really strong start to the year for our Electrical Americas business, and they posted really, really positive numbers. And I’d say maybe it’s early in the year. And we have one quarter behind us, and we just thought it’s prudent at this point, given the fact that it’s early in the year to let’s see how the rest of the year unfolds. Certainly, if things continue with what we’ve seen, there could be upside to that number. I would say as well that as you think about as the year goes on, the comps get in some cases, a little bit more challenging. There’s a little bit less contribution from price in some of the subsequent quarters. But once again, the business outperformed our expectation across the board most of which is obviously on the volume side in Q1. And so there is certainly the potential that the business does better than what we’re currently forecasting.
Nicole DeBlase: Got it. That’s very fair. And then similar question on free cash. You didn’t raise the guidance for the full year despite higher earnings. Is there something going on with net working capital or some other line item that causes the offset? Or is it just a bit early in the year, and you kind of want to see how that line item trends?
Craig Arnold: No, I’d say largely, it’s early in the year. And just really, we just thought it’s prudent at this juncture not to take the number up. We’ll obviously revisit it as we get through Q2, but it’s just early in the year.
Operator: And the next question is from the line of Andrew Obin from Bank of America.
Andrew Obin: Yes. I guess the question is everybody is asking about data centers, but maybe a slightly different direction. China, what are we seeing? How is your Electrical business in China performing within Electrical Global? And you have a very specific strategy there on JVs. Just maybe — just talk about how the deals are performing relative to your expectations. So the two-part question.
Craig Arnold: No, I appreciate the question, Andrew. And I would say our China business continues to perform very well. In fact, we grew high single digits in Q1 in our China business. And to your point, we do have a very specific strategy for how we play the China market specifically through joint ventures. And in many cases, as you know, these are minority joint ventures. And our joint ventures, by the way, if you just take a look at our joint venture performance, we obviously don’t consolidate this revenue, but they grew some 35% in 2023. So we’re getting a lot of great growth in the joint ventures in China. And as you know, strategically, what we tried to do there is really finding a way to partner with local Chinese companies who then give us the ability to broaden our portfolio to compete in Tier 2 and Tier 3 markets, both in China and around the world.
And so we’re absolutely thrilled with how well these JVs are playing out, and our team is executing, and it just gives us a lot of additional capabilities as we think about future growth of the company.
Andrew Obin: Excellent. And just a more technical question. I don’t know if — I apologize if I missed it, but can you just talk about electrical channel inventories on the product side? Where are we?
Craig Arnold: Yes. I would say that, once again, I think inventories are largely well balanced and well aligned right now. I mean, as you can tell by the growth in our backlogs, our backlogs continue to grow and lead times are not getting better and our book-to-bill, 1.2 in Electrical, which I think is a great indicator of where we sit today with respect to inventory in the channel. So today, I would say that it’s obviously going to be the odd product line or 2 where the dealer inventories could be a little long. But overall, inventories, I think, today are very well balanced and given the backlogs that we continue to build and certainly all the conversations that I’m in with our distributors and customers is that they’re looking for more stuff sooner, and they’re looking for shorter lead times than we can currently deliver to.
Operator: Our next question is from the line of Jeff Hammond from KeyBanc.
Jeffrey Hammond: Craig, just on this data center growth curve, in the slides, you kind of bump it from 16% to 25%. And I think the technology there you had a different time frame, but I think the pushback of the 11 — 10.8% growth was like why isn’t it higher? So just wondering how maybe we should think about that 10.8% differently and how to kind of incorporate capacity constraints or labor constraints versus kind of the numbers you put in the deck today?
Craig Arnold: I would say that what we’ve seen since we posted those other numbers, which were quite frankly a little bit stale, was that we certainly have seen just fundamental data center market independent of what’s happening with AI has been accelerating. The world, as we’ve talked about before, just continue to generate processed or increasing amounts of data. And then on top of that, you have this explosive trend in AI and these AI training data centers just require and consume just orders of magnitude more power than a traditional data center, and we’re obviously starting to see those orders and those negotiations come through now. And so that’s really what’s driving the change in the outlook for the market, not so much that we’ve decided that the labor constraints have been resolved, particularly or any particular power constraints overall have been resolved.
It’s really simply a function of the fact that what we’re seeing in our negotiations, what we’re seeing in our orders have just accelerated that much between the old number and the new number.
Jeffrey Hammond: Okay. That’s helpful. And then just on the capacity expansion, I think in 3Q, you laid out kind of the areas you’re bucketing for investment. Can you just talk about what starts to phase in earlier? Do you get any capacity online this year? Or is this more into ’25? And then if anything is kind of baked into the guide for these capacity adds this year?
Craig Arnold: We do start to see, as I mentioned, in terms of kind of what holds the margin expansion back a little bit is the fact that we are, in fact, bringing on and starting up new lines and new facilities beginning certainly, a lot of the spending in Q1, but certainly in the second half of the year, we start to see some of that capacity come free to the point where we actually have the ability to deliver more. So it’s really second half of this year and then into 2025 in earnest.
Operator: Our next question is from Phil Buller from Berenberg.
Philip Buller: We’ve talked about capacity constraints several times. It sounds like you’re pretty much at capacity in places. And I know you flagged this $1 billion of investment. I guess I’m wondering if $1 billion is actually sufficient to capture with that — that growth that’s yours to lose, I guess, as I’m sure you get a really nice return on making those kinds of investments. So do you see an opportunity to invest more beyond $1 billion for CapEx expansion? Or are you choosing not to do so because of these bottlenecks like other people’s labor, perhaps meaning you don’t necessarily need to invest today and instead can do a bit more on the pricing side? That’s question one.
Craig Arnold: I appreciate the question. And as you can imagine, we’re spending a lot of time right now internally reassessing and reevaluating whether or not we’re doing enough. The $1 billion, by the way, that’s an incremental number that’s on top of the base. So I just want to make sure I clarify that. But we don’t — we don’t intend to be the bottleneck here. We want to make sure that we have all of the capacity in place to deal with the growth that we see, the forecast that we’re getting from our customers. So we are not constraining ourselves with respect to the investments. . One of the good things about our business model overall, and I remind the group is that we do tend to be relatively asset light. A lot of what we do in the electrical business is assembly and test.
So we can bring on relatively significant amounts of capacity for relatively speaking, not a lot of CapEx dollars. And so we do intend to revisit the number given the fact that our forecasts are going up especially in certain verticals like data center to make sure that we do have enough capacity.
Philip Buller: And on that topic, I guess, an extension of it, the competitive landscapes when markets are as great as this, normally someone tries to find a way to play perhaps by adding capacity. Are you seeing any shift in market shares either from traditional players or from new entrants, please?
Craig Arnold: Yes. No. I mean, not particularly. I mean everybody is obviously adding capacity. The market is good for everyone right now. One of the things that we tried to give you a sense for how we’re doing is that by providing some of these win rate numbers that we showed you from mega projects, some of the win rate numbers that we showed you for non-res construction projects is an indicator of the fact that we think we’re doing very well in the context of this expanding market. And so I’m not — I don’t anticipate dramatic share shifts in the market, especially in a period of time when the industry is sold out in so many places. And the other thing I would tell you in terms of — we oftentimes get the question around new entrants, Chinese competitors and others coming into our market.
And I would say that we really are not seeing any material impact from, let’s say, the Chinese or other electrical equipment providers in the North America market. We have a strong position here. We have an outstanding channel. We’re absolutely well known in the market. The bigger, the more complex the project, the more likely they are to pick a company like Eaton. So I think we’re just very well positioned for the future here.
Operator: Our next question is from Nigel Coe from Wolfe Research.
Nigel Coe: The piece negotiation numbers are just extraordinary. I just want to make sure I understand the definitions. So would a negotiation be where you have an active negotiation or RFP in place with a — and this represents the dollar number of potential contracts under negotiation. And then, when you think about, say, a data center or especially data center given the permitting and power challenges, would that project be fully permitted before you get into a negotiation situation?
Craig Arnold: Yes. The answer is yes and yes. Negotiation would be a place where we are actually in an active negotiation in response to an RFP, request for proposal a request for quote. And certainly, if you think about data centers and others, once again, these projects tend to be already permitted down the road. As I did mention in some of the outbound data, there’s always been a level of cancellations, especially when you look at some of these mega projects, and we talked about in my outbound commentary that the cancellation rate that we’re seeing is around 10%. That rate is actually below what we’ve seen historically, but there’s always going to be a certain level of cancellations in any of these projects, but they — absolutely these tend to be or generally approved projects before we get to a negotiation.
Nigel Coe: Okay. And I know you’ve got about 10 questions on capacity. So let’s throw another one. Get away from the new greenfield capacity, but thinking about your existing footprint, are there opportunities to add another line or another shift extend over time to increase capacity in existing footprints? Or is there just to be constraint and that’s just not on the table?
Craig Arnold: Yes. I mean I think it varies depending upon which product line you’re talking about. In some cases, it is, in fact, us adding a line in existing footprint because we do have capacity to do it. In some cases, it’s adding additional shifts, utilizing existing assets. But in some cases, it means a new greenfield facility, and we’ve had to, in fact, stand up some additional manufacturing plants to deal with the growth that we’re seeing. So it’s really a combination of all of those and varies depending upon which particular product line or business you’re referring to.
Yan Jin: Okay. Thanks, guys. We have reached to the end of the call. As always, our team will be available to address any follow-up questions. Thanks for joining us, and have a great day, guys.
Craig Arnold: All right. Thank you.
Operator: Thank you. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T TeleConference. You may now disconnect.
