This is my first year as chairman of Eaton, having assumed the position in June of last year. I am humbled and honored by the opportunity to lead this great company.
As you know, Sandy Cutler retired at the end of May 2016 after 41 years at Eaton, 16 years as Chairman and CEO. Our company was transformed under his leadership and he handed me a strong company and one well suited for the challenges ahead.
Perhaps the most noteworthy of these challenges continues to be softness in most of our markets. While we thought we had planned conservatively for 2016, our markets turned out to be a bit softer than we had anticipated.
Executing well in a challenging environment
The good news for us is we know how to operate in this environment. Our company is over 100 years old and has survived for a reason – we are true to our values but willing to adapt our business strategy and priorities as the need arises. We took decisive action during 2016 to adjust to these ongoing headwinds and our management team rose to the occasion. It is never easy to move a large organization in response to a changing environment, but we were able to make significant adjustments as the year went on. Overall, we are pleased with how well our team performed, creating strong momentum as we go into 2017.
Among the year’s financial and operating highlights were:
We eliminated $210 million of structural costs, positioning the company well for the time when our markets turn up.
We improved safety – reducing our recordable incident rate by over 13 percent.
We reduced our environmental footprint by increasing the number of operating sites to 95 that do not place waste in landfills and reducing our energy use and water consumption.
We generated record cash from operations of $2.6 billion. Excluding capital expenditures of $0.5 billion, our free cash flow was $2.1 billion. Our free cash flow as a percentage of sales was a record 10.4 percent, and the ratio of free cash flow to net income was 107 percent.
We repurchased $730 million, or 11.8 million, of our shares.
A significant list of accomplishments, but we do understand that the biggest challenge we and other industrial companies face is how to accelerate growth. This is our top priority and each of our businesses had several notable accomplishments during the year.
Electrical: We continued to invest in intelligent products and software – such as PredictPulse remote monitoring and management services for data centers and Ephesus wireless LED control systems for sporting and industrial environments – positioning Eaton to be successful for a future in which customers and their systems will become increasingly interconnected.
Hydraulics: Our focus on improving our cost position and revitalizing our manufacturing capabilities is paying off. Each of these actions puts us in a stronger position to support customers and to grow. We also continued to invest and evolve our core technologies, which has allowed us to secure future business with our partner OEMs and distributors.
Aerospace: We’re winning on the most important military and commercial platforms by delivering the right technologies for our customers. Our efforts to improve our execution have resulted in better on-time delivery performance, which has been recognized by our customers.
Vehicle: Our continued focus on power efficiency, emissions and compliance-related solutions is paying off with new business wins for our Procision dual-clutch automatic transmission, valve and powertrain products.
An enhanced strategy
Building on our strong reputation as a power management company, we also made a number of important enhancements to our overall company strategy. This begins with a change in the way we talk about the company. We Make What Matters Work is our new brand promise and we think it conveys a strong statement about the difference Eaton makes in the lives of our customers, our shareholders, our employees and in our communities every day.
I strongly believe that the key to how well we deliver on our promises begins with our employees, all 95,000 of them. As a part of refreshing our strategy, we are clarifying what we expect from our employees. We expect our employees to be ethical, passionate, accountable, transparent, efficient and to continue to learn. These expectations are clear, simple and have been enthusiastically embraced by our employees. They represent the new criteria we use when determining how we recruit, develop and promote Eaton leaders.
As part of this new beginning, we also set new five-year financial goals – to deliver 2-4 percent revenue growth, expand our corporate and segment margins by 200-300 basis points and deliver greater than 10 percent free cash flow as a percentage of sales, with all of this yielding 8-9 percent annual EPS growth. While important, we also understand that you don’t lift and excite an organization of 95,000 people with only financial goals. So we also established a set of aspirational goals:
1. To be our customers’ and channel partners’ preferred supplier
2. To make work exciting, engaging and meaningful for our employees
3. To ensure the safety, health and wellness of our employees
4. To be a model of inclusion and diversity in our industry
5. To make our communities stronger
6. To be active stewards of the environment
These six aspirational goals will guide our company as we deliver on our brand promise and create value for you, our shareholders.
We also modified our corporate strategy to bring additional focus to organic growth, margin expansion and capital deployment. Organic growth will continue to play a central role in how we define success across our company and measure our leaders. To drive growth, we plan to capitalize on technology differentiation, leverage our channel and service strengths and deliver superior value for our customers. You should also rest assured that Eaton is well positioned to win in the increasingly connected world in which we live. In the Internet of Things (IoT) space, we make the "things." It is our electrical, aerospace, hydraulic and vehicle components that do the sensing and provide data to the internet. Each of our businesses is investing heavily and will be ready for today’s and tomorrow’s internet opportunities.
We have also put in place a multi-year plan to expand our margins by reducing structural costs and improving our operations. In our three-year restructuring program, covering 2015-2017, we will spend an estimated $440 million and will generate estimated savings per year of $518 million. We also intend to put additional emphasis on our product portfolio, accelerating growth where we have good margins and fixing or exiting products that have substandard margins.
Lastly, we will continue to be disciplined in the way we manage capital. First, we will invest aggressively to win in all of our businesses. Second, we will consistently return cash to shareholders through a dividend that grows with earnings and through a consistent program of share buybacks. Our $3.0 billion share buyback program covering the period 2015-2018 has thus far repurchased $1.4 billion of shares, placing us on track to complete the program as we have outlined it. And third, we will make strategic additions when merited while ensuring that our existing portfolio of businesses continues to create the highest value for our shareholders.
Looking forward to a powerful future
As we look toward the future, we remain optimistic and excited by our prospects. We continue to see powerful megatrends that will create enormous opportunities for years to come – a growing global population, investments in vital infrastructure in the U.S. and around the world, the importance of protecting the environment and rapidly changing technology in an increasingly connected world.
These trends are creating and will continue to create large growth opportunities for Eaton.
Just as important, we believe we have the right strategy. Over the last few years we have been busy – lowering our structural costs and improving our ability to execute within our operations – and building value propositions that are compelling for customers. This is what makes Eaton unique, this is what we do best. We develop products and solutions that are safe, reliable and efficient – solutions that solve our customers’ most complex and mission critical challenges.
Our company is moving forward and getting better every day. And when markets begin to recover – as they always have – all of the hard work our team has done over the last couple of years will yield significant benefits.
I would like to thank our shareholders, customers and employees for your faith in Eaton over the past years. We will continue to provide attractive returns, outstanding products and a great environment for our employees to work and prosper.