SPX Technologies Inc

F:SPW0

Earnings Call Transcript 2020-Q2

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the SPX Corporation Second Quarter 2020 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Paul Clegg, VP of Investor Relations and Communications. Please go ahead, sir.

[Paul Clegg, executive]

Thank you, and good afternoon, everyone. Thanks for joining us. With me on the call today are Gene Lowe, our President and Chief Executive Officer; and Scott Sproule, our Chief Financial Officer.

The press release containing our second quarter and year-to-date results was issued today after market close. You can find the release and our earnings slide presentation as well as a link to the live webcast of this call in the Investor Relations section of our website at spx.com.

I encourage you to review our disclosure and discussion of GAAP results in the press release and to follow along with the slide presentation during our prepared remarks. A replay of the webcast will be available on our website until August 6.

As a reminder, portions of our presentation and comments are forward looking and subject to safe harbor provisions. Please also note the risk factors in our most recent SEC filing, including our disclosures related to the ongoing COVID-19 pandemic.

Our comments today will largely focus on adjusted financial results. You can find detailed reconciliations of historical adjusted figures to their respective GAAP measures in the appendix to today's presentation.

Our segment reporting structure combines the results of our Heat Transfer and South African operations into an All Other category, which is excluded from our adjusted results.

Our adjusted earnings per share also excludes nonservice pension items, amortization expense and investment true-up and onetime costs associated with acquisitions.

Finally, we will be conducting virtual meetings with investors during the third quarter, including our participation in the Ideas Conference on August 27, and the Vertical Annual Global Industrials Conference on September 9 and the Sidoti Fall Conference on September 23.

And with that, I'll turn the call over to Gene.

[Eugene Lowe, executive]

Thanks, Paul. Good afternoon, everyone. Thanks for joining us. I hope that all of you and your families remain healthy and that you're managing through this challenging environment. On the call today, we'll provide you with a brief update on our overall results and segment performances for the second quarter. We'll also discuss the impacts of COVID-19 pandemic, and our current view of the key deliverables -- the key variables driving the second half of 2020 and beyond.

Now I'll touch on some of the highlights from the quarter. Our performance in Q2 exceeded our expectations on a number of fronts despite some clear headwinds. The benefits of our diverse end markets and of our strong business system were apparent during the quarter as many of our businesses experienced strong results, while we saw the impact of the pandemic expand elsewhere in our portfolio. We ended the quarter with an even stronger balance sheet and additional liquidity. We are well positioned to continue our growth initiatives, including potential strategic acquisitions.

Looking forward, we anticipate that we'll generate a solid level of cash and earnings in the second half of the year.

Turning to our adjusted results for the quarter. Both revenue and segment margin were similar to prior year levels. The benefit of acquisitions and the strong performance in our Engineered Solutions segment offset headwinds in our HVAC and Detection & Measurement segments associated with the pandemic.

Adjusted EPS was $0.64, $0.03 below the prior year. I'm also very pleased with our year-to-date performance, which includes growth of more than 11% in adjusted operating income.

Given the quickly shifting macro environment, I think it is helpful to discuss what has changed over the last 3 months since our Q1 earnings call. Our HVAC segment performed ahead of our expectations in the second quarter. We saw a swift recovery in our China cooling sales and strong operational execution in our U.S. and European-based cooling operations. Our Americas team was particularly effective in executing on Q2 scheduled backlog, and we experienced fewer-than-anticipated COVID-related delays associated with customer sites and order rates.

Heating orders associated with our midyear boiling stocking program were also better than expected. As we look forward, recent quote and order trends for our nonresidential HVAC business have slowed, which is consistent with the decline we saw earlier this year in leading indicators like the ABI and Dodge Index.

In Detection & Measurement, our locators business, which is our shorter-cycle business, was already experiencing a large reduction in orders at the end of Q1 and entering Q2. While overall levels of demand remain notably down from the prior year period, the decline was not as severe as we were anticipating. And we have seen significant sequential improvements over the last several weeks from the trough experienced in early Q2.

While we're still seeing healthy frontlog in our project-based businesses and Detection & Measurement, the timing of deliveries of certain projects has been impacted by pandemic-related delays. This is particularly the case for certain communication technologies equipment. These delays are due largely to administrative issues, such as timing of government approvals and limited ability to travel to commission orders. Funding, on the other hand, remains intact, and we anticipate ultimately delivering on these projects.

Finally, our Engineered Solutions segment continues to perform ahead of our expectations and well above the prior year's level due to the strong operational execution of our transformers business.

As we did last quarter, I'll provide you with an update on the current state of our operations with respect to managing the unique environment of the pandemic. Our COVID-19 task force, which I am a part of, continues to meet regularly to carefully monitor and implement refinements to our procedures in order to help prevent the spread of coronavirus and to protect our team members and communities. As case rates expand in different parts of the U.S., overall, the number of employees testing positive for the virus has been consistent with local trends. Our processes for maintaining safe sanitary facilities and managing and containing any occurrences in the workplace are functioning as intended to maintain employee safety as a top priority. To date, our facilities have not seen any material interruption in operations.

To address our employees directly for a moment, I know what a challenging environment this has been. And our journey is not over yet. I really appreciate the incredible fortitude you have all shown. You're an exceptional group of people and a team that I'm proud to be a part of.

Turning to our value creation road map. I wanted to focus on 2 key themes today that are important foundations of long-term value creation. First, during the quarter, SPX published our annual sustainability report in the governance section of our website. We feel good about the progress we've made on our sustainability goals. And we believe we have the right initiatives in place to continue driving towards a best-in-class ESG profile.

Second, one of our strategic initiatives for the year is a plan to expand our diversity and inclusion programs, encompassing a comprehensive range of actions, including the creation of a global Executive Diversity Council, which I will chair, to guide initiatives and training for all employees. We're also creating networking and action groups across the organization that will highlight and develop solutions to challenges faced within the company and in our communities.

Furthering a culture that embraces diversity and inclusion, where all employees have a voice and feel that they can develop and thrive will be critical to our ongoing success. This will be a journey that SPX will remain committed to for the long term, and I am proud of the effort and focus of our teams that are bringing this process along.

And now I'll turn the call over to Scott to review our financial performance.

[Scott Sproule, executive]

Thanks, Gene. I'll start with our results for the quarter. On a GAAP basis, we reported earnings per share of $0.62. On an adjusted basis, which excludes the impact of the items noted by Paul, EPS was $0.64. Overall, our solid results for the quarter were driven by strength in our Engineered Solutions segment and a better-than-expected performance in our HVAC segment.

Turning now to our adjusted results. Revenue was similar to the prior year. The benefit of acquisitions offset a 3.3% reduction in organic revenue in a modest currency headwind. Segment income was down only slightly, while margin was flat. Given the significant headwinds associated with the current environment, we are very pleased with these results.

Now I'll walk you through the details of our results by segment, starting with HVAC. Revenue increased 1.1%, a 10.4% increase from acquisitions was largely offset by an organic decline of 8.9% and a modest currency headwind. The organic decline was driven by lower heating volumes, including the impact of the pandemic, partially offset by stronger cooling sales in international markets. Adjusted segment income rose by $2.1 million and margin increased 150 basis points as a result of strong operational execution and a more favorable product mix in our domestic cooling business. Overall, we are very pleased with our strong first half performance in our HVAC segment.

Looking forward into Q3, we anticipate a low single-digit organic revenue decline and a less favorable sales mix associated with softer market demand for nonresidential HVAC products.

In Detection & Measurement, revenue declined 9.4%, including an organic decline of 8.9% in a modest currency headwind. The organic decline was due to lower sales of located products and delays in Communication Technologies project sales associated with the pandemic. Adjusted segment income margin declined 530 basis points due to lower sales and less favorable mix as the pandemic-related decline in sales was focused in our highest margin product lines. Overall, we anticipate a decline in Q3 revenues in the mid-teens and a reduction in margin reflecting lower year-on-year sales of locators and delayed execution of Communication Technologies project sales.

In Engineered Solutions, revenue for the quarter increased 5.6%, reflecting continued strong execution in our transformers business, including better pricing discipline. Segment income increased $4.6 million and margin increased approximately 260 basis points to 12%, reflecting the stronger operating performance and more favorable pricing. Looking forward into Q3, we anticipate revenue growth of mid- to high single digits. As always, Q3 margins will be sequentially lower than Q2 resulting from our annual transformer facility maintenance outage, but we do expect an increase in Q3 margins compared to 2019.

Turning now to our financial position. Our balance sheet further strengthened during the quarter as net leverage declined modestly to 1.5x, the lower end of our target range. Adjusted free cash flow was $21 million, and cash used in South Africa was negligible. At the end of the quarter, readily available cash and borrow -- revolver borrowing capacity totaled more than $370 million.

While the dynamics of the pandemic remain uncertain, we currently anticipate a significant amount of cash generation in the second half will further strengthen our balance sheet and liquidity position.

Turning to our near-term outlook. For Q3, we anticipate a low single-digit organic decline in total adjusted revenue. This view encompasses growth in Engineered Solutions more than offset by an organic decline elsewhere primarily in Detection & Measurement. Our visibility into full year results remains affected by the pandemic and current macro environment. Given the level of uncertainty, we cannot provide a specific guidance range for the year. That said, based on where we are today, we would not expect our full year earnings to be substantially different than 2019. This view comes with several assumptions, including that our facilities remain fully operational, our customers and our supply chain remain largely functional and that we do not experience material event-driven disruptions, such as government shutdowns.

In the appendix to today's presentation, we have once again included estimated decremental and incremental margins by segment as well as some additional color to help you with modeling.

With respect to the discretionary cost reductions we implemented last quarter, we expect most of these remain in place for the time being. We need these restrictions in certain areas such as travel, that we anticipate will sequentially raise our third quarter corporate expense. Although we do not anticipate the need to take further actions, we remain prepared to do so if conditions deteriorate.

Now I'll turn the call over to Gene for some commentary on end markets and his closing remarks.

[Eugene Lowe, executive]

Thanks, Scott. What we're currently seeing in our end markets is largely consistent with the divergent geographic trends playing out with the COVID-19 pandemic and the cycle dynamics of our diverse end markets.

In HVAC, in our nonresidential markets, demand is slowing, consistent with market indicators. For residential boilers, preseason stocking orders held up well in Q2. As is typical, we anticipate that winter weather will be the key driver for heating in the second half.

In Detection & Measurement, our locator sales strengthened in China to normal levels. And we appear to have passed through the trough in demand in most other markets, including the U.S. Overall, our other Detection & Measurement end markets are mixed, with travel and access restrictions restraining near-term demand. Yet, we continue to see frontlog development for projects associated with government, municipal and quasi-governmental entities.

In transformers, we have seen little change in utility customer behavior, apart from a trend to favor more U.S.-made equipment although we have seen some slowing of CapEx spending among municipal customers. And in-process cooling, our current backlog supports our second half expectations although we are seeing some moderation in forward demand. For reference, we have repeated key metrics about the diversification of our end market exposure in the appendix of today's presentation.

I'm very pleased with our strong performance for the quarter. Our diverse end markets and strong operating culture have helped provide a level of stability to our overall results. I believe we have the right team and right processes to continue managing through the current challenging environment. While the near-term outlook remains subject to risks associated with the ongoing health crisis, at this point, we expect to generate significant cash and further strengthen our financial and liquidity position in the second half of 2020.

As we look ahead, we continue to see ample opportunity to deploy capital, including for strategic acquisitions that will help further position us to accelerate our growth and profitability in 2021 and beyond. And for the right opportunity, we are ready to do so in the second half of this year.

Before I turn the call back to Paul, I'd like to take a moment to recognize Scott for his immense contributions to SPX over the last 15 years. As you know, Scott will be retiring from his role soon, and this is expected to be his last earnings call. We recently announced that Jamie Harris will begin in the CFO role in mid-August. Scott, I personally want to thank you for all that you've done for the company and for the SPX team. You've been an invaluable leader in the organization and it has been great working with you.

[Scott Sproule, executive]

Thanks, Gene. I really appreciate your kind words. It has been a great privilege working with you and the SPX team. I'm proud of my tenure at SPX, and particularly with the company we have all built together since the spin. To all the analysts and investors listening in, it has sincerely been my pleasure to work with you. And to all my SPX colleagues, thank you for your support and camaraderie over the years. This has truly been a team effort. Jamie will be an excellent fit here at SPX and brings a lot of great experience to the role. With Gene, Jamie and the rest of the SPX leadership team, you are in very good hands.

[Paul Clegg, executive]

Okay. This concludes our prepared remarks. Operator, we are ready to go to questions.

[Operator]

[Operator Instructions] Our first question comes from Damian Karas with UBS.

[Damian Karas, analyst]

And Scott, congratulations on your retirement. It's really been a pleasure working with you over the years.

[Scott Sproule, executive]

Thank you. Appreciate that.

[Damian Karas, analyst]

It's an opportunity to cause you some heartburn here 1 last time. In all seriousness, I know I'm going to get questions about this, so I figured I'll just ask. Could you just discuss what your thinking was in not reinstating guidance? I mean considering how resilient your business was through the peak of the pandemic. It does sound like you're mostly seeing improvement throughout the quarter, maybe even nonres [indiscernible] was the exception, but is there not -- is there a reason that we should expect no more worsening of sales activity from the second quarter?

[Scott Sproule, executive]

Damian, this is Scott. So it's really around the -- some of the macro and not want to put something out there that potentially something occurs to. We try to frame it up as best we could on giving our kind of expectations a little more detail on Q3 and then on the full year, which, obviously, you can kind of back into a little bit generally Q4. But to be able to provide kind of a range of outcomes, not just the macro, but also some of the timing that we talked about for the contact project orders which, as you know, are kind of discrete in nature and could be large and big swings to our profitability were some of the reasons why we decided not to put guidance back, but wanted to provide some clarity on what we're expecting.

[Damian Karas, analyst]

Okay. Fair enough. And on HVAC, thinking about the 9% decline there, how many points of growth do you think the pandemic cost you in that segment? And I was wondering if also you could just maybe elaborate a little bit on the nonres order codes. You mentioned them slowing. Are we talking kind of double-digit declines versus last year? Or is it more modest than that at this stage?

[Eugene Lowe, executive]

Yes, Damian, this is Gene. I think if you look at the -- we would say the majority of the decline, and if you look at, if not all, of it, we're down about 8.9% organic in actually both HVAC and Detection & Measurement was really driven by COVID. The businesses there are executing very well. So that would be my assessment. We do have data. And there is a little bit of gray areas on some movements and so forth. But generally, we believe it's -- the decline is driven by COVID. If you look forward in the nonres, it's pretty much -- we are seeing some impact in terms of -- and if you look at the ABI Index or you look at the Dodge Index, these are probably the 2 most relevant leading indicators for us. There has been some slowdown in nonresi activity. And we do expect to see that as a headwind in the back half of the year. But we have taken that into account into what we've communicated for Q3 and what we've communicated for the full year. As we've said, we expect our earnings to be similar to '19. But specifically with HVAC, we will see a little bit of headwinds due to the slower activity levels that happened in the first half of the year. As a reminder, most of our products get ordered in the range of 6 to 8 months after a project is initiated. So a slowdown in Q1 or Q2 would impact our products a little bit later.

[Damian Karas, analyst]

Okay. Great. And 1 last quick one. Just want to ask you guys about cost items. I mean, the actions that you had taken, are you planning to keep those in place for the time being? Or now that you're through the pandemic and you've seen how the business performed, have you started to think about pulling some of those cost actions back?

[Scott Sproule, executive]

This is Scott. So we have largely kept them in place. So as I kind of had in the prepared remarks, and just as a reminder, we have said for the impact of 2020, it would be about $15 million to $20 million. So Q2's realization was in line with that range. Now we have lightened up some of our restrictions around travel. A specific area being able to kind of reengage on some of the OpEx initiatives that we have that we kind of locked down as an example and then others for customer visits and such. So we're not going to have the full realization of that you see at the top end of that range that we previously gave. So probably kind of bring that back a few million dollars spread evenly over Q3 and 4, but still $15-plus million for the year.

[Damian Karas, analyst]

That's helpful.

[Eugene Lowe, executive]

Damian, from a modeling standpoint, you'd see some of that in the corporate expenses. As we mentioned in the prepared remarks there, which we'd expect to be sequentially a little bit higher in 3Q.

[Operator]

Our next question comes from Bryan Blair with Oppenheimer.

[Bryan Blair, analyst]

Solid execution. Another really strong quarter from your transformer business. You've indicated that 3Q looks good on a year-on-year basis. So I was hoping you could offer some more color on how to model that? Is the second quarter year-on-year margin expansion a reasonable range to anticipate for 3Q?

[Scott Sproule, executive]

Yes. So as I said, I mean, we always have the down -- the sequential decline from our Q2 to Q3 perspective because of our plant maintenance. But we do expect year-over-year margin expansion in Q3, similar level as what we've experienced in the first half. What I will caution as you're modeling is when you start looking at Q4, it becomes a tougher comp, and we're not going to have that type of margin expansion. So if you go back to what we talked about in the Q1 call, we saw some of these improvements kind of progressively showing up in the results in 2019, whereas we had much stronger results coming out of Q4 than the earlier parts of the year for Engineered Solutions. So we are expecting a good quarter but not necessarily the strength of improvement that you've you seen so far this year.

[Bryan Blair, analyst]

Got it. Appreciate the detail. And then in Comtech, any chance you can size the delayed projects? You mentioned funding is secure. Is there visibility at this point to project release?

[Scott Sproule, executive]

We have good visibility on the projects. We have decent visibility on the release, but that's been the challenge. A lot of this is going through government or quasi-government agencies that have just really slowed down the approval process. So we don't have a concern around the funding for these projects. It's the timing of them getting through. And so that's another reason, as I said with the previous question, around 1 -- not restating guidance is because these things are just moving at an abnormally slow pace. So it's difficult to project where they're going to come out. And when we looked at our second half, that's part of the reason why we're showing a mid-teens organic decline in Detection & Measurement in Q3. And we would expect those projects to start delivering in Q4 and some of them are already going to carry over into 2021.

[Bryan Blair, analyst]

Okay. Makes sense. And you sound a little more optimistic about the M&A environment certainly relative to last quarter. Any further color you can provide on your funnel? And given your current balance sheet position, expected cash flow strength, what should we think about as dry powder if we look forward, say, 6 to 12 months?

[Scott Sproule, executive]

Yes. So let me start on just the -- why we feel more confident. Obviously, when we kind of say 90 days ago, trying to put any type of a forecast around the second half was near possible with all the variable and how fast things were moving. We feel like we have a decent handle around the second half. Obviously, we ended the quarter at the low end of our leverage range. So as we look at the financial performance over the second half and how we think it could come out, we do see good cash flow generation and stable earnings, which is going to give us a natural delevering. So that's what gives us the confidence that, yes, we can kind of get back into a capital deployment mode. And I'll let Gene talk about kind of the pipeline and even going back to the -- what we thought about coming into the year and where we are now.

[Eugene Lowe, executive]

Yes. And Bryan, just to take back, if you look at Q4, Q1, we had been communicating that we felt like we had the strongest pipeline that we've had in 5 years. And I think that's largely a function of we really tightened up our strategies, and we know exactly where we want to grow and how we want to build out our platforms and our HVAC and our Detection & Measurement businesses. And so there was a good amount of activity going on. Now obviously, COVID slowed things down, I think as Scott alluded to, when the crisis first started, there's just a lot of uncertainty on any forward forecasting. So that was a big issue. And then the second thing is it's much harder to execute M&A when you can't travel, right? Due diligence and integration, to do this properly and effectively you have to be on site, and you need to be looking people in the eyes. You need to be talking to customers, and that had been slowed down during the process -- or during the COVID crisis. But where we sit today, I do think there is an uptick in activity. The -- our strategies haven't changed. I think if you look at our last 5 bolt-ons that we've done over the past 2 years, leadership positions in niche engineered segments, it's very consistent. Our strategy hasn't changed, but I think we're starting to feel better. And if the right opportunity were to arise, we would be willing to move forward in the back half of the year.

[Scott Sproule, executive]

And just, I'll jump in there is just -- even though we're feeling more encouraged, we're going to be prudent about it. Of course, we're not going to be in a position where we're going to significantly lever up the company, but we do feel like being at such a low end of our range that we do have capacity to start looking at moderate size strategic acquisitions.

[Operator]

Our next question comes from Brett Linzey with Vertical Research.

[Brett Linzey, analyst]

And first, congrats to Scott. Appreciate all the help over the years.

[Scott Sproule, executive]

Thank you.

[Brett Linzey, analyst]

And first, a couple of HVAC and then transformers. First, just in heating, you indicated strong preseason orders. How did orders look and track year-over-year in June and then July? And just a reminder, what channel inventories look like as we head into the season?

[Scott Sproule, executive]

So when we talk about the preseason, coming into the quarter, one naturally when you come off of a warmer Q1 demand, there's always a decline year-over-year. So we anticipated that. And then I would say we kind of -- we're a little bit concerned about what the strength of the channel is going to be so. When it came in stronger than anticipated, that was a very good sign to us about the strength of the channel, both from an inventory level as well as the -- I'll say, the liquidity position of our channel partners. And so that drove some of the improvement that we talked about and really put the demand level that we saw very similar to prior periods going back to '16, '17, where we were coming off of also a warm Q1 end of the winter season demand. So we felt good about that, and we're continuing to see a healthy order pipeline here in the early part of Q3 through that channel, which again, just gives us further confidence about inventory levels and the strength of the channel.

[Brett Linzey, analyst]

Okay. And then just shifting to the cooling nonres side. What does the bidding pipeline look like? And how is it tracking year-over-year? And I guess, as you put that into a picture and thinking about the 2008 declines. I think you said cooling peak to trough in '08 was down 15%. Is that the type of drawdown that you might see as this -- as the business lags? Or what are your expectations there?

[Eugene Lowe, executive]

Yes, Brett, this is Gene. The -- I think if you look at it and if you look at the back half of the year, I would say the activity levels in terms of quoting and bidding, which is usually a pretty good proxy for what turns into purchase orders and revenue is down in that neighborhood of around 15%. And as a reminder, as you know, our cooling business, there is half of it, which is typically replacement. There's half of it, which is typically for new projects. When you do see some slower activity level in new projects, typically, all the contractors go do more refurbishments or replacement-type work, which reduces some of the impact. But I would say right now, that impact to be in that range for cooling, at least on the quote activity we're seeing right in front of us at about 15%.

[Brett Linzey, analyst]

I appreciate that. And then just one last one on transformers. The first time I've heard the words favorable price for a period of time. Is that specific to SPX? Are you seeing peers in the industry move on price? Any color there?

[Eugene Lowe, executive]

Yes, Brett, I would -- my view is this is something that the team has really done a fantastic job, and you really saw the improvement over the last year, really an improvement every quarter. And then this year, it's really been nice, nice execution. I actually believe this is not market price. I actually think this is pricing discipline. And these guys -- the team has really put together a very strategic pricing process for pricing to value. When you have an advantaged lead time, an advantaged technology, when you have an advantage, you've already done the engineering design, these type of things, you have an advantage in the bid and not just to be the low guy out there. And through this process, these guys have really been able to have an impact on margins. And I think that's some of the benefit that we're seeing on the year-over-year improvement. The improvement in the first and second quarter is very high. And it's a combination of both, I would say, the pricing initiatives, the strategic pricing initiatives and then really good execution as well as a good mix, a very, very favorable mix in the first half. We do expect Q3 to be up in terms of margins over Q3 of last year. And then really, Q4 of last year will be a tougher comp. We would expect to be somewhere in line with Q4 of '19. But I would say the progress that, that business has made has been extremely impressive. And we really like the trajectory that, that business is on. And there's a really good team there driving it. But back to your fundamental question, I do not believe it's market price.

[Operator]

Our next question comes from Joe Mondillo with Sidoti & Company.

[Joseph Mondillo, analyst]

So outside of the transformer business, are you seeing any growth within any of your businesses, I guess, maybe the boiler business? But I guess, maybe specifically at D&M, just curious on what's going on in that segment?

[Scott Sproule, executive]

Yes. I mean I would say the other businesses are stable to some modest growth within D&M. In the boiler business, just to be clear, we're not seeing growth there. As we said, we came off of a tough Q1. And we do expect to have a decline in the year. We do have a tough comp in Q4 as well because it was a higher-than-average Q4 of 2019, represented a higher-than-average demand profile. So kind of a colder winter demand profile, even though it tailed off really late. So we -- and we've kind of set our expectations more towards an average season. So overall heating is anticipated to be a decline. But when you -- going back to the Detection & Measurement, we are seeing growth in the businesses. We talked about radio is down clearly. We're seeing the delays in the projects in the communication technology side. The other side of the communications technologies businesses are kind of holding in there. And then you have the transportation side of the business, which is seeing growth.

[Joseph Mondillo, analyst]

And regarding that radio business, I know visibility is limited, but a lot of construction is going on right now. And so anything related to these construction projects that are happening is benefiting, but I know radio is probably a little different in terms of how that is maybe more of a leading indicator, I guess, maybe. So would you anticipate, if, say, '21 is a down year for nonres, radio could actually be performing okay as 2020 really sees the effects. I'm just wondering how you see the trajectory of that business relative to the nonres cycle?

[Eugene Lowe, executive]

Yes. Joe, I mean, I think from my view, on radio, radio is the ultimate short-cycle business. It reacts very quickly as we saw in the crisis. But it's also been coming back very nicely. And there's a lot of different types of activity that drives demand. It is nonresi. It is residential construction. It is putting in gas lines. It is putting electrical lines. It is putting in cable. It is putting in fiber. Any time you need to dig, which you're required to do in many countries, you have to scan. And we obviously have the market-leading position in that business globally. So it really does reflect the overall economic situation. So if there are large swaths or countries that are shut down, that would be an impact to us. But what we're generally seeing is Asia has come back very strong. China has come back very quickly. U.S. after -- and Europe after being down pretty strongly at the end of Q1 and beginning of Q2, we're seeing really nice sequential improvement, but it is a reflection of overall economic activity. And so in a normal environment, we think we'd be back to normal in our normal growth path. And -- but if you are in a world where there's much less economic activity, much less building or digging, we do think that, that would have an effect on that business. But right now, as I look to 2021, I would expect the improvement for 2020, and I would expect improvement for 2021.

[Scott Sproule, executive]

Yes. So I mean the sequential rate that we've seen still down on the second half, but nothing like what we saw in Q2. We talked about locating inspectors. A reminder, radio is half of that. The inspection business is a much more stable business that is continuing to grow in a modest growth, but still steady growth. And what we've seen is the volatility in the locate side, just as Gene elaborated on. We saw upwards of 20% decline here in Q2. It was very steep in the first part of the quarter and a nice recovery, and we're seeing -- so we have a better exit rate, but still a lower rate than the year ago.

[Joseph Mondillo, analyst]

And did you say that in terms of the 3Q guide for D&M, sales down mid teens? Did I hear that right?

[Scott Sproule, executive]

Organically, yes.

[Joseph Mondillo, analyst]

Organically, right?

[Scott Sproule, executive]

It still -- which represents -- again, it's a reflection of a continued year-over-year decline in the inspection -- or sorry, located side of the business, radio. And then also, we're anticipating very few of those project orders executing for communication technologies business.

[Joseph Mondillo, analyst]

Okay. And shifting to HVAC. Organic declines of 9% in the quarter, but you saw 100 basis points of -- I think it was -- I think I was looking at gross margin improvement. Is that just purely cost management? Or how are you able to see those?

[Scott Sproule, executive]

It's a combination. There is some cost management, obviously, in there. But it's also a combination of very strong operational execution, particularly in the domestic side of that business. Saw a nice recovery in China, in particular, in Q2 in that business. And then we do -- we are seeing some benefits. We've talked about -- we haven't been able to move our business system and CI programs as far as we'd like, given everything, but we do have some benefits going on. So there is some supply chain benefits that are coming through there in the quarter based on what we were able to get some traction on with those initiatives.

[Eugene Lowe, executive]

A really nice execution by the teams, and particularly on the cooling side, the cooling globally, U.S., Europe and Asia, really doing a very nice job there.

[Joseph Mondillo, analyst]

Okay. And as far as the nonres part of the HVAC business, a lot of the HVAC, I guess, your peers have seen pretty drastic declines in the second quarter. And seemingly, it sounds like things have improved throughout the quarter and maybe there's a little bit of improvement in the back half of the year. Is that the dynamic you're seeing? Or has it gotten worse throughout?

[Scott Sproule, executive]

No. I think what we saw, and I'll start with the cooling is the larger piece of the nonres, then you have electric heating largely is the other piece of it. But what we saw in Q2, and this is part of why we actually executed better than we anticipated, was we saw -- it was a pretty resilient business. Strong execution on the backlog. We did not see the level of site or customer delays that we anticipated could come up with all the restrictions and the shutdowns and the lockdowns. So we really kind of executed through normalcy. But as Gene talked about, we did start seeing late in the quarter, those order rates come down, particularly in the cooling business, and this is where we talk about our linkage to kind of ABI and Dodge and being 6 to 8 months on a trailing stat. So we're anticipating that we're going to have some decline there over the second half in that business.

[Joseph Mondillo, analyst]

Okay. And just in general, as far as cost management and any sort of execution or temporary cost cuts or anything that you did sort of at the worst of the downturn. How did that play out? And how does that translate into sort of 3Q? I don't think you did any huge significant cost cuts like maybe some other companies. But just wondering if there's anything temporary that comes back or anything structural that you permanently took out...

[Scott Sproule, executive]

There has not been really, I'll say, structural, been very minimal, anything from a real structural perspective. It's really been hiring delays or not filling roles, open roles and the kind of travel restrictions, obviously, incentive comp programs give you outlined with how year-over-year performances, those type of things that we're in, and obviously, discretionary spend areas. Those are what we've kind of put together and said, we put a real strong clamp on. That's where I talked about last time, said $15 million to $20 million impact for the year. I would say in Q2, we realized the benefit of that, kind of, I would say, towards the top end of that range. So if you just normalize that over the 3 quarters. But we have loosened up some of our restrictions, particularly around travel and some discrete spend. So when you look at Q2 and -- sorry, Q3 and Q4, you want to kind of back off $1 million or $2 million per quarter of that run rate. So we're probably -- we're going to be on a full year basis in the $15-plus million of cost -- temporary costs. So those will come back over time, but those will be brought back in time, aligned with the increase in the revenues, right, so you get kind of the -- you'll get the earnings associated with the revenues as well.

[Joseph Mondillo, analyst]

Okay. And just last question. I just wanted to come back to HVAC. The 3Q sort of guide that you put out there, I guess, it was low single-digit organic revenue growth. Is that correct?

[Scott Sproule, executive]

Correct. Decline line actually, low single-digit...

[Joseph Mondillo, analyst]

Decline, decline, right? And so if you are anticipating weakening at the cooling business or at least the nonres exposure that you have there, which is most of it -- I assume you're assuming growth on the heating side?

[Eugene Lowe, executive]

So the heating side will benefit a little bit from some of the orders that came in, in 2Q. But there's still a piece of heating that is nonresi that will have -- would have a similar impact to cooling. Yes. That's right. So I was just going to say the organic decline is really going to be around both heating and cooling, particularly in the domestic cooling. We do have some benefit in the international markets just similar to what we saw here in Q2. And then as we talked about, there's going to be a mix -- it's kind of a mix down when you have some of that organic -- based on organic declines, it will be a little bit of margin pressure. And when you look at the ultimately -- the reported results, a reminder, we -- Patterson-Kelley acquisition was late Q4. So you're still going to get a benefit from the revenue side and a little bit -- and the profits, obviously, for the full year of that acquisition in 2020.

[Joseph Mondillo, analyst]

Right. Okay. And so I guess, given your visibility relative to the comments that you've made on the cooling and the nonres, does that visibility sort of say that 4Q maybe a little tougher. I'm just sort of addressing the low single digits and the fact that you sort of were talking about nonres and potentially hitting that trough of down 15%. I guess you're referring to the orders. And so your visibility with the orders and the backlog, does that sort of maybe signal that the 4Q could be a little worse than 3Q as far as what you can tell right now?

[Eugene Lowe, executive]

Joe, let me take a crack, and we may have been stating things a little bit more negatively than we should have. And most of our comments around the Americas, and we're actually having a lot of improvement in EMEA and APAC. So if you look at Q3, we're not seeing a lot of organic decline, we're actually relatively flat in the cooling business. And we would anticipate we are seeing decline in Americas in that teens, but it is being offset by growth in EMEA and APAC. And then if you look at Q4, you will see some organic decline there, and that would be where you'd see some of the impact of the slowdown in bookings starting to manifest itself, particularly in the Americas.

[Operator]

Good luck, Scott, congratulations, good luck with everything.

[Scott Sproule, executive]

Thank you.

[Operator]

[Operator Instructions] Our next question comes from Walter Liptak with Seaport.

[Walter Liptak, analyst]

Congratulations, Scott. I wanted just to ask about the D&M projects. And I wondered if the projects that are delayed, are those tied to government budgets that have already been set? And then just maybe some color around what needs to happen or what could happen to close those? And as we get closer to kind of government year-ends, could there be a budget flush, where you get some of these orders?

[Scott Sproule, executive]

Sure. I'll start and Gene can add in. So first, let me -- as a reminder, we have projects both in the transportation side and the communication technology side. So really, what we're talking about is on the communication technology side, where we've seen the delay. And we're still seeing healthy activity on the transportation side. So these budgets, yes, the budgets are set. We do see that there's naturally some -- as you get towards the end of the year, some budget money that could come through. But we also -- some of these budgets, we know some of the projects have been extended for the government funding has been extended beyond the year. So we feel good -- that's why we say we feel good about the funded status of these projects. It's just the timing -- exact timing is more challenging to figure out given how slow the approval process has been.

[Walter Liptak, analyst]

Okay. And as the crisis starts to abate at some point and maybe some of these projects get released, is there a possibility where your capacity gets used up? And these things, you've built up a backlog maybe going out into 2021 or something? Or is it -- do you have the capacity to meet the demand for the projects that you see in the funnel?

[Scott Sproule, executive]

I think we have the capacity. I mean, I don't think you're going to see kind of a huge catch up, if you will, in the year, but we do have the capacity. I'm not concerned about that. For items that we know that we're kind of single-sourced on, we'll take the investment and start working on those when we have the capacity to do that. So I'm not concerned about it from our capacity to meet the orders once they do get kind of through their administrative process.

[Walter Liptak, analyst]

Okay. Great. And then just a couple more quick ones. The transformer business, I thought I heard you say that utilities want a U.S. supplier or they're pulling their supply chains more local. I wonder if you can provide some more detail on that.

[Eugene Lowe, executive]

Yes. Walt, I would say, if you look at the market and what's going on in the general transformer market, I'd say 2 trends that we're seeing: one would be on the positive side is exactly what you're saying, is more of a buy American bias. And this is probably as a result of some of the edicts that have come out of the President's office and some of the targeting of some countries that are not friendly, perceived to be friendly to the U.S. So as a reminder, that's really most of the medium power market, which is the bulk of our business is predominantly domestic. And if you get to the large transformers, the EHV transformers, you do see a higher percentage of import activity there. So we would actually see that as a positive trend in the large or the EHV transformers. So I'd say that is a trend that we are seeing in the marketplace. On the other side, which is a little bit of a headwind, I would say, is on the municipal market, small municipalities, we are seeing a little bit of slowing of order activity there. That's not the biggest percentage of what we do. Most of what we do is with public power or the large utilities. But in that segment, which accounts for about 25% of our business, we have seen a moderation of order activity. So I'd say there's been some trends that are positive. And then I'd say 1 trend, it's a little bit of a modest headwind for us.

[Walter Liptak, analyst]

Okay. Great. And then the last one, just the tax rate. I don't know if you gave kind of a ballpark for where you think the tax rate will come in, in the back half?

[Scott Sproule, executive]

Yes. Well, we did in the back of the deck, we tried to give a few things. I'll just point that out to help other folks on the call as well. That will. But to call it out here, we said for 3Q, we'd model something in the low 20s, kind of the 23%, 24% range is what's in the deck.

[Operator]

Our next question comes from Damian Karas with UBS.

[Damian Karas, analyst]

Just a quick follow-up question here. You called out the international cooling. I was a little surprised by that just given the last I checked, I think the HVAC segment was maybe 10%, 15% international, but mostly North America. So just curious, I mean, how strong was that international? Did it really move the needle in the quarter?

[Scott Sproule, executive]

For specifically Q2, Damian?

[Damian Karas, analyst]

Yes. Yes. Can you maybe put a number around kind of the growth rate?

[Scott Sproule, executive]

It's a small base, right? As you said, but it did have a decent impact for the quarter, and we're actually having a pretty good year in total. Part of it is the bounce back that we saw in China coming off of a really tough Q1, so you kind of got that mix. And then in our EMEA business, it's really had a lot of -- has a lot of nice backlog coming into the year, which has been very stable. So it's more of the execution on that backlog that we're seeing. But you're talking for the quarter, you're talking probably 5% of positive growth.

[Damian Karas, analyst]

Okay. Okay. So that's for that international portion. Great. And then I just want to ask you about material costs. I know you do hedge a portion of your metal supply, but just wondering if you anticipate maybe seeing some margin tailwinds later this year or next, thinking about lower steel and materials input cost?

[Scott Sproule, executive]

So specifically to commodities, we've seen a little bit of tailwind from commodities. Not a lot. And we're not expecting to have significant tailwinds from commodity. Most of what we're seeing from a benefit to us is more around what we're doing for supply agreements and more sourcing activities.

[Eugene Lowe, executive]

One follow-up there that Scott's comment about the 5% was really about HVAC overall, not just the cooling side. Just want to clarify that.

[Scott Sproule, executive]

Sorry. Yes. Yes.

[Eugene Lowe, executive]

The 5% growth from the international. Yes.

[Operator]

And I'm not showing any further questions at this time. I would now like to turn the call back over to Paul Clegg for any further remarks.

[Paul Clegg, executive]

Okay. Thank you all for joining us. This concludes the call, and please stay safe. We look forward to talking to you again next quarter.

[Operator]

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.