Earnings Call Transcript - SPXC Q2 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to the SPX Corporation Second Quarter 2020 Earnings Conference Call. Please be advised that today’s conference is being recorded. 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, VP of Investor Relations and Communications

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 one-time 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.

Gene Lowe, President and CEO

Thanks, Paul. Good afternoon, everyone. I appreciate you joining us today. I hope you and your families are doing well in these challenging times. During this call, we will give you a brief overview of our overall results and segment performances for the second quarter. We will also talk about the effects of the COVID-19 pandemic and what we see as the key drivers for the second half of 2020 and beyond. I will highlight some key points from the quarter. Our performance in the second quarter surpassed our expectations on several fronts despite facing some clear challenges. The advantages of our diverse markets and our robust business system were evident, as many of our sectors performed well even while the pandemic affected other parts of our portfolio. We finished the quarter with a stronger balance sheet and more liquidity, positioning us well to pursue our growth initiatives, including potential strategic acquisitions. Looking ahead, we expect to generate solid cash flow and earnings in the latter half of the year. Regarding our adjusted results for the quarter, both revenue and segment margin were comparable to levels from the previous year. The contributions from acquisitions and strong results in our Engineered Solutions segment helped offset challenges in our HVAC and Detection & Measurement segments due to the pandemic. Our adjusted earnings per share was $0.64, which is $0.03 lower than the previous year. I am also pleased with our year-to-date performance, which shows over 11% growth in adjusted operating income. Given the rapidly changing macro environment, I think it's useful to discuss what has shifted over the last three months since our Q1 earnings call. Our HVAC segment outperformed our expectations in the second quarter, seeing a quick recovery in our China cooling sales and strong execution in our U.S. and European cooling operations. Our Americas team was effective in managing the scheduled backlog for the second quarter, and we encountered fewer COVID-related delays in customer sites and order rates than anticipated. Heating orders from our midyear strategy were also better than expected. Looking forward, the recent trends in quotes and orders for our nonresidential HVAC business have slowed, reflecting the decline we noted earlier this year in leading indicators like the ABI and Dodge Index. In Detection & Measurement, our locators business was already experiencing a significant decrease in orders at the end of Q1 moving into Q2. While demand remains lower compared to the previous year, the decline was not as severe as we had expected, and we have seen notable sequential improvements in recent weeks from the low point in early Q2. Although we continue to see a strong project pipeline in our project-based businesses and Detection & Measurement, the timing of certain project deliveries has been affected by pandemic-related delays, particularly in communication technology equipment. These delays are mainly due to administrative challenges, including the timing of government approvals and limited travel to complete orders. However, funding remains stable, and we expect to fulfill these projects ultimately. Meanwhile, our Engineered Solutions segment has consistently outperformed our expectations and surpassed previous year levels due to strong operational execution in our transformers business. As I did last quarter, I will provide an update on our operations concerning the unique challenges posed by the pandemic. Our COVID-19 task force, of which I am a member, continues to meet regularly to monitor and adjust our procedures to prevent the virus's spread and protect our team members and communities. With case rates rising in various parts of the U.S., the number of employees testing positive for the virus has aligned with local trends. Our safety processes and managing any occurrences in the workplace are functioning as intended while keeping employee safety a top priority. Thus far, our facilities have not faced any significant operational interruptions. I want to take a moment to address our employees directly. I understand this has been a challenging environment, and our journey is not yet complete. I sincerely appreciate the incredible resilience you all have demonstrated. You are an outstanding group, and I am proud to be part of this team. Turning to our value creation roadmap, I want to focus on two essential themes that are fundamental to long-term value creation. First, during the quarter, SPX published our annual sustainability report in the governance section of our website. We are pleased with the progress we’ve made on our sustainability goals and believe we have the right initiatives to continue moving towards a best-in-class ESG profile. Second, one of our strategic initiatives this year aims to enhance our diversity and inclusion programs, which includes creating a global Executive Diversity Council that I will chair to guide initiatives and training for all employees. We are also establishing networking and action groups throughout the organization to spotlight and tackle challenges faced within the company and our communities. Fostering a culture that embraces diversity and inclusion, where every employee has a voice and feels they can grow and succeed, will be critical to our long-term success. This journey is one SPX is committed to for the foreseeable future, and I am proud of the dedication and focus of our teams in advancing this process. Now I will turn the call over to Scott to discuss our financial performance.

Scott Sproule, CFO

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 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.

Gene Lowe, President and CEO

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. 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, CFO

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, VP of Investor Relations and Communications

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

Operator, Operator

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, CFO

Thank you. Appreciate that.

Damian Karas, Analyst

It’s an opportunity to cause you some heartburn here one 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 the exception, but is there a reason that we should expect no more worsening of sales activity from the second quarter?

Scott Sproule, CFO

Damian, this is Scott. So it’s really around some of the macro and not wanting 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 contract project orders which 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 orders? 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?

Gene Lowe, President and CEO

Yes, Damian, this is Gene. If you examine the main cause of the decline, we are seeing approximately an 8.9% organic downturn in both HVAC and Detection & Measurement, primarily due to COVID. The businesses are performing well overall. That's my evaluation. We have data, and there are some uncertainties regarding certain movements. However, we generally believe that the decline is linked to COVID. Looking ahead in the nonresidential segment, we are noticing an impact, particularly if we reference the ABI Index or the Dodge Index, which are crucial leading indicators for us. There has been a slowdown in nonresidential activity, and we anticipate that will act as a headwind in the latter half of the year. We have factored this into our communications for Q3 and our full-year outlook. As we mentioned, we expect our earnings to align closely with those of 2019. Specifically for HVAC, we anticipate some headwinds because of the reduced activity levels seen in the first half of the year. Keep in mind that most of our products are typically ordered 6 to 8 months after a project starts, so a slowdown in the first two quarters will impact our products later on.

Damian Karas, Analyst

Okay. Great. And one 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, CFO

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 Q4, but still $15-plus million for the year.

Gene Lowe, President and CEO

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 Q3.

Operator, 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 Q3 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 Q3?

Scott Sproule, CFO

Yes, as I mentioned, we typically experience a sequential decline from Q2 to Q3 due to plant maintenance. However, we do anticipate year-over-year margin expansion in Q3, similar to what we experienced in the first half. I would advise caution when modeling for Q4, as it will present a tougher comparison, and we won't expect the same level of margin expansion. In the Q1 call, we noted that improvements gradually appeared in the 2019 results, with much stronger results for Engineered Solutions in Q4 compared to earlier in the year. We expect a solid quarter but not necessarily the same level of improvement that we've seen thus 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, CFO

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 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, CFO

Yes. Let me start by explaining why we feel more confident. Ninety days ago, it was nearly impossible to forecast the second half due to all the variables and rapid changes. Now we believe we have a good understanding of what to expect in the second half. We ended the quarter at the low end of our leverage range, and as we assess financial performance, we anticipate strong cash flow generation and stable earnings, which will contribute to natural deleveraging. This gives us the confidence to return to a capital deployment mode. I’ll let Gene discuss the pipeline and how it relates to our initial expectations for the year and our current position.

Gene Lowe, President and CEO

Yes. Bryan, looking back at Q4 and Q1, we communicated that we believed we had the strongest pipeline we've seen in five years. This is mainly due to us refining our strategies and having a clear understanding of our growth areas and how we plan to develop our platforms and businesses in HVAC and Detection & Measurement. There was substantial activity; however, COVID introduced delays. As Scott mentioned, the initial crisis brought significant uncertainty to forecasting. Additionally, executing mergers and acquisitions is much more challenging without the ability to travel. Due diligence and proper integration require on-site presence to engage with people directly and converse with customers, which was hindered during the COVID crisis. Currently, I sense an increase in activity. Our strategies remain unchanged, and if you examine our last five acquisitions over the past two years, they all reflect leadership in niche engineered segments, demonstrating consistency in our approach. We are starting to feel more optimistic, and should the right opportunity arise, we would be prepared to proceed in the latter half of the year.

Scott Sproule, CFO

I will jump in and say that while we are feeling more encouraged, we will remain cautious. We are not planning to take on significant debt, but being at the low end of our range gives us the capacity to consider moderate-sized strategic acquisitions.

Operator, 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, CFO

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, CFO

When discussing the preseason as we entered the quarter, we expected a year-over-year decline after a warmer Q1 demand. We were a bit concerned about the strength of the channel, but when it turned out to be stronger than expected, it reassured us about the channel's resilience, both in terms of inventory and the financial position of our partners. This improvement contributed to our demand levels, echoing periods from 2016 and 2017 when we also experienced a warm Q1 following the winter season. Overall, we are optimistic and continue to see a strong order pipeline in early Q3, which further supports our confidence in inventory levels and channel strength.

Brett Linzey, Analyst

Okay. Shifting to the cooling nonresidential side, what does the bidding pipeline look like and how is it tracking year-over-year? Considering the 2008 declines, you mentioned that cooling went down 15% from peak to trough. Is that the kind of decline we might expect as the business lags, or what are your expectations?

Gene Lowe, President and CEO

Yes, Brett, this is Gene. If we look at the second half of the year, the activity levels in quoting and bidding, which usually correlate well with purchase orders and revenue, are down around 15%. As a reminder, in our cooling business, half of the work typically involves replacements and half involves new projects. When we see a slowdown in new projects, contractors often shift their focus to refurbishment or replacement work, which lessens some of the impact. Currently, we anticipate that the impact on the cooling sector, based on the quote activity we're observing, is 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?

Gene Lowe, President and CEO

Yes, Brett, I believe the team has done an outstanding job, and we've really seen the improvement over the past year, with noticeable progress each quarter. This year, the execution has been excellent. I don't think this is just about market pricing; I believe it's about pricing discipline. The team has established a very strategic pricing approach that focuses on pricing to value. When you have advantages such as lead time and technology, along with prior engineering design work, you can enhance your competitiveness beyond just being the lowest bidder. Through this strategic process, they have positively influenced margins, contributing to the year-over-year improvement. The enhancements in the first and second quarters are quite significant. This success stems from the combination of our pricing strategies, excellent execution, and a very favorable mix in the first half of the year. We anticipate that Q3 margins will exceed those of Q3 last year, although Q4 of last year will present a tougher comparison. We expect to perform similarly to Q4 of 2019. Overall, the advancement of that business has been remarkably impressive, and we are pleased with the progress it’s making, supported by a strong team driving these efforts. To address your fundamental question, I do not think it’s solely based on market price.

Operator, Operator

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

Joe 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, CFO

I would say the other businesses are stable with some modest growth in D&M. However, in the boiler business, we’re not seeing growth. We experienced a challenging Q1 and expect a decline for the year. Q4 comparisons will be tough as it followed a higher-than-average demand profile in 2019. Although the demand tapered off later in the season, we have set our expectations to align with an average season. Overall, heating is projected to decline. On the other hand, in the Detection & Measurement segment, we are witnessing growth. Radio is notably down, and we are facing delays in communication technology projects. Other areas within communications technologies are holding steady, while the transportation segment is experiencing growth.

Joe 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?

Gene Lowe, President and CEO

Yes, I believe radio is a quick-reaction business that responds rapidly to changes, as demonstrated during the crisis. It has been recovering well, driven by various activities such as non-residential and residential construction, as well as the installation of gas, electrical, cable, and fiber lines. Any project that involves digging requires scanning, and we hold a leading market position in this sector globally. The current economic environment greatly influences our performance. If large regions are closed down, it will affect us. However, we are noticing strong recovery in Asia, particularly in China. The U.S. and Europe, after experiencing significant downturns at the end of the first quarter and beginning of the second, are showing promising sequential improvements, reflecting overall economic activity. Under normal conditions, we anticipate returning to our usual growth trajectory. However, if economic activity diminishes significantly, particularly in construction or excavation, that will impact our business. Looking ahead to 2021, I expect an improvement over 2020 and continued progress in 2021.

Scott Sproule, CFO

Yes, the sequential rate we've observed is still down in the second half, but it's not comparable to what we experienced in Q2. We discussed the need for locating inspectors, and it's important to note that radio accounts for half of that. The inspection business remains more stable and is experiencing modest but steady growth. We've noticed volatility in the locate side, as Gene mentioned. There was a decline of over 20% in Q2, which was significant at the start of the quarter, but there has been a nice recovery. We have a better exit rate now, although it's still lower than the rate from a year ago.

Joe Mondillo, Analyst

And did you say that in terms of the Q3 guide for D&M, sales down mid-teens? Did I hear that right?

Scott Sproule, CFO

Organically, yes.

Joe Mondillo, Analyst

Organically, right?

Scott Sproule, CFO

It still reflects a continued year-over-year decline in the inspection side of the business, specifically in radio. Additionally, we expect very few of those project orders to execute for the communication technologies business.

Operator, Operator

Okay. Moving on to HVAC. There was an organic decline of 9% this quarter, but we noticed a 100 basis point improvement in gross margin. Is this solely a result of cost management, or what factors contributed to this improvement?

Scott Sproule, CFO

It’s a combination of factors. There is some cost management involved, but it's also due to very strong operational execution, especially on the domestic side of the business. We experienced a nice recovery in China during Q2. Additionally, we are seeing some benefits; while we haven't progressed our business system and continuous improvement programs as much as we would have liked, we do have some advantages. There are supply chain benefits that have emerged this quarter as a result of the progress we've made with those initiatives.

Gene Lowe, President and CEO

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.

Joe 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, CFO

No. What we observed, particularly with cooling, which is a large segment of the nonresidential market, along with electric heating, was that in Q2, our performance exceeded expectations due to a resilient business and strong execution on our backlog. We did not experience the site or customer delays we had expected amidst the various restrictions and lockdowns, allowing us to maintain normal operations. However, as Gene mentioned, we began to notice a decline in order rates late in the quarter, especially in the cooling segment. This relates to our connections with ABI and Dodge, as we look at trailing statistics from 6 to 8 months. Therefore, we anticipate experiencing some decline in this area during the second half of the year.

Joe 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, CFO

There hasn't really been much in terms of structural changes; it's mostly been about hiring delays and not filling open roles, alongside travel restrictions and adjustments to incentive compensation programs based on year-over-year performances. We've been quite strict about discretionary spending, which I mentioned previously could lead to a $15 million to $20 million impact for the year. In Q2, we saw the benefits of that, likely toward the higher end of that range. If you look at Q3 and Q4, we will adjust by reducing that run rate by about $1 million to $2 million per quarter, as we've relaxed some of our restrictions, especially regarding travel and certain expenditures. On a full-year basis, we expect to see temporary costs exceed $15 million. These costs will gradually return, in line with revenue increases, ensuring that earnings will follow along with the revenue growth.

Gene Lowe, President and CEO

Okay, and just last question. I just wanted to come back to HVAC. The Q3 sort of guide that you put out there, I guess it was low single-digit organic revenue growth. Is that correct?

Scott Sproule, CFO

You’re seeing a decline, right? If you anticipate a decrease in the cooling business or at least in the non-residential exposure, which is mostly what you have there, I assume you're expecting growth in the heating sector?

Gene Lowe, President and CEO

The heating segment will see some benefit from orders received in Q2. However, there is still a portion of the heating market, specifically non-residential, that will reflect similar impacts as the cooling sector. The organic decline will primarily affect both heating and cooling, especially in domestic cooling. We anticipate some advantages in international markets similar to what we observed in Q2. As we mentioned, there will be a mix-down due to organic declines, which may exert slight margin pressure. Lastly, regarding reported results, keep in mind that the Patterson-Kelley acquisition occurred in late Q4, so we will continue to benefit from its revenue and profit contributions for the full year of that acquisition in 2020.

Joe 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 Q4 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 Q4 could be a little worse than Q3 as far as what you can tell right now?

Gene Lowe, President and CEO

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.

Scott Sproule, CFO

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

Operator, Operator

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, CFO

Sure. I’ll start and Gene can add in. As a reminder, we have projects in both transportation and communication technology. The delay we’re discussing is on the communication technology side, while we continue to see strong activity in transportation. The budgets are established, and there is typically some budget money that may become available as the year ends. However, we know that some projects have had their government funding extended beyond this year, which gives us confidence in the funded status of these projects. The challenge lies in determining the exact timing due to the slow approval process.

Walter Liptak, Analyst

As the crisis begins to ease and projects are potentially released, is there a chance that your capacity could be fully utilized? Given your backlog, could this extend into 2021? Do you have enough capacity to fulfill the demand from the projects you see in the pipeline?

Scott Sproule, CFO

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.

Gene Lowe, President and CEO

Yes. Walt, I would say, if you look at the market and what’s going on in the general transformer market, I’d say two 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 one 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, CFO

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 Q3, we’d model something in the low 20s, kind of the 23%, 24% range is what’s in the deck.

Operator, Operator

Thank you. 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, VP of Investor Relations and Communications

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, Operator

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