伊頓 (ETN) 2020 Q2 法說會逐字稿

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earnings call. With me today are Craig Arnold, our Chairman and CEO; and Rick Fearon, Vice Chairman and Chief Financial and Planning Officer. Our agenda today, including opening remarks by Craig highlighting the company's performance in the second quarter. As we have done on our past calls, we will be taking questions at the end of Craig's comments. The press release and the presentation we'll go through today have been posted on our website at www.eaton.com. Please note that both the press release and the presentation include reconciliations to non-GAAP measures. A webcast of this call is accessible on our website and will be available for replay. I would like to remind you that our comments today will include statements related to the expected future results of the company, and are therefore, forward-looking statements.

Our actual results may differ materially from our forecasted projection due to a wide range of risks and uncertainties that are described in our earnings release and presentation. They're also outlined in our related 8-K filings. With that, I will turn it over to Craig.

Okay. Thanks, Yan. We'll start on Page 3 with recent highlights from the second quarter. And as you can imagine, I'm extraordinarily pleased with the way our teams have executed in the midst of this pandemic and the economic downturn. We've done a good job of keeping our employees safe, have delivered for our customers and certainly generated exceptional cash flow, all while flexing our costs at record rates. Our results, while off of last year, certainly in absolute terms, were better than expectations, and we continue to make an important investments for the future.

Q2 earnings on a per share basis, $0.13 on a GAAP basis and $0.70 on an adjusted basis, which excludes $0.20 of charges related to acquisitions and divestitures and $0.37 related to the multiyear restructuring program that we just announced. Our Q2 revenues were $3.9 billion, down 22% organically. As we noted on our Q1 earnings call, April was down approximately 30%. This was followed by slightly better volumes in May and then relatively strong finish in June, which was down, let's call it, low double digits. In fact, I mean, just as a point of maybe amplification, our electrical business in the Americas, in Europe and Asia, all posted low single-digit organic growth in revenue in the month of June. And so once again, our electrical businesses are remaining very resilient in the face of this pandemic and economic downturn. Segment margins were 14.7%, down 110 basis points from Q1, and our decremental margins were at 25%, 5 points better than our guidance of 30%. Once again, a good indication of how well our teams have done in controlling the elements that are really within our control.

However, recognizing that some of our businesses could be looking at a slow and certainly, what you could call a prolonged recovery, we announced a multiyear restructuring program of $280 million, including $187 million charge in Q2. These actions will reduce structural costs for sure and are targeted in those end markets, including commercial aerospace, oil and gas, NAFTA Class 8 truck and North America and European light vehicle markets, where these markets have been certainly highly impacted. I'll provide more details on this program in a few minutes, but they're covered on Page 12.

The other clear highlight for the quarter was our operating cash flow, which was $757 million and free cash flow of $667 million, both very strong results and which gives us the ability to really reaffirm our free cash flow guidance of $2.3 billion to $2.7 billion and a midpoint of $2.5 billion. So teams continue to do great in converting on cash as well.

Finally, as most of you know, we made an important announcement during the quarter regarding sustainability and our commitment to 2030 sustainability goals. I thought it would be helpful just to put this announcement in the context in order to show you how it fits within the broader strategic framework of the company, which we do on Page 4.

As it simply stated, at Eaton, sustainability really is at the core of our mission. We talk about our mission being to improve the quality of life and the environment. And certainly, that means sustainability. In fact, if you think about all of our value propositions with customers, they're built around creating safe, reliable and efficient solutions, let's call them sustainable solutions. And so as we oftentimes say, what's good for the environment is good for Eaton. We believe that meaningful efforts to support the environment are fundamental to how we create value for customers, and it's certainly a place where we think Eaton should play a leadership role. Sustainability, as we think about it, really presents growth opportunities to help our customers solve their business goals. And to this extent, against this objective, we've laid out 10-year plans that include investing $3 billion in R&D to create sustainable products over this period of time. This also includes reducing our emissions from our installed base of products and upstream sources by some 15%.

Just to maybe give you an example of where we think this really fits with our overall strategy. Sustainability really is about capitalizing for Eaton on secular growth trends around electrification, for sure, across all of our businesses and also in energy transition. Sustainability, I tell you, is also an important part of how we run the company on a day-to-day basis. Since 2015, and we reduced our absolute greenhouse gas emissions by some 16%, and we're certainly on track to deliver our 2025 targets. By 2030, we now have committed to achieve science-based targets of 50% reduction of greenhouse gas emissions from 2018 levels. We're also committed to be carbon-neutral by 2030, a target that we'll achieve through a combination of initiatives, including carbon offsets, such as reforestation, continue to optimize our sourcing of renewable electricity in all of our operations as well as delivering energy storage solutions. And so pretty comprehensive set of plans that we have that we think will deliver this 2030 goal.

And finally, to achieve these goals, we obviously have to continue to work on building a workforce that's engaged and passionate about making a difference. And so this will continue to be a large priority for the company overall. And so hopefully, that provides just a little context in terms of why we think sustainability is such an important initiative for Eaton and how we're going to convert on that and turn it into accelerated growth for the company.

Now turning to Page 5, we summarize our Q2 financial results, and I'd noticed a couple of things on this page. First, acquisitions increased sales by 2%. This was more than offset by the 8% impact from divestitures and also, we had negative currency impact of negative 2%. I'd also remind you that we now recognize all charges related to acquisitions, divestitures and restructuring at corporate rather than at the segment level. And we did this because we'd hope it would make it easier for you to do your forecast by quarter by segment without the volatility that comes with these types of onetime charges.

Next on Page 6, we show our results for Electrical Americas, revenues down 29%, 9% decline in organic revenue, a 19% impact from M&A, and this was primarily the divestiture of the Lighting business and a small impact from negative currency as well of 1%. Operating margins increased 130 basis points to 20.7% and these margins were certainly favorably impacted by the divestiture of Lighting, but also our teams did a great job of controlling costs to really counter the impact of the economic impact of COVID-19. This combination resulted in a very strong decremental margin performance up 16%. So this segment continues to prove to be highly resilient when you look at margins, but also when you look at orders and backlog. Orders increased 2.1% on a rolling 12-month basis, with strength in residential and utility and data centers. And of note here, our data center orders actually were up some 7% on a rolling 12-month basis. And lastly, our bookings remained strong. They were up 11% versus last year.

Turning to Page 7. We have our results for the Electrical Global segment. Revenues were down 16%, with a 14% decline in organic revenues and 2% headwind from currency. Operating margins here declined some 160 basis points but to a very respectable 16% and decremental margins here were also very well managed, coming in at 26%. Orders declined 4.6% on a rolling 12-month basis with most of the significant declines coming, as you would expect, in global oil and gas markets and in industrial markets. So not an unexpected result with respect to where we saw strength and weakness. And lastly, our backlog for Electrical Global increased 2% on a year-over-year basis.

On Page 8, we summarize our Hydraulics segment. For Q2, revenues were down 32%, with a 30% decline organically and a 2% currency impact. Operating margins were 9%, and orders for the quarter were down 33.7% year-over-year. And this was driven really by weakness in both OEMs and the distributor channel, both. We continue to work closely with Danfoss and completing the customary closing additions of regulatory approvals. And I would tell you that Danfoss organization remains excited about owning the business. We do, however, now expect the transaction to close at the end of Q1 next year. The delay, as you can imagine, due to the COVID-19 impact, which has impacted the pace of some of the regulatory approvals that we expect.

On Page 9, we summarize our results for the Aerospace segment. Revenues declined 27%, with a negative 35% in organic growth, offset by 8% increase from the acquisition of Souriau. Operating margins declined to 14.8%. And really, this is due to lower sales, but also the acquisition of Souriau also had a dilutive impact on margins.

Orders declined 12.8% on a rolling 12-month basis, with particular weakness in the quarter, as you would expect in commercial OEM and aftermarket. It is worth noting, I would tell you, though, that orders for the military aftermarket were up 13% on a rolling 12-month basis. Backlog was down 5% year-over-year overall. Certainly, as everyone here understands, the commercial aerospace markets are grappling with significant declines in passenger demand, and this is impacting our business and certainly impacting both the OEM and the aftermarket. Just maybe some context here, while we think about this as kind of a near-term dislocation and we're taking certainly the needed steps to position this business for the future. We remain confident in the long-term attractiveness of aerospace market, and we'll certainly do what we need to do in order to manage our margins in the meantime.

Next, on Page 10, we summarize our results for the Vehicle segment. Revenues declined 59%, 52% of which was organic. In addition to the divestiture of the Automotive Fluid Conveyance business, which impacted revenues by 4%, we had 3% negative impact on currency. The decrease in organic sales was really driven by, I'd say, widespread customer plant shutdowns due to COVID-19, which really resulted in lower Class 8 OEM production as well as continued weakness in light vehicle production. Just -- once again, it's a little bit more color on this one, during Q2, most light and commercial OEMs had shutdowns that ranged between 6 and 8 weeks. These shutdowns, which really began, let's say, in late March, occurred throughout the month of April and extended into mid-May. And so many of our customers were shut down for almost half the second quarter. But production is now certainly beginning to come back online.

Global light vehicle market production was down 55% in Q2 and Class 8 OEM build was down from 70% in Q2. We now project NAFTA Class 8 production to be 175,000 units for the year, which is down slightly from our prior forecast of 189,000 units, but still down some 49% from 2019. This steep reduction and certainly the sudden reduction in OEM production led to operating margins of a negative 6.4%. But I would add, this business has once again done a great job of managing decrementals. And despite this tremendous reduction in revenue, delivered a respectable decremental margin of 33%. Not surprisingly, and much needed, we do expect better market conditions in the second half, and our business will be well positioned to participate in this recovery.

Moving to Page 11. We have our eMobility segment. Revenues were down 33%, all of which was organic, organic margins of negative 3.6% -- excuse me, operating margins of negative 3.6%, primarily due to lower volumes and particular weakness in the legacy internal combustion engine platforms. And once again, the ongoing increase in R&D expenditure. We continue to be enthused, by the way, about the long-term potential of the business. And quite frankly, have seen nothing but upward revisions in the expectation for the penetration of electric vehicles. And so a market that we still think will be very attractive long term.

We're very well positioned once again with the common technology platforms that we're creating, leveraging the strength in our core electrical business. A good example of this idea of everything becoming more electric is one of the recent wins that we've had with the truck OEM, a $21 million program for export power inverter for a major commercial truck customer. And so in almost every aspect of our business, there's more electrical content, and we're well positioned once again through this particular segment to participate in that growth. Overall, we've won programs with a value of approximately $500 million of mature year revenue.

On Page 12, we show the details of our plans to accelerate and, I'd say, expand our restructuring actions. And I say accelerate because for the most part, we're pulling forward a number of the restructuring ideas that we would have done anyway. Given the economic implications of the pandemic, we naturally have a greater sense of urgency and also more capacity to take on these projects. We announced the $280 million multiyear restructuring program, as we noted, designed to eliminate structural costs, and we've taken charges of $187 million in Q2, and we expect to see additional cost of $93 million realized through 2022. Just to characterize those additional dollars, we'd expect to deliver over the next 3 years, some $33 million of charges in the second half of this year, $55 million in 2021 and $5 million in 2022. We.

Would expect to realize $200 million of material benefits from these actions once they're fully implemented, and we think full year implementation is 2023. Approximately 2/3 of these costs are in our industrial businesses, principally vehicle and aerospace, and the remaining 1/3 is within our electrical sector, particularly with an emphasis on our oil and gas business that we'll report through our Electrical Global segment. Naturally, we're focused on those businesses serving end markets that are more severely impacted by the pandemic.

And then turning to Page 13, we do our best to provide a Q3 outlook on revenues versus last year. And while you can imagine that all these markets will be stronger than what we realized in Q2, this is really a year-over-year look for Q3 versus last year. For Electrical Americas, we expect organic revenue to be between down 2% and up 2%, so essentially flat with strength in residential, utilities, data centers, offsetting weakness in industrial markets. For Electrical Global, our current view is organic revenues will decline between 10% and 14%, with strength in Asia Pacific and data center markets, offset by declines in Europe and once again in the oil and gas market. For Aerospace, we expect organic revenues will be down between 28% and 32%, with continued strength in military, offset by really significant declines in all of the commercial markets. And for Vehicle, we project revenues will decline between 30% and 34%. So markets are still very weak in absolute terms, but these markets will be up significantly from Q2. And for eMobility, we expect declines of between 13% and 17%, once again, pressured from legacy internal combustion engine platforms. And lastly, for Hydraulics, we think markets will be down between 23% and 27%. For Eaton overall, we're estimating Q3 revenues to be down between 13% and 17%. And so an improvement versus Q2, which was down some 22%. But still in absolute terms, markets are still in decline.

Moving to Page 14. Here, we provide our best look at guidance for Q3 and some commentary on the full year. But for Q3, we expect organic revenues to decline between 13% and 17%. And this really does include what we know about July, where we saw low double digit declines. We've elected not to provide full year revenue guidance given the kind of the ongoing uncertainty around the pandemic and its impact on markets in Q4. As many of you are aware, we are still dealing with the pandemic in various regions of the U.S. and around the world, we're still seeing a growth in the number of cases. And so we're still living in this period of uncertainty.

We do think Q2 will be the trough for organic revenue declines. And barring a second wave of the pandemic, Q4 should be better than Q3. For Q3 and full year, we expect decremental margins of between 25% and 30%. And for Q3, we expect our tax rate on adjusted earnings to be between 15% and 16%. We're maintaining our free -- 2020 free cash flow guidance, the range of $2.3 billion to $2.7 billion. And I would note that this range does, in fact, include now the impact related to the multiyear restructuring program that we announced, and that was not in our prior guidance. As a point of reference, in the first half, just to give you some comfort around our ability to deliver this number, we generated some 35% of our $2.5 billion midpoint that's in our free cash flow guidance. And this number is very consistent with our performance over the last 5 years. And so we do tend to be a bit back half-loaded.

We're providing new guidance for share buybacks, and we're saying between $1.7 billion and $1.9 billion for the year. And recall that we repurchasing $1.3 billion of shares in Q1 with the proceeds of the Lighting sale. We continue to deliver strong free cash flow, and we now plan to buy back between $400 million and $600 million of shares in half of the year. And finally, and maybe just like we are doing here inside our company, just to bring it back to kind of the broader longer-term strategy and where we're headed as an organization. And we will continue to effectively manage through the short-term challenges associated with the pandemic, but we also remain focused on the broader strategic and financial goals that we've laid out in our meeting in New York, and we've summarized once again here on Page 15.

Number one, ensuring that we continue to move the company in the direction of becoming what we say as an intelligent power management company that takes advantage of important secular growth trends, and we talked about them being electrification, energy transition, IoT and connectivity and blended power. So these trends are continuing and despite whatever temporary hiccups we're experiencing, we think long term, it's the right place to be. By doing so, we're working on creating a company that's going to deliver better secular growth. And better growth through various cycles, higher margins and with much better earnings consistency.

Our long-term goals have not changed. It includes 2% to 3% organic growth, 20% segment margins, 8% to 9% EPS growth and $3 billion a year of free cash flow. And with our strong cash flow, we'll continue to be focused and disciplined in how we deploy it by investing in organic growth as a top priority, delivering top quartile dividends, an ongoing program of share buyback then actively managing our portfolio while being a disciplined acquirer. So we continue to remain excited by the Eaton story. I hope you are as well.

And with that, I'll turn it back to Yan.

Okay. Good. Thanks, Craig. Before we start our Q&A of our call today, I do see that we have a number of individuals in the queue with questions. (Operator Instructions) With that, I will turn it over to the operator, who will give you guys the instruction.

(Operator Instructions) And our first question is from Nicole DeBlase from Deutsche Bank.

Yes. So I guess maybe starting with the restructuring actions that you guys are taking, Craig. So the information on the costs were helpful. I guess maybe some color qualitatively around what you're actually focusing on, headcount versus maybe footprint or other things. And I guess where I'm going with this is cadence of payback over the next few years, including the second half of '20 as well as, I guess, why it's taking some time to actually get the payback from those actions?

Yes. I appreciate the question, Nicole. And as I mentioned in my opening commentary, and one of the things we've talked about historically is that we always, as a company, have kind of a future view of restructuring projects that we'd like to take on. And the pacing items generally tend to be our own internal capacity to deal them with them and manage them effectively as well as our customers' ability to absorb them without creating disruptions for them. And certainly, in the event of an economic downturn like this one, it gives everybody more capacity to take on these projects. And so a lot of what we're doing today, I'd say, when you talk about footprint versus headcount, I think the important way to answer that question is that it's all structural. And so these are all cost items that were taken on that will not come back in the event that -- or when revenues return. And so these are things that are really focusing on taking structural fixed costs out of our system, some of which will be headcount, some of which will be around footprint. We have not yet made these announcements completely internally in terms of where those impacts are going to be. And so we'll wait and provide that detail a little later on. But it will be completely structural.

To your point around timing, I think some of these items, obviously, will impact and have a benefit earlier than others. But it's one of the things I would say, as you think about the decremental margins that we're delivering as a company and what's embedded in our guidance, it's one of the reasons why we can deliver these very strong decrementals is because we are flexing our businesses and flexing our costs. And so I'd say, as we think about this payback, a $280 million investment with essentially a $200 million return. This is a very attractive program in terms of the return on the investment. And we'll get some of the benefits sooner, some will come later, but in aggregate. It's extraordinarily strong returns on these dollars that we're investing.

Got it, Craig. That's helpful. And you kind of teed up my follow-up there, I guess. And I wanted to hit on decrementals. The 25% was obviously impressive this quarter and above your own 30% guidance. I guess how do we think about that through the rest of the year? I mean to me, we kind of know that 2Q, at least we hope, will be the low point with respect to revenue. So I guess is there any possibility that 25% could actually become something better in the second half as you guys execute on cost savings and perhaps you get a little bit of sequential improvement in revenues as well?

Yes. I appreciate the question. And our teams just have done an extraordinary job year-to-date on decremental margins and as we flex costs. And embedded in that guidance of $25 million to $30 million is, once again, the uncertainty around whether or not we end up experiencing a second wave of the pandemic. And as you know as well as anyone, we're seeing these hotspots around the U.S. and potential threats of going into some form of, if not full shutdowns, retrenchments in many of our markets. And so there's still a lot of uncertainty, and it's one of the reasons why we still have this fairly wide range of decrementals, as you can imagine, as well. We took a lot of extraordinary onetime costs in Q2, around time off without pay, and travel was essentially came to a grounding halt. And so some of these costs will certainly come back as the year unfolds. But if we don't end up with a second wave, in the second half of the year, we will likely do better than kind of the midpoint of this range of decrementals that we've laid out.

Our next question will come from the line of Joe Ritchie.

Craig, maybe just starting out, why don't we -- I'd love to hear your thoughts on just nonres construction, specifically in your exposure to it. There's a lot of concern as we kind of head into 2021 that the markets are going to downturn. And so I'd be curious to just hear how your business is positioned for potential nonres downturn? and how maybe some of these actions that you're taking are potentially like offsetting measures for that?

Yes. Yes. Thanks, I appreciate the question. And when you use the term nonres construction, really, that's -- for us, that's really most of our electrical business, right, because that's everything other than residential and residential today, would account for less than 20% of our total business. And so it's a really big category. The way we tend to think about it is that maybe just take you through some of the key important segments for us. We think as has been the case for some time, we think data centers continues to be a very strong market and are performing well in the near term, and we think long term, continues to be strong. We think the utility market continues to be a very attractive market and will perform well over the long-term and has held up extremely well. Residential, by the way, and I know you asked the nonres question, but residential has just been extraordinarily strong and -- with essentially high double-digit kind of growth numbers in Q2 overall. So resi continues to be extraordinarily strong.

And then, I mean, I think the kind of spear of your question really gets to this whole question, what's going to happen within commercial markets. And there's been a lot of talk and speculation around the death of the office and whether or not anybody is ever going to go back to the office again. I don't think that's the case, by the way. In fact, I can point to examples where companies have actually had to take down more office space because you have the social distance now on offices. And so you need more space to house the same number of individuals. But certainly, there's certainly some risk to what we call the office piece of nonres. Certainly, if you think about retail, those markets will probably be weak. But offsetting that, there will be other markets that are strong. We think that you think about warehousing as a segment, we think, will be strong. We think water, wastewater market will be strong.

And so I think the fact that our electrical business has held up so well or better than others would imagine is the fact that we do play across so many of these different end markets some of which are experiencing some of these negative forces, others of which are seeing positive impact. And as a result, this business is extraordinarily resilient. And so we remain very optimistic about the prospects of our electrical business. There will be dislocations in perhaps certain markets or certain regions of the world. But by and large, we think the market will be just fine, and using kind of China as a good proxy for the rest of the world as they get -- it should come through the pandemic. China is already back to positive growth, both in sales and orders. And so we're hopeful once we get through this and we get a vaccine, we get an effective therapeutic that the markets are likely going to return to trend level of growth.

That's helpful color, Craig. And maybe my one quick follow-up is more on just free cash flow. It was nice to see you guys affirmed the range for this year. I guess as you're thinking about next year, also in the context of some of the cost actions that you're taking, I know it's too difficult at this point to say exactly what the number will be next year. But if growth starts to return to something that's a little bit more normal, what are your thoughts on your ability to grow free cash flow in 2021?

The way we generally think about it is that certainly, in periods like this as we decapitalize the business and we're freeing up a lot of cash from working capital. But also, as you saw, the earnings are down dramatically. And so as we continue to -- as we expand through an expansionary cycle, the earnings will be up significantly. And then with that, your cash flows will be up. And so if you think about Eaton over time, and through various cycles, our cash flows have been just amazingly consistent in terms of generating very strong free cash flow, really, at all points of expansion and contraction. Rick, did you want to add something?

I'm just going to add a little color on the trends in electrical. We measure it in a lot of different ways. But one of the ways we measure it is looking at our negotiations for large projects in the Americas. We have very good data, and it's a very big business for us. And if you take out the activities related to oil and gas, our negotiations in the second quarter were flat with a year ago. And so it gives you some indication that the balance that Craig talked about on all these different segments, they come together in a way that creates a lot of stability. And that gives us a fair amount of confidence that even with the turbulence and the macro economy, there are enough sources of strength that those sources offset the weak spot.

Our next question is from the line of Jeff Sprague from Vertical Research.

I just would like to get a little additional color on Vehicle. Obviously, a very, very tough quarter. Production on the automotive side starts to look better as the lockdowns ease. Just give us a little sense of what you're thinking for the profit trajectory there? Should this be the only quarter where we see an operating loss? And maybe give us a little color on how much, if any, of these restructuring benefits might flow through to those businesses in the back half?

Yes. I appreciate the question, Jeff, and it's been kind of a long time since we've ever because -- since we lost money in our vehicle business. And I'd just say, once again, just an extraordinary combination of events when you look at some of these numbers around production, both in Class 8 and in global light vehicle, essentially, half the quarter was lost. And so the team once again did, I think, an extraordinary job in maintaining a 33% decremental in that environment. We certainly -- to look forward, volumes are going to be significantly better than in Q2. We would fully expect that the margins for the business this year will be double digit, and we would not expect to see a loss in the Vehicle business in any subsequent quarter, barring another return to this horrific market kind of event that we experienced over the last quarter. The details around where the benefits are going to flow, once again, we've not made internal announcements specifically to some of these initiatives. And so we'll give you more color later on. It's certainly fully embedded in the decremental margin assumptions that we've laid out for the year, but you certainly can expect our Vehicle business to return to attractive levels of profitability post Q2.

Great. And second question, just on aero. Do you think we've seen the bottom in aftermarket activity? Or do we still got to kind of deal with the delayed impact of parked airplanes and used material and stuff kind of working its way through the system and maybe we're a quarter or 2 out on the bottom there?

Yes. I mean it's a good question and one that everybody trying to get their arms around specifically in terms of what's the outlook for aerospace, specifically, what's the outlook for aftermarket in terms of our consumers are going to be comfortable getting back on planes flying again, which is as you know, is what drives the aftermarket. I'd say we had pretty horrific numbers in terms of aftermarket in Q2, down fairly dramatically. So it's tough to imagine that things could get much worse than what we experienced in Q2. Activity levels in general, as you're well aware, are improving. There's more planes flying today. There's more hours of flights today than there have been certainly over Q2. Many parts of the world, in many regions of the world, their numbers are better than ours in the U.S. If you think about Asia, you think about Europe, they've done a better job of getting handle on the pandemic. And so you're seeing the data there improve perhaps at a faster rate than the U.S. data. So I think it's quite -- it's unclear today. And a lot of planes on the ground, and you talk about this idea of parting out airplanes and how that's going to impact the aftermarket, I just think it's too early to tell whether that's going to have a prolonged impact or not.

Our next question is from Nigel Coe from Wolfe Research.

Just wanted to really dig into your sort of your 3Q framework and the down low double digits first...

I'm sorry, Nigel, we -- you're coming through very faint. We can barely hear you. So maybe you can just speak up a little bit.

Maybe I'll use my handset. Is that better?

Perfect. Perfect.

Yes. I've got a very dodgy headset. I need to invest. My home office still needs a lot to be desired. So the July down low double digits versus the down 13% to 17% framework. And I understand you want to be conservative. But is there any reason why July would be better than the 3Q framework? And then just within that, Electrical Americas looking to be flat versus the down 9% in 2Q. Again, just what's slipping between 2Q and 3Q? And any end markets to call out there would be helpful.

Yes. I appreciate the question, Nigel. And I think what we're really trying to deal with here is how precise we can actually be in setting any of these forecasts. And I would tell you that if you think about June and July kind of essentially running at about the same levels and as we think about our Q3 forecast, we really think about it mostly as a continuation of what we experienced over the last couple of months. And so I think on the margin, whether it's 1 or 2 points better or worse, it's really difficult to judge.

But one of the things that has us a little bit nervous, as we'll freely admit, is the fact that you are continuing to see the spread of COVID-19 in so many parts of the U.S. And so if there's a concern that we have that could potentially take the next couple of months down slightly below what we've experienced over the last 2 months, it's whether or not the U.S. specifically, and then you have obviously, regions like India and Brazil, whether or not we get a handle on the spread of the pandemic. So that's the piece that has us all just a little bit nervous and perhaps a little bit conservative around what does the real outlook look like for the balance of Q3.

Yes. And then Electrical Americas, what's slipping -- what's getting materially better between 2Q and 3Q?

Yes. In Electrical Americas, I'd say that for the most part, they experienced kind of the same kind of shock to the system that the other kind of parts of our businesses experience, where you've had a lot of construction projects essentially to shut down in Q2. As you're well aware, there were certain regions of the U.S. where construction was deemed essential. There was other places where constructing projects were simply delayed. And so I think the catch-up effect that we're seeing a little bit in the Americas, specifically, is the fact that we would anticipate that you don't see the kind of wholesale shutdowns of the U.S. economy that we experienced in part of Q2. And so on an incremental basis, quarter-over-quarter basis, we would expect the Electrical Americas business to perform better.

Also, Nigel -- it's Rick, we had some production challenges during Q2. We had to re-layout plants, and we had some plants where the plants had to be closed for certain periods due to COVID issues. And so that constrained our sales. And we've sorted through all that. And that, particularly in places like residential, will allow higher sales volumes in Q3.

And our next question is from David Raso from Evercore.

Can you clarify your comment, if I heard you correctly, the month of June, did you say Electrical Americas posted low single-digit revenue growth? Same thing for Electrical Global? I'm just trying to -- if that is correct, why then does it step down the flat for Americas in the third quarter if you're already up low single and then global goes from up single-digit to actually the next quarter down 12% at the midpoint? I'm just trying to understand what you're really seeing in July in the electrical business.

Yes. What I was really trying to convey in that comment. First of all, you heard me correctly, electrical, essentially around the world actually did pose positive sales growth in the month of June. But it's oftentimes difficult to read too much into a given month because there's also some catch up, right? We talked about the fact that we had, as Rick noted, we had factories that were shut down, we had projects that were delayed. And so we think it was certainly a little bit of catch-up that took place in the month of June. One of the reasons why we experienced kind of growth across the region and projects that perhaps should have been delivered in April or May, that slipped into the month of June. And so as the economy in the U.S. specifically, continue to open. And so we do think there was some catch-up in the month of June. And so on the margins, things are slightly worse or about the same as the June rate in subsequent months. It's really because of this catch-up effect that we think we experienced in the month of June.

But is that what you're seeing in July? I mean especially global, are we going from up low single, say, there was some catch-up, then to put down 12 in the third quarter. Have you seen that much giveback already in July? Is it global already down that much in July?

Yes, I'd say that, once again, in terms of the -- you say global specifically, what we're experiencing overall as a company in terms of the guidance numbers that we provided, that's consistent with what the company has experienced. I don't think we provided specific guidance for Electrical Global overall. But -- so I'd say that it's certainly consistent with our overall guidance for the quarter for Eaton overall.

I appreciate that. Yes. I was just saying international, you call it global, but the international business being down 12% organically in the third quarter, coming off of a June that was up low single. It's just enough of a delta. I just don't see if you saw a big drop-off in July already to suggest that for the electrical international business.

What we are seeing, David, is we are seeing pronounced weakness in oil and gas. I mean it is not coming back. And so that's what's driving that -- the weakness in Electrical Global. Our global oil and gas business is all reported in Electrical Global. So that's really the factor that is causing the markets to be as weak as we estimate. If you were to take that out, Electrical Global would look much like Electrical Americas.

Sure. But in the month of June, oil was down big, I assume, and you still put up low single-digit growth in electrical international. So anyway, I'm just trying to understand it. And then lastly, go ahead...

I was just going to say there is a lot to this pent-up demand and people, we, being able to deliver on customers wanting us to deliver projects that had gotten delayed. And so that June is distorted by that a bit.

That's fair. And just lastly clarification to an earlier question, did you say Vehicle margins for the year would be back to double digit?

Yes, I did.

The next question is from Jeff Hammond from KeyBanc.

I just want to dig in on some of these markets that are proving more resilient in Americas. Can you just talk about where kind of the incremental utility spend is seen or where you're seeing the most resilience? And on the data center side, I know we were planning for kind of an air pocket, and that seems to be coming back. Is that coming back stronger or in line with expectations?

Yes. I'd say in the utility market, Jeff, I think it's pretty broad-based is what we're seeing really in utility markets. Those markets are holding up fairly well. And I would say that within the U.S., I can't really -- I don't know that there's a very different story depending upon what region of the U.S. you're looking at. But where we play in the utility space, on the distribution side, as obviously, resilience and investing in grid resilience continues to be an important need in so many of our communities around the U.S., it continues to be fairly stable and predictable market. In data center, specifically, what we're really seeing is a return in hyperscale. And as we've talked about on prior calls, hyperscale does tend to be lumpy. You get large orders, and then they'll go quiet for a while and you get large orders again. So if you think about data centers overall, we saw very strong growth in hyperscale in the quarter that really is a return to growth as they continue to kind of build out their requirements.

Okay. And then just on the Hydraulics sale, is that just a function of timing around approvals? Or is there anything else going on?

I think it's a general slowdown in the market that you're experiencing in Hydraulics and specifically in construction. The ag market is holding up a bit better. Certainly, the China market is holding up very well in the context of the pandemic and really have already returned to growth. And so it's really just the general slowdown in the construction market that's having a big impact on Hydraulics.

And Jeff, if you were also asking about the timing of closing the sale, it's really a function of many of the regulators are still working from home. And so that's greatly slowed their ability to process all of the filings. I mean in any large transaction like our sale of Hydraulics, we're talking about thousands and thousands of pages of material. And without their staffs at hand, without the ability to easily copy things and have team meetings, it just is taking longer. And really seeing that for all acquisitions, not just ours. So we're not surprised by it. Things are progressing in a normal way. We're receiving the kinds of questions that we would expect to receive is just taking a bit longer to get those questions.

And I mentioned in my opening commentary that how enthusiastic Danfoss remains around the transaction itself. And if anybody wants to get a sense of their real enthusiasm, the founder of the company and the CEO posted a video this week on LinkedIn, where they're making the announcements to their organization about to bring in together of these 2 businesses and professing their enthusiasm to get this transaction closed. And so we remain absolutely convinced that while it's been a quarter delay, the transaction will close, and they love the transaction, and it's going to create real value for them.

Our next question is from John Inch from Gordon Haskett.

Craig and Rick, just to put a finer point on this non-resi issue. We get these questions all the time. Could you just remind us how big the new build portion for office buildings is as a percent of, say, Electrical Americas and Global because that would be -- seem to be the one area that debatably, right, could be at risk or is not necessarily going to expand. I can't imagine it's that big, but maybe you could just frame it out for us in terms of its magnitude.

Yes, I don't have the new -- I don't have that split. I mean, maybe one data point, John, that may be helpful for you to kind of quantify or gauge the impact. Today, if you think about the office piece of kind of our electrical business, what goes into office build, it's just under 20% of the total electrical business. And so to your point, within that, some of it's new build, some of it's retrofit and modifications. And so hopefully, those -- that data point, we can try to get to the data around what's new versus remodel and refurb, but it's under 20% of the total business. And I do say, I think it is debatable in terms of where this is going to ultimately take us in terms of whether or not working from home has been wonderful to date and companies have managed it longer term. I think it's still an open question mark around efficiency and organizational effectiveness in working from home. And as people come back to offices and this need to social distance is going to require more space. And so I think it will be an interesting one to watch in terms of how it unfolds.

Yes. No, I don't disagree with that. And I think historically, you've said retrofit is sort of 40% to 50% of the whole electrical business, so maybe we can extrapolate that. I'm not sure.

It's more like 25% to 30% for the whole electrical sector.

Okay. All right. So I had that number wrong, but that's -- it's still winnows it down. Just as another clarification. Is the $280 million charge on top of the $50 million to $60 million of quiet restructuring you guys do every year? Or are you going to be lumping in that $50 million to $60 million with the $280 million? So kind of the whole thing gets called out over the next couple of years of the charge enactment?

Yes. It's really the latter, John. And that was my point that I was making in my opening commentary around we had a number of restructuring programs that we were intended to do anyway and pulling those forward and accelerating them. And so it's really the latter. So we intend to take this one charge related to the $280 million laid out the way we articulate it. And that would then eliminate the other restructuring programs that we would have otherwise planned to do over the next 3 years.

Our next question is from the line of Andy Casey from Wells Fargo Security.

Can you talk about M&A potential? I'm just wondering if the dislocation has created any incremental opportunities. And then can you comment on any valuations you might be seeing?

Yes. Appreciate the question, Andy. And certainly, we remain, obviously, in a position where we have the balance sheet that gives us that optionality around keeping M&A on the table. And as we talked about our cash flow generation this year as well as certainly, the M&A event that will take place with the sale of Hydraulics, and we'd expect to bring in another $2.85 billion of cash with that transaction when it closes. So the balance sheet is in great shape, and we have plenty of firepower.

Having said that, I would tell you, though, that given the level of uncertainty around market outlook as well as the fact that valuations and companies coming to terms with the fact that perhaps some of their businesses aren't worth today what they were worth maybe 3 or 4 months ago. That does take some time for that new reality to set in. And so I would say today that valuations have not and expectations have not necessarily come down commensurate with the change in market outlook. And so those 2 things together says we will continue to actively work the pipeline. We are, in fact, having a number of conversations. Our focus and priorities continue to be largely around the electrical business. We think, in this environment, we'll have to see whether or not Aerospace clears up -- the future of aerospace and outlook clears up enough that for us to get back on kind of front foot in and around an Aerospace transaction. But right now, I'd say that we're working the pipeline. It's an active pipeline. But valuations have really not yet come in.

Okay. And then a real quick one, I guess, for Rick. You gave the Q3 framework. If you isolate out the kind of nonrecurring stuff like occurred in Q2 beneath the segment operating profit line, do you expect any sizable change in things like corporate pension and other?

Not any significant change. It should be relatively consistent.

And our next question is from the line of Andrew Obin from Bank of America.

Just a question on inventories in the channel. Can you just tell, have dealers been destocking during this? Where is the level both in North America and internationally as far as you can see? Is there a need for it for restocking basically?

Yes. I think the question around whether or not there's a need for restocking is still yet to be determined, Andrew. I can tell you that we did experience some destocking during the course of Q2. And that destocking is certainly behind us now. And today, when we do our channel checks and talk to our distributor partners, they'll tell you that they feel like the inventory levels today are well aligned with their outlook for revenue. And so I think it's too early maybe to make a call on inventory restocking, but certainly, the destocking of inventory has stopped and is behind us now.

And just in terms of supply chain, I've -- between China, between sort of Mexico shutting down, have you guys made any changes to your internal sourcing, internal supply chains post COVID?

Yes. I'd say nothing material. One of the things that we've always done and believed in strongly is manufacturing in what we call [zero in] currency, which means essentially we -- what we sell in a region, we generally make in a region. We do, in fact, ship some parts around -- and components around the world. I would tell you that throughout this whole entire pandemic, our supply chain has held up extraordinarily well. And I can say with confidence that we didn't lose a single order because our supply chain broke down. And somehow, we ended up with an inability to deliver. The bigger challenge that we experienced as a company really is what largely took place along the border. As companies and countries have had different criteria around what industries are deemed essential. And so there was a period of time when we had some challenges with the Mexican definition versus the U.S. definition. I can tell you that today, that's behind us as well. But for the most part, supply chain has not been a big challenge for us during this current pandemic.

And our next question is from Julian Mitchell from Barclays.

Maybe just trying to understand the free cash flow a little bit better. Within that $2.5 billion midpoint for this year, maybe help me understand what's the Hydraulics' contribution within that? And also, what's the cash portion of the restructuring charges in that number, please?

Yes. I don't have at hand the exact Hydraulics portion. We'll address that off-line. The cash part of the restructuring charge is probably on the order of $50 million. And so that's why we believe that our guidance, even inclusive of that cash portion of restructuring still holds true.

Understood. And then maybe just a second one around the aerospace, maybe margin dynamics. Help us understand what the impact of Souriau-Sunbank was and that integration within the, I think, almost 1,000 basis points drop in the aero margin in Q2. And maybe how you see that impact from the acquisition playing out over the balance of the year? And I don't know if you quantified, but maybe help us see what the commercial aftermarket revenue drop was in Q2, please?

Yes. Souriau-Sunbank and its impact on margins, I have to do some quick math.

I have, but...

You have it offhand, Rick?

Let me just see what I have here. Yes, it -- I mean the margins of Souriau pre-acquisition were in the high teens. And that, obviously, compared to our business that was in the 22% to 24% range. And so I think the easiest way, Julian, is just to use those numbers. And we also gave you the overall sales volume of Souriau, which is about $300 million a year. And so that should allow you to back into the impact from Souriau itself.

100 bps or something like that?

I think probably 150 bp.

150.

Okay. Good. Thank you all. I think we have reached to the end of our call, and we do appreciate everybody's questions. As always, Chip and I will be available to address your follow-up questions. Thank you for joining us today, and have a good day.

Thank you. And that does conclude our conference for today. Thank you for your participation and for using AT&T conferencing services. You may now disconnect.