Eaton Corporation - Q2 2023
August 1, 2023
Transcript
Operator (participant)
Ladies and gentlemen, thank you for standing by, and welcome to the Eaton Second Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. Should you require assistance during the conference, please press Star, then zero, and an operator will assist you offline. As a reminder, your conference is being recorded. I would now like to turn the conference over to your host, Yan Jin, Senior Vice President of Investor Relations. Please go ahead.
Yan Jin (SVP of Investor Relations)
Hey, good morning, guys. Thank you all for joining us for today's Eaton Second Quarter Earning Call. With me today are Craig Arnold, our Chairman and CEO, and Tom Okray, Executive Vice President and Chief Financial Officer. Our agenda today includes the opening remarks by Craig, then he will turn it over to Tom, who will highlight the company's performance in the second quarter. As we have done in our past calls, we'll be taking questions at the end of Craig's closing commentary. The press release and the presentation we'll go through today have been posted on our website. This presentation, including adjusted earning per share, adjusted free cash flow, and other non-GAAP measures. They're reconciled in the appendix. 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 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 the presentation. With that, I will turn it over to Craig.
Craig Arnold (Chairman and CEO)
Thanks, Yan. Hey, today, we're pleased to mark the end of the first quarter with one of our strongest performances ever, and a performance that strengthens our conviction about our long-term growth prospects. Our teams continue delivering on our commitments, propelled by both strong markets and good execution. We'll begin with some of the highlights of the quarter on page three. Well understood at this point, megatrends, reindustrialization, infrastructure spending, are continuing to expand our markets, driving our revenue, orders, and backlogs. We posted another quarter of record financial performance with strong revenue, margins, and earnings growth, and we executed well. Our first half performance, along with our growing backlog, is what allows us to once again raise our full-year guidance. We're raising our 2023 guidance for organic growth, margins, and adjusted EPS. Our EPS growth at the midpoint of our guidance is now up 16%.
Tom will walk you through the details shortly. From my perspective, the highlights of the quarter really are our growing backlogs, up 22% on Electrical and 26% in Aerospace, with a book-to-bill ratio of 1.2 for both Electrical and Aerospace. We also generated strong operating and free cash flow, $1.2 billion and $900 million, up more than 200% and 600% respectively. Free cash flow in the first half of the year is almost $800 million above prior year. We're on track to deliver our full-year guidance despite the higher growth and higher receivable balances. Overall, we're pleased with the results and well-positioned for the second half. Moving to slide four, we wanted to provide a simple framework that summarizes how we think about key growth drivers across our businesses.
The important megatrends are listed here on the left, and each markets and our segments are listed across the top of the page. At the intersection is where we see these trends having a material impact on our growth rate of our end markets. Without getting into a lot of the detail, the important message is that this long list of mega projects is impacting many of Eaton's end markets. What we intend to do during the course of our quarterly earnings call today and really into the future, is really to talk about these trends and how they impact our end markets. Today, we'll spend a few minutes on infrastructure spending and the Inflation Reduction Act, reindustrialization, and an update on mega projects, as well as a look at Eaton's position in the utility and Aerospace markets.
We're highlighting the Inflation Reduction Act since its considerable upside to the initial estimates of future government spending, and on mega projects because they continue to grow dramatically. We picked the utility segment since it's quickly becoming one of our largest markets. It was approximately 15% of Electrical Americas sales last year and is running well ahead of that rate this year. We received also some extensive questions from investors about our position in this market. Lastly, we'll highlight our Aerospace business through the double-digit growth outlook, ramping defense and commercial platforms, including a substantial new win on the Bell V-280 Valor platform. Moving to slide 5, we're showing an updated look at expected spending tied to the Inflation Reduction Act. Most of the spending is focused on improving US infrastructure. As you can see, the estimates have increased significantly.
At the time of passage, estimates on the cost impact, including credits and incentives, was $271 billion. The legislation was recently rescored, government spending is now expected to be $663 billion, up nearly 2.5 times, due to really what is an uncapped program. Importantly, these tax credits, because they're uncapped, are expected to continue to grow. These dollars are naturally a strong catalyst for infrastructure spending, much of it targeted at industries where Eaton will be a significant benefactor. The implementation of the IRA is in the very early stages, we think will provide significant tailwinds over the next 10 years. Very little of this impact is currently in our order book, none of it has impacted revenue yet. On page 6, we have an updated chart showing the continued growth of mega projects in North America.
We introduced this chart last quarter, you'll recall that we included announced projects that are greater than $1 billion in this category. The value of announced mega projects has increased by $116 billion, or 20%, between March and June. The momentum continues, and we'd expect the category to continue to grow at well above historical trends. We've seen recent announcements for EV, semiconductor plants, and new battery plants, so really across the board. A few examples of some of the other major projects include $174 billion of downstream oil and gas or chemical, $33 billion of LNG export terminals, and $64 billion in power generation and renewable energy projects.
Just another confirming data point, the Dodge data for U.S. industrial projects continues to expand at a record pace, with 12-month manufacturing construction starts up 72% on a 12-month basis, on a rolling 12-month basis, up 84% if you include LNG activity. As a reminder, only 25% of these mega projects have started, so we're just at the beginning of this reindustrialization mega trend. Lastly, I'd remind you that we expect each of these mega projects to have between 3% and 5% electrical content. Moving to page 7, we highlight the utility segment of the Americas business. As we reported, in 2022, this market accounted for approximately 15% of Electrical Americas revenue and represents an even bigger percent to date. We've historically viewed the utility segment as a stable but slow growth business, generally in the low single digits.
Over the next decade, utility distribution CapEx will account for 60% of the total utility CapEx globally, growing at a CAGR of 9%. Over the 2022-2025 period, we would expect an 11% CAGR. The impact of sustainability initiatives across the globe have significantly boosted this number. This includes grid modernization, renewable energy, electrification of everything, enhanced reliability and safety needs, and government incentives are all contributing to this growth outlook. While the electrical needs of the world continue to increase, our utility customers are finding it challenging to maintain an increasingly aging grid infrastructure. As a point of reference, over 70% of U.S. transmission and distribution lines are over 25 years old.
We're naturally making capital investments to address the growth here and have already committed to new capacity in our three major product families: transformers, voltage regulators, and line insulation products. It's worth highlighting that in this quarter, our Americas utility business backlog has increased 45%. Organic revenues grew 30% in the Americas and 20% in our global segment. The graphics on page 8 highlight Eaton's unique position in the North American utility market, where we're primarily focused on distribution. Given the significant changes taking place in this market, including the need to integrate renewables, undergrounding for increased resiliency, the increased demand for grid services, we could not be more pleased with what we have to offer in this segment. You can see from this slide that we have a broad position in the market.
In fact, we have the industry's broadest portfolio of utility solutions. This includes grid planning software, design and engineering services, a complete offering of critical utility products, automation software, as well as extensive project management expertise. We also offer a broad range of digitally enabled hardware, grid edge controllers for overhead, underground, and for substations. Lastly, our Brightlayer solution for utility includes distribution planning software, distribution and substation automation, as well as smart grid communication, sensors, and demand management. Overall, we're well positioned given our substantial portfolio of hardware, digitally enabled software, and solutions. In the quarter, we secured a broad range of wins in the market, including hardware solutions for voltage regulators, power distribution, digital solutions for grid planning, in our software we call SIM, in smart metering, and also in utility services.
Moving to page 9, we'd like to highlight another well-known trend, the growth in Aerospace markets. As you can see, we expect double-digit growth in each of the years between now and 2025, driven by the rebound in commercial OEM, commercial aftermarket, and increased defense spending. The commercial market is expected to be very strong, as Airbus and Boeing are both significantly increasing production volumes and are expected to materially increase production on their most important platforms. For example, Airbus is expected to increase production on the A320 from 45 to 50 per month currently, to 75 per month by 2026. Boeing is expected to increase production on the 737 from 31 per month currently, to 50 per month in the 2025 to 2026 time frame.
Global passenger air travel is expected to return to 2019 levels by the end of this year and grow at a 11% CAGR between now and 2025. We also expect to see increased defense spending, driven by various global conflicts, and, and governments allocating more dollars to our type of equipment to improve fleet readiness. Our Aerospace business is especially well positioned on key defense platforms, both those targeted for modernization and on new platforms that are being ramped up. On slide 10, in addition to the high volume single aisle growth that you hear so much about, the next group of key platforms driving into growth today and into the future are listed here. These platforms are a good representation of important platforms ramping in the near term over the next five years, and critical growth platforms for future decades.
In all cases, we have more content than ever on each of these aircraft. In the future category, we're showing the win with the Bell on the Bell V-280 Valor program. The V-280 is a replacement for the Blackhawk helicopter, and we have 5x more content and are still bidding for more opportunities. We put the KC-46A and the F-35 in the next category, aircraft that will be ramping in the near term and will contribute materially to our revenue growth beginning next year. As you can see, our content per aircraft here is 2-3x the legacy platform. Lastly, we're starting to see once again, growth in the wide-body market. The long-haul market has been especially weak during the COVID and post-COVID period, and is now beginning to pick up.
The important message here is that as these programs ramp up, we'd expect to grow faster than our end markets, given the increased content on each of these programs. Between market recovery and increased content per platform, our Aerospace business is expected to see significant growth over the next five years or even longer. Now, I'll turn it over to Tom, who will take us through the financial slides.
Tom Okray (EVP and CFO)
Thanks, Craig. I'll start by providing a summary of our record Q2 results. Organic growth continues to be strong, up 13% for the quarter, the 6th quarter in a row with double-digit organic growth. Operating profit, an all-time quarterly record, grew 21%, and segment margins expanded 150 basis points to 21.6%, also an all-time quarterly record. We posted solid incremental margins of 33%, up sequentially from 27% in Q1. Adjusted EPS increased by 18% over the prior year to $2.21, an all-time quarterly record and well above the high end of our guidance range.
Looking at our first half results, we've had a very strong start to the year, with organic growth up 14%, segment margins up 130 basis points, incremental margin of 30%, and adjusted EPS growth of 17%. Finally, last year, we explained that we were making a deliberate decision to invest in working capital to protect our customers and their orders. With supply chains improving, we are now able to better optimize working capital. The result, together with strong earnings, is a 600% increase in free cash flow in the first half of the year to $900 million. Moving on to the next chart. Our Electrical Americas business delivered another very strong quarter. The megatrends are having a favorable impact on our U.S. business. We set all-time quarterly records for sales, operating profit, and segment margin.
Beginning with the top line, organic sales growth of 19% remains very strong. Electrical Americas has generated double-digit organic growth for six consecutive quarters, with five of the quarters greater than 15%. On a two-year stack, organic growth is up 35%. In the quarter, there was broad-based growth in nearly all end markets, with especially robust growth of 25%-30% in data center, utility, industrial, and commercial and institutional end markets. Operating margin of 26.4% was up 320 basis points versus prior year, benefiting from higher volumes and effective management of price cost. On a rolling 12-month basis, orders grew 7%, with particular strength in data center and distributed IT, industrial, and commercial, and institutional end markets. Book-to-bill ratio remains above 1. We increased backlog by 30% year-over-year, and sequentially, 3%.
It's worth noting that we secured orders for two large data centers- worth nearly $300 million, including content to support these customers' AI growth projections. Finally, our major project negotiations pipeline in Q2 was up more than 17% versus prior year, and nearly 9% sequentially. From especially strong growth in data center, institutional, government, healthcare, and transportation markets. On a two-year stack, our negotiation pipeline was up 65%. Overall, Electrical Americas continues to have a very strong year. On page 13, you'll find the results of our Electrical Global segment, which posted all-time record sales of nearly $1.6 billion. Organic growth was up 6%, which was partially offset by a small divestiture. This represents a two-year stack of 18% organic growth. The growth was broad-based, driven by strength in utility, data center and distributed IT, and industrial end markets.
Operating margin of 18.5% improved 20 basis points sequentially, was down 40 basis points compared to prior year. The year-over-year decline was mostly driven by unfavorable product mix, partially offset by effective management of price cost and higher volumes. Orders were up 1% on a rolling 12-month basis, with strength in utility and data center and IT end markets. Importantly, book-to-bill remained greater than 1. Before moving to our industrial businesses, I'd like to briefly recap the combined electrical segments. For Q2, we posted organic growth of 14%, incremental margin of 38%, and segment margin of 23.4%, which was up 200 basis points over prior year. On a rolling 12-month basis, our book-to-bill for our electrical sector remains very strong at 1.2, and our record backlog grew 22%.
We remain very confident in our positioning for continued growth with strong margins in our overall electrical business. The next slide highlights our Aerospace segment. We posted an all-time quarterly sales record and a Q2 operating profit record. Organic growth was 14% for the quarter. We've posted double-digit growth in five of the last six quarters in this segment. Growth was driven by broad strength across all markets, with particularly strong growth in commercial OEM and commercial aftermarket, which were up 21% and 30% respectively. Operating margin was 22.5%, up 60 basis points over last year, primarily driven by higher volumes. Growth in orders and backlog continued to be very strong.
On a rolling 12-month basis, orders organically accelerated from up 21% in Q1 to up 26% in Q2, with especially strong growth in defense, OEM, and aftermarket for both commercial and defense. Year-over-year backlog growth increased 26% in Q2, in line with growth in Q1. On a rolling 12-month basis, our book-to-bill for Aerospace remains very strong at 1.2x. Moving on to our Vehicle segment on page 15. In Q2, organic growth was up 6%. We saw particularly strong growth in North America, light vehicle, APAC, and EMEA markets, all up double digits. Operating margins came in at 15.3%. During the quarter, we delivered improvements in our manufacturing facilities, which contributed to sequential margin improvement of 80 basis points. We continue to win new business tied to clean technology solutions, including multiple clean commercial valve actuation programs.
Additionally, we've won over $60 million per year in program length extensions and volume increases with multiple OEMs. On page 16, we show results for our eMobility business. We generated another quarter of strong growth. Organic revenue was up 18%. Margin improved 100 basis points versus prior year, mostly driven by higher volumes. Overall, we remain very encouraged by the growth prospects of the eMobility segment. Far in 2023, we have won new programs with more than $450 million of mature year revenues, positioning us very well to exceed our 2025 target of $1.2 billion of revenues. Through these wins, we continue to find opportunities to leverage expertise across all segments. For example, we reached an agreement with a major OEM to supply power electronics control unit for an electrically heated catalyst to meet emissions regulations.
This win demonstrates Eaton's ability to leverage capabilities across our entire portfolio, including core technology in both Electrical and industrial businesses, such as brake torque, power protection, and Bussmann fuses. We've also capitalized on our extensive Vehicle expertise and added content in connectors from our Royal Power acquisition. Moving to page 17, we show our Electrical and Aerospace backlog updated through Q2. As you can see, we continue to build backlog, with Electrical stepping up to $9.1 billion, a sequential increase of 2%. Electrical backlog is up about 110% since Q2 of 2021, and over 200% higher than Q2 2020. Aerospace backlog is holding steady at $3 billion. This is a 30% increase since Q2 2021, and over 100% higher than Q2 2020.
On a rolling 12-month basis, book-to-bill was 1.2 for both Electrical and Aerospace. With absolute orders remaining at high levels and record backlogs, our book-to-bill over 1 times is yet again, a key metric that gives us confidence in our outlook into the quarters to come. With all the tailwinds in our end markets, we think it is likely that we will have high levels of backlog going forward, which enhances our visibility over the planning horizon. On the next page, we show our fiscal year organic growth and operating margin guidance. We are raising our organic growth guidance for 2023 in both Electrical Americas and for the total company. We now expect organic growth in Electrical Americas of 14%-16%, up 300 basis points from our prior 11%-13% guidance.
This represents a 600 basis point improvement from our starting 2023 guidance for the business. In total, we're raising our 2023 organic growth outlook to a midpoint of 11%, up from a 10% midpoint in our prior guidance. Our strong end market growth forecast, expanding negotiations pipeline, and building backlog provide tremendous visibility and confidence in this 2023 outlook. For segment margins, we are increasing our total Eaton margin guidance range by 40 basis points, from a prior range of 20.7%-21.1%, to a new range of 21.1%-21.5%. This is a result of an improved outlook in Electrical Americas, where we increased the range by 80 basis points on strong demand and continued strong operational execution.
The increased outlook now represents a 110 basis point increase from the midpoint of our 2022 all-time record margins. In summary, at the halfway mark, we remain well-positioned to deliver another very strong year of financial performance. On the next page, we have additional guidance metrics for 2023 and Q3. Following our strong first half performance and improved organic growth expectations for the year, we're raising our full-year EPS range to $8.65-$8.85. At the midpoint, the $8.75, we have raised guidance by $0.35. This represents 16% growth in adjusted EPS in 2023 over prior year. We now expect currency translation to be roughly neutral. The remainder of our full-year guidance remains unchanged.
For Q3, we're guiding organic growth of 9%-11%, segment margins of between 22%-22.4%, representing a 100 basis point improvement at the midpoint versus prior year, and adjusted EPS in the range of $2.27-$2.35, a 15% increase versus prior year at the midpoint. I'll hand it back to Craig to wrap up the presentation.
Craig Arnold (Chairman and CEO)
Thanks, Tom. Now turning to page 20. As a reminder, last quarter, we raised our growth assumption for the utility market to strong double-digit growth, and we increased our residential market outlook to flat from declining. We're now increasing our growth assumption for the commercial institutional and for data center markets to strong double-digit growth. In addition to stronger than anticipated demand for new projects, existing buildings are being retrofitted with more electrical infrastructure as EVs continue to increase their penetration in the market. Data center demand continues to remain at very high levels, and we now expect to see double-digit growth in this market as well. The balance of end markets continue to perform well and are tracking along our prior projections. While the macroeconomic outlook remains choppy, we continue to expect growth in almost all of our markets. I'll close with a summary on page 21.
As you can tell, we're feeling good about how our markets are performing this year, and we think they'll be strong for many more years to come. In fact, the mega trends that we've discussed for some time now are expected to be even more impactful than we originally anticipated. Our markets are strong, but we also had solid execution in the quarter and delivered another strong set of results that included a number of financial records. As we look to the back half of the year and into 2024, our increasing backlogs provide great visibility on our growth outlook. As noted, we raised our guidance for growth and EPS for the second time, and our largest business, Electrical Americas, continues to post new records. With that, we'll open it up for questions you may have.
Yan Jin (SVP of Investor Relations)
Hey, thanks, Craig. For the Q&A today, please limit your opportunity to just one question and one follow-up. Thanks in advance for your cooperation. With that, I will turn it over to the operator to give you guys the instructions.
Operator (participant)
Thank you. Ladies and gentlemen, if you wish to ask a question, please press one, then zero on your touch-tone phone. You will hear an acknowledgment tone that you've been placed in a queue. You may remove yourself from queue at any time by repeating the one-zero command. If you're using a speakerphone, please pick up your handset before pressing the number. Once again, if you have a question, please press one, then zero at this time. Our first question will come from the line of Joe Ritchie from Goldman Sachs. Please go ahead.
Joe Ritchie (Managing Director and Senior Equity Research Analyst)
Thanks. Good morning, and congrats, everyone.
Craig Arnold (Chairman and CEO)
Thanks, Joe. Appreciate it.
Joe Ritchie (Managing Director and Senior Equity Research Analyst)
Yeah. Look, my first question, you guys called out a few of those large data center wins that you booked into orders this quarter. I'm just curious, Craig, maybe, maybe just kinda help contextualize, you know, what that means for, from like, a, you know, content for data center and how that's shifting for your business, you know, now that there's, you know, a lot of discussion around, you know, generative AI and what that means for you guys?
Craig Arnold (Chairman and CEO)
Yeah, no, I appreciate the, the question, Joe, and I know there's been a lot of discussion in and around AI and how it's gonna impact, you know, the world, not, and not only kind of data centers. I, I would tell you that, you know, the data center market, you know, as we've talked about on these calls for some time now, has been strong, and it's been strong for multiple years. You know, AI aside, you know, that market has been growing at double digit. I'd tell you that, you know, the, the big wins that we booked during the quarter, I'd say most of that really has nothing to do with the, the AI impact yet. A lot of that is in the future.
A lot of the major, you know, data center players are still trying to sort out the way they're gonna configure their data centers to deal with this AI environment and the increased energy intensity. I'd say for us, it was just another very strong quarter of data center wins that really has not seen the impact yet of this whole emergence of generative AI. It's, we're, you know, we're feeling great about that market, and we think, you know, generative AI and its downstream implications are just gonna keep that market strong for, for a much longer period of time, and we're well positioned there.
Joe Ritchie (Managing Director and Senior Equity Research Analyst)
Well, that's, that's, that's great to hear. maybe, maybe just a broader question around your backlog and the type of visibility that it's providing for you. I think I asked you last year whether, you know, why, why wouldn't you be able to grow, you know, double digits this year, and now it looks like you're very well on track to do so. trying to really kinda think through the implications of your backlog today and what that means for, for 2024 and beyond. Any comments around that would be helpful.
Craig Arnold (Chairman and CEO)
Yeah, I mean, as you can imagine, you know, we're not in a position to provide guidance at this point for 2024, you know, given the fact that it's still early in the year, we'll probably have an opportunity to do that, you know, towards the, the end of the year, as we would normally do so. To your point, I mean, the backlog continues to grow, and the backlog, as you saw in these reports, is up multiples of where we've been historically, which gives us much better visibility, better visibility than we've ever had, into the outlook for, you know, for the upcoming, you know, 12-18 months. So we're feeling very good about, you know, what 2024 is gonna look like.
It'll be another strong growth year for the company, and, we'll certainly, you know, provide some guidance on what the year looks like, you know, as a part of our normal process of and timing for giving the outlook. The backlog, it certainly gives us a lot of courage with respect to what we think the year is gonna look like, given that the growth and where it is relative to where it has been historically.
Tom Okray (EVP and CFO)
Maybe I can just piggyback.
Craig Arnold (Chairman and CEO)
Please, yeah.
Tom Okray (EVP and CFO)
Onto that a little, a little bit. You know, we've seen a lot of focus on order intake, and, you know, certainly that's a, that's a very important metric to look at. But it's important that you look at it in the context of this historically high backlog that we have, together with the protracted delivery times and lead times that we have. As, as Craig alluded to, we're nearly three times our historical backlog coverage. We went through modeling scenarios where you look at various order intake declines, and combine that with robust organic growth. We're confident that we will not hit our historical backlog coverage, timing until two to three years out.
You know, we're, we're very bullish on the, the transparency that the backlog gives us, and it, it really does mute the order intake and order decline a little bit.
Joe Ritchie (Managing Director and Senior Equity Research Analyst)
Super helpful. Thank you.
Operator (participant)
Thank you. Your next question is Josh Pokrzywinski for Morgan Stanley. Please go ahead.
Josh Pokrzywinski (Executive Director)
Hi, good morning, guys.
Tom Okray (EVP and CFO)
Morning.
Craig Arnold (Chairman and CEO)
Hey, morning.
Yan Jin (SVP of Investor Relations)
Morning.
Josh Pokrzywinski (Executive Director)
I feel like you guys have done a really great job of kind of scoring some of the, you know, some of the background announcements, whether it's the mega projects or, I guess, you know, slide 5, with, you know, some of the stuff from IRA. Maybe just, you know, give us an update on where we are in looking through that. I, I would imagine the vast majority of that is not really in the order book. You talked about, you know, really high, customer interaction or, you know, engagement or kind of the front log. I, I forget what the exact term was. But, you know, where, where are we through, you know, kind of those, you know, orders or initial discussions yet?
Craig Arnold (Chairman and CEO)
No, appreciate the, the commentary, Josh, and, and this is, I think, really an important message with respect to, you know, some of these big government stimulus spendings or whether it's the government stimulus spending and its impact or the mega projects that we're talking about. We do think one of the key messages that we think is important to, to kind of get your head around, is the fact that most of this impact has not showed up at this point in our order book, and it certainly has not shown up in our, in our revenues. We did talk about, you know, on, on some of the infrastructure projects, some $2 billion of projects that we have visibility to. We've won visibility. $1 billion of that have been out to quote, we won about half of that.
That is a really small piece of the total dollars that will ultimately be spent tied to some of these, infrastructure and other mega projects that we talked about. It is very early innings for us with respect to the forward-looking programs that we've shared with you on these calls, and it's what gives us confidence that what we're dealing with here is a long-term, you know, structural shift in our business with respect to the underlying growth rates. We'll certainly continue to report out as we learn more, and we'll do this on a quarterly basis. Really encouraged by the fact that, you know, most of the goodness that we're talking about is still the future.
Josh Pokrzywinski (Executive Director)
Got it. That's helpful. Maybe just a quick follow-up. Respecting that, you know, orders and backlog have kind of their own cadence right now with what you guys are going through and just explained, are the shorter cycle parts of electrical seeing kind of that, you know, lead time normalization show up in orders? I think some of your peers have, have seen that. Obviously, you guys are longer cycle and, you know, things like switchgear maybe don't fall into it, but any part of that where you're, you're seeing either like a destock or a lead time normalization show up?
Craig Arnold (Chairman and CEO)
Yeah. We're, we're certainly not seeing any destocking across the business, but in fact, to your point around the short cycle businesses, whether that's resi or what's happening in the MOEM channel or distributed IT, those would be three shorter cycle markets that we clearly have seen a slowdown in orders overall, and, and, and lead times as a result of that, have come in quite nicely in those three end markets. Obviously, being more than offset by strength in, you know, the other much larger segments that we serve, but in those three short cycle pieces of the business, we have clearly seen, you know, lead times come in. We've seen orders moderate in those three end markets.
Josh Pokrzywinski (Executive Director)
Helpful call as always. Best of luck, guys.
Craig Arnold (Chairman and CEO)
Thank you.
Tom Okray (EVP and CFO)
Thank you.
Operator (participant)
Thank you. The next question is from the line of Chris Snyder from UBS. Please go ahead.
Chris Snyder (Executive Director and U.S. Multi-Industry Analyst)
Yes, thank you. I want to follow up on Josh's question, specifically around the Inflation Reduction Act. You know, it sounds like not much orders yet on the back of the IRA. Like, is it reasonable to think that orders there could start coming through in 2024? When we look across all the company's various business lines, you know, which ones do you think will, will benefit most from the IRA specifically? Thank you.
Craig Arnold (Chairman and CEO)
Yeah, I, I do think, and in terms of the timing, you know, for sure, you know, as we think about 2024, we would expect to start to see, you know, those projects be clarified, negotiations, and some orders begin to show up in 2024. Maybe some, you know, early shipments at the best case at the end of the year. But as you know, these projects tend to be much longer term, and a lot of these dollars are going to support mega projects. Mega projects, just by definition, tend to be much longer cycle than the typical stock and flow business that we have. So we would expect to start to see that begin to show up next year. Your point around which companies would benefit the most, I'm not sure. I mean, clearly-
Chris Snyder (Executive Director and U.S. Multi-Industry Analyst)
Oh, sorry, which verticals within... Sorry, which verticals within the company? My apologies.
Craig Arnold (Chairman and CEO)
I'm sorry? Which-
Chris Snyder (Executive Director and U.S. Multi-Industry Analyst)
Which vertical? Sorry, which verticals-
Craig Arnold (Chairman and CEO)
Oh, verticals.
Chris Snyder (Executive Director and U.S. Multi-Industry Analyst)
within the company? Yeah.
Craig Arnold (Chairman and CEO)
You know, I'd say clearly, as we think about the various verticals, and we kind of laid that out in our presentation on slide 4, and this was. You know, appreciate your commentary, because what we really tried to do on slide 4 in our PowerPoint, is to give you a sense for the key mega trends and how they impact the various verticals that we participate in. If you look at infrastructure spending, you know, the great news for us is that it is very broad, plays across the board, and impacts most of our segments. I'd say it, it certainly will show up most materially, I'd say, in the industrial segment.
If you think about, what's going on today in the investments in, you know, new EV factories and battery factories, what's going on in, in the chemical space, a lot of it will show up in what we call industrial, industrial facilities. It really does you know, cut across pretty broadly in, in most of the end markets in which we participate.
Chris Snyder (Executive Director and U.S. Multi-Industry Analyst)
No, absolutely. I very much appreciate that. Maybe following up on, on that industrial comment, you know, everyone, I think, has kind of seen the, the massive, you know, manufacturing starts, that's now leading to higher activity put in place. You know, how should we think about, you know, the, the lag, you know, in which that flows to your business from the start to when it starts generating revenue for Eaton? You know, as you said, these are very long cycle projects. Just wondering, you know, kind of how long, you know, could a single facility kind of generate revenue for you? Thank you.
Craig Arnold (Chairman and CEO)
Yeah, no, appreciate that question. As you, as you can imagine, as we've seen the significant transition to these mega projects, we've spent a fair amount of time internally trying to answer the same question from, from an announcement, you know, to a negotiation, a negotiation to an order, an order to a shipment. It, it varies widely, depending upon the type of project you're referring to. I'd say it could be as short as, you know, six months, it could be as long as three years. When you think about on a lot of these mega projects, they do tend to be longer in nature, so they would tend to be on the longer end of that cycle, just by virtue of the size of these projects.
Tom Okray (EVP and CFO)
I think the exciting thing about it, as, as we said in the prepared remarks, we see each quarter, like, $100 billion coming, coming in, and then it is going to give us a nice cadence going forward for quite some time. Just to come back to the Inflation Reduction Act, I mean, we put that, we put that particular act in for illustrative purposes. You know, just to draw your attention, we've also got the Infrastructure Act, the CHIPS Act, and in Europe, the EU Recovery Plan. When you put all this together, there's just a ton of government stimulus supporting key parts of our business.
Chris Snyder (Executive Director and U.S. Multi-Industry Analyst)
Thank you.
Operator (participant)
Thank you. Our next question is from Nicole DeBlase from Deutsche Bank. Please go ahead.
Nicole DeBlase (Managing Director and Senior Equity Research Analyst)
Yeah, thanks. Good morning, guys.
Craig Arnold (Chairman and CEO)
Morning, Nicole.
Tom Okray (EVP and CFO)
Morning.
Nicole DeBlase (Managing Director and Senior Equity Research Analyst)
Maybe just on free cash flow. Noticed you guys raised the EPS guidance by a pretty considerable amount, but free cash flow remained consistent. Can you just talk about, you know, the drivers of that? I'm sure part of that has to do with your working capital plans for the second half. Thanks.
Tom Okray (EVP and CFO)
Yeah, that's a great question, Nicole. Yeah, we're up almost $800 million. You know, the, the majority of that, around, let's call it $550 million, was, was working capital optimization, and, you know, $250 million was, was from earnings. We, we debated, do we, do we take up the, the guidance on free cash flow? We thought, 'cause it, it kind of fits within the range right now, we, we'd give it another quarter. We're happy the way it's going. Obviously, up 600% is something to, to be happy about. We've improved, improved cash conversion cycle by 9 days. That said, we still have a lot of work to do, and, you know, we, we wanna get our free cash flow margin up even, even higher.
Craig Arnold (Chairman and CEO)
I'd just add, you know, as we grow as well, we're, we're obviously putting more cash into receivables, and so it's.
Tom Okray (EVP and CFO)
Yeah, great point.
Craig Arnold (Chairman and CEO)
... we're having to fund as well, the increased working capital as a result of the higher growth.
Nicole DeBlase (Managing Director and Senior Equity Research Analyst)
Got it. Makes sense. Then on the non-resi vertical, obviously, like, ongoing questions about the strength there. Are there any patches within the whole non-resi complex where you guys are seeing any signs of, of slowing activity?
Craig Arnold (Chairman and CEO)
Yeah, no, and appreciate the question, and once again, if you just think about it in the context of the end market segments that we've laid out on slide four, I mean, most of what we do is non-resi. In the context of your question, specifically, as we mentioned, we have seen a slowdown in, you know, what we call distributed IT, and we have seen a little bit of a slowdown in what we call the MOEM segment of the market as well. You know, fortunately for us, those tend to be smaller segments of the market, and the growth in the other verticals is clearly more than offsetting that weakness. Yeah, we have seen a little bit of a slowdown in those other two verticals as well.
Tom Okray (EVP and CFO)
That said, if you look at the first half of the year, organic growth, I mean, we're up in every single end market. Some of them obviously significant more than others.
Craig Arnold (Chairman and CEO)
Including resi, which we actually.
Tom Okray (EVP and CFO)
Yeah, including resi, yeah.
Craig Arnold (Chairman and CEO)
We took our numbers, if you recall, from the prior quarter, Nicole. We actually took our outlook for the year up in resi, where we originally thought that that market would've been, would've been down, and we took the market up, to the point where, you know, resi is doing much better than, quite frankly, we anticipated as we began the year.
Tom Okray (EVP and CFO)
Absolutely. MOEM is also-
Craig Arnold (Chairman and CEO)
Sure
Tom Okray (EVP and CFO)
is also up first half of the.
Julian Mitchell (Managing Director and U.S. Industrials Equity Research Analyst)
Excellent. Thanks, guys. I'll pass it on.
Craig Arnold (Chairman and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from David Raso from Evercore ISI. Please go ahead.
David Raso (Senior Managing Director and Partner)
Hi, thank you very much. I apologize if I missed this earlier. The Electrical Americas, the organic growth, right? The, the first quarter, 22, 19, back half of the year, we're looking for about 10.5, as per the guide. What % of that growth has been pricing, like, say, or even the assumption for the second half, whatever you're willing to, to discuss? Then just a sense of the pricing that's in the backlog. I'm just trying to get a sense of, obviously, the backlog is a little bit more the mega trend than, than the smaller, shorter cycle projects and, and businesses. I'm just trying to get a sense of that pricing dynamic relative to the overall organic sales growth.
Craig Arnold (Chairman and CEO)
Yeah, I appreciate the question, Dave. I'd say that, you know, one of the reasons why we are forecasting a slowdown in growth between the first half and the second half, is really the strong comparables. If you look at the back half of the year, we were up, you know, some 19%. A lot of that, quite frankly, was price, and we're getting a lot less contributions for price in the back half of this year. When you take a look at it actually on a two-year stack, the growth essentially is the same. It's about 30% versus 2021, essentially normalizing for the really strong back half, a lot of which was price.
In terms of price in the backlog, I would say that, as, as you will likely recall, one of the things that we did was we actually repriced our backlog, in much of it. So if you think about the underlying performance today, what you're seeing in the Electrical Americas business, and we're shipping a lot of that out of backlog because the backlog is so long, is it's essentially, we don't expect backlog to have a material impact on the underlying performance of the business as we ship it.
David Raso (Senior Managing Director and Partner)
I guess trying to maybe get a little more detail on that, that the back half of the year, or, or if you want to even discuss 2Q, what are volumes in the guide for the back half of the year? Just trying to think about, essentially, supply chains improving. Obviously, some of these demand drivers shouldn't fade away that quickly versus some of the shorter cycle businesses that are turning down. I'm just trying to balance volume and price exiting the year.
Craig Arnold (Chairman and CEO)
Sure, sure. I, I know you're really trying to get at the split between price and volume that, you know, we've, we've told you before on these calls, we're not gonna provide it. What I would just tell you is that we are getting much greater contributions from volume than we are from price in the second half of the year.
David Raso (Senior Managing Director and Partner)
All right, I appreciate it. Thank Thank you so much.
Craig Arnold (Chairman and CEO)
All right. Thank you, Dave. Appreciate it.
Tom Okray (EVP and CFO)
Yeah, I mean, keep, keep in the context of the prepared remarks, we've, we've raised organic growth in Electrical Americas 600 basis points since the original guide, and, and our fiscal year guide is, is 15%, which is, which is fairly sporty. Obviously, we can all do the math on the implied for the back half, but, but I think overall, when you step back and look at it, pretty, pretty aggressive.
Craig Arnold (Chairman and CEO)
Volumes are growing.
Tom Okray (EVP and CFO)
Volumes are growing, for sure.
Craig Arnold (Chairman and CEO)
We'd love to think we could get 15% price, but...
Tom Okray (EVP and CFO)
Right
Craig Arnold (Chairman and CEO)
we can't.
David Raso (Senior Managing Director and Partner)
Thank you.
Operator (participant)
Thank you. The next question is from Julian Mitchell, from Barclays. Please go ahead.
Julian Mitchell (Managing Director and U.S. Industrials Equity Research Analyst)
Thanks. Good morning. I, I just wanted to start with the Electrical Global business. You know, you mentioned some of the, the very strong markets and maybe some of those that are a little bit weaker. You know, how long are you expecting that weakness to last? When we look at the profitability in Electrical Global, you've got that nice sort of margin turnaround in the back half, which I think is driving an acceleration in year-on-year profit growth to sort of close to double-digit levels in the second half. Maybe just help us understand the main drivers of that pickup.
Craig Arnold (Chairman and CEO)
You know, I appreciate the question, Julian, and I would say that on a relative basis, certainly Electrical Global is not growing at the same rate as we're growing in the Americas, but I wouldn't call those markets weak. I, I would still say those markets are seeing, you know, pretty attractive growth. With respect to the first half versus the second half, as we mentioned to you in, in some of the up-front commentary in Tom's, we did have a particular mix challenge in our Electrical Europe business in Q2.
So those margins were held back due to some very specific mix-related issues in that business, and based upon, you know, the visibility that we have into the second half, we do believe that, that they do not repeat, and the business gets back to a more normal level of profitability in the second half of the year. We have pretty high confidence that that's gonna take place.
Tom Okray (EVP and CFO)
Yeah, a couple, couple other areas that we're counting on in addition to mix in the, in the back half is, is higher volume and, and being better in terms of our productivity, in terms of manufacturing.
Julian Mitchell (Managing Director and U.S. Industrials Equity Research Analyst)
That's really helpful. Thank you. Then, I, I'm not sure you'll sort of hazard a guess at this, but I just thought I'd check because it was in focus at one of your electrical peers this morning. When you think about your backlog to revenue coverage, you know, total company, it's gone from sort of 20% towards, you know, 50%+, in the last three years at Eaton. You know, some of your peers who also have good sort of megatrend exposure, they're talking about that backlog normalizing maybe to 30% of sales. Not asking you to put a fine point on your view of that for Eaton, but maybe just a sense of the pace at which that backlog to sales may normalize.
I guess the experience of a lot of other companies is once the backlog peaks. It doesn't seem to stay there very long. It sort of starts to move down as customers normalize lead times.
Craig Arnold (Chairman and CEO)
You know, I, I appreciate the question, Julian, and in many ways, we're talking about the unknowable, right? Given the uncertainty around what the future looks like. I would say, though, if you think about Eaton's business, and that's why we thought it was so important to go back to slide 4 in our PowerPoint presentation, to talk about the breadth of our portfolio and how it's impacted by these various mega trends. I would tell you that we aren't the same as other electrical companies, and some of them are exposed to some, but not others. I would just say, you know, what makes Eaton unique here is really the breadth of our portfolio and the end markets that we serve, and how each of these markets are benefiting from these mega trends.
Yeah, you know, I'm not sure what particular, you know, electrical peer you're referring to, but I would say that we would likely have much broader exposure to a number of these trends than other electrical companies.
Tom Okray (EVP and CFO)
Yeah. I mean, just to add to that, I think we had it included in the prepared remarks, but it, I think it bears repeating. Our backlog in the quarter is up 220% since the end of 2019. With all the mega projects, the stimulus spend, the, the secular trends that Craig just mentioned, we, we don't have a lot of discussion about the backlog going down.
Craig Arnold (Chairman and CEO)
If you think, I mean, there are certain electrical companies, for example, who would play heavily inside of factories, you know, who maybe don't play on the infrastructure side. We are a massive infrastructure player. I just want to just point that out in terms of as you think about Eaton versus other companies, you can't really necessarily draw a straight line correlation between us and them. We saw, we obviously have seen our peers announce, and there's a very difference in growth in a number of the peers this quarter, too, a function of the fact that, you know, we play in very different end markets than some of our other electrical peers.
Tom Okray (EVP and CFO)
We also have that nice mix of going through the channel as well as these big mega projects with direct to the customer. We've got this nice balance.
Craig Arnold (Chairman and CEO)
Yeah
Tom Okray (EVP and CFO)
... as well in that area.
Craig Arnold (Chairman and CEO)
Right. The point that Tom's picking up on, that I think is a really an important one, is this notion around if you take a look at what's happening, you know, with a number of our distributors, oftentimes you'll want to draw a straight line between what you're seeing in the distribution channel to what we're experiencing in our own business. To Tom's point, these big mega projects that we're talking about, a lot of this, these big infrastructure-related investments, these are direct projects that are not flowing through distribution. You also will see, perhaps, a decoupling between how we could perform versus some of the electrical distributors as well.
Julian Mitchell (Managing Director and U.S. Industrials Equity Research Analyst)
That's very helpful. Thank you.
Tom Okray (EVP and CFO)
Thank you.
Operator (participant)
The next question is from the line of Stephen Volkmann from Jefferies. Please go ahead.
Stephen Volkmann (Managing Director and Equity Research Analyst)
Oh, great. Thank you for fitting me in. I wanted to actually switch to Aerospace, if I could. Appreciate your comments there.
Craig Arnold (Chairman and CEO)
Thank you.
Stephen Volkmann (Managing Director and Equity Research Analyst)
I know, right? Appreciate your comments there on sort of the medium-term outlook, looks very robust. I'm curious how you think the real ramp that you outlined in OE, will impact margin mix over the next sort of three to five years.
Craig Arnold (Chairman and CEO)
Yeah, no, appreciate the question, and, and, and what you're kind of poking at a little bit, understandably, is the fact that, you know, OE margins tend to be, you know, well below aftermarket margins. But, you know, the good news here is we're finding that both OE and aftermarket, which is really tied to revenue passenger kilometers or revenue passenger miles, both of those pieces of the business are essentially ramping. If you, if you heard what we reported in our numbers, we actually saw even more growth in aftermarket in the quarter than we did on the OE side. So we don't, we don't anticipate a negative mix impact from this ramp on the OE side as we look, you know, out to the forecast for the next number of years. To your point, it is certainly something to watch.
If you ever get in, in any way inverted there and, and OE is growing, and aftermarket isn't, it would certainly have a negative impact on margins, but that's not our anticipation.
Tom Okray (EVP and CFO)
Yeah, just to remind you with a couple of numbers here. Our trailing 12-month, our rolling 12-month is, in the aftermarket, is 25%, and that's really 25% on both defense and commercial.
Craig Arnold (Chairman and CEO)
OE and aftermarket-
Tom Okray (EVP and CFO)
Yeah
Craig Arnold (Chairman and CEO)
... which is really the important point. Yeah.
Stephen Volkmann (Managing Director and Equity Research Analyst)
Great. That's super helpful. Then just one quick, longer-term question, Craig. I mean, given all these trends across all your businesses, we're obviously going to have a period of very strong growth here. I just don't think we've compounded at these types of levels over multiple years in the past. How do you think about capacity here? Because rates of growth seem like they're really kind of inflecting for a longer term.
Craig Arnold (Chairman and CEO)
First of all, you're absolutely right. You know, this is a very different electrical industry, a very different Eaton than the one that perhaps your grandfather and grandmothers knew. As a result of that, we are making, you know, fairly sizable investments in capital equipment. We talked about it in the last earnings call, some of the big investments that we're making in the utility space, and I mentioned in my outbound commentary, we've made investments in transformer capacity, voltage regulators, and line insulation products. These are essentially capital investments that are ongoing right now. We've made some fairly sizable investments in our circuit breaker capacity over the last couple of years, and so we are having to invest more in capital equipment.
I would say even on, in the big scheme of things, the, the level of investment, you know, is maybe gonna tick up 0.5% more of sales, maybe another 1% of sales, but very well manageable in the context of the overall growth of the company.
Tom Okray (EVP and CFO)
Yeah, the important thing is the, the focus is really there. We're just recently with our board and our strategy session, and a big part of that was the capacity related to meeting this, this, this hyper growth. You know, we're, we're, we're very hungry. There's a lot of food on the table. We're very hungry.
Stephen Volkmann (Managing Director and Equity Research Analyst)
Great. Well, with that, I'll let you go off to lunch. Thank you.
Operator (participant)
Thank you. The next question is from Nigel Coe from Wolfe Research. Please go ahead.
Nigel Coe (Managing Director and Senior Research Analyst)
Thanks. Good, I guess it's good afternoon now. Lunch sounds good to me. We've covered a lot of ground, so back to electrical. You mentioned, I think, Craig, retrofits, which I think retrofit activity, which I think was in relation to C&I end markets in, in particular. I know you've talked about this in the past, increasing load content, and I think it was in, in relation to charging specifically, but maybe just talk about what activity you're seeing within retrofits and, you know, how you, how you think that develops over the next couple of years.
Craig Arnold (Chairman and CEO)
Yeah, no, no, certainly appreciate the, the question, and we do, you know, you do... You know, if you think about today, why we are feeling, you know, incrementally more positive around what's happening today in commercial and institutional, and, and a bit of this is, is simply what we're all experiencing around, you know, the growth in electrification, the growth in EV charging infrastructure, and the investments that are being put in to support, you know, the growth and the demand for electricity on the grid. So in terms of quantifying the impact of that versus the impact of the new build, I can say we're, we're probably today not smart enough to do that with any degree of precision. I can tell you that it is, it is an important piece of what we're seeing in terms of growth.
It will contribute to growth. You know, how do you, you know, quantify the impact of retrofits versus the, the new build stuff? You know, we're, we're trying to work through some of those, you know, questions and answers, but, you know, and things are moving so quickly right now that, quite frankly, we, we haven't had a chance to really put pen to paper and really try to figure it out. We are gonna see, to your point, we're gonna see it, you know, in both new buildings, and we're gonna see a lot of retrofits and modifications, whether it's in a home, to put in electrical infrastructure in a, in residential, and whether it's in, you know, commercial buildings or offices to support EV charging, to support the addition of solar, the additions of battery storage.
I mean, all of these, you know, investments that are being made to improve your electrical capacity, resiliency, you know, a lot of that will go into existing buildings.
Nigel Coe (Managing Director and Senior Research Analyst)
Yeah, that's great.
Craig Arnold (Chairman and CEO)
We'll probably maybe be a little smarter on this topic and, and, and get you a little better answer than that, but, certainly an important one for us, but one we're still trying to quantify.
Nigel Coe (Managing Director and Senior Research Analyst)
No, I agree. Then on data centers, I just wanna take the other side of the, of sort of the, you know. Are, are you seeing any signs of weakness? Doesn't look like it, but are there any signs of weakness out there? I'm thinking maybe China perhaps might be, might be a bit softer. Then when you think about, you know, generative AI and, you know, GPU, you know, racks, does this increase the revenue per megawatts, or does this just increase the total megawatts in, in the markets? Any thoughts there would be helpful.
Craig Arnold (Chairman and CEO)
Yeah. I mean, to, to your, to your first question, are we seeing any signs of weakness? I would say not really. I mean, you know, whether geographically or whether it's, you know, it's not just either the hyperscalers. We're seeing it colo, we're seeing on-prem, we're seeing it around the world. Globally, we're seeing, you know, strength in the data center market. To the point around, once again, you get back to this important question around AI's impact on data centers and the way they're gonna be configured. Certainly, we understand that they're gonna need more power. The power density of these racks is gonna go up. We still don't know.
I think it's early days, and it's, it's one that we know we owe you an answer, and we know we owe ourselves an answer on that one as well, as we continue to talk to some of the big, you know, data centers, providers around how they're gonna be configuring these data centers and how they're gonna change. Hard to say, we're, we're still in the early innings, and we don't yet have all the answers to how they're gonna be reconfigured.
Tom Okray (EVP and CFO)
Yeah, just, just a little bit more on Craig's point in turn, in your question on slowing. Each part of the world for the first half of the year, data centers, including hyperscale, grew double digits. It's just a matter whether it grew mid-double digits or in the twenties or in the thirties. We're seeing robust growth across the board.
Nigel Coe (Managing Director and Senior Research Analyst)
Okay, that's great detail. Thanks a lot.
Operator (participant)
Thank you. The next question is from Steve Tusa from JPMorgan. Please go ahead.
Steve Tusa (Managing Director and Senior Equity Analyst)
Thanks for letting me in.
Craig Arnold (Chairman and CEO)
Yeah, Steve, no problem.
Steve Tusa (Managing Director and Senior Equity Analyst)
When you said greater contributions from volume and price in the second half of the year, what, what exactly did you mean by that? Did you mean that you just expect the skew to be more towards volume in the second half versus the first half? Or maybe just a little bit more color on, on, you know, what you meant by that.
Craig Arnold (Chairman and CEO)
No, that, that's primarily what we're referring to, Steve, because if you think about, you know, most of the big price increases that we put through in our business, most of those showed up, you know, in the second half of last year. We got some modest price increases this year, but most of the big price increases that we got, we got in the second half of last year. They're really baked into the comparable for 2020, you know, 2022, and we're anniversarying those big increases right now. Just on the relative contributions to growth, on a relative basis, we're gonna get it- getting it more from volume than we are for price in the second half of the year.
Steve Tusa (Managing Director and Senior Equity Analyst)
Okay. That, that, that's helpful. Then just on the Electrical Americas business, I mean, should we think about this, this margin you're doing, especially here in the second quarter here? I mean, is, is that like, I know you have it going down sequentially in the second half, I guess, a little bit. Is, is that the jumping-off point for next year? How, how sustainable is that, and any, any moving parts there that you wanna call out as we, you know, tinker with our models for next year?
Craig Arnold (Chairman and CEO)
Yeah, no, and I'd say that, you know, our team continues to execute well. We certainly had a little bit of perhaps favorable mix in Q2, and maybe that's what you're seeing in terms of the relative change between Q2 and, and the back half of the year. There's nothing, there's no unusuals in those numbers. That's just straight operating performance, execution by our team. Yeah, the, the simple answer is, yeah, that should be the jumping-off point as we think about, you know, what this business should look like into 2024 and beyond. Obviously, we're gonna have volume growth, you know, and so the business is performing well, and we'd expect it to continue to perform well.
Tom Okray (EVP and CFO)
Yeah. Steve, I would just add, we know what the implied say for the, the segment margins. We're hoping we do better than the implieds.
Steve Tusa (Managing Director and Senior Equity Analyst)
Right. Is that the jumping-off point for next year? Like, is, is that a sustainable number that you can improve on next year?
Craig Arnold (Chairman and CEO)
Yes.
Tom Okray (EVP and CFO)
Yeah.
Steve Tusa (Managing Director and Senior Equity Analyst)
Okay. Straightforward. Thank you.
Operator (participant)
Thank you. The next question is from Deane Dray from RBC Capital Markets. Please go ahead.
Deane Dray (Managing Director and Senior Equity Analyst)
Thank you. Good day, everyone.
Craig Arnold (Chairman and CEO)
Hey, Deane.
Tom Okray (EVP and CFO)
Hi, Deane.
Yan Jin (SVP of Investor Relations)
Hi, Deane.
Deane Dray (Managing Director and Senior Equity Analyst)
Hey, covered a lot of ground, but I did hear a couple references to unknowables and a, and a choppy macro. It kind of begs the question about the initial assumption for this year, so long ago, it seems, for a mild recession. Is any clarity in terms of your assumption there, is it that everything seems to be skewing much higher?
Craig Arnold (Chairman and CEO)
Yeah, no, I mean, I think to your, to your point, Dean, we, like so many others, had anticipated a mild recession this year. Our thinking around recession continues to be pushed out as it does for, I think, most of the economists in the world. At this juncture, I mean, we're feeling pretty good about the year. It's one of the reasons why we're taking up our guidance. I think the bigger message becomes, in the event of a mild recession, very much consistent with what we said originally, even in the event of a mild recession, given the mega trends and the stimulus spending and the strength of our end markets, we don't believe it's gonna have a material impact at all on Eaton's growth.
That's what we said at the beginning of the year, and that's what we continue to believe.
Tom Okray (EVP and CFO)
Yeah. Dean, I'll take you back to an earlier response. You know, we've modeled even, even with, you know, downturns in order intake, we are very confident that we can power through that, given our backlog and the mega trend.
Deane Dray (Managing Director and Senior Equity Analyst)
Yep, that seems clear. Then just a very quick follow-up on Stephen Volkmann's question about capacity. When we were all together in New York a while back, we talked about shortages of smart switchgear and transformers. Is that in any way holding back the utility demand, at least that, how much you'll be able to supply, and how does that change?
Craig Arnold (Chairman and CEO)
Yeah, no, I'd say the, as an industry, things are better. I'd say we are the industry and some of the supply chain choke points are materially better today than they were, let's say, this time last year. We're clearly not out of the woods, and there are certainly certain markets and verticals that are still very much challenged with respect to lead times, and the utility market is one of those. As we mentioned on these calls before that, probably the, the longest lead time device we probably have today in the company is a transformer that goes into the utility segment. So very much a function of which end market and which product you're talking about. In general, things are getting better, but there's, each lead times are still extended.
We're still not back to, let's call it the, you know, pre, you know, 2019 levels of lead times. We think our lead times are competitive with our peers in the marketplace. But yet we're still not back to where we were in 2019, and we still are extended in certain product lines.
Deane Dray (Managing Director and Senior Equity Analyst)
Thank you.
Craig Arnold (Chairman and CEO)
Great. Thank you.
Operator (participant)
Thank you. Our next question is from Brett Linzey from Mizuho. Please go ahead.
Brett Linzey (Managing Director)
Hey, good afternoon. I just wanted to follow up on that utility comment there. You gave the growth framework to 25, I think you said 11% growth. How should we think about Eaton's relative growth in the context of, you know, wallet share per opportunity or any share shifts from some of these capacity additions?
Craig Arnold (Chairman and CEO)
Yeah, I mean, I'd say, you know, Eaton's relative performance, I think, you know, with respect to our peers, as we talked about before, and it's one of the reasons why we included that chart, is that, you know, all of our peers aren't the same. We play very broadly across the utility end segment. As I said in, in my commentary, we think we are the broadest player. We have a broader portfolio of solutions in the utility market than any of our competitors. So we think we are very well-positioned to grow, you know, at market, to grow and perhaps grow faster than the market. We are today, you know, as are most of our peers, capacity-constrained.
I do think that the real limiter on growth in terms of the utility market these days, is really gonna be our ability to add capacity to deal with the growth that we're seeing. That is the one segment where lead times are still quite extended. Until we get this new capacity online, it's gonna be very difficult for us to grow at a much faster rate than the overall market.
Brett Linzey (Managing Director)
Okay, great. Just, just one follow-up, and I, I apologize if I missed it, but on the project funnel, you guys have been giving that, you know, that rate of growth year-over-year and sequentially. Just, just curious how that fared in the quarter?
Tom Okray (EVP and CFO)
Yeah, the, the negotiated, the major projects, yeah, it was, it was up 17% year-over-year and 65% on a two-year stack.
Brett Linzey (Managing Director)
Great. Thanks a lot. Best of luck.
Tom Okray (EVP and CFO)
Thank you.
Craig Arnold (Chairman and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Joseph O'Dea from Wells Fargo. Please go ahead.
Joseph O'Dea (Managing Director and Senior Equity Analyst)
Hi. Thanks for taking my questions. I'll ask them both together because they're kind of related. One's lead time related and one's backlog. Any additional color, if you think about some of the biggest kind of revenue product categories, just some perspective on where lead times are, you know, where they were at their worst, kind of what you need to get back to for normalization. Related to that, and I think all the tailwinds that you're discussing on sort of the mega project support out there, the stimulus support out there, I think, Tom, your comment was, you know, it might take two to three years for backlog to get back to normal.
I guess, you know, even as these lead times correct, is, is, is backlog back to normal, you know, really the expectation or, you know, you think it's gonna take, you know, take quite some time before we really start to see any kind of notable step down in these levels?
Craig Arnold (Chairman and CEO)
Yeah, no, I'd say maybe just kind of addressing kind of the first part of your question, which is kind of on lead times. As, as I mentioned, on to the prior, on the prior, question, lead times are in fact still extended. They've improved somewhat, certainly more so in some of the, you know, shorter cycle businesses. We talked about, you know, resi, MOM, distributed IT. For the big project-related stuff, you know, a lot of those lead times today are still fairly well extended, and for utility markets, they, they probably haven't improved much at all. It really does vary widely, depending upon which vertical you're referring to. Until once again, I said, we, we are sold out.
We, we don't have a lot of excess capacity today to really deal with what has clearly been a, a much faster acceleration in growth than what we originally did in some of these big industrial-centered kind of product lines and, and businesses. Until capacity comes online, we would not anticipate that these lead times get materially better. The same thing I would say would be true of backlogs. They're obviously, to your point, very much interrelated. Until you can release, you know, reduce your lead times, borrowing of, of, of, you know, of significant slowdown in the markets, which we don't anticipate, you're really not gonna deal with, you know, reducing your backlogs either.
We do think that, you know, under a normal planning horizon, the way we're thinking about it, backlogs stay elevated for some period of time. I think what Tom was trying to do was simply to try to provide a little comfort around that. Even if markets slow down, we should continue to be able to post very attractive revenue growth because we can simply eat backlog.
Tom Okray (EVP and CFO)
That's right. That's, that's, that's right. The two to three years that I quoted is in a turndown situation and is arguably conservative.
Joseph O'Dea (Managing Director and Senior Equity Analyst)
Got it. makes sense. Thanks a lot.
Tom Okray (EVP and CFO)
Thank you.
Operator (participant)
Thank you. At this time, there are no further questions. Thank you. Please continue.
Yan Jin (SVP of Investor Relations)
Hey, thanks, guys. As always, Chip and I will be available to address any of your guys' follow-up questions. Thanks for joining us today. Have a great day.
Operator (participant)
Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Event Conferencing. You may now disconnect.
