SPX FLOW, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the SPX Flow First Quarter 2020 Earnings Conference Call. At this time, all participants' lines are on a listen-only mode. After the speaker's presentation, there will be a question-and-answer session, and to ask a question during the session, press star 1 on your telephone. Please be advised that today's conference is being recorded, and if you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Scott Gaffner. Thank you, and please go ahead, sir.

Thanks, Chris, and good morning, everyone. Let me start by thanking you for joining us for a discussion of our first quarter 2020 financial highlights. This morning, we issued a news release detailing our financial performance for the three months ended March 28, 2020. The news release along with the presentation to be used during today's webcast can be accessed on our website at spxflow.com. A replay will also be available on our website later today. Joining me on the call today are Mark Michael, President and CEO, and Jamie Easley, Vice President and Chief Financial Officer. Taking a look at today's agenda, Mark will start with a safety message, a discussion around our evolving response to COVID-19, along with some thoughts regarding the essential nature of the industry's reserve and the overall health of the balance sheet. Jamie will then walk you through details of the Q1 results, our financial position, and the discussion regarding our scenario analysis planning and cash conservation actions we have taken or could take depending upon economic conditions. Mark will wrap up with an update on our ongoing strategic transformation, and following our prepared remarks, we'll open the call for questions. Before we begin, a brief reminder that elements of this presentation contain forward-looking statements that are based on our current view, principal risk factors that may impact our performance. Those elements are subject to change, and we ask that you view them in our most recent SEC filings. In the appendix of today's presentation, we've provided reconciliations for all non-GAAP and adjusted measures presented. And with that, I'll turn the call over to Mark.

Thanks for the introduction, Scott. Good morning, everyone, and thanks for joining us on the call. Our purpose at SPX Flow is to help feed and enhance the world by delivering high value solutions at the heart of sustaining our diverse communities. As the world faces extraordinary challenges posed by COVID-19, our purpose is accentuated. I'm impressed with the way our team is working together across the globe to navigate these challenges. rapidly implementing new protocols that prioritize health and safety while maintaining business continuity to fully support customers. We have remained open for business with limited disruption as we support many customers who deliver essential items to first responders and consumers. Our first quarter performance demonstrates our nimble operating structure, maturing business operating system, and emphasis on driving high quality revenue. We're in a strong financial position and are managing prudently in the current macroeconomic environment. We'll spend an appropriate amount of time discussing our Q1 results, order trends, financial position, and cash sensitivity in detail. First, however, I'll highlight the character and resiliency of our people at SPX Flow and the merits of our strategy. Just as we started our last earnings call, I'll begin today with a safety message. The safety, health, and well-being of our people is a priority that we never compromise. Wherever we are in the world, I encourage our global team to think safety first and do the right thing always. This is an important aspect of our people-first culture, which has been the backbone of a resilient approach to the COVID-19 pandemic. As we continue to work through the unique and unprecedented challenges, I would like to extend best wishes to our entire SPX Flow team and their families, as well as our business partners and communities around the world. On the topic of community, I want to highlight inspiring acts of kindness our team has demonstrated in support of local communities and frontline workers. In New York, our team in Rochester engineered and produced plastic parts utilizing are 3D print capabilities for medical-grade face shields, which are critical to the safety of medical workers, keeping their face masks dry and protecting their eyes. I want to give a shout-out to Richard Keen and Jordan Meal, who spearheaded this effort, and to the entire team in Rochester for supporting frontline workers in New York, a state that is being hit hard by the virus. In Germany, at the request of a local hospital whose staff was spending valuable time manually filling bottles with hand sanitizer, our team in Nordstedt converted a traditional beverage dosing system into an automated bottling system for hand sanitizer. The time gained in this process is given back to medical workers as they focus on helping patients. In other parts of the world, Our teams have donated emergency supplies in Busan, South Korea, collected donations for orphans in China, shared inspiring messages with sidewalk art in North Carolina, and provided meals to local schools to feed children sheltering at home. A big thank you to our team members who have taken time to serve and help others. These touching acts of kindness and support reflect the collective character of our people at SBX Flow. As we navigate through this historic situation, our guiding principles are to prioritize the safety, health, and well-being of our team members, support our customers and maintain business continuity, preserve our strong financial position and liquidity, and continue to mature our business operating system and execute our long-term strategy. I'm confident in our ability to effectively manage through this downturn and be in a strong position to capitalize on growth and value creation opportunities as the economy recovers. Looking at our guiding principles in detail, our first objective is to protect our people by prioritizing safety, health, and well-being. This includes mental health awareness, which is an area of focus for us. Early in the year, we activated our crisis management team to steer us through this pandemic. Best practices applied early in Q1 by our teams in China and South Korea were replicated across our sites later in the quarter. We proactively restricted travel and third-party visitation. We implemented higher standards of PPE and increased sanitation across all sites. And we transitioned to voluntary work from home protocol for office workers before it was regulated by local governments. For government regulations, safety requirements, or family needs have impacted our employees, we've maintained certain compensation and benefits. I want to commend our site leaders, HR team, and crisis management team for their collaboration and swift decision-making, which has kept our people safe and informed. Our second objective is to support our customers and maintain business continuity. On this front, we initiated weekly business continuity calls engaged operational and functional leaders across regions to provide real-time situation reports and gain the support needed to resolve any disruptions. Many of our customers supply essential elements to consumers and frontline workers in the fight against this pandemic. As part of the supply chain that helps feed and enhance the world, much of the work we do has qualified as an essential manufacturer, at many locations and we continue to work closely with our suppliers to maintain continuity on that end. I want to thank our manufacturing, supply chain, sales, customer service, and project delivery teams for their outstanding and courageous effort. It has been an extraordinary and greatly appreciated. When we discuss our why at SPX Flow, we focus on our purpose statement. SPX Flow innovates with customers to help feed and enhance the world by designing, delivering, and servicing high-value solutions at the heart of growing and sustaining our diverse communities. This pandemic and economic downturn underscore why we work hard every day to support our customers in highly critical, specialized sanitary and industrial markets. Our process technologies play an integral role in the production of many consumer goods. We support hundreds of well-organized consumer brands commonly found in homes across the world, products ranging from plant-based nutritional beverages, yogurt, and condiments to shampoos, skin cream, and other personal care products. This positioned us as a critical part of the supply chain that helps feed and enhance the world, and as such, we've worked hard to maintain business continuity in a healthy work environment. To keep our manufacturing operations up and running, Ty Jeffers and his team have done an outstanding job implementing new standards to promote healthy and clean work environments for employees while managing the dynamic impacts of COVID-19. We've been able to keep production at a high level while navigating strict dynamic requirements that vary based on regional and local conditions. On this slide, we feature our six largest multi-product sites, all of which ran with significant uptime during the quarter despite various logistical challenges. Shidu China was our first facility to be disrupted by the pandemic, which we talked about on our Q4 call in February. Today, I'm happy to report Shidu is operating at full capacity. As the pandemic spread across the globe, we applied our learnings in each country and manufacturing location to keep our team safe and operations open. I'm pleased that our other five key sites located in Europe and the US have all remained operational throughout the pandemic. I'm also extremely proud of all our manufacturing teams for their courageous commitment to serving customers during this time of need. Even with the essential nature across many of our customer segments, orders in the first quarter were down 19% sequentially and 9% year-over-year ex-currency. Industrial orders were flat sequentially and down 4% year over year. Orders for mixers and dehydration equipment were healthy, particularly for long lead time jobs. In contrast, orders for heat exchangers, hydraulic tools, and industrial pumps were down. From a regional perspective, industrial order growth in the Middle East and China was offset by declines in North America and Europe. In food and beverage, we experienced double-digit order declines sequentially and year over year. On a global basis, components and aftermarket orders were down low double digits with declines in each major region. The level of systems orders in Q1 was historically low, reflecting the impact of COVID-19 on project activity in China and Europe. Encouragingly, in April, we saw a nice rebound in system orders out of China as the economic activity resumed. Our third priority as navigating this pandemic is to preserve financial strength and flexibility. We enter the year with the net proceeds from the sale of power and energy. Today we have over $1.1 billion of available liquidity, including $600 million of cash on hand. And our credit ratios are well below our debt covenants. Net debt is currently less than $100 million and net leverage is approximately 0.4 times. Our strong financial position gives us flexibility to invest in our long-term strategy and create value through disciplined opportunistic capital allocation while maintaining a healthy balance sheet. To emphasize the importance of cash management while maintaining a healthy balance sheet. To emphasize the importance of cash management, Jamie and his team implemented a cash war room that emphasizes cash conversion, working capital efficiency, and return on investment. This is a valuable process that we are integrating as a permanent fixture into our business operating system. Additionally, we completed a robust cash sensitivity analysis to identify our cash break-even point across various economic scenarios. With this, we identified options to safeguard profitability maintain positive free cash flow, and stay within our debt covenants. In the current environment, we are assuming a 15% to 25% year-over-year decline in orders and are managing costs prudently. We have already curtailed discretionary spend and variable costs and are limiting new hires to customer support roles, select strategic positions, and our early career programs. If the economic downturn is deeper or more prolonged, our scenario analysis identified actions that can be rapidly implemented to adjust our cost structure with volume levels while maintaining the ability to support customers and fully participate in an economic recovery. Jamie will go through more of these details later in the call. Our fourth guiding principle is to create value through the economic downturn by executing our long-term strategy. The near-term challenges have not changed our value creation thesis. While this challenging economic and social environment is impacting our business in the near term, it has given us greater conviction in our strategy and created a heightened sense of urgency in listening to our customers and delivering the system. Experience by exceeding commitments with speed, quality, and service excellence. For our team at SPX Flow, we're creating an authentic culture that stimulates change, empowers decision-making, and encourages customer-focused innovation, a culture where we exceed our commitments, obsess over customer service, and win together. Today, we are better positioned than in previous recessions to support our team in serve our customers, and maintain financial strength, liquidity, and strategic optionality. I'm confident in our ability to effectively invest through this downturn and be in a strong position to capitalize on growth and value creation opportunities as the economy recovers. At this time, we'll turn the call over to Jamie.

Thanks, Mark, and good morning, everyone. I'll echo Mark's comments regarding our culture and resiliency. It has been impressive and I'm blessed to be part of this team at SPX Flow. I'll begin with a brief recap of Q1. For the quarter, we reported revenue of $289 million with $29 million of segment income and EBITDA of $22 million. As compared to our guidance ranges, segment income and EBITDA exceeded expectations on modestly lower revenue. It was driven by solid operational execution, cost controls, and productivity as evidenced by gross margin of 35%. As compared to the prior year period, gross margins expanded nearly 200 points despite a 23% or $84 million decline in revenue. The revenue decline across both segments and reflects a lower level of opening backlog partially due to our emphasis on reducing exposure to large dry dairy projects, COVID-19-related delays, and weakness in short-cycle industrial demand. Looking at these segments, beginning with industrial, organic revenue declined 11% to $191 million, reflecting the global slowdown in short-cycle industrial activity that began in the back half of 2019 and continued throughout the quarter. COVID-19 also caused shipment delays at facilities where work was limited to essential business by government mandate. Organic orders were down 4% year over year, but relatively flat on a sequential basis. In the quarter, we were awarded a handful of medium-sized mixer orders, which tend to be longer cycle in nature. Outside of that, short-cycle industrial orders declined, consistent with broader global market trends. Segment income was $9 million, or 6.2% of revenue. Decremental margins were 38%. Moving on to food and beverage. Q1 revenue was $138 million, down 19%, or about $30 million on an organic basis. The organic decline was primarily related to a lower level of revenue from large dry dairy systems and low double-digit declines in component sales. Despite the revenue decline, segment income remained flat at $19 million, with segment margins up 340 points year-over-year to 14.1%. This reflects the efforts of the team to hit operational objectives and deliver a higher quality of revenue. I'd like to recognize Isabel Balmier and her F&B Systems delivery team and service teams. Their innovative approach to installation, commissioning, and service during these challenging times has been remarkable. This is the third consecutive quarter in mid-teens or better operating margins for food and beverage. Given the volatile and unprecedented economic landscape, the ongoing impact of COVID-19, and the short cycle nature of our business, we do not believe it is prudent to provide our traditional financial guidance at this time. In lieu of that approach, we thought it may be helpful to frame up a basic set of assumptions. We have assumed organic orders could decline between 15 and 25 percent year-over-year with the most significant impact occurring in the middle of the year. Decremental margins in Q2 could fall to a 15 to 20 percent range before normalizing in the second half of the year to 30 to 40 percent. By segment, decremental margins in our industrial segment tend to flex with volumes at or near gross margin levels. The decremental margins in food and beverage are a bit more nuanced and can vary based on the timing and execution of systems, as well as trends in higher margin component and aftermarket business. During the quarter, we performed a robust cash sensitivity analysis across a wide range of economic scenarios to assess the impact that a steeper decline in demand would have to our profitability and cash performance. Within these scenarios, we mapped out various options to mitigate the immediate impact from lower volumes, including a variety of cost and cash levers that can be rapidly implemented as necessary. Under our current working assumption of orders dropping 15 to 25 percent this year, we took steps in Q1 to reduce our cash outflows for the full year by approximately $35 million. In this scenario, we anticipate generating positive free cash flow for the full year at a healthy conversion rate to net income. If the rate on order declines approach 35%, we are prepared to take actions to reduce controllable costs by an incremental $45 million. In this scenario, we see a path to generating positive free cash flow. And if orders fall even further to half of our 2019 orders, we could take additional actions that would result in an incremental $65 million or $150 million cumulative semi-variable reduction. The simple message here is that we are prepared to take actions that protect our compliance with credit agreement covenants and maintain free cash flow at break-even or better but it also leaves us with flexibility to fully support customers as the economy recovers. I'll also note that the actions contemplated in our scenario planning would be thoughtfully deployed, if required, with careful consideration and with great empathy, consistent with the guiding principles Mark discussed previously in our people-first culture. Taking a brief look at our financial position, We are showing here both our financial position at the end of Q1 as well as a pro forma look at the start of Q2 because the sale of our power and energy business was completed on the first day of the second quarter. Following the sale of power and energy, cash on hand was approximately $650 million, gross debt was $711 million, and net debt was just about $60 million. Net leverage at the end of Q1 was 1.9 times and was 0.4 times following the receipt of cash proceeds from the divestiture. Our capital allocation intentions remain unchanged with a prioritization of debt reduction along with opportunistic share repurchases. Our maturities are staggered with no material principal payment required until 2022. Between cash on hand and our revolver, we now have over $1.1 billion of available liquidity. Looking at our credit ratios versus debt covenants in our credit agreements, we are well positioned in the current environment. And our adjusted free cash flow with a quarter was a usage of $23 million due primarily to a lower level of operating income and $6 million of CapEx from our discontinued P&E business. We also had a modest investment in inventory due mostly to timing of shipments at the end of the period. Our guiding principles for capital allocation are illustrated on this chart. We intend to maintain a strong balance sheet and financial flexibility to allow us to invest in our business through all economic cycles. Our target net leverage is between 1.5 and 2.5 times. We are clearly below that level at this moment, which we believe to be a prudent state in this environment. Our investment decisions will continue to be based on generating attractive ROIC above our WAC to drive compounding free cash flows. In the event that free cash flow exceeds attractive investment opportunities, we will evaluate the most efficient method to return capital to shareholders. Despite the challenges presented by COVID-19, We still plan to increase the level of investment back into our business gradually over the next few years, and we are building a funnel of organic opportunities that include CapEx to modernize our facilities, improve our velocity and drive productivity enhancements, technology investments to enhance our digital customer experience and support our internal operations and data-driven culture, and to increase levels of R&D, partnerships, and new product development to drive innovation with and for our customers. We also have an acquisition pipeline that is aligned to our strategy, and we are increasing our focus and capabilities in that area. With that, I'll turn the call back over to Mark for closing remarks.

Thanks, Jamie. As I mentioned in my opening comments, as we navigate through this historic situation, our guiding principles are to prioritize the safety, health, and well-being of our team members, support our customers and maintain business continuity, preserve our strong financial position and liquidity, and to mature our business operating system and execute our strategy. Despite the near-term disruptions, we remain excited about the future. We see opportunities to differentiate with our key customers by leveraging our financial strength, global reach, and premier process technology. The strategic portfolio moves we executed in 2019 have significantly reduced our exposure to cyclical commodity markets and dramatically improved the risk profile of our business. We're building a premier process solutions enterprise with strong technical expertise, global capabilities, and well-recognized brands with leading market positions. The projected financial profile is clearly more attractive than our historical performance with goals of delivering mid-teens EBITDA margins and double digit ROIC. As we focus on growing high quality revenue streams, we believe we can achieve mid-single digit organic growth through an industrial cycle with strong cash conversion. Our strategy is based on an integrated set of choices that define where we will play, how we will win, and the core capabilities that support a winning outcome, all of which ring true even in the current environment. We are focused on increasing our presence in attractive micro-verticals within sanitary, life science, and industrial markets where market growth is driven by secular trends and customers value our process expertise and high-quality products. In support of this strategy, we established growth teams to drive a higher level of accountability and empower them to build capabilities around customer intimacy, velocity, and vitality. Strengthening our relationships with key customers and providing a differentiated customer experience is a key emphasis for these teams. I am monitoring the progress of these teams on a regular cadence as part of our business operating system. On the acquisition front, we have an attractive funnel of opportunities that would expand our core process offerings. We continue to build out our M&A capabilities to prudently evaluate opportunities and support execution. In closing, I'm proud of the resiliency demonstrated by our global team and the solid performance we delivered in the quarter. I want to thank all of our people for their teamwork, customer focus, and positive contributions. We have a nimble operating structure and are in a strong financial position. We are better positioned today than in previous industrial recessions to support our team, serve customers with excellence, and maintain financial strength, liquidity, and strategic optionality. I'm proud of our team members across the world for their united effort and fortitude in navigating through this global pandemic. And I'm confident we will effectively manage through this period and be in a stronger position to capitalize on growth and value creation opportunities when the economy recovers. We remain committed to our long-term strategy with a narrow focus on the critical few areas that will drive success. First, creating an engaging, winning culture for our people. Second, delivering a differentiated customer experience and investing in our business to deliver long-term value creation for all stakeholders. And that concludes our prepared remarks, and at this time, we'll open up the call for questions.

Thank you. And as a reminder, to ask a question, you'll need to press star 1 on your telephone. To withdraw your question, please press the pound key, and please stand by while we compile the Q&A roster. And our first question comes from the line of Mike Halloran with Bayer. Your line is now open.

So let's start with... Mike.

All right. And our next question comes from the line of Nathan Jones with the default. Your line is now open.

Good morning, everyone. Hi, Nathan. I want to just start with a question on the cost-out actions here. It looks like Most of the things that are coming out here in the first $35 million are things that would just naturally come out of the model with revenue downturn and not a whole lot of, I guess, more structural cost reduction actions. Can you maybe just talk a little bit about the choice that you're making here between possibly sacrificing a little short-term margin versus maintaining long-term capabilities for the recovery on the back end?

Yes, sure, Nathan. I'll start it off, and then Jamie can jump in. So to your point, there are some costs that were variable-related that are naturally coming down, and that's accurate. The other thing that we are doing, though, is managing really efficiently in our factories. So Ty and his team have been systematically removing contractors, reducing overtime, and also with our core team managing to the volume. And coming out of the quarter, we actually maintained a consistent level of efficiency across all our sites, which was really encouraging to see, and even had an improvement on a Q1 to Q1 basis, 2019 versus 2020. So we're managing that very effectively. And then the third thing we did was – really put a freeze on hiring, as we mentioned in the prepared remarks, except for some key positions that support customers, our early professional program, for example. And so that's worked very well. From a structural standpoint, if you look back over the last four years, we've taken a lot of structural steps already in the business. Our original A restructuring plan we did back in 2016 and 2017 consolidated eight plant locations, consolidated a shared service center, and really restructured our overall functional group to be de-layered. And we invested in some of our high-value centers in India. And we haven't stopped since that point, though. What I would share with you is that in 2018 through 2020, we've continued to consolidate some small facilities. in manufacturing, and we've consolidated a few warehouses. We've reduced footprints in various locations in the commercial part of the business. So we've taken a lot of structural steps during the past four years, and with the current downtrend in business, we didn't see a need to take any additional structural steps any time in the near term. because we've already made a lot of progress in that area. What we want to do is stay poised and ready for business to come back, and that's been important for us as we've looked at this. We have enough levers that we can work with over the next six to 12 months that we feel we can stay very nimble, reduce our cost structure, and most importantly, stay prepared for return in business. And we struggled with that a bit in the last structural moves that we had to take back in that 16-17 timeframe. So we're in a much better spot and really ready to navigate this. And the operating structure that we put in place is extremely nimble, and we can adjust rapidly. Now, if we saw a more prolonged downturn, this thing extended out a couple of years, obviously we would have to think differently. but we're planning to be ready to serve customers when business starts to respond. Okay.

I guess my follow-up question here on capital deployment, you guys had said post the P&E sale, which you got nicely in under the wire there, that you plan to pay down some debt and to buy back some stock. Given the environment that we're in now, companies are all looking to protect liquidity and Are you still looking to buy back the stock in the short term here? I mean, you talked about doing it opportunistically in your prepared remarks. The stock price is pretty depressed at the moment and has been pretty depressed over the last couple of months. What's your thoughts there on doing the buyback now or around now versus hanging on to the liquidity in the short term?

Yeah, Nathan, I'll take that one. So you have the nail on the head. Closing the P&E business on the first day of the second quarter has improved liquidity over $1.1 billion of liquidity. Net debt is kind of on that pro forma basis as of that day, 0.4 times. So kind of a reminder of the backdrop and position of liquidity first. We have continued to say and will be committed to returning excess cash to shareholders. We got the board authorization to repurchase $150 million of shares in the early part of May. We've not been able to trade on that, obviously, because of the blackout period. But as we close this quarter reporting here and we move to the second half of the year, I do think that we will look at that, to your point, opportunistically. We're not going to use any large programs. And so I'd say that we would move at that cautiously, keeping an eye towards the market conditions, keeping an eye toward our liquidity, and then other potential uses of capital. So it'll be smaller and more cautiously likely in the second half of this year.

Great. Thanks. I'll pass it on. Thanks, Dave.

Thank you. And our next question comes from the line of Mike Howard with Bayer. Your line is now open.

Can you guys hear me this time? We got you, Mike. Good morning. Sorry about that.

First, can we talk about how you're looking at the rest of your top line? Press release said 15% to 20% overall revenue declines. DEC talked about 15% to 25% order declines. What is that predicated on? Is that based on what you're seeing so far through April, contact with your customers? I mean, how are you guys getting there? And any thoughts by division would be appreciated.

Yeah, sure, Mike. Yeah, what we're seeing here starting the second quarter is a slower environment in our run rate business. The industrial product lines are are trending in this range we indicated from a full-year perspective at 15 to 25 percent down. And as we've looked at the trends, that's what we're seeing here in the early phases. But, hey, look, you know, this is everybody has been saying throughout the earnings guidance season, visibility is pretty limited, and it's hard to really predict and forecast what's going to happen. But the trends are would suggest that we would see 15 to 25 percent down overall in our orders, which would in some form translate into an impact on revenue. Now, about 70% of our business is short cycle now. About 30% is longer cycle. And so that's where we're seeing, you know, the impact is in this shorter cycle business. So should it recover, we should, you know, could be able to see a better outcome. In the longer cycle business, like systems, for example, We've actually seen some good rebound in our systems orders coming into the quarter, primarily out of China. So that's been nice to see, and we'll have to see how that holds up. Europe's the other area where we see a big part of our systems order, and that's also continued to be a bit slower here as we've entered the second quarter. In our F&B shorter cycle business and the components and aftermarket, again, I would think about that in a similar vein as that 15% to 25% down in orders on an annualized basis. And, again, there's different conversion rates for the shorter cycle business versus the longer cycle. And, again, good news is it'll pick up rapidly if we do see an improvement in orders. And that's why we want to stay prepared and our structure is nimble and we're going to be able to respond should we see that happen.

Thanks for that. And then I just want to understand the decremental guidance that you gave or at least framework as it sits today, 15% to 20% decremental second quarter, moving to that 30% to 40% range in the second half. Why would the decrementals worsen in the back half of the year? Is it timing of cost outs? Is it the variable costs in the second quarter that you're pulling out are going to be greater than what you're thinking if things improve a little bit in the second half? Just... Help me understand the puts and takes on that and the trajectory there.

Yeah, Mike. So it's mostly related to the dry systems business that we would have had more revenue in the first half of 2019. So if you look into the first half of 2019, we had sort of $25 to $30 million of dry systems business that was at or around break-even margins and then There were costs during that period of, say, $5 million to $7 million in the food and beverage segment that, again, were in the first half of 2019. So once you move into the second half of the year, you lap those situations and the decrementals move up to the 30% to 40% company-wide. And that's the nuances within food and beverage. Industrial, I'd say, is pretty consistent at or around gross margin levels in the 35% to 40% range.

Mike, the other thing I would mention, too, you know, we've got our 2% to 3% cost-out program that we've initiated, and as we move through the second half of the year, we anticipate we'll start to see, you know, some impacts from those programs because those have been in progress since the middle of late, late last year. We had the plans in place in the middle of last year and have been We started executing them in the fourth quarter, and as we move through this year and get into the second half, we'll start to see some impact from those.

So are the decrementals that you lined out inclusive or excluding the cost-out savings and some of the variable cost reductions you're looking at?

That would be fully inclusive of all those things we mentioned.

Okay. Great. Appreciate it. Thank you, guys. Hope everyone's safe. Yeah, Mike. You too, Mike.

Thank you. And our next question comes from the line of Julian Mitchell with Barclays. Your line is now open.

Hi, good morning. Good morning. Maybe just the first question around the free cash flow. That was clearly worse year on year in Q1. I think working capital may be a big culprit. It looks like accounts payable and accrued expenses was a much bigger headwind there. year on year in Q1, you know, almost $50 million out. So maybe help us understand what's going on in that payables line and how you see working capital for the year as a whole in terms of a cash tailwind, presumably assuming your revenue guide of sort of 15% to 20% down, you know, how much of a help to free cash do we get from working capital?

Yeah, you got it. So one, I'll start with saying that our expectations around free cash flow generation are unchanged. We still believe that we'll convert over 100% of net income in the year, and that'll still hold in the future periods as well. That's expectation. Q1, as you point out, had a couple unique situations relative to the prior year comparison. So the biggest driver was would be just the year-over-year change in cash earnings. So from a continuing operations basis, the cash earnings were about 20% different year-on-year. And then you had asked the question around the payables and accrued lines. So that is the largest driver. Within that line, a couple of things go on. We typically pay our interest on bonds in the first quarter of the year. We also pay our prior year cash incentive plans out in the beginning of the year, so those two would have been roughly the same in 2020 as they were in 2019. Uniquely, in 2020, in Q1, we did have about $15 million of discrete tax payments that were made. Within there, a few things that were going on. One, we made some real strides last year to simplify legal entity structure and And when we did so, we ended up desiring to repatriate some cash back to the U.S. And on that, we accrued about $10 million of withholding taxes. And we wanted to bring those back last year so that we could use some foreign tax credits to offset our future cash outflows on the tax reform bill. So that $10 million or so will come back and over the next five to six years as we offset that multi-year tax bill. And then we also had a discrete legal entity move in 2018, I believe, in one of our Nordic countries where we had a tax bill for approaching $5 million that got paid out here in the first quarter. So those are kind of the bigger moves in the accrued and AP line. Then to your point on the broader working capital situation, we had a slight amount of inventory investment that was made here in the first quarter. So most of that relates to some delayed shipments at the end of the quarter, which we believe will catch themselves back up in Q2 or Q3. So I don't expect that that's going to be a headwind over the course of the year. And then, as you mentioned and alluded to, with volumes being down 15% to 25% this year on the order line, We do think and believe that we'll see some tailwinds from working capital as it begins to unwind. AR and DSO, really excited about where and how that's held up year to date. We've not had any meaningful movements in that. We've had customers paying on time. Really a nice story, and I would attribute that to a lot of the work that our team's have done. We put some processes in place here in the first quarter to where regional teams are meeting, talking very regularly about collections and about DSO and about any customers who are requesting extended payment terms. So a great job of managing that. I've got to close with saying the way to think about free cash flow for the full year would be that it's roughly down with the revenue and order declines that we've provided, so that $15,000 to $25,000 percent on the top line is a way to think about it.

That's very helpful. Thanks, Jamie. And maybe just my second question on margins. So just trying to understand in food and beverage, then, do we assume maybe margins up year-on-year Q2 and then rolling over year-on-year in the second half? And help us understand in Q1 why or how gross margins are up healthily, operating margins down considerably. Is that just simply a mixed thing around systems and food and BEV in terms of why the OPEX was so heavy?

Yeah, so if you kind of walk F and B, I think, is your main question. So you get into the second half of last year, we had 15.1% segment income in Q3 of last year, right at 18% as we exited Q4. And then here in Q1, you've got 14%. And most of that is just going to be the mix that you've mentioned there. So timing of systems revenue is far and away the largest driver of that change. So it's a pretty straightforward bridge on that front. Yeah.

Hey, Julian, this is Mark. I just also mentioned to the point, we expect food and beverage systems – be a mid-teen margin site business. And, you know, that's a big change from the historical view of our food and beverage business, where it's been kind of high single, low double-digit business. And, again, a big part of that is the transformation we made over the last two years to exit this large dry dairy business and get a better mix, better margin profile. And Dwight and his team have done a great job in executing that. And so with the systems projects that we do have now in backlog, they're – more consistent with the type projects that drive longer-term sustainable aftermarket business. They're at better margin profiles. They're easier to execute in many cases because we do a lot of the work in our factories and, again, a lot of the content feeds out of our factories. So we're really happy with the progress we've made in food and beverage systems. Now, you do still have a bit of a lower margin profile on systems versus that components in aftermarket business. So Mix in some cases will influence a bit the margin profile, but I can tell you the execution across food and beverage is at a much different place than it was two years ago and even entering 2019. And we're really pleased with the progress. So we expect and anticipate that food and beverage will continue to be this kind of mid-teens operating business. When we see volume come back in the food and beverage components, that's when the leverage will really happen for this part of our business. And when we're seeing these kind of 100 to 105 million levels versus, you know, getting up into the 115 to 120 million level on components and aftermarket, the leverage really starts to kick in dramatically.

Perfect.

Thanks very much. You bet. Thank you.

Thank you. And our next question comes from the line of Nigel Coe with Wolf Research. Your line is now open.

Thanks. Good morning, guys. Good morning. So I just wanted to maybe pick up on maybe the SG&A topic that Julian just mentioned. You know, obviously we saw a fair amount of deleverage on SG&A, and your mix is different. You've been shrinking the sales base, so SG&A obviously has increased as a portion of sales. But when you think longer term, is there an opportunity to – materially lower the SG&A central sales going forward?

Well, what I would say, Nigel, is that, you know, again, we're at a much lower volume level, obviously, and as we indicated, we don't want to compromise our ability to respond to the markets when we see volume come back. And, you know, our plans and what we're putting together in terms of how we expect we can grow the business going forward would you know, continue to bring that down as a percentage. And so that's an important aspect. It doesn't mean we have to add SG&A, but we expect we'll be able to manage with our current SG&A structure and our sales structure to support growth, with the caveat that there's some strategic areas that will, you know, add some level of resources to support in product development and R&D, things of that nature. Overall, the 2% to 3% cost-out program that we're executing does have about 30% of that associated with SG&A. So there will be some reduction in SG&A as we go forward with that program. But at this stage, we want to ensure that we stay well-positioned for a recovery and that we manage the cash flows as well as the P&L costs through this near term in a very prudent manner so that we don't jeopardize the upside when we see a rebound.

Great. Thanks, Michael. And then you're normally very good at giving quarterly kind of boundaries, and I understand why you don't want to do that right now, getting the visibility, but two Qs normally flat slightly up versus one Q. I'm assuming that you're expecting two Qs to be down sequentially, but any color there would be helpful.

Go ahead, Jamie. Well, you know, we've said the orders we're seeing on the full year are going to be down 15% to 25%. We also think that will be kind of the trend here for Q2. You know, we've now seen orders in April come through, and, you know, Mark mentioned it earlier, but we've seen – some stabilization in our F&B systems business in Q2, at least order intake-wise. And then we've seen our componentry in F&B and industrial. I'd say there's kind of a steadier intake to what we've seen sequentially, but I do think it will step down in that 15% or so as we work through the rest of Q2. But one thing I will remind you is that on the revenue line, we came into the year with a backlog position where we knew Q1 was going to be down significantly. And so as you do work your way through Q2 and we work our way through the full year, we do expect an increase in revenues in each of those quarters.

Hey, Nigel, I'd add to our shippable backlog at this stage of the year is – in a pretty good spot. It's really kind of consistent with what we saw last year, and the margin profile of that shippable backlog is about 300 basis points higher, a little more than that. So we've got a really pretty decent backlog. So to the point, this really hinges on orders, and that's why we want to stay nimble and prepared. And again, with about 70% of our business now being short cycle and 30% long cycle, we've got to stay poised and in a prime position to to respond rapidly when we see orders return. So, again, we feel like we're in a really great spot and ready to serve customers and take advantage of opportunities when the markets come back. Right. Okay. Thanks very much. You bet.

Thanks. Thank you. And our next question comes from the line of Dean Dre with RBC Capital Markets. Your line is now open.

Thank you. Good morning, everyone. Good morning. And I also want to say I appreciate hearing all the acts of support that you all have done recently, so I appreciate that.

Thanks, Tim.

Thank you. Just want to go back to the free cash flow sensitivity, which is really helpful, and I know there's been a couple questions, but just to clarify. So the first column, the order's down 20%. That's your base case. for the year because that's the midpoint of you're down 15 to down 25. So you say pre-cash flow positive, but Jamie had said you were also expecting pre-cash flow to exceed 100%. So is that what we're interpreting here?

Yeah, that's right, Dean.

I'm sorry? No, go ahead. All right. And then it didn't look as though you were cutting CapEx. in this basically the first tranche of $35 million reduction. Is that right?

Yeah, I think, Dean, we'll see about $5 million of CapEx slip out. So we have modeled $40 million coming into the year. We'll have about $5 million slip out. I'd say that most of that was discretionary non-growth CapEx that will just move into the early part of 2021.

Got it. And then can you just clarify, Jamie, what you're including in semi-variable costs for the cost takeout?

Yeah, sure, Dean. So that would be all of our labor that's direct and salary. That would be professional fees, contractor costs. We do include CapEx within that as well, and then what we would view to be more of the discretionary cost lines like T&E, trade shows, supplies, et cetera.

Good. That's helpful. And then... You mentioned, because you do have plenty of firepower on the balance sheet, when do you think M&A markets open up? I mean, right now there's still, you know, everything is kind of at a standstill, and certainly seller valuations need to be reset. But when might you at the earliest start seeing some opportunity shake out?

Yeah, Deans, Mark, we've been, you know, working towards building a funnel for the past 18 months. And most importantly, too, our overall team has been creating a platform that we can do M&A. And Vusa Malingo, who we brought in from Ingersoll Rand, has been instrumental in helping put that program together. So we've been monitoring opportunities across our target markets and our target product lines, again, very close to the core for the past 18 months or so. And we do still see some of those potential opportunities being active even during this period, some of the smaller ones, and there's some even medium-sized ones that – we think will still move forward in the markets. Now, whether or not we're able to be successful in participating in some of those, we'll have to see how they shake out and if there's a really good value creation opportunity for us. And that's first and foremost, is there a good ability to get a return on invested capital above our WAC over, let's say, less than a five-year time period. So that's really essential and key for us in the evaluations that we're doing. We've got a good approach now to assessing acquisition opportunities. So that's number one. Number two, in terms of the timing, again, we do see some opportunities still active. The fundamental question, and I think this is probably consistent with everyone, is the ability to do due diligence, to do the deep-level assessments that you want to do on locations and meet with management teams and things of that nature. So I think that will continue to be a bit of a headwind here over the next few months, but it wouldn't preclude us from actually working through creative ways to accomplish that, given the fact that we've been able to continue to run the business over the last two months in a very dynamic environment with all our office folks really working from home 100% of the time and then staggering our factory folks as they go in. If there's an opportunity that presents itself and there's a potential seller that wants to move forward, we'll be in a position that we'll be able to respond, assuming a potential seller is also comfortable in a position that they want to go.

Bill Walsh Thanks. And look, I know we're at the bottom of the hour, but I did want to ask you this question. It's more about the dairy industry. And maybe you can just give us some color and perspective. And I know this is not an SPX flow problem, but it is an industry problem. And maybe it's just more of a temporary nature. But there have been some heartbreaking news stories of dairy farmers in the U.S. not having a market for their milk. So they're just basically pouring it down the drain. So it just says something's wrong with the supply chain. I know schools are closed and restaurants, so the whole demand is. is out of whack, but why wouldn't the U.S. be building a strategic powdered milk reserve like China does, or maybe we are? But just what's broken, and how does this get fixed?

Good question, Dean. I think that's what you said at the end there. It's a step that will happen across the globe, quite frankly. It won't just be the U.S., but it will be Europe, too, and other nations that start to build reserves of milk powders as – as we kind of go through this, and to your point, you know, the consumer side in the supermarkets has been extremely strong while you've got other areas in the restaurant industry, service industries that are really down. So commodity prices have come down and, you know, aren't really projected to have an inflection point until you go out probably six to 12 months. You know, having said that, For where we're positioned, while dairy is still important to us, there are many, many other products that we're providing our equipment into now that go beyond dairy, including the alternative dairies as well as the condiment space. So we still see a good funnel and a good pipeline. But it is a challenging situation, to your point, with the oversupply of milk. It's been there for a while, as we know, since going back to kind of 2014, 2015 time frame, and it kind of abated some and kind of normalized, and this has just really kind of tipped it over here, at least in the medium term.

Appreciate all the color. Best of luck to everyone.

You bet. Best of luck to you, too.

Thank you. I'm not showing any further questions on the phone line.

Thanks, everyone, for your participation today. At this time, we'll close the call, and as usual, we'll be around to take your follow-up questions. Have a nice day.

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