SPX FLOW, Inc.

Good morning, ladies and gentlemen, and welcome to the SPX Flow Q2 2020 earnings call. At this time, all the participants are in a listen-only mode. Lady Rue will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star, then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Scott Gaffner, Vice President of Investor Relations, Strategic Insights.

Thanks, Whitney, and good morning, everyone. Thanks for joining us for a discussion of our second quarter 2020 financial highlights. This morning we issued a news release detailing our financial performance for the three months ending June 27, 2020. The news release, along with the presentation to be used today during the 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 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, provide some thoughts on how we are managing through the pandemic, along with highlights of our solid operating performance in the second quarter and some of the key milestones we've hit in our transformation. Jamie will then walk through details of the second quarter results, An update on our working assumptions for the full year, highlights of our cost actions and how we continue to invest through the cycle, along with a discussion of our balance sheet and capital deployment. Mark will wrap up with an update on our strategic direction. Following our prepared remarks, we'll open the call for questions. Before we begin, a brief reminder, the elements of this presentation contain forward-looking statements that are based on our current view of our business and markets. Those elements are subject to change, and we ask that you view them in that light. Principal risk factors that may impact our performance are identified in our most recent SEC filings. In the appendix of today's presentation, we provided reconciliations for all non-GAAP and adjusted measures. And with that, I'll turn it over to Mark.

Thanks for the introduction, Scott. Good morning, everyone, and thank you for joining us on the call. As we entered the second quarter, the economic and health challenges were unprecedented. Our strong second quarter results demonstrate our nimble operating structure, which has led to an effective and resilient response to the COVID-19 headwinds. During these extraordinary times, celebration of achievements are often subdued, but I believe our organization has reached some key milestones this quarter that deserve to be highlighted. At the end of the second quarter, we essentially had no low-margin, large, dry dairy projects in the backlog. We completed the sale of our power and energy business. We achieved record gross margins. We realized improved safety levels in our operations. We began to return excess capital to investors through our share buyback program. And following the close of the quarter, on July 16th, we filed for the redemption of the $300 million senior notes due in 2024 which will result in $17 million of annualized interest savings. As we approach our five-year anniversary as a public company this September, I would like to personally thank each and every stakeholder that has been with us on this journey to high performance. We now enter the next phase of our journey with one foot forward. We will be prudent during the current economic cycle, but we are moving to offense from defense. Our strong financial position and stable cash generation allows us to invest through the cycle to grow profitably. 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 our resilient approach to the COVID-19 pandemic. As I said before, we had several key safety milestones in the quarter. Specifically, June was the first month we've had without any recordable injuries. I'd like to thank Tracy Beaudry and our EHS professionals, our site leaders, and the whole organization for their tireless efforts to keep our employees safe and healthy. As we navigate through this historic situation, our guiding principles remain intact. 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, 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. The business is proving to be more resilient than past cycles. The team has come together around a common purpose, and we're beginning to think more offensively regarding growth and capital deployment. I'm pleased to report that orders ended better than the scenario planning we undertook at the start of the quarter, which is reflective of our strategy positioning us in essential process applications. Despite the challenging demand environment, our team continues to remain selective on orders, yielding a higher quality backlog with margins up 200 points versus 2019. Through a combination of our strategic portfolio actions to create a higher quality of revenue and a relentless focus on productivity and cost containment, we generated quarterly gross margin approaching 37%, up 290 points versus 2019, and up 190 points sequentially. We strengthened our balance sheet in the quarter with net leverage at 0.2 times reflective of the margin performance and the strong free cash flow characteristics of the business. Our ample liquidity of more than $1.1 billion allowed us to move forward with our capital allocation priorities as part of our value creation model, which included share repurchases of $6 million in the quarter. And as mentioned, on July 16th, we announced the redemption of of our $300 million senior note due in 2024. This will result in annual interest savings of $17 million. Jamie will review these items in more detail later in the presentation. The second quarter also marks a significant milestone in the transformation of our company as we close the divestiture of the power and energy business early in the second quarter for approximately $400 million of net proceeds. We believe we have created a process solutions business that is less cyclical with high-quality revenue streams, allowing for sustainable margin improvement going forward. In the second quarter, we also essentially completed the exit of low-margin, large, dry dairy projects, achieving an important milestone in the strategic transformation of our food and beverage systems business. I'm extremely proud of our teams for the high level of execution and resulting margin performance delivered in Q2, especially considering the macroeconomic headwinds. You can see that we've posted a gross margin of 37% with steady progression over the past six quarters, despite the industrial recession that began in 2019, which has been compounded by the global pandemic. As I said before, I believe this level of margin improvement is sustainable following our strategic actions to create high-quality revenue streams combined with improved operational performance by the commercial and manufacturing teams. Sequentially, orders improved moderately, up 1 percent, better than expected and a significant accomplishment in the current COVID-19 environment. The results are reflective of the resiliency of our food and beverage business which offset expected weaker industrial markets. Industrial orders were down 11% sequentially, with short cycle product categories being the most impacted by the global macroeconomic weakness. While down, these results were better than we planned for our industrial business at the start of Q2. As anticipated, our industrial aftermarket business held up moderately better than our original equipment product lines. as capital spending budgets continue to be cautiously deployed in the current environment. Encouragingly, industrial orders were stable in Europe and Asia Pacific, with weaker markets being experienced in North America due to the pandemic. In food and beverage, we experienced a significant rebound in orders following some delays in systems orders in the first quarter. Sequentially, orders were up 20 percent, highlighting the resiliency of these essential markets. Systems orders nearly doubled from a historically low first quarter level, which was impacted by delayed project activity in China and Europe due in part to the impact of COVID-19. On a global basis, food and beverage aftermarket orders were up about 4% with strong service wins in June. Component orders were down low single digits reflective of capital deferrals in the current pandemic environment. Encouragingly, bid rates in North America, which is our largest region for F&B equipment sales, have been increasing early in Q3. And at this time, I'll turn the call over to Jamie.

Thanks, Mark, and good morning, everyone. I'll begin with a brief recap of Q2. Orders declined 10 percent year-over-year in the second quarter. Organically, orders were down 7.6%, but the decline was much less severe than we had anticipated heading into the quarter. We saw significant strength from our resilient food and beverage end markets. Revenues were down 20% in the second quarter, and organic revenues declined 17.6%, mainly due to lower end market demand, but also due to the impact of our strategic decision to exit the low margin dry dairy product lines. I'm glad to say that our backlog has no low margin dry projects of significant size. Despite the lower level of shipments, segment income margins rose 110 points to 12.7% due to strong project execution, productivity initiatives, tight cost controls, and positive net benefit from price cost. Importantly, we generated $24 million of adjusted free cash flow in the quarter and we still expect cash conversion for the full year greater than 100% of net income. Looking at the segments, beginning with industrial. Organic revenue declined 19%, reflecting the global slowdown in short cycle industrial activity that began in the back half of 2019 and accelerated in the second quarter due to the impacts of COVID-19. Despite these short cycle headwinds, the team executed well and contained decremental margins to 25 percent driven by productivity and cost containment initiatives. Segment margin was 12.2 percent, which was down 260 basis points year-over-year and was predominantly driven by lower level of revenue. Organic orders were down 14 percent year-over-year as our short cycle dehydration and hydraulic businesses were significantly impacted by the global economic slowdown. Moving on to food and beverage. As Mark mentioned, this business has proven to be resilient and more stable through the cycle, balancing out some of the cyclical exposure in our industrial markets. The strategic actions we undertook starting in 2018 to improve the quality of revenue continues to pay dividends and are evident in the margin performance. Despite Q2 revenues being down 16% organically, segment income rose 37%, and margins were 13.2%, 540 basis points year over year. Organic orders were flat in the quarter, with systems orders coming back nicely following some delays in the first quarter. The majority of the sequential rebound came from China as anticipated. Based on our better-than-anticipated results in the quarter and an updated view regarding our end markets, we are providing an update to the full-year working assumptions that we laid out last quarter. As you might expect, our original assumptions were provided at the depth of the pandemic when the global economic outlook was highly uncertain. Our experience thus far has been better than feared, and we are still taking a cautious view as the world attempts to reopen. From an order perspective, we experienced better than anticipated demand across all product lines in Q2. We now expect organic orders to decline 10 to 20 percent versus our prior expectation of down 15 to 25 percent. Organic revenue is now expected to decline 10 to 20 percent versus 15 to 20 percent prior. The improvement is a function of better order trends we experienced in the second quarter along with an improving velocity as we execute on the existing backlog. Decremental margins are still expected to normalize in the second half of the year in the 30 to 40 percent range. By segment, decremental margins in our industrial segment tend to flex with volumes at or near gross margin levels. The decremental margins in our food and beverage segment are a bit more nuanced and can vary based on timing and execution of systems, as well as trends in higher margin component and aftermarket business. As Mark noted, we will be cautious and prudent during the current economic cycle, and we are focused on generating the cost savings we identified and began actioning last quarter. The worst-case scenarios that we planned for at the start of the quarter are no longer likely given the current economic outlook. They have, however, helped us broaden our playbook over the long run and remain actionable if conditions were to worsen. During the quarter, we made significant progress on the $35 million of actionable cost that we identified to start the quarter. We pause most hiring, reduce variable cost, and are actioning our two to three percent cost takeout plans, which were developed in 2019. We are also using the current crisis as an opportunity to create positive cultural change regarding cash conservation. By pushing decision-making further down in the organization and empowering our teams to take quicker action, we are starting to build a pipeline of activity that will modestly aid cash generation over time. Lastly, as we mentioned earlier, We are moving to offense from defense, and as part of that effort, we continue to invest in our future based on our strong financial position and stable cash generation. These areas 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 increased levels of R&D, partnerships, and new product development to drive innovation with and for our customers. Taking a brief look at our financial position, we're showing here both our financial position at the end of Q2 as well as a pro forma look following our announced intention to redeem the full $300 million of our 2024 notes on August 17th. As you can see, we have ample cash on hand at just over $650 million to fund this redemption, which is in line with our stated priorities for the use of the power and energy proceeds. Net leverage at the end of Q2 was 0.2 times. Between cash on hand and our revolver, we now have over $1.1 billion of available liquidity. And we generated adjusted free cash flow for the quarter of $24 million as we saw working capital improve driven by lower accounts receivable balances. Based on 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 range is between one and a half and two and a half times. We are clearly below this level at this moment, which we view to be prudent in this environment. Our investment decisions will be based on generating attractive ROIC above our WAC to drive compounding free cash flows. After funding all attractive investment opportunities, we will evaluate the most efficient method to return excess cash to shareholders. 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 will turn the call back over to Mark for closing remarks.

Thanks, Jamie. As we approach our five-year anniversary as a public company, I've had time to reflect on the journey and admire all that the team has accomplished in transforming the company to build a solid foundation for profitable growth. Through the sale of the power and energy business, along with the strategic exit of low-margin dry dairy projects, We have created a higher quality of revenue evidenced in the record gross margins near 37% this quarter. Our portfolio mix is proving more resilient, and our operating systems have matured, aiding us in making faster and better decisions. Our balance sheet strength with low net leverage at just 0.2 times, along with the cash generation potential of the business, allows us to invest through the cycle in line with our capital allocation framework. The actions of our team members over the past five years has created a high-performing culture, a more sustainable organization, and a foundation that allows us to shift to offense. And with that, we'll open it up for questions.

Okay. Ladies and gentlemen, if you have a question at this time, please press the star and then the number one key on your touchtone telephone. If your question has been answered, or you wish to remove yourself from the queue, please press the pound key. Your first question is from the line of Nathan Jones with Stifle.

Good morning, everyone. Good morning, Nathan.

Good morning, Nathan. Just a couple questions to start off with on the order rates. You know, one queue was down 7.5%. Second quarter was down about 10%. You're still guarding... full year down 10 to 20. Can you talk about the things that are driving, I guess, the assumption that things deteriorate a little bit in the back half?

Yeah, sure, Nathan. So as you mentioned, you know, we're performing better than planned, and we did improve the outlook from the original being down 15% to 25% year-over-year to being down 10% to 20%. And the resiliency of the F&B business, as we talked about, has been – Really exciting to see Q2 being actually better than Q1, industrial down, but better than planned. So all in, the business is performing well on the order front and reflective of these essential markets that we're playing in. So a couple things to consider as we look at the second half of the year. First, there's typically some seasonality to the third quarter as you go across the globe, especially in Europe. So we took some of that into consideration. And if we look at by segment, we're anticipating the food and beverage will stay pretty steady through the second half, but industrial could continue again to see some headwinds as we move through Q3 with some seasonality also indicated in that. So that's kind of the real difference is as we look at Q3, we've built that in. We think that's a prudent thing to do just given the current environment and the typical seasonality that we see.

Is it fair to say that that's a fairly conservative, I mean, certainly the bottom end of that range, given that you're, you know, slightly better than 10% in the first half, the bottom end of that range would seem to be very conservative?

Yeah, so, you know, I think the way that we should think about it and everyone should think about it is that we had a good Q2. It was kind of a V-shaped in the quarter with the way orders developed, and we We want to be prudent in our approach to how we're thinking about orders, but we want to build on the Q2 results, you know, as they present themselves as we move through the second half of the year. So, you know, there's still a lot of uncertainty out there, especially in the OE part of our business and some of the CapEx that can go into the industrial space. But all in, good Q2 results. And as we look to the second half of the year, we want to build on that. And, you know, hopefully the markets will be there. And if they are, we should be able to improve upon kind of where we're sitting right now. But, again, being prudent, we feel is the right thing to do given the current environment. And we'll see how things develop as we move through the third quarter and into the fourth quarter.

I get it. Makes sense. One more time. Nathan, what I'd add to that is around F&B systems. So you may recall that we had a really nice Q4 last year in the F&B systems line, and expecting that to be in the second half of this year up a bit from the first half, but still year over year is going to be down. So that's still a little bit of the upper end of that range that we've given would be driven by, in part, F&B systems.

Okay, my follow-up question ends on the SG&A level. You know, 29, 30-odd percent consolidated in the first half, which is, you know, clearly up a lot, understandable in this steep revenue decline environment, but clearly too high for it to be sustainable at that level as a percentage of sales. I know you're maintaining capability to take advantage of the rebound. Can you talk about how you're thinking about getting that SG&A number down to a reasonable level as a percentage of sales. Is it growing into the SG&A structure? Are there reductions that you need to make to the SG&A structure? And maybe any comments you could give us on what you think the optimal level of SG&A is as a percentage of sales.

Yeah, Nathan. So... A couple of things I'd say to that is certainly in the second quarter we begin actioning these $35 million of what we're calling semi-variable cost. A portion of that would hit the SG&A line. Some of that is going to be in part in the gross margins as well. So it's all really nice traction on that throughout the quarter, and I think building some momentum toward the end that will certainly help in the second half. The other I'll mention is the 2% to 3% cost-out programs that we announced in 2019. About two-thirds of that is in the gross margin line, and then another third of that is going to be in SG&A. And we did have some restructuring here in the quarter that would, in part, relate to second-half savings in SG&A. So you will begin to see those take shape over the second half of this year in the SG&A line and then are expected to see the full benefit to those in 2021. But clearly, the levels that we're at this year in revenues and the order trends that we're seeing, we are going to have higher revenues in the second half of this year. And while the markets are really uncertain, kind of see what next year looks like. But there is an aspect of the percent of SG&A to revenue in which it will improve as revenues go up in the second half and into next year. So there's a modest amount of growing into it, but I can tell you that this is an absolute focus to Mark and mine, and we're spending a lot of time with the team through the discretionary cost outs and then through the 2% to 3% cost out plan to get this in a better place.

I'd just add to that, Nathan, that as we talked about in the last update, Our intention is to stay at the ready for the business when it does start to respond and come back. As we move through the quarter in Q2, and we've talked about the orders already and how that performed as well as the leverage on those orders as they start to come back will be significant. Orders that we are looking in these shorter cycle businesses leverage at 40 to 50 percent. We want to make sure we're organizationally ready to handle that. If we look back through prior cycles and some of the restructuring that we were going through back in 2016-17 timeframe, early 18, we were not in a position where we could respond well to a return of business, and we want to ensure that we do that. And, again, a bit to Jamie's point, we'll look to grow into it a bit. You know, the longer-term view, as we grow the business, we would see, we expect to see SG&A, you'd ask about what the future looks like, you know, move down into the low 20s. So, yeah, a bit inflated in the current environment. But, again, as we think about growth and orders coming back, the markets coming back, that should come down pretty quickly.

Great. Thank you very much. I'll pass it on.

Thanks, Nate.

Your next question is from the line of Mike Halloran with Baird.

Good morning, everyone. Good morning. A similar question on some levels on the revenue line, the 10% to 20% revenue guidance. Could you just talk about what the assumptions would be to get to the low and the high end? Essentially, what kind of sequential trends are you assuming? What kind of environment are you assuming in the different iterations there in any context around it?

Yeah, just I'll mention on the orders first, and then maybe Jamie can also mention some things on the revenue and the conversion. But as I stated on the orders, you know, we look at Q3 having some seasonality to it and kind of the continued headwinds that are existing, especially in North America in the industrial space. We've put the biggest part of where we expect orders in, to be a bit slower as we look at the second half of the year in the industrial business in Q3. So the conversion rates that we think about when we look at those order rates wouldn't be significantly different than what we typically experience. And so the real difference there is how we're thinking about industrial orders in the third quarter.

Yeah, that's right. You know, what I'd say is backlog as well, Mike. Backlog as of the end of June compared to the same time last year in June is about flat. You know, what we see in that mix of backlog is a bit heavier toward the F&B systems and some of the OE product lines and industrial systems. So that's protection as we look at the second half, but Mark's spot on there as we think about the opportunity to achieve the low end of that range or towards the upper end is really going to be predicated on what we see in orders in Q3 given the shorter cycle. nature of the revenues and orders that we have.

I would mention one other thing about the backlog. You know, a great thing about the backlog that we're looking at where we are this year versus last year at this time, it's at a similar level, as Jamie mentioned, but it's also up about 200 basis points. So, again, it sets up well for high-quality revenue streams as we move through the second half.

And that makes sense on the backlog conversion, but if I think about it just in terms of the type of environment you're assuming, is it you know, you've got a little bit more of an equilibrium in this June-July type timeframe. Are the sequential patterns expected to be relatively normal from that level if we think about it at the midpoint of the guidance range and then fluxes above and below depending if you're at the bottom end or the upper end of the range, or is there some other different thought process?

Yeah, no, that's exactly right, Mike.

That's exactly right. Okay. And then on the dairy side of things, Mike, You know, any changes to the consumer purchasing pattern or your customer purchasing pattern in terms of the mix of business, the types of projects that are coming your way? Anything relevant from you that's changing from a landscape perspective?

What I would share, what we saw happen in the quarter, you know, in terms of the kind of regional dynamics, as I mentioned, North America, the F&B run rate business has been pretty steady, but it's been more of the projects that, Where we provide components into is a bit slower in the quarter. The good news is in North America we did see bids picking up for that component-type business in F&B. And, you know, F&B in North America is a bit less about systems and more about our component and aftermarket business. So it was good to see bids starting to pick up in North America in early Q3 here. In APAC, a good snapback, especially in China for our systems business and across the region. We saw good orders in our components and aftermarket. So F&B is holding up pretty well in APAC. And in Europe, we were really excited to see the performance in Europe as things really improved across the board for F&B. If you just double-click into the dairy part of the business, again, which is a smaller percentage of the business overall now in just pure, you know, typical dairy, there wasn't any significant changes. You know, again, we have a lot of emphasis now on the non-dairy part. products that the consumers are trending towards. So we're really happy with where food and beverage is performing right now. The projects that we do pursue are ones that fit well with our customers where we add value, and we're creating these better revenue streams, higher value revenue streams as a result of that, and you see that's flowing through in the margin performance.

Great. And if I could sneak one last one in. Just any help on the corporate expense line, on the unallocated line, how you think that tracks the remainder of the year?

Yeah, Mike. A couple of items in the corporate line. So what I'd say, you know, as we drive the pay-for-performance culture, there's going to be some movements in the corporate line for that incentive comp. And then The second would be some depreciation that we're seeing. So as we completed the sale of the power and energy business and looked to set the balance sheets of the two organizations around parts of that, we end up with IT and technology assets that will be depreciated on our books going forward, obviously non-cash, but that will sit in our corporate expense line. And then what I'd say in the quarter, We had about a million dollars or so of one-time non-repeating costs that we transitioned some IT service work internally. And so getting that on the firm footing going forward, we had about a million dollars there. So those are the biggest changes that you'll see on the corporate expense line for the full year.

So more like a first quarter run rate than a second quarter run rate or somewhere in between?

It's probably closer to the second quarter. What I'd also say is on the gap, it's more the first quarter, sorry, the strategic fees that we have will adjust out that you'll see on the gap financials. Make sure you pick that up, too. There's about, I think, $2.5 million, $3 million worth of strategic costs that we'll pull out that are in second quarter.

Great. I appreciate it. Thanks, gentlemen.

Thanks, Mike. Thanks.

Your next question is from Brett Lindsay with Vertical Research.

Hey, good morning, everybody. Good morning. Hey, first question just on the gross margin performance. The progress has obviously been very impressive here despite the revenues moving lower, and I understand the whole portfolio remix. Have we now hit a new baseline as all the dry dairy business has essentially moved out of the P&L? Or do you think you can continue to march the gross margin profile higher in the coming quarters? Any color on the expectations would be great.

Yeah, we expect to continue to improve our gross margins. And it's an important part of our objective. We'd like to move gross margins into the 40 range over a period of time. And there's several angles on that. You know, first and foremost, our factories and our systems part of our organization are really focused on productivity and improving their performance. So good cost controls there, good efficiencies and investments we're making back into those areas to get a better outcome. So producing high-quality products and system solutions, for our customers at a lower cost is part of our objective and part of the culture that we've instilled. And so our Pathway to Excellence program plays a big part in that. Secondly, I would share with you that as we look at our ability to manage price cost, these product lines afford us that opportunity, and that's really a positive outcome for us. And then overall, too, within just our general cost structure and some of the 2% to 3% cost-out programs that we're working on, which includes elements of materials and supply chain, also will help improve the gross margin line. So a number of different things continue to go on that will improve our gross margin line as we look towards the future.

Okay, that's great. And then just shifting to the $35 million of cost-outs, you know, sounds like the actions are progressing as planned. Is that fixed cost slice of that bar chart really what you view as more structural going forward? And then of that semi-variable piece of the bar, are you finding new ways internally to be more efficient and maybe that bucket, you know, is more permanent in nature? Or are you thinking most of that 35 reverses at some point?

Hey, Brett. So just to be clear, in the fixed part of that bar chart, that's interest, bond redemption costs, prior year, incentive comp. So that's what's in that line. What we call semi-variable would be labor, third-party contractors, professional fees, and then more of the discretionary cost of T&E supplies, et cetera. So that's the line and the category which our 2% to 3% cost-out programs would be geared towards. And what I would say is that a large part of that is the structural costs that are going to come out. There is, as I mentioned, some cost in there, such as T&E, which we would expect. when things normalize to come back into the business and in the P&L. But by and large, that semi-variable category is what we're attacking and attempting to make structural.

Got it. And so the Q2 restructuring that you did is included within that $35 million of anticipated savings? That's correct. Okay, got it. All right, thanks a lot. Great quarter. Thank you. Thank you.

Your next question is from the line of Julian Mitchell with Barclays.

Hey, good morning, everyone. This is Jal for Julian. Good morning. Maybe starting with focusing on the decrementals, you know, obviously really strong performance here in industrial this quarter. I think based on kind of the working assumptions, it's sort of implied that you guys are expecting the decrementals maybe, you know, widen a little bit from that 25% heading into Q3. So just wanted to get your thoughts there on, you know, what the assumptions are, maybe what the moving pieces are on kind of that sequential trend.

Yeah, sure. So if you look at the second half of the year, the volume declines that we have are by and large going to be our F&B components and then our industrial product lines, which for the most part carry above company average gross margins. So you've got to understand the mix of the revenue decline second half last year to second half this year. So if those were to just flow through, then we would see 45% to 50% decrementals. But what I would say is what would get us in the 30% to 40% that we've used for the working assumptions would be the cost containment actions that we've talked about and the attention to reducing those semivariable costs that were just asked about in the last question. So that's kind of the walk on decrementals for the second half.

Got it. Thank you. And then any, you know, color or interesting data points on, you know, either order trends or kind of sales trends, you know, maybe heading into the end of the quarter or maybe July, year-to-date, or sorry, month-to-date? I know you mentioned kind of bid that, you know, F&B recovering, but just anything beyond that would be helpful.

Yeah, sure. As Mr. Kahneman mentioned, I mean, What we saw in Q2 was really a V-shaped view of Q2, really good April, a slow May, and a rebound in June. Early in the quarter here in Q3, we're progressing really as we had planned and looked at at the outset of the quarter at this stage. When I mentioned that bid rates are picking up in North America for our F&B components business, that's good to see. Those conversion rates can happen at any point in time. They don't necessarily happen in the third quarter. They could happen in the fourth quarter. It depends on how customers move forward with their plans around capital deployment. But it's good to see the bid rate picking up. You know, the underlying run rate business in North America for F&B in the component business has stayed pretty steady overall. If you look at industrial, again, the biggest thing about industrial is the North American market. As we mentioned, we've seen stability in Europe. stability across Asia Pacific as we move through the quarter Q2. And, you know, the important part is that short cycle business that's a big impact, especially in North America.

Perfect. Thank you.

Your next question is from Walter Liptack with Seaport.

Hi. Thanks. Good morning, everyone. Good morning, Walter. With this talk about specific on it, you know, I know you've got some good general... Hey, Walt, we're losing you there, Walt. Okay. Can you hear me okay now? Can hear you now. Okay, great. I wanted to drill down into the industrial a little bit more and just get a little bit better idea of some of the businesses that are more general industrial, like the hydraulic tools. And, you know, did you see a pickup happening in June or July, like in inventory refresh or any increases in bidding activity? And then, I guess, as the virus started, cases start to pick up again and maybe some of the openings slowing. Is that what's causing the cautiousness about the third quarter in industrial?

Yeah, so for industrial, as we mentioned, the shortest cycle business that we have in the company, and it flows through the industrial part of our business, and that would be hydraulics and the dehydration business. It's kind of the quickest to turn on and the quickest to turn off. So we did see that develop in the second quarter. not dissimilar to what other companies in the space are reporting. So right now we're planning for there not to be really any significant change in that view as we move through Q3, again with hopefully some pickups starting to happen as we get into the fourth quarter. So, you know, that's the biggest part of the industrial business that's being – that's being impacted in the short cycle business. We do have some mixer business that's project related that's tied to CapEx that also will have some timing elements to it, depending on what customers do. But overall, from where we entered Q2 to how we performed through the quarter and then flashing forward looking to the second half of the year, Really what we've taken into consideration, as I mentioned, this lower level that we typically see in the third quarter from a seasonality standpoint and then layer in the current economic environment, with that kind of picking back up again as we move into the second half of the year as the seasonality kind of rolls off.

Thanks. That helps. And then with food and beverage, It sounds like that business is doing well. What we're hearing from other food processors is that same thing, that the BID activity picked up. Can you tell, is it for new equipment, is it for capacity expansions, or is this more for components? We've heard some customers in the food and beverage area are automating to try and deal with the virus so they can have more social distancing. maybe fewer people on the factory floor, et cetera.

Yeah. So, again, as we mentioned, good performance for our food and beverage business, and we expect that to continue as we move through the second half of the year. As we go across the regions, Asia Pacific, again, we saw a nice rebound in our systems business and components and aftermarket. We're improving also really steady. And then I was really happy to see Europe and how Europe performed in the second quarter versus our expectations and a really improving backdrop in Europe. As we get into North America again, which is where our biggest components business is for food and beverage, and remember in North America it's not as big a systems market. There's a lot of systems integrators that are our customers as well as those OEs that those integrators are supplying to. So typically what influences the components business in North America or how those projects are being released that the integrators are working on with the OEs and we're kind of triangulating with them. That's the part of the business where the bid activities picked up. So underlying run rate business for a components business in North America has stayed good in food and beverage and where we've seen headwinds, and this was even before COVID-19, there had been some slowness in that part of the market. It It really has been a similar scenario and, if not, exasperated a bit in COVID-19 because the food and beverage companies are running at such a high level. So now that they're, I would say, getting accustomed to the new environment, they're starting to pick back up looking at these programs that they had been planning and which can include a number of things. They can be product line extensions. They can be normal kind of brownfield upgrades that they're doing, refurbishments. So there's a whole host of different activities that go on with our customer base that buy our components that influence that outcome that are kind of these smaller to medium-sized projects.

Okay, got it. Thanks. And then last one from me. When you were talking about the capital allocation strategy, it sounds like as this develops, it's more of an internal focus than M&A. I wonder if you could talk about the appetite for M&A at this point and what the pipeline might look like if you're doing that.

Yeah, sure. I appreciate you asking that question, Walt. Yeah, I mean, it's a combination. I mean, we definitely are looking at how we're investing back into our factories with CapEx and into our product development programs, as well as other industries. data digitization efforts, but we have built a programmatic M&A process. It's well-defined. It's in place. We've built that through some internal capabilities and some third-party resources. It starts with identification all the way through doing assessments and due diligence and integration. So a very good process put in place by Busamalingo and his team and the broader functional organization. So we're in a good spot to start doing and looking at M&A, and we're in fact doing that. So the good funnel has been built over the past 18 to 24 months, and we're looking at opportunities. Importantly, we want those opportunities to align with our strategy is an important filter that we look at every opportunity. It's got to advance our technology or create a market or customer access that we don't have today. Clearly it's gotta be value creation, an ROC greater than our WAC. And importantly too, as we run it through our filters and think about the future, we definitely want to pay attention and will pay attention to our capital allocation structure. So we wanna ensure we can invest through the business cycles as they happen, maintain that strong balance sheet. and stay within our target net leverage. If we were to go outside our target net leverage, our commitment would be we would get back into that within a 12-month period. So we're going to be prudent, but we've put a good process in place for M&A. We've got a funnel that's developing. We're looking at opportunities. and we're excited about that. It's an opportunity to really grow the company in a different way than we've been able to do historically. We've played a lot of defense over the past four years to get us to this point, and this is a good opportunity with the strength of our balance sheet to look at value creation opportunities in the M&A space.

Okay, great.

Okay, thank you. Good quarter, guys. Thank you.

Your next question is from the line of Dean Dre with RBC Capital.

Good morning. This is Jeff on for being good morning. First question is actually by China. I was wondering if you can just give us an update on how that region performed in the quarter and how the recovery is playing out there and maybe how the activity there has impacted your view on a recovery path for the other regions.

Sure, yeah. Good quarter in China. Orders were good. F&B components were improving as we went sequentially quarter to quarter. And that's the view I'm really providing is on a sequential basis. I think that's the most important view that we can think about right now. So sequentially, orders were getting better in our components business systems. As we mentioned, had a really nice rebound, a really slow Q1 for our systems business in F&B. And then industrial orders have been really, I'd describe, steady, not dissimilar to F&B. North America, we do have some nice mixer business in China, which can have some different views from month to month and quarter to quarter based on timing of some of the projects. But overall, I would describe our industrial business as steady in China. So as we step back from it to the second part of your question, how do we – How do we view China, the Asia-Pacific region, and even move across Europe? There's been steady improvement across those regions as they went into the pandemic sooner than we did in North America and across the Americas region. So I would anticipate and hope there's a similar aspect that plays out across the U.S. market, especially given the size of it for our business. But we'll have to see how that develops. And that's, again, why we want to make sure we're prudent in all our planning as we look to the second half of the year. But, yeah, your point is spot on, and we've been managing our business accordingly as we've seen markets open back up and ensuring that we can stay at the ready to respond to customers and, at the same time, keeping all our employees safe.

Yeah, that's really helpful. Thanks. And then? Maybe shifting gears, I know you're expecting the 30% to 40% decrementals in the back half of the year, but maybe thinking longer term, kind of as we shift to more growth mode, maybe 2021 timeframe, how are you thinking about incremental margins? Is it around the same rate as the decrementals, or could it even be higher as some of these semi-variable costs kind of shift to permanent takeoffs out?

Yes, sir. So, As I mentioned earlier in the response, you know, most of the volume pressures we're seeing year-over-year in the second half are going to be in our product lines in F&B and industrial that are above average gross margins. So we do expect that when those product lines come back, we're going to see incremental margins, I'd say 45% to 50%. And then, you know, that's benefited by, to your point, some of the discretionary cost out, which we're making structural. through our 2% to 3% cost-out program. So that's how we're thinking about incrementals in 2021 and beyond.

Yeah, I'll just add, that's the exciting part. The business should leverage really well on this higher value revenue in the shorter cycle business that we have today. And we're really excited about that because the operations is in the ready-go position. And as those orders start to develop, we'll be in a good spot to respond to our customers.

Great. Thank you.

At this time, there are no further questions.

Thanks, Whitney. And we appreciate everybody's interest in SPX Flow and taking the time to talk to us today. We're around all day to chat about the quarter and about our long-term strategy at the company. So please feel free to reach out. Thanks.

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