Q2 2019 Earnings Call
Guidance call at this time, all participants are in a listen only mode.
Later, we will conduct a question and answer session and instructions will follow at that time.
And what's your take what 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 Mr., Ryan Taylor Chief strategy Officer.
Thanks, Dan and good morning, everyone. Thank you for joining us.
With me on the call today are Marc Michael our President and CEO and Jamie easily our Chief Financial Officer.
Our Q2 2019 earnings release was issued this morning and can be found on our website SPX flow dot com.
This call is also being webcast with a presentation that is located in the investor section of our website.
Which includes details of our Q2 results.
A replay of this webcast will be available on our site later today.
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.
And in the appendix of todays presentation, we provide reconciliations for non-GAAP and adjusted measures.
Before we begin today I want to highlight some key changes to our reporting.
As announced on May 2nd 2019, we are focusing our strategy on building a premier process solutions enterprise and as part of that strategy. We are pursuing a sale of our power and energy business.
And our Q2 financial reporting the results for the power and energy business were reported as discontinued operations for all periods presented.
Reflecting management's determination that it it is probable the sale of the business will be completed within the next 12 months.
The continuing operations of the company, we reported in two segments.
Food and beverage and industrial the latter of which now include certain product lines previously reported in the former power and energy a reportable segment.
These product lines are not being offered for sale.
Most notably this includes our Bronto lubi metering and dosing pump business.
Note also that the appendix includes Recasted segment results for 2017 and 2018.
These costs that were previously allocated to the former power and energy segment total approximately $6 million on an annual basis or roughly 1.5 million per quarter.
Additionally, in accordance with GAAP accounting.
A portion of interest expense has been allocated to discontinued operations in all periods presented today.
And in our guidance.
The allocate a portion totals approximately $13 million of interest expense on annual basis.
And approximately $3.25 million per quarter.
Our 2019 guidance is now on a continuing operations basis with certain measures adjusted to exclude discrete items that are unique to the year.
This includes investments, we're making to support our long term strategic growth plans.
Note that our 2019 guidance is pegged at currency rates as of June Thirtyth.
And lastly, with respect to the Divesture upon energy. Please keep in mind that this process is ongoing and we intend to provide comments and updates only when we determined that further disclosure is appropriate or required by law.
Specifically, we do not intend to disclose confidential elements.
Oh the sale process.
With that I'll turn the call over to Mark.
Thanks, Ryan Good morning, everyone and thanks for joining us on the call.
2019 represents a significant pivot point for our business as we're taking deliberate steps to narrow our portfolio focused enhance customer.
Focus and further simplify our operating structure.
To say Q2 was a busy quarter for team is an understatement.
I want to start out this morning by thanking all our team members across the enterprise for their hard work.
Tireless effort and positive contributions to the quarter.
I'm pleased with the progress made on many fronts and confident in our plan to build a premier process solutions enterprise with a strong balance sheet and customer centered growth strategy.
We're excited about the future and remain committed to creating long term value for our shareholders customers and employees.
Since the start of 2016, we've been on a journey to transform SPX flow into a high performing operating enterprise.
We've made significant progress along the way the journey to high performance continues in 2019, as we work towards driving a world class customer experience, creating a higher quality of revenue and expanding gross margins.
On the strategic front, we've been taking deliberate steps to reduce our exposure.
To cyclical power and energy markets and large dry dairy applications.
These verticals contributed to volatility in our historical operating performance and overshadowed the underlying profitability and quality of revenue generated in our high value product lines.
As we begin the second half of 2019, we are nearing an inflection point in this portfolio transformation.
In dry dairy execution on the large orders we went back in 2017.
He is winding down and we have been methodically, reducing our exposure and that micro vertical.
In parallel the process to sell our power and energy business is moving forward with positive momentum.
As Ryan mentioned the results of this business reported as discontinued operations, reflecting our confidence in completing a sale within the next 12 months.
As we approach that milestone I want to ensure you that we understand the scope of the supporting costs for the business are well prepared to reduce overhead in a timely manner upon completing the divestiture.
Once complete we intend to quickly redeployed the proceeds on organic investments further de leveraging and returned to shareholders.
This will further strengthen our balance sheet and provide ample financial flexibility to invest for growth and create value through disciplined.
Oh, I see centered capital allocation going forward.
With an eye on the future we are aligning our organization designed to enable optimum value creation and deliver world class customer experience as a premier process solutions enterprise.
As part of this concept, we are committed to achieving 2% to 3% cost productivity through the reduction of overhead cost immaterial spend.
Along with further simplification and streamlining of our functional support.
We've invested substantial time in the first half of the year detailing our plans to achieve this goal.
We are refining those plans and expect to execute them over the next 12 to 18 months.
Our goal in that timeframe is to achieve mid teens, EBITDA margins and double digit Auro I see.
In our process solutions business.
Over the long term, we believe there is potential to achieve an even higher margin and are always see profile through organic growth and continuous operational improvements.
We believe this portfolio products has organic growth potential in the 4% to 6% range through an economic cycle.
Dwight Gibson transitioned into a broader role leading one combined commercial team with increased focus on utilizing innovative customer and market analytics to drive growth.
He is realigning his team to drive even more focus on product development commercial operations and project delivery.
Dwight and tie Jefferson, our VP of global manufacturing and supply chain are working closely together.
To optimize and leverage our pathway to excellence lean approach and increase speed and efficiency of customer fulfillment.
Looking at our Q2 results I want to first highlight the chart on the right side of this slide which compares our actual results on a consolidated and comparable basis versus our may 2nd adjusted guidance, which includes power and energy.
As you can see we exceeded our guidance ranges for revenue and profitability.
We delivered $513 million of revenue and $64 million of EBITDA.
On the old segment reporting, both food and beverage and power and energy exceeded revenue expectations through strong backlog conversion.
Segment income came in at $62 million $6 million or 11 cents per share above the mid point led by strong gross margin performance in industrial and power and energy.
Our power and energy team delivered double digit operating margins in the period and grew orders more than 40% from Q1 to Q2.
Driven by pipeline valve orders in North America.
And global aftermarket.
I'm quite proud of Jose Larios and his team for executing at a high level operationally, while also managing the divestiture process.
On a consolidated basis comparable to our guide we delivered 65 cents a bps, that's 18 cents or 38% above our mid point.
Also in the quarter, we completed our strategic restructuring actions on time and under budget.
With the large dry projects in food and beverage ramping down Accordingly, we completed actions late in the quarter to reduce our cost structure and that technology category.
Additionally, we also closed a facility in South America.
Strengthening our balance sheet has been a consistent point of emphasis for us for the past three years and Weve made remarkable progress over that time.
In Q2, we made a voluntary prepayment of $20 million on our term loan and ended the period with net leverage at 1.8 times.
A significant milestone.
To top it all off at the end of June we proactively amended our senior credit facility extending the maturity to 2024, while also achieving modestly better pricing and increasing capacity to support our long term growth strategy.
We now have no material required debt payments until 2022.
I want to reiterate I reiterate my sincere gratitude to our teams.
For their effort in the quarter were executing our strategy and effectively manage the things we can control.
Turning to the economic environment softening macroeconomic conditions contributed to year over year order declines across most of our businesses in the first half.
In the second quarter orders from for continuing operations declined 14% year over year on an organic basis broadly, reflecting delayed capital spending across our customer base.
With a slowdown in short cycle activity across most of our industries.
From a regional perspective. These impacts were most prominent in North America and to a lesser degree Asia Pacific.
Our original guidance for the year anticipated a healthier demand environment to drive sequential order growth.
While we are encouraged with the stability of orders from Q1 to Q2, we have reduced our full year revenue guidance by $50 million to reflect the level of orders booked in the first half and the current economic environment.
Even without adjustment to revenue, we anticipate profitability in the second half to improve significantly.
Looking at the second half guidance as compared to the first half.
We're targeting approximately 250 points of margin expansion at the segment level, primarily driven by gross margin improvement.
Additionally, we expect to see incremental cost savings half to half.
The majority the margin expansion is expected in our food and beverage systems business, where we've been increasingly selective on new orders over the past year, while also improving project execution delivery.
We focused our funnel of system opportunities on higher value market segments, where we have world class process expertise.
In areas, such as fermented dairy nutritional beverage condiments, and fats and oils.
In contrast, we've been methodically, reducing our backlog of large dry dairy projects.
And expect to see a 20 million dollar decline in this revenue stream in the second half, which will be accretive to the overall margin profile in food and beverage.
Our second half guidance assumes order rates across our short cycle product lines and in our spares and service business remained stable for the first half.
With that underlying assumption, our second half revenue targets for components and aftermarket sales in both segments are roughly flat to the first half.
Looking at the full year guidance.
This chart provides a high level walk from the consolidated guidance. We provided on may 2nd to the continuing operation guidance. We provided this morning.
We've taken the discontinued operation out of our guide this represents $500 million of revenue about $50 million of segment income and approximately $72 million of EBITDA, which is not fully burdened with supporting cost.
And the continuing operations, we lowered our organic revenue target by approximately 3% or $50 million.
We adjusted our segment income and EBITDA targets to reflect our first half performance the lower anticipated second half revenue volume along with countermeasures, we implemented to mitigate those declines.
On a continuing operations basis, we are targeting about $1.5 billion of revenue $200 million of segment income and approximately $180 million of adjusted EBITDA.
This guidance assumes corporate expense of approximately $50 million, which includes the $6 million of annual cost supporting the power and energy business.
As the execution of our strategy progress isn't at the appropriate time, we intend to provide more discreet modeling assumptions for the following items related to the sale of our power and energy business.
The amount of net divestiture proceeds and the expected timing and breakdown of capital redeployment.
The cost and benefits associated with our 2% to 3% cost productivity goal as well as further detail on these actions and phasing of margin benefits.
And investments in strategic growth, including new product development and capital expenditures, which we expect to increase gradually over the next few years.
That concludes my opening remarks at this time I'll turn the call over to Jamie to provide more color on our Q2 results guidance and financial position.
Thanks, Mark and good morning, everyone I'll begin with earnings per share.
We reported Q2 EPS of $1.47 cents per share.
EPS from continuing operations was 27 cents EPS from discontinued operations was $1.20 cents per share.
The discontinued EPS included a 95 cents or $41 million tax gain resulting from basis differences that are expected to be realized on the power and energy divestiture.
Looking at EPS from continuing operations, the effective tax rate for the quarter was 50% well above our guidance assumption of 29% due to losses incurred in countries, where we do not expect to realize a tax benefit.
A portion of these losses related to costs incurred with the facility closure in South America.
On a on an adjusted basis, we are using a 29% tax rate consistent with our guidance to calculate earnings per share. This is a tencent adjustments from reported EPS.
The other adjusted items include one penny of professional fees associated with investments, we are making this year to develop.
Our growth strategy.
Four cents charge related to strategic restructuring actions and a three cents benefit from mark to market gain on the legacy equity investment.
Excluding these items adjusted EPS from continuing operations was 39 cents in the period.
This is the same basis, we were using for full year guidance.
Taking a look at the segment results and starting with industrial.
Note that figures in all periods have been Recasted to include Braun in lieu Bay and other smaller product lines previously reported in the power and energy segment.
Q2 was $207 million down 5.5% year over year currency was a 2.4% headwind.
Organic revenue declined 3% due to lower level of capital projects and a decline in shipments of dehydration equipment.
These declines were partially offset by growth in heat exchangers and mixers.
Despite the revenue headwinds segment income improved 8% versus the prior year coming in at $31 million or 14.8% of revenue.
Margins expanded 180 points driven by higher gross margins, which came in at nearly 37%. This reflects improved operating efficiency across our factories.
Net benefits from cost price as well as increasing our focus on driving a higher quality of revenue.
Looking at orders organic orders were down 8% versus the prior year period, reflecting the overall slowdown across industrial short cycle demand, particularly in North America.
The decline was across the majority of our industrial products with the exception of our lightning and plenty mixers, which saw high single digit growth in orders, we continue to see exceptional performance with our mix of business. This year.
Moving on to food and beverage.
Revenue for the quarter was $179 million down 5% year over year.
Currency was a 3% headwind.
Organic revenue declined 2%.
This was due impart to a lower level of systems revenue than anticipated.
Component sales in North America were also down versus the prior year, partially offset by modest growth in aftermarket sales.
As it relates to North America, we believe the decline in component revenue is due to delayed capital investments by U.S. food and beverage producers most likely attributable to tariffs imposed on exports.
Segment income was $14 million and margins were 7.8%.
Profitability in the quarter in the quarter was diluted significantly by net losses incurred on two large dry dairy installations and certain costs to exit a facility in South America.
The lower volume of high value components sales also contributed to the year over year income and margin declines.
We expect margins to improve significantly in the second half as Mort described.
Organic orders in this segment declined 21% broadly, reflecting customer delays on capital investments for process systems, particularly in Asia Pacific and the lower level of orders for components in North America.
Dwight Gibson and his team continue to remain disciplined and strategic in their approach to systems opportunities.
That funnel systems opportunities is healthy and we are seeing much better quote and order activity at the outset of Q3.
Moving on to guidance, taking a look first at our Q3 guidance on a continuing operational basis.
We are targeting approximately $370 million of revenue. This represents a high single digit decline to the prior year.
We are assuming a currency headwind.
Between one and 2% and an organic revenue decline in the high single digits.
Our guidance assumes a mid single digit organic decline in the industrial segment and a double digit organic decline revenue decline in our food and beverage a large portion of which reflects the revenue contribution from large projects ramping down.
Overall, our organic revenue assumptions for Q3 reflects the softer order development, we've described and the broad slowdown in short cycle industrial activity, we've experienced over the last two to three quarters.
We were targeting about $50 million of segment income margins of approximately 13%.
We're modeling corporate expense at around $12 million. This includes 1.5 million of cost supporting the power and energy business.
Adjusted EPS is expected to be between 41 and $48 million.
I'm sorry, adjusted EBITDA is expected to be between 40 $148 million and our adjusted EPS guidance range is 41 to 53 cents per share.
This assumes interest expense at $7 million and a 27% tax rate.
Looking at the full year continuing operations guidance.
Let's first walk through the material changes to our may guidance in a little more detail beginning with the segments.
In our industrial segment, we are now targeting about $815 million revenue and margins in the 14% to 15% range.
This guidance for the segment now includes approximately $80 million of revenue previously reported in our power and energy segment.
This is primarily our brawn and Lubi product line.
On an organic basis, we reduced our target for industrial revenue $20 million from the May guide, reflecting the slowdown in short cycle demand.
In food and beverage, we reduced our revenue target for the full year to a range of $675 million to $695 million.
This reflects a lower level of component revenue as well as the delays we have seen in customer spend on capital projects.
Margins in food and beverage are now expected to be in the 11% to 12% range.
This reflects the low level of profitability in Q2, which was below our expectations and the impact of decremental margins on the reduced component revenue.
Two other key updates to our guidance as mentioned a few times already corporate expense now includes $6 million of annual cost supporting the power and energy business.
We are keeping these costs in our guidance to maintain accountability for addressing upon completing the divestiture.
Looking at interest expense, we are now allocating about $13 million of 2000, Nineteens interest expense to discontinued operations.
Consistent with the accounting methodology for disc ops.
Our continuing operations interest expense is now $30 million for the year.
As you think about modeling interest expense in future years, I think $30 million with reasonable if not conservative estimate.
Based on our thoughts today the use of the proceeds the divestiture proceeds it is fair to assume we will look to reduce our annual interest expense to $30 million or less.
The next slide offers a more comprehensive view of our full year guidance ranges and modeling assumptions. We've covered a lot of this already so I'll be brief.
For 2019, our adjusted EPS from continuing operations guidance is $1.85 cents per share at the midpoint.
No. This assumes $30 million of interest expense and a 29% tax rate.
Adjusted free cash flow is expected to be between 80 and $90 million.
This assumes just over $20 million of Capex modestly positive working capital impact for the full year.
Moving on now to our balance sheet liquidity and capital allocation principles would start and take a look at the credit facility.
During the quarter, our treasury team work together with our lender group to successfully amend our senior credit facility.
As a reminder, our Pryor facility had been in place since the spin off in 2015 and was set to mature in Q3 2020.
Our new facility includes a $20 million a $100 million term loan.
$500 million revolver borrowing capacity and use the in certain foreign currencies, a 10% increase from our previous facility.
And a $150 million foreign credit instrument tranche, which allows for the issuance of guaranteed instruments to provide performance security to our counter parties in certain transactions.
Through the amendment process, we were able to modestly improved pricing.
Simplified our pricing grids.
And are now able to fully not our global cash balance against gross borrowings for purposes of compliance reporting.
On the right side of this slide you can see the maturity schedule for all of our debt instruments, including our senior notes.
No that our maturities are staggered and we have no material required principal payment until 2022.
I would like to thank our banking partners for their continued support of our company.
Getting this amendment finalize marks an important step towards providing committed financial capabilities to our teams.
As we pursue value creation through our strategic plans.
On this next slide you can see an overview of our current capital structure at the end of Q2, we had $187 million of cash on hand.
And gross debt of $732 million.
And net leverage was down to 1.8 times at the end of the period.
Debt to total capital was 42%.
Just over 80% of our outstanding debt is it attractive fixed rates with just under 20% floating debt, which has interest rates at approximately four in a quarter.
As I mentioned previously our adjusted free cash flow for the year is expected to be between 80 and $90 million. The majority expected to be generated in the second half.
We remain committed to using the majority of the cash to reduce debt.
Through June we paid down $20 million of debt or full year commitment to debt reduction remains $50 million to $75 million.
Between cash on hand, and our revolver, we have over $650 million of liquidity today and when we consider the potential proceeds from the power and energy divestiture, we expect to be in a very strong financial position.
As we consider our options for deploying these proceeds based on current information our attention would be to allocate it to a mix of organic growth investments further deleveraging and returning to shareholders.
Stepping back and thinking in more general terms of capital allocation, our approach will be ROI see based.
You can see our guiding principles on the right hand side of this chart.
ROI see centered approach to deliver enhanced shareholder return.
Invest in business through all economic cycles.
Maintain a strong balance sheet and financial stability.
Target net leverage between 1.5 and 2.5 times.
We intend to target financial ratios that are consistent with investment grade profile.
Going forward, we will continue to prudently invest capital in areas of opportunity that provides strong ROI see.
And create long term value consistent with our strategy.
With that I will turn the call back over to Mark for closing remarks.
Thanks, Jamie.
In closing 2019 represents a significant pivot point for our business as we execute our portfolio strategy.
To simplify our operating structure.
And enhance our customer focus.
Our objectives include driving a higher quality of revenue throughout our portfolio aligning our organizational design to enable optimal value creation and a world class customer experience.
Continuing to drive improved cost productivity throughout our operations.
And strengthening our balance sheet to being up position to invest in our business throughout economic cycles and have flexibility to invest capital on the highest return opportunities.
Once again I want to thank our teams across the enterprise as well as our business partners for their hard work tireless effort and positive contributions to the quarter.
We are excited about the future and remain committed to creating long term value for our shareholders customers and employees.
That concludes our prepared remarks this morning and at this time.
Well open up the call for questions.
Ladies and gentlemen, if you have a question at this time. Please press Star then the number one key on your Touchtone telephone.
If your question has been answered all your wish to remove yourself from the queue. Please press the pound.
The first question is from me. Thank you.
From Stifel.
Hi, Good morning, this is Adam Farley on for Nathan.
Hey, good morning, Hi, Adam.
I just wanted to talk about the.
Commentary around short cycle to begin with how does your order book progressed through the quarter.
It was a weakness broad based across end markets are more concentrated and then also if you could just comment on some of the longer cycle projects. How is how is that holding up as well.
Yes, sure Adam I'll, I will take that and Jamie jump in if you've got any color to add I think it's I think it's best that we look at it by segment I think the main stories would be a in food and beverage.
We're seeing overall market demand a bit softer and in North America.
Our short cycle business for the components part of of what we do in the market is slower than we expected.
As we mentioned we believe this is really associated with with tariffs from China that are influencing customers' capital spend decision. So.
That's that's influenced a slowdown in our north American short cycle components business.
And in China, our systems business, it's been a bit slower to develop than we planned some of that's due to timing we had some allies in hand in Q2.
That didn't translate into orders and.
We're actually starting to see those come through here at the beginning of Q3. So we're off to a good start in our systems business in Q3.
The other thing I would say on our systems business as we've indicated.
Throughout the last couple of years is the discipline in pricing that were maintaining in the select tivity of the projects. So in some cases.
We are walking away from some orders if the pricing has gotten too competitive so.
Yeah, that's kind of the situation in China, I would say that in China on a sequential basis, we did see.
A pickup in our business overall, and food and beverage, which which was nice to see.
And in food and beverage in Europe .
We are seeing some improvements and we hope to see that region.
Really exceeded our expectations and see some upturn there.
With with what's going on with the with the trade Wars.
As some of the slowdowns happened in North America.
We believe that some of the purchases are starting to happen out of Europe .
From from China purchasing goods and.
We hope to see some upturns in our European business as a result of that.
So pretty pretty kind of mixed story, there in food and beverage, but overall I would sum it up slower North American component business.
Slower than we expected in systems in China, but expected to recover in the second half of the year and we're already seeing some of that in.
Here in Q3 and in Europe , we're pacing at or better than what we'd expected to so far in the year.
And then if we look in industrial I think the big story in industrial it was a bit of a moderation in our sorts cycle orders, especially as exiting Q2.
We still hydraulics and dehydration slowing a bit.
Mick mix orders were still pretty good.
And then our pumps business was pretty stable sequentially.
So.
You know across North America, and Europe that was kind of the story in North American Europe and then.
In China.
And across the APAC region, we really saw a nice acceleration from Q1 to Q2.
In our in our short cycle industrial business.
So again a bit a bit of a mixed story there in industrial slower in North American Europe , but accelerating.
In China in the APAC region. So you know that's what brought us to.
Really holding our short cycle business kind of consistent with what we saw in the first half again, given the sequential stability. We saw in our orders overall from Q1 to Q2 in the short cycle part and so we've really just maintain that through the second half of the year with a an uptick of our orders planned in the systems business based on.
The developing orders in China.
So again as I mentioned Q3's off to.
Good start meeting our expectations and we're on track as we've gone through the first five weeks or so here.
That's really helpful. Mark and then just turning to this cost cost productivity goal can you just try some color on some of the initiatives you guys are doing and then an update on your.
Operational excellence journey, and what other what areas in the business you can continue to improve on.
Yeah, Adam I'll take that one so.
You know as we we talked last time, we were together I think we mentioned at your conference.
The plans that are coming together.
Around that have been developing nicely going back a bit we we engaged a third party to really go through function by function.
Our cost helped us do some benchmarking and they'll also helped us give thought to how to set these functions up or make modifications to the functions that would benefit us in the long run as we look to grow so that works wrapped up the the teams the functional leaders have looked to that I have set their plans out.
As we work through Q2, we finalize those plans and are ready to to begin executing on those you know there is a piece that is woven through the comments that we had this morning that there is a required level of functional support that.
Goes along with the PSD business, so as long as we continue to to to run and operate the PSD business, we're going to need to quite a bit of those resources in order to do so so really what the teams are doing is making sure that the plans are ready.
And to the extent they can be actioned earlier than the exit of peony will do so.
But it's really needing to time those in concert with the sale of the business the execution of the Tia say of those of that business and.
Then go ahead and move through through the.
So so what I would say is.
So as it relates to the divestiture process timing of that is difficult to predict a the process is going very well.
As we.
Seek to get that wrapped up most likely that most of these actions will get started maybe toward the end of this year and then we'll we'll begin to really materialize through the course of 2020.
Okay. Thanks, I'll pass it on.
Thanks Al.
Thank you. The next question is from Mike Halloran from Baird.
Hi, good morning, everyone.
I might do.
So just sticking on that train of thought here.
How much.
Just try to give some context around.
How much the the sale process here.
Is.
Impacting the timing knows how quickly can move on some of these productivity initiatives certainly sounds based on the past response that year.
Getting yourself prepared setting up in certain areas moving and other areas, but maybe give some context to the pacing as we look to here how much of this now is preparation for before final sale, then acceleration or is it pretty consistent across the board there.
Hey, Mike it's Mark.
As Jamie was mentioning I mean, the 2% to 3% cost out initiatives, we have theres nothing really impacting.
Significantly our ability to move forward with those again as Jamie mentioned, we've got plans in place each function.
Has there particular goals and objectives and they've identified the pathway to get there. So we'll start working on those as we go through the second half of the year and expect to fully realize those benefits for the time, we exit 2020, and so as we.
Get into early part of next year will provide a complete schedule around how we expect those to develop based on our 2020 guidance, but a well defined and we know how those are going to layer in as we move through the 2020 time period on the 2% to 3% margin expansion through cross productivity.
And the other point that was mentioned in the.
Prepared remarks, the $6 million of costs that we've got in the corporate line. That's the cost that supports the penny business and that's the part that the timing of that coming out will depend upon.
A bit of the transaction timing to close timing and how long those support costs are needed now what's important is that 6 million would be intended to cover in a t. a say a with the new owner until which point that those those support services aren't needed anymore and then we would we would take those costs out of the business.
Makes sense and then.
On the SMB system side.
Is the second quarter over the last of the lower margin stuff or does any of that trickle through into the third quarter from here.
Yeah, we.
Have a minimal amount of revenue associated with the large dry dairy projects in both Q3, and Q4 kind of evenly split between the two quarters about a $5 million in revenue for each quarter.
So once that trends.
That's how the backlog we're finished with that revenue stream on those large dry dairy system projects, what I would I would mention about the backlog and what's supporting.
Part of the gross margin expansion, we expect to see in the overall.
Margin improvement is about a 400 basis point.
Improvement as we get into the second half of the year. If you compare to where we started the year. So our backlog is really improving across the board with about 400 basis points in total and the systems business, even looks a bit better than that as we go into the second half of the year in terms of margin performance improvement.
That's good that's very good and then last one from me the.
So obviously going to be in a really good financial situation. Once the transaction closes just from a balance sheet perspective, maybe just talk a little bit about one of the one of the problems that you're thinking of looking at which is even more targeted inorganic.
Opportunities on the acquisition side is that something you're building the funnel for now and what does that look like from your perspective.
We are we're building the funnel now.
We're actually doing some additional work with some third party support to to look at various Michael verticals, where we can.
Identify really high value high quality of revenue streams that we want to pursue.
So we'll look at things that are close to the core and some some near Adjacencies.
But we are building that funnel and as that develops and opportunities present themselves, we'll be considering them, we're going to be discipline, though is we've always been and thinking about how we're deploying capital and make sure that we can create value and deploying that capital and get a good return.
Thanks, Mike appreciate it.
You bet, Mike Thank you.
Thank you. The next question is from Julian Mitchell from Barclays.
Hey, good morning, everyone. This is Jeff Carvallo on for Julian.
Good morning.
So I guess one quick question on some of these project push out you're seeing from your customers.
You say that you know some of its stemming from sort of trade and tariff conflicts.
Do you get a sense of how far the push outs or is it kind of a one quarter to quarter out or do you think your customers are sort of sitting on the sidelines until there is a bit more of a solid resolution I guess, especially in light of.
Things ramping up this week.
Yeah, well that's that's a good question you don't really I'm a bit a bit tough to call exactly what the timing will be that's why we feel we've been prudent in looking at what the run rates have been.
In our shorter cycle business that tends to support a especially in North America some of that.
Capital deployment, where customers may be are doing upgrades.
So we anticipate that we will continue to see a.
Steady rhythm in our and this is specifically in our food and beverage business.
But albeit at a slower level than what we've seen historically over the last couple of years.
This is really a bit unprecedented typically these slowdowns or more short in nature for this short cycle business, but.
We started experiencing it even if you go back to the second half of last year, and it's kind of continued through so.
But but difficult to make that call, but the pipeline, though it's still there we've got a funnel that's active.
It's it's it ticked down a bit in Q4, but came back to the first half of the year in terms of the funnel, but the conversion rates have been.
A lot slower than historical but we're watching it closely we know.
But the projects are and we're well positioned when should the customers and when the customers decided to release the capital.
Yes, I'd just add to that a those.
A description of the components business in the U.S. and then I think you were also asking about.
Some of the FNB systems business so.
You know you saw one of the slides our our systems business has in the last few quarters doing $40 million to $45 million of revenue what we do have in the second half is.
A fairly significant up tick in order intake around systems.
I think Mark mentioned in his prepared remarks that we've seen a strong July already around the systems business and and those are the projects that we've done more selective and watching and are seeing come through now and and Mark also made reference to the margins and backlog in the quality of those bookings and.
The references he gave to 400 basis points of backlog margin improvements since year end.
600 basis points of margin improvement from June of last year. The projects that we are taking on here in Q3 and for the rest of the year should be at or or accretive to to those margins.
Got it thanks for that and then one quick follow up just getting back to capital deployment.
Leverages starting to trend down towards that kind of 1.5 or lower end of your target and so I'm. Just curious if there is sort of a you know.
And timeline for one more.
Deployment to unify the return to shareholders or acquisitions come into play I know that cash flows kind of earmarked for debt pay down right now and so.
Particularly in I guess in light of power and energy closing is that something that has to come first before you see more buybacks more dividends more acquisitions or is that just kind of running analysis on the whole.
Right basis.
Yeah, I would say that you know we've committed to getting our debt down to the lower end of our range as you referenced there and I think we'll continue to do that through the course of the year.
And then the playbook certainly opens up quite a bit whenever we completed the divestiture of TNT and so the the approach that we're going to take at that time will be to probably keep a certain amount of cash on the balance sheet to pay for some of the restructuring activities that we've talked about here. There's there's also some investments that we'll make either within our factories are on the organic side of the business.
There were also as you as you made reference to they're going to target a return to shareholders in some fashion in between now and then we'll continue to watch where the stock trades with the best approach to that will be but but we do recognize the dilution effect of selling to be any business and.
That will be taken into consideration whenever we we look to deploy those proceeds you and I would just add to that I mentioned that.
Once we understand what the proceeds are for the sale from the sale of the power and energy business and we look at which areas we want to.
Redeploy that capital in those proceeds.
Hey, if we if we end up under one five for a period of time. That's that's okay right I mean at a healthy strong balance sheet and uncertain times is a good position to be in and that allow us.
No more flexibility and more dry powder to do things, we want to do over time so.
Our target range is one 5% to five but being below one five for a period of time with a really healthy balance sheet.
During a these these kind of uncertain times.
That won't be a bad position to be it will be a really good position to be in.
Got it thanks I'll be all for me.
Thank you.
Thank you. The next question is from Robert Barry from Buckingham Research.
Hey, guys good morning.
Hi, Robert.
I agree with you on the comments on the balance sheet at this stage in the cycle sounds good to me.
I wanted to just clarify a couple of things here on slide 10.
And then the guidance bridge, so you're pulling out 500 million in revenue for power and energy 50 million in segment income I think that implies that 10% margin.
I think you had guided to nine and.
Fran and lose a business I thought it was even higher than that.
Kind of implying that would be coming out would be more like I don't know seven or 8%.
As there are some.
Adjustment in the math there.
Well Robert I, what I would say is the.
The shift from the power and energy business to run into our industry you're correct is.
It's principally the brawn and Lou day brand, which does have.
Segment margins slightly above the average for that business.
In addition to that there are smaller moving pieces within there that are generally aren't material, but but but they may affect the the total that you'll see come over so it's principally the <unk>, the brawn and little bit brown, but but some more that's coming over as well.
You know as it as it relates to the reduction of revenue and margins and operationally. So we'll have revenue coming down $50 million and the EBITDA coming down by $5 million.
You know about about half of that revenue reduction were related to our systems business and then the other half would would be the shorter cycle componentry.
Oh.
From our standpoint are happy to see the Decrementals there really benefited by some of the margins that we've talked about now in backlog some of the the price cost improvements that we've seen over the course of this year. So really we're trying to protect on on the on the EBITDA side of the de leverage.
But back to your point on what's coming over there there are some details and moving pieces that Stuart or I can help you with later.
Yeah actually in where you win.
It's going to go next so.
3 million out of.
EBITDA on 50 million of sales.
Especially when it sounds like you're also now including $6 million of costs kind of implies that the.
Kind of like for like EBITDA guidance is.
A little bit better.
Is that right.
It sounded like there were a couple of things that might be tracking better than you thought price costs are.
But I wanted to clarify that.
Yeah, I think that's it that's the that's the main driver would be how we're seeing price cost develop.
Over the course of the year and then as we kind of look forward and.
What some of our trends, we see on the inflation side, and where we sit with prices continuing to see that momentum will be the biggest difference yes. The other thing I would add to that Robert.
There's there's price there is our supply chain teams doing a great job on mitigating inflation is Jamie it was mentioning and then.
Can't under.
Under emphasize the impact of our systems switch you know and what we are doing with these more liquidity lucrative liquid projects.
And having a better margin profile, so we're really going to see a.
A significant flip in the margin profile there as we go into the second half of the year. So a lot of this will show up in.
Half to half in our in our food and beverage business with a better systems margins. The restructuring is another important piece that we're we've also done two and completed.
Got it I guess, just lastly for me and maybe this also points to things tracking better.
On the cash flow I think you were guiding midpoint.
15.
Five.
So thats $30 million less on pulling out $72 million of EBITDA.
There's like five or 8 million of Capex there so it seems like.
I would have expected.
60, 570 million of cash flow out and you're only reducing the guide by 30. So is there also some.
I don't know working capital tracking better or something else in that bridge I'm missing.
No I think if you take it back to what's on the the face of the statement of cash flows. So youre today will have in total so this would be continuing ops in disc ops.
$30 million of free cash flow.
As we work throughout the course of the year, we do expect that to to trend back up to call. It the $1 million to $115 million and then the splits between disc ops and continuing ops are difficult to to get to from the from the GAAP financial statements and it comes from a place of.
Of of how certain balance sheet positions have to go through continuing operations and maybe disconnected slightly from.
From the piano tiles of disc ops, and continuing ops, but what I'd say in broad strokes Robert is that.
We do see some level of improvement starting to come through and working capital, particularly and they are.
And the last bit of Q2, we saw some pretty significant improvements in inventory.
And then the other big driver for Us on the working capital front and free cash flow would be our systems business. So as a reminder, you those those tend to be.
Larger orders and do come with a degree of down payments and milestone payments the front end of those projects and as Weve.
Taken in less number of systems orders this year.
That's been a headwind for us and I think we've mentioned now a couple of times. The developments we've seen already in July and what were expecting through the remainder of the year, we're expecting that that will turn positive for us as we exit the year.
Alright, thanks for all that color.
Welcome. Thank you thanks Robert.
Thank you. The next question is from Nigel Coe from.
Research.
Thanks, Good morning.
Good morning.
So we've covered the you know the kind of the plumbing side by sides and some that we did mention near the fifth the fifth sort of option.
Well, the organic investment, which will allow companies to talk about but I'm. Just curious what that means for you guys and I'd be curious if there's any degree of constraints that you've had in the last year or two with investing organically in your business and then kind of how that might change with a stronger balance sheet.
Yeah.
Yes, sure. So I think about a a couple of different buckets, the first would be and new product development and investments to.
Uh huh.
To change the level of.
Of NPD the come out to them. So the white and his team have done some restructuring here recently reorganization and they have created an organizational design, which I think are going to allow us to to bring ideas to the forefront faster on while better visibility across the organization to those potential investment opportunities.
And give them then that team a framework of where and how investments and new products are tied to our strategy.
So I think historically you would have seen that we spend roughly 1% of our revenues on NPD.
We believe that.
An absolute driver of future success is going to be to push up the vitality index and the vitality of our revenue profile to improve the quality of revenues and that would would do to I'd say at least double over a period of time so.
So the team is working on really really again identifying those opportunities pulling those the forefront to we're going to look to fund those on a more rapid pace than we have historically.
So that would be on on the product side and then as we look to the plants.
We've historically spent in capex a bit less than depreciation and there are a number of our plans, which we believe could significantly benefit from some recapitalization and tie jennifers and his team are aligning that back to the product strategies and bring those ideas forward. We've seen some come forward more rapidly here in just the last couple of months, we expect to continue to see those come through in the second half of this year and into next year. So.
So capex recapitalization, a factory automation those type of investments that we believe would allow us to reduce the lead times of our products serve customers faster at a higher quality.
Those are those are roughly the buckets of of organic investments I think we're going to focus.
Hey.
Nigel the other one thing I would mention.
Is that will this 2% to 3% cost productivity.
Objective, we have and as we go through the next 18 months, we'll need to play.
A certain amount of cash and capital towards that so the good news is and I think that the beginning of your question was presented to us.
In the past over the past several years from doing the things that we wanted to do in terms of capital deployment.
Everything's gone towards debt reduction and our restructuring efforts I mean, that's a hasn't been a very balanced approach. So Jamie his goal is to really balance that out and mine too.
In terms of how we're deploying capital and being.
Hitting hitting more important areas in products and in our in our plants and how we're returning to shareholders and.
And organic investment so.
We're going to look to really balance out that capital deployment much differently than it's been in the last three years and we're going to be able to do that on the back of a much stronger balance sheet and better cash flows.
Thanks, that's helpful.
Mark you just touched on this hearing in terms of driving towards that 23% said go is there a need to you know with maybe some of the activity on the projects and obviously the that we get them on environment is there a need to do a another big Bang restructuring program.
Yeah, I don't I don't see a big Bang restructuring program some of the things we put in place over the last couple of years learning from experience and being very disciplined in our our hiring efforts, we've been managing our overall cost structure and head count much more effectively.
So even as we saw moving through the first half of this year.
Thanks, not to developing as we had anticipated.
We were.
Slowing down the hiring process in certain areas and making sure that we weren't running as much overtime in our facilities, reducing our contractor head count so.
I don't see the need for Big Bang, we'll continue to manage that prudently as we move through the second half of the year and look and see how orders develop.
And then a quick follow on.
Obviously, you discontinued the path and the bulk of the power and energy portfolio and given that you have dissected sit and talk to that.
It's industrial.
I'm not sure how about and the question is but just just have some sense can you give us some sense in terms of how the business is tracking versus your original plan. So we can do some sensitivity around what we can see as proceeds has the business the business checking more or less the plan, though is it.
As it deteriorate in Shelby.
For power and energy.
Yes.
Yeah, No I mean, Jose Larios and his team did it.
Great job in Q2, and we mentioned that as we expected the order rates recovered.
Sharply from Q1 to Q2 with a good north American pipeline valve orders.
They executed it.
The double digit.
Income margins.
So much better than anticipated hit the revenue objective so.
Really good execution and couldn't be more proud of the team and.
They are on the right right path and just.
To reemphasize, we've we've made that switch already internally were really Jose and his team are running that part of the business and they've spent the big part of Q2, while all not only executing a good quarter.
Going through various aspects of management presentations and factory visits from interested buyers and so we're already moving into the to the second phases of.
Of.
Due diligence and expected to be doing final bids pretty soon for power and energy. So it's performing well Jose and his team are doing a great job and.
We're confident as indicated about a positive outcome.
Yeah, I think that I would just add to that.
Bart mentioned the orders, which we have seen come in through through Q2, which at the end of Q1. We said there was some timing differences there those orders that we expected to be timing of all come in.
Here in the second quarter, the aftermarket stream in order profile of that business continues to remain strong.
And just look at the the margin performance for that business.
It's it's up almost 200 basis points from where it was in Q2 of last year and kind of on the old basis, our segment income margins for that for peony.
Here in Q2 would have been the highest it has been for for well over a couple of years. So the business is performing very well.
Jose and team as Marty mentioned have done a lot of proactive outreach to customers and customers are responding well factories are performing well. So it's nice to see that business holding together very well through all the things that Mark mentioned, that's been going on this quarter.
That's great to hear thanks, very much thanks.
Thank you. The next question is from Brett Linzey from vertical research.
Hi, Hi, good morning, guys. Good morning.
Hey, just wanted to come back to productivity in some of the streamlining efforts. It's good to hear the teams are primed and ready to go here, but just in terms of pace.
Once once initiated what's the timing of when these products have productivity savings start to ramp is it.
More backend loaded heavier lifting any color on the phasing now that the plans are finalized would be great.
Yeah, I would say that they.
They are a somewhat backend loaded so a number of the actions that we have are ones that require a fairly significant degree of planning a fairly significant degree of of execution across multiple parties multiple jurisdictions et cetera. So.
They're in motion now I think that to Mark's point earlier, we'll see some of them take place over the second or the second half of this year.
We're really began to take shape and the first half of next year, I think well over half of the.
The savings will begin to hit in the second half of 2020, but but its a unlikely that we're going to see the full annualized benefit before 2021 of all the actions but.
So there is the piece that relates to PMT that the teams have to make sure. There is certainty around knowing when that business will go on with the TSH needs will be but the remainder of the the projects are are well under progress and planned and will begin to be executed fairly soon.
Okay, Great and then maybe just a question on China specific to orders.
How how were orders in the quarter in this segment and then what are you assuming in the guide for the balance of the year and then the follow up there would be have you seen any type of nationalist stance with respect to.
New bids and activity in in that region.
Yes, sure. So in China, I was just maybe break it down again, food and Bev between food and beverage and industrial.
So systems business in the quarter was a bit slower than we expected.
But as I mentioned, we had some allies in hand that we'd expected to.
Translate into orders within Q2 that didn't happen, but we're already seeing them come through in Q3, So Q3 orders coming in and systems have picked up.
And then in food and beverage for more of our components business and aftermarket business, we did see that increase sequentially within the quarter. So overall.
The business and food and beverage.
Is.
Operating.
As we expect to exit as we expected with the exception of some some timing associated with the systems orders.
I would just follow on with that saying that we're we're still saying really disciplined and our selectivity on systems business and pricing and that goes across the entire business.
And then is as you look at the industrial business in China and across Apacs for that matter we saw a.
A nice acceleration of our industrial component business, our short cycle business from Q1 to Q2.
In China. So overall I would say in China, you know the business is.
The first half of the year is performing well.
We expect it to perform well in the second half and even look better with the systems business that should come in and we're already seeing here in early.
Q3.
And.
I couldn't point to any specifics to say that there's any evidence of nationalism.
We're just we're well anchored there with our teams we're localized with our teams.
And they're they're they're executing the plans they have in front of them.
Hello.
Sorry, I just one quick follow up with the sale process could you just speak to the types of.
Buyers that are looking at the asset is a combination of strategic and financial buyers and maybe just some color on how long the bid list looks today.
Yes, we've had interest from both and I would say its.
Healthy.
Bidder list and were pleased with the the overall interest.
And I'm not going to go into a lot of depth on the number of bidders and who is still in the process, but again, we're confident that.
Things will progress.
Through the second half of the year and as I mentioned.
We've gone through already first round bids weve gone through management presentations.
We've gone through site visits and we're in the process of due diligence right now in preparing for a second round final bid. So process is moving along well and will provide an update as soon as there's significant developments on that front.
Okay, Great I appreciate it thanks, you bet.
Thank you. The next question is from Deane Dray from RBC capitals.
Hi, Thanks. Good morning, this is Andrew krill on for Deane.
Just wrapping up on T. any another quick question just can you comment it seems like the process is going well, but just has the choppiness and oil and gas recently had any impact on potential sales multiples and would you be willing to sell the business and pieces rather than the whole segment at this point. Thanks.
Yes, Hi, Andrew.
Well, maybe work backwards from there now we plan to sell the business as.
No one business as we've defined it we don't have any intention to break it apart and sell it individually.
And the interested parties or looking at the business that way.
And as you can see from the performance that we're getting from the team or what the teams have done.
Include not only in Q2, but building up to this point performance has continued to improve and.
No we would expect that to support a good value of <unk> for the company for the business as an outcome.
Okay got it and then just lastly on tariffs and now recently the pressure is kind of seem to continue to ratchet up. So just before you commented price cost seems to be in your favor still but just have you seen any increasing in our direct input costs at this point and I can you just give us some other color on your confidence then offsetting any potential increases thanks.
Yeah, you know tariffs specifically on the products that we produce.
At this stage, there's there's not really an impact there and the most recently announced tariffs it doesn't to it doesn't really touch our area. What I would say is our supply chain team has done a really nice job this year in minimizing any inflationary.
Implications, so throughout the year or impacts throughout the year.
So so we're in a.
A good spot with what our commercial teams have done on price or supply chain job. The teams doing a good job in tariffs themselves on our products were producing.
Art, having a significant impact as we move through the second half of the year, we wouldn't expect that given the recent announcements.
But going back to what is impacting is that in the food and beverage part of our business.
Those customers are being impacted and we believe those terrorists Chinese tariffs that the shares from China.
Or influencing their capital deployment decisions and that's what's impacted our short cycle volumes.
Okay, great. Thank you you about Andrew.
I'm showing no further questions at this time I would like to turn the conference back to Mr. Ryan Taylor.
Hey, Thanks, Dan.
I appreciate everybody joining the call today that concludes our webcast for the Q2 earnings presentation and Stuart will be available throughout the day to answer any follow up questions that you might have.
Thank you for your participation and we'll talk to you next time.
Thanks, everyone.
Ladies and gentlemen. This concludes today's conference. Thank you for your participation and have a wonderful day you may all disconnect.