SPX FLOW's (FLOW) CEO Marc Michael on Q1 2017 Results - Earnings Call Transcript

| About: SPX FLOW, (FLOW)

SPX FLOW, Inc. (NASDAQ:FLOW)

Q1 2017 Earnings Conference Call

May 3, 2017 8:30 AM ET

Executives

Ryan Taylor - Vice President of Investor Relations

Marc Michael - President and Chief Executive Officer

Jeremy Smeltser - Chief Financial Officer

Analysts

Andrew Crone - RBC Capital Markets

Mike Halloran - Robert W. Baird

Adam Farley - Stifel

Ryan Cassil - Seaport Global

Nigel Coe - Morgan Stanley

John Walsh - Vertical Research

Ronny Lloyds - Credit Suisse

Robert Barry - Susquehanna

Operator

Good day ladies and gentlemen. And welcome to the Q1, 2017 SPX FLOW Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will have a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Ryan Taylor, you may begin.

Ryan Taylor

Thanks, Tiya and good morning everyone. Thank you for joining us this morning. With me on the call are Marc Michael, our President and CEO and Jeremy Smeltser, our Chief Financial Officer. Our Q1, 2017earnings release was issued this morning and can be found on our website spxflow.com.

This call is also being webcast with a presentation located in the Investor Relations section of our website. I encourage you to follow along with the presentation during our prepared remarks. A replay of this webcast will also be available later today on our website.

As a reminder, portions of our presentation and comments are forward-looking and subject to Safe Harbor provisions. Please also note the risk factors in our most recent SEC filings. In the appendix of today's presentation, we have provided reconciliations for all non-GAAP and adjusted financial measures presented today.

And with that, I’ll turn the call over to Marc.

Marc Michael

Thanks Ryan. Good morning, everyone. Thanks for joining us on the call. This morning I'll provide an overview of our Q1 performance in order trends. Jeremy will then take you through the details of our Q1 results, financial position and guidance. And I'll close with a brief update on our journey to transform SPX FLOW into a high performing operating enterprise.

Overall, we had a solid start to the year with our first quarter results in line or better than our expectations. And positive momentum in several key areas including order growth, improved cost structure and reduced leverage. Orders were up 18% sequentially and up 2% over the prior period. Highlighted by key order wins supporting our customers in the midstream oil and food and beverage markets. Book-to-bill was 1.2x in the quarter leading to 16% or $129 million of sequential growth in backlog.

Adjusted free cash flow was $28 million and we generated an additional $20 million of cash proceeds from asset sales. As a result, we reduced net debt by 5% and our net leverage ratio to 3.9x. Our realignment program remains on track. We realized $17 million of year-over-year cost savings in the first quarter. Segment income margins expanded 40 points year-over-year despite a 12% organic revenue decline, underscoring the benefits of our realignment program and reduced cost structure.

I am encouraged by our solid start to year and continued signs that we are in the early stages of a cyclical recovery in our key end markets. Despite this growing confidence, we continue to plan prudently. We reaffirmed our 2017 guidance today and barring any unforeseen market headwinds, we believe we are in good position to achieve the upper half of our 2017 guidance range.

As we move into Q2 and look to the second half of this year, we expect a meaningful ramp in revenue and profitability, supported by the ending Q1 backlog and sequential benefits from cost savings.

Moving on to Q1 orders. On a consolidated basis orders were $535 million, marking our highest level since Q2, 2015. The strong start to orders was broad based across all three segments driven by an increase in small to medium size capital orders and continued momentum in run rate component in aftermarket orders. Sequentially, orders improved 18%, or $82 million with OE orders up 24% and aftermarket orders up 9%. On a year-over-year basis, orders increased 4% organically, an impressive result considering a rough comparison to Q1, 2016 when we booked two large food and beverage orders totaling $48 million.

Taking a closer look at Food and Beverage, Q1 orders were $184 million, up 15% sequentially. The increase was driven fairly evenly across aftermarket components and systems. We are seeing nice traction on our organic growth initiatives particularly for components and aftermarket growth. The system orders were of the small to mid sized nature averaging just over $1 million per order. These skids or modular systems are typically installed at existing process factories and support our customers' investment in new products operational efficiency and sustainability. Skids systems are beneficial to our business as they drive component pull through from our manufacturing sites, increased our install base and build customer intimacy in turn providing us greater opportunities to grow our aftermarket business. We are seeing a healthy level of activity in this part of the market as our customers invest in their organic initiatives to produce new products or expand into new geographies. Southeast Asia and Europe are notable regions where we are seeing the highest level of growth opportunities.

Moving on to Power and Energy. Q1 orders were $168 million, up 37% sequentially and 26% versus the prior year, driven largely by key order wins in North American oil pipeline markets. Our M&J Valve product line is well positioned in this market with long standing customer relationships, high quality control valves and competitive lead times. During the quarter, we awarded several contracts to support key customers as they move forward with pipeline projects, many of which were deferred throughout 2016. And on the pump side where we have a small but growing presence in the midstream market, we had a few nice order wins in line with our strategy to gain share in that part of the oil market.

In the upstream, our pump offering is concentrated in offshore applications where we continue to see very low levels of investment. We continue to believe capital investment in this part of the market will lag recovery in the broader oil industry. Aftermarket orders for the segment were up mid single digits sequentially for the second consecutive quarter. We are encouraged by the level of Q1 orders for Power and Energy and believe we are in the early stages of cyclical recovery in our related markets. That said, we expect OE orders to moderate in Q2 particularly in the midstream and we continue to focus on improving our cost structure in this segment.

In our Industrial segment, orders were $183 million in Q1, up 7% sequentially and 2% year-over-year. On sequential basis, the increase was broad based across nearly all the product lines. We believe this reflects the positive macro trends in industrial manufacturing and PMI indices, as well as some level of distributor restocking. This is our shortest cycle and highest margin segment with about 50% of the revenue concentrated in North America. We have well recognized brands across our industrial product lines with leading market positions particularly for our mixers, dehydration and hydraulic technologies which can be applied across several end market verticals.

Given our market position and positive momentum in the broader North American industrial markets, we are optimistic about the growth opportunities for this segment.

Moving on to our realignment program. In Q1, we realized year-over-year savings of $17 million. This represents 31% of our full year 2017 target. During Q1, we also recorded $9 million of charges related to incremental realignment actions. In Q2, we expect an additional $5 million to $10 million of special charges. From a footprint perspective, we continue to make steady progress. On that front, we are ramping up production of sanitary valves, homogenizers and heat exchangers at our new facility in Bydgoszcz, Poland. The team there is focused on driving productivity and efficiency gains and continues to lower our lead times to support our customers. In parallel to these efforts, the transition of the manufacturing operations for marine and agriculture pumps from Sweden into Bydgoszcz is progressing as planned should be completed by the end of Q3. We also have one smaller site consolidation in North America plan to be executed later this year.

Overall, we are on track to achieve $55 million of savings for the year and we are working diligently to complete the remaining actions. Our goal is to be substantially complete with a realignment program by the end of this year. As we closer to completing this significant step in our journey, we are pivoting our focus towards growth with an emphasis on the aftermarket and higher value product lines. I'll provide more color on that in my closing remarks.

And this time, I'll turn the call over to Jeremy.

Jeremy Smeltser

Thanks Marc. Good morning, everyone. I'll begin with the comparison of our Q1 results versus our guidance. Our Q1 results were in line or slightly better than our guidance. Revenue was $433 million and included a currency benefit of $8 million during the period. Segment income was $35 million at the high end of our guidance range, driven by a better operational performance that we anticipated in our power and energy segment. Corporate expense and special charges were in line with our expectations. Excluding special charges, adjusted EBITDA was $33 million at the high end of our guidance range.

EPS was in line with our guidance on both the GAAP and adjusted basis. As compared to our adjusted midpoint guidance, operating income was $0.06 favorable driven by power and energy? This was offset by $0.07 of charges related to non operational item which were not anticipated in the guidance primarily higher interest expense and a few discrete losses reported as other expense.

Interest expense was higher due to the rise in LIBOR throughout the quarter as well as elevated interest within our foreign cash pooling arrangement resulted from certain strategic planning initiative. In other expense, we recorded losses related to foreign currency transaction and to a legacy equity investment we are liquidating in Q2. It is also notable that we recorded $0.03 tax charge related to required change to the accounting for stock compensation.

Net of all these items, adjusted EPS for the quarter was a $0.01 loss. On a GAAP basis, we reported a loss of $0.18 per share in the period which includes $0.17 of special charges associated with our realignment program.

Looking now on our consolidated results, again revenue was $433 million, down 14% or $72 million year-over-year in line with our expectations. Currency had a 2% impact. Organic revenue declined 12% primarily reflecting our lower backlog position entering the year.

Segment income was $35 million at the high end of our guidance range. And margins improved 40 points year-over-year to 8.1% underscoring the continued benefit from our realignment program.

Moving on to the segment results beginning with Food and Beverage. Revenue was $166 million, down 10% versus the prior year. Currency was a modest headwind. Organic revenue was down 9% due primarily to lower revenue from large system project. Aftermarket sales grew 2% year-over-year. Segment income was $50.5 million or 9.3% of revenue. Savings from restructuring actions and cost production initiatives offset a large portion of the impact from the organic revenue decline.

In our Power and Energy segment, revenue was $106 million, down 29% or $44 million versus the prior year. Currency had a 4% impact. Organic revenue declined 25% or $38 million due primarily to a lower volume of OE sales. To lesser extent, aftermarket and service sales were also down.

The decline in revenue led to absorption challenges in our manufacturing plant. These headwinds were partially offset by savings from restructuring actions that we did last year. We reported a loss in the period of $1.5 million, a better result than we anticipated in our guidance.

As previously discussed, we expect Q1 to be a low point for revenue and profitability in power and energy. We expect the financial performance in this segment to improve in a meaningful way as the year progresses, given the backlog bill and savings from incremental actions to further improve our cost structure.

And our Industrial segment, Q1 revenue was $161 million, down 5% versus the prior year. Currency had a 1% impact. Organic revenue declined 4% due to lower sales of hydraulic tools and dehydration equipment. Segment income was $21 million, up $2 million versus the prior year. And margins increased 170 points or 13.1%. The improved profitability underscores the benefit from our realignment program and the related cost savings.

Looking now at our financial position, we ended the quarter with just over a $1 billion of total debt, down 5% sequentially. Cash on hand was $209 million. Net debt was $846 million, down $48 million from year end. Adjusted free cash flow in Q1 was $28 million, a solid start for the year particularly as compared to our historical working capital cycle.

We also generated $20 million of proceeds from asset sales in the period. We expect to generate an additional $10 million from asset sales in Q2. As it relates to capital allocation, we plan to allocate the majority of our available capital this year towards the realignment program, organic initiative and debt reduction. In Q1, we allocated $55 million to debt reduction, bringing net leverage down to 3.9x at the end of the period. Going forward, we'll continue to focus on de-levering with our goal to reduce net leverage to approximately 3.25x by year end.

Looking at backlog, our Q1 ending backlog was $913 million, up 16% or $129 million sequentially with backlog building across each segment. On the year-over-year basis, backlog declined 3% due to currency which more than offset a modest organic increase. About 80% of the current backlog is expected to convert to revenue over the balance of this year. This represents about 40% of our midpoint revenue target for the year, comparable to our backlog covered at the same point last year.

For the second quarter, we are targeting $490 million of revenue, up $60 million as compared to Q1. We expect revenue to grow sequentially across each segment reflecting the backlog build in Q1. About 70% of the Q2 revenue target was in backlog in third quarter. We expect solid leverage on a sequential growth with segment income expected to improve by about $20 million to between $50 million and $60 million. On a GAAP basis, our EPS guidance range for the quarter is $0.28 -$0.38 per share. This includes $5 million to $10 million of special charges.

Excluding special charges, our adjusted EPS guidance range is $0.40 to $0.50. As Marc mentioned earlier, we reaffirm our 2017 guidance today. While we are off to a solid start this year with positive order momentum, even that our first quarter result represent a relatively low percentage of our full year target. We think it's prudent to hold our guidance this time. That said, there are few notable puts and takes to consider. Starting with currency translation. FX rate moved in a favorable direction during the first quarter. Based on ending Q1 rate, there is about $36 million tailwind to our full year revenue target and $3 million tailwind to segment income

About 25% of this benefit was realized in the first quarter.

Q1 orders were well above the order run rate in our guidance. If we continue to see this level of quarterly orders through the balance of the year, it would provide upside to our full year revenue and segment profitability. This upside will be partially mitigated by an increase to variable incentive compensation at both the segment income and the corporate expense line. And interest expense is expected to remain at about $15 million to $16 million per quarter over the balance of the year. That's $4 million to $5 million headwind as compared to our current midpoint guidance.

Barring any foreseen market headwind, if we execute on the element within our control, we believe we are in a good position to achieve the upper half of our 2017 guidance range.

We are also maintaining our 2018 financial framework which assumes flat to 3% revenue growth over our 2017 guidance. We've been providing this 2018 view to illustrate the benefit that realizing the realignment savings we have to our key financial metric. The impact and the trends in currency rate, orders and interest expense that I just described for 2017 are also applicable to our 2018 financial.

With that, I'll turn the call back over to Marc for closing remarks.

Marc Michael

Thanks Jeremy. In closing, we are off to a solid start to the year with an improved financial position, higher backlog and positive order trends. What I'm most excited about are the opportunities within our control to continue transforming SPX FLOW into a high performing operating enterprise. We are in the very early stages of this journey which began with our spin-off from SPX Corporation at the end of 2015. In 2016, we quickly addressed our cost structure throughout through the realignment program. We also enhanced our focus on continuous improve by implementing consistent metrics across our manufacturing function with an emphasis on cost, quality and on time delivery.

Additionally, we've applied proven root cause analytics to drive a higher level of value to our customers on large project execution and delivery .At the outset of 2017; we established key performance indicators across all functions to drive an overall higher level of performance and accountability throughout the enterprise. And we are investing for profitable growth with an emphasis on aftermarket penetration, localization of our high value product lines and channel management.

Importantly, we are aligning our strategic workforce planning in a balanced manner to support growth while also improving our cost structure. And we are selectively elevating the talent on our commercial and operational teams with an emphasis on improving our product management and product delivery capabilities.

In summary, I'm proud of our teams across the world for what we've accomplished since becoming an independent standalone company. We simultaneously transition to an operating structure and weather cyclical downturns in our key end markets. A significant accomplishment. As we move forward, I firmly believe there is a great potential for us to execute at a higher level and expand our market share. We are still in the early stages of elevating SPX FLOW into a high performing operating enterprise with a vision of creating a wining culture to accountability, team work and a proven system for driving sustainable growth. And we are steadfastly committed to supporting our customers and creating value for our shareholders.

That concludes our prepared remarks. Appreciate you are joining us on the call this morning. At this time, we'll be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Our first question comes from the line of Deane Dray from RBC Capital Markets. Your line is open.

Andrew

Hi. Good morning. This is [Andrew Crone] for Dean. I am also -- can you give comment on pricing you are seeing across all three of the segments please?

Jeremy Smeltser

Sure. I'd say sequentially very steady to the second half of 2016. We haven't seen any major changes I'd say since the middle part of last year and just as a reminder last year one of the areas we did see decline in pricing was in the midstream market that Marc talked about this morning.

Andrew Crone

Okay. And then can you give any color on I guess what's assuming for the rest of the 2017 and guidance, is there any pricing or improvement stable versus kind of what have been current so far?

Jeremy Smeltser

We feel the stable.

Andrew Crone

Okay. And then just quick follow up on. Can you give some color on for food and bev, looks like kind of the only segment where you didn't see an organic uptick in orders and maybe what you are seeing in front long there and on dry versus wet dairy? Thank you.

Marc Michael

Yes, Andrew. It's Marc. So if you look at last year we did have some large system orders approximately $50 million of large system order last year in Q1. So if you look in and strip those out the run rate part of our business is stated a very healthy level and a strong level in the smaller mid sized type system orders as well as our components and aftermarket business. So on a year-over-year basis that would be a nice improvement and then we also saw an uptick sequentially. So that still continued to be a good part of our business overall.

Jeremy Smeltser

On the front log, I'd say it's relatively steady. We do think that Q1 and Q2 will probably the high watermarks for orders from food and beverage system perspective base and what we see a timing of the front log. Certainly that started out that way in Q1. We'd expect it to continue in the Q2 and then perhaps moderate in the second half of the year. But overall the environment is improved. It's just could be lumpy on the project side.

Operator

Thank you. Our next question comes from the line of Mike Halloran from Baird. Your line is open.

Mike Halloran

Hey, good morning, everyone. So why don't we continue on that thread and just talk about the theme of sustainability here. Obviously, understand why you'd want to be conservative in your outlook. I want to make sure things kind of play out as they are today. Maybe talk about the factors out there that give you comfort that the trend is sustainable and if there is anything out there that makes you little bit more worried about whether then you can continue to get pull through?

Marc Michael

Yes. I'll start it off and then Jeremy can add any additional point. As you look at Q1, one of the important places we did see an uptick in our orders was in our midstream valve business. These are some orders that we've been tracking for a while that had been deferred in 2016. So those came in Q1. We did see a pickup there. The front log remains active but we do expect the level of order intake to moderate as we move through the balance of the year for our midstream valve business. We also have been focusing on midstream around some of our ClydeUnion Pumps business and taking that technology more than stream, our product managers have done a nice job there. So we won some orders in Q1 and those continue to be a bit lumpy in their timing. So we need to take that consideration. And as we progress and look at our industrial orders through the quarter, we saw steady progress but we really want to ensure that there is a continuation as we move through Q2 and I think that will be important that we see a continuation of those industrial orders moving through Q2. So when we get to the end of the quarter, we'll be in a much better position to assess what the second half of the year would look like. As far as is risk are concerned, I'd say just ducktail to on to that the industrial piece having that continued momentum, it's going to be an important piece of what we have to really watch as we move not only through the second quarter but in the second half of the year.

Mike Halloran

And then on the power and energy margins, just help with the cadence, you are obviously sounds like you are expecting 1Q to be little watermark with the losses but I think guidance assumes a pretty healthy ramp from here so maybe just help give some color around how that looks through the year and what the exit rate potentially look like?

Jeremy Smeltser

Sure. I mean we do expect it to increase pretty dramatically sequentially as we progress through the year. And lots of that thinks about what we do in that segment. We cut a lot of metal, write a lot of bricks-and-mortar and so absorption is a real key and so at a $106 million of revenue in Q1, it's just a real challenge to absorb that level of big cost so a lot of it will come from sequential uptick in revenue which a lot of it will be driven by the midstream orders, pipeline orders that Marc just mentioned. A lot of those we took in Q1 will actually deliver in Q2 and in Q3. So we should exit the year at a higher level than the full year target for margin. And what happens next year will really be depended on the orderbook for the remainder of the year.

Operator

Thank you. And our next question comes from the line of Nathan Jones from Stifel. Your line is open.

Adam Farley

Hey, good morning. Adam Farley on for Nathan. Following up on industrial, there have been a lot of broad reports I mean improving general industrial economy. Are there any notable areas of strength and weaknesses you guys have seen in the business?

Marc Michael

Yes. Adam, it's pretty broad based what we saw in the first quarter. Our mix of business and portable was good in terms of order intake. Still little slower in the larger type orders and mixers but again that the run rate business was good. Hydraulic was good in the quarter. Again some of that -- we can look to some distributor restocking in Q1 which typically takes place but good year-over-year and sequential improvement there also. And then we really watch our dehydration orders and how they progress and we saw a steady trend upward as we progress through Q1 in our dehydration business. So again the underlying view would be that there is progress been made in the industrial market and again that as I mentioned earlier, we want to insure we continue to see that as we move through Q2 here for the balance of the year.

Adam Farley

Okay. That's helpful. Turning to Food and Beverage. Can you just provide a little bit more detail on how you are thinking about the supply demand balance especially on the dry side of the dairy business?

Marc Michael

Yes. We saw some moderations as we were exiting the end of last year we saw prices start to rebound in the dry dairy commodity market and that's pull back a bit, they are moving through the first quarter and I'd call it moderated maybe is better word to describe it as we did pretty substantial uptick moving through Q4 last year in terms of where pricing was. Our front log as Jeremy mentioned is remained pretty active and we still do have a number of dry projects out there. The liquid projects remain active too. We didn't see - we haven't seen a big change in our front log for quite some time now in terms of the overall activity that we have. But also Jeremy mentioned really there is a timing element with some of these projects. A lot of the larger projects we expect would potentially happen are here in the first quarter and second quarter and larger prices again -- right now have been those that have been typically less than $15 million. There are couples out there that we are working on that are of the larger size. But we'll just have to see how they actually shake out in terms of the timing. I'd mention that some of the European customers are indicating some additional capital deployment moving through 2017. So that's an encouraging sign. But overall it's been really steady and continuous improvement the way I'd describe it in our food and beverage order intake across the smaller to mid sized system orders and then steady progress [Technical Difficulty] in aftermarket.

Operator

Our next question will come from the line of Ryan Cassil from Seaport. Your line is open.

Ryan Cassil

Hi, guys. Nice quarter there. Just kind of wanted to follow back up on the cadence of industrial. Did you guys make a comment on sort of what we've seen here through April? Sort of how is that trend we saw progress through the quarter continued? Any color there.

Jeremy Smeltser

Yes. I'd say during first quarter we were relatively consistent. We did have some nice capital orders in March. And April is relatively consistent with how we started the first quarter. In my mind in industrial I would say the industrial one thing to think about if you go back to that industrial orders start looking at by quarter, Q1 this year looks very consistent with Q1 last year. And we did see a sequential decline in Q2 through Q4 last year. So we've been cautious and not increasing that in our run rate from our first round of guidance and I think we just as Marc mentioned earlier we have to see how things progress during Q2. We do have some level of distributor restocking that's true in hydraulic. It's also true in dehydration. We want to make sure that we see that Q1 order run rate follow through to the Q2 before we get more proactive on our thought for that market.

Ryan Cassil

Okay. Is that the biggest driver of sort of the potential upside you guys noted if trend continue to the upside of your guidance? Is that a biggest variable you are sort of looking at in industrial business?

Jeremy Smeltser

It's -- I'd say it's most impactful to margin. I think it's unlikely to be massive revenue increase, probably the larger variable from a revenue perspective as if we see more of these capital type project start to hit we saw one or two in Q1. And if you recall in the past in that segment across the various products would be 6 or 8 years and from the last couple of years we really haven't seen -- hardly any at all. So that would be in my mind the bigger driver to stop.

Ryan Cassil

Okay. That's helpful. And then in the P&E segment, could you quantify what the impact of those midstream quarters were on your total order number? I am really just trying to get a sense for excluding that if you think it's going to moderate sort of what the run rate is in the quarter after that?

Jeremy Smeltser

Yes, sure. If you look specific to that to the OE Valve across all of our OE valves, we averaged $20 million a quarter last year. And we did almost $50 million of orders in Q1 and that in the OE valve side. So it was the biggest driver obviously by far about three quarters of sequential order increase in that business and as Marc mentioned, while it does look better than last year in the front log, we don't expect and we don't see anything like what we saw in Q1 to continue in particularly the middle part of the year.

Ryan Cassil

Okay. So $30 million of what you consider kind of incremental or maybe non repetitive orders but that's still get to you flat to up year-over-year on the orderbook? Is that fair to think about?

Jeremy Smeltser

Yes. As Marc mentioned earlier, we saw a nice improvement sequentially in the aftermarket then also on the Clyde pump side in the midstream and downstream. So we are making progress there I think from an internal initiative perspective and there is some additional level of capital spending by our customers with oil sustaining here around the $50 mark.

Ryan Cassil

Great, okay. That's helpful. And then lastly on the food and beverage side. The decremental margins look like they are about 10% or so which is much lower than we saw last year which is great but overall margin little over than we expected but really just kind of implies a bigger ramp as we move through the year. Does that start in the second quarter? Is that more second half weighted when you start to see those savings benefits?

Jeremy Smeltser

We would expect to see it in the second quarter. In my comments earlier around P&E apply somewhat to food and beverage as well. It's a pretty low revenue quarter for us so we didn't fully absorb across all of our plan.

Operator

Thank you. And our next question comes from the line of Nigel Coe from Morgan Stanley. Your line is open.

Nigel Coe

Yes, thanks. Good morning, guys. Obviously very encouraging quarter. So the order rates -- the order rate is $535 million. I think you are planning on the second half order run rate in your full year plan. So even if we back out that $30 million on the OE valve side, it's still running well above second half run rate. So I am wondering if we do sort of just stall back a little bit from 1Q, and if we do want to some fair analysis, what kind of incremental margins should we put on any revenue upside you manage to get to your plan, would it be sort of gross margin or is this some cost that back that you would need to think about as well?

Jeremy Smeltser

Sure. I think about it two ways. I think about it first on the currency side that I mentioned in the prepared remarks at around $35 million to the full year model, really coming at less than segment income margins because of the profitability of where those -- that currency translation benefit come. So that's about $3 million of segment income improvement on $35 million of revenue. Then on the organic side, I think thinking about it from a gross margin perspective is the right way to think about it with the caution that we had in the prepared remarks that for the first I call it $50 million to $75 million of potential review upside you would see an increase in variable incentive compensation expense for our short-term bonus programs across the world, which would mitigate the gross margin pull through somewhat. But yes gross margin is the way to start.

Nigel Coe

Okay. And that's actually my next question was how do you think about the step up in incentive comp as we start scaling back up in these cycles?

Jeremy Smeltser

Yes. I'd say across all of the various plans that we have. You could see $10 million to upward to $50 million of incremental expense if it is driven by revenue and gross margin. We talked about earlier this year that we did add orders and EBITDA to our short-term incentive compensation plan and so anything that you put in your model from an orders and EBITDA perspective just think about as it ramps it would dial back down in that $10 million to $50 million range depending on how high you would model it.

Nigel Coe

Okay. That's helpful. And then just final one for me would be -- you mentioned that pricing is sequentially stable the second half, obviously raw material inflation is come back in a pretty big way here so can you just maybe comment on what you realized in price cost in the first quarter? What's embedded in your backlog for price cost? And then maybe just comment on the offsets that you are seeing from mix as the OE projects versus aftermarket services? Obviously, there is richer mix right now.

Jeremy Smeltser

Yes. I mean on the raw material front, we are certainly seeing a little bit of inflation but as it's typical both the upside and downside in the majority of our markets, we've been able to pass through relatively quickly. So we are pleased with our performance there and we do have a lot of great initiatives going on in our supplier chain organization to offset inflation. We anticipated that it would happen this year. So that's not big challenge for us. We basically assume that we don't see a net negative on inflation for raw materials. Mix side, the larger projects with the exception of the midstream as it relates to power and energy, they typically come at lower margin than the component and aftermarket. But they do have a strong benefit to absorption and the plans so in general for us the pull through particularly for the first layer of capital project increases in our run rates will come through at margins that are coming close to our average gross margins. Is that answered your question?

Operator

Thank you. And our next question comes from the line of John Walsh from Vertical Research. Your line is open.

John Walsh

Hi, good morning. Hi, so with a lot of operational ground covered, I was curious if you could comment on -- so yesterday there was an 8-K that came out, looks like there are some new management proposals ahead of the annual meeting around board classification and some other items. So I just wondering if you kind of comment on that and any color there you could provide?

Marc Michael

Yes, sure, John. Yes, so that was in reference to looking at some things we'll address at the 2018 annual meeting. And coming out of the spin and the structure that we had for the Board we felt was very much appropriate for where we were as a new company. And given that the changes that we were going through and that we've continued to progress on as we gone through last year and the early part of this year. So as we thought about 2018, we'll be well into two and half years into the post spin. And it -- as we looked at it, as the Board looked at it, it's a good time to address our structure at that stage given what we well underway we wanted to be establishing ourselves as an independent company.

John Walsh

All right. And then as we think about growth going forward, we've heard from some of your peers and even more broadly that there has been some supply chain issues with vendors. Wanted to know your comfort level around your supply chain and if there are any issues or any thoughts there?

Marc Michael

Yes. We haven't seen any significant issues within our supply chain vendors thus far in the year.

John Walsh

Got you. And then just lastly, I am just wondering if you can kind of comment specifically around what you are seeing in China little more around the different businesses and kind of what China was in the quarter for you overall?

Marc Michael

What we are seeing -- China is a little slower for us in terms of some of the order intake. We do expect that to pickup as we move through the year with some of the project timing. But it started out the year a little slower than where we were seeing in 2016. We also had some larger projects; I'd say the medium sized projects that were earlier in the year in 2016 in China. So again timing in China for some of the projects will influence in the food and beverage partner of the business. The outlook of order intake, where we are encouraged is in the industrial side of the business. China has new policies in place where they are extending their EPCs outside of China into the Middle East and other parts of Europe. And we expect that to start create opportunities as we look to the future. Maybe a little less about this year but as you move through potentially the second half or latter half of the year into 2018, our industrial business has opportunities for growing our product to penetration with the larger Chinese EPC. So we are still encouraged about China. It has been a little slower though moving through the first quarter of the year in terms of our order development.

Operator

Thank you. And our next question comes from the line of Ronny Lloyds from Credit Suisse. Your line is open.

Ronny Lloyds

Hey, good morning, guys. Looking at the industrial margin here, strong expansion in Q1 and then what assumes for the full year in guide? Is the step down just a function of the conservatism? You guys have talked about on the top line or are there any change in mix or anything they also call out that would reverse any of the progression made in Q1?

Jeremy Smeltser

No. I think our full year target is higher than our first quarter performance and that reflects primarily the additional cost savings that we expect to roll through the year.

Ronny Lloyds

Okay. And then looking at the $140 million in the savings, you said Q1 orders are above, is there any risk that $140 million given that demand setting up that you might have to add back cost or you can't take out as much cost as you initially expected when the program is started?

Marc Michael

No. Ronny, we are still committed -- we are committed to the $140 million. For that matter we'll continue to work on continuous improvement activities that as we through the year and into 2018 to look for additional opportunities. And if you think about add backs too, if we do have to add various back it would be more in the direct labor side just on the volume basis, but we feel pretty comfortable with where we are right now. Lot of changes again was structure related so we are not expecting any risk to the $140 million and we believe we'll manage through any inflection points in volume very effectively.

Ronny Lloyds

Okay. And then just lastly real quick on the food and beverage side. There were no more elevated kind of cost that had kind of hit you guys in the margin in the back half of the year in Q1 right.

Marc Michael

No. What we planned for Q1 played out as we expected and hence we are finishing up some of the projects we talked about. We still expect that to happen in Q2 and we plan for that accordingly.

Operator

Thank you. Our next question comes from the line of Robert Barry from Susquehanna. Your line is open.

Robert Barry

Hey, guys. Good morning. Congrats on the solid quarter. Wanted to follow up on the earlier question about modeling potentially upside. When you are talking about the incremental variable comp of 10 to 15, was that on incremental upside of $50 million to $75 million of revenue over and above the high end of your range?

Jeremy Smeltser

I was thinking about it from the mid point up is what I was thinking.

Robert Barry

I see. So if you coming at the high end of the revenue range the high end of the EBITDA does not factor the incremental variable comp?

Jeremy Smeltser

It does at the high end of our guidance range. It already reflects a portion of that 10 to 15 that I mentioned but the problem is there is multiple variables that drive what that would be, Robert, because we are using orders as a metric, we are using EBITDA as a metric and we are using free cash flow dollars as a metric. So it really depends on where exactly the upside comes from. So I am just -- I am trying to give a framework for people to kind of logically think about what it could be in total. But it's very difficult to dial with a more specifically.

Robert Barry

Got you, okay. And maybe I can follow up more offline but it sounds like if the revenue is just at the high end it doesn't mean necessarily that the EBITDA will be in part because of variable comp?

Jeremy Smeltser

Well, I think as it relates to our specific model that we build to drive the range of our guidance that most likely -- the most likely scenario that would get us to the high end of our revenue and EBITDA would include the incremental incentive comp. I think it's just really to think about -- if you think about 35% or so pull through at the EBITDA margin line from additional revenue it's just thinking about modeling in that incremental expense that would drag it down. And we've reflected that within our guidance range but anything above that which I think is what Nigel was asking about. We have to model in additional expense.

Robert Barry

Got it, okay. Just more of a strategic question, to what extent do you think some of these order, solid orders you are reflecting are share gain. I mean we see some big players having some operational issues and other is undergoing a pretty big strategic transition. Do you think that's benefiting you? Is that showing up in the orders here?

Marc Michael

Yes, I'd say that we've done a lot of work in our factories on improving lead times and putting ourselves in a better position to be successful with our customers. So, yes, when we look at what our operation has accomplished in better lead times and again as we continue to address the cost structure, we believe that put us in a more favorable position to take share in the market.

Robert Barry

Yes. To what extent our lead time is competitive across the portfolio?

Marc Michael

It depends on which part of the portfolio we are speaking about but for the most part I'd say we are very competitive or better in some cases than market lead times. But it's something we continue to look at from our project managers assessing that and feeding that back into our manufacturing team so that we can look at ways to make improvements that we need to. And one of our big initiatives that we've talked about is looking at our high value product lines and localizing those in countries where we see opportunities for growth so closer to our customers. So leveraging our footprint more effectively. And we've done that throughout 2016 and even getting more aggressive with that in 2017. So that's also helping our lead time position by localizing a lot of a product lines in our factories around the world. So that we can improve our lead time and our cost structure.

Robert Barry

Got you. Maybe just finally from me, wanted to come at the pricing question from a different angle. I mean if you think about booked margin on these orders, is that accretive to margins say where you end in 2016 or kind of neutral or dilutive?

Marc Michael

Relatively neutral.

Ryan Taylor

Hi, this is Ryan. Thanks Robert and thanks to everyone for joining us on the call today. That concludes our Q1, 2017 earnings call. As per the usual, Stuart and I'll be available throughout the day to answer any follow up questions that you might have. Thanks for joining us.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.

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