Global X U.S. Cash Flow Kings 100 ETF
Q3 2018 Earnings Call Transcript

Published: 30 Oct 2018

[Operator:]

Good day, ladies and gentlemen and welcome to the Q3 2018 SPX FLOW Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to VP of Investor Relations, Ryan Taylor. Sir, you may begin.

[Ryan Taylor:]

Thanks, Shabby and good morning, everyone. Thanks for joining us today. With me on the call this morning are Marc Michael, President and CEO and Jeremy Smeltser, our Chief Financial Officer. Our Q3 2018 earnings 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. And as a reminder, a replay of this webcast will be available on our website later today. Portions of our presentation and comments are forward-looking and subject to Safe Harbor provisions. And 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 measures presented. And with that, I will turn the call over to Marc.

[Marc Michael:]

Thanks, Ryan and good morning everyone. Thanks for joining us on the call. I will begin this morning with an overview of our year-to-date performance, updated guidance and consolidated results for the third quarter. Jeremy will then take you through a detailed review of our segment results, financial position and guidance. Through the first 9 months of 2018, we have taken positive steps on our journey to transform SPX Flow into a high-performing operating enterprise. Revenue has grown 9% year-over-year, including 5% organic growth. However, gross margins have held flat at about 32% as pricing actions and supply chain initiatives have not neutralized the impact from cost inflation in our year-to-date results. SG&A as a percent of sales is down 240 points year-over-year to 21.7% reflecting the annualized cost savings from the realignment program and lower incentive compensation. These benefits were partially offset by strategic hires for supporting our growth and continuous improvement efforts. EBITDA has grown 25% year-over-year and EBITDA margins have expanded 140 points to 11.2%. Notably, the mix of orders has been consistent with our product line strategy securing high single-digit order growth in our highest value product lines while maintaining discipline and selectivity in areas of our portfolio where we are focused on enhancing performance. Over time, we expect this strategy will result in a higher margin profile across the enterprise in a more consistent level of operating performance. Capital allocation this year has been focused on organic investments and debt reduction. Gross debt has been reduced 6% year-to-date and we plan to make an additional $30 million prepayment our term loan tomorrow, which will bring total debt reduction of the year to approximately 10%. Net leverage is now at 2.4x down a full turn from a year ago. We expect to exit this year with a net leverage at approximately 2.1x, a comparable level for us to consider expanding our capital allocation actions. Despite this progress we are behind where we expected to be as it relates to margin expansion this year due primarily to a lack of price realization and unfavorable mix. Our revised full year guidance reflects these developments which materialized in Q3 and are also expected to impact our Q4 margins. During Q4, we are implementing additional surcharges and price increases. However, we do not anticipate these actions will provide a material benefit to our Q4 margin performance. Accordingly, we have reduced our profit and margin expectations for the fourth quarter and the year. For the full year, we now – excuse me, for the full year we are now expecting organic revenue growth of 4% to 5% and EPS between $2.21 and $2.34 per share. EBITDA is expected to be between $232 million and $240 million which now includes $8 million of currency losses. And free cash flow is now expected to be in the range of $90 million to $100 million approximately 100% conversion of net income. Looking at our fourth quarter expectations as compared to the prior year we are targeting 2% to 5% organic revenue growth and about 90 points of margin expansion. This level of margin improvement is about 300 points below our previous expectations reflecting the unfavorable mix and lower pricing realization. We expect to deliver strong free cash flow in the range of $60 million to $70 million consistent with historical Q4 seasonality. Reflecting back on the past 2 years we set a solid foundation for the future. We executed our realignment program, reduced net leverage and grew our high value orders. Given this I am not satisfied with the lower level of profit and margin expansion we now expect to deliver in 2018. Going forward we will aggressively work to better – to get better and take the necessary steps to stay on path to high performance. Shifting our business mix to higher value components and aftermarket streams and driving the culture of continuous improvement with solid operational execution are paramount for our success. I ensure you the entire organization is motivated to achieve these goals, increase customer satisfaction and deliver shareholder value. Looking at orders Q3 orders were $500 million. As compared to the prior year we saw strong organic growth across our industrial product lines and solid growth in power and energy driven by $15 million midstream valve order. In food and beverage solid growth in component and aftermarket orders was offset by a lower level of system orders. This was largely due to a $28 million dairy processing order we were awarded in the prior year period that did not repeat. Aftermarket orders across the enterprise grew 7% year-over-year with growth across all three segments. On a sequential basis orders moderated as anticipated due to a lower level of food and beverage system orders and midstream valve orders. As I mentioned, our order development continues to be consistent with the growth strategy we described at our investor presentation earlier this year. Our product line strategy is aimed at shifting our business mix to a higher margin profile in simplified operating environment. Our aggressively invest product lines serve high specification applications with faster cycle times across common operational platforms. Over time, we believe this shift towards higher value, higher margin products will feature more prominently in our revenue and margin profile. And we continue to be encouraged with our order development on this front. Through the first 9 months on an organic basis versus the prior year orders in our aggressive investment category grew high single-digits with growth across all six product lines led by mixers and food and beverage pumps and valves. Orders in the opportunistic invest category were up low single-digits driven by midstream valve order growth. And in the three product lines where we are enhancing performance orders declined double digits reflecting our selectivity and discipline. In this category we are seeing modest improvements in the quality of new orders. We ended Q3 with backlog just over $1 billion. Year-over-year backlog is up 7% or $70 million on an organic basis. Quarter-to-quarter backlog declined modestly. At this time I will turn the call over to Jeremy for a detail review of our financial results.

[Jeremy Smeltser:]

Thanks Marc. Good morning everyone. I will begin with earnings per share. Q3 EPS was $0.77, exceeding the high end of our guidance range and $0.15 better than our midpoint guidance. As compared to our midpoint operating income was $0.09 better due primarily to lower incentive compensation expense in both the segments and in corporate. Other expense was a $0.04 headwind to our guide due primarily to currency losses most notably further devaluation of the Angolan Kwanza. This headwind was mostly offset by lower interest and minority interest expense. And taxes were $0.07 benefit driven primarily by revision of our estimate for the transition tax liability. The effective tax rate in our reported results was 22%. Excluding discrete tax items, our underlying tax rate was 28% in line with our guidance assumptions. Moving on to the segment results beginning with food and beverage, Q3 revenue was $195 million, up 10% from the prior year. Organic growth was 7% driven by mid single-digit growth and component and aftermarket sales and a higher level of systems revenue. The accounting change to ASC 606 revenue recognition drove a 5% increase in revenue and currency was about a 2% headwind. Segment income increased 38% to $27 million with margins up 280 points to 14.1%. The increase in profitability was due to a lower level of incentive compensation expense in the growth and component sales. On the order front, continued growth in our component and aftermarket orders was offset by a decline in system orders. In total, orders were $158 million down 16% year-over-year. Recall that we were awarded a $28 million dry dairy system orders in Q3 2017. In contrast, we did not book any system orders greater than $10 million in Q3 2018 consistent with our strategy to be selective on large projects. Overall, the market trends in food and beverage are healthy and we continue to emphasize growth in our higher value component and aftermarket offerings. Taking a look at power and energy, Q3 revenue was $147 million, up 4% year-over-year. Organic growth was 7% driven by an increase in OE pump shipments supporting our North American midstream customers. This was partially offset by a decline in higher margin bowel shipments into the same market. Aftermarket revenue grew low single-digits. Segment income was $11 million and margins were 7.5%. As compared to the prior year, profitability was lower due to unfavorable revenue mix, increased warranty expense and a bad debt charge on a project awarded in 2014. These items were partially offset by savings from cost reduction initiatives and lower incentive compensation as compared to the prior year. Orders were $146 million, up 5% organically driven by orders from midstream pipeline valves in North America. Notably, we were awarded a $15 million order for pipeline valves scheduled for delivery in 2019. Aftermarket orders grew low single-digits on an increased level of replacement activity in upstream oil and nuclear safety applications. We are encouraged by the elevated level of aftermarket activity as well as the continued demand for OE products in the midstream. Wrapping up the segment results with industrial, first I want to mention that two of our industrial product facilities are located on the East Coast of North Carolina. Those sites both experienced downtime in September as a result of the impact from hurricane Florence. Fortunately, our team members in those locations took the proper safety measures to protect themselves and their families. Our facilities incurred minor damage and are up and running. Overall, the storms impacted us by about $1.5 million on the margin line. Moving on to the results, industrial segment revenue in Q3 was $189 million, up 7% year-over-year. Organic growth was 9% driven by increased shipments of mixers, dehydration units and pumps. Segment income was $27 million, up 22% year-over-year and margins expanded 150 points to 14.2%. The increase in profitability was driven by the organic revenue growth and lower incentive compensation versus the prior year. Orders grew 9% on an organic basis to $196 million driven by high single-digit growth in mixers and dehydration units and mid single-digit growth in pumps and hydraulic tools. Moving on to guidance beginning with Q4, revenue is expected to be between $530 million and $550 million, currency is expected to be 1% to 2% headwind versus the prior year, and we expect organic growth of 2% to 5% concentrated in our industrial and food and beverage segments. We’re targeting $58 million to $66 million of segment income with margins at about 11.5%. Our Q4 EPS guidance range is $0.54 to $0.67 per share. This assumes a tax rate between 29% and 30%. And we expect to generate approximately $62 million of EBITDA and $65 million of free cash flow in the quarter. Looking now at more detail supporting our revised full-year guidance. Our underlying assumptions for revenue have been updated to reflect the year-to-date results and the timing of shippable backlog scheduled for delivery, as well as our book and turn assumption for the fourth quarter. Based on these items as compared to the previous guidance, we have narrowed our organic growth range to 4% to 5%. Operating income is expected to be $187 million or 9% of revenue, representing 190 points of improvement over the adjusted operating margin reported in 2017. We expect EBITDA to be between $232 million and $240 million, which now includes $8 million of currency losses not assumed in our guidance at the outset of the year. At the midpoint, we’re targeting 17% EBITDA growth versus the prior year. Our EPS guidance is $2.21 to $2.34 per share and assumes a tax rate between 25% and 26% for the full-year. And we’re targeting free cash flow in the range of $90 million to $100 million or approximately 100% conversion of net income. Taking a brief look now at our financial position. Free cash flow for the quarter was $25 million, including $5 million of CapEx and $2 million of restructuring payments. We ended the quarter with $222 million of cash on hand and $838 million of total debt, down 6% from year-end. Tomorrow we plan to make an additional $30 million prepayment our term loan, which will reduce the outstanding balance to $175 million and bring total debt reduction this year to 10%. Net leverage was 2.4 times at the end of Q3, down more than half a turn from the beginning of the year. We expect to exit this year with net leverage slightly above two times. Consistent with our historical seasonality, we expect strong free cash flow conversion in the fourth quarter. We expect to enter 2019 in a very solid financial position with optionality to expand our capital allocation actions. That concludes my prepared remarks. And at this time, I’ll turn the call back over to Marc.

[Marc Michael:]

In closing, we’re on pace this year to deliver mid-single-digit top-line growth while improving operating margins about 200 points to 9% and reducing net leverage to just over two times. While we’ve made good progress over the past two years to set our foundation for growth and improvement, I’m not satisfied with our operational execution this year and the lower level of profit and margin expansion in our revised guidance. Going forward, we will aggressively work to elevate our performance while executing our product line strategy and continuous improvement initiatives. There remain ample opportunities for improvement and our global team is engaged and committed to achieving a higher standard performance, greater customer satisfaction, and in turn, more value for shareholders. I'm confident in our ability to transform SPX FLOW to high-performing operating enterprise. That concludes our prepared remarks. And at this time, we’ll open the call for your questions.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from Mike Halloran from Baird. Your line is now open.

[Mike Halloran:]

Hey, good morning, everyone.

[Marc Michael:]

Good morning, Mike.

[Jeremy Smeltser:]

Good morning, Mike.

[Mike Halloran:]

So, couple of questions here. First one, just some thoughts on the underlying demand dynamics, puts and takes. Obviously, you’re getting orders where you want to get them, but maybe talk a little bit about the underlying trajectory going into next year across your businesses, sustainability of the trends you’re seeing, any signs of pressure in any place where you rethink acceleration can come, essentially just looking at the landscape it's obviously pretty choppy, but still healthy and want to understand how that's reflected in your overall outlook and thought processes as we had in the next year on the top line?

[Marc Michael:]

Yes. I will kick it up Mike it’s, Marc and Jeremy any additional color. You know what we saw coming out of Q3, it met our expectations, but we did see a higher percentage of OE equipment orders really focused in industrial and then the well bores that we achieved. So those were a bit ahead of our expectations. So of the positive we did see what I would say less of some of the other areas around pumps and valves and food and beverage for example in the quarter. Now in some cases that’s not in common to see a slowdown in the third quarter just based on some seasonality, I wouldn’t say that was dramatically different from a seasonality perspective year-over-year, but it was slower in July and August with some pickup in September. So we are watching that closely to your point and seeing how things developed here in Q4 and that’s going to be important in how things set up for next year. Obviously with the dynamics that are developed as we have gone through the last six months as we all know with trade and tariffs and a strong dollar we are just paying close attention globally. In the quarter on a year-over-year basis again we still saw pretty good performance across North America, recently well in Europe and even in China, but again it’s something we got to pay close attention to as we are going through the fourth quarter here to see how things are to setup a 2019.

[Jeremy Smeltser:]

I agree with all that. I think that was year-over-year we think sequentially we indicated we expected a moderation in order level from the Q2 level at $575 million, but it did moderate further than I expected it too frankly. And as we look at the dynamics of that, the market on one key one which is a slower first half of the quarter and really not enough time to catch up in September. And then as I look at the front log what we are seeing is more talk of delays in customers’ projects than we are seeing things disappearing in the front log. And I think market on the head which is some of the level of uncertainty we are seeing around trade and tariffs and the like is likely delaying some of those customers final decision making on their capital projects.

[Mike Halloran:]

Okay, that makes sense and so color there. And then obviously the margins you guys hit on the slower than expected price realization versus was obviously a lot of inflationary pressures in the quarter, could you talk a little bit about what this means going forward in terms of when do you expect to be able to become whole, is this a blip in the radar and then ‘19 is more or less back on track, is this something that systemically might linger longer than one or two quarters, maybe just try to frame how long you think it takes to get back towards the price cost neutral timeframe?

[Marc Michael:]

Yes. Sure Mike. So maybe just a little color around the dynamic that happened in Q3, so if recall back on the Q2 call, we talked about being modestly priced positive for the first half of the year. And we were expecting an acceleration of inflation and that did happen, but the dynamic that also happened on the pricing side it was a lack of price realization more in our engineered equipment part of our business, so more focused in power and energy and industrial, more weighted in that area. So that costing and pricing is done on the bid to bid basis and again there are bit more engineered type products. So we are tightening up this process and José and his team are looking at additional price increases in that part of the business for P&E and industrial delights is looking also at some additional price increases in food and beverage. Ty and his team are also working aggressively on the cost side. So we will take those steps during the fourth quarter and we would anticipate some improvement starting develop, I mean sometimes that’s a little bit hard to predict the exact timing, but that’s the stuff for taking and we will watch closely how that develops as we move into 2019.

[Jeremy Smeltser:]

Yes. I agree with Marc. Again on that I think historically the cycle in these businesses over the last two decades we have been able to offset cost inflation with price. I don’t think there is any reason why we can’t do it. Again this time certainly with our expectations a little slower out of the gate, but we will have to be very disciplined on that as we head into the fourth quarter here and in early 2019. And I think the only question Marc will be the overall macro and the bigger challenge of getting price through if market conditions do slow down.

[Marc Michael:]

Yes. And just one final note thought there I mean this has got top attention from all our team to work on recovering this, because we have been placing an emphasis on it throughout the year and even going back to the latter part of last year, so the team is fully engaged and we are taking really aggressive steps to tighten this up.

[Mike Halloran:]

Great. I appreciate the time as always.

[Marc Michael:]

Thanks Mike.

[Jeremy Smeltser:]

Thanks Mike.

[Operator:]

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

[Nathan Jones:]

Good morning everyone.

[Marc Michael:]

Good morning Nathan.

[Jeremy Smeltser:]

Hi Nathan.

[Nathan Jones:]

Just following-up on the on the price-cost side of it, I mean as you guys said you had positive first half, expected inflation in the third quarter, I know you guys have significantly improved the processes around there over the last couple of years, expanded the use of SAP, but was there a gap in here in process improvement that maybe delayed visibility into this kind of pricing issue that you have or will be correcting, I am just – I was a little surprised that this really crept up and beat you in as bigger way as it did this quarter given how it had been in the first half of the year, given the process improvements, so just any color on the process side of how pricing versus cost is working in there and if there was a problem with the process is that being corrected?

[Marc Michael:]

Yes. Nathan, so as I was kind of mentioning to Mike a lot of this developed in our engineered equipment side of our business, so heavily weighted in power and energy and then also some in industrial. And that pricing is done on – let’s call it bid to bid basis, less about what’s just in standard costing and standard type pricing sheets and things of that nature, so that is where a big part development and you are spot-on, it’s tightening up that process around the costing and bidding side of that. We have line of sight to what costing looks like. But we just we need to go back and make sure everything is being reflected appropriately and then the right margin profiles are developing from that. So José and his team are on top of it. They have taken some additional steps already here in the quarter, but it is the tightening up process around that engineered equipment part of the business.

[Nathan Jones:]

How confident are you that you wanted to say I repeated this kind of thing, because this is bid out on a project to project basis, those kinds of projects are going to continue to happen, have you gained better visibility into that, have the teams gained better visibility onto that so that these things are priced appropriately?

[Marc Michael:]

Yes. The answer is yes, we have taken into consideration as we are looking at the current period and we will evaluate it more as we move into 2019. The second half backlog is heavily weighted towards more of the product lines that are engineered or in some cases as we know in food and beverage we have got some large systems that are flowing through from orders last year. So it’s those engineered products also that are at a higher percentage in the second half backlog, so up let’s say roughly 20% year-over-year in that area. So we have taken that into consideration in terms of how we have considered the outlook, but we have got to move rapidly to make these adjustments.

[Nathan Jones:]

Okay. Then I am going to move onto orders here, it’s definitely very nice to see, the higher order growth in the targeted areas and the lower order growth in the kind of lower margin areas here, I assume that means that pricing and backlog continues to improve or certainly the margins in backlog continues to improve, is there any kind of information you can give us on what kind of shift has been in the quality of margins in the backlog and how you would expect that to progress over the next few quarters?

[Marc Michael:]

Sure. I think probably not few quarters, but the next couple of quarters anyway as it relates to how much backlog we carry which as you know is about half the year’s revenue give or take. So for the fourth quarter what we see is a relatively similar level of margin and backlog that we saw at the beginning of Q3 and that’s reflected in the fourth quarter guidance that you see which is relatively steady from Q3. And we are seeing improvement from the mix shift that you just referenced Nathan, but we do have still some of the lower margin projects some from last year, some from earlier this year that we have to deliver in Q4. As those clear the backlog heading into Q1 and Q2 we do see an improvement in margins and backlog for what’s there so far. Obviously, we have started quarter with around 80% give or take depending on the quarter of – that quarter’s projected revenue and backlog, but we’re seeing that improvement for Q1. If we execute well here in Q4 as Marc talked about, we should expect to see that continue for Q2.

[Marc Michael:]

And I would just add overall executing the strategy that we put in place, still ample room to grow these high-value product lines as a percentage of our mix and continue to change that and that will happen. I mean, if you look at our systems orders on a year-over-year basis in food and beverage that’s going to come down significantly. And so there's still a lot in our control and that – in the – to expand margins really through improved productivity. So, lot to be – we’re working hard on that side too, ties you know inthe factories and we’ll do another part to the organization also. So, the strategy that we’re executing still holds firm and the backlog will catch up to that as we move into next year.

[Nathan Jones:]

Awesome. That's helpful. Thanks very much.

[Jeremy Smeltser:]

Thanks, Nathan.

[Marc Michael:]

Sure, Nathan.

[Operator:]

Thank you. And our next question comes from Robert Barry from Buckingham. Your line is now open.

[Robert Barry:]

Hey guys, good morning.

[Jeremy Smeltser:]

Good morning, Robert.

[Marc Michael:]

Good morning, Robert.

[Robert Barry:]

I guess I wanted to follow up on a couple of things here. So, it sounds like on the price realization front, it’s more your execution versus the market not accepting the pricing. Is that right?

[Jeremy Smeltser:]

I think on the standard product side, where we have global list prices and discount authority around the world, we didn't get as much realization in that kind of roughly half of the business as we expected, but we got a decent amount and I expect that, that will continue to improve sequentially as the market absorbs those changes. So as Marc mentioned earlier, it’s really more on the engineered side. And I would say it’s a combination of the market slowing a little bit, so in the areas where we expected to get more price we actually saw lower orders as compared to the expectations. As I said earlier, the moderation from Q2 to Q3 in orders was 15% quite a bit higher than I expected. And also there is opportunity to – for us to be more disciplined on the engineered to order bids around the world. I think we got a slow start in Q2 – Q3 frankly and we will catch up on that in Q4.

[Robert Barry:]

Got it. Yes, I guess I'm just trying to get a sense of your confidence of the margin profile of the backlog improving. I mean, you talked about going back for more price, so kind of your – what’s your confidence level on getting it. And then you talked about things improving in the backlog based on what's in there now, but I assume given your discipline you’re not going to put anything in there going forward that would be dilutive to the margins in the backlog. So, can you talk a little bit about kind of the mix expectation or confidence level of really seeing the mix improvement in the backlog like in the next couple of quarters?

[Marc Michael:]

Yes, sure. So, Robert, if you look at the profile of how our orders have developed through the first 9 months that we’ve been providing the slide that reflects that, so high single-digit growth and aggressively grow low single-digit growth and are opportunistically growing down double-digit in the enhanced performance. So, the mix is definitely changing. Again, what we’re executing in the backlog in the second half of the year and to a large extent here in Q4 are ramping significantly here in Q4 from where it was is these projects again that we booked in the second half of last year in food and beverage systems, there was a – that $30 million order in Q3, if you recall, there was about a $55 million order in Q4. So those are being executed right now and then we do have some additional ClydeUnion Pump orders and some heat exchanger orders that are also flowing through here in the second half and a lot in Q4. So, the order profile is changing and it's changed throughout the year and that will support a different mix as we start moving into next year. So, I'm comfortable that mix is going to change, we’ll probably again see backlog start to decline a bit as we exit the year, but again that's based on more the food and beverage systems orders, but higher quality is what we're expecting from food and beverage systems to in terms of the order profile that we’re taking in. So all-in we – the strategy around orders is proceeding as we planned and we expect to start to see that improvement as we move through 2019.

[Robert Barry:]

Got it. Got it. So, it sounds like maybe the risk around margin going forward is really around price, you know –

[Marc Michael:]

Yes, that’s going to be a really important piece – that’s going to be an important piece for us is getting things back on track in these engineered products to gain price there.

[Robert Barry:]

Got it. Maybe just lastly for me on the cash flow outlook, I understand why the dollar amount is coming down, but the conversion rate also down that just because of how you are tracking on compensation expense or is there something else happening with the conversion?

[Marc Michael:]

No, it’s really a revised outlook for inventory at the end of the year, which is based on a building backlog for revenue in Q1 that we don’t expect to get as much the first half inventory build out as we previously expected.

[Robert Barry:]

Got it. Okay, thank you.

[Marc Michael:]

Thanks Robert.

[Operator:]

Thank you. Our next question comes from Walter Liptak from Seaport Global. Your line is now open.

[Walter Liptak:]

Hi, thanks. Good morning.

[Marc Michael:]

Good morning.

[Walter Liptak:]

Good morning. I don’t want to beat a dead horse on the margin, but last quarter you guys talked about the midstream picking up and you took an order, I think it was for some of the J&M valves. And I wonder if that was the culprit where you took a big order into distribution and I got this price. I think what we are trying to get to is just a one-off or is there something where there is more risk to price cost in the future?

[Marc Michael:]

Yes. The M&J orders you are referencing from towards the end of Q2 were at a reasonable and expected margin, so there really wasn’t anything specific like that.

[Walter Liptak:]

Okay, alright. And thinking about food and bev, you talked about aftermarket being up, can you give us an idea of the kind of growth rate that you are seeing sort of consistency to it?

[Marc Michael:]

Yes. So, we have been averaging about mid single-digit growth rate in the food and beverage aftermarket. We have had a couple of quarters where it’s been high single-digit and a couple where it’s been low to mid, but averaging right at mid, so pretty pleased with the development there.

[Jeremy Smeltser:]

If you look across all those aggressively and grow product lines that’s the emphasis and on a net basis overall they are up high single-digit right, so good performance across all six of those product lines. And that’s what we are encouraged about against where we are mentioned in terms of mix change going forward as we look out into 2019. And I will just add one other point around those particular product lines they fit into our operational strategy much more cleanly, they have much faster cycle time, so we can execute those and much quicker on the revenue profile in for out basis in a given 90-day period and they also have a much faster working capital cycle. So those particular product lines for this food and beverage aftermarket or all the other components that fit within that aggressively grow are really a top priority for us and growing nicely.

[Walter Liptak:]

Okay, alright. Thank you.

[Jeremy Smeltser:]

Thank you.

[Marc Michael:]

Thank you.

[Operator:]

Thank you. Our next question comes from Brett Lindsey from Vertical Research Partners. Your line is now open.

[Brett Lindsey:]

Hi good morning all.

[Marc Michael:]

Good morning.

[Jeremy Smeltser:]

Good morning.

[Brett Lindsey:]

I just wanted to come back to food and beverage, I certainly understand the deemphasis on the systems fees and focus on quality, could you just maybe size the revenue impact that you expect from this de-emphasis in selectivity in Q4 and really into 2019 as we fine-tune our models? And then separately just on the backlog as you look at the schedules you have visibility to when do you start to really work through the remainder of that tougher or poorly priced backlog and that starts and inflect positive?

[Jeremy Smeltser:]

Yes. So I think we have a heavy log of revenue here in Q4 on some of the lower margin backlog, a little bit of it will bleed into next year first half as well, Q4 I think is the largest quarter for that. On the overall level of revenue, our orders on an annual basis, I think it still remains to be seen exactly how much decline we would expect from this strategy of being highly selective and the mix shifting massively towards the liquid side thus far year-to-date, I don’t have that probably Marc to you.

[Marc Michael:]

The change year-to-date, to get to the specific number we can circle back to you on that depending on how Q4 shapes up we could be looking at a year-over-year decline of as much as say $100 million of order intake depending on how Q4 shapes up, but again it’s consistent with our strategy. Now we have got to look at how productivity on the flipside starts to play out as we move into 2019 in terms of across our organization in food and beverage systems. What I think is important the liquid mix is significantly higher and we have achieved in terms of order intake this year and that will continue to be the strategy. And just to remind everyone the importance of that is that it pulls through products from our factories, the equipment from our factories, it creates a healthy aftermarket annuity stream and the project sizes that we are taking into the backlog now are much easier to execute, so it’s a de-risk on the execution side of the business too. So that’s an important emphasis for us around the systems business overall improving the performance of that business as we go through the year and Dwight and his team are really laser focused on this.

[Brett Lindsey:]

Okay, great, good to hear. And then maybe just back to price cost and really the element we didn’t talk about is tariffs, maybe just an updated view on your expected impact from tariffs with the expanded scope to list three and then as you think about 2019 based on the cost base adjustments you might be making and what you know today, how big of an impact do you expect?

[Jeremy Smeltser:]

Yes. So we haven’t seen huge impact yet from tariffs. I would say probably just over $1 million through the end of Q3. Potential for that to step up here with the announcements of yesterday on an annual basis for 2019 a little difficult to get precise, but probably less than $10 million depending on volumes. So I think that specifically we will – that will definitely be picked up in all of our processes whether it would be raw materials and food and beverage and pass-through through surcharges or in our cost build sheets for the engineered side of the business.

[Brett Lindsey:]

Okay. So you think that $10 million is kind of net of actions you might be taking?

[Jeremy Smeltser:]

No, I think that’s gross, I think we will take actions to offset all or nearly all of it.

[Brett Lindsey:]

Got it. And then maybe just one more trying to just to find your point on the state of business there, how did orders perform in the quarter in the China region and then maybe just the tone of business across your segments? Thanks.

[Marc Michael:]

On a year-over-year basis, China performed pretty well kind of mid single-digit on a year-over-year basis. We did see lower systems orders, but again much of that is reflected not only in China but across our business globally. F&B components and aftermarket were again in that high kind of high double-digit area, so good growth there. And again emphasis for the team and then another area that José and his team are really focused on is our industrial products and we are seeing a lot of traction in our industrial products not only on the year-over-year basis, but as we have gone through this year and even if we reflect back the latter part of 2017. So China is still holding up so far again some of the project business and systems hasn’t been as strong, but again that’s not unexpected.

[Brett Lindsey:]

Okay, great. I appreciate the color.

[Marc Michael:]

Thank you.

[Jeremy Smeltser:]

Thank you.

[Operator:]

Thank you. Our next question comes from Julian Mitchell from Barclays. Your line is now open.

[Unidentified Analyst:]

Hi, this is Jason on for Julian. Good morning guys.

[Marc Michael:]

Good morning Jason.

[Jeremy Smeltser:]

Good morning Jason.

[Unidentified Analyst:]

Just addressing the pricing point again, just sort of any specificity that you could give around what generally the lag between recognizing inflationary headwind is whether it would be in the quarter or between quarters and how long it takes to push through responsive pricing increase, any color you could give there even if it’s just sort of general in terms of months would be appreciated?

[Jeremy Smeltser:]

Yes. I mean I think if you look at our typical lead times on the short side of the engineered products is probably you are looking at a quarter on the long side, you are looking at a year from time and order to delivery. I would say on average this is likely to take us a couple of quarters to get fully caught up in the order book and start seeing it fully come through margins in the middle of next year. I think we will make progress here in Q4, I mentioned already that as the backlog is already being building for Q1 margins are improving from what we see in the backlog for Q4. So I expect that that will get better sequentially as we proceed through the middle of next year.

[Marc Michael:]

And just I mentioned just to reemphasize a point that Jeremy made earlier, we are talking roughly half the business is more in a list price through SAP and then about half the business of these engineered part of our business where we are tightening everything up. So that’s the part that takes a little longer to work its way through just based on the nature of those projects or those orders.

[Unidentified Analyst:]

Understood. Just as a quick follow-up, is there no an understanding as you are pushing to these price increases and orders in books now that there could – there is potential for further pricing increases to offset further inflationary headwinds should they arise, whether it be from raw materials, tariffs, etcetera, is that sort of taken into expectations as you are thinking about pricing increases moving forward, not more so on the customer and not just internally?

[Marc Michael:]

So the question is around customers.

[Unidentified Analyst:]

Yes. I am just trying to think when you think about pushing through pricing increases in Q4 and you talked about the potential to push through further ones if there are incremental inflationary headwinds to offset which makes sense, is this an understanding that the used price increases will have to happen given that Q4 will have to be stronger than Q3 etcetera?

[Marc Michael:]

I think in with our general market as I mentioned earlier as I think back over the last couple of decades I mean I think as we have been in inflationary periods we have always been successful passing through. So I think it doesn’t happen day one in some markets yes and in some markets no, but historically there has been an expectation in really every area where we play that cost inflation does roll through the market. And I don’t think there’s any reason to expect that will be different this time around.

[Unidentified Analyst:]

Yes, great, understood. Thank you.

[Marc Michael:]

Thanks Jason.

[Jeremy Smeltser:]

Thank you.

[Operator:]

Thank you. And our next question comes from Deane Gray from RBC Capital. Your line is now open.

[Andrew Krill:]

Thanks. Good morning, this is Andrew Krill on for Deane.

[Marc Michael:]

Good morning Andrew.

[Andrew Krill:]

Good morning. Can you comment on your 2020 targets, now I think arguably last quarter you are a little bit further behind on EBIT margins, are there any new levers to pull like what are your comments that will be hitting various targets out to 2020?

[Marc Michael:]

Yes. Sure Andrew. If you go back to our March conference the backdrop to our projections if you remember was based on global GDP at around 3%. And okay projections are kind of moving around on that as we have gone through the last six months. And the new backdrop that we have with stronger dollar and the inflationary elements and the rising tariffs and the impact that’s having we are going to move rapidly through these price increases, but we don’t know what that does to the market dynamic, it’s hard still to predict that. As we mentioned some slowing sequentially more than we expected on our Q2 to Q3 order, so we are going to watch that closely. Having said that we are executing our strategy and so there is still again ample room to continue to grow our order intake on these high value product lines where our focuses has been and we have continued to be successful on that as we move through Q3. So that part around the globe there is there still ample opportunity. There is still much in our control to expand the margins through productivity. And again those are some of the things that Ty Jeffers is working in our factories and that José and Dwight will be working in their organizations. And so those were the two key areas if you recall in our 2020 plan that we are going to drive the performance improvement. It was change in the mix and improving our productivity. It was about two-thirds from change in the mix about a third from productivity. So that thesis holds firm and we are continuing to execute that. What we can’t predict obviously is what’s going to happen in the macro markets and if that creates any headwind based on all the dynamics that are happening right now. So we evaluate our progress here in Q4 and we will be developing our views on 2019 and obviously share that in great detail when we get to our February call.

[Andrew Krill:]

Got it. Thank you. It’s helpful. And then just quickly follow-up for P&E for 4Q implicitly kind of down sales and weaker sales, so just – do you have any view on potential 2019 growth should we still expect maybe down sales in the beginning of 2019 for that segment?

[Marc Michael:]

Well, I think what we are seeing is other than the midstream pockets of strength that we have talked about particularly on the valves side is that we are still just kind of bouncing along the bottom in power and energy. As you know upstream spending has increased this year, but it’s been predominately if not all onshore and our business is really focused on the offshore there. And so at this point in time we don’t see any change there, we would expect to continue at relatively the level of volume that we have been at with again probably pockets of improvement in orders and following revenue on the midstream valves side.

[Andrew Krill:]

Got it. Thank you very much.

[Marc Michael:]

Thanks, Andrew. Thank you.

[Operator:]

Thank you. And our last question comes from Brett Kearney from Gabelli & Company. Your line is now open.

[Brett Kearney:]

Hi, guys. Good morning. Thanks for taking my question.

[Marc Michael:]

Good morning. Sure.

[Brett Kearney:]

Just want to ask with continuing to bring the net leverage down, I guess looking into 2019 and you are broadening your capital allocation opportunities, anything from an M&A standpoint that stands out to you or kind of how the funnel is filling in on that side?

[Marc Michael:]

Yes. Sure, Brett. If you recall, we brought on Vusa Mlingo earlier in the year who has been working with our product managers on fine-tuning our strategy around opportunities. And what I would say is that we want to really stay close to the core, the core being revolving around these key product lines that provide the highest return for our business and for shareholders and there is a lot of opportunities surrounding that core part of the business and us aggressively grow product lines that go into industrial applications and sanitary applications that we believe will offer lot of opportunities, so that’s where Vusa is spending his time with the product managers to create a list and looking at opportunities going forward.

[Brett Kearney:]

Great. Thank you, Marc.

[Marc Michael:]

You bet.

[Ryan Taylor:]

That’s the last call in the queue. So at this time, we are going to wrap up our webcast for today. We appreciate everybody joining us on the call and Stewart and I will be available throughout the day for any follow-up questions that you might have. Thanks for joining us.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a great day.