Good morning. My name is Nick and I'll be your conference operator today. At this time, I'd like to welcome everyone to Verde's 1st Quarter 2020 Earnings Conference Call. All lines been placed on mute to prevent any background noise. Please note that this event is being recorded.
I'd now like to turn the program over to your host for today's conference call Ms. Lynn Maximiner, Vice President of Investor Relations. Please go ahead.
Thank you, Nick. Good morning, and welcome to Verde's first quarter 2020 earnings conference call. Joining me today are Verda's Executive Chairman, David Cote, Chief Executive Officer, Rob Johnson, Chief Financial sir, David Fallon, and Chief Strategy And Development Officer, Gary Nieder Plume. Before we begin, I would like to point out that during the course of this call, We will make forward looking statements regarding future events, including the future financial and operating performance of Verdez. In forward looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward looking statements.
We refer you to the cautionary language included in today's earnings release, and you can learn more about these risks in our registration statement or SEC statement and other filings with the SEC. Any forward looking statements that we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events. During this call, we will also present both GAAP and non GAAP financial measures, our GAAP results and GAAP to non GAAP reconciliations can be found in our earnings press release and in the investor slide deck found on our website at investors. Dotcom.
With that, I'll turn the call over to Executive Chairman, David Cote.
Thanks, and good morning, everyone. Wanna welcome you to the Verde of investor call to announce our Q1 twenty twenty results. Before I turn it over to Rob Johnson, I want to begin with a few opening remarks. As we spoke last time and as many of you know, I was fortunate to be able to work for Honeywell for about 16 years. Those who invested with us made a great return.
That performance was marked by consistent annual improvements in the people, processes, and portfolio of the businesses that made up Honeywell. We did all the seed planting for new products, services, process improvement, and other growth initiatives needed to perform well for a long time. The world is in a very different place than where we spoke a couple of months ago. But those opening remarks stay true, whether we are at a period of economic expansion, or economic contraction. If you look at our success at Honeywell, it really took off after the great recession.
And I attribute that success largely to the fact that we continue to implement an operating system. We drove technology investments, and we planted seeds even during that difficult time. Why do I bring it up? Because we're doing that same kind of seed planting averted. Now, some of you may conflate our withdrawal of guidance, even in the face of good artist growth, With the liquidity scenarios we've included and conclude, we see a serious problem looming.
That would be an error. They are 2 entirely separate points. We've withdrawn guidance because we can't be sure we can ship. Given government's shutdown of facilities for us and suppliers at various times. Additionally, our service people sometimes I'm allowed to access the facilities.
Our credibility matters greatly to us. And we don't want to guide the numbers may not be able to deliver even in the face of strong orders. Totally separately. We have included a couple of liquidity scenarios to demonstrate that even if sales fell to $4,000,000,000 or even in a 25% sales decline, we will be just fine. It's not a forecast.
It's an attempt to make you feel comfortable that we're just fine. Combining these 2 separate points into the erroneous conclusion that we are forecasting disaster is well erroneous. This time has been difficult for everyone, but it also has demonstrated how important data centers and the edge are to our society. It is clearly critical infrastructure and reaffirmation this is a good industry. We have a great position in that good industry.
And even at this difficult time including our own customer focus while still seed planting, I am just as excited today as I was 3 months ago about our future. Now, I'll turn over the call to Rob who can take you through the business in a little more detail. Rob?
Thank you, Dave, and welcome everyone today. As I said on the last call, I really value the advice that Dave has provided to the team since he's been engaged with Vertiv, and I especially appreciate his counsel now as we navigate through these pandemic times. Before I walk you through the slides, it goes without saying that we have been proactive protecting the safety of our employees and our customers. We've implemented precautionary measures from temperature screening to increased cleaning and disinfecting of facilities to social distancing at work, just to name a few. Additionally, our service technicians have followed Verde's safety protocols and adhere to additional safety measures adopted at customer sites.
Safety of our Vertiv employees and our customers has been and will continue to be at the forefront of everything we do. I want to thank the Vertive employees for their hard work during Q1 and give a shout out to the manufacturing workers and the service technicians who have continued to provide products and services to our customers and conduct day to day business with the utmost of caution amidst COVID-nineteen. I appreciate their steadfast commitment to Vertiv. It's their unwavering dedication that has allowed us to serve our customers enable those customers to provide technology and vital applications to To all of our employees on the front line, I say thank you. Let's take a look at the slides, starting with Slide 4.
Overall, the demand side of our business was very robust in Q1 as orders were up 13% compared to the first quarter of 2019. We exited Q1 with a record high backlog of $1,600,000,000, which can be attributed to cloud co location and telecom customers around the world were delivering vital applications so students could be educated online, hospitals and healthcare facilities could function, workers could work from home and businesses experiencing a surge in demand during the stay at home mandate could deliver. On the revenue side, despite almost all of our manufacturing facilities being up and running, we have been deemed essential. We were still adversely impacted by COVID as many of our facilities are still dealing with some level of disruption. Additionally, Q1 of 2019 had a few large projects complete, which made a difficult comparison.
In Q1, we proactively implemented cost actions to protect the business, haven't seen and felt the impact of COVID in China before things spread to other parts of the world. These cost actions are expected to generate $60,000,000 of benefit by the end of the year. David will address liquidity later, but we feel good about our position today and know that even under a variety of downside scenarios that Dave spoke to, we will be able to with directives of governments around the world as they relate to pandemic actions. This pandemic has put us and others in a position where things will remain dynamic and unpredictable over the next several months. Because of this we are withdrawing our previous guidance.
I can tell you this, however, Vertiv has been designated as an essential business. We see strong demand for our products and services, We are taking short term and long term actions to make sure we continue to serve our customers. We are nimble, flexible and responsive We are ready to adapt, react, and serve in ways that will be needed for today and tomorrow and in the future. Turning to Slide 5. There's a lot of content on this slide, so I won't hit every bullet, but we wanted to provide you with additional knowledge and deeper in about our business.
The 1st quarter CoVAD impact of $80,000,000 was roughly 60% supply base and 40% demand base. On the supply side, I'm proud to tell you that all of our facilities with the exception of a small plant in China are back up and running Now, not all of our facilities are running at 100% because there are still many things they are struggling with, parts issues, logistics constraints, but nonetheless, we are able to operate at some level in every region. The supply side is aggressively being monitored on a daily basis as issues arise. Whether it's government health inspections, supplier output, logistics, and many more, there's just a myriad of obstacles that our team has to continue to overcome on a daily basis. The Vertiv team has done an outstanding job to carefully and methodically resolve these issues as they arise.
In places all over the globe, so we continue to supply products to our customers and assist them with their services needs. Moving on to the demand side. Certainly, the headline number of orders being up 13% is great accomplishment of the sales and marketing team. Each region grew orders substantially with EMEA leading the way at 26% year over year growth in Q1. The orders were largely driven by cloud, large Covalocation and telecommunication companies.
The area where we saw softness was within the small and medium sized business that is served by our IT channel partners who have been adversely affected by the pandemic. As this segment of the business starts to come back, we expect to see demand continue. Turning to Slide 6. As I mentioned previously, we were in early identifying and addressing and implementing a number of different cost actions for Q1. The entire leadership team and Board of Directors took a 10% base pay cut.
While this may not be new news to most of you, what you didn't know is that they volunteered to do this. I didn't even have to ask them. Additionally, merit increases for employees were halted for 2020, The 401 K match in the U. S. Has been stopped and every department has been tasked with a discretionary 15% cut.
Furthermore, Dave mentioned in his opening remarks about use of furloughs, and we have implemented those across every function and every jurisdiction where it's allowed. Employees have been understanding and supportive of our efforts to utilize these measures to make sure Vertiv stayed strong and financially healthy. These actions and a few others will contribute to $60,000,000 of P and L benefit during the rest of 2020. We are also being aggressive on the revenue side. Our sales and service teams are strengthening ties with the customer providing updates and reassurances to them regularly.
We have enhanced our marketing message and have increased our social media presence as we look for additional ways to reach those in either the products and services that we provide. The selfless nature of our 19,000 plus employees is a testament to the culture of the organization, our desire to be present and helpful to those who meet us, our willingness to work while we battle COVID-nineteen, I am proud of the way Vertiv and its team have acted and reacted to all the unknowns we faced in Q1. With that, I'll turn it over to Dave Fallon to give a deeper dive into
Thanks, Rob. Turning to Slide 7. This page provides a summary of our debt structure in our current expected future liquidity. Starting on the left hand side, we remind investors that we were able to time the SPAC transaction and debt refinancing quite well, with neither likely available to us in this current market environment. However, as result, we possess a rather simple long term debt structure with a $2,200,000,000 term loan maturing in 2027.
With $1,000,000,000 at a variable rate currently at 3.4% and $1,200,000,000 swap to a fixed rate of 4.1 dollars resulting in a relatively modest annual cash interest run rate of less than $90,000,000. Which is inclusive of interest on our $455,000,000 asset based lending facility or our ABL. Now, our counter parties to our ABL are all large, well known reputable banks. Hence, we believe there's little counter party risk, related to credit in our ABL. Our term loan contains no financial maintenance covenants and our ABL contains only 1 springing financial maintenance covenant if our availability falls below, forty $5,500,000 or 10 percent of the total facility.
The spring and financial maintenance covenant is a fixed charge coverage ratio, that must be to violating this covenant even under significant downside scenarios. The right hand side of this page summarizes our liquidity, a strong $446,000,000 at the end of the first quarter, including $289,000,000 of non restricted cash. $157,000,000 available on our ABL. Cash flow in the first quarter in a few slides. But $100,000,000 of that use of cash was pursuant to discrete payments, related to the SPAC transaction and cash interest, which will not recur going forward.
We continue to expect positive free cash flow for the full year, including slightly negative in the second quarter, and significantly positive in the 3rd and 4th quarters. This projected quarterly cash flow cadence is consistent with prior years as we generally used cash in the 1st quarter. And 2nd quarter free cash flow is generally somewhat modest due to lower collections from lighter seasonal first quarter sales. Normally, a large percentage for our full year free cash flow is generated in the second half of the year. We feel quite good about our liquidity projections, even under unlikely significant downside scenarios.
For example, even if sales are modeled to decline an improbable, 25% from last year. And as Dave mentioned, at the outset and just for avoidance of doubt, we provide this illustrative downside scenario simply to demonstrate confidence in our liquidity and not as any form of directional guidance, but even under this extreme scenario, our projected liquidity low point in 2020, bill does not drop below $300,000,000 as lower adjusted EBITDA is partially offset by a recovery of working capital, which runs at about 22.5 percent of sales. And for further clarity, this $300,000,000 lower point is not a year end liquidity figure. But this would be projected to occur at some point intrammonthinthe4th quarter. As our liquidity ebbs and flows intra quarter, but is generally highest at each quarter, and year end.
In addition, under this and any significant downside sales scenario, our liquidity is also negatively impacted by lower collateral on the ABL, as lower sales reduce eligible accounts receivable supporting the borrowing base. Of course, this modeling scenario also assumes that customers continue to pay amounts owed to us in a timely manner, and we pay suppliers similarly. As of today, we have not experience any significant collection issues. In addition, our modeling does not assume the benefit of any additional cost actions, which certainly would be likely in a significant sales downturn, nor does this scenario include the benefit of any potential additional liquidity actions, including contractually extending supplier payment terms, establishing local lines of credit, or even though we do not foresee a dire need at this point, opportunistically accessing debt financing markets. Next slide 8, turning to Slide 8.
This page summarizes our first quarter financial results versus last year's first quarter. Net sales were down $158,000,000 or 15 percent, including approximately $80,000,000 due to COVID-nineteen and $19,000,000 from unfavorable changes in foreign exchange rates as most global currencies weakened, versus the U. S. Dollar in the first quarter. The remaining $59,000,000 reduction projects in last year's first quarter, predominantly in Americas and EMEA.
Adjusted EBITDA declined $40,000,000 from last year, due to the lower top line and partially offset by lower fixed costs from prior year restructuring activity. Adjusted EBITDA margin declined 260 basis points, primarily due to the lower of leverage, lower leverage of fixed costs. And to the far right, free cash flow declined $158,000,000 from last year's first quarter. Including $100,000,000 combined due to discrete payments pursuant to the SPAC transaction and cash interest that will not recur going forward. We will provide a more fulsome, in free cash flow in just a couple of slides.
Finally, on this slide, we include a note at the bottom, it explaining that pursuant to our debt refinancing at the beginning of March, where we raised a new term loan and concurrently paid off several high interest rate notes, we recognized $174,000,000 loss on extinguishment of debt, $99,000,000 of this loss was a non cash write off of deferred financing fees and $75,000,000 was a cash payment for the early redemption of the notes. Neither of these items is included in adjusted EBITDA and the cash payment for early redemption or the $75,000,000 is included in financing activities in the statement of cash flow. This page summarizes our first quarter segment results. I won't delve into the details, but COVID-nineteen certainly negatively influenced each of the 3 regions. We disclosed the top line impact for each region on page 5 of this presentation.
Including $50,000,000 of the $80, in APAC as China was virtually shut down in February. However, excluding the impact of COVID 19 and adjusted for $8,000,000 of foreign exchange, APAC sales increased $23,000,000 from last year's first quarter, primarily on the strength of telecom and larger co locations and hyperscale customers. Net sales in the other two regions were down from prior year, even excluding COVID-nineteen and foreign exchange, primarily driven by several larger projects that shipped in the first quarter of 2019. Lower adjusted EBITDA and EBITDA, adjusted EBITDA margin in each region was primarily driven by lower year year net sales. Next, turning to Slide 10.
This chart bridges 1st quarter free cash flow from last year. While we have historically used cash in the 1st quarter, Free cash flow this year was further negatively impacted by lower sales from COVID-nineteen, which significantly contributed to the $41,000,000 increase in inventory and a $40,000,000 reduction in adjusted EBITDA. In addition, cash interest in this year's first quarter was actually $33,000,000 higher than last year, as we accelerated accrued interest payments on the notes we paid off pursuant to the debt refinancing. And we were also negatively impacted by the timing of interest payments on the former term loan. Of course, on a go forward basis, our quarterly cash interest will be significantly reduced as reflected by the $79,000,000 run rate adjustment in the green bar farthest to the right.
1st quarter free cash flow was also negatively impacted by $21,000,000 of discrete costs pursuant to the SPAC transaction. So in summary, on a pro form a, run rate basis, we used about $103,000,000 of free cash flow in the first quarter with approximately $80,000,000 directly or indirectly attributable to COVID-nineteen. And despite this negative free cash flow in the first quarter, we still expect significantly positive free cash flow for the full year. And with that said, I turn it back over to Rob.
Thanks, David. As we turn to Slide 11, it's important to communicate the fact that critical digital infrastructure is more necessary now than ever before because of the world's growing need and dependency on vital applications. While we remain cautiously optimistic on the balance of the year, the dynamic nature of the situation makes it extremely difficult to provide guidance at this time. We do feel good about at this time to be able to peg a number for 2020. What I can share, however, is internally we have run multiple scenarios as discussed earlier, and sensitivity analysis.
And even in the most aggressive downside case with sales at $4,000,000,000, we would still be in a position to deliver approximately 500,000,000 in adjusted EBITDA. Clearly additional cost actions would be taken, which we have, but those 8 actions have been identified and are realistic from a timing and savings but have no reason Now turning to Slide 12 and in closing. I want to thank you for your support over the past quarter and then the quarters to come. We participate in a great industry, as Dave said. We have the leadership in position and never has critical digital infrastructure to support the vital applications of the world been so important as it is now.
As we continue operating during this dynamic time. We will continue to invest as Dave said for the future while managing for today. This strategic approach will prepare us to be even more successful when we emerge from this pandemic and the world adapts to a new normal. Thank you again for your support. Stay healthy.
I now turn the call over to the operator who will open the line up for questions.
Questions. First question comes from Nicole Devault with Deutsche Bank. Please go ahead. Sorry. I was on mute.
Good morning, guys.
Good morning, Nicole. Hi.
Maybe we could hello. Maybe we could start with, the cost savings. So the $60,000,000 that you guys are targeting It seems to me that these are kind of all incremental actions relative to the medium term margin expansion plan that you've laid out. Maybe you could talk about, you know, the temporary versus structural nature of the cost savings. It seems to me like these are all temporary and they will come back when demand resumes.
And maybe the ability to pull some of the medium term cost items that you guys are working through into 2020 as demand is weak.
Yes. So, Nicole, hi, this is Rob. What I would tell you is, they're not costs that we expect to come back into the business when we return back to work. These are cost and we'll realize, as I mentioned in my comments, we'll benefit from these whether there are furloughs, whether there are merit increases, whether it's the discretionary expense decrease. So we fully expect to realize these costs and see them hit the bottom line throughout the quarter.
We
have And you are correct. We continue to operate on what we've talked about in the past, the other levers for margin expansion utilizing the VirTra operating system as a utilization to increase and better our margin profile. And all of the other fixed cost content things, everything we've talked about that's separate of the $60,000,000. This was really in addition. And as Dave Fallon mentioned, there are additional levers that we can pull if necessary, if we see demand or changes in the environment.
David Powell, any other thoughts?
If I could interject a bit, you are a bit right there, though Nicole. I mean, once volume comes back, Yes, people will expect merit increases will return the 401, that sort of thing. But as Rob points out, these are very real cost savings this year. So we will get those. And some of those costs only come back if the volume really comes back.
And independent of that, I guess, somewhat complimentary to it to one point, we're working all our plans to keep fixed costs constant as we go forward. So I put all that together and say, this is a smart thing for us to be doing right now and helps us to achieve everything we've talked about. But at the same time, we want to be prepared for the future. And as volume comes back, which we suspect it's going to, given everything we see in our industry, and we think that's going to be pretty darn good, Yes, some of that may come back, but it's only going to come back with volume that's in that 45% contribution margin range.
Got it. That's really helpful. And then, can we also maybe dig in a little bit to what you guys are seeing in April Most companies have been willing to comment on that a little bit just because we don't really have a ton of visibility, sitting here with, you know, what you guys seeing in the early stages of this in North America and Europe, is that something that you're willing to give some color on?
Yeah. Hi, this is Rob. Just at a high level, what I would tell you, we expect throughout, Q1, April, to see orders continue. In a growth trajectory. And then we expect to see some impact, from the COVID and from our ability to deliver.
We don't have exact numbers. We really don't know. And again, as we mentioned, we're battling every day all around the world to make sure we can supply our factories open, sub suppliers. So I would just say that we expect the orders to continue to be favorable and we expect to have some COVID impact as we go through Q2 like most other companies have suggested.
And when you say favorable, do you mean orders are still up year on year? Versus like the quarter versus the 1Q order growth?
Yes.
Okay. Thanks. I'll pass it on.
Your next question comes from Mark Delaney of Goldman Sachs. Please go ahead.
Yes, good morning. Thanks for taking the questions. First, hoping the company could discuss the demand environment both in terms of how the first quarter closed and if any business slipped out compared to what the company had been expecting when it held its last earnings call in March. But maybe more importantly, given the record backlog and based on what management knows today, is Virtu still expecting a pickup in 2h20 sales compared to 1h20 on a qualitative basis?
Hey, Mark. Rob here again. A couple of comments there. We did see, to answer your first question, we did see some push outs basically access to sites happen in the combination of not being able to fulfill orders or push outs because of site access or areas being shut down, for example, like Singapore today is. We do expect and this has been consistent with what we've talked about since the beginning that the second half would be an upside for us.
Now again, given COVID, no one can predict how long the thing will last and when every country will be back to work, but the expectations are that the 2nd half will be an up a path as we said in the past.
Got it. That's helpful. And then my second question, I just wanted to better understand one of the comments in the in the press release, I think they can only talk about a stable, demand environment, but also orders were up 13% year over year. So I'm just trying to better reconcile some of the commentary, some of the puts and takes in orders that the company is seeing and just kind of better understand stable relative to the order growth that was reported? Thanks.
Yes. Mark, just just going through that at a high level, but to hopefully give you enough color here. As we had been talking about and I think in our last conference call, we talked about the fact that there was this digestion going on in the U. S. And we would expect in Q1 to begin to see orders pick up, specifically in the colo and hyperscale space.
We saw real strength, in the colo hyperscale telecommunications. And so that drove a lot of that. And that was what we had expected and it had happened. I think there were some orders, people had placed orders in advance to get in line because they want to make sure they're going to get their product. The areas which you would expect, small to medium business and enterprise during these times and the channel type business, would be, would not be on a growth trajectory right now.
But again, with the products we're releasing, with our focus on that market, we fully expect when people get back work that we'll have recovery there.
Okay. And then just lastly, a follow-up on the questions related to cost and SG and A dollars were fair amount less than what I had been anticipating and how they talked about some of those incremental savings still to come. So maybe just help us understand how to think about SG And A dollars in 2Q and then throughout the year and maybe those trend lower than the levels that we're were reported in the first quarter or again, just some of the temporary actions that I realized will be achieved you did some of the temporary costs start to come back in. And so, OpEx dollars start to back up compared to where we came in at for the first quarter? Thanks.
Yes, I have a couple of comments. This is Rob again, and turn it over to Dave or David. But what I would tell you is the world is going to be, I think, different. I don't can't predict exactly what it's going to look like. I think we've learned to do work in a different way, which could affect some of our discretionary expenses whether it's travel, the T and E side of things.
So I would fully expect that then, and our team is working on new ways of doing work that are more efficient and more effective. And give you an example, during this time training for our sales for our service people traditionally is something where we fly them in. They sit in class and it's expensive. We've been able to do and use tools online, online testing, online classes. So we'll continue to take the efficiencies and the things we've learned during this pandemic and apply those to drive more efficiency going forward.
David Fallon?
Sure. And just some further detail on that $60,000,000, probably about 70% of that will impact us and A. So a good portion of the cost actions that we put in place will benefit SG and A going forward. And I think some of the drivers of the lower year over year SG and A in 1Q versus the first quarter last year will continue going forward. We were able to put in place some restructuring activity last year, which we will benefit from in each quarter going forward.
So we certainly have some tailwinds behind us as it relates to SG And A, but also, reminding folks that we are continuing to invest in innovation and technology and specifically R And D, even through, some of the top line issues and, that R and D will be rolling through SG And A. So, even though if you look year over year, we do not anticipate a significant increase in SG And A because we believe we can offset some of the higher costs of R And D with some of these favorable SG and A trends. We wouldn't, necessarily expect significant reductions going forward.
Got it. Thank you.
Next question comes from Lance Vitanza of Cowen. Please go ahead.
Hi, thanks guys. Thanks for all the helpful color. I wanted to actually focus on slide 5. I found that very helpful. And I'll start, I was surprised to see the demand impact so significant.
I mean, 40% of the 80,000,000 revenues, so roughly $30,000,000. And I'm just trying to figure out how does that square with the commentary around orders being up year over year across the board? And specifically, does demand in this context? Does this year include the inability to access customer locations? Or when you refer to demand, are you really specifically referring to just customers saying, we no longer want what we thought we wanted
Yes. Hi, this is Rob again. A few comments on that and then I'll hand it over to David. What I'd say is we had what we haven't seen customer demand, someone place an order and then cancel that. We have not seen canceled orders.
So what we have seen, as you mentioned, and you direct on is that the access to the site are people actually pushing it out just because they're shut down and we can't access that site. So the combination of not being able to manufacture the goods because of the things that are happening in our manufacturing facilities and the access to sites really drove, that revenue, that $80,000,000 COVID impact.
Okay. That's super helpful. And kind of what I expected, but wasn't clear. So then to the extent that this revenue is deferred rather than lost, obviously nobody knows when the lockdown ends, but once the lockdown does end, how quickly would you think all else equal, we expect to see that deferred new return. I mean, I would think it would be pretty quick, meaning in, you know, within a couple of months from whenever the lockdowns are over.
Is that a fair estimation? I wouldn't say within
a couple of months only because I don't know when our factories and rest of the supply chain will be at full strength and full health. That's going to be dependent, but access to sites will open up. And we'll certainly have a large backlog to work through. And get that out. So I would expect to see, as we've talked about, and again, even pre COVID, that the second half will have a nice jump into it.
And I think based on what we've seen in the backlog and customer, customer overall demand, we're not seeing people cancel or delay. Now I did mention, and we did talk about the channel, things with small to medium business who knows, how these are going to come back in various verticals, whether it's entertainment, or whether it's travel, some of those have been it pretty hard. And I just can't predict how that's going to come back, but we do see other areas, like health care. And the thing I'm so excited about is this work from home initiative is really driving the fact that we need more edge devices. Latency has become a real huge issue.
I bet every one of you experienced that in your home. So overall, we see the world coming back and our stuff being more even more vital than what it was prior to COVID. Understood. Maybe just 2 quick follow ups on that.
The first is, could you remind us what percentage of your revenue currently comes from the channel? And then secondly, the EBITDA impact that you saw from the COVID hit in the first quarter is about 35% to 40% flow through. Is that what whatever the revenue impact turns out to be in the second quarter. We don't know. But whatever that revenue impact is, should we expect the same kind of flow through to EBITDA that we saw in the first quarter?
Sure. I'll handle the first part and then turn it over to David. On channel side, that represents about 15% of our overall global revenue. So it's around $700,000,000. David Fallon on the margin side or flow through?
Yes. So, we apply a 40 per sent, contribution margin to the $80,000,000 COVID sales impact. And the reason we use a number that is probably a little bit lower than what we have been broadcasting as our contribution margin is because 50 of that 80,000,000 in APAC. And in general, our contribution margins in APAC are lower than the other 2 regions. For the sake of modeling, going forward, we would anticipate any lost sales in PAC, whether it's related to COVID or otherwise, to be somewhere between the 40% 45%.
So probably a little bit higher than what we used in the first quarter.
Thanks very much guys. I appreciate your time.
Your next question comes from Scott Davis of Melius Research. Please go ahead. Hey,
good morning guys.
Good morning, Scott.
Hi. Is there any impact on price in the quarter? Is price generally pretty flattish at this point? Or are you able to get any positive price, particularly with new products?
Yes. So, great question. And I would say within the quarter, we did, we were able to get some price We have actions ongoing actions we did last year and will continue this year to drive price in areas. New products being delivered to the market, give us some unique features and give us a little bit of pricing power as well. So the combination of just being maniacally focused on pricing on a global basis.
And new products intros that have innovative features that allow us to get more price than our competitors. For example, new models of our DSE air conditioner that allow higher margins for us. So we're we've been still able to get price during this time in various areas. We're very focused on that.
Okay, that's helpful. And then I probably should ask this question a while ago, but how much of your backlog has a down payment? What's kind of the standard in and putting something into backlog, which obviously the confidence in that backlog love to get your opinion on that as well. But first question really relating to how much of that requires a down payment?
Yes, Scott, not much, not much at all. Very little do we have prepayment cash upfront on that. Now the backlog is supported by very healthy healthy companies, those orders that are coming on, whether it's below hyperscale Telecom, although all companies are affected by this pandemic, We have a really solid base of very financially stable companies that have placed these orders And, we feel real confident that we won't be, be seeing canceled, canceled orders. The demand is as high as you can.
Okay.
And just a point of clarification, please go ahead. I'm sorry.
Yes, Scott. The other thing that I add is just, right now, this is a tremendous proof point that data centers are important not just now, but going forward. And it's hard to imagine that these orders don't get, don't continue. At the Rob's point, historically, we've had it's been the backlog tends to be pretty robust. The other thing, Scott, is I know you got another Biz question, but I strongly expected some kind of shot about Brady going to the Bucks, but I guess you'll have to send me a note.
Well, I have to admit after we've had 25 companies report in the last several days. I'm pretty brain fried to even think about football right now, but But, your Patriots are going to suck for a long time, Dave, and it's going to be fun to watch it. Really know. Oh, man. Anyways, to to get back to the brass, tax here.
Couple of just cleanups and, hopefully, you don't have a lot of other questions. They're just coming off if if you do. But it it am I to assume that if 70% of that $60,000,000 is SG and A, then the other 30% is kind of at the factory level. You know, and perhaps some of that could be structuralpermanent? Is that possible?
Hi, Scott. This is David Fallon. Absolutely. So if you look at the large components of the 60,000,000, probably a third of that is discretionary spending. And that is more than likely the bucket of costs that we would be targeting going forward to to be a permanent reduction.
So a portion of that is G And E as an example. And we're all kind of learning new ways to do business without jumping on a plane. And, so if you look at the different components, I would say there's going to be something of that $60,000,000 that certainly flows through, into next year and going forward. And, and if we look at one thing, one philosophy that Dave Cody has brought to us is a fixed cost is a fixed cost, whether it's in the factories or in the office. And we treat all costs the same and certainly a significant portion of this will be, benefiting the factories as well.
Okay. That's super and sorry. I have one last final one. Inventories, the was it the shutdown in middle of the March that kind of caught you guys with your pants down, if you will, on inventories, because that was a pretty meaningful build up that we saw. And presumably, you saw issues I would imagine in China, particularly earlier in the quarter that has all surprised inventories built that much.
Yeah. So, absolutely, the, the negative impact from COVID and we as we got through the first quarter, we were actually in line with our internal projections as it relates to the top line. And things moved south really quickly in China, virtually shut down, all of February. And then, of course, the impact in the other regions accelerated into March. So as we were putting our inventory, build plans together as of early February, we didn't necessarily anticipate the size of the negative impact that actually occurred.
So I would attribute a very large portion of that $40,000,000, if not all, just related to our sales planning projections based on where we were sitting at the end of January.
You made a mistake of trusting your sales force. I get it. I do that all the time. Well, thank you guys. Good luck to you.
Your next question comes from Nigel Coe of Wolfe Research. Please go ahead.
Nice to hear from you.
Hey, Dave. Long time to speak. How are you?
Very well. Thanks. The captivity suits me well, it seems.
With the banter with you and Davis, it felt like a Honeywell call circa 2009. So I thought one of the highlights of the quarter was services growth, remained, remained in place. And I'm just curious how the, you know, the shop in place restrictions have impacted services. And then on top of that, maybe just characterize, you know, the service book in terms of transactional, stroke discretionary services versus contractual?
Yes. Hi, Nigel. Thanks for the question and your time here. The services, one of the areas of growth, if you look at and recall, when we kind of on the road and going through is services and the channel IT. So services has been a real focus for us to expand that, get higher capture rates and so forth.
So we expected to see growth there. Where we were able to get access, we do have about 50 5, 60 percent of our services are under contract. And whether the preventive maintenance and so on, And we've seen some pushback on preventive maintenance and people going to more critical services necessary during this time or what we call startup services. So we did see an uptick in the actual services, but we did see a downtick a little bit in the spare parts side of things. So the combination of the 2 kind of led us to a little bit of growth there.
We expect coming out of this, especially, you know, as Dave mentioned, things are so vital now customers really want to make sure they get the health checks on their systems and so on. So I would expect and we'll continue to invest in service people, service personnel, to make sure that these networks remain vital and robust.
Right. Yes, that makes sense. And then, I thought the free cash flow scenario analysis was very, very helpful. And given that the down 25% isn't your, clearly, isn't your best case scenario, but in that scenario, are you assuming that working capital can deliver at the same rate of sales? So that 20% remains very constant on sales by year end.
And then I think you call out, David, that the 2Q free cash flow could be negative. Is that normal seasonality for free cash flow?
Yes, just to address the second one. Absolutely, if you look at the cadence of our quarterly free cash flow, our first quarter historically has been negative. And, our second quarter toggles between slightly positive or slightly negative, certainly free cash flow in Q2 will be impacted by the lower sales in Q1. So we are anticipating a slight use of cash in Q2 this year. And as it relates to the recovery of working capital.
The way we are modeling and actuals hold true to this is if we look at, our historical movement in working capital. But, we're assuming a 22.5 percent recovery in working capital per dollar. Of sales, whether that goes up or down. And, if you compare that to the 42.5 percent or so contribution margin on sales, for every dollar of sales loss, we lose about $0.20 of free cash flow. And that $0.20 is $0.42.5 contribution margin less than or less the 22.5 percent for working capital.
This concludes our question and answer session. I'd like to turn the conference back over to Mr. Rob Johnson for any closing remarks.
Thank you, operator, and thank you all of you for those questions. As Dave stated in the beginning, We are investing for the future during this COVID period, in R&D and in salespeople and services. We'll continue to do that, so we come out much stronger. We're taking the appropriate actions on cost, and we have additional levers, if necessary, if this pandemic gets worse. We're continuing to drive the long term margin expansion that we've talked about, and we'll continue to pull those 4 or 5 levers.
And want everyone to be clear, as we've mentioned many times, we feel we have solid liquidity. I want to thank all 19000 plus employees around the world for working hard every day to take care of our customers. We appreciate all your time Please stay safe. We look forward to speaking to you again soon. Thank you very much.
This concludes the call.
Conference is now concluded. Thank you for attending today's presentation. You may now disconnect.