Q3 2019 Earnings Call
Third quarter 2019 earnings call at this time all participant lines are in listen only mode. After the speakers presentation there'll be a question and answer session.
Asked the question during the session you would need to press Star then one on your telephone please be advised to today's conference is being recorded.
If you acquire any further assistance. Please press Star then zero I would now like to hand, the conference over to your Speaker today, Brian Taylor Chief Strategy Officer. Please go ahead Sir.
Thank you Sarah and good morning, everyone.
Thanks for joining us on the call today.
With me here, our Marc Michael our President and CEO , and Jamie easily our Chief Financial Officer.
Our Q3 2019 earnings release was issued earlier this morning and can be found on our website SPX flow dot com.
This call is also being webcast.
The presentation for the webcast is located in the Investor section of our website includes details over Q3 results.
A replay of the webcast will be available on our site later today.
No doubt elements of this presentation contain forward looking statements that are based on our current view of our businesses and their markets.
Those elements are subject to change and we ask that you'd be them in that light.
Principal risk factors that may impact our performance are identified in our most recent SEC filings.
And in the pen appendix of today's presentation. We've also provided reconciliations for all non-GAAP and adjusted measures presented and with that I'll turn the call over to Mark.
Thanks, Ryan Good morning, everyone and thanks for joining us on the call.
Our third quarter results underscore the progress we made owner strategic transformation into a premier process solutions enterprise.
Additionally, our operational performance in the period demonstrates the ability of our team to execute on many levels in a volatile economic environment.
Our financial results exceeded guidance.
We delivered strong margin expansion in cash generation further strengthened our balance sheet and made significant progress with respect to our strategic initiatives.
I want to think our teams across the enterprise for their hard work tireless effort and positive contributions to the quarter.
We're excited about the future and committed to delivering a differentiated customer experience.
Creating and engaging winning culture for employees and investing in our business to strengthen our core capabilities and drive long term growth in attractive micro verticals.
I'll begin with an overview of our third quarter results.
In Q3, we delivered $384 million of revenue.
Exceeding the high end of our guidance range on better than expected project execution in our process systems business and a higher level of shipments across her factories.
We achieved gross margins of 35% up 270 points year over year and up 120 points on a sequential basis.
Segment income was $56 million and segment margins improved to 14.6% up 60 points year over year and 300 points sequentially.
As compared to our midpoint guidance segment income was $6 million above expectations, driven by Chris operating performance across the business.
Adjusted EPS was 59 cents and exceeded our midpoint guidance by 12 cents driven by segment income and margins.
The margin performance and strong cash conversion in the period demonstrate the higher quality of revenue profile, we've been working towards.
And also illustrate the potential to create long term about value by focusing our strategy on serving customers.
In select process applications.
Looking your free cash flow on a total company bases, we generated $48 million of free cash flow.
This was net of $7 million of Capex, including investment in our power and energy facilities.
We remain committed to strengthening our financial position as evidenced by continued debt reduction in the quarter.
Through nine months, we have now reduced gross debt by $40 million. We ended Q3 with net leverage at 1.7 times down from 2.4 times a year ago.
And near the low end of our target range.
With respect to Divesture of power and energy.
We're in the latter statute stages of the sale process.
Jose Larry iOS and his team are doing an exceptional job running the business. While also managing the due diligence of the sale process.
They delivered a strong operational performance in the quarter that included solid EBITDA growth and margin expansion, along with 9% order growth versus the prior year.
As we evaluate the most attractive use of divestiture proceeds our intentions are to prioritize further debt reduction.
Particularly given the current macro economic and geopolitical uncertainty.
After that the priority we plan to return to.
Excuse me after that we plan to return a portion of the proceeds to shareholders.
While maintaining ample flexibility for organic investments to drive a higher level of productivity.
Modernize our manufacturing engineering and R&D facilities.
Further simplify our global cost structure.
And ramp up new product development efforts.
Our pivot in 2019 to higher quality revenue is evident when you look at the sequential progression of revenue and segment income.
From Q2 to Q3 segment income margins expanded 300 points on flat revenue.
This inflection underscores our focus on quality of revenue improved operating and project execution net benefits from pricing and supply chain initiatives and cost savings from restructuring actions.
Taking in or earlier in the year.
This improvement was driven by our teams and food and beverage who delivered record segment income margins of 15.1% in the third quarter nearly double the profitability achieved in Q2.
The team in food and beverage has been selective on process system orders over the past 12 to 18 months, while dramatically improving execution on project delivery.
They refocus the funnel of new opportunities on higher valued liquid applications such as permitted dairy.
Nutritional beverages and find foods.
And these applications, we provide world class prospects expertise.
And deliver high value propositions to customers from the initial design and installation of the process solutions through the lifecycle of the equipment.
They also require many of our process components, providing an attractive annuity stream of service Spears and consumable where parts.
In contrast.
George Stride dairy projects have been lower value proposition and lower aftermarket potential given this we have methodically reduce the backlog in that category.
At the end of Q3, there were no material dried dairy projects in backlog.
I'm extremely proud of our teams for the level of margin performance delivered in Q3, especially in light of the macroeconomic headwinds.
Despite the challenging demand environment. Our team continues to remain selective on orders, yielding a higher quality backlog and increasing our ability to perform a consistently at a higher level.
In Q4, we expect steady segment income dollar margin performance on a lower revenue base further demonstrating our commitment to higher quality revenue and improving operational performance.
Turning now to orders this slide shows quarterly orders by segment going back to Q3 2018.
Over the past five quarters, our order trends reflect the global industrial slowdown and ongoing tariff and trade discussions. These dynamics have led to delays in capital spending decisions from our customers and channel partners, particularly for our short cycle product lines.
Looking specifically at Q3, 2019, and focusing on organic variances.
Total orders were $350 million down 4% year over year, but flat sequentially.
Industrial orders were $190 million down 10% year over year, reflecting a broad based order decline across the product lines.
Concentrated from a regional perspective in the U.S. in China.
On a sequential basis industrial orders were down 5% due to a slowdown in Europe somewhat consistent with historical seasonality.
In Asia Pacific sequential order trends were mixed.
And in North America, we saw an uptick in orders for mixers hydraulic tools and dehydration equipment. The latter two product lines are traditional bell weather is for us to watch.
Overall, the uptick in North American orders in Q3 is encouraging and we'll be watching order trends closely in Q4 as we prepare for next year.
And our food and beverage segment Q3 orders grew 4% year over year to $160 million.
This growth was led by process systems orders in Asia Pacific with a modest increase in global aftermarket orders.
This growth was offset partially by decline in component orders on a sequential basis orders grew 6% led again by process system orders in Asia Pacific and to a lesser extent in Europe .
Component orders were flat sequentially very encouraging to see stability in that area of food and beverage.
Following three consecutive quarters with orders relatively steady in the range of $350 million to $360 million.
And given continued uncertainty in the macro environment.
We intend to plan prudently for 2020.
Moving onto our full year guidance for continuing operations.
On the strength of our Q3 results and modestly better organic revenue expectations. We raised the low end of the guidance range for revenue EBITDA and EPS.
At the midpoint, we're now targeting just over $1.5 billion of revenue.
With adjusted EBITDA between 180 in $185 million in adjusted EPS of approximately $1.90 cents per share.
We're holding our free cash flow guidance in the range of $80 million to $90 million.
As we look to next year, we intend to take a balanced approach as we navigate or business through the near term demand environment, ensuring we proactively manage costs. While also investing for long term growth inline with our strategy.
We have begun executing on our previously announced 2% to 3% cost productivity goals.
In addition, we're evaluating opportunities to further simplify our global cost structure.
That concludes my opening remarks at this time I'll turn the call over to Jamie.
Thanks, Mark and good morning, everyone.
Again with a third quarter segment results starting with industrial.
Q3 revenue was $205 million down 3% to the prior year nearly all related to currency, which was a 2.8% headwind.
Organic revenue decline modestly on a lower level of pump shipments, which offset organic revenue growth in mixers.
Segment income was $29 million essentially flat to the prior year with margins up 10 points to 14%.
The margin improvement was driven by a higher quality of revenue and net price benefits.
These improvements were partially offset by a normalized level of variable incentive compensation as compared to the prior year.
Orders declined 10% year over year on an organic basis.
As Mark described this decline was broad based across all our product lines, reflecting the impact of the global and industrial slowdown over the past 12 months.
Moving on to food and beverage.
Revenue in the period was $179 million down 8% year over year.
Currency was a 3% headwind.
Organic revenue declined 5% or $10 million due to a lower level of revenue from large dried dairy systems.
This was partially offset by mid single digit growth and component an aftermarket sales.
The organic decline and systems was anticipated and is consistent with our strategy to drive higher quality of revenue throughout our business.
In the third quarter, nearly two thirds of food and beverage revenue was comprised of component in aftermarket sales.
Revenue related to systems represented approximately one third of revenue it was comprised mostly of liquid processing.
The contribution of revenue from large drive systems was only 3% of revenue in Q3 2019 down from 10% in Q3 2018.
Despite the lower level of revenue segment income was flat to the prior year at $27 million and margins expanded 100 points to 15.1%.
The margin improvement was driven by higher quality of revenue savings from cost actions taken in the first half and pricing benefits.
These improvements were partially offset by a normalized level of variable incentive compensation as compared to the prior year.
We believe this level of margin performance is indicative of our value proposition to customers and as achievable going forward.
Orders grew 4% on an organic basis, driven by liquid process systems in Asia Pacific and modest growth in global aftermarket.
Turning now to earnings per share.
We reported 39 cents per share from continuing operations.
This included a noncash impairment charge of 18 cents related to a corporate asset classified as held for sale.
Professional fees of eight cents.
Relating primarily to ongoing development of our enterprise strategy and long term growth plan.
And a net tax benefit and the tax provision of six cents as compared to the effective rate of 27% assumed in our guidance.
Excluding these items adjusted EPS from continuing operations was 59 cents per share.
In discontinued operations, we reported a loss per share of $1.13 cents.
This includes a 29 cents charge related to the settlement of a legal matter in a noncash in nature impairment charge of $1.17 cents per share.
The impairment was based on developments in sale process and indications of fair value received through the conclusion of the third quarter.
The charger reduce the carrying value of net assets of discontinued operations to estimated fair value.
Less cost to sell the business.
We expect to file our 10-Q later today and then we'll have additional disclosures on this item.
The legal settlement related to certain technologies related to a series of long term nuclear power projects that are substantially complete in terms of our production revenue recognition and receipt of payment.
The settlement releases our company from further claims by the customer.
On ordinary warranty obligations.
The inclusion of these items in our Q3 2019 results are indicative of our progress on the divestiture process and our commitment to executing the portfolio transformation.
In terms of operational results of the power and energy business Jose and his team delivered a solid quarter inline with our expectations highlighted by EBITDA growth and margin expansion with orders up 9% year over year.
Moving on to Q4 guidance on a continuing operations basis, we are targeting approximately $360 million of revenue.
About a 12% decline to the prior year.
This assumes a 1% to 2% currency headwind and about a 10% organic revenue decline.
At the segment level, we are targeting a double digit organic decline in food and beverage, reflecting a lower level of revenue from large dry systems.
And a mid single digit organic decline and.
Industrial reflecting the slowdown in short cycle activity experienced over the last 12 months.
Despite the revenue decline, we are targeting growth and segment income dollars and margins between 14, and 15% consistent with Q3, and a 200 to 300 basis points.
Over the prior year.
We're modeling corporate expense at around $13 million.
This includes approximately $2 million of support cost of the power and energy business.
Adjusted EBITDA is expected to be between 46 and $51 million and our adjusted EPS range is 49 to 61 cents per share.
This assumes $7 million of interest expense and the seven and a 27% tax rate.
Taking a brief look at our financial position at the end of Q3, we had $218 million of cash on hand, and net leverage was 1.7 times.
Gross debt was $723 million down $115 million or 14% versus the prior year.
This includes $40 million or debt reduction to the first three quarters of this year.
On the right side of the slide you can see the maturity schedule of all our debt instruments, including our senior notes.
Note that our maturities are staggered and we have no material required principal payments until 2022.
Beyond cash on hand, and our revolver.
We have over $700 million of liquidity Im sorry between cash on hand in our revolver, we have over $700 million of liquidity today.
We're in a strong and flexible financial position and expect to further strengthen strengthen our position following the divestiture.
As we evaluate redeployment of the divestiture proceeds we intend to prioritize debt reduction along with the returned to shareholders inorganic investments.
Once we've reached that point, our ongoing capital allocation were broaden with the emphasis shifting towards growing our business through attractive ROI see opportunities both organically and inorganically.
As well as a return to shareholders.
And preparation we continued to build our funnel of investment opportunities, including investments to modernize our facilities innovate new products and strategic acquisition targets.
This is an exciting time for SPX flow as we approach. The next phase of our journey, we're well positioned to create value by investing in high ROI see opportunities to grow our business with that I'll talk to turn the call back over to Mark for closing remarks.
Thanks, Jamie.
Clearly we are excited about the future.
We are building a premier process solutions enterprise with strong technical expertise global capabilities, and well recognized brands with leading market positions.
We are focusing growth in Michael verticals within attractive sanitary and industrial applications, where our expertise and highly valued.
And where growth is supported by secular trends.
The projected financial profile is clearly more attractive with near term goals of delivering mid teen EBITDA margins and double digit our IC.
As we focus on growing high quality revenue streams, we believe we can achieve 4% to 6% organic growth through and industrial cycle and convert cash in a very attractive rate.
The risk profile in our business and exposure to cyclical commodity markets will be dramatically lower going forward.
This yield greater consistency and predictability in our performance.
We're in a strong financial position today and that will further strengthen following the divestiture, creating ample ability for us to broaden our capital allocation.
In closing 2019 represents a significant pivot point for our business.
As we execute our portfolio strategy.
Simplify our operating structure.
And enhance our customer focus.
Our third quarter results underscore the progress we made owner strategic transformation.
The level of margin performance and strong cash conversion in the quarter.
Highlights the value of our underlying business, while also demonstrating the ability of our team to execute.
In a challenging demand environment.
Our strong financial position will allow us to invest in our business throughout the economic cycles.
With flexibility to invest capital on the highest return opportunities.
On the strategic front, our team is working with various external partners to develop a detailed roadmap to drive long term growth in targeted Michael verticals.
In support of our enterprise strategy, we continue to be innovative with our organizational design and operating model with emphasis on driving a higher level of accountability, enabling cross functional team work and focused product groups and building core capabilities around customer intimacy velocity.
Vitality.
As we plan for 2020, we intend to take a balanced approach as we manage our business through the near term demand environment.
Ensuring we proactively manage cost while investing at appropriate levels to deliver a world class customer experience.
And drive long term growth at double digit ROI C.
I want to thank our teams across the enterprise as well as our business partners for their hard work tirelessly effort and positive contributions to the quarter.
We're excited about the future and remain committed to creating long term value for our shareholders customers and employees.
That concludes our prepared remarks this morning and at this time, we'll open up the call for questions.
Thank you.
As a reminder to ask a question you need to press Star then one on your telephone to withdraw your question. Please press the pound key.
Please standby, while we compiled the Q and a roster.
Our first question comes on the line Nathan Jones with Stifel. Your line is now open.
Good morning, everyone. Good morning, good morning Bhavan.
Good luck to start off focusing on some of your last comment that Iran Enterprise strategy.
Hi levels of Accountability Cross functional team walk customer intimacy all of that kind of stuff I know, it's it's fairly difficult to a two encapsulate that fairly short answer on an earnings call, but I think.
Kind of cultural change within the organization has been very important in your transformation and the improved execution within the company. So maybe you could give us a little more color about.
How you've gone about that.
The result, how how it benefits your cost of my house benefit your employee benefit shareholders.
And what you can do to continue to improve that that culture within the organization.
Yeah, Nathan its its an important step that we've taken over when working on actually over the last four years since the spin.
I started with really strengthening our our functional capabilities and that's really been the the emphasis up until we entered 2019 and we started this this pivot to.
An emphasis on the markets and customers that we serve in.
Effectively looking across the company in the enterprise and saying Okay work in our teams work more closely together on key products key micro verticals to deliver the best customer experience possible and that includes a number of area. So we had to make some difficult decisions as we've talked about so focusing on areas that we can provide more value.
To customers and it includes exiting some of.
The business that we've historically done.
But I would say the some of the big things. We've also done is invested back into our factories and it is a different way on the velocity front is we're calling it and describing it.
We have a third parties that we've invited in to help look at all the various elements of the value streams, starting with when we first engage with the customer all the way through shipment in service to accelerate speed.
Through each of the product areas again, all the way through the to the factories and fit to we ship the product and then how we service at the end.
From a vitality standpoint, and emphasizing vitality in the company a renewed focus on NPD and that's.
Really just in the early stages and the teams are building funnels around around new products were looking at a value engineering, our product lines as an important step.
And then I'd come back to the customer as a kind of key punch point is that.
That's that's really the emphasis of why we're taking all the steps. We are we have to be able to service customers in a differentiated way and it's really the emphasis that we have so as we've looked into make investments back into the business organically and inorganically.
This the focus that jamie's broad around return on invested capital and how we deploy.
Cash.
Back into capital opportunities to get a good return for shareholders is really ramping up so.
This this is why we're really excited about this stage of the journey with lot of hard effort to lot of heavy lifting to get us. This point and as you are describing now it's a pivot to how we.
Really start to create value.
Going forward, where as you could make a case over the last several years.
We've worked really hard to preserve value and now we have the opportunity.
To really start creating a different outcome for our customers and for our shareholders.
Thanks for that.
My follow up question is probably around that the redeployment of capital here It sounds like power and energy is fairly well advanced and potentially probably we'll hear something before the end of the year on that.
You got to have a very flexible capital structure.
And.
Good day of capital to reinvest AD buys organically and Inorganically.
Are you guys have paid doing a lot of walk.
Segmenting the market looking at where that.
Best places to deploy capital.
Do you kind of described the process in the resources being used to identify those most attractive verticals, what kind of timeframe, you're looking at to be ready to go into that more aggressively.
And when the time comes to re enter the M&A market will kind of hurdle rates youre going to be setting for yourself.
Yeah sure so.
First Nathan all mentioned, the divestiture process and power and energy, it's an active process with several firms we are in due diligence and management to meetings are continuing and overall.
Everything is progressing well the management team that has in place with.
Jose and his group are doing a fantastic job and as we mentioned they delivered good performance in the quarter.
As it.
Pertains in regards to where we're going to be with our balance sheet, we're going to be in a really healthy position with our balance sheet.
To redeploy capital again in a much different way and as I mentioned that and we said through several times throughout the prepared remarks.
Focusing on return on invested capital is going to be really an important part of how we view investments that we make in so it's really important the work that we're doing right now with a with a leading with a leading firm in the space. There is helping support us evaluate.
Market opportunities and that work will be largely concluded at the ended the year and has been going ongoing for some time, we think we're going to have really a good line of sight to the areas that we want to deploy capital again. This is both organically and to look at it inorganic opportunities and.
We've been working on this throughout the year and I feel that will be in a good position going into next year to how have well defined areas to look for capital deployment opportunities that can get a good return.
I would mention just two additional things associated with that we're also putting together growth teams around key product areas in micro verticals that will have an accountability and responsibility to make those assessments.
Based on how we're establishing the strategy and maybe let maybe Jamie speed some of the hurdle rates will be looking out for investments.
Yes, and so you know the teams working on a variety of different investments and so as we kind of walk through the value creation model, but we would look first to organic investments within the business and so.
We have really taken the chance over the last three to six months to overhaul of the way, we think about investments in the way we push through the concepts of ROI see into our organic investment.
A pipeline is that's working through so what we expect to see is that the the hurdle rates and the time to create value on the organic front is going to be quicker.
And higher than it would be for the inorganic opportunities and then as we get on the organic in the as we look to the inorganic side. It was all the work that Mark just described which is how our teams think about micro verticals. How are the teams think about growth opportunities within those Michael verticals those regions.
Those product lines.
You know the synergies the cost opportunities the other.
Margin improvements that we would expect from those inorganic opportunities are going to be part of the way we think about.
The returns of that so you know the just depending on the price of these acquisitions in the value that we can create it will probably be thinking about that and the number of years or the duration of time than it would take to have an ROI see above our WACC and not knowing exactly what those are in front of us.
It's hard to say as we as we think now but thats the framework and which will apply to think about those of US yeah. I would mention one other thing on the inorganic opportunities is will be very disciplined in that assessment align with our strategy around our core capabilities and so we're looking at product lines in Michael verticals, where we're familiar with with.
Operating and that we see no. Good returns we get in our core business today, and so thats an important I think uptake that.
We will be very laser focused on that and I would anticipate that as we're looking at those opportunities there'll be opportunities as Jamie mentioned known to expand margin, but where we can see really good growth opportunities in.
Areas of verticals that are that are that are growing at a outpaced level.
So thats going to be an important part of how we think about deploying.
Capital Inorganically, two and again that that process is maturing well with the work that Ryan has been doing with blue saline gun and all the efforts that have been going on with with the third party from that that supporting us. So we feel really good about where we are going into 2020.
To start again, the next phase of the journey and.
We're thinking about this again not to about 2020 in the 12 month period, we're thinking about this over the next three to five years and how we can create a a great outstanding return for our shareholders.
Thanks for all the DHL, that's fantastic I'll pass it off.
Thanks, Nick Thanks.
Thanks.
Thank you.
Our next question comes from the line of Mike Halloran with Baird. Your line is now open.
Good morning, everyone.
Hey, so so.
It seems like you guys, some despaired trends happening right deceleration on the industrial side.
Had some project helping.
In Asia, and the FNB side, and then aftermarket find components of the.
Up here.
Can you give some thoughts on one where you see the market's heading as we move into 2020.
Sustainability of the trends on either side, how you kind of thinking about it as we look forward by end market.
Yes sure Mike.
Well first overall as we mentioned.
The trends kind of in the 350 to 360 million dollar.
Range of orders over the last several quarters now the one caveat that I would mention in Q3.
Europe tends to have some seasonality to it intends to be lower.
Then the other quarters of the year just based on the holiday periods that take place in Europe .
Well, what we see in going across the regions and I'll kind of toggle between the regions and the markets first in the markets industrial as you see it stepped down in.
In Q in Q3.
But we feel that's Morgan indicative of what's happening in the global macro economic environment, We don't feel that there's any share loss or areas, where we're not participating it's just a slower overall market environments. So we'll be watching that closely as we move through the.
Quarter.
And as you can see in food and beverage it's been.
Relatively stable over the last several quarters both on our in combined.
Components in aftermarket business, which is good to see some better performance in the aftermarket with a little slower but for this and components.
And then systems has been pretty steady too and we see some opportunities developing there some of those came through in Q3.
And.
We expect some more to come through in Q4, so those could be a bit of a swing item on the topline revenue profile, but I think overall the key message around how we're approaching both the end markets is this thesis around high quality of revenue. So that we get really good margin profiles and we'll continue to do that and.
Be selective in our systems business and and our come core components and aftermarket business, we see that is being less about collectivity and more about what the the markets or are bearing right now and in some regards.
So if I if I go across the regions just to give a sense of what we see across the regions. Europe was was slow and as I mentioned with some seasonality FNB was a bit weaker overall and industrial was was softer, but but it was kind of mixed across the product lines.
It was encouraging to see that North America stabilized and was kind of in the low single digit range overall FNB components in aftermarket point kind of combined together were stable and was encouraging to see that the industrial business in North America grew.
Uhhuh sequentially kind of mid single digit so we'll be watching that as we kind of rolled through here in the fourth quarter.
Good momentum in China, food and beverage was really good across the board in not only in our systems business, but also in components and a in aftermarket in our industrial orders in China, where I would describe as a bit mixed also some components were up in some were down.
<unk> had some offsets and then across the rest of Asia Pac we saw some steady improvement there to kind of up low single digits FNB being the primary driver with components and aftermarket being kind of stable and systems being system to orders improving modestly.
With industrial again being a bit mixed so I kind of has set a mouthful there, but if I if I backed up from it I would describe it as the industrial business continues to be impacted more by the global economic and geopolitical environment food and beverage components and after markets remain stable and consistent.
For us and we see good systems opportunity, even with the selectivity that we have.
Kind of developing in front of us.
And then you touched on briefly the focus and higher quality revenue and the positive impact that's happened on the margin profile.
Could you just talked about the sustainability of what you saw from the margin in both segments as we looked at the third quarter, and obviously revenue swings around seasonally.
But is there anything in the third quarter. The you don't think is sustainable relative to the revenue levels as you look forward.
The short answer is I don't see anything that keeps it from being sustainable.
We were looking to.
Have a similar level of performance in Q4 and as we've worked on this higher quality of revenue that's achieving gross margins now in the 35% range with.
Backlog margins up about 300 basis points since the started the year.
And that's continuing into Q4.
It's really what would predicates performance going forward, we feel is the again to the more the markets and what that provides us in the industrial segment, how we improve our performance for customers and can we.
Take additional position in share in that space.
And then in food and beverage this the bid at the same applies for components and aftermarket business continued to service customers well in the systems business I think will afford us opportunities, where we continue to be selectively selective on liquid opportunities so that that playbooks not changing that's the playbook that we.
Been working to execute now for the past several quarters and it's starting to.
Ended in the results that were seeing in Q3 in Q4, and so we're not changing that as we move into next year. So I'd expect that to continue and quite frankly, we're going to work to improve beyond that as we move through 2020 into 2021, there Mike maybe I'll just add to that I think thats. The right question and we said in the prepared remarks.
We are we expect this level of margin performance in the SMB segment I think market on it we are seeing good improvement in margins and backlog from that began the year about 300 basis points.
It's also important to point out the nature of the backlog in the food and beverage.
Systems business and it is a the larger liquid systems are types of systems that we've historically had a more consistent level of delivery on and so as it relates to any of the past charges that we would see in particular quarter I think the the nature of the backlog is going to help us state.
Realize that.
As we've talked a bit about cost price relationship here throughout the course of the year I think we've seen really since late last year. The the team develop a.
A level of capability within the organization on on pricing and being thoughtful around that I believe that's going to continue to be the case and be positive for us.
And then marks made some some references to this but the investments that we're going to make and customer intimacy through outreaches customers voice of customer spending more time with our customers I think that's going to give us.
Better and more insight into our new product development investments that we're going to make and we would expect that those types of investments over time are going to allow us to maintain and expand gross margins segment income lines.
Lastly, I'd point out here is all the improvements that we've talked about that are going through our factories are pathway to excellence some supply chain changes that we've made but the the factories in the execution of tie Jefferson. His team is really starting to show up in the gross margin line, you've seen that in the consistency of.
Gross margin this year.
And we expect that to continue.
Great appreciate the answers.
Thanks, Mike.
Thank you.
Next question comes from the line of Julian Mitchell with Barclays. Your line is now open.
Hey, good morning, everyone. This NGL on for Julien.
Good morning.
Good morning, I, just wanted to ask on industrial growth seems to have held up kind of well this quarter relative to some of the tougher order numbers being put up this quarter in last.
Can you just talk a bit about what was resilient I know North America, you guys cited but if theres anything else therein.
Maybe what you see you know kind of meeting into more weakness next quarter with mid single digit decline expectation.
Yes.
The industrial part of the business is what were keeping a close I honestly, we've been indicating throughout the call and.
It did hold up reasonably well in the quarter, especially given the fact that again, we typically see lower seasonality.
In the European market.
Specifically in North America, where we did see to the best improvement in our industrial business.
That was.
Primarily associated with our mixers and our dryers and our hydraulics business were kind of rebounded versus Q2, and one of the <unk> one of the two of the product lines that we always look closely to to give us an indication of what's happening in the markets is our dryers and our hydraulics business because it does tend to be are shorter cycle business.
Shorter cycle businesses in many regards that when the demands picking up we typically see those product lines are kind of pick up the first so we'll be watching the development here in Q4, it's still a bit of I would describe as a choppy environment I'm even month to month, we'll see I'm kind of ups and downs through.
Through the month, so as we.
Look back at the past 90 day period, North America was kind of the stand out and again Europe industrial was a bit a bit mixed China was a bit mixture and the rest of APAC was a big mix. So.
Good to see North America, I'm, having some improvement and we'll continue to watch that as we move through the quarter. One thing that I wanted to mention to you know the profile of our business. Now is is about 85% going through our factories and as we do have this profile of more business and our fact.
Trees is as we look to execute and the work that the tie and team are doing this concept of velocity is really a core to what they're focused on so.
With shorter cycle business will also be able to convert backlog more quickly.
And reduce our lead times are accordingly, and again serve customers better. So we think thats going to put us in a better position as we move forward also in this concept, though of faster cycle business that will execute through our backlog more quickly and orders that we receive in a quarter being at execute them more quickly is an important.
Concept.
Got it and then turning back to margins.
Racing is she has been a good tailwind for you guys. Just looking ahead are you seeing any pushback from your customers just kind of given.
Got any prices coming down tariff maybe not.
Increasing as rapidly as they've been sort of in the past year.
Where do you think thats sustainable going forward.
We're continuing to evaluate.
No price cost and to the point Weve been able to stay ahead of cost and it's not just been price theres been a lot of good work done in our supply chain organization to to help offset.
Offset the cost so the more margin performance improvement, that's associated with kind of price and our supply chain initiatives.
Our helping US stay ahead of tariffs in the inflationary curves.
As we look forward our supply chain teams are going to continue the the same playbook that they've been working on to achieve.
Better cost positions and a on the price front, we'll we'll monitor and look at the the product lines and C, which ones maybe you're.
Experiencing more pressure from.
Commodities or inflation tariffs and make adjustments accordingly on the pricing on the pricing front, so going forward I.
We will can continue to do both and be really targeted with our pricing initiatives.
Got it thank you.
Thank you.
Thank you. Our next question comes from the line of Robert Barry.
And Ham research your line is now open.
Hey, guys good morning.
Morning, Robert.
Thats on the South corridor.
Yes, I hear about crisp execution.
Great.
Just wanted to clarify the comment I think you made it before about the backlog.
I think it was entering the year up 300 amps, but year to date I think the segment margin is up only 90.
So what are the puts and takes there why isn't that more given how strong the backlog was entering the year.
Cost has been pretty good.
Yeah, I'll take that one Robert So you know if you go back to through kind of looking at full year performance. You go back to Q2, you remember some of the discrete charges that we had in the quarter, which you know wouldn't have been in the backlog and expected as we entered into the year.
And then you know I think as as we continue to see the the cost price relationship play out over the course of the year.
And that's still coming into backlog I think that would explain the the backlog margins that were seeing as we exit Q3, yeah I'd just add to that to the the overall mix change in the backlog to has still been developing throughout the year now what we've been taking down the dry Gary.
A period of time, we're also focusing on our systems business in a different way in terms of the margin profiles and application expectations. That's been developing throughout the course of this year two so.
You know that the trend that we're starting to experienced here in Q3 in terms of margin profile and what we expected Q4 and as we've been describing going forward.
That higher level margin and more consistency is more indicative I think of that that margin profile increased versus the first half of the year, we still had some.
Things, we were dealing with in the backlog.
Got it and I guess, you are forecasting a pretty nice.
For Q.
Hey, Robert we probably are having trouble hearing you.
Yeah. I was also just kind of observing that I think you're also expecting a pretty nice increase in fourq you.
We are right.
So I think you said earlier dry dairy is now out of the backlog just to be clear I know theres been some proactive deemphasis of things like heat exchangers and other products as well.
Do you anticipate as you and the year, they're being anything in the backlog, that's no longer being strategic or how much yet end of year.
Yeah, just just to maybe be I'm more specific on the dry dairy we do still have.
Dry Gary into backlog the revenue from these larger projects is now de Minimis in terms of the overall amount that's in the backlog and the the there the orders that we have taken.
In dry have been much smaller in nature as we've gone through 2018 and 2019.
Overall for our systems order intake.
The dry order intake is been less than 10% of of the total systems business. So.
That's a big change, obviously and that's what we've been describing that systems order intake in food and beverage is only 10% dry now where if you go back historically that could have been 40 or 50% in a given year.
So the dry business will be a as we've described a much smaller part going forward will still be taking and looking to take some orders on targeted application opportunities, but ones that we can execute and have a regional reasonable margin profiles and strategic customer applications to them.
On the heat exchanger business, we'll we'll still have heat exchanger business in the backlog and we still do continue to work on taking orders there, but if you go back to about two years ago. Now also we switched our and focus and emphasis there to be more selective on applications, where we feel we can perform better in areas.
Such as food and beverage applications HPC applications and then improve.
Our performance to support the aftermarket in service side of the business. So those parts of the business will still be there, but just have a much smaller.
Level than they have been historically.
Right right and it sounds like any orders you are taking there are far more strategic and.
That's right that's right and there would be in the markets that we you know would would tie back into some of the strategic work that we're doing and making sure.
We've got good confidence and the growth in those markets and the margin capacity and capabilities within those markets.
I guess, just lastly from me you mentioned earlier marketing planning prudently for 2020, I'm, probably going to get into too much detail at this point, but just big picture do you think especially given these industrial orders in the end market, they're the right way to think about 2020 framework as maybe low single digit organic topline decline.
A point or two of segment margin expansion.
[noise] picture.
Yeah, I think if we look towards 2020 I mentioned, a couple of things one thing to keep in mind is that we will have a kind of first half headwind from these try dairy projects that we were executing during the first half of 22019 and so that's between let's say 35 and 40 million to.
Dollars of headwind that will show up in 2020 with a big part of that being in the first half of the year. So it's just a place marker to keep in mind, it's actually a good thing again, so just to keep reminding.
Ourselves that.
Those projects didn't carry much margin with them so.
That topline drop associated with that's okay. The other I think he swing factor then would be a exactly the point we've been talking about how did the industrial orders develop in the markets develop as we move through the fourth quarter and into next year and I think you can look at that you know that line and start to get a sense of where.
2020 could shape up given kind of those two two factors.
And then as far as the margins concerned.
But as we've been describing our intentions are to continue to achieve a margin consistent with what we've seen in Q3 in Q4.
In our gross margin line and we're really focused on the gross margin expansion.
We're going to continue to work on that and I'll be a part of what where we'll talk more about in February but a will want to grow our gross margin and also I would just mentioned too on the cost line the cost.
Efforts that were working on are gonna be important to us at 2% to 3% cost out.
As well as other opportunities we're gonna be considering so I think there will be margin expansion opportunity there will want to define that a little more specifically, though when we get to February .
Fair enough that's very helpful. Thank you you bet.
Thank you. Our next question comes on line of Brett Linzey.
Research Your line is now open.
Hi, Good morning, guys good morning.
Hey, just wanted to come back to the P. any proceeds questions sounds like in your prepared remarks, you're leaving a bit more towards organic investment adverse inorganic and repo.
You've had some time to rule if those plans evaluate the pipeline could you just give us a senses to what the split might look like between organic in order inorganic and I guess. The question is are you willing to kind of live through some of the lost earnings or do you do you look to at least backfill that with M&A in repo.
Before you start to make those organic investments.
Yeah, I'll take down Brett.
So the way we worked through the decision making on investments is through our ROI see model.
So we are looking towards making organic investments, but what I would say is that as we sit here. We don't have organic investments that are not being funded that are waiting on being funded from the divestiture of the p. any business Weve I'm really given our teams the green light to think more long term.
Arm and strategic around NPD investments around how we spend money to get closer to customers understand end market demand and then also on the Capex line thinking about how we modernize our factories to get product out the door quicker to customers with less error rates et cetera.
You know and bid on the also maybe on the Capex line also thinking about.
Digital and investments that will allow us to operate more efficiently internally how to improve the capabilities et cetera of our of our products. So all that work is ongoing now and we'll continue to fund that and continue to use kind of the balance sheet and those the stability of our financial position post IPO.
You too to just be a different company as it relates to those type of investments when when we get around to the the proceeds from the the process. You know we are going to first look to de lever there where we would just think that's the prudent thing to do were well right now we're at 1.7 times leverage, but when when that EBITDA.
It comes out to your point, we're going to need to so to look at the debt load and address that pretty aggressively then once we consider the remaining proceeds we do expect that there will be a return to shareholders and this and I think what we'll do is kind of just look and see what the with the.
Situation is at that point in time and determine the mechanisms and the amount of doing so.
Okay got it thanks, and then just shifting to the to 2% to 3% productivity.
You've had the explicit target for quite some time, obviously strong margins here in Q3 did did you get productivity usually come through in the quarter.
And then as we think about that 2% to 3% how does that ramp overtime and then should we think about R&D in some of the MPD stuff netting against that to come to some sort of net number below two two to three.
Yes, so we go back to the 2% to 3% to do we announced we announced that back earlier in the year and and as a framework for that that was intended to streamline our future process solutions business at the time that was not a volume related program in of itself.
What I would say is those programs related to the 2% to 3% or now finalized our teams are aware of what needs to do the teams have been mobilized and we'll begin executing on those we we saw very minor amount begin to happen towards the end of Q3 and that will begin to ramp up into Q4.
Looking kind of forward, maybe thinking about the two or 3% more broadly what we're expecting is roughly two thirds of that is gonna be on the gross margin line, we're expecting a benefits from store strategic sourcing savings the teams productivity.
It is and then some structural cost around factories.
The piece coming from the functions. So the one third that will come through the us Gionee line.
That will be net of investments are excited about some of the investments we're going to make around voice of customer some communications data analytics those types of.
Of initiatives that are going to allow us to.
Really try to grow once once we get done with the program.
The the savings as you think about phasing those I.
I think you could model, 25% of those savings coming through and 2020 or so we'll be more specific with that when we get into the guidance phase in February of next year, but I think for now that's a good place to start and then we're still expecting full run rate will be observed.
And seeing coming through the PNM 2021.
Okay, Great and then maybe just one follow up you noted double digit process system orders in Asia Pac in Europe , where these small medium size or any large chunky orders worth calling out.
They were there were more small and medium sized ah fitting to slow activity profiles that weve that we've been describing okay, great nice quarter guys. Thanks. Thank you. Thanks Brett.
Thank you. Our next question comes from the line Walter Liptak, What's Seaport Global your line is now open.
Thanks, Good morning, guys good morning.
I wanted to ask.
A couple of more sector questions, especially around industrial and.
And especially on the order trends.
We're orders are pretty consistent in North America through the quarter.
Or is that.
Yes International's week.
But north America came through okay. During the quarter and now we're stabilizing into the fourth.
Or is it the things around are getting slower in North America.
Yeah, well as mentioned on industrial what we saw in North America sequentially was orders up come into the mid single digit range and again it was still a bit mix as I described previously.
We saw our mixers and dryers in hydraulics business, a tick up and then we had oh I'm a little slower performance in our pumps in our heat exchangers.
Versus Q2, but overall kind of netted to up kind of mid mid single digit growth sequentially. So we were pleased to see that.
Again, our dryers in hydraulics business can be a an indicator of more economic vitality given the short cycle nature of those particular product lines. They they.
When customers have a need there they ordered them or them quickly and we're set up to respond to that market requirement quickly as you go across really the rest of the globe, what I would say about industrial its just a softer environment with mixed results from product line to product line, that's as to how we described.
Europe is as well as China, and the rest of Asia Pacific's so.
If if north America can stay stable and and start to see some modest improvement as we move forward that'll be good sign and then hopefully we'll see that a same trends start to fall through around the rest of the CLO.
Okay.
Okay. Good thanks for that color.
I just wanted to ask about the comments was tariffs I was there anything specific from customers, where they said or where you saw.
And I guess I'm thinking more about the food and beverage business, where they were able to where you can find that linker correlation between the two.
As opposed to just kind of a general malaise a international.
Yep.
Yeah, well I think what we've said leading up to this point was that we do believe our U.S. components business has been affected by some of the the global tariffs or particularly the Chinese and U.S. tariffs and specifically some of the reverse tariffs coming from China. So as the the Chinese of Hudson.
Italian Tory tariffs on on products coming out of the Americas, We think that that's had a an influence on our customers who would be making capex decisions in the U.S. for constructing and making product that would be going into China.
The <unk>.
The one quarter of encouragement here would be that we did see some stability in our U.S components business.
And we'll continue to watch that pretty closely but that's been.
A fairly significant impact on this year to date, yeah, and just one additional comment on that so that was kind of the food and beverage view and.
Just as we were describing I think what we've seen in the industrial markets, including North America up until this a bit of sequential recovery and in Q3.
It is overall just pressure from a slower macro environment and.
So you can kind of been kind of choppy so kind of continue to watch it but.
Hopefully, we're reaching a point, where where we're troughing I guess swapped all see how that plays out across in the industrial landscape.
But you know the good news and things that we're doing a we're controlling the things we can control as we've been describing which is employed improving our operations are looking at our new products investing back into the organization and expanding our margins even in this kind of more difficult environment.
Okay. Okay.
Okay and last one for me is you guys talked about the strategic front and some external partners.
Doing a deeper dive into the process solutions part of the business I Wonder.
And I may have missed it earlier in the call and I think you alluded to a couple of things, but I wonder if you could just.
I just was a little bit more color.
With us programs are.
How long do you think they'll they'll take would you know what's the expected goal from that.
Yes, so we're working with the leading from in the industry and this this we've been working with them for the last a six month or so and.
We're looking it.
Taking the industrial verticals as well as the call it the sanitary verticals and.
On a double and triple clicking into those verticals to look at more of a micro level to identify areas, where we can apply our current technology in a better way in different way and then identify where potential gaps may exist either in technology or customer access and channel.
And so as we're is we're working through that what we're building is an organic pipeline too for the teams to work on a as well as it's a what's helping us create.
Ideas and directions around inorganic opportunities, where the technology gaps or the customer access maybe too much of a stretch to do do organically. So we're well into that that process. It will be concluding at the end of this year.
It's really an extension of a lot of the things we've been working on for the past two years and what the way I would describe it Walt is that this will be really are our playbook of how we think about and work on our.
Capital deployment and looking at high return on invested capital.
Going forward so over the next to kind of three to five year time horizon. So it was a it's a very dynamic process.
It was very broad based in the beginning and now we're really narrowing that down to areas, where we believe we can get.
The best returns for investment could growth markets good margin profiles, good aftermarket annuities.
Okay and the benefits of this I'm like its organic growth.
Or M&A as opposed to its a combination of the two yeah. It's a combination of two Walton, that's where what will want to do and what we will do for investors. This is holding an investor day.
Next year in in in the first half of the year to give a broader backdrop on how we see that playing out on the on the longer term horizon.
Okay, Great alright, thank you.
Thanks, well.
Hi, This is Ryan thanks brought a that we're over time for the call. We appreciate all the thought for questions.
And a deep south responses by our team I'm going to conclude our call right now just fine. Thank all our teams across where all four for the strong performance in the quarter and Stuart will be available for the day to answer any follow up questions analysts and shareholders may have and we appreciate your time Docgenix time.
Thank you everyone.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.