Q3 2020 Regal Beloit Corp Earnings Call
Hello, and welcome to the Regal Beloit third quarter 2020 earnings call.
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Great. Thank you Keith Good morning, everybody welcome to Regal Beloit third quarter 2020 earnings Conference call. Joining me today are Louis Pink on our Chief Executive Officer, and Rob Reinhardt, Our Vice President and Chief Financial Officer.
Before turning the call over to Louis I would like to remind you that the statements made in this conference call that are not historical in nature are forward looking statements forward looking statements are not guarantees since there are inherent difficulties in predicting future results and actual results could differ materially from those expressed or implied in forward looking statements for a list of.
Factors that could cause actual results to differ materially from projected results. Please refer to today's earnings release, and our FCC filings.
On slide three we state that we are presenting certain non-GAAP financial measures. In this presentation. We believe that these are useful financial measures to provide you with additional insight into our operating performance and for helping investors understand and compare our operating results across accounting periods and in the same manner as management. Please read this slide forever.
It makes in regarding these non-GAAP financial measures and please see the appendix for reconciliations of these measures to the most comparable measures in accordance with GAAP.
Now let me briefly review the agenda for todays call Lewis will lead off with his opening comments then Rob Ray hard we'll provide our third quarter financial results in more detail discuss our fourth quarter guidance as.
As well as share some high level thoughts on 2021 and on potential election impacts. We will then move to Q1, <unk> after which Louis will have some closing remarks.
Now I will turn the call over to Louis.
Thanks, Rob and good morning, everyone. Thanks for joining us to discuss our third quarter earnings and to get an update on our business.
Thank you for your interest in Regal.
For the second quarter in a row this unprecedented global pandemic weighed on our orders and sales improve.
Impacted some of our key manufacturing operations and supply chain and further tested endurance of our associates.
So before getting started I'd like to thank all my Regal colleagues around the world for their hard work and resourcefulness as they remain focused on serving our customers while remaining disciplined about keeping our workplace safe.
While many of our end markets remain challenged in the third quarter I'm encouraged that a number of bright spots also started to emerge, which we hope will prove sustainable.
Order rates for the company turned positive in August and have remained so through October with notable material improvements in our North America residential H.B.A.C. business, which saw orders up 27% in September and tracking up 22% and <unk>.
Coburn, while orders in our pool pump business rose, 32% in the third quarter and are tracking up nearly 38% to date in October.
In addition, two of our businesses climate and commercial returned to positive top line growth in the quarter nicely exceeding our expectations.
While industrial was nearly flat and P.T.S. narrowed its year over year rate of decline materially versus last quarter with the recovery in North America is short cycle industrial showing early signs of momentum but.
But upside on that front still ahead of us.
We also made significant further progress on our 80 20 initiatives and on executing our multi year restructuring program.
As you May remember, we define before the pandemic arose.
Our cost out plans are firmly on track indeed, despite seeing our top line declined just under 2% in the quarter as koby the impacts remain Regal.
Regals adjusted income from operations rose by over 19%.
Contributing to that performance, our adjusted gross margin was up 300 basis points versus prior year.
If we meet or exceed our fourth quarter adjusted EPS guidance midpoint will actually deliver EPS growth this year despite the pandemic.
Our CFO rubbery hard we'll share some initial thoughts on how we're thinking about 2021 later in the call, but on the margin front I'm pleased to say, we see some indications that the pace and scale of our cost out opportunity may allow us to deliver ahead of schedule on our goals.
As shared at Investor day to achieve 300 basis points of adjusted operating margin expansion in three years or by 2022.
Beyond margin the story on cash flow is consistent we generated 100 ml $111 million of free cash in the third quarter.
For a conversion rate of over 170%.
Progress with gaining share also remains evident in key parts of our portfolio in data center alternative energy trying to commercial market and perhaps most notably in our modest sort unit material handling business, where our innovative conveying solutions.
One is gaining traction in the last mile package sorting and distribution applications.
Our mod sort team is also a great example of how Regal is using technology outside of our product development function.
Such as from marketing and lead generation.
Mod short burst booked nearly 2 million dollar order during the third quarter, which originated with an end users web search earlier in the quarter.
Improved digital customer experience activities have and will continue to receive significant investment at Regal.
To me the message. This performance sends is very clear.
We are structurally improving this business and I couldn't be more proud of our Regal associates, who are learning adapting and acting with a sense of urgency to drive these changes.
As I have stated on prior calls at Regal.
I'd always comes first.
As the Pandemics duration has tested our focus and resolve I can assure you that our Regal associates around the world remain disciplined about balancing the need to produce our essential products.
While keeping our workplaces safe.
From an operational standpoint, all of our facilities are currently functional though our capacity levels in Mexico are still not quite where we'd like them to be.
Conditions in Mexico seemed to improve steadily during the third quarter with almost all of the states, where Regal has operations moving to the lower risk yellow category in the Mexican government's color coding system for defining risk and regulating permissible activity.
Yes.
But in the last couple of weeks several of these day to move back to Orange in one state to read.
These changes typically result in more of our associates meeting to remain out on a government mandated health decree.
We were down to having only about 2% of our workforce in Mexico out on the health decreased at the end of the third quarter.
But as of today that level has increased to roughly 4%.
Of course, we are monitoring this daily and leveraging our global manufacturing network to best service our customers.
Shifting to orders.
Declines of 6% in July turned to growth in August and September, which saw orders up 4% and 2% respectively.
October with a few days remaining in the month is tracking up roughly 11%.
We are seeing strength in north American residential HB AC pool pump and datacenter markets with order rates in our Pts segment, just starting to show signs of better momentum as the North America short cycle General industrial end markets begin to recover.
Consistent with recent data points, such as the I guess, some order rates and capital goods orders.
We see potential upside to recent order trends if restocking in Pts starts to occur in any meaningful way.
For now.
Our best estimate is that stronger momentum starts to occur in early 2021, but many moving pieces remain regarding end user confidence in activity levels.
Rob will share additional order details by segment in his remarks shortly.
Before concluding I would like to discuss a couple of recent developments of investor interest.
First I'm very pleased that in September we published our latest sustainability report.
The report reaffirms regals commitment to increasing the energy efficient benefits our products bring to our customers and to society, while reducing the impact of our manufacturing processes on the environment and also meaningfully contributing to the communities, where our associates live and work.
Sure.
My mandate to the team working on this year's sustainability report was to raise transparency around our ESG products and initiatives and in particular do so by including more data.
And I believe our team delivered.
That said one of the reports themes is regal being on and SG journey.
So while I am pleased with how our efforts around sustainability governance and social responsibility had been advancing there's much more we can do and will do.
In particular, I'm challenging our business leaders to further refine their sustainability strategies and to create more specific roadmaps for driving year over year improvement on a select few business relevant metrics.
I'd encourage you to read the report.
The next topic I'd like to cover is our portfolio, we're always evaluating our portfolio of businesses for their fit with Regals long term strategic objectives around gross margins and return on capital.
Indeed at our Investor day back in March we had alluded to a cadence of portfolio review to ensure such alignment.
With co bid our focus has rightfully than elsewhere, but.
But having just come out of an annual strategy review discussion with our board we are refreshing, our our our evaluation of our portfolio.
We made a lot of changes since I joined the company roughly 18 months ago.
Including bringing on new leaders that over half of the 22 businesses that sit behind our four segments and adding many new members to our executive leadership team.
We also decentralized pushing operating control out to the businesses rigorously started applying 80 20 principles to improve margins and growth.
Added personnel transparency down to the plant level.
Reorganize many of our go to market efforts and are increasing our investment in focus on innovative sustainable products that solve our customers' challenges.
And frankly, I've had a chance to personally get to know our businesses more intimately so.
So with the benefits of time, many fresh eyes and much more granular data, we think taking a fresh look at the portfolio would be valuable.
The last topic on which I'll share some thoughts is indoor air quality or I Q, because it's getting a lot of attention with our customers and with investors.
We believe it's early days on the I.Q. front, but to the extent it gains traction I think Regal has a large role to play.
And we're investing to ensure were there for our customers as they help end users with Q solutions.
First many of the eye acute initiatives being discussed involve stronger filtration and more frequently exchanging indoor outdoor air.
Both of these upgrades require more powerful motors and if customers want to at least maintain the energy efficiency levels. They saw before making any I acute enhancements.
Stronger motors will also need to be more efficient.
Addressing these needs is right in Regals technology sweet spot.
Second Regal is already in the market with a blower product that helps introduced aired outdoor air into an office classroom and restaurants.
The Regal advantage is how we integrate the blower components the motor the wheel the housing assembly into more of a plug and play offering which accelerated the Oems design cycle, expediting time to market and reducing development costs.
We think this lead time advantage will be critical as property owners seek expedited upgrades to their buildings. So tenants can feel safe inside.
We're also testing a patented you be light solution, which involves introducing a UBI light strip into one of our blower housing.
This system contains the UBI light in the blower housing while continuously cleansing airborne pathogens from the air flowing through it.
We believe this compact solution, which is easy to integrate with existing systems will be great for the retrofit market.
Other products are also in the works, but I think these are a couple of representative examples of what we're doing.
The last point I'll make on I accuse that it's an opportunity for regal to leverage its technology expertise to be there for our customers as they seek to address evolving customer needs and to do so in an expeditious and cost effective manner.
This is how Regal, we'll win with our customers.
And with that I'll turn it over to Rob who will take you through our third quarter results in more detail and share our reintroduced guidance for fourth quarter and 2020.
Thanks, Louis and good morning, everyone.
While the third quarter continued to be impacted by covered related pressures. Our team turned in very strong performance on growth margin expansion and free cash flow, including 230 basis points of adjusted operating margin improvement and 171% cash flow conversion.
In addition, with our order rates now in positive territory and showing some signs of stabilization, we feel comfortable providing guidance for the fourth quarter and also ending the pause on our stock purchase program.
Before diving into our results by segment I do want to preface that we won't be speaking about our profitability improvements in terms of leverage or deleverage rates on today's call simply because they're not as meaningful this quarter, we're generating higher profit dollars despite lower sales.
I will note, however that our cost out and productivity actions have been significant significant needle movers. This year, resulting in 9% de leverage on a year to date basis.
Starting with commercial systems organic sales in the third quarter were up 1.3% from the prior year.
The result was driven largely by strength in our pool pump business, which was up almost 20% in the quarter. In addition to ongoing share gains in China and to a lesser extent.
In our North America large commercial applied each fax business.
As we enter October momentum in pool remains strong with month to date orders tracking up almost 38%.
Limiting the degree of growth we saw in the quarter were ongoing covered related operational disruptions in our Mexico operations, which prevented us from executing on as much of our backlog as we had hoped.
But we're optimistic and expect to see greater progress on this front in the fourth quarter, which should provide a nice tailwind to commercials topline performance.
In addition, we saw roughly two point headwind from our ongoing proactive pruning of low margin accounts.
As we continue to execute on our 80 20 initiatives.
As a reminder, while our pruning initiatives pose headwinds to the top line. They are also a factor contributing to margin expansion.
The adjusted operating margin in the quarter for commercial systems was 12% up.
Up 310 basis points compared to the prior year.
This margin was up due to favorable price cost and mix benefits, partially offset by freight headwind incurred as we work to serve our customers as expeditiously as possible in the face of our Mexico manufacturing and supply chain disruptions.
Orders in commercial for the quarter were flat, reflecting strength in pool pump and Asia net of weakness in our larger commercial HVAC business.
Tobar orders are tracking at 21% with broad based strength led by pool.
The continued upward momentum in commercial orders gives us further confidence that we may be entering a period of stability and a return to growth.
Albeit with an ounce of caution largely due to the uncertainty around the potential second wave of code 19 disruptions.
Industrial systems organic sales in the third quarter were down 2.9% from the prior year.
The segment saw continued sizable large corporate related declines in the general industrial and oil and gas markets, partially offset by strong sales into the data center market, where our products provide standby power.
Pruning actions were approximately two points of top let lyne headwind in the quarter.
The adjusted operating margin in the quarter for industrial was 6.7% up 610 basis points compared to the prior year the.
The margin improvement was driven by 80 20 continued cost reductions our supply chain optimization actions in North America favorable mix and positive price cost.
Partially offset by the impact of lower volumes.
We are very pleased with the significant improved profitability executed by our industrial industrial team, especially given continued covered related headwinds on the top line.
Well, we want to point out that benefits from mix and to a lesser extent price cost or particularly favorable in the third quarter. So while the segment would've seen nice sequential and year over year margin gains even without these benefits we would not expect to see the same degree of gains in this segment's operating margin in subsequent quarters.
Yes.
However to be clear, we continue to expect to see meaningful year over year improvement in industrial margins.
As we deliver on our strategy as discussed during our Investor day presentation, just eight months ago.
Orders in industrial for the quarter were down 3%, but would have been down further were it not for the strength and the data center business.
Currently order rates for October are tracking up just over 2% with continued strength in data center plus some early signs of improvement in the core North America industrial business.
Partially offset by mixed results across Europe, and modest weakness in Asia.
All of our facilities are operational in Europe, and Asia, and we will be closely monitoring covered related impacts on all of our businesses.
Turning to climate solutions.
Organic sales in the third quarter were up 2.5% from the prior year.
The increase was primarily driven by our North America residential HVAC business, which we attribute to a combination of favorable end user demand plus significant channel restocking.
The strength in residential HVAC was partially offset by weakness in Europe.
Sure on light commercial HVAC market and ongoing weakness in commercial refrigeration, which has a sizable exposure to the still struggling hospitality vertical.
In addition, our proactive pruning actions were approximately three points of top line headwind in the quarter.
I'll provide a little more color on what we saw in residential HVAC has has this has been an area of heightened investor interest.
Orders in our HVAC business, which reflects products, we sell into air conditioning and furnace markets were up 12% in August up 27% in September and are tracking up almost 22% month to date in October.
We believe the strength largely reflects channel restocking after inventories became severely depleted during the second quarter.
Plus decent end user demand.
We do expect further strong momentum in residential HVAC, because it's our sense that Oems are still working to rebuild channel inventories to more normalized levels.
Indeed, we believe our strong orders in residential HVAC could have been materially stronger if Oems had been able to fully meet desired restocking levels.
That said.
Any early cold weather could result in a shift to by our OEM customers to producing more furnaces, leaving air conditioning inventory below normal until more robust stocking activity occurs in early next year ahead of the 2021 cooling season.
We see Regal benefiting from this air conditioning restock, whether it occurs in the fourth quarter or next year and from any accelerated shift to building furnaces as we have leading positions in both markets.
In addition, we remain optimistic that we will see more mixed benefit. This winter from the mid 2019 mandated shift to higher efficiency furnaces, which did not occur last winter due to the warmer than normal weather.
The adjusted operating margin in the quarter for climate was 17.1% flat with the prior year period favorable mix continued cost reductions and volume or.
Your margin tailwinds in the quarter, but offset by headwinds tied to FX higher freight cost to serve our customers and slightly weaker price price cost.
While leverage on climate growth of 18% is below our run rate target level. It is still in line with our expectation expectations for this quarter, given particularly strong lower margin OEM demand still elevated corporate related costs and a recent decision to make some additional product development investments related to indoor air quality.
City.
I'd also like to note that while we did see some pressure this quarter from bright price cost. We expect this dynamic to improve as we exit the fourth quarter.
With further improvement in the first quarter and second quarter of 2021 as benefits from our material price formulas become more impactful.
Orders in client for the quarter were up 3% largely on North America residential HVAC looking at month to date October orders for this segment are tracking up almost 17% again on strong North America HVAC, along with early signs of recovery in Europe and commercial refrigeration.
Turning to power transmission solutions for Pts.
Organic sales in the third quarter were down 8.9% from the prior year significantly narrowing the rate of decline compared to the 21.1% decline posted last quarter.
The organic decline reflects continued pressure on the North America General industrial end market and to a lesser extent headwinds in oil and gas lumpiness any alternative energy market and our proactive approach.
To provide proactive actions to prune lower margin business in the third quarter, our pruning actions.
Weighed on sales by roughly 70 basis points, partially offsetting these headwinds were nice share gains in our model sort unit material handling business, which Louis discussed earlier.
Adjusted operating margin in the quarter for Pts was 12.8% up 90 basis points compared to the prior year.
Favorable price cost continued cost reductions and to a lesser extent favorable mix more than offset volume related pressures.
Orders in Pts for the quarter were down approximately 7% largely on headwinds in that general industrial and oil and gas end markets.
Looking at month to date October orders are tracking up slightly to last year with improvements in our short cycle businesses, partially offset by oil and gas headwinds.
I'll remind you our short cycle general industrial focus bearings business stabilized during second quarter, but customers have tended to border at demand versus showing an appetite to restock we.
We did finally start to see some evidence of restocking in September.
At a very modest pace, despite channel inventory that remain lean.
So we expect nice tailwinds in this business when end user confidence rises enough for more meaningful restocking to occur.
On this slide we.
We highlight some key financial metrics for your review.
A few notable highlights first.
Our strong free cash flow of $111 million or 171% of adjusted net income, bringing our year to date conversion to almost 200% second.
Second the continued balance sheet de leverage with our net debt to adjusted EBITDA down to 1.3 times at the end of the third quarter.
Finally, with some stability in our orders are our cost actions on track and our strong free cash flow. We felt it made sense to in the pause on our stock purchase program.
Consistent with our past practice, we will not be making any forward looking comments about our stock purchase plans and no stock purchases are assumed in our current guidance.
Moving onto the outlook for the remainder of this year 2020.
With a couple of months left in the year, our order rates back in positive territory and evident in some level of stability, we feel prepared to provide more detailed guidance.
We expect fourth quarter adjusted diluted earnings per share in a range of $1.46 to $1.66.
Up almost 25% year over year at the midpoint.
That implies 2020 annual adjusted diluted earnings per share in a range of $5.45 to $5.65, which at the midpoint is actually up, albeit modestly versus our 2019 adjusted EPS.
We're very pleased that we can provide guidance showing year over year growth in annual adjusted EPS. Despite the severe cold weather related headwinds we've battled throughout 2020.
A few modeling considerations to keep in mind for.
First the fourth quarter is typically weaker for us due to seasonality in particular in our HVAC and pool pump businesses.
Second we're certainly assuming no material negative impacts from a second wave of COVID-19.
Third we do expect relative weakness at industrial as we lap some sizable projects in the prior year fourth quarter and complete a large data center project that benefited the third quarter of this year.
Finally.
We're not assuming a significant tailwind from restocking in a short cycle industrial channel and Pts, which we think is more likely to occur in the first half of 2021.
Speaking of 2000 22021, we aim to provide more detailed guidance. When we report fourth quarter results. However, there are a few themes you should keep in mind as you start to model next year.
First the vast majority of the cost cutting we have done this year is real resulting in permanent savings with the exception of $6 million related to temporary pay cuts and furloughs in the second quarter second.
Second we have indicated previously that you are 80 20 initiatives our supply chain moves and our other restructuring actions. We are in a position to achieve leverage rate above 30% when the business is consistently growing again.
Finally, our top three end markets, our consumer general industrial and nonresidential construction.
Which represent roughly 20%, 20% and 15% of our total sales respectively.
We believe the consumer market relevant to our products has been fairly resilient this year and will continue to be in 2021.
The general industrial market has been under pressure this year and we would expect some recovery in 2021, but we would not assume returning to pre committed levels.
We do see some risk to the nonresidential construction market in particular for roughly half of our exposure that is in the us.
While we're not prepared to start forecasting end market growth rates, we would we would note that various analysts have been setting the nonresidential growth bar in a range of flat to down for next year. In these cases, we challenged the business leaders to adjust their strategies accordingly, either through more aggressive cost actions and or greater urgency.
I'm pursuing share gains we've clearly demonstrated the success of this approach throughout 2020.
Next as Louis alluded to earlier, we feel very good about how our cost out 80, 20, and best value country sourcing initiatives are tracking.
While we're still finalizing our our operating plans for 2021, we're increasingly confident that we can track ahead on our goal of delivering 300 basis points of adjusted operating margin expansion by 2022.
We will look to share more details on this front when we report our fourth quarter and provide guidance for 2021.
At the bottom of this page. We've included some additional assumptions that can be used when modeling the remainder of this year.
I'd also like to touch briefly on a topic that is surely top of mind for many of US which is the upcoming us election.
Three significant themes standout include potential changes to our two corporate tax rates impact.
Impacts on investment spending for alternative energy and infrastructure.
And China trade policy.
Regarding tax rate those who are following us when the current administration pass lower corporate tax rates may remember that our already low tax rate changed very little only by about one percentage point. Therefore, while we do believe that an unwinding of the 2018 tax cuts in jobs Act would have minimal impact on Regal its impact.
Well at this point to anticipate how tax policy in the U.S. might evolve from here.
Regarding investment spending on investment on alternative energy and or infrastructure more broadly, we'd expect any increase in spending to benefit Regal.
We have growing direct exposure to solar and wind in our Pts and motor businesses, which also have potential exposure to infrastructure investment, especially to the extent such investments are focused on commercial construction.
Finally, as it relates to China trade policy, we believe what's most relevant for investors to consider is our flexible global manufacturing presence, which enables us to serve our global customers profitably, while under under a wide variety of potential tariff scenarios.
Before moving to Q and a.
I want to once again, thank all of our Regal associates for everything they're doing to deliver for our various constituents our customers our shareholders and our fellow associates. During these very difficult times.
Our results in Q3 showed very strong execution and material progress on our journey to structurally improving that through the cycle profitability of our business.
And with that I'll turn it back over to the operator, operator, we're now ready to take questions.
Yes. Thank you we will.
We'll now begin the question and answer session.
Ask the question you May Press Star then one on your Touchtone phone.
If you are using a speakerphone please pick up your handset before pressing the keys.
Just try your question. Please press Star then sue.
This time, we will pause momentarily to assemble the roster.
And the first question comes from Mike Halloran with Baird.
Hey, good morning, everybody excellent quarter, great to see the progress.
Okay. So.
So first question lots of lots of information there really appreciate it just want to make sure I understand how you guys are thinking about the trajectory by the various business units going into next year.
Hoping you could weave in what you think is sustainable based on what we're seeing today, where do you think you have maybe a little excess in the short term with restocking versus where you've got more restocking. That's on the comm I know you gave a lot of that content in the prepared remarks, but if you wouldn't mind, just going piece by piece and how you're thinking about the momentum of each of the businesses heading into may.
Next year.
Sure on the topline just on just on the topline side just on the top line, yes sure.
This is Louis all I'll take it and then Rob will likely jump in as well, but I'll do it by business and I'll do it a little bit by market.
So we're cautiously optimistic.
We still see in the Pts segment, it's early days and there will need to be really a rebuild of inventory in the channel.
Climate, it's you.
That's a consumer driven market for us we certainly are Oems have reported some nice momentum, we're seeing that momentum in our order rates the continued to be strong.
Right now we would also say that theres a need for restocking in that space, where the where our Oems or are just meeting demand levels, but theres a need to restock as well commercial pool.
Steve stay at home markets.
Our certainly on the upswing.
You've seen that reported with some of our peers as well we feel very good there were even more excited there because of the.
Regulation that comes out in the middle of next year that drives further energy efficiency is which is perfect for our our product in our technology, but.
But then I would tell you industrial a little bit more.
If and not in the datacenter space, which we're definitely gaining share but in anything that has a significant capital investment and whether it's metals paper.
The large motor applications.
We're just not seeing that that kind of rebound and so I'll go into too quickly into markets.
General industrial broadly under pressure.
Mostly from Covidien, but we definitely see with the I.S.M. being above 50.
Some momentum and we would expect 2021 stronger.
Industrial distribution certainly there was plenty of channel Destocking until mid June we're seeing some modest signs of restocking at this point and expect some some upside as I said pool pump anything work from home is strong and so strong demand residential hvdc, yes.
With the warm weather this summer as well that that certainly helped.
And there are certainly consumer strength and restocking activity.
Our oil and gas both midstream and upstream is very weak and so that again impacts our industrial business and a bit of our Pts business.
And then.
No other verticals that we would highlight datacenter material handling bright spots some.
Some bright spots in agriculture, China commercial and Australia.
Asia Pacific a weak construction markets for us right now.
And then EMEA.
EMEA is still slow and I certainly think coated.
Is having an impact there are some market uncertainties, and then where we play as well.
Our business there is in hospitality with our commercial refrigeration space oil and gas and marine all markets that are under pressure and we would expect to continue under pressure into.
2021, so hopefully that gives you a perspective and.
I understand how we're thinking about it no no. It does and then on the cost outside.
Obviously really good progress here, maybe give some context on what's next and what you're seeing that provides the incremental confidence to pull forward that 300 basis points of improvement and what are the steps that you need to take from here to drive to that.
To that goal at a sooner date.
You know, Mike I think we were a bit in an enviable position because we outlined a three year.
Cost reduction program as we put together our our strategies for 2020 and so we were in the you know again, an enviable position that we had started some momentum and so to answer your question why do we see.
The opportunity to perhaps pull this forward is.
We still have room to improve here manufacturing plant consolidations as we outlined in our Investor day would take us two to three years.
20 is the driver of everything we're doing we have significant simplification around product rationalization, that's going to help us and we're continuing to work on again, a two to three year plan and then our focus on best value country sourcing is really.
Really paying off and we believe will benefit our segments going forward.
The last that we really haven't baked in any significant way, but where where we're spending up with is our focus on lean.
So my first 18 months of with Regal 80, 20, and was absolutely the right place to focus decentralizing the organization getting more accountability and ownership of the PML right place to refocus we're now ready to really.
Emphasize driving.
Driving lean focused on process, removing waste variation and overburden.
I commented on the last earnings call that we hired an individual who is a subject matter expert in this space, who now reports directly to me. This is a an initiative that we are driving from the executive leadership team and I think we'll provide.
It's a it's a marathon it's not a sprint it's not a we get it done tomorrow, but over the next three to five years. It will further help us transform our manufacturing and capability. So all of these things Mike on the cost side give us confidence that.
We're transforming this business and.
Hey are fighting team is doing an excellent job.
Last one from me really strong cash generation is always really good cash position.
You've taken the buybacks buyback paas off the table, you're not going to be back in the market potentially how are you balancing the opportunity set to buy back your own shares versus what's available in the marketplace. What's the thought process today and then how aggressive do you think you could be with either of those external capital allocation decisions.
Yes, Mike This is Rob I'll take that one so.
Hey, right now we're talking about we're going to revert back to our strategy of being balanced debt in our capital allocation approach.
Obviously, including dividends and Capex on projects at short Paybacks, and as you said opportunistically buying back shares and also.
Looking for inorganic at the same time.
We were weak we can be and will be at the right opportunity.
Aggressive in our approach to organic investment that meets our acquisition target metrics. It's a disciplined approach we talked about at Investor day, we want to see you know.
Opportunities with gross margins at 35% range, we want a differentiated product offerings, we want leading market positions and we're going to look for opportunities that give us an opportunity to see a ROI see above 8200 basis points above our WACC by three to five years, depending on the asset.
So that's kind of how we're looking at it and we will absolutely be balanced and we can be aggressive at the same time and both of them in all of those categories quite frankly, but but in share buybacks and as well as as M&A and which was specific to your question.
Let me, let me add onto the DS M&A seem there too Mike.
Hey, I'm very conscious that this will be my first acquisition.
Anything that we do in this space and the valuations must make sense.
That there needs to be significant synergies and a clear strategic fit.
We've seen many opportunities the funnel is strong we've we've invested in working a more structured program around the funnel and we feel good about our funnel.
Your regions or elevated and we're not going to overpay, but I am sure. There are options out there for us and so to Rob's point, we will be balanced in our deployment of capital and I think there will be opportunities in the in the future.
Hey, Thanks, a lot for your time appreciate it.
Thanks, Mike as Mike.
Thank you and the next question comes from Julian Mitchell with Barclays.
Hi, good morning.
So good morning, maybe just trying to keep the questions a little brief see I guess on the portfolio Lewis I think you'd mentioned that fresh look so that was somewhat intriguing I suppose I mean, I had thought that perhaps you might try and push the margins up across the board, but full perhaps looking.
Could divest some business is one that if anything had changed.
In your mind on that front or is it simply that the macro environment today is more conducive to.
Assets, changing hands and that sort of thing and how broad or substantiate that hurt your fresh look might be.
Yes, so really the point of bringing it up Julian was that it was brought up at our Investor Day. We just came out of a strategy review with our board.
We are.
Constantly evaluating the position of our businesses the performance of our businesses and so I just wanted to emphasize that this is something that is top of mind for me and my leadership team as we think about strategy I couldn't agree with you more that there is still.
Value creation shareholder value creation in our ability to run margins up and especially in a couple of our less performing businesses, certainly industrial and I couldn't be more proud of our what our industrial business has done to date and believe that there is there's more runway there but.
But at the same time.
I think it's healthy for us to constantly challenge ourselves and say.
Is the best business.
Is that our our businesses best suited with us at Regal or perhaps elsewhere. So it was yes, perhaps a little intriguing to put that paragraph into my.
Our prepared remarks, but it was done in just to simply intentionally to reinforce to the investment community that we are focused on portfolio management. We are looking for a growth earnings growth as well as good return on our invested capital, which I think is our responsibilities for.
For shareholders and so that was the point hopefully hopefully that's clear.
Thank you that is yes, and then my second question just stepping back to margins.
You mentioned restructuring charges this year of 29 million.
Is that kind of the peak year and that drifts down next year.
And then on the industrial business you mentioned, some tailwinds specific to Q3.
So where do you think the real sort of baseline margin is today in that segment.
Okay.
Yes, Drillings, Rob Hey, So first of all you asked about the restructuring is it up is it a peak we're still working through our plans for next year, but.
But this year was certainly I want that's higher than what we may normally experience.
Again, it's certainly tied into some great cost actions that we've taken and we're reaping those benefits I wouldn't expect it to continue at a pace.
Where we are today just to answer your question, but certainly we will continue to have restructuring as we enter 2001 now.
How do we think about industrial margins and progression from here.
Hey, we had a pretty you know we did at particularly good project levels in the third quarter as we talked about and a lot of that's in our data Center business was also helped our mix and we still see further margin improvements year over year in the fourth quarter, but as we said that maybe not sequentially you may not see that level of improvement.
And we will talk more about this and on the fourth quarter call, but you know we laid out a framework at Investor day that called for 8% to 11%.
Margins for the industrial business and we absolutely believe that's the right range to think about industrial margins going forward. We're tracking as we talked about ahead of that ahead of that pace or maybe see the higher side of that range, but that's the range that we laid out we're still tied into that at this point.
Great. Thank you.
Okay. Thanks, Julie Thank you and the next question comes from Nigel Coe with Wolfe Research.
Thanks, Good morning.
Hi, good morning on quota.
So you mentioned.
Yes, a lot of noise around.
Q.
And you talked about the need for more sort of larger more efficient motives.
And that kind of scenario.
Gary I laid out a pretty aggressive sort of TV set for that but I'm. Just wondering are you seeing any signs a tool that perhaps 21, we might get mixed up.
Around that issue and then the second part of that question. Two part question is how do we go from 14 to 15 seer.
It could be a time does that have any indications so the motor system within the been the wood.
Within the equipment to achieve that.
Yes so.
Nigel I'll take that so so first of all are we seeing any indications that would there will be a significant.
Upside in 2021 from my queue I'd say, it's fairly early days.
No. We are in discussions with Oems, we do think our product and technology positions us very well to help solve the energy consumption and efficiency issues that will come along with the Q.
We've already talked a little bit about this of having what we think are some plug and play solutions that will position us well with Oems and we've already got one on the market today with an OEM.
But I think it's early days, so I'm I'm not quite ready to.
Comment on do we think that will have a significant uptick for 2021.
With regards to the sea or regulation absolutely. The next to your regulation just drives another level of energy efficiency requirements and again this is where our technology is and where a technology leader in our variable speed motors in solutions and so we think we're going to be well suited to benefit.
From that.
So we see that as a positive tailwind for us.
Great and then a quick follow on excess free cash flow you've been.
So those things trade working capital Tailwinds now about six quarters as we sort of turn the corner on on on volumes do we need to rebuild.
Working cap and 21, we'll keeping steady here.
I will tell you Nigel that free cash flow has been very strong as you seen trade working capital has been a source of cash through most of the year in the third quarter. It was a use of cash, but we do expect it to be a source of cash for the year as we exit the year.
We have more runway to go here, especially in the area of inventory and we've made that that that point very clear and the way we've talked about trade working capital in the past and so we are not taking our foot off the gas we have plenty of runway and we expect it to be a source of cash as we move forward now obviously that depends on volumes.
These have to build back for volumes, but we would expect steady state that inventory and trade working capital will be a nice source moving forward.
You know I think we've gained some momentum here just to just to add on that I agree with Rob's comments you know, it's all about now measuring days on hand, and we've put a lot more discipline in our organization around inventory management, but there is still opportunity there. So.
I couldn't agree more this will be a.
Should be a benefit for us.
Great. Thanks.
Thanks, Dan.
Thank you and the next question comes from Jeff Hammond with Keybanc.
Hey.
Good morning, guys.
All right, Jeff just on.
Fourth quarter, good color on the orders and certainly the guide, but just trying to pinpoint you know how you're thinking about sales into for Q, either you know kind of all in do we grow organically or.
It looks like maybe two of the four segments would would see growth and maybe to the four would still be down any help there would be great.
Sure Jeff.
First of all you know we would expect further progress on industrial.
On a year over year basis.
Maybe not quarter over.
Not necessarily quarter over quarter sequentially Abbott third quarter sets us saw such nice tailwinds.
From project activity in that that sort of thing, but all for all of our segments are expecting tailwinds and fourth quarter.
Related to the Bottomline cost actions productivity 80 20, but.
But but volumes are a little bit uncertain.
And so could pose some some degrees of offset one consideration for climate is the strong momentum we've seen with a large HVAC Oems and.
And to the lesser and to the extent that that continues through the quarter, especially on a c. side that will benefit volume leverage and it could be a.
Mix headwind for us because as Oems are are lower on the margin side, but from a topline perspective, we would still expect to see some nice nice momentum going forward into the end of the fourth quarter on a year over year basis, where we will see pressure.
It's certainly we would expect pressure and both our industrial and Pts segments to be clear.
And on a year over year basis.
Okay. That's a that's real helpful. Rob.
Just on the long term margin targets I mean, we would have thought maybe with a pandemic.
In between that those get pushed out but it just seems like you've made a ton of progress. This year. So just maybe level set us on more broadly I know you touched on industrial more broadly how you're thinking about.
Progress on on hitting those.
Yeah, So Jeff I'll take that you know it it's again it's.
We believe we are driving the transformation of the business and 80 20 as it was the starting point to help us do so and really dug into a quad perspective of ensuring that we are providing the maximum value to our highly valued customers that buy a product serving them.
Better providing better solutions in that space. So that has gained momentum.
Across the board a little bit faster than we anticipated plus as as we said we outlined to a three year program to transform which included plant consolidations product rationalization and now we're accelerating our lean efforts we outlined those.
At Investor day, except for lean and lean is now added addition.
Additional tailwind so.
You know we are feeling more confident.
No just most of that is cost centric opportunities and then with.
Our growth we believe that the margin potential is there the potential is there to pull forward to 303 because that.
80, 20 is driving us to.
Valued the right segments into put our focus of our sales force on those segments and then as we talked about in Investor day, our investment in additional R&D 100 basis points over the next three years is allowing us to produce better understand our customer needs and help solve their problem.
Problems and develop products that position us for accelerated growth. So all of these things are giving us more and more confidence.
Or that we should be able to pull forward the 303.
Okay, and then just sneak one more in there on the 80 20.
Certainly that's that's a topline headwind and additive to margins, but as we look into 21 do you still think that 80 20 topline head headwind continues or is that maturing.
Yes, I'd say it's.
It will continue but it will not continue at the extent that we saw in 20 or so it will temper a bit and then 22.
Two will temper, even a a little bit further we've we modeled.
The 80, 20 pruning effect to be stronger in year, one, but but then declined over that period.
Hey, again, I, you know as I've said to the investment community as I said say to every one of our associates, we need to provide differentiated products and solutions that solve our customers'.
Challenging problems cost competitively.
And so that's our focus at Regal.
Okay perfect. Thanks Louis.
Sure. Thank you.
Thank you and the next question comes from Watson Liptak with Seaport.
Hi, Thanks, Good morning, guys, great quarter, especially on the margin.
Yes. Thank you.
I'd be just a follow on from Jeffs question.
80, 20 grinning.
Those nicely aggressive I guess, a little bit more I think than that.
Than we thought but what in the Pts segment. It looked like there was as much religious better they don't have as many.
Pruning situations they have to go through why was the the critical mass in that segment.
Yeah, I'd say that that's a fair very simple assessment.
You know our gross margins and we've been pretty clear on this our gross margins in our power transmission business are stronger than the rest of the portfolio and so that likely gives you a first indication that they should have less pruning and you know it.
We sell more through distribution and power transmission business. So of course that helps the uplift in the margins there and so.
So I think thats really the main driver.
Okay great.
Switching over to the.
Comments about.
Climate with the HPC always.
Considering the low manufacturing is done down in Mexico, and you've got this strong residential mark going on or is it there.
As for a change in the seasonality, we see more of that inventory build in the fourth quarter and first quarter guidance.
Destock building in the channel.
You know it it's really hard to say right now because there are quite a few variables out there one that variable is weather and if if weather. If we have a cold winter, there's going to be a turn pretty quickly to furnace built another variable is coated and the ability for the Oems.
As well as us for that matter to ramp up the production to be able to meet the demand as well as meet the inventory levels. So you know I I am not quite ready to give a clear picture of that there could be a change here what I can say is that we've got some nice momentum.
The trailing three month order rates in the HPC space is 20% or.
For us and that's going to propel us strongly we believe through Q4 and should into next year.
Okay, Great and then the last one for me is just on the.
The restructuring.
Planned consolidation has it started yet.
Are you are there are plants or.
Or is that something that happens in 2021 22.
No no absolutely. It has started we've communicated.
That there would be a five manufacturing plants that would be announced or closed through 2020, we have not yet communicated the impact for 2021. So what it does it has definitely started.
Okay, great. Thank you.
Thanks, Paul.
Thank you and the next question comes from Joe Ritchie with Goldman Sachs.
Thanks, Good morning, everyone.
Thanks Sandra.
Just a couple of quick ones from me as you as you think about that the 30% plus incrementals into in 2020 line is there a certain amount of volume that you need to come through the system in order to in order to achieve that and then.
Secondly, as you kind of think about the margin targets.
300 basis points by 2022 in similar comment in terms of what you already have within your own control.
To drive strong margin if the volume does come back.
Yes, so that the significant part of the 303 it was a cost focus.
And so Joe we feel pretty pretty good about keeping that momentum of course, we do need some volume to return, but we think the markets are going to provide that kind of tailwind.
Oh you asked are we done is do we need a certain amount of volume to get the leverage going forward and I'd say.
It shouldn't be.
We should be able to see volume leverage year over year going into by segment. No. We tell you that we probably lever a little bit stronger in Pts, we love or lessened climate, a little less in industrial a little stronger in commercial but overall.
Oh no.
No I don't think its going to be highly tied to us a minimum level of volume that comes with it.
Okay, Great. That's good to hear Lewis and then maybe my quick follow on question.
You talked a lot about you know that the work that you're doing in the products that you have for data centers and share gains that you're experiencing maybe maybe talk a little bit more about what what you think is allowing you to gain share in the data center market.
Hey, I'm excited about this business and I believe that we have further growth opportunities I've got a team.
That understands the the application that is able to easily and with speed customized solutions to better meet the requirements of their customer. This is where we want to drive more at Regal.
Deeper understanding of the application and being able to provide solutions that differentiate us and do it with speed and cost competitively in that team is doing it very well for us and so I believe there is runway for us to gain further share in this space.
That's great to hear and then stop everybody.
Thank you. Thank you.
Thank you and as there are no questions I would like to turn the photo management, Frank causing how much.
Thank you operator to summarize while our third quarter results continued to be impacted by COVID-19.
A number of bright spots also emerged on orders and sales performance and I feel extremely good about how old the Regal team is executing on our restructuring actions leveraging 80, 20, managing our working capital and signal selectively pursuing share gain opportunities.
We continue to transform this business.
And I believe it's increasingly evident in our results.
Most notably we drove year over year operating profit improvement on down sales were 300 basis points of adjusted gross margin improvement.
And we see a path to material further upside.
While we're still not out of the woods uncovered 19, we're remaining focused on keeping everyone at Regal safe and on executing what's under our control to keep moving down the path towards our longer term gross margin and our IC goals.
Thank you again for your interest in Regal.
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.