Global X U.S. Cash Flow Kings 100 ETF
Q3 2019 Earnings Call Transcript

Published: 1 Nov 2019

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the SPX FLOW Third Quarter 2019 Earnings Call. At this time, all participant lines are in a listen-only mode. After the speaker’s presentation, there will be conduct a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]I would now like to hand the conference over to your speaker today, Ryan Taylor, Chief Strategy Officer. Please go ahead, sir.

[Ryan Taylor:]

Thank you, Sarah, and good morning, everyone. Thanks for joining us on the call today. With me here are Marc Michael, our President and CEO; and Jaime Easley, our Chief Financial Officer. Our Q3 2019 earnings release was issued earlier this morning and can be found on our website, spxflow.com.This call is also being webcast. The presentation for the webcast is located in the investors section of our website and includes details of our Q3 results. A replay of the webcast will be available on our site later today.Note that elements of the 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 view them in that light.Principal risk factors that may impact our performance are identified in our most recent SEC filings. And in the appendix of today's presentation, we've also provided reconciliations for all non-GAAP and adjusted presented.And with that, I'll turn the call over to Marc.

[Marc Michael:]

Thanks, Ryan. Good morning, everyone, and thanks for joining us on the call. Our third quarter results underscore the progress we've made on our strategic transformation to 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 and cash generation further strengthened our balance sheet and made significant progress with respect to our strategic initiatives.I want to thank our teams across the enterprise for their hard work, tireless effort and positive contributions to the quarter. We are excited about the future and committed to delivering a differentiated customer experience, creating an engaging winning culture for employees, and investing in our business to strengthen our core capabilities and drive long-term growth and 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 our 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 crisp operating performance across the business. Adjusted EPS was $0.59 and exceeded our midpoint guidance by $0.12, 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 value by focusing our strategy on serving customers in select process applications.Looking at free cash flow on a total company basis, we generated $48 million of free cash flow. This was net of $7 million of CapEx, including investment in 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 the divestiture of power and energy, we are in the latter stages of the sale process. José Larios 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 macroeconomic and geopolitical uncertainty. After that the priority we plan to return -- 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 taken in -- earlier in the year.This improvement was driven by our teams in 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 refocused the funnel of new opportunities on higher value liquid applications such as fermented dairy, nutritional beverages and fine foods.In these applications, we provide world-class process expertise and deliver high-value propositions to customers from the initial design and installation of the process solutions through the life cycle of the equipment. They also require many of our process components, providing an attractive annuity stream of service spares and consumable wear parts.In contrast, large dry dairy projects have a lower value proposition and lower after-market potential. Given this we have methodically reduced the backlog in that category. At the end of Q3, there were no material dry 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 consistently at a higher level.In Q4, we expect steady segment income dollar and 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. and 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 bellwethers 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.In 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 on to 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 are now targeting just over $1.5 billion of revenue, with adjusted EBITDA between $180 million and $185 million, and adjusted EPS of approximately $1.90 per share.We are 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 our business through the near-term demand environment, ensuring we proactively manage costs, while also investing for long-term growth, in line with our strategy.We've 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. And at this time, I'll turn the call over to, Jaime.

[Jaime Easley:]

Thanks, Marc, and good morning, everyone. I'll begin with the 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 declined 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 Marc 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 dry dairy systems.This was partially offset by mid-single-digit growth, in component and aftermarket sales. The organic decline in systems was anticipated and is consistent with our strategy to drive a higher quality of revenue throughout our business.In the third quarter, nearly two-thirds of Food and Beverage revenue was comprised of component and aftermarket sales. Revenue related to systems, represented approximately one-third of revenue and was comprised mostly of liquid processing.The contribution of revenue from large dry 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 a 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 is 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 $0.39 per share from continuing operations. This included a non-cash, impairment charge of $0.18, related to a corporate asset classified as held-for-sale, professional fees of $0.08, relating primarily to ongoing development of our enterprise strategy. And long-term growth plan.And a net tax benefit in the tax provision of $0.06, as compared to the effective rate of 27% assumed in our guidance. Excluding these items, adjusted EPS from continuing operations was $0.59 per share.In discontinued operations, we reported a loss per share of $1.13. This includes a $0.29 charge related to the settlement of a legal matter. And a non-cash impairment charge of $1.17 per share.The impairment was based on developments in sale process and indications of fair value, received at the conclusion of the third quarter. The charge reduced 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 it will 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.This settlement releases our company from further claims by the customer, beyond 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, José and his team delivered a solid quarter, in line 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 in 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 up 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 million and $51 million and our adjusted EPS range is $0.49 to $0.61 per share. This assumes $7 million of interest expense, 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 of debt reduction through 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 -- I'm sorry, between cash on hand and our revolver we have over $700 million of liquidity today. We're in a strong and flexible financial position. And expect to further strengthen our position following the divestiture.As we evaluate redeployment of the, divestiture proceeds, we intend to prioritize debt reduction along with a return to shareholders and organic investments. Once we've reached that point, our ongoing capital allocation will broaden with the emphasis shifting towards growing our business through attractive ROIC opportunities, both organic and inorganically, as well as a return to shareholders.In preparation, we've 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-ROIC opportunities to grow our business.With that I'll turn the call back over to Marc for closing remarks.

[Marc Michael:]

Thanks, Jaime. Clearly, we are excited about the future. We're building a premier process solutions enterprise with strong technical expertise, global capabilities and well recognized brands with leading market positions. We're focusing growth in micro 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 ROIC. As we focus on growing high-quality revenue streams, we believe we can achieve 4% to 6% organic growth through an industrial cycle and convert cash at a very attractive rate.The risk profile in our business and exposure to cyclical commodity markets will be dramatically lower going forward. This should 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've made on our strategic transformation. The level of margin performance and strong cash conversion in the quarter highlight 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 road map to drive long-term growth in targeted micro 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 teamwork and focused product groups and building core capabilities around customer intimacy, velocity and 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 costs while investing at appropriate levels to deliver a world-class customer experience and drive long-term growth at double-digit ROIC.I want to thank our teams across the enterprise as well as our business partners for their hard work, tireless 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.

[Operator:]

Thank you [Operator Instructions] Our first question comes from the line of Nathan Jones with Stifel. Your line is now open.

[Nathan Jones:]

Good morning, everyone.

[Marc Michael:]

Good morning, Nathan.

[Jaime Easley:]

Good morning, Nathan.

[Nathan Jones:]

Marc, I'd like to start off focusing on some of your last comments there around enterprise strategy, high levels of accountability, cross-functional team work customer intimacy all of that kind of stuff. I know it's fairly difficult to encapsulate that in a fairly short answer on an earnings call.But I think that 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. What the results are? How it benefits your customer? How it benefits your employees? How it benefits shareholders? And what you can do to continue to improve that culture within the organization?

[Marc Michael:]

Yes. Nathan it's an important step that we've taken over -- we've been working on actually over the last four years since the spin. It started with really strengthening our functional capabilities and that's really been the emphasis, up until we entered 2019 and we started this pivot to an emphasis on the markets and customers that we serve and effectively looking across the company and the enterprise and saying, okay, where can our teams work more closely together on key products, key micro verticals to deliver the best customer experience possible.That includes a number of areas. 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 that some of the big things we've also done is invested back into our factories in a different way on the velocity front as we're calling it and describing it.We have 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 a customer all the way through shipment and service to accelerate speed through each of the product areas again all the way through to the factories and until we ship the product and then how we service at the end.From a vitality standpoint and emphasizing vitality in the company renewed focus on NPD and that's really just in the early stages and the teams are building funnels around new products, we're looking at value engineering, our product lines is an important step.And then I'd come back to the customer as kind of a key punch point is that 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, the focus that Jaime has brought 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 is why we're really excited about this stage of the journey with a lot of hard effort, a lot of heavy lifting to get us to this point and as we were describing now, it's a pivot to how we really start to create value going forward, whereas 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.

[Nathan Jones:]

Thanks for that. And my follow-up question is probably around 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're going to have a very flexible capital structure and a good deal of capital to reinvest there both organically and inorganically.I know you guys have been doing a lot of work, segmenting the market, looking at where the best places to deploy capital are. Do you kind of describe the process and the resources being used to identify those most attractive verticals? What kind of time frame 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, what kind of hurdle rates you're going to be setting for yourself?

[Marc Michael:]

Yes. Sure. So maybe first, Nathan I'll mention the divestiture process in Power and Energy. It's an active process with several firms. We are in due diligence and management, meetings are continuing and overall everything is progressing well. The management team that is in place with José and his group are doing a fantastic job and as we mentioned they delivered good performance in the quarter.As it pertains and 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 and we've 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 do investments that we make. And so, it's really important the work that we're doing right now with a leading firm in the space that's helping support us evaluate market opportunities and that work will be largely concluded at the end of 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, we'll be in a good position going into next year to 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 products areas and micro verticals that will have an accountability and responsibility to make those assessments, based on how we're establishing the strategy. And maybe, I'll let maybe Jaime speak to some of the hurdle rates, we'll be looking at for investments.

[Jaime Easley:]

Yes Nathan. So, the team is working on a variety of different investments. And so as we kind of walk through the value-creation model, we would look first to organic investments within the business. And so, we've really taken the chance over the last three to six months to overhaul the way we think about investments and the way we push through the concepts of ROIC into our organic investment pipeline as that's working through.So what we expect to see is that 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 -- and as we look to the inorganic side, all the work that Marc just described which is how our teams think about micro verticals, how our teams think about growth opportunities within those micro verticals, those regions, those product lines, 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 the -- just depending on the price of these acquisitions and the value that we can create, we'll probably be thinking about that and the number of years or the duration of time that it would take to have an ROIC above our WACC and not knowing exactly what those are in front of us, it's hard to say as we think now, but that's the framework in which we'll apply to think about those investments.

[Marc Michael:]

Yes. I would mention one other thing on the inorganic opportunities is we'll be very disciplined in that assessment and in line with our strategy around our core capabilities and so we're looking at product lines and micro verticals, where we're familiar with operating and that we see good returns we get in our core business today. And so, that's an important I think uptake that we'll be very laser-focused on that and I would anticipate that as we're looking at those opportunities, there will be opportunities as Jaime mentioned, not only to expand margin, but where we can see really good growth opportunities in areas of verticals that are growing at an outpaced level. So, that's going to be an important part of how we think about deploying capital inorganically too.And again, that process is maturing well with the work that Ryan has been doing with Vusa Mlingo and all the efforts that have been going on with the third-party firm that's supporting us. So, we feel really good about where we are going into 2020 to start to get in the next phase of the journey and we're thinking about this again not set up 2020 in the 12 month period, we're thinking about this over the next three to five years and how we can create a great outstanding return for our shareholders.

[Nathan Jones:]

Thanks for all the detail. That’s fantastic. I’ll pass it on.

[Marc Michael:]

Thanks Nathan.

[Jaime Easley:]

Thanks Nathan.

[Operator:]

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

[Mike Halloran:]

Good morning, everyone.

[Jaime Easley:]

Hey Mike.

[Mike Halloran:]

So, it seems like you got some despaired trends happening right deceleration on the Industrial side had some project help in Asia on the F&B side and then aftermarket fine components a little up a year. Can you give some thoughts on, one, where you see the markets heading as we move to 2020? Sustainability of the trends on either side, how you're kind of thinking about it as we look forward by end market?

[Marc Michael:]

Yes. Sure Mike. First, overall, as we've mentioned, the trend has kind of been in the $350 million to $360 million 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 and tends to be lower than the other quarters of the year just based on the holiday periods that take place in Europe. What we see in going across the regions and I'll kind of talk between the regions and the markets.First in the markets, Industrial, as you see it stepped down in Q3, but we feel that's more again indicative of what's happening in the global macroeconomic 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 environment. 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 and aftermarket business which is good to see. Some better performance in the aftermarket with a little slower performance in components.And in systems it's 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 in our core components and aftermarket business, we see that as being less about selectivity and more about what the markets are bearing right now in some regards.So, if I go across the regions, just to give a sense of what we see across the regions in Europe, it was slow as I mentioned with some seasonality. F&B was a bit weaker overall and Industrial was softer, 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.F&B components and aftermarket, when kind of combined together were stable. And it was encouraging to see that the Industrial business in North America grew sequentially kind of mid-single digit. So, we'll be watching that as we kind of roll through here in the fourth quarter.Good momentum in China. Food and Beverage was really good across the board in not only our systems business, but also in components and aftermarket. And then our Industrial orders in China were -- I would describe as a bit mixed also some components were up and some were down. That kind of had some offsets.And then across the rest of APAC, we saw some steady improvement there too kind of up low single digits. F&B being the primary driver with components and aftermarket being kind of stable and systems being -- systems orders improving modestly with Industrial again being a bit mixed. So, I kind of have said a mouthful there, but if I backed up from it, I would describe it as Industrial business continues to be impacted more by the global economic and geopolitical environment. Food and Beverage components and aftermarkets 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.

[Mike Halloran:]

And then, you touched on it briefly, the focus on higher-quality revenue and the positive impact that's having on the margin profile. Could you just talk about the sustainability of what you saw from the margin on both segments, as we look to the third quarter? And obviously, revenue swings around seasonally, but is there anything in the third quarter that you don't think is sustainable relative to the revenue levels as you look forward?

[Marc Michael:]

The short answer is I don't see anything that keeps it from being sustainable. We're looking to have a similar level of performance in Q4 and as we've worked on this higher quality of revenue, it's achieving gross margins now in the 35% range with backlog margins up about 300 basis points since the start of the year and that's continuing into Q4.It's really -- what predicates performance going forward, we feel is -- again the more in the markets and what that provides is in the Industrial segment, how we improve our performance for customers and can we take additional position and share in that space.And then in food and beverage this -- the bit of the same applies for components and aftermarket business continue to service customers well, and the systems business I think we look forward to opportunities where we continue to be selectively -- selective on liquid opportunities. So that playbook is not changing.That's the playbook that we've been working to execute now for the past several quarters and it's starting to end in the results that we're seeing in Q3 and 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.

[Jaime Easley:]

Yeah, Mike maybe I'll just add to that. I think that's the right question and we've said in the prepared remarks that we would expect this level of margin performance in the F&B segment.I think Marc hit on it we are seeing good improvement in margins and backlog from the beginning of the year about 300 basis points. The -- 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 our 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 a particular quarter, I think the nature of the backlog is going to help stabilize that.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 team develop a level of capability within the organization on pricing and being thoughtful around that. And I believe that's going to continue to be the case and be positive for us.And then Marc made some references to this, but the investments that we're going to make in customer intimacy through outreaches to the customers, voice of customers, 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 at the gross margin and segment income lines.Maybe lastly I'd point out here is all of the improvements that we've talked about that are going through our factories, our pathway to excellence, some of the supply chain changes that we've made, but the factories and the execution of Ty Jeffers and 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.

[Mike Halloran:]

Great. Appreciate the answers.

[Jaime Easley:]

Thanks, Mike.

[Marc Michael:]

Yeah. Thanks, Mike.

[Operator:]

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

[Unidentified Analyst:]

Hey, good morning, everyone. This is Jaao [ph] on for Julian.

[Jaime Easley:]

Good morning.

[Marc Michael:]

Good morning.

[Unidentified Analyst:]

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 and last. Can you just talk a bit about what was resilient? I know North America you got excited, but if there's anything else there and maybe what you see, kind of, leading into more weakness next quarter with that mid single-digit decline expectation?

[Marc Michael:]

Yes. The Industrial part of the business is what we're keeping a close eye on as 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 the best improvement in our industrial business that was primarily associated with our mixers and our dryers and our hydraulics business were rebounded versus Q2 and 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 our shorter-cycle business, shorter-cycle businesses in many regards that when demand is picking up, we typically see those product lines pick up the first.So we'll be watching the development here in Q4. It's still a bit of -- I would describe it as a choppy environment even month-to-month we'll see ups and downs through the months. So as we look back at the past 90-day period, North America was a stand out and again Europe Industrial was a bit mixed, China was a bit mixed and the rest of APAC was a bit mixed. So good to see North America having some improvement and we'll continue to watch that as we move through the quarter.One thing that I wanted to mention too the profile of our business now is about 85% going through our factories and as we do have this profile of more business in our factories as we look to execute and the work that Ty and team are doing this concept of velocity is really core to what they're focused on.So with shorter-cycle business, we'll also be able to convert backlog more quickly and reduce our lead times accordingly and again serve customers better. So we think that's going to put us in a better position as we move forward also. And this concept though of faster cycle business that will execute through our backlog more quickly and orders that we receive in a quarter being -- execute them more quickly is an important concept.

[Unidentified Analyst:]

Got it. And then turning back to margins. Pricing has been a good tailwind for you guys. Just looking ahead, are you seeing any pushback from your customers? Just given commodity price is coming down, tariffs maybe not increasing as rapidly as they've been in the past year, where do you think that's sustainable going forward?

[Marc Michael:]

Yeah. We're continuing to evaluate price cost and to the point we've been able to stay ahead of cost and it's not just been price. There's been a lot of good work done in our supply chain organization to help offset the cost. So the margin performance improvement that's associated with price in our supply chain initiatives are helping us stay ahead of tariffs and the inflationary curves.As we look forward, our supply chain teams are going to continue the same playbook that they've been working on to achieve better cost positions. And on the price front, we'll monitor and look at the product lines and see, which ones maybe are experiencing more pressure from the commodities or inflation tariffs and make adjustments accordingly on the pricing front. So going forward, I -- we'll continue to do both and be really targeted with our pricing initiatives.

[Unidentified Analyst:]

Got it. Thank you.

[Marc Michael:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Robert Barry with Buckingham Research. Your line is now open.

[Robert Barry:]

Hey guys, good morning.

[Jaime Easley:]

Good morning, Robert.

[Marc Michael:]

Good morning, Robert.

[Robert Barry:]

Congrats on the solid quarter.

[Marc Michael:]

Thank you very much.

[Robert Barry:]

I think it was a crisp execution. I just wanted to clarify the comment I think you made it before about the backlog. I think it was entering the year at 300 bps. 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 up more given how strong the backlog was entering the year and price cost has been pretty good I think?

[Jaime Easley:]

Yeah. I'll take that one Robert. So if you go back to -- if you're looking at full year performance, you go back to Q2, you'll remember some of the discrete charges that we had in the quarter, which wouldn't have been in the backlog and expected as we entered into the year. And then I think as we continue to see 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 backlog margins that we're seeing as we exit Q3.

[Marc Michael:]

Yes. I'd just add to that too. The overall mix change in the backlog too has still been developing throughout the year. Now while we've been taking down the dry dairy for 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 too.So the trend that we're starting to experience during, Q3 in terms of margin profile and what we expect in Q4, and as we've been describing going forward that higher-level margin and more consistency is more indicative I think of that margin profile increase versus the first half of the year. We still had some things we were dealing with in the backlog.

[Robert Barry:]

Got it. Got it. And I guess you are forecasting a pretty nice improvement in 4Q.

[Jaime Easley:]

Robert, we're having trouble hearing you.

[Robert Barry:]

Yeah. I was also just kind of observing that I think you're also expecting a pretty nice increase in 4Q?

[Jaime Easley:]

We are trying.

[Robert Barry:]

So, I think you said earlier dry dairy is now out of the backlog. Just to be clear, I know there's been some proactive de-emphasis at things like heat exchangers and other products as well. Do you anticipate as you end the year, there being anything in the backlog that's no longer deemed strategic? Or how much might be at end of the year?

[Marc Michael:]

Yeah. Just to maybe be more specific on the dry dairy, we do still have dry dairy in the backlog. The revenue from these larger projects is now de minimis in terms of the overall amount that's in the backlog. And 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 has been less than 10% of the total systems business. So, that's a big change obviously and that's what we've been describing that the systems order intake in Food and Beverage is only 10% dry, and now where if you go back historically, that could have been 40% or 50% in a given year.So, the dry business will be -- as we've described a much smaller part going forward, we'll still be taking and looking to take some orders on targeted application opportunities. But ones that we can execute and have reasonable margin profiles and strategic customer implications to them.On the heat exchanger business, 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 about two years ago, now so we switched our 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, HVAC applications and then improving our performance to support the aftermarket and service side of the business. So, those parts of the business will still be there, but just at a much smaller level than they have been historically.

[Robert Barry:]

Right. And it sounds like any orders you are taking there are more strategic and makes profit.

[Marc Michael:]

That's right.

[Jaime Easley:]

That's right. And that will be in the markets that we would tie back into some of the strategic work that we're doing and making sure we've got good confidence in the growth in those markets and the margin capacity and capabilities within those markets.

[Robert Barry:]

Yeah. I guess just lastly for me. You mentioned earlier Marc, I think planning prudently for 2020. Probably don't want to get into too much detail at this point. But just big picture do you think, especially given these Industrial orders and the end-market there, the right way to think about 2020 framework is maybe low single-digit organic top line decline by a point or two of segment margin expansion? Just kind of like big picture.

[Marc Michael:]

Yeah. I think if we look towards 2020, I'd mention a couple of things. One thing to keep in mind is that we will have a kind of first half headwind from these dry dairy projects that we were executing during the first half of 2019, and so that's between, let's say, $35 million and $40 million 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 it can -- so just to keep reminding ourselves that those projects didn't carry much margin with them. So, that top line drop associated with that's okay. The other I think key swing factor then would be exactly the point we've been talking about how do the Industrial orders develop and the markets develop as we move through fourth quarter and into next year? And I think you can look at that line and start to get a sense of where 2020 could shape up given kind of those two factors.And then as far as the margin is concerned, as we've been describing our intentions are to continue to achieve a margin consistent with what we've seen in Q3 and 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 it will be a part of what we'll talk more about in February, but we'll want to grow our gross margin.And also I would just mention too, on the cost line the cost -- the efforts that we're working on are going to be important to us at 2% to 3% cost out as well as other opportunities we're going to be considering. So, I think there will be margin expansion opportunity there. We'll want to define that a little more specifically though when we get to February.

[Robert Barry:]

All right. Fair enough. That’s very helpful. Thank you.

[Marc Michael:]

You bet.

[Operator:]

Thank you. Our next question comes from the line of Brett Linzey with Vertical Research. Your line is now open.

[Brett Linzey:]

Hi, good morning, guys.

[Marc Michael:]

Good morning, Brett.

[Brett Linzey:]

Hey, just wanted to come back to the P&E proceeds question. Sounds like in your prepared remarks you're leaning a bit more towards organic investment versus inorganic and repo. You've had some time to roll up those plans evaluate the pipeline. Could you just give us a sense as to what the split might look like between organic and inorganic? And I guess the question is, are you willing to kind of live through some of the lost earnings? Or do you look to at least backfill that with M&A and repo before you start to make those organic investments?

[Jaime Easley:]

Yeah. I'll take that one, Brett. Yeah. So the way we work through the decision-making on investments is through our ROIC model. So, we are looking towards making organic investments. But 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&E business. We've really given our teams the green light to think more long-term and strategic around NPD investments around how we spend money to get closer to customers understand end-market demands, 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.And then, also maybe on the CapEx line also, thinking about digital and IT investments that will allow us to operate more efficiently, internally how to improve the capabilities, et cetera of our product. So, all that work is ongoing now, and we'll continue to fund that and continue to use kind of the balance sheet and the stability of our financial position, post P&E to just be a different company as it relates to those type of investments.Now, when we get around to the proceeds from the process, we are going to first look to delever there. We just think that's the prudent right thing to do. Right now, we're at 1.7 times leverage but, when that EBITDA comes out, to your point, we're going to need to look at the debt load and address that pretty aggressively. And then, once we consider the remaining proceeds, we do expect that there will be a return to shareholders in this, and I think what we'll do is kind of just look and see what the situation is at that point in time and determine the mechanisms and the amount of doing so.

[Brett Linzey:]

Okay. Got it. Thanks. And then just shifting to the 2% to 3% productivity, you've had that explicit target for quite some time obviously strong margins here in Q3. Did you get productivity come through in the quarter? And then, as we think about that 2% to 3%, how does it ramp over time? And then should we think about R&D and some of the NPD stuff netting against that to kind of become some sort of a net number below 2% to 3%?

[Jaime Easley:]

Yeah. So, if we go back to the 2% to 3% that we announced, we announced that back earlier in the year 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 and of itself. What I would say is those programs related to the 2% to 3% are now finalized. Our teams are aware of what needs to do the teams have been mobilized and we'll begin executing on those. We saw a 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 2% to 3% more broadly what we're expecting is roughly two-thirds of that is going to be on the gross margin line. We're expecting benefits from strategic sourcing savings, the team's productivity, initiatives and then some structural cost around factories. The piece coming from the functions so the one-third that will come through the SG&A line that will be net of investments. So we're excited about some of the investments we're going to make around voice of customer, some communications, data analytics, those types of initiatives that are going to allow us to really try to grow, once we get done with the program.The savings as you think about phasing those. I think, you could model 25% of those savings coming through, in 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, it's a good place to start. And then we're still expecting the full run-rate will be observed and seen coming through the P&L, in 2021.

[Brett Linzey:]

Okay, great, and then, maybe just one follow-up. You noted double-digit process system order in Asia Pac and Europe. Were these small-medium size or any large chunky orders worth calling out?

[Marc Michael:]

They were more small medium-sized to fit into selectivity profiles that we've been describing.

[Brett Linzey:]

Okay, great. Nice quarter guys. Thanks.

[Marc Michael:]

Thank you.

[Jaime Easley:]

Thanks, Brett.

[Operator:]

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

[Walter Liptak:]

Thanks. Good morning, guys.

[Marc Michael:]

Good morning.

[Walter Liptak:]

I wanted to ask a couple more sector questions, especially around Industrial and especially on the order trends. Were orders pretty consistent, in North America through the quarter?Or is it that the international was weak. 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?

[Marc Michael:]

Yeah. As mentioned, on Industrial what we saw in North America sequentially was orders up kind of in the mid-single-digit range. And again it was still a bit mixed, as I described previously.We saw our mixers and dryers and hydraulics business, tick up. And then, we had a little slower performance in our pumps and our heat exchangers, versus Q2, but overall kind of netted to kind of mid-single-digit growth, sequentially.So we were pleased to see that. Again our dryers and our hydraulics business can be an indicator of more economic vitality, given the short-cycle nature of those particular product lines.When customers have a need there, they order 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, it's just a softer environment with mixed results from product line-to-product line.That's how I would describe Europe as well as China, and the rest of Asia Pacific. So, if North America can stay stable. And start to see some modest improvement, as we move forward, that will be a good sign. And then, hopefully we'll see that same trend start to follow through around the rest of the globe.

[Walter Liptak:]

Okay. Good. Thanks for that color. I also wanted to ask about, the comments with tariffs. Was there anything specific from customers, where they said, -- or where you saw demand?I guess, I'm thinking more about the Food and Beverage business, where they were able to -- where you can find a link or a correlation between the two, as opposed to just kind of a general malaise international?

[Jaime Easley:]

Yeah. Yeah, Walt, I think what we said leading up to this point was that, we do believe our U.S. components business has been affected by some of the global tariffs, particularly the Chinese and U.S. tariffs, and specifically some of the reverse tariffs coming from China.So as the Chinese have had some retaliatory tariffs on products coming out of the Americas, we think that that's, had 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 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 us, year-to-date.

[Marc Michael:]

Yeah. And just one additional comment on that, so that was kind of the Food and Beverage for you. And just as we were describing, I think, and what we've seen in the Industrial markets, including North America up until this bit of sequential recovery in Q3, is overall just pressure from a slower macro-environment.And it's again kind of choppy. So we got to continue to watch it. But hopefully we're reaching a point where we're troughing. I guess we'll have to all see how that plays out, across the Industrial landscape.But the good news and things that we're doing, we're controlling the things we can control as we've been describing, which is improving our operations looking at our new products, investing back into the organization and expanding our margins, even in this kind of more difficult environment.

[Walter Liptak:]

Okay. And a 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. So 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 provide us with a little bit more color, what those programs are? How long do you think, they'll take? What's the expected goal from that?

[Marc Michael:]

Yeah. So, we're working with the leading firm in the industry. And this -- we've been working with them for the last six months or so. And we're looking at taking the industrial verticals as well as call it the sanitary verticals.And kind of 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 and different way and then, identifying where potential gaps may exist, either in technology or customer access and channel.And so, as we're working through that, what we're building is an organic pipeline to -- for the teams to work on. As well as it's what's helping us create ideas and directions around inorganic opportunities where the technology gaps or the customer access may be too much of a stretch to do organically.So, we're well into 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 our playbook of how we think about and work on our capital deployment and looking at the high return on invested capital going forward.So over the next kind of three-to-five-year time horizon, so it was -- 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, good growth markets, good margin profiles, good aftermarket annuities.

[Walter Liptak:]

And the benefits of this Mike, its organic growth or M&A's as opposed to...

[Marc Michael:]

It's the combination of the two. Yeah. It's a combination of the two Walt. And that's where. But what we want to do and what we will do, for investors is hold an Investor Day, next year in the first half of the year to give a broader backdrop on how we see that playing out on a longer-time horizon.

[Walter Liptak:]

Okay, great. All right, thank you.

[Marc Michael:]

Thanks, Walt.

[Ryan Taylor:]

This is Ryan. Thanks Walt. That -- we're over time for the call. We appreciate all the thoughtful questions and the detailed responses by our team. We're going to conclude our call right now.I just want to thank all of our teams across the world 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. Talk to you next time.

[Jaime Easley:]

Thank you everyone.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.