Regal Rexnord Corporation (RRX) Earnings Call Transcript & Summary

Okay. We're going to go ahead and get started. Welcome, and good morning, everyone, to Regal's 2020 Investor Day. I'm Rob Cherry, Vice President of Investor Relations. I've been with Regal for 5 years, and I'm excited to kick off my second Investor Day with the company. Our day will begin with a strategic and then a financial overview. Following these overviews will be presentations from each of our operating segments. We have time built into our agenda for Q&A after each of these segments, but we're going to hold off on the strategy and financial Q&A until the end of the morning. Before we begin, I'd like to remind you of the disclaimers on Slides 3 and 4 regarding forward-looking statements and non-GAAP financial measures. These measures and our associated reconciliations to reported results can be found in the appendix of today's presentation as well as online at our investors website. And now it is my pleasure to introduce Louis Pinkham, Chief Executive Officer of Regal.

Great. Thanks, Rob, and good morning, everyone. Thank you for joining us for Regal's 2020 Investor Day. It is great to catch up with so many people that I have met over the last 12 months, and it is great to meet so many new people interested in our story. It has been an exhilarating 11 months of change at Regal, and I'm excited to update you on where we have been, where we are today, our improved performance momentum and where we plan to go in the future. Before I get started, I would like to recognize Rakesh Sachdev, our Chairman, who is in attendance today. I would also like to thank Rakesh and the Board of Directors for their continued support during my first year as CEO. So let's get started with why invest in Regal. When you think Regal, you should think energy efficiency. It is at the core of our most profitable technology, differentiated and fastest growing products. Energy efficiency, along with electrification and digital connectivity are global trends that Regal is well positioned to capitalize on. Regal has a wealth of recognized and respected brands with differentiated technologies to solve customer challenges. This has resulted in a large installed base that provides Regal's superior access to the distribution channel and drives like-for-like recurring sales. In the end, one of our primary goals is helping our customers successfully grow. Our global footprint is an asset and a competitive advantage. It enables us to produce in the most cost-advantaged locations, in proximity to our customers and in a flexible manner. The last point is critical for weathering disruptions like the recent trade war and coronavirus challenges. 80/20 is now the way we think and operate. It is a methodology, not a one size fits all formula. But it is a powerful methodology that is providing improved margins and putting us on what we call our road to 300 in 3, which is 300 basis points of margin expansion in 3 years. Free cash flow has been and will continue to be a strength of Regal. We complement that with a balanced capital allocation approach, rooted in return-based analysis and decision-making. Simply put, we will invest our capital where it will provide the best long-term returns for our shareholders. Sustainability is an overused word, it is everywhere. And sometimes means little. But at Regal, it can be seen in our products that reduce energy consumption and lower emissions and in our operations, where we have reduced energy and water consumption and hazardous waste disposal by more than 40% over the last 3 years. It is in these measurable results that sustainability has true meaning. As you think of Regal, we believe these are compelling reasons to invest in our future, and we will be expanding on each of these today. While most of today will be about the future, let me take a moment to recognize Regal's past. Our roots established more than half a century ago originated in the manufacturer of metal cutting tools and gearboxes. In 1955, we were known as Beloit Tool and established our headquarters in Beloit, Wisconsin. We have rebranded our company several times since 1955, and our culture continues to evolve, becoming one focused on integrity, responsibility, diversity and inclusion, customer success, innovation with purpose, continuous improvement, performance and a passion to win, all with a sense of urgency. I share this with you because we are committed to continuing the legacy built by our predecessors. When we go to work every day, we are stewards of this great company and are committed to driving the company forward for another 65 years. Let me give you a brief overview of Regal as we are organized today. We recently resegmented into 4 segments. Our largest segment is now Climate Solutions. It sells fractional horsepower motors as well as small fans and blowers. The primary brand in this segment is Genteq, which is the brand for our ECM or high-efficiency motors serving the residential HVAC market. We enjoy a leading share position in that market and high-efficiency motors now make up approximately 50% of our motor sales in this segment. Next is Commercial Systems, which sells fractional to 5-horsepower motors and larger fans and blowers. The main applications are commercial HVAC, where we sell into the Marathon brand for fan motor applications; Nicotra Gebhardt for air handling solutions; Genteq for hermetic motors, which mainly go into compressor applications; and lastly, for pool pump, we go to market with our leading Century brand. High-efficiency is only about 10% of our motor sales in this segment. But similar to climate, regulations are driving and will drive the growth of variable speed solutions in the commercial segment. Our third largest segment is Power Transmission Solutions. We sell a range of PT products, including bearings, gearboxes, couplings and conveying solutions. We have a number of leading brands in this segment, many of which enjoy a top 3 market share position. In PTS, approximately 65% of our sales go through the distribution channel, driving reliable like-for-like replacement sales. The last segment is Industrial Systems. This segment sells our largest motors up to 12,000 horsepower. It also sells alternators up to 4,000 kilowatts as well as paralleling switchgear and transfer switches. Marathon is the brand used for our industrial motors and alternators in this segment. The other brands you see here have strong customer recognition in niche market applications. Each of the segment presidents will provide you more detail on these businesses in their presentations today. Now let me step back and give you our perspective on macro trends driving our business. As I have already mentioned, energy efficiency is a key driver for Regal. Sustainability is a trend impacting our industry at both a residential and commercial level. What that ultimately means for Regal is the continued shift in demand from constant torque or single-speed motors to variable speed motors. This shift continues to benefit our climate business, and it is in the early stages of benefiting our other motor businesses. Regulation has and continues to be a tailwind for Regal. This past year saw the positive impact from the FER regulation on our furnace business. In the near future, there will be regulations in pool pump, commercial HVAC and residential air conditioning that will provide similar tailwinds. It has been our experience that the march of energy efficiency regulation, while choppy at times, has continued because of the trend to enjoy legislative support from a broad constituency. Beyond the environmentally conscious energy-saving regulations, a sharper focus on reducing emissions is driving the macro trend of electrification. This trend is most obvious with the rapid growth in electric vehicles. That is not a current market for Regal, but we are definitely seeing efforts to replace smaller gas and diesel engines with electric motors in a variety of applications. This will clearly be a long-term driver for Regal. The last trend that I want to highlight is connectivity. This can take the form of digital experience tools to make transactions easier or products to improve monitoring, diagnostics and preventative maintenance. In increasing numbers, customers in the industrial space are expecting these tools and services and Regal is well positioned to take advantage of this trend. In addition to making the most of the opportunities presented by these macro trends, we believe we also need to continually leverage certain of our own core strengths to outshine our competition and better serve our customers. Specifically, to succeed, we believe we must utilize our global footprint, our differentiated technology that drives our installed base and our channel access to OEMs and distribution. Fundamentally, our core strength is in the design and assembly and test of our product. As an example of this strength, we were first to market and are the market leaders in variable speed technology and controls. Our global footprint allows us to produce in the most cost-advantaged locations in proximity to our markets and our customers and in a flexible manner. It also provides us with the ability to react to market-disrupting events in a manner that we believe is faster than our competition. At the same time, our installed base provides a prime source of application expertise desired by OEMS, and it also provides distributors with an attractive market for like-for-like replacement sales. Before going any further on strategy, I think it would be helpful to recap what Regal accomplished in 2019. To start, we recognize that our centralized organizational approach had run its course and that Regal needed to decentralize in order to drive a higher level of accountability throughout the organization. Next, we launched our 80/20 initiative. The 80/20 methodology is now firmly rooted at Regal, and you will be hearing about it throughout the morning. We then began a second phase of simplification, in which we announced a number of plant and product line consolidations. These consolidations will drive significant savings and improve Regal's margins. The company made progress on these in recent years after a decade of numerous acquisitions, but there are still more opportunities to leverage. We are now executing on these projects and have our sights set on still more opportunities. With the decentralization and the subsequent creation of business units, Regal needed to infuse new leadership talent into the businesses to fill new roles and to bring fresh perspectives, new ideas and a new sense of urgency. Balanced with our tenured team, this is a powerful combination. Finally, in 2019, we strengthened the discipline in the organization around capital investment decision-making. Whether it is new product development, new market penetration, investment in inventory for growth, CapEx or M&A, we are demanding a return-based approach that ensures Regal is maximizing value for our shareholders. 2019 was a foundational year for Regal and has undoubtedly put us on a path for profitable growth. I am a firm believer in structure follows strategy. That is why, once we decided that the business needed to run at a business unit and plant level, we took the step to decentralize. It also had the benefit of driving $15 million in annual savings, which we are already seeing and improved our sales per employee by 7%. There is now accountability and a focus on the P&L at a business unit level that simply did not exist in the past. In fact, full P&L visibility was previously only at the segment level at Regal. It is now at the level of 23 business units and over 16 manufacturing plants. Having 80% plus of our business on one single instance of ERP certainly helped us achieve the significant transformation quickly. You will later hear today from our 4 segment presidents: Jerry Morton, who leads our PTS Segment; Scott Brown, who leads our Commercial Systems segment; Eric McGinnis, who leads our Industrial Systems segment; and John Kunze, who leads our Climate Solutions segment. Also presenting today is our Chief Financial Officer, Rob Rehard. And in attendance, our Chief Information Officer, John Avampato. As I have already mentioned, we have infused new talent into the businesses, including at the corporate level. We have added a new Chief HR Officer, who started with Regal yesterday, and she is with us here today. Cheryl Lewis comes with a rich background of talent development and organizational performance improvements with 10 years at ITW, partnering with one of the segment leaders and 15 years with Panduit in the lead HR role. Also with us is Justin Baier, who has joined Regal as Vice President, Business Development and Strategy. Justin comes with a background in consulting with BCG, and he spent the last 4 years in business development and strategy at Fortive. Combined with our tenured managers across the organization, we have the depth of skills and leaders in place to drive accountability and performance at the right level of the organization. The last position of my leadership team to fill is the Vice President, Regal Business System. We will find the right leader who understands the value of a holistic business system and is a subject matter expert in 80/20 in the context of driving lean and continuous improvement. With this new organizational structure, I am confident in the success in the future for Regal. As we announced on our fourth quarter earnings call, we resegmented by splitting commercial and industrial, while leaving PTS and climate unchanged. Each segment is led by a president who reports directly to me. The rationale here was straightforward: to drive transparency, focus and accountability in the commercial and industrial businesses. It is clear that industrial has issues. And separating it from commercial sends a clear signal that we are focused on fixing the business. It is also consistent with our previous messaging that there were good and not so good parts in C&I, as the commercial business, while not where we want it to be, has performed reasonably. So what is our plan with industrial? First, let's unpack the business that make up the segment. To start, we have 3 solid niche businesses with strong brands. They are Rotor, Cemp, and Thomson, our marine motor, explosion-proof motor and switchgear businesses, respectively. These are good, profitable businesses. We are focusing them on continued profitable growth. Next, our largest businesses in the segment, our industrial motors and alternator businesses operating under the Marathon brand. These businesses have not been cost competitive. It is quite simple. We are focusing these businesses on cost-out and margin improvement. With 3 new business unit managers and a new sales leader, we have injected new leadership in this segment. We have also weighted in the near term the segment's incentive plan toward margin improvement and away from sales. We have clear plans to increase our margins in this segment by 200 to 300 basis points over the next 12 to 18 months and a path to exceed Regal's LAC over the cycle. So in summary, we are actively and aggressively addressing the segment performance, and we believe we have a clear path to margin improvement. However, we acknowledge that time is of the essence. In my opinion, the success of the business is also directly aligned with the cadence of performance management. From strategic planning to policy deployment to annual operating plans to operating cadence, Regal now has a deeper, more robust process in place with improved rigor. Along with the reorganization and the added talent, we have improved our ability to operate the business in a structured manner and more effectively react to changes in market conditions. The Regal business system is how we manage the business. Although we have made improvement, the fundamentals have always been in place at Regal. It starts with sustainability. At Regal, we are proud of our performance from an environmental, social and governance perspective. Let's begin with our environmental footprint. The numbers on this slide speak for themselves, 20% less energy, 14% less water consumption, 43% less hazardous waste and 17% less nonhazardous waste all since 2016. While good, it still is not enough and needs even more focus. Each of our businesses have set aggressive objective for year-over-year improvement as we are responsible for reducing our carbon footprint. From a product perspective, or what we refer to as our handprint, Regal is driving sustainability every day. From fans that consume 15% less energy than competition to conveyors that eliminate lubricants and save millions of gallons of water per application, to high-efficiency motors that reduce carbon dioxide emissions, to premix blowers which reduced nitrogen oxides by 75%, Regal is doing its part through its products to help the planet. In terms of governance and social matters, Regal also leads. We are proud of the representation of women on our Board and the shareholder-friendly governance policies that you see on this slide. We are also active in the community with organizations like United Way and their efforts to serve so many local needs. And lastly, but most importantly, we strive every day to provide a safe work environment for our associates. The 35% reduction in our recordable rate is good progress, but the ultimate goal remains 0. A key part of the Regal operational cadence is policy deployment. Simply put, these are clearly defined critical objectives that have a rigorous process behind them to drive execution. As you can see from this chart, these objectives are specific to each segment and are weighted to organic growth, cost-out or working capital, depending on the strategy of the individual segment. Reflected in this chart is the clear focus of cost-out for commercial and industrial, while climate and PTS have a balance of growth and cost-out. And to ensure alignment, the variable compensation for our leaders by segment is aligned to these objectives. The ultimate reason to share this with you is to demonstrate that objectives are no longer peanut buttered at Regal or in a one-size-fits-all approach. They are targeted to drive the right behavior and performance by our businesses and our business leaders. Those of you who have heard me discuss 80/20 before will recognize this message. It is my fundamental belief, if a customer values your product, it will be clear in the margin you earn. Our 80/20 approach is based on this principle. When working through the traditional A and B segmentation exercises of 80/20, an illustration of which can be seen on the lower left of the slide, this principle becomes even more clear. The key is execution. Either we become more competitive, partner with our customer to improve the situation or we exit the product line or the business. The objective is to better manage our margin mix and every one of our segments has opportunities to do this better. It also serves to help us diversify our customer base. Ultimately, the goal is to best position the businesses for profitable growth. It is still early days for us with 80/20, but we are off to a great start. 80/20 is also integral to our cost-out initiatives in the areas of footprint consolidation, product rationalization and best value country sourcing. Regal has significant opportunities to take cost out. Simply put, we have more capacity than needed in our manufacturing footprint. Using 80/20, we see a path to reducing our footprint by almost 25%. Also using 80/20, we are tackling the number of SKUs we have and are targeting a reduction of over 40%. Lastly, we have significant focus on better utilization of best value country sourcing. We see an opportunity to increase that percentage by over 2,000 basis points by 2022. On the bottom of this slide is our target to improve the percentage of sales on a single instance of ERP systems. You will note that the goal is modest, but you will also note how high the number is to begin with. This very high level of ERP commonality is a real competitive advantage and a key reason why Regal was able to swiftly reorganize and resegment the company. In the investment thesis I presented at the beginning, I cited differentiated technology. We recognize the need to develop and lead with technology, which we have done successfully in the past and plan to accelerate in the future. Every one of these products shown on this slide either has a leading share in the market or has technology that has a step change differentiation from our competitors. To truly innovate, you must invest. Regal is making those investments. We are committed to a 100 basis point increase over the next 3 years in our investment in R&D and engineering from roughly 2% of sales to 3%. Regal also has over 1,200 active patents that we will continue to leverage and augment. Ultimately, the goal is to solve our customers' challenges with differentiated but also cost competitive product. Product innovation, geographic expansion, commercial initiatives and connected technology are the main growth drivers for Regal. I have grouped examples here which you will hear more about in the segment presentations to demonstrate how Regal is taking a multipronged approach to growth. What's of note is that we are not singularly focused on designing and making products that we think the market wants. We are working and partnering with our customers in entering markets to solve challenges and fill known gaps, innovation with purpose. Turning to capital allocation. Rob will share more details later, but I want to emphasize our approach at a high level. Our first priority is to invest in the business. We believe that organic growth ultimately provides the highest returns on invested capital, and therefore, our focus is on innovation, new products, new routes to market, capacity and productivity to better support our customers' needs. Second, we will look to grow through disciplined M&A. Discipline means deals driven by attractive markets, high fit, clear cost synergies and acceptable returns. Third, we will return capital to shareholders through regular dividends and opportunistic share purchases. In terms of portfolio management, we have pruned approximately $270 million in sales since 2018, and we'll continue to systematically evaluate the portfolio. We are not providing any new specific targets at this time. However, what I want to stress is that we are taking a nonbiased approach to evaluating the portfolio with a clear emphasis on shareholder returns. Going into more detail on our M&A approach. We use a traditional funnel mechanism. We look for market attractiveness then specific targets, followed by fit with Regal and lastly, acceptable deal metrics. We currently are only considering bolt-on deals for climate and PTS as both commercial and industrial are focused on cost-out and margin improvement initiatives. I will reiterate that our approach to M&A will be disciplined and focused on value creation not just strategic fit. Frankly, we will be conservative until we establish a track record with clearly accretive deals with acceptable returns. Looking forward, we believe our strategy and our initiatives will firmly put us on a road to 300 basis points of margin expansion by 2022, with 8% to 10% compounded annual growth in earnings per share. This will be accomplished mainly by 80/20 and cost-out initiatives, and we are not expecting a lot of help from the market. Furthermore, we believe our strategy will provide a sustainable foundation for long-term value creation. Rob will provide more details on how we will achieve these objectives in his section. So when I think about what Regal will look like in 5 years, we are driving a technology-led business that meets and exceeds our customers' expectations, focused on sustainability, that has a world-class business system, led by top talent, where gross margins are 35% with a GDP-plus growth profile and reduced cyclicality in total shareholder returns in the top quartile. A bit motherhood and apple pie, but we have laid the groundwork to achieve this vision, and I'm confident that we have a path. I will end with -- by returning to the question of why invest in Regal. From the global energy efficiency trend to our 80/20 effort to the continued strong free cash flow, I firmly believe that you will hear a compelling case today on why Regal is a very attractive investment. With that, I will now turn the podium over to Rob Rehard, who will provide a financial review before we dive deeper into the businesses.

Thanks, Louis, and good morning, everyone. Well, I'd like to start by thanking everyone for attending today and for listening on the webcast. I very much share Louis' enthusiasm for the changes that we have made at Regal and for the exciting opportunities that we have in front of us. In the next few slides, I will review our recent historical performance, provide an update on our 2020 guidance and then jump into our forward-looking view. This slide provides a snapshot of our performance over the last 4 years. Please note that all years have been adjusted to eliminate divestitures and provide you with a clean comparison across the time frame. Our sales showed modest organic growth and were clearly impacted by market headwinds as well as the 80/20 account pruning implemented in the latter half of 2019. FX translation was also a headwind to us during this time frame. Despite the sales headwinds, we grew adjusted operating profit over 8% as we leveraged volume, positive price/cost, and more recently, our 80/20 initiative. At the EPS level, we grew at an annual compounded growth rate of over 7%. Volume and productivity drove about half of the growth, while lower share count, lower interest and a favorable effective tax rate drove the other half. Lastly, our return on invested capital was trending well through 2018, at which point the economic downturn in 2019 created headwinds that set us back. However, despite these headwinds, we improved ROIC by 100 basis points over the last 3 years. Certainly, not where we wanted to end 2019. But we also have greatly improved our focus on ROIC to ensure we are making investments that drive long-term profitable growth and ultimately, shareholder value. Free cash flow continues to be outstanding at Regal and, as Louis pointed out, is a key part of the Regal investment thesis. We have been above 100% of adjusted net income for the last 7 years and have done so in both up and down economic cycles. Reductions in trade working capital have been one of the main drivers for this free cash flow performance. While we've delivered meaningful improvements in working capital over the past year, there is still plenty of runway to continue this trend over the next 12 to 24 months. And we continue to expect trade working capital to be a source of cash in 2020. In 2019, Regal had over $800 million in cash available from a combination of operating cash flows, proceeds from asset sales and surplus cash coming into the year. We returned a portion of that cash directly to our shareholders through both opportunistically purchasing our shares and paying dividends. We maintained our dividend payout ratio at our target of 20%. In addition, we invested in growth opportunities as well as debt reduction. We ended the year with a net debt-to-EBITDA ratio of 1.7, well within our comfort zone. There was no M&A activity in 2019 as valuations were challenged, and we will not invest in assets that cannot provide an acceptable return for our shareholders. We're committed to a balanced approach to capital deployment, and we feel we achieved this commitment. Finally, as Louis mentioned, we have refocused the company to a disciplined returns-based approach to capital spending. We use a term creativity before capital to set the tone for all associates to consider all options before deploying capital. We base all of our capital allocation decisions on returns. I will provide more on this topic later in my presentation. Here is a little more detail on our dividend payment history. As you can see, it grew at a compounded annual growth rate of 6% over the last decade, and we increased it every year. This is one of the ways we return cash to our shareholders. The recent resegmentation brings an opportunity to improve visibility and focus on our CapEx allocation in the Commercial and Industrial Systems segments. This slide provides a perspective on how our CapEx was allocated on average over the last 3 years as a percentage of the total CapEx deployed. Historically, our CapEx allocation was primarily based on volume and on projects as needs were identified and brought to management. We continue to prioritize business continuity and maintenance investments. However, we have shifted our approach to a disciplined returns-based allocation, which will ensure that all the projects with the highest returns are being prioritized and funded. As noted on this slide, the shift from the historical allocation methodology to the returns-based methodology is meaningful across the segments, moving from an average of 56% invested in commercial and industrial over the past 3 years to approximately 42% invested in these segments in 2020. This will also allow us to better align CapEx spending to strategic priorities by segment. For our 2020 guidance, which we gave on our fourth quarter earnings call in early February, there has been no change in our view for the full year. However, we do believe that there has been a shift in the cadence for the year. For organic sales, we still see the year as flat to slightly down. Remember, this includes approximately negative 2% of 80/20 account pruning. We still see the first half of the year down year-over-year with a recovery in the second half on easier comparisons and improving demand. On adjusted EPS, we are holding to our range of $5.65 to $6.05. It should be noted that the full impact of the coronavirus on our operations in China is becoming more clear. However, the overall impact on demand is still unclear. At this point, we believe the operational impact will be on timing between the first and second quarters, with between $4 million to $5 million of operating profit impact in Q1, with much of the recovery in Q2 and Q3, but the situation is still fluid and subject to change. The coronavirus is primarily impacting the commercial and industrial segments, as those segments are most exposed to China production and the China market. As I stated, the demand side is still unclear and could have additional impact on our performance. The sooner the global markets return to stability, the less impact on demand. Lastly, for free cash flow, we remain committed to generating over 100% of adjusted net income. As I mentioned earlier, working capital improvements will continue to be a major driver of this performance. So in summary, we are cautious, but we are holding to our full year guidance. Now let's turn to our forward-looking 3-year financial plan. There are 3 building blocks to our plan: growth, cash generation and capital deployment. We expect organic sales growth above market, 250 to 300 basis points of margin expansion and an adjusted EPS compounded annual growth of 8% to 10%, which is above our operating profit growth. We expect free cash flow above 100% of adjusted net income, as we continue our disciplined approach to working capital management. As discussed earlier, we have refocused the company to a disciplined returns-based approach to capital investment. Our internal investments must have less than a 1.5 years payback, while M&A must meet strict return criteria. We expect net debt-to-EBITDA to stay below 2x, well within our comfort zone. As always, this is subject to our M&A activity. Lastly, with the improvements in profitability we've discussed along with reducing our invested capital base in areas like trade working capital and manufacturing footprint and a disciplined approach towards returns-based investments, we expect to improve ROIC by 250 to 300 basis points over the next 3 years. Overall, we believe this plan creates a sustainable foundation for long-term value creation for our shareholders. Now let me provide some more details on our sales growth outlook. We expect to continue with our 80/20 account pruning over the next 3 years albeit at a lower rate overall than we have guided in 2020. The 80/20 pruning starts to diminish year-over-year on a comparable basis in the out-years. We expect our organic growth to be in a range of 2% to 3%. That includes market growth at GDP rate. The remainder of the growth will come from new products and markets, share gains and price. So overall, and excluding 80/20 pruning, we are expecting GDP-plus organic sales growth over the next 3 years. Turning to margin. Let me give you some more color on what we are calling the road to 300 in 3. There are 5 drivers with one related to volume growth, but the other 4 all related to cost-out initiatives. Let me start with cost-out initiatives. The drivers in order of magnitude are restructuring, supply chain efficiency improvements, utilizing best value country sourcing, SKU reductions and other 80/20 actions, including account pruning. The remainder of the margin improvement is expected to come from volume leverage and mix. Together, these drivers are expected to deliver $90 million to $100 million in adjusted operating profit improvement. What is clear is that our road to 300 in 3 is mainly driven by cost-out initiatives on which we have a clear line of sight. We would expect any incremental tailwinds on volume growth to generate strong operating leverage. Now I'd like to take a couple of minutes to walk you through how we view ROIC in terms of the makeup of our invested capital base, along with the key drivers we are focusing on to ensure we maximize our ROIC going forward. First, on the left side of this slide is a graphic indicating the composition of our invested capital base and is grouped from least actionable at the bottom to most actionable at the top. As expected, the most actionable items are those associated with trade working capital, representing 25% of our invested capital base. While the least actionable, which includes items like goodwill, represent approximately 55%. Moving to the right side of the slide are the key ROIC improvement drivers. Of course, the most impactful driver to making meaningful improvements to this metric is operating profit improvements. However, we recognize that we must continue to improve our invested capital base to reduce the capital intensity for each of our businesses. We will do this through trade working capital optimization, ensuring we realize high returns on our organic investments, reducing our footprint through consolidation of facilities and maintaining a disciplined financial approach to all M&A activity. As we've highlighted today, we have changed the way we operate. This includes the way we measure our teams. We review ROIC within the businesses to ensure we are making the right decisions that improve this metric and ultimately create shareholder value. Taking the longer-term view on margins, let me walk through the segments. In commercial, after performing at 9.1% in a tough year for pool pump and commercial HVAC, we believe this segment has the ability to perform in a range of 10% to 13% through the cycle. In Industrial, after performing at a disappointing 0.1%, driven by the trade war and a tough year for power generation, we believe this segment has the ability to drive cost out and perform in a range of 8% to 11% through the cycle, but this will take time. In climate, after performing at a record level of 16.9%, despite a tough year for weather, we believe this segment has the ability to further improve and perform in a range of 17% to 20% through the cycle. Finally, in PTS, after performing at a record level of 13%, facing a year of industrial weakness and severe destocking in the distribution channel, we believe this segment has the ability to further improve and perform in a range of 15% to 18% through the cycle. To summarize, we believe that longer term, our businesses have the capability to improve margins in excess of the road to 300 in 3 target. Looking forward on cash. Over the next 3 years, we expect to have a range of cash availability of $1 billion to $1.1 billion. Of that, $700 million to $800 million will come from operating cash flow. This provides the flexibility to deploy cash in a manner consistent with our balanced capital allocation methodology. This also leaves substantial capacity to deploy capital in M&A and/or share purchases. Additionally, by 2022, we expect to have an incremental debt capacity of approximately $1.9 billion. We clearly have a very strong balance sheet with significant flexibility. Turning to capital allocation. Let me expand on what Louis previously shared with you. Our first priority is to invest in the business when acceptable returns are present. This could be in new product development, capacity for growth, digital initiatives and automation. We believe that organic growth can ultimately provide the highest returns on invested capital. Second, we will look to grow through disciplined M&A, most likely bolt-ons. However, larger deals are still possible if the fit is high. We will have strict discipline around the fit and financial criteria with the 3 key financial criteria being: one, ROIC to exceed Regal's weighted average cost of capital by 200 basis points by year 3 and certainly no later than year 5; two, EPS accretive in year 1; and three, strong cost synergies. Lastly, we will return capital to shareholders through regular dividends and opportunistic share purchases, the latter being the option when we see a lack of suitable returns for other investments. These capital allocation priorities align with those that we have previously communicated. Historically, like most other industrial companies, Regal has been challenged to sustainably improve margins across the various economic cycles. We recognize this and are actively working to increase the flexibility of our cost structure and diversify our market exposures in the pursuit of lowering the cyclicality of the business. To start, we believe that our actions around overhead elimination, such as footprint consolidation, working capital optimization and product rationalization will help to dampen volatility. These cost structure actions provide flexibility to more quickly align to market conditions. In addition, our initiatives around connectivity and the recurring revenue it can generate with services like monitoring, diagnostics and predictive maintenance can also help. Also helping our efforts like our expansion into new products and new markets, such as the differentiated high-speed motor solution you will hear about later in the commercial segment presentation, to name one example. All of these serve to diversify our business and consequently reduce the impact of cyclicality on our overall performance. Finally, we have reduced our exposure to highly cyclical markets like oil and gas, primarily through the $270 million of revenue divested over the past couple of years. Building on these successes, the ultimate goal is to reduce the cyclicality of our businesses. To summarize, we have reaffirmed our 2020 guidance. Our 3-year plan calls for GDP-plus growth, a road to 300 basis points of margin expansion, EPS growth of 8% to 10% compounded, free cash flow above 100% of adjusted net income and 250 to 300 basis points of ROIC improvement. We have a strong balance sheet with significant flexibility. Our capital allocation will remain balanced and just as importantly, focused on returns. Lastly, we are making efforts to increase the flexibility of our cost structure and to diversify our market exposures in the pursuit of lowering the cyclicality of the business. With that, I will now turn the podium over to Jerry Morton, our PTS President, who will provide a review of our Power Transmission Solutions business. As a reminder, we will have time at the end of the morning for Q&A for both Louis and me.

Thank you, Rob. Good morning, everyone. I'm Jerry Morton, President of the Power Transmission Solutions segment of Regal. I joined Regal in 2015 as part of the acquisition from Emerson Electric. Prior to that, I spent 28 years with Emerson in their Power Transmission business. Today, I will provide you with an overview of this segment, summarizing our performance results and giving you some insight into our key initiatives and actions to drive value. In the 33 years that I've been in the power transmission industry, I truly feel this is one of the most exciting times to be in this business. Power Transmission Solutions is a compilation of well-known brands in the mechanical power transmission industry. Many of these brands have been industry-leading in their space for decades and have built up significant brand loyalty and a tremendous installed base. We are organized around 5 product groups: bearings, mechanical components, gear drives and gear motors, couplings and conveying systems. Many of these products enjoy a top 3 share position in the markets they serve. These products are utilized in a multitude of applications, including material handling, aerospace, HVAC, solar power, metals, bottling and small parcel handling, just to name a few. This combination of highly recognized brands, leading products and diverse applications has generated an installed base of approximately $5 billion, the result of which is a very attractive stream of replacement sales. Our footprint is global with significant sales, manufacturing and distribution capabilities in all 3 major economic regions of the world. We strike a balance with our footprint by being close to the customer and then utilizing best value locations within the region. This strategy allows us to be responsive, flexible and cost competitive. Now let's take a look at our results and market trends. We had a strong sales growth trend from 2016 to 2018, but then had market headwinds in 2019. Despite the 2019 bump in the road, our compounded sales growth was 3% over this time frame, while our operating margins improved by 230 basis points. In fact, I couldn't be more proud of our team who ensured that we expanded margins in 2019 despite these sales headwinds. This was accomplished with rapid cost-out actions and the launching of our 80/20 journey, both of which enabled the margin expansion, but more importantly, will set us up for profitable growth as market returns. Our installed base drives our regional profile to be largely in the U.S. and Canada with a substantial European presence and the balance being in Latin America and Asia. Our roughly 50-50 split between OEM and aftermarket delivers a strong gross margin profile for this business. Our strength in the aftermarket is also an enabler for us to drive growth initiatives focused on the installed base. Looking at our end markets. We have a strong base in the general industrial market, followed by material handling, metals and the rapidly growing renewable energy space, along with a smaller portion in aerospace and oil and gas markets. In 2019, our top markets had a soft year for demand, except for renewables. The general industrial slowdown, which led to destocking as well as the secondary effects of the trade war and the decline in oil and gas took their toll. However, we see accelerating growth in the near term in these markets, especially in small parts of material handling and renewable energy. We are strongly focused in these 2 markets with innovative new product solutions and focused commercial teams. Let's take a look at some of the initiatives that will drive our profitable growth. Given our strong presence in the general industrial markets and our superior channel partner relationships, it is imperative that we have a strong and motivated commercial team. We have made significant structural enhancements to this group in order to drive profitable success. To win new business in this space, you must have the appropriate sales support resources available. We have committed to this through several key actions. First, we increased our sales coverage by 46%. The higher density of our sales resources increases our customer interactions and responsiveness. Second, the sales team must have a customer service infrastructure to complement their efforts. Therefore, we increased this group by 60%. Third, the expanded sales team must also have the right commercial analytics to succeed. So we built a strong commercial operations team that gives our sales force the information required to make the correct selling decisions. And lastly, a dedicated pricing organization was formed to make analytics-based pricing decisions to ensure our pricing aligns with our value to our customers, thereby maximizing our profit. To support all of these actions and resources, we need the right processes and tools to enable success. So first, we enhanced our variable compensation program by focusing on greater incentives for profitable growth. The key tool here is the continuous communication of individual performance through a mobile phone app. At any time, a sales associate can simply pick up their phone and see exactly where they stand performance-wise. Second, we manage our opportunity funnel using an enterprise-wide customer relationship management tool. This gives us visibility at any time of the status of new opportunities we are pursuing. This is critical, especially when supporting a strategic account with many locations and multiple sales associates. Excellent communication with strong alignment is key to driving growth with these key accounts. Lastly, but just as important, we recognize there is a new generation of sales professionals in our industry. So training and development is more important than ever. As such, we have extensive training tools both in the classroom as well as online through our digital learning platform in order to enable our new hires and our distribution partners to quickly become productive. All these improvements are driving lasting results in the performance of this business. Another key to supporting our customers are digital tools that make it easier to self-serve when they so choose. To execute this, we have one of the most extensive product information management systems in the industry, far exceeding our closest competitors. In the upper left corner of this slide is a high resolution, 360-degree spinnable image of one of our products. Today, we have over 15,000 such photos in our database. These images cover virtually all of our popular catalog products. This allows our customers to see the product at all angles to ensure proper selection. Below that picture is a picture of a 3D CAD model that can be downloaded at all required formats for the customer to incorporate into their designs. This is also a spinnable image that allows the customer to see the product at all angles. In total, we have 47,000 SKUs incorporated into our active product information management system that are 3D CAD capable. All of this capability and rich product content is available at our website as well as the website of select distribution partners. In addition, the rich content is accessible through our mobile application and is clearly a differentiator for Regal in the market. The secret sauce here is that the data is directly tied to our engineering systems and is continually updated. The customers are assured to have the most up-to-date certified product data straight from the source, thereby optimizing the customer buying experience. This is a major improvement over most systems in the market, where information quickly grows stale and out of date. Once the product is purchased, a different set of information is needed for product installation and operation. We support this customer need by using QR code capability and a mobile app. The user can scan a carton or the actual product itself with a mobile device and be directed immediately to the applicable information to install, maintain, troubleshoot and replace, if necessary. This easy-to-use functionality not only greatly improves customer productivity and satisfaction, it facilitates repeat orders for Regal. Years after installation, the end user can scan the code and get direct access to our channel partners to support replacement, make it easy for our end users who may not have direct contact with us to identify the product and place an order. In the material handling space, especially the part being driven by e-commerce, customers are desiring safer, faster, quieter and more reliable solutions. The movement of poly bags, the fastest-growing type of packaging, is particularly troublesome for traditional material handling systems. Our unique and proprietary Modsort technology utilizes a belt over belt configuration with PLC-controlled rollers to move product in any direction desired. The unit on the left is the base module for this technology. It can be programmed to move a product in any direction desired from a simple right angle transfer to dynamic vectoring, as shown here directing a poly bag into a sortation tote. With this modular design, we can easily retrofit existing conveying systems which use people to sort and move packages. Regal's ModSort solution is quiet, safe, portable and scalable. The installation shown on the right is a sortation solution utilizing ModSort technology to sort inbound and outbound packages at a repair-and-return facility. The packages run through a scanner and information is fed to the ModSort modules, which subsequently direct the packages to the desired station. The ModSort solution adds -- allows for rapid retrofitting of existing equipment, eliminates the need for manual sorting, increases throughput and sorts at an accuracy rate of over 98%, all contributing to enhanced ROI for the customer. Today, the sorting of e-commerce packages in the last mile for parcel, post and delivery stations is manual and the package variation is tremendous. The ModSort solution can effectively handle these packages safely and reliably and much more cost-efficiently. The payback for implementation is typically less than 1 year. In addition, the modularity and scalability allow for rapid capacity additions in an application that is growing at 20-plus percent annually. The ModSort solution is a game changer for the last mile in the material handling market. To fully appreciate this technology in action, please visit our YouTube channel, shown in the lower right of the slide. Our next area of focus is around custom gear drives and gear motor solutions. The strength of combining the Regal motor and the Regal gear drive application know-how and product capabilities is the ability to bundle a total solution to meet or exceed our customers' challenging application requirements. Not many of our competitors can do this. Plus our broad range of solutions in this space, coupled with the speed and flexibility of our product implementation teams, gives us a distinct competitive advantage. In the last year, we've established a tiger team approach, forming a dedicated group of cross-functional resources focused on quick turnaround product design solutions so that we can customize to our customer needs faster than any of our competitors, a true advantage. The product shown on the left of the slide is a stainless steel high-efficiency right angle gear drive increasingly popular in the food and beverage space. This drop-in solution allows for rapid retrofit with higher efficiency and broader performance characteristics than traditional drives. On the right of this slide is a gear motor with an integrated onboard drive, specifically designed for the baggage handling industry. This drive solution delivers exceptional performance in an easy-to-retrofit package. These are just a couple of examples of the numerous solutions our teams have developed to solve specific customer problems. We are seeing significant growth in this solution offering with more than $20 million in sales in 2019. Our strategy is to be the fastest solution provider of custom gear drive and gear motor solutions. As digital technology and products become more entwined, the natural next step is connected products. Here are 3 new solutions that Regal has introduced to the market. In this barrel coupling application on the left, wear of the internal components is important to coupling performance. Through remote monitoring of the wear, maintenance can be scheduled in the application to avoid any unplanned downtime. The Sensi-Torq solution in the middle allows for remote monitoring of a gear drive for system performance adjustment as well as predicting any potential system failures. Leveraging our connected products, we also offer monitoring and diagnostic services through our Perceptive Technologies services team. These services monitor end-user critical equipment applications for performance optimization. The example shown on the right is of a rolling stand in the steel mill where our equipment is monitoring performance. Perceptive Technologies, although a small part of PTS, doubled sales in 2019. We expect another doubling of sales in 2020, with margins roughly twice our fleet average. We continue to invest in resources at Perceptive Technologies and are confident that we will continue to see accelerating growth. As you can see at Regal's PTS business, we aren't just focused on the product, but focused on how best to solve our customers' challenges through ease of doing business, bundle customized solutions and connected measurement and monitoring services. We know that if we can help our customers profitably grow, we will also profitably grow. We are excited about our growth opportunities and the future in this business. While top line growth is critical to our success, we must also continue to improve our operational performance and maintain competitiveness and improve margin performance. For this, we are using 80/20. As we continue to lean our operations, we have identified additional opportunities to reduce our footprint. This will not only reduce cost, but also reduce the environmental impact of our operations. Our 3-year plan will reduce our footprint by 1/3 and increase our revenue density as measured by sales per square foot by 62%. Even more dramatic is our planned reduction of active SKUs. By employing 80/20, we have an opportunity to optimize our product portfolio and reduce our SKUs by approximately 40%. This will allow us to both improve service while reducing costs. In preparation for a recent facility consolidation, we performed an 80/20 analysis of the business at the effect of the operation. Instead of just picking up what we had at that operation, which we would historically have done, we took a clean sheet approach and made certain that we justified any equipment moves before we invested in those actions. As you can see from the metrics on this slide, using 80/20, we found tremendous opportunities to improve the margin performance of the products at this location. Although some product-pruning revenue impact is expected in the short term, we immediately expect to double the gross margin and position the business to grow by focusing on the more profitable portion of the portfolio. Another benefit of 80/20 is that it enables the implementation of productivity tools such as automation. By simplifying the portfolio of products, it allows for increased standardization, thus making automation more practical and cost-efficient. Shown here are 2 cobots facilitating production. Cobots can be deployed quickly, and by nature, have backup redundancy, if they fail for any reason. At Regal, we are seeing less than 1-year payback in these type of investments. So why will we win? Regal's PTS segment is a great business, and we are in the early innings of a winning strategy that will drive significant profitable growth. We are well positioned in our markets. Making it easier to do business with our customers through e-commerce is a differentiator for Regal, and we continue to invest heavily. Our ModSort conveying solutions will transform the last mile of sorting and is poised for accelerated growth. Our focus on custom solutions in the gear drive and gear motor space will pay dividends with high-value sales. We approach connectivity with the goal of providing a compelling solution that adds value to our customer. And lastly, balancing our growth initiatives with productivity improvements utilizing 80/20 is driving sustainable improved performance and value creation in the business. I hope you see now why I'm so excited about our future. With that, I'm happy to take any questions.

Jerry, maybe one over here. So I think, Louis, at the beginning, talked about digital connectivity. If I look at the PTS division, it's got good growth in periods, but tends to be extremely cyclical and volatile. So maybe help us understand, if some of those connectivity efforts -- what are you doing in PTS specifically to smooth out cyclicality, maybe improve the recurring sales content of the business? Particularly as I think over half of the sales are aftermarket, so it's a much higher share than Regal overall and that should lend itself to more stability, but it doesn't seem to.

Yes. Very good question. First, if you look at our digital strategy, we first started with foundation. If you do not have the foundation, the things that layer on top of foundation aren't very effective. So we've put tremendous effort on our product information database, our new website, our digital customer service to build that platform and get that stability. As you know, in the distribution space, being able to serve and making it easy for the customer is key to that annuity sales going forward. So we're certainly focused there very tightly. As we layer on the additional functionality of connected products and then monitoring and diagnostics, we will do that as there is a compelling value proposition. And we work with our customers closely to layer those new applications on and new capabilities on as we move forward.

Maybe, Julian, I'll add to that. Recall also that we divested 2 businesses in oil -- in PTS. One was in oil and gas that's going to help with the cyclicality. And absolutely, to Jerry's point, we will continue to invest in the connected solutions and Perceptive Technologies, and we're excited about that growth potential and at margins -- and we have good -- really nice margins in this segment, but at margins much -- even much stronger than our fleet average of this segment.

Yes? Go, Mike.

Jerry, so just some thoughts on the competitive landscape. It's a pretty fragmented marketplace. So kind of a twofold question. One, what do you see your competitors doing right now on a lot of these R&D, connected strategy, et cetera, initiatives? And then secondarily, how do you look at the M&A landscape within this space, specifically the opportunity set to consolidate?

Okay. Mike, as you know, there's been tremendous consolidation in the space over the last decade. Still more to come, we think. We're certainly going to be there as well, looking for the right valuable assets to bring into our portfolio. But yes, this is an area that still has some runway, from that standpoint, we believe. Again, you got to make the right choices to fit the portfolio, really important. On the IoT space, it's really a mixed bag. There's some that are pushing forward especially in the IoT connected, others that aren't so much. Again, ours is built from the foundation up and make sure that what we bring out, we can fully support.

Cliff Ransom. Jerry, I've gotten enthralled with the possibilities in the industrial arena, broadly defined for IoT, but I'm not looking to maximize -- optimize a component. The real issue would be how to optimize the facility or the process or the plant. But to me, the real benefit comes, when you develop all of that information, you build better products. How well equipped do you think your folks will be to take these streams of data and turn it into actionable information that produces evermore competitive specific products?

Yes. So you're exactly right. The domain knowledge that you gleaned through the process is extremely valuable, and we are capturing that as we move forward. The rolling mill example that I showed you there is a prime example of that type of domain knowledge that we're building and applying that into other solutions across our industrial space. We'll continue to do that. Our team is continuing to grow as we see more and more applications for that. We're not trying to push on our customers. Again, we're focused on compelling value solutions for them, and we'll continue to move in that direction. Yes, sir?

Yes. Chris Glynn here. So it's interesting to see the segment margin targets kind of expect something with commercial and industrial than your underperforming pieces. At the same time, PTS has been pretty steady all along and almost indicating maybe at entitlement run rate. So curious to see the significant gap up. And I know this slide was framed up as maybe a longer time horizon than the 300 in 3, but how do you fit into this? And where do you get that thrust? I mean at the upper end, it's a 500 basis point increase. So maybe let's deal with the lower end, 200 or 300 basis points for you from what seemed like a very steady state business for some time.

Yes. First, we've grown 230 basis points over the last 3 years. So we've shown the ability to do this even in a down market in 2019. So I think we have the capabilities to do that. If you look at our history, we did a significant simplification effort prior to acquisition. When we were acquired, we focused on our synergy plan. We've completed that a full year ahead of schedule. We then went into growth mode and grew at very high rates in '17 and '18, and now we're coming around full circle to that next level of improvement that's been on the table for some time. We're very confident in our abilities to do that. We have a track record of doing that, and we definitely see a path to that 15% to 18%.

Is mix the biggest driver there?

Yes. We have a strong deck throughout that period. It's not front-end or back-end loaded, strong deck. 80/20 is a huge driver to it. I showed you one example here of what it can do for you in a facility when you really look at where the value is and how much time you're spending on the 20s. 80/20 is a huge driver to what we have in our plan. Okay. Yes, sir?

Going back to that facility you just alluded to on Slide 62, where does this lie in terms of the opportunity set, how extreme, an example of this? And then secondly, what was the catalyst for this incentive structure change or just the P&L visibility that Rob alluded to?

Great. So when we looked at this facility, we had, as Louis talked about, too much square footage. We looked at where we could best leverage, identified a location where we could make that product elsewhere. When we first looked at it, we said, let's look at it from an 80/20 lens. Who's buying the product, at what volumes? Where is the sweet spot of this business? And how much time and money are we spending on these 20s? What we have found as we move forward is that type of profile exists in many of our operations, that same type of extreme situation where you're spending half your effort, okay, on things that, frankly, aren't adding value. And we see that as we dig deeper, we get more and more insight into that. Okay. All right. I think we'll wrap up there. We're going to take a break now. We'll resume at 10:20 in this room, okay? Thank you very much. [ Break ]

Good morning. I'm Scott Brown. I'm the President of the Commercial Systems segment, and I've been with Regal for 15 years, and I came from General Electric. This morning, I will provide you with an overview of the commercial segment, and then I will share our key initiatives to simplify, grow and create a better tomorrow. This is an exciting business to be leading at this moment in time. We have significant structural margin improvement opportunities and compelling growth initiatives in areas that help the world use less energy. Let's start with the overview, and then I will move on to our growth initiatives and our 80/20 actions. We go to market with 5 well-known and trusted brands. Our Marathon brand has a 100-year history and is primarily focused on general purpose applications across a diverse range of markets with leading positions in United States. Our Century brand has leading positions in leisure pumping applications and irrigation. The Leeson brand has carved out niche positions around the food and beverage segment for wash-down duty applications. Our Genteq brand comes from the Climate Solutions segment. We use this brand in commercial HVAC for chiller compressor applications, where we have a leading market position. Our Nicotra Gebhardt brand has a long history in Europe, focused on fan and blower applications in commercial HVAC markets. Our products are motors, controllers, blowers and fans, along with integrated motorized fan systems for constant and variable speed applications. Our main end markets are general industry, commercial HVAC and water systems for leisure and non-leisure applications. We have 26 major sites across the globe. Our manufacturing sites position us to leverage best value country sourcing and serve our customers. As you heard from Louis, and I will show you later, we still have more opportunities to optimize these assets, and we have clear plans to do so over the next few years. Our technology sites are globally located, which allows us to leverage a 24-hour development team and locally serve our application engineering requirements worldwide. These engineering centers are built on a rich set of core competencies that Regal has been establishing over many years. Continuing with the overview. Let's now look at the business performance and the market trends. Commercial Systems has approximately $900 million in sales and 9% to 10% operating margin. In 2019, we saw difficult pump markets with significant destocking in the channel due to a late start in the pool season and an unprecedented wet summer season, challenges in China due to trade uncertainties and our efforts to prune sales that don't align to our margin profile. In addition, in 2018, the Nicotra Gebhardt acquisition joined Commercial Systems group. As typical during the first year of an acquisition, corporate charges are not allocated but were allocated in 2019. Excluding these charges from the 2019 results, the Commercial Systems group would have deleveraged at 14.3%. This deleverage rate is a strong indicator that we took corrective actions early, leveraging our new decentralized structure. We are primarily a North American business with a growing presence in Europe and Asia and Pacific. 1/4 of our business is aftermarket served through the distribution channel. Our largest end market is general industry at approximately 40% of the segment. This market serves thousands of customers in a broad range of U.S. submarkets, such as commercial kitchens, laundry, machinery, construction and building infrastructure to name a few. This provides the segment market diversity, and consequently, resilience to individual market fluctuations. Our other 2 end markets, commercial HVAC and water, make up roughly 60% of the business. Overall, in 2019, our markets were challenged, but typically grow at GDP rate. However, commercial HVAC and water, in particular, are expected to experience some regulation tailwinds going forward. All of our end markets are seeing a shift from constant speed to variable speed applications due to energy efficiency, more sophisticated product needs as the middle class grows in developing countries and digitization. In 2021, all U.S. pool pump motors will need to move from constant speed to variable speed in order to meet the new Department of Energy energy efficiency regulations. We are the market leader in this space and are well positioned with the next-generation products that will meet this regulation. In the U.S. and Europe, new directives and standards, such as the Ecodesign directive, continue to set higher energy efficiency requirements on OEM packaged air conditioning and ventilation units, including the motors. Again, all of these regulations and policies will accelerate the shift from constant to variable speed applications. This will result in a growth and mix-up opportunity for Regal. Customers are looking for greater efficiency, smaller packages, intelligent products, and of course, lower cost. These demands are mainly driven by the megatrends of sustainability and digitization at a competitive cost. Regal is a respected and trusted supplier that these customers are turning to, to help meet these challenges. Power density, form factors, electronics packaging and application control are core technologies where Regal leads that allows us to exceed our customers' requirements. As a respected and trusted supplier, we partner with our customers to better understand their needs and differentiate our solutions. As we continue to lead with innovation, we are committed to investing in R&D at Regal, and we will benefit from the 100 basis points of increased spend that Louis spoke of earlier. So building on the overview, let me now shift to some of our key growth initiatives. We are excited about our new generation variable speed pool pump motor line launching at the end of 2020 ahead of the 2021 U.S. Department of Energy regulation. Leveraging our extensive knowledge of this application as well as our close OEM relationships, this new pool pump motor provides the best value compared to competition in terms of safety, reliability, efficiency, packaging and cost, not just for the OEM but for contractors and homeowners as well. On top of energy savings, our next-generation variable speed motor will be Bluetooth-enabled for tracking of energy consumption for end users. This new line will also allow Regal to sell a bundled solution, with integrated controls for variable speed at a higher average selling price and margin and penetrate an underserved segments such as the smaller pools, which should expand the market opportunity by $25 million. This new product line will continue to position Regal as the industry leader in the pool pump motor space. The next growth initiative highlights the opportunities we have with our Nicotra Gebhardt acquisition. Nicotra Gebhardt, based in Europe, is an innovation leader in energy-efficient blower and fan systems. This is an approximately $1 billion available market, where Regal only plays in approximately 50% due to the European focus. The example illustrated here is a pioneering new motorized fan line that represents a 15% lower system energy consumption than the next nearest competitor. Furthermore, as a direct-driven fan, meaning the motor is directly connected to the fan shaft, it generates 50% reduction in energy cost compared to a belt-driven fan. This combination of Nicotra Gebhardt with our motor business is powerful. Leveraging our technology strength in both fan and motor design and applications is positioning Regal to lead in the growing energy efficiency -- efficient package space, which is margin-accretive to Regal. With our global position, we are taking the Nicotra Gebhardt solution worldwide to access the full market opportunity. The commercial HVAC end markets due to macro sustainability trends are requiring OEMs to develop new platforms to meet the more stringent energy efficiency requirements. Every OEM takes a unique approach to these trends, all of which are putting demands on the 4 core technologies: power density, form factors, electronics packaging and application control that I discussed previously. With Nicotra Gebhardt now integrated into the Regal motors and controls business, we have one global team with deep knowledge and experience in these core technologies and are successfully addressing all of the product options that the OEMs are considering. Shown here are longer radial shaped motors, shorter axial length designs, an integrated motorized variable speed fan, an external rotor motor, demonstrating that we can offer the most flexible breadth of solutions in the industry. Our scale from technology to manufacturing is a core differentiator for Regal. This powerful combination of Nicotra and Marathon motors positions us for deeper penetration into existing markets and is opening up new markets to Regal, which we sized at approximately $250 million. Our last growth example is with our high-speed motors. Most motors run in the 1,800 to 3,600 RPM range. With Regal's technology, we have developed a line of motors that can run up to 20,000 RPM. We provide hermetically sealed motors that integrate with OEM compressors for commercial HVAC chiller applications. These applications have been moving to higher speed designs for power density and energy efficiency. We have taken these proven capabilities and leverage the technology to new applications, like higher speed blowers, as shown in the lower picture on the screen. This is a motor integrated in a blower assembly for a water treatment plant aeration. In these demanding applications with severe consequences of downtime, customers are attracted to our proven experience versus the smaller players that are serving this emerging segment. This is a new $200 million market for Regal, where we have differentiated technology, strong manufacturing expertise and have effective access to the market. We are excited about this new opportunity and believe we will grow rapidly through 2020 and beyond. Hopefully, you are hearing from the description of these growth initiatives that Regal's Commercial Systems business is not just a motor and fan supplier, but using technology to differentiate from competitors, grow share and expand into new global markets. We see significant structural margin improvement opportunities in Commercial Systems that 80/20 is unleashing. In this next section, I will show you how 80/20 is helping us simplify the business by rationalizing our footprint, reducing our SKUs and improving our productivity. We are embedding 80/20 into our operating cadence with clear objectives for each business and improvements that fall to the bottom line. We have actions underway to reduce our SKUs by roughly 40%, which will enable us to remove 1/4 of our manufacturing footprint. As we are downsizing, we are shifting more sourcing to best value country locations. All these actions will drive continuous margin improvement. Due to our many acquisitions, we have significant unnecessary complexity still to be rooted out of the Commercial Systems segment. Referencing this case study of our North American motor operations, you can see the complexity in our business. 20% of our customers make up 96% of our sales and 20% of our product SKUs make up 89% of our sales. A staggering 80% of the customers are actually only 4% of our sales in this example. We are seeing similar trends at nearly every business where we are deploying 80/20. Just consider the resources it takes to support that 80% of business. This is why we are driving simplification across Regal. We are looking at all aspects of how we support our business model more efficiently. We have started making changes to our manufacturing assembly lines within our plants and are seeing early sizable benefits around service and productivity. We are making tough decisions on pruning unprofitable business so that we can focus our efforts on the highly valued customers and products. We are also taking a structured approach to SKU reduction and a surgical price management on products. Some may call this product management 101. But what 80/20 is doing for commercial motors and all of Regal, for that matter, is driving an ongoing structured framework to improve the performance of the business. We believe that 80/20, with our plant consolidations and best value country-sourcing activities, will drive a 300 to 400 basis point gross margin improvement in this part of our business over the next 2 to 3 years. In this case study, we were evaluating the rationalization of one of our facilities with approximately 100,000 square feet, 200 employees and $35 million in sales. 80% of the sales were to approximately 25% of the customers, making up only 7% of the product SKUs. Normally, the long tail of product complexity would be an inhibitor to moving such a plant or in this case, we were going to move all of the SKUs, which would have translated to significantly lower annualized savings. Instead, using our 80/20 methodology, we are simplifying the SKUs offered by 50%, and with that, transferring most of the remaining 75% of customers onto our A product platforms. Although we are anticipating losing approximately $3 million in sales, we improved our cost savings from the consolidation from approximately $5 million to $9 million through simplification. Now we can focus on those products that provide superior margins and drive growth in accelerated rate. In this case, less is more with 80/20. While we are simplifying our products with 80/20, we are also introducing value analysis, value engineering, or VAVE, methodology as a standard approach on all new product introductions and product transitions. We have started our first workshops and developed our first trainers. The example here of a motor frame illustrates the power of this approach. A motor frame is usually wrapped around the motor. Traditionally, we would have assumed that the frame is needed and brainstormed how to reduce the cost of the frame. With VAVE, we focused on the functionality of the part or the assembly. This opens one's mind to different possibilities such as, "Why do we need a frame at all?" It may be difficult to see in this picture, but the motor shown is a prototype with the middle section of the frame removed. We are in the early days of this journey, but our first workshops are capturing 10% to 20% cost out possibilities versus the traditional 1% to 3%. So let me summarize why we will win. We have a solid business foundation in leading technology which will allow us to benefit from positive macro and regulatory trends. We are well positioned in the pool pump market with technology and connected solutions. Sustainability is key to the success of all of our new products, including our commercial air handling and our high-speed motor solutions, which is allowing us to expand into new global markets, and clearly, 80/20 will drive significant positive structural changes for our business. The underlying theme, I hope you heard, about the Commercial Systems segment is simplify, grow and create a better tomorrow for all stakeholders. Thank you for listening, and I'm now -- we'll take questions.

Scott, it's Cliff Ransom. I should know the answer to this question, but perhaps you can help me with a little historical framework. We've known forever that variable speed motors were much more efficient in many, many, many applications and very cost-effective. But customer acceptance, which has been so dramatic in the last, say, 10 or 15 years, what changed that from a customer point of view? Was it the cost of the motor, the cost of energy? What -- we went through -- my sense is, correct me if you think I'm wrong, we went through a big inflection point on the desirability of a variable speed motor. What created that?

Yes. What I'm seeing, Cliff, is that besides the regulations are picking up, okay, there's more regulations that are moving people to variable speed, the OEMs that we work with, this is part of their value that -- of their values for their own company and then how they're moving ahead with sustainability. And it's just a trend that's out there in the marketplace that they see that's a good thing to be doing even voluntarily. And so you see some of these large OEMs, for example, in the commercial HVAC space that they're very proud of what they're doing on this front.

And then very quickly, on the pool exposure, is it that you're selling motors to the Pentairs and the Haywards of the world?

We sell through OEMs and also into the aftermarket through distribution.

So you guys mentioned you're expanding in Europe given efficiency trends and regulation in that region. With Asia still 15% of sales, how are you thinking about your exposure there? And kind of any efficiency trends or regulation upcoming in that region?

So it's a question about our growth in Asia. Is that what you...

Yes.

How we're thinking about our growth in Asia? Yes. So we have a certain presence in Asia, and we want to grow in Asia, but we are being very careful at focusing where we can profitably grow in Asia. And we actually see pockets that are -- we're fairly profitable, and they are actually underserved pretty sizable markets. So our strategy there is a bit more we're going to focus and not be spread out as much over many different segments, where we see there's some attractive markets, where we can be very profitable.

A couple of questions, one on pool pump. Can you just frame what you think the opportunity is from this 2021 energy efficiency regulation? And then separately on the form factor, motor form factors, just talk about what your customers are really leaning towards in terms of the different form factors. And I know you talked a lot about axial at trade shows, et cetera. Maybe just adoption there.

Yes. I'll take on the first one first about sizing up the pool pump motor opportunity. We're -- as I said, all those pool pump motors will have to move to variable speed per the regulation in that. So we expect it to be a fairly quick changeover through 2021. We're not prepared, I think, to give guidance about the size of that opportunity at this time.

No, but clearly, as we saw in the climate space, when there was a transition from standard motors to variable speed, there's a mix-up for Regal, but we're not ready to quantify what that is.

Now the question about form factors and what we see the OEM's doing, it really is a mixed bag right now. They're all taking different approaches. So we think it's very valuable of what we're doing of having the flexibility. You will see some players out there saying, "There's only one way to play" and have only one type of solution. And we're seeing we're getting a lot of attention because how to address these regulations as a total system by the OEMs gets pretty complicated. So they want a lot of flexibility of people that can work with them, of different ways of supplying either the motor or the integrated control with the motorized fan.

How would you compare your market positioning to capitalize on some of these changes relative to the competitor base? Where do you stand on the innovation side, the capabilities, the technical side of the ability to hit some of these regulation targets, the efficiency targets, things like that relative to the competitors out there?

You meant -- you heard earlier that -- where I talked about where we had leading positions. So on the pump segment, we are a market leader there, which we have wonderful relationships with the OEMs and understand that space very well and in the aftermarket. So I think we're very well positioned there to have the best value propositions and the solutions for the regulations coming up. And then as you know, Regal has very good relationships commercial HVAC-wise as well. So the same kind of thing. I think we're very close to the OEMs to understand that change. Is that the answer to your question?

Yes. No, poorly worded. Maybe talk about what you think the competitors are doing today to try to get towards where some of those leading positions that you historically have are? Are you seeing people try to dynamically change their approach to the marketplace? Or is there more complacency in the marketplace? How are those responding to the change?

Yes. I would say more traditional. I know -- more traditional approaches that I'm seeing from competitors. Clearly, as we move up into the energy efficiency and integrated controls, there are certain people that can't run that race. And so Regal's got that kind of background and that capability. So it's changing the competitive landscape a bit, this move into this variable speed, to do it well and provide that. And so some players are dropping off.

Yes. And the only thing I would add, and I'm not sure Scott would elaborate, is in air handling. So the acquisition of the Nicotra Gebhardt was strategic for us in taking that next level. The technology that we're a leader in motors, with their handling and partnering that to drive a total systems solution that's truly a differentiator in energy efficiency, we're seeing momentum there as well.

Yes. And if I try to emphasize that a bit, maybe it didn't come through as much of having a motor control company and an air moving company with the expertise we have all under the same roof. Now the trick is bringing them together, and we brought them together under my segment. Where traditionally people would just be an air moving company or just a motor company, we're finding solutions here that I think other people would not find because of that combination.

This question relates to the R&D efforts. You mentioned your division will participate in the 100 basis point of increased spend. Just thinking about the effort it takes now to serve the long tail of your product SKUs, it seems. Do you have to expand that R&D effort? Or do you have enough headspace right now from SKUs that are maybe service bio-spec engineer? Or is there just going to be a transition of talent, growth in talent? How do you view the investment in -- within commercial?

Yes. I don't see -- the R&D efforts will be very much focused on some of the higher volume, big customers' efforts that we will be doing. So I don't see the tail inhibiting us, if that's part of your question, of being able to put these investments in place. We already have core strengths on this front. I could see a shift, technical skill shift as well that we're doing in the business to focus more on those 4 areas -- increase our focus even more on those 4 areas that I talked about earlier on the pitch. Does that answer the question?

More so if so much of R&D spec work is being spent right now on that 20% tail, are you able to just transition that to the core profitable part of your portfolio? Or do you need that transition as well as incremental investment in R&D?

Yes.

Yes. Let me try, and then Scott, if you don't mind adding on. It's a good question. And as we consolidate and rationalize, absolutely, we're going to free up some engineers' time, just focus on the smaller number of SKUs. But clearly, Regal wants to profitably grow. And we're saying we're going to grow at GDP-plus. I'd like to see us grow faster than that. And I believe that by investing more in innovation and technology, we'll be able to expand our products and solutions and better service our customers' needs. So that's really more of the driver here. I agree with you, as we consolidate and rationalize, we're going to free up some engineers' time to support the business, but we want to take it a step further. And hopefully, you heard of some of those products in Scott's presentation, in Jerry's, and you'll hear it in Eric's and John's as well.

Yes. All right. Thank you.

Now I'd like to introduce Eric Mcginnis, President of our Industrial Systems segment.

Thanks, Scott. Good morning, everyone. So my name is Eric Mcginnis. I've been -- I'm the President of Industrial Systems. I've been with Regal for 27 years, and I came with the GE acquisition in 2004. So let me start off with just a quick overview of my business. So we have 4 main brands within Industrial Systems. Marathon is our global general purpose industrial motor brand, which serves 3 main applications: pumps, fans and compressors. These motors are 61% of our sales. Marathon is also our global generator brand. We design and assemble alternators, which are a critical part of generator solutions. Thomson is our brand of paralleling switchgear and automated transfer switches along with the growing 24/7 in-field solution offering. Data center construction is the largest end market for this business unit. Thomson manufactures specialty products for critical applications and is known for solving tough application problems. We have 2 brands in Europe that specialize in custom products for niche applications. These business units have deep market application knowledge and help solve their customers' problems. Rotor manufactures marine duty motors and Cemp manufactures explosion-proof motors mostly for oil and gas applications. These brands are well known for application expertise, reliability, great service and short lead times. Industrial Systems has approximately 2,900 total employees, which is down 17% from a year ago and manufactures our products in 15 locations around the world. We are in the process of simplifying our locations to reduce overhead costs without impacting service to our customers. Each of these facilities are driving productivity and working on cost out activities using 80/20. Our current strategy is to manufacture, warehouse and modify our products on the same continent where we sell. 2019 was a very challenging year for industrial systems, but I am confident in a rebound in 2020 and future year prospects. In 2019, sales declined by $90 million or 13.5%. And although we took significant cost out of the business, we ended the year at breakeven. Top line challenges were driven by the global industrial slowdown, the trade dispute between U.S. and China and the cost challenges we faced due to the additional tariffs on industrial motors sold from the U.S. or sold in the U.S. from China. Our products we're on list 1 of the 25% tariff. And unfortunately, we did not have an alternate facility to move this product to in a timely fashion. Of the top 5 industrial motor companies selling into the U.S. market, we were the only company that manufactured industrial motors in China for the U.S. market. Over the last 12 months, we built a new motor facility in Monterrey, Mexico, and in December of 2019, started manufacturing industrial motors for the U.S. market. This will create significant savings, which we will see in 2020 and beyond and will reduce our inventory levels. Industrial Systems has a significant presence in China, larger than the other segments within Regal. This, of course, put further pressure on our performance in 2019. Finally, the majority of our sales go to OEMs with the aftermarket at 23%. We saw declines in just about all our end markets in 2019. However, market data suggests that we have hit the bottom and should start seeing a minimal rebound this year. In particular, we are already seeing strength in data center construction and starting to see a slight rebound in power generation and oil and gas applications. So we have 2 key growth initiatives in 2020. Our Thomson business unit, which specializes in solving customer problems quickly with custom engineering systems, has recently been successful in providing a solution for a large end user in the high-tech space. In data centers and high tech, the window of time between the investment decision and the start-up of the facility continues to shorten. The Thomson team quickly customized an elegant hybrid power distribution unit design exceeding many of the customer requirements. The customer approved the design. Prototypes were built and the design was proven in record time. Thomson was recently awarded a $10 million order for production in 2020. We expect this volume to repeat in the future, and now Thomson has a differentiated hybrid power distribution solution that we are now offering to other end users. The ability to customize with speed is a competitive advantage for the Thomson brand. Our Rotor and Cemp business units have strong application knowledge and manufacture differentiated products for critical uses. Additionally, they have a large portfolio of certifications required in the markets they serve. These businesses are examples of previous acquisitions where Regal obtained significant product application knowledge in a niche segment in a limited geography but did not leverage this capability outside of its home markets. Now, however, our European customers have moved to Asia and are asking Rotor and Cemp to manufacture their products in region to support their local needs. With our global footprint, we were able to leverage our manufacturing capability in China to produce Rotor and Cemp products. Our engineering teams are ensuring that we manufacture in China using local sources with the same quality and reliable products as produced in Europe. Quality and reliability are the value differentiators for these brands. Our primary focus is on current customers, but this now opens a larger market for us, which we are sizing at approximately $130 million. So you will notice that Industrial Systems -- the Industrial Systems business only has 2 major growth initiatives as we recognize the focus for us must be on margin improvement, which will, in time, position us better for profitable growth. This is a clear mandate for our Industrial Systems business and aligns with how we are measured and compensated. The largest initiative we have in industrial motors is consolidating to our global TerraMAX platform. We currently have proliferation of designs to the many acquisitions we have made over the past years. We have used 80/20 to greatly simplify our design platforms and to reduce the number of different components in our motors. TerraMAX will allow us to reduce the number of platforms from 14 to 4, while better positioning us to meet the regulations of both NEMA and IEC. With the simplified global platforms, we plan to further leverage our supply base using best value country sourcing to reduce costs. By standardizing the required components, we are able to reduce our inventory levels and require our suppliers to provide just-in-time delivery. Depending on the size of the motor, this program reduces cost for our product between 10% and 25%, with an average cost reduction of 18%. The TerraMAX platform will not only increase the margins in our current business but allow us to be more cost competitive in end markets where we cannot compete today. Our generator business is also margin-challenged and has too much complexity. Last year, we conducted an extensive value analysis, value-engineering workshop. This included a detailed teardown of our products and our competitors' products, which allowed us to develop a clean sheet alternator solution that will reduce our cost by 15% to 25% depending on the model. Using 80/20 methodology, the team was able to reduce the stocking requirements by nearly 2/3. The value of this now was to stabilize -- the value of this was our ability to standardize and simplify our offering and now transfer this production to a more cost competitive operation while establishing enhanced modification capability in our U.S. warehouses. We are using 80/20 in everything we do. We must reduce complexity and cost fast so we can regain our cost competitiveness in the market. We will be reducing our manufacturing facilities from 15 to 12 over the next 24 months, while improving service levels to our customers. Our simplified designs for motors and generators are instrumental in making -- in enabling this to happen. We will reduce total product SKUs by approximately 40% by 2022. We will also be closing many of our warehouses this year and developing closer relationships with our key distributors. We are also using 80/20 on the front end of our business. We completely revamped our motor distribution program in North America. We eliminated overlapping products that were using different brands, and we eliminated SKUs where we reduced the low -- where we reduced -- was low and moved over to made to order, low demand. In total, we reduced our stock SKUs from 5,800 to 1,600 for a 72% reduction. We then bucketed these 1,600 SKUs into 3 categories of gold, silver and bronze. These stock classifications can be seen across our supply chain and drive focus to improve service levels on critical SKUs. The gold SKUs, which are the majority of our stock motor sales are now warehoused across our entire rep network. And in the fourth quarter of 2019, we saw nearly 100% increase in sales due to availability, which is driving good profit mix. Through this program, we also expect our inventory to decrease by approximately $30 million, significantly improving our turns. So why will we win? We recognize the need to improve performance of our Industrial Systems business, and are confident we have the right plan going forward. Taking costs out and improving margins are a top priority. 2019 was very challenging with the downturn of the market and the tariff impact. As Louis shared, we have restructured many of our business units and brought in new talent to ensure improved execution. Our new manufacturing facility in Mexico is now operational. So the negative impacts from the tariffs will lessen through 2020. We are also seeing an early rebound to the global industrial markets, and we have great profitable niche brands in Thomson, Rotor and Cemp, which will benefit from the rebound in the market. With the launch of our new TerraMAX motor design and our simplified generator design, we will improve our margins and allow us to grow in markets where we can't compete today. 80/20 is who we are at Regal and definitely at Industrial Systems. We are simplifying our designs, reducing our manufacturing facilities, warehouses and product SKUs, and are improving our go-to-market strategies. This will allow us to take cost out of our operations by lowering overheads and leveraging our supply base. I'm very excited about the future of Industrial Systems after a very challenging 2019, and I'm convinced we can achieve 8% to 11% operating profit through the cycle. We are doing the right things to take cost out and simplify everything we do. Thank you. I'm happy to take questions.

Eric, so you have a lot of sort of wood to chop. Maybe the first question around the margins. So you gave 2 different sales splits by product and by end market, which was helpful. Any sense you can give us on what the distribution of profitability is across those different pieces today just so we can understand how much of them are running way below that target level, what share of sales, if any, are within the target level today to try and understand sort of how you get there on that?

Yes. It's a mix. Distribution is about 75% of our -- or 25% of our sales, 75% is OEM. The cost-out activities that we're going to do affect our total product offering. Our margins are a bit higher in distribution through OEMs, but both channels will see the impact of the cost-out with the new designs. The designs will impact what we're selling in distribution and OEM, and the leveraging of the supply base will have an equal impact. Does that help?

Yes, that's helpful. And in terms of, I guess, the path forward, you're trying to improve margins across the whole segment today. At what point do you sort of reevaluate and say, "Okay, this 15% of the segment or 30% or whatever it is, it's just not worth the time and energy and money to turn it around, so maybe we should not just do PLS but broader divestment, exit?" Like at what point or time horizon does that happen?

Well, there's a couple of things. So our #1 initiative is to take cost out so that we can be competitive and make acceptable margins at our current business, but that's not going to be the case always. So we have product lines and customers that still won't be acceptable. And so we'll increase price and prune those businesses, which will help the overall profitability of Industrial Systems.

And we're doing that today. We're -- the business is -- absolutely through 80/20 is identifying opportunities. With that, we are raising price, and in some instances, maintaining the business and in some instances, losing.

Eric, it's Cliff Ransom. I'd like to ask you about one sentence that you sort of told us. You said market data suggests or indicates that the market has bottomed out and maybe getting better. Can you tell us what market data you're looking at when you say that?

Well, we're looking -- most of that are our current orders. We had a pretty good orders, income level in the fourth quarter. And it's starting off pretty decent in the first quarter, largely driven by some of the large projects that had been delayed are starting to come in, specifically in the data center construction market. In the NEMA data that we look at every month, it is still showing that unit volume for industrial motors is down, but not as far as it was down a year ago. Got off easy. Great

So I'd like to introduce John Kunze, the President of Climate Solutions.

Great. Thank you, Eric. And hello, and good morning. I'm John Kunze. I'm the President of Climate Solutions. I've been a part of Regal for now 13 years and joined Regal as part of the Fasco acquisition in 2007. It is my pleasure to share with you this morning the compelling success story of our Climate Solutions business. I will cover an overview of where we play, provide some color on how we are performing, and share with you some exciting updates on how we're accelerating investment in new products and geographic expansion to grow the business and how we're using 80/20 to improve margins and service our customers. The brands and products of Climate Solutions are broadly featured in OEM equipment used to heat and cool air for space conditioning, heat water and provide refrigeration for perishable goods. We are a technology leader and the pioneer of variable speed and programmable motor technology. Our teams focus deeply on understanding customer applications and challenges and developing products and solutions that resolve those challenges, which has resulted in strong patent positions and enviable market shares in the markets where we play today. Genteq, Century, Fasco and Evergreen are all well-respected and market-leading brands. So if you look at this chart, we have the strongest global footprint in the industry, with 26 core facilities. Our solid manufacturing presence allows us to take advantage of optimal cost in the supply chain, while ensuring superior local quality and service. As Louis stated earlier, this is a clear competitive advantage for Regal. Today, we're fortunate to have a footprint, especially in Mexico, India and China that is allowing us to adapt to a very dynamic environment of changing trade tariffs and unfortunate global health concerns. As a result of the changing global trade dynamics of the past 2 years, we've moved production across these 3 regions to best support our customers. Most recently, we are responding to some customers' urgent request to protect them from long and distant supply chain disruptions. Regardless of the situation, we are in a superior position to serve our customers and leverage our best cost supply chain. Next, I'll provide an update on our performance and share with you a few of the market trends, particularly in the regulatory arena that are providing segment tailwinds. I'm extremely proud of my team's performance in 2019 and over the past few years. In 2019, we grew profit 9.5% on a 1.2% sales decline. And since 2016, we've grown our operating margin rate by 260 basis points. We have focused our efforts on higher-value products and solutions while effectively driving cost out of the business. Although sales grew at a modest 2.5% compounded rate over this period of time, they were on a 5% pace before we hit the 2019 headwind. Even so there's no question that we know how to drive profit growth. North America continues to be our primary market, but international markets are key to our future success. Our technology and value chain serves the OEM space extremely well, and we're growing our presence and focus in the distribution channel. Overall, 78% of our sales are made to our OEM customers, while 22% is in the aftermarket. As Louis shared, we believe in strategy and then structure. At Climate Solutions, we have general managers who are responsible for the strategy to profitably grow in our key end markets, as listed on this slide. Our product management, marketing and sales leaders and engineers have strong domain experience, which better positions them to resolve customer challenges. Our end markets are HVAC, combustion, general industry, distribution and commercial refrigeration, all of which are being driven by macro trends, including energy efficiency, a growing global population and growing middle class and connected solutions. We like the positions we have in the market today and believe the markets will grow on average at GDP levels. So 2 of the biggest catalysts driving the North American HVAC, water heating and appliance markets have been the lift in replacement equipment sales that we've seen from the installation run-up from 2005. Some industry experts have called 2020 as the final beneficiary of pent-up demand -- pent-up replacement demand based on a 15-year replacement cycle. Others feel that because HVAC reliability has improved, the replacement cycle is even longer. Even if we do start to see this decline, housing starts seem to be supportive of continued increased demand in this space. Regulations have helped to transform our industry, and we have benefited from them, as we are the technology leader with products and solutions that differentiate us in the market. As you may recall, the FER regulation on gas furnace, electrical energy efficiency shifted approximately 3.4 million gas furnaces from standard efficiency motors to high-efficiency motors. We were very well positioned here because of our existing share and the investments we made in new motor technology and increased capacity to serve. We continue to be on a path to gain $40 million of incremental revenue on an annualized basis from this regulation change, and we expect to see much of this in 2020 and 2021. We're now laser-focused on the new 2023 air conditioning regulations, where our OEM customers are challenged with another step-up in energy efficiency and also refrigerant changes. This is creating an environment where customers will be more reliant on very competent suppliers to help them with proven solutions, testing and qualification capability. Efficiency regulations are pushing equipment manufacturers and their suppliers to have well-integrated, high-performance solutions at competitive costs. Our track record and continued focus and investment in purposeful innovation in this space puts us in a leading position to outperform for our customers while growing our business. So I'd like to now give you an update on some exciting growth initiatives in Climate Solutions. Our ECM Made Easy campaign targets a channel where we're very well positioned to grow. Historically, the aftermarket has been a standard efficiency motor market. 2 years ago, we set off to develop a line of Evergreen motors that leverage our proven experience and success in the OEM space by providing a simple lineup of just 3 Regal proprietary, programmable ECM motors that replace 32 standard motors. Sales for Evergreen have increased over 37% over the past 2 years to date, we're still less than 7% penetrated. So we have a lot of upside left. The value proposition to the contractor is significant reduction in inventory and improved productivity. Inventory outages are minimized, as Regal solution requires only 3 motors to meet all potential customer needs and can be programmed for the specific repair application on site. The benefit for Regal is a higher-margin solution sale where we have differentiated technology. Another area where we're expanding on a long history of success in gas combustion, in residential and commercial boiler applications. We are the market leader in flue gas draft inducers in North America. With the acquisition in Fasco and Jakel, Regal combined our combustion knowledge with our ECM motor position to create a line of premix blowers. This sustainable product line reduces gas consumption and nitrous oxide emissions versus traditional blowers and is differentiated from our competitors with improved performance, capability to operate at a larger range of temperatures and a smaller overall package. After success in North America, we've taken this solution to the larger European and global markets. Customer acceptance has grown and has been beyond expectations. The global market for premix blowers is over $300 million. Today, we have a very small share, but have a great path to grow and continue -- and can leverage Regal's global position to better penetrate those markets. So everyone is talking about IoT, but if you can't establish a value for the customer, IoT fails. We're perfectly positioned to provide a unique customer solution in commercial refrigeration applications. Historically, we'd sell a motor and a fan, typically designed as a packaged solution. Based on our deep domain knowledge, we have developed a connected solution that provides customers with 24/7 health monitoring of their refrigeration equipment. We've created a business model that's gaining traction because it addresses clearly understood and quantifiable high-cost pain points, refrigerator downtime and food or product spoilage. Through health monitoring, we know when the refrigerator is about to fail and can dispatch a service technician to resolve the problem. With this solution, we're providing a differentiated service to our customers, saving them money and gaining a recurring revenue stream for Regal by providing a real-time monitoring of their critical equipment. What do we want you to take away from this? The market opportunity is not huge, but shows how Regal is leveraging our technology to better -- to solve customer solutions. In this example, sales may be relatively low, but margins will be 2 to 3x our fleet average, a big win for Regal. Next, I want to share with you how we are leveraging 80/20 to simplify our operations, lower our cost and improve our performance to our customers. This year, we'll close 2 facilities and 3 more over the next 2 years. We are aggressively simplifying our operations by reducing our square footage requirements by 13%, focusing on our A product and reducing our product SKUs by 38%. We are attacking complexity across our business. We're focusing our efforts in our existing facilities to increase productivity at all levels. In this example of automation deployment, our manufacturing engineers designed a solution, partnering with an OEM that allows us to reduce labor -- reduce employee labor from 18 to 6, over 3 shifts, while doubling output. We've installed this solution in one of our Mexico facilities. And even with the lower labor rates, we've achieved less than a 1-year payback while improving quality to less than 100 parts per million, which is a real victory. We have a saying at Regal, creativity before capital. But with this type of savings and improved quality, it's a no-brainer. At Regal, we're evaluating more and more of these types of automation transformations. As all of my team members have commented, 80/20 is now who we are at Regal. In this case study, we are leveraging 80/20 to overperform for our highly valued customers. We are very purposefully concentrating our sales, customer service and engineering associates on the 20% of the customers that make up 80% of the revenue. Our teams are excited to be evaluating and implementing this level of attention to our top customers. And while it is early days to point to increases in sales, customers are providing great feedback that they're getting preferred support. We know that over-serving our top customers will help them win. Together -- and together, we can grow our business. So -- and so why will we win? I'd like to leave you with confidence that the Climate Solutions segment is well positioned for long-term profitable growth. We have a great story and a position in the market. The recent organizational changes at Regal allow us to further build on our application knowledge and -- that our customers are expecting. We have developed a strong record of financial performance, and you should be confident that we will continue to perform. Energy efficiency regulations continue to provide tailwinds for this business, and we're well positioned to take advantage of them in the market. Because of our long history and significant installed base in ECM motors, new markets and connectivity have great potential for Regal. And finally, 80/20 will make us a higher performing customer -- or company for all of our stakeholders. We clearly have a bright future ahead. And with that, I'm happy to take any questions.

Maybe -- you mentioned some of the different market views on the U.S. resi HVAC cycle. Maybe just give us sort of your own perspectives on where you think we sit in that. And also perhaps any color on the short term around inventory levels in that market and how good you feel about the outlook for this year in HVAC?

Yes. So anyway, we feel like we may have another year or 2 before the replacement peak of 14 years ago was eclipsed. We feel like units have gotten a little more reliable than they had been in the past. But we know that that peak is coming. And so that's why we're implementing all of the additional focus on new markets and international opportunities and connected solutions and things of that nature. So -- but to answer your first question, it's -- we feel like we might have another year or 2 in that cycle. And remind me of the second part of your question.

Just around the inventory levels.

Okay, inventory levels in the channel. So we did some channel checks. Every quarter, we touch base with each of our large OEMs. And predominantly, the inventory levels are where they expect them to be at this point in time. Cliff?

On this gas premix blowers, can they be retrofitted into existing units?

No. I wish, I wish they could. They can't. They have to go into a unit designed for that type of combustion. The old technology used to draw the draft through the heating compartment. This technology forces -- it premixes the gas and the air and forces it through the combustion compartment for a more efficient burn. But it can't be put into an old technology unit. I wish it could, Cliff. That would be a great opportunity for us.

You had a sale right here. The other question that I had was -- I loved your example of the head count reduction and the speeding of the flow and everything. But you've got an -- how did you handle, in that example, the 4 people that were freed up?

We put them -- there's always attrition in the operation. That gave us 4 people that we didn't have to replace -- when you have attrition in the operation and people leave for whatever reason, we didn't have to hire 4 more. So...

Of course, on the other hand, you want your attrition numbers to go positive?

Yes, yes. Yes, we would like that. We do have a little bit of attrition in each one of our operations, and it occurs. But we didn't have to replace those 4 in that operation.

Yes, Cliff, I'll just add to that. I mean these are large facilities. One of the strengths of this business is the scale. And so the ability to absorb 4 head count or, in this case, 12 for each shift was not much of an issue.

John, you guys have done a great job with the margin improvement over the years. And it seems like your facility reduction and some of the other rationalization is a lot less than some of the other businesses. But just understanding -- but you have, I'd say, a more impressive runway in terms of kind of through-the-cycle margins than I would have anticipated. Just kind of talk about confidence level to get there, some of the headwinds around customer concentration in the industry, et cetera.

Yes, good point. I mean we -- and we didn't talk about that. There is some potential consolidation in the industry. We all know that. Each one of them are our current customer. Every one of them in that space are our current customer. And we expect them -- that they will be in the future. And especially with all the regulation changes, they're going to need typically a larger organization that has all these regulation changes, needs very competent suppliers to help them. And a very small niche supplier usually doesn't do well with an even larger scale company. So we feel confident that we're well positioned there, because we service them all. So if one buys the other, it becomes okay for us either way. And then our confidence to get there, there's still cost-out opportunities in this business. Our team has taken a lot of cost out of the business, but there's still -- there's always more. And we're always evaluating better ways to do things, better ways to source product or build product. So we're very confident in our cost-out initiatives. We're just concentrating everything we've got outside of the cost-out initiatives to find those other markets to grow, expand distribution, expand in commercial refrigeration, expand internationally and then also be the beneficiary of customers that need our help meeting energy efficiency standards with more ECM, because we feel really good about that as well.

I'll emphasize one point that John just made. Those growth initiatives that John and his team are driving are also at margin levels above his fleet average. That's going to help them.

Yes. Anything else? Yes. Okay. Thank you for your time today. With that, I'll turn the podium back over to Louis Pinkham for a summary and Q&A.

Thanks, John. Before we turn to Q&A, I would like to provide a brief summary of the messages that you've heard today. We believe our strategy in our 80/20 and cost-out initiatives will firmly put us on a road to 300 basis points of margin expansion by 2022, with 8% to 10% compounded annual growth of earnings per share. We are not expecting significant market tailwind to help achieve this result, but we are excited about our growth initiatives, as reviewed by all of the segment presidents, but especially those in Climate Solutions, Commercial Systems and PTS. We will also continue to deliver strong free cash flow above the 100% net income and will drive 250 to 300 basis points of ROIC improvement. We are laser-focused on returns in the business. As a reminder, there are 5 drivers on our road to 300 in 3, with 1 related to volume growth, but the other 4 all related to cost-out initiatives. The drivers in order of magnitude are restructuring, supply chain efficiency improvements, utilizing best value country sourcing, SKU reductions and other 80/20 actions, including account pruning. The remainder of the margin improvement is expected to come from volume, leverage and mix. What should be clear is that our road to 300 in 3 is mainly driven by cost-out initiatives on which we have clear line of sight. We would expect any incremental volume growth to generate strong operating leverage. I will end by returning to the question of why invest in Regal. From the global energy efficiency trend to our refocus on initiatives to accelerate organic growth, to our 80/20 efforts, to our return-centric capital allocation policy, to the continued strong free cash flow, I firmly believe that you have heard a compelling case today on why Regal is a great company with a great team that is a very attractive investment. Thank you again for joining us today. And with that, I'll open it up for questions.

Maybe the first question. On Slide 22, you had a list of sort of major productivity efforts around SKU reduction, footprint consolidation. And those are obviously over a sort of 3- to 4-year period. How back-end loaded or front-end loaded are those measures? If we look in the filing for 2019, you can see the mass of cost reduction has already occurred. So I just wondered, is this a -- how confident do you feel on these targets? How much of it is already booked or in motion today versus being left for next year or the year after?

It's relatively a straight line. There's opportunity from '20 to '22. And every year, we have a clear path. Every one of our segments has a clear path to drive cost improvement and productivity. So one year versus another, there really isn't -- the only thing I will clarify on that is from an account pruning or a pruning perspective, that's going to be a little bit more front-end weighted than toward the back end.

And then maybe just a shorter-term question because the environment is very dynamic. I mean a couple of the segment presidents mentioned demand or inventories in climate and maybe a bit of a pickup in industrial. I just wondered if there were any broader comments on organic sales or orders trends, whatever you can say for the current environment.

Yes, maybe I'll start and then go from there. Coming in the year, we were actually feeling a little bit more bullish. We were seeing a bottoming out. We're going to see better comps certainly going into Q2 and beyond. Coronavirus is a question mark on when it's going to -- how it's going to impact demand. And so it's hard for me -- I wish I could sit here today and say we're very well positioned. I do think we are very well positioned to take advantage when the market tailwinds come back for profitable growth. I'm a little concerned, though, based on what we're seeing in the market. Now to Eric's point, February was an extremely strong orders month for our Industrial Systems business. We're seeing some strength in the data center market. It was a little bit weaker than we anticipated in the Commercial business and the PTS business, which I think right now is just a bit of market uncertainty. But again, to the point Rob made earlier today, stability would help. Hopefully, that clarifies.

Yes. Louis, thanks for sharing the longer-term margin targets for the segment. They clearly transcend the 300 in 3. I'm curious about the thought process for putting those in here today, given that this is a company that maybe hasn't caught up to historical 3-year targets margins in the past, and maybe it's enough to put up a new 3-year target and sell us on that. But you went beyond that. And just kind of curious about the rationale there.

There's no question, we have room to gain a bit more credibility in our drive of hitting those 3-year targets. But as we dug into the businesses and with a renewed focus, 80/20, best value country sourcing, taking some tough decisions around plant consolidations, SKU rationalizations, we see a path that's longer term than that 3 in -- 300 basis points of improvement in 3 years. The other reason why we felt it was compelling and important is we see a path in particular in our Industrial Systems business to get back to our weighted average cost of capital. We think that's critically important for shareholder returns. And so although that's going to take a bit longer than our 3-year path, we felt it was important to emphasize that point. And so that's why we put those targets in.

So a couple of questions here. First, a housekeeping. The 8% to 10 earnings CAGR over the next few years, is that purely organic? Or does that assume some level of capital deployment to buybacks...

It doesn't assume any buyback activity. However, there is -- obviously, the EPS growth outpaces the operating profit growth largely due to the fact that interest expense will come down over the period as well. But there's nothing else in there that would -- that you should consider.

Okay. Perfect. And then the second one, if you would turn the clock back [indiscernible], you talked about a lot of the options from a portfolio perspective. Fast forward to today, it seems like you're very comfortable with what you have in terms of portfolio size and more focused on product line rationalization [indiscernible]. So could you talk a little bit more about what led you to that decision? How much of this has to do with the opportunity set that you see with the existing portfolio getting towards above the level of acceptable returns before thinking about something greater? And just some context and some history on how you got to this decision point.

Yes, Mike. Maybe I'd be a little bit more balanced, though, in my commentary here that all options are still on the table as we look at the business. We will take a non-biased view of the portfolio all the time. I do think there's a clear path in every one of our businesses to improve the performance and help us return value to our shareholders. And so that's what we're here today to talk about and we feel really confident about. Now if at any point in the future we feel that one of our businesses could be better positioned elsewhere, then that will be a consideration. That's not on the table right now.

I feel like Bernie Sanders putting my hand up. I'd like to address a question on talent and depth of talent. You basically said you want to fix things, and I'll come back to that, if I may. But -- and I know it's a lot easier to restructure acquisitions in the first 100 days than after 10 years. But when I look at your footprint, it just strikes me as way too large. Is that an opinion that you would agree with?

Absolutely.

Okay. And then the second thing is -- I'm a -- I used to call myself a lean zealot, and I've become a lean crank, and I'm really tied into metrics. And I get nervous when I hear cost out, cost out, cost out because, to me, the things that are important are safety, employee engagement, quality, delivery, innovation, productivity. And cost is somewhere about #7 on there. Is cost out getting this emphasis just because it's the fastest way to get the initial rebound in margins?

Yes, it's a great question, Cliff. What I'm going to tell you as an investor is very different than what we talk about in our plants. We talk about SQDCG in our plants. Safety is always first, safety of our associate, safety of our product. Then quality. The quality that we specified for the product, we have a commitment to the customer to provide. Then delivery. We have a responsibility to provide service and solutions to our customer and meet our commitment. But SQDCG is in order for a purpose. There's a safety issue, our associates are empowered to stop. There's a quality issue, they're empowered to stop the line. We're not going to ship a poor quality product just to deliver the product or to hit -- that is emphasized over and over. But next is cost. And in order to be successful, you must be cost competitive. That's the discussion we talk about with all of our associates all the time. So safety -- you do safety, quality, delivery and cost well, you will grow. That's the message. Slightly different than the message we're sharing here today, because we believe that there is a path, especially with 80/20, to help simplify the business and improve the performance of the business. And a lot of that is going to come from cost out.

Louis, I appreciate the emphasis on moving to more decentralized management approach. Just wondering how -- at what pace you can move that at and as you're moving to decentralized, what you have to do to condition the middle management pool.

Yes, it's a great question. I -- the reality, and my team will smile when they say -- when I say this, patience is not a virtue of mine, and we've moved fast. Now one of the benefits we have is over 80% of our portfolio is on one single instance of ERP, which has helped us incredibly. Regal historically did not bring in a lot of outside talent. I made the comment on the fourth quarter call that of our 25 business unit and sales leaders, we've replaced 12 of them. 4 of them we brought from the outside, who are bringing new ideas, new perspectives. I think that has helped us significantly, that fresh talent, a different approach. So I feel really good about the team, but we will continue to assess the capabilities of that team. One of the reasons why it was critically important to me to bring on a chief HR officer that's a partner to our executive team and who has this experience in being part of a performance-driven organization is why Cheryl came onboard. And so we're thrilled to have her after 2 days as well.

Okay. And then on the industrial margins, I think Eric indicated he got off easy. But I think we have to go back to that because you've gone from breakeven to at least longer-term time frame, TBD, 8% to 11%. Should we envision that on something like 80% to 90% of the current sales mix? It doesn't seem like cost or cost productivity can enact such a paradigm shift in profitability.

So let me take part of that, and then Louis, you can add on. First of all, we said that we would get about 200 to 300 basis points of improvement over the next 12 to 18 months in industrial, purely cost play there. We have a lot of help -- self-help opportunities. That's where that's coming from. After that 18- to 24-month time frame, we shift to growth. You have to get organic growth in order to continue the pace to deliver the 8% to 11% that you're referring to in the deck.

So a couple of other questions. One, could you talk about -- I mean obviously, the ROIC focus from an investment perspective has been pervasive across the presentations. Could you talk about what that criteria is, how you guys go about identifying, implementing and then deciding how it gets allocated? Is there a cap to how much allocation dollars are available? Or is this, if you can hit that hurdle, you are willing to put the capital forward?

So first of all, we -- as we stated, we look to invest organically first. So we will always...

It was 100% inorganic question.

Yes, okay. So there is no "cap" if you have a strong payback at below 1.5 years on a project. So we're always going to look there first. There is no -- when we're looking at any investment that we're making, it's always returns-based. So that's how we're evaluating. But again, we're not looking at caps. We're saying, if you have a good project, we're going to invest.

And how would you characterize the funnel of opportunity set as it sits here today versus maybe when you first started, Rob?

It's grown tremendously. The opportunities that we're seeing today with that 1.5 year payback time frame have grown over the last couple of years, especially over the last year. There's just a renewed focus. We -- I can tell you, in the past, it was a 2- to 3-year payback. And you would think, well, when you reduce that down to 1.5 years, possibly you would -- that funnel would come down and would be less than what it was in the past. It's actually the opposite. There's such a focus right now on creativity before capital. And any project that we see, which there's plenty of them, are still within that 1.5 years' time frame. So it's actually the exact opposite of what you might naturally expect.

And then second, kind of broad question. When you think about Mexico kind of being the hub of your manufacturing operations, could you just update us on the percentage? And then as you're thinking more broadly with all the supply chain, things that might or might not be happening with the coronavirus, how is that a competitive advantage? And do you see customers taking more of a regionalized approach any more so than they have in the past?

Mike, I'm not sure I caught the first part, but I think it was about what we expect from an overall Regal perspective on the square foot reduction over this next 3 years.

No, no, no. It's just an update on Mexico in general. What percentage of the overall portfolio represents, for your manufacturing base, competitive advantage? Any more regionalization push from your customer base, things like that?

Yes, sorry. Thanks for clarifying. Again, I would say the strength is that global footprint, and it's not just a Mexico-centric discussion. It's Mexico, it's India, it's Southeast Asia, it's China. What our customers are looking for us to do is to provide them product that's cost competitive and meets their service needs with good quality. Now right now, we have a little bit of a regionalization push. And by the way, it's benefiting in particular our climate business because of our strength of our footprint in Mexico. But I don't really truly believe that it's a long-term question. As long as I can continue to support and service, I think being the global supplier that I am, I don't believe that regionalization is going to have that much pressure.

Just quickly on the invested capital portion of the equation. Working capital currently 25% of your invested capital. Is there -- you gave a free cash flow target. But with distribution offloading, SKU rationalization in facilities, do you have a target for what working capital should be as a percent of sales?

Not that we provided. We do have internal targets. We measure our teams too. One of their objectives in their performance goals and what they get paid on is trade working capital improvement. It varies by segment. So we haven't disclosed what our internal target is, but it's certainly the driver behind the 250 to 300 basis points of ROIC improvement in addition to the operating profit improvement.

Okay. And this is just more of a technical question. But the operating margin expansion matches the ROIC expansion. It seems like there's a lot of tangible upside on the denominator of that equation in terms of invested capital. So if done right, working capital improves, facilities improve. Can the ROIC exceed that operating margin expansion target?

We believe it can.

Okay. Well, great. Well, thank you all very much for coming. Thank you for your interest in Regal. Hopefully, you've heard from us a very compelling story of the value creation we believe we can drive with the business and look forward to proving that to you every quarter and over the next 2 to 3 years. Thank you.