ChampionX Corp (CHX) 2020 Q3 法說會逐字稿

Welcome to the ChampionX Third Quarter 2020 Earnings Conference Call. My name is Adrienne, and I'll be your operator for today's call. (Operator Instructions) Please note this conference is being recorded.

I'll turn the call over to Byron Pope, Vice President of ESG and Investor Relations. Byron Pope, you may begin.

Good morning, everyone. With me today are Soma Somasundaram, President and CEO of ChampionX; and Jay Nutt, our Senior Vice President and CFO. During today's call, soma will share some of our company's highlights during the quarter. Jay will then discuss our third quarter results, our integration and synergy capture update and our fourth quarter outlook before turning the call back to Soma for some summary thoughts on our strategic priorities of the company. We will then open the call for Q&A.

During today's call, we will be referring to the slides posted on our website. I would like to remind our participants that some of the statements we will be making today are forward-looking. These matters involve risks and uncertainties that cause material difference in our results from those projected in these statements. Information concerning risk factors that could affect the company's performance and uncertainties that could cause material differences to actual results from those in the forward-looking statements can be found in the company's press release as well as in ChampionX's annual report on Form 10-K and those set forth from time to time in ChampionX's filings with the Securities and Exchange Commission, which are currently available at championx.com. Except as required by law, the company expressly disclaims any intention or obligation to revise or update any forward-looking statements.

Our comments today may also include non-GAAP financial measures. Additional details on reconciliations to the most directly comparable GAAP financial measures can be found in our third quarter press release and slide presentation for this call, which are on our website.

I will now turn the call over to Soma to discuss ChampionX's third quarter achievements.

Thank you, Byron. Good morning, everyone. I would like to welcome our shareholders, our analysts and our employees to our third quarter 2020 earnings call. Hope you and your families are doing well. Thanks for joining us today.

Let me start by welcoming Byron to our team. We are excited to have him onboard to lead our ESG and Investor Relations effort.

Before turning to our business results, let me first update you on our ongoing response to the COVID-19 pandemic. The health and safety of our employees remains our highest priority, and we have continued to take all necessary steps to protect them. In addition to all necessary precautions, personal protective equipment and physical distancing procedures, we have implemented flexible work schedules to support our employees with their personal situation as schools began to reopen this fall. I'm grateful to all our employees around the world for their continued dedication through this uniquely challenging period. They continue to demonstrate remarkable adaptability and flexibility during this particularly uncertain time.

The third quarter was momentous for our organization as it marked our first full quarter as a new company. The merger of Apergy and legacy ChampionX has transformed our company into a global leader in production optimization solutions. The strong financial profile of the combined company has positioned us well to navigate the challenges of the current environment as well as the long-term global energy transition. Our teams are working very well together and executing remarkably on synergy opportunities. Our cost synergies are tracking well ahead of our plan, and we are starting to see early indication of revenue synergies starting to materialize.

We continue to receive very positive feedback about combining this company from our customers and the potential value we may bring to them. The strong results we achieved in the third quarter is a validation of the strength of the combined company. We are truly excited about our future.

On Page 5 of the slide deck, you know us well enough to know that we always start with our organizational purpose of improving lives of our customers, employees, shareholders and communities. This purpose continues to be the North Star and guiding context for our company. We are passionate about our purpose of improving lives, and that pursuit is supported by our positive culture.

We continue to nurture our positive culture by 4 simple operating principles. First, we will always be relentless advocates for our customers. If our customers win, we win too. Second, our employees are our biggest strength, and we will always remain committed to their safety and well-being. Third, we will continue to develop and deploy technology that delivers positive impact to the safety, efficiency and productivity for our customers in a sustainable manner. Fourth, we are driven to improve with a culture of continuous improvement, and we will always remain humble and curious.

The work we do is highly focused around providing products and technology that drive our customers' success. To that effect, on Slide 6, we share an example of a sustainability use case in which our Production Chemical Technologies team has helped a North Sea E&P operator reduce their carbon footprint. We will be sharing more with you going forward on our company's ESG strategy, but this example illustrates how our customer-centric business strategy is already, in many ways, interwoven with our stakeholders' sustainability goals.

Slide 7 speaks to the differentiated outcomes for ChampionX which stem from being fierce advocates for our customers. Our highly motivated team of over 6,500 employees around the world are focused on a collaborative approach to solving problems for our customers. We have a deeply rooted cultural foundation, and we are driven to helping our customers succeed. We clearly view our culture as a competitive advantage as illustrated by the results of Kimberlite's recently published 2020 artificial lift supplier performance report, in which it points out to our artificial lift business having the highest customer loyalty in the industry. We have received this honor now 5 years in a row.

Jay will take you through our third quarter financial results momentarily, but let me just share a few high-level thoughts. Our strong results demonstrate the power of our strengthened portfolio and expanded global scale as well as the cost synergy opportunities, all of which we identified as key reasons to bring together our 2 organizations. We generated $633 million of consolidated revenue and $87 million of adjusted EBITDA. We continued our track record of delivering positive free cash flow in an emphatic fashion in the third quarter as we delivered $133 million in free cash flow before transaction expenses and $100 million in free cash flow including the transaction expenses.

As expected, many of our North American-oriented product lines, led by our artificial lift solutions, experienced a strong sequential increase in revenue during the third quarter as E&P operators began to increase their production-oriented OpEx spending. This more than offset the impact of Gulf of Mexico hurricanes on our production chemicals business during the quarter. Also as anticipated, our consolidated international revenues declined during the third quarter as customers further curtailed spending, but we believe our international business has now stabilized.

Against a challenging market backdrop, our teams executed well on accelerating the cost synergies from the merger as well as our cost takeout efforts in both legacy Apergy and legacy ChampionX, which helped us post such strong EBITDA and free cash flow generation in the quarter. Given our strong synergy performance and the pipeline of opportunities ahead of us, we are increasing our targeted cost synergies to $125 million, which we still anticipate fully capturing within 24 months of the merger closing. This increase in synergies is evidence of both the strategic and financial benefit of the combination, but also testimony to how well the 2 organizations operate together.

I would now like to turn the call over to Jay to discuss our third quarter results and our fourth quarter outlook.

Good morning, everyone. Thank you for joining us this morning, and I hope everyone is staying safe and healthy. For our discussion this morning, I'll first be commenting on the GAAP results and then I'll be referencing the pro forma results in order to provide for a stronger comparability.

As seen on Slide 9, third quarter 2020 revenue of $634 million improved sequentially by $335 million, primarily due to having a full quarter of revenues associated with the legacy ChampionX businesses. Included in our quarterly revenues were $50 million of cross supply sales to Ecolab. These sales, which will continue for approximately 3 years from the merger closing, are associated with the post-merger arrangements as part of our transaction agreements, and we do not recognize margin on these sales from an EBITDA perspective. Revenue associated with these sales is allocated to corporate and other within our financial statements.

We generated strong cash flow from operating activities of $111 million during the third quarter. This performance is after making significant cash disbursements for transaction and integration expenses of approximately $33 million in the quarter. Year-to-date, we've generated $189 million of cash from operations, which is after settling $76 million of transaction and integration expenses.

Our free cash flow to revenue ratio was 16% in the third quarter, up from 12% in the previous quarter. Excluding the impact of transaction expenses, the cash flow to revenue ratio was 21% in the third quarter compared to 24% last quarter. This performance was achieved through improved operating earnings sequentially, combined with the continued strong working capital contributions as we maintained disciplined balance sheet management during the quarter. In the third quarter, we invested $13 million in capital expenditures, primarily for maintenance activities and some initial capital integration-related activities.

Looking at our pro forma results, which are presented in our earnings release schedules as if the merger of Apergy and ChampionX closed on January 1 of 2019. Third quarter revenue of $634 million included the $50 million of cross-selling activity. Sequentially, revenue increased $19 million or 3%, driven by a strong rebound in Production & Automation Technologies volumes of the cyclical trough experienced last quarter combined with the increased cross-sale volume. These increases more than offset sequential declines in the other segments. Geographically, as anticipated, third quarter revenue increased sequentially from the second quarter pro forma revenue by 12% in North America but declined 6% internationally.

For profitability, for the third quarter, consolidated adjusted EBITDA was $87 million and represents a 38% sequential increase against the pro forma second quarter performance. The increase was driven by higher volumes in our Production & Automation Technologies business, benefits of accelerated cost synergy realization and the momentum of our proactive approach to cost management executed across our business portfolio.

During the quarter, we also benefited from some isolated items of approximately $6 million, primarily related to gains on fixed asset sales and collections of previously reserved customer receivables.

Turning to Production Chemical Technologies. Revenue in the third quarter was $410 million, a decrease of $23 million or 5% from the second quarter pro forma results. The sequential decrease was driven by the anticipated further decline in international spending and some expected pricing concessions for selected customers. Production chemicals are consumable products, which are an integral part of maintaining production levels. So as operators continue to bring production back online over the coming quarters, we expect to see revenue growth start to return to this segment.

Geographically, North America revenue was flat as increases in the U.S., while positive, were not as robust as we had anticipated coming into the quarter due to the shut-ins in the Gulf of Mexico caused by multiple named storms. As a result, the growth in the U.S. was offset by a reduction in Canada. International revenue declined 9%, driven primarily by reduced revenues coming from customers in the Middle East, Europe and Russia.

Profitability in the segment improved sequentially even with the lower revenues. Segment adjusted EBITDA was $72 million, which represents a sequential increase of $13 million against the pro forma second quarter performance or 22%. Segment adjusted EBITDA margin was 17% in the current quarter compared to 14% in the pro forma second quarter. This sequential improvement illustrates the strong execution and realization on synergies as well as the incremental benefits of the cost reduction actions. Segment performance also includes $700,000 of net benefits from gains on dispositions of fixed assets and other items. We expect the improved margin profile achieved in the current quarter to continue as we move forward.

Looking at Production & Automation Technologies. Total segment revenue increased 19% and finished at $137 million in the third quarter, an increase of $22 million due to higher volumes across our artificial lift portfolio as customer spending began to recover from the compressed levels experienced in the second quarter. In digital products, production and artificial lift-related revenues increased modestly on a sequential basis but total revenue was lower by 20% as international intelligent completion-related revenues declined at a greater pace. Over time, we expect our digital revenues to resume growth at the healthy double-digit rates we've previously experienced as customers place a greater focus on leveraging digital solutions to reduce inefficiency and adopt our modular fit-for-purpose approach. From a sequential geographic perspective, North American and international revenues increased 22% and 10%, respectively.

Third quarter segment adjusted EBITDA was $25 million, which represents a sequential increase of $11 million or 72%. Our Production & Automation Technologies teams continue to execute superbly as segment adjusted EBITDA margin was 18% in the current quarter compared to 13% in the second quarter of this year. The sequential improvement was driven primarily by the higher volumes and the benefits of structural cost actions previously executed as well as rigorous cost management. We were also helped by $2.8 million of isolated benefits, including gains on the disposition of facilities and collections of previously reserved receivables, making the normalized margin for the quarter 16.2% or 360 basis points higher sequentially.

Moving to Drilling Technologies. Segment results continued to be negatively impacted during the third quarter by declining worldwide drilling activity and the related destocking of inventories by customers. We're seeing improved order activity as we exited Q3 and early into Q4 due to the restocking by some customers and some incremental rig count additions in the U.S. Based upon the recent customer order rates, we believe the effects of customer inventory destocking activities are mostly now complete.

Segment revenue was $16 million in the third quarter, representing a decrease of 25% sequentially but still outperformed the 35% sequential decline in the U.S. average rig count. From a profitability perspective, segment adjusted EBITDA was negative $3 million in the current quarter, down from the positive $2 million in the second quarter. While segment adjusted EBITDA margin was negative in the third quarter, the levels did reflect offsetting benefits of proactive cost actions executed within the segment while preserving our core capabilities. As we look ahead, we expect the business to achieve positive EBITDA in the fourth quarter.

Turning to Reservoir Chemical Technologies. Revenue for the quarter was $21 million, which represents a decrease of 24% sequentially, driven by international revenue decline and continued challenges in North America. Pro forma segment adjusted EBITDA was a loss of just over $1 million in the third quarter versus a pro forma loss of nearly $10 million in the second quarter of this year.

Second quarter -- the current quarter results were positively impacted sequentially by $2.5 million of isolated benefits during the third quarter primarily related to the collection of previously reserved receivables. We still have work to do to improve the profitability in this segment, and our teams are acutely focused on delivering this outcome. We believe that some of the early impacts of the actions are beginning to show up in the results, and we expect that as volumes stabilize and start to grow over the coming quarters, we'll continue to see the benefits of the actions contributing to margin improvement.

Before moving over to the balance sheet, I'd like to update you on the progress we've made capturing the synergies from the merger, which is summarized on Slide 10 of the presentation. Our integration is tracking ahead of schedule, as you can see in the current quarter results. Our teams hit the ground running at the merger close, and we're pleased with how the organizations have come together to execute on synergy opportunities.

The primary drivers of the accelerated synergy savings that contributed to the current quarter earnings improvement came from execution on supply chain opportunities and a fit-for-purpose lower cost structure as we integrate the business as part of ChampionX. As the teams continued their work through the quarter, further synergy opportunities have been identified, and the teams are building plans to capture those savings. These additional opportunities are heavily weighted towards supply chain productivity improvements, but we also see incremental G&A savings to be realized. Given our improved line of sight towards the additional savings that will come from the cost of goods sold efficiencies and the G&A efficiencies, when combined with the public company cost avoidance savings that are already being achieved, we're now increasing our expected run rate of cost synergies to $125 million versus the previously targeted $75 million within 24 months of merger closing. When we exit the year, we expect to be in the $70 million to $80 million run rate range.

Beyond the cost savings synergies, we continue making progress capturing the additional revenue growth opportunities made possible by the merger. On our North American joint sell uplift, we established targeted joint sales teams, which consist of both artificial lift and chemistry sales personnel to deliver the best solutions to the customer. We achieved our first wins during the quarter, securing new artificial lift business through our chemical technologies resources.

On digital uplift, our digital and chemistry teams have also made progress in bringing cutting-edge technologies to legacy ChampionX chemical customers in building new combined offerings. These are small early wins, but it's encouraging to see how our teams have been able to demonstrate the benefits of our combined capabilities in such a short amount of time since closing of the transaction.

On international artificial lift expansion, we secured our first international wins, and we're mobilizing our teams to execute on the contracts. Securing these initial artificial lift contracts are important milestones for the organization, and it demonstrates the value of our Better Together approach. Overall, we're making terrific progress on our cost synergies and achieving initial success on revenue opportunities, and we look forward to sharing with you the continued progress in the coming quarters.

Turning to Slide 11 and the balance sheet. Third quarter ending debt was $1 billion, and cash at the end of the quarter was $171 million. During the quarter, we repaid $82 million of debt. And as a result of the very strong operating cash flow, we were also able to cover the final transaction expenses and still close the quarter with a healthy cash balance that grew by $30 million sequentially. While we anticipate further integration expenses which will be settled from available cash and cash flow from operations, our final transaction expenses are essentially behind us.

At September 30, our net debt to the trailing 12-month pro forma adjusted EBITDA was 1.9x, comparable to our net leverage of 1.8x at June 30. Our available liquidity at the end of the quarter was $527 million, including our cash and approximately $355 million of undrawn capacity on our revolver.

As seen in the quarterly results, we continue to be highly focused on managing our cash flow and preserving strong liquidity. As we move ahead, we'll continue to execute on our capital allocation framework with the priority of using our free cash flow to invest in technologies to support our growth initiatives and use the available excess cash to pay down debt and reduce leverage.

Turning to Slide 12 and our near-term outlook. We expect to post a modest sequential increase in revenue in the fourth quarter with revenues in the range of $635 million to $650 million. We expect to achieve EBITDA in the range of $80 million to $90 million. On this slide, we've also provided some other specifics pertaining to our fourth quarter outlook.

As we head toward the close of the year, we're encouraged by the structurally improved margin of the company and the cash flow profile resulting from the solid operational performance, contributions from strong synergy execution and the benefits resulting from the cost structure reductions. As a result, we anticipate that we'll conclude the year with a pro forma adjusted EBITDA margin, excluding cross-selling revenues, higher than the previous trough year of 2016 and that we'll accomplish this on approximately $250 million lower revenue. Based on the structural cost base improvements made in the business, depending upon the product mix and associated incremental margins applied, we believe that we can now achieve pro forma 2019 adjusted EBITDA margin of 18.4% on significantly lower revenue.

Finally, we're pleased with our robust cash flow performance and the improved profile of the combined company due to the synergy execution and reductions in cost structure. The strong performance through the third quarter gives us further confidence that we'll maintain free cash flow as a percentage of revenue of more than 10% for the year.

With that, I'll now turn the call back over to Soma for some summary comments before we open the lines for Q&A.

Thank you, Jay. Before we open the call to questions, I would like to turn your attention to Slide 14 of our deck and share with you the strategic priorities of new ChampionX, which will drive our organization through these challenging times for our industry and differentiate us from our competitors as the energy transition unfolds in the coming years.

ChampionX has 5 clear strategic priorities as we move forward, and we will periodically update you, our stakeholders, on the progress we are making on each of these priorities. So let me frame for you what they are and share some of the key elements of these priorities.

First, realize our Better Together potential. We are even more excited now about the opportunities that's ahead for our company than we were when we first closed the merger in large part because of the clear evidence of how culturally aligned the legacy Apergy and legacy ChampionX teams are. So we will continue to build on our purpose of improving lives as we leverage our collective expertise to bring differentiated production, digital and diamond sciences solutions to our customers. We remain committed and laser-focused on realizing our cost synergy goals, and we will thoughtfully leverage shared service opportunities where they make sense.

Second strategic priority, accelerate digital and digitally enabled revenue streams. We realize that digital has become a buzzword in our industry of late. For ChampionX, our strategic focus is on leveraging our proven digital capabilities to further expanding our base of new digital revenue streams which are a natural extension to our production optimization expertise, such as monitoring, modeling, failure analysis, analytical services. It also means growing our base of digitally enabled revenue streams by using our digital capabilities as an enabler to further support sales of existing production-oriented products. We will actively collaborate and establish partnerships to fully leverage the industry's digital ecosystem to achieve our objectives.

Number three, leverage global footprint to expand international sales. We have shared with you our plans to expand our artificial lift business in key international geo markets by leveraging the already truly global footprint of our chemical technologies business. And so our strategic priority is to execute superbly to deliver on this objective. We are already seeing some early wins internationally, which speak to the opportunity set before us to grow our market share in both artificial lift and production chemicals with IOC and NOC customers.

Fourth strategic priority, build enterprise-wide continuous improvement rigor. The beauty of the organizational lineage of legacy Apergy and legacy ChampionX is that both organizations have the well-honed mental muscle and industrial mindset to pursue continuous productivity improvement, and we will leverage this to drive automated workflows and elimination of waste to ensure that we are perennially in the vanguard in terms of how we manage our cost structure even as activity levels eventually improve next year and beyond. We will use digitization as an enabler to automate internal business processes to improve efficiency and reduce cost.

Lastly, evolve our portfolio for sustained growth. We will continue to leverage our core capabilities across energy markets and natural adjacencies to position ChampionX for sustained growth through the energy transition. As we continue to use our through-cycle free cash flow generating ability to further pay down debt toward our target level, rest assured that we will continue to allocate capital in ways which are consistent with our value-creation framework, which includes a sustainable return mechanism to our shareholders over time. We are actively developing our ESG framework and road map consistent with our corporate purpose and our business strategy. So as you can see, while our recent focus has been on taking actions to reduce costs and integrate our 2 businesses, we are continuing to keep our attention squarely focused on future and these growth-enabling strategic priorities.

Today, ChampionX is more geographically diverse with larger scale, expanded customer relationships and a broader portfolio of production optimization products, including cutting-edge digital technology. We are a critical partner to our customers in production optimization. The structural cost actions we have taken, combined with the synergies from the combination, has positioned us for strong margin performance and free cash flow generation.

While we cannot control the macro environment or our stock price, we can control our strategic choices and operating execution, and on both dimensions, I'm incredibly pleased with where ChampionX is today. We are well positioned to be a long-term winner in our industry and deliver strong financial performance for our shareholders.

Finally, I want to thank all of our employees around the world for their continued efforts and passion in improving the lives of our customers, our employees, our shareholders and our communities. I'm proud of their dedication, focus and resolve as we work to come through this unprecedented environment stronger than we were before. I'm proud of their accomplishments, and it is a privilege for me to lead such a great team.

With that, I would like to open the call for questions.

(Operator Instructions) And our first question comes from George O'Leary from Tudor, Pickering, Holt.

More of a conceptual question to start off, but it's something that I think is underappreciated by investors. For the production chemicals business in particular, you guys have some really strong customer relationships there. And I was just curious. If you think about longer-dated projects on the upstream side, whether it's longer-dated international or offshore type projects, how early do customers bring you in to come help them as they seek to develop assets?

Is it in the exploration phase, as soon as they have hydrocarbon shows? Just trying to think of ways you guys could emphasize the strength of those customer relationships and how early you guys are brought in to help solve customers' technical issues as they look to develop assets.

Yes. George, it's a great question, and you're exactly right. The strengthened -- the strong relationships our production chemicals team have with customers around the world really plays well into this. Typically, customers that are developing their new projects, we typically get involved anywhere between 2 to 4 years ahead of when the first production happens.

So that's so because we work very closely with them in testing the chemistries, developing very specific chemistries for that particular field and solving the problems for them. And that relationship continues all the way throughout the production cycle because, as you know, as the wells continue to mature, there will be different chemistries needed and different problems to solve. So 2 to 4 years ahead of the first production is when everything starts.

Great. That's very helpful, Soma, and provides some good context to think about going forward. A little bit more of a myopic question, so I apologize, but just thinking about the fourth quarter and the guidance provided. There's a decent bit of moving pieces, especially given Gulf of Mexico impacts last quarter and kind of the continued hurricane season. We just saw data roll through in Louisiana.

So you saw nice improvement in artificial lift results quarter-on-quarter. How should we think about -- to the extent you can provide kind of more granular color on top line progression by businesses, what's going to be a relative bright spot and what's going to be a little bit softer? Any incremental color on the guidance for the fourth quarter would be incredibly helpful.

Yes, George. So let me just walk you through each of the segments. And so on the Production Chemical Technologies, as we've mentioned, sequentially, we see improvements in the international activity. And the Gulf of Mexico, just to dimension that, is about a $3 million hit in Q3 for us. So we expect -- as Q4 rolls along, we expect a sequential improvement in our U.S. business as well.

And as you know, the production chemical technology -- production chemicals don't hit -- don't experience the same level of holiday impacts or seasonal holiday impacts like you may see in artificial lift because it is very -- it's a consumable for their production volume. So in PCT, we see improvement in international, and we see possible improvement also in the U.S.

Then when you go into artificial lift, in artificial lift, we expect a sequential decline, which is primarily seasonal. We see that every year. Now if there is -- if customers improve their operating spending as we go towards the end of the year, we may see an improvement. But right now, our view is that, sequentially, artificial lift will see a decline in Q4, which is consistent with prior years.

As you move into Drilling Technologies, we expect Drilling Technologies to be positively up from Q3 to Q4. In the past, we have updated you on the progress of the destocking. We think that it's largely complete. And we also see the incremental improvement in the U.S. rig count is also going to help us with the order rates.

We have seen now, George, 3 months of improving order rates in Drilling Technologies. So when you go into August, September, now into October, we are seeing 3 months of improving order rates. I know it's from low levels, right?

To give you an idea, August to October, our order rates are up about over 30%, right? So you can see that improvement in order rates happening. So we think that sequentially, Drilling Technologies will be up.

And then when you go into Reservoir Chemical Technologies, as you know, that our teams are very focused on improving the operational performance. And we do think that in Q4, we will see the benefit of that coming through. So we expect a possible improvement in the top line. Albeit it will be modest, but we do expect a top line improvement in RCT.

And our next question comes from David Anderson from Barclays.

I just wondered if we could dig in a little bit more on the international side of the production chemicals. So maybe talk about the mix a little bit. I mean you guided softer in the third quarter, so it wasn't a surprise. But just curious where that decline was more pronounced. I assume that offshore part was probably pretty stable, but was it Middle East related?

I was just wondering -- you said you expected to kind of increase in the fourth quarter. I was just wondering if maybe you could talk about more specifically which regions are bottoming and then starting to increase as we think about going into year-end. Just speaking about the international side of production chemicals.

Yes. Dave, I think from Q2 to Q3, we saw the international declines, particularly in Middle East, and we saw that also in Russia and Caspian areas. So those were the primary decline areas. And as we move into Q4, we see those areas starting to improve.

So we are expecting a sequential improvement in both of those areas. We are expecting a modest improvement in the Latin America as well. And then the -- I talked to you about the U.S. So it's primarily Middle East, Russia is where we saw the sequential decline -- Russia and Caspian, and that's where we also see -- expect to see some improvement in Q4.

Okay. And then international expansion of lift has been a big goal of yours, and I know we've talked about international cross -- the cross-selling of lift to chemicals. So it's great to see you announced an award this quarter.

Just a few questions about how this award came up and how you supply it. So was this a prior ChampionX customer that you're now pulling in lift? Or was it a new customer that you brought into this package?

And also I'm just kind of curious on how it worked on the customer side. We've often talked about chemicals procured in one division, lift in another. Is that how it works? Can you maybe just give us a little bit more color in terms of how this came about and then how we're thinking going forward of accelerating this revenue synergy opportunity internationally?

Yes, Dave. As we have shared before, the -- leveraging the international footprint, we feel that the early -- the initial stage of the opportunities we will win is because of leveraging the existing footprint of ChampionX in those countries where there is good artificial lift markets. It's not necessarily that we are bundling artificial lift and chemicals. And I think that opportunity will come eventually, but we don't -- that is not we are -- what we're seeing as the first set of opportunities.

So this particular case, what you mentioned, is in a country where ChampionX has good established operations, and they have good relationship with the customers. They have local legal entities. They have local operations. So this is really, again, has an artificial -- is a good artificial lift market where we don't have, meaning legacy Apergy did not have, the presence. So now we were able to quickly qualify for the bid and participate because we have the local infrastructure, we have the local ability to support it.

And our teams work together really well. And when I say our teams, I'm not just talking about our sales, commercial teams, but our supply chain teams, our legal teams. Because this involves how the customer is going to place the order, how we are going to recognize revenue, so there's a lot of, as you can imagine, detailed work that is to be done behind it. Our teams work superbly together to show that we can get this done. And this is -- I think this is a good example of how opportunities will double up in those artificial lift markets where internationally -- where ChampionX -- the chemical technologies business already have solid footprint.

And our next question comes from Scott Gruber from Citigroup.

Yes. So the great cloud hanging over the oil services industry here is concerned that oil demand recovers from the pandemic but there's just so much OPEC spare capacity out there that there's just not much of a need for CapEx lifts to start non-OPEC supply growth for some time. But you guys obviously have some exposure to increase in production out of OPEC via more chemical sales.

So I was wondering if you could just put some color on that. I mean if we say that OPEC is able to bring back some 5 million barrels a day, ignore timing, what is the impact on production chemicals from that type of production growth from the OPEC+ group?

Yes. I think what -- Scott, what -- as we have shared before, the production chemicals business, the way to think about it is production volume growth, right, plus/minus pricing, plus/minus share. So you would expect -- if the OPEC production growth increases by 5%, you should expect us to trend closer to that with our production chemicals. Because we have good exposure to OPEC producers, so you should expect that in the production chemical side.

Got you. Yes, it's a very differentiated exposure versus most others.

And then turning to the U.S., thinking about recovery and impact on your drilling segment. Obviously, the destocking/restocking cycle has made the drilling business even more cyclical than the U.S. rig count. You guys provide good data in your presentations for the last couple of quarters. I was just eyeballing the '16, '17 recovery, where you saw drilling revenues outpace the U.S. rig count during the first few quarters of recovery. Yes, the twist this time is just how deep the downturn has been, and you guys have said that destocking is largely done.

But given the pullback in crude prices here, if we're just grinding higher on rig count over the next 12 months, how do you think the pace of drilling revenues moves relative to rig count? Does it still outperform? Or is it more in line, at least for the first few quarters, if it's a grind?

Well, I definitely think, Scott, it will outperform, given the extent of destocking that has happened with our customers. So I definitely think it will outperform, which is very consistent with what we have seen in every destocking/restocking cycles before. So I definitely think it will outperform.

And our next question comes from Chris Voie from Wells Fargo.

So margins for drilling and reservoir chemicals are the laggards here. I think you expect positive EBITDA in the fourth quarter for drilling, but it sounds like reservoir chemicals might still be negative. Obviously, higher revenues are a critical lever here. But I wonder if you can help us understand what's left to do on the cost side of these businesses.

So in that perspective, can you give us a sense maybe of what like 2021 exit rate margins could be for those segments if activity remained at current levels? Could reservoir chemicals get positive in that scenario? And could drilling get to mid- or high single digits? Just curious if you can give us a little bit of color there.

Yes. Chris, as we shared in the Q3 call -- the second quarter call specifically -- let me talk about Reservoir Chemical Technologies. So our teams are very focused on executing on what we can control, so it revolves around the cost actions which they are executing on. And we shared with you that near term without this meaningful volume improvement, it will be difficult for us to get this to a breakeven, in the near term meaning Q3, Q4.

But our teams are also working on making this business in a more variable cost base, so -- which means over -- and that's going to take a little bit of time. That's -- when I say a little bit of time, 9- to 12-month type of time period to execute on reducing the fixed cost structure. So if the volume doesn't improve, I would expect in the 9- to 12-month period, when we execute on reducing our fixed cost structure and making it more variable, we would get to a breakeven in those types of scenario.

But we may get to a breakeven ahead of that because, as I mentioned, we are starting to see some volume improvement. And we mentioned that Q3 to Q4, we do expect a volume improvement. So if the volume comes through, we may get there even ahead of that. So I hope that gives you some color.

And then as you go into Drilling Technologies, it's for us -- I mean this -- as you know very well, this business is really -- it does well -- as the volume starts returning, the incrementals are -- will be really high. And so we do think that as we -- in Q4, we'll get positive. And then as volume sequentially improves from there, you should see the margin expansion coming through.

Okay. That's helpful. And then if we switch to margins for production chemicals. I think you typically expect about a 4% to 6% pricing headwind.

Just curious if you think that is fully already in place -- the full pricing impact is already in place for production chemicals. And if so, is there a material upside to the 17% margin this quarter as you go through 2021?

Yes. So I would say here -- you'll remember, in the last call, we mentioned that we do expect an incremental percent or so, in Q3 sequentially, pricing impact, and we did experience as expected. So I would say our Q3 performance indicates the pricing -- the full pricing impact in our production chemical business. Now with respect to margin improvement in the production chemical business, yes, as volume starts improving, you should see incremental margin improvement as we go forward.

And our next question comes from Ian MacPherson from Simmons Energy.

Congrats on the good results.

Thank you.

Soma, I wanted to maybe gently push back a little bit. To me, guiding -- obviously, you know and I don't. But the outlook for U.S. lift down in the fourth quarter strikes me as a little bit discorded from at least what I would have expected, hearing others that see -- yes, there's always seasonality.

But last year, for example, completions and well count were clearly trending down third quarter to fourth quarter, and that doesn't seem to be the case from other sources that I've heard this quarter, this year, notwithstanding seasonal impacts. Do you think that there's any pocket optionality for your U.S. lift business relative to how you've guided it? Or am I just astray on this thinking?

Yes. Here's how -- I'd say, Ian, that our guide is not based on what I would say anything we know specifically. It is more informed by, typically, what we see in the previous years because that is the seasonal holiday impact.

Now as you know, we are also in artificial lift. That's a short-cycle business. So if the customer activity continues to keep up, you will see us outperforming. For example, October is continuing to stay strong in activity, right? So we are starting October really well in artificial lift.

Now we have also seen in the past that as we get into past Thanksgiving, sometimes those activities slow down because customers decide to reduce activity during the holiday period. So again, it is more based on we are a short-cycle business and more based on, historically, we always see Q3 to Q4 sequentially lower because of the holiday. But I would say that I'm very encouraged by our October activity.

So can we outperform? Possible, if it keeps up, right? So -- but we just want to be prudent.

Okay. I got it. Jay, can I ask you to refresh us on go-forward free cash flow aspirations? If you want to peg it against EBITDA conversion or revenue conversion. It strikes me that your upsized cost synergy targets should accrete mostly to the bottom line on free cash flow conversion. So could you update us on how to think about that for 2021, for example?

Sure, Ian. So for the near term, you're right, based upon the structural cost changes in the business, the synergy realization that we're having, we believe that free cash flow conversion from EBITDA -- or from revenue should be permanently stepped up from where we were in the previous cycles. You may recall that we've previously talked about a 2016 to 2019 period of 45% to 46% EBITDA conversion. And we believe that we are now comfortably above 50% and probably approaching 60% on a run rate basis in this near term, just given the change in the cost structure and the higher earnings that we expect to have going forward.

So the working capital has been a significant contributor to us in 2020 based upon receivable release and better management of inventory and we believe that we can maintain the days in the cash cycle and increase the velocity of the working capital turnover. So we would say that we're going to be permanently higher than where we were in the 2016 to 2019 period, probably in the upper end of the 50% to 60% range and even higher as we close -- above 60% as we close this year.

And our next question comes from Tommy Moll from Stephens Inc.

Soma, I wanted to double back to Production Chemical Technologies margins and again, using the impressive level you put up in the third quarter as kind of a new baseline. As you look ahead, is there a way you could frame what a reasonable assumption would be for incremental EBITDA margins there? And just as a sub bullet, on your synergies that have yet to be realized, how much of that is within the PCT segment?

Yes. So we have talked before, a good incremental to think about on our Production Chemical Technologies on a normal basis would be in the high 20s type of an incremental. Now the -- we do expect our Production Chemical Technologies business to be a beneficiary of a lot of the synergy efforts because that is the largest part of our business. And so that should continue to contribute to the margin expansion as well.

So let me frame it this way. If -- given everything to be the same, if there is no revenue improvement, let's assume, then still the margin on our Production Chemical Technologies in 2021 as we exit -- should improve as we exit 2021 because of the incremental synergy delivery in that segment. So yes, we expect more margin upside to the Production Chemical Technologies segment because of the synergy deliveries.

Very helpful. And as a follow-up, I wanted to ask about CapEx for next year. I understand it's early, that numbers are probably shifting around as you budget. But is there any way you could frame what a reasonable range would be in dollar terms? Or if not, then maybe just refresh us, on a percent of revenue basis, what we should think about.

Sure, Tommy. This is Jay. I would say as we -- we're still working through our plans for 2021, as you can imagine. But today, we're very focused just on maintenance capital and integration-related capital, and we're running closer to 2.5% of revenue.

So as we look forward into 2021, if there is not a significant increase in growth in the business, we would not have growth capital. And you should be thinking about a similar number in terms of 2.5% of revenue for 2021 in this early stage development.

And this concludes our question-and-answer session. I'll turn the call back over to Soma for final remarks.

Again, thanks again, everyone, for your continued interest in ChampionX and joining this call. We look forward to talking to you in our Q4 earnings call. Meanwhile, please stay safe and healthy. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating, and you may now disconnect.